MARKET MOVER - BNP PARIBAS - Investment Services India
MARKET MOVER - BNP PARIBAS - Investment Services India
MARKET MOVER - BNP PARIBAS - Investment Services India
You also want an ePaper? Increase the reach of your titles
YUMPU automatically turns print PDFs into web optimized ePapers that Google loves.
Market Economics | Interest Rate Strategy | Forex Strategy 28 July 2011<br />
Market Mover<br />
Market Outlook 2-3<br />
Fundamentals 4-24<br />
• US: Much More Adjustment Needed 4-6<br />
• Eurozone Summit: The Reaction 7-9<br />
• France: Budget Consolidation Is On 10-11<br />
Track<br />
• France: About Credibility and Debt<br />
Brake<br />
www.GlobalMarkets.bnpparibas.com<br />
12<br />
• UK GDP: You Cannot Be Serious! 13-14<br />
• Japan: How to Finance It All 15-18<br />
• Japan: Exports to China Remain 19-21<br />
Low<br />
• Australia: Excessive Volatility 22-24<br />
Interest Rate Strategy 25-54<br />
• US/EUR Spreads: Impact of a US 25<br />
Downgrade<br />
• US: Impact of a Potential US<br />
Downgrade<br />
• US: Missed Payments Shocking<br />
Front USTs<br />
26-33<br />
34<br />
• MBS: Staying Underweight 35-37<br />
• EUR: OIS/BOR Spreads Still Wider 38<br />
• EMU Debt Monitor: CDS, RV 39-41<br />
Charts, Redemptions<br />
• UK: Trading BoE on Hold for Longer 42<br />
• JGBs: Negative Factors to Increase 43<br />
• Global Inflation Watch 44-47<br />
• Inflation: Unequal In Face Of Debt 48-49<br />
• USDi: Sell 5y5y Forward Inflation 50-53<br />
• Trade Reviews 54<br />
FX Strategy 55-62<br />
• FX: So What if the US Loses its 55-56<br />
AAA Status?<br />
• Little Justification For BoJ<br />
Intervention<br />
57-58<br />
• AUD: The Future is Rosy 59-60<br />
• Factors Behind The Soaring Bird Set 61-62<br />
to Hold<br />
Forecasts & Calendars 63-77<br />
• 1 Week Economic Calendar 63-64<br />
• Key Data Preview 65-71<br />
• 4 Week Calendar 72<br />
• Treasury & SAS Issuance 73-74<br />
• Central Bank Watch 75<br />
• Economic & Interest Rate Forecasts 76<br />
• FX Forecasts 77<br />
Contacts 78<br />
• The agreement at the Eurozone Summit was a major step<br />
forward but some of the spread tightening has unwound – we<br />
discuss the reasons why in the following pages.<br />
• Securing an agreement on the US debt ceiling is proving<br />
difficult, let alone delivering a longer-term plan credible<br />
enough to allay S&P’s concerns.<br />
• The uncertainty is not helping the US economy, as is<br />
evident from the latest Beige Book and data flow.<br />
• It is also adding to tensions in markets, with stress on<br />
USD liquidity increasing. Our strategy recommendation is to<br />
pay OIS/BOR spreads.<br />
• Core EGBs have room to richen in ASW terms as well as<br />
against US Treasuries. The probability of a US downgrade has<br />
increased, which should keep the 10-year T-Note/Bund spread<br />
on a widening bias.<br />
• At the upcoming ECB press conference, Mr Trichet is<br />
likely to be enthusiastic about the summit agreement, cooperative<br />
on liquidity provision but cagey on the SMP.<br />
• The flow of news suggests greater emphasis on the<br />
downside risks to growth and higher uncertainty, potentially<br />
opening the door to a pause in policy normalisation.<br />
• JGB yields should continue to test their downside over the<br />
coming days, given latent demand.<br />
• In forex, the see-saw between the EUR and the USD has<br />
continued. Our bias for EURUSD is upwards, but a last-minute<br />
US debt deal would see the USD spike temporarily.<br />
• Recent rallies in the AUD, NZD and CAD should continue<br />
as investors seek alternatives to the G3 majors.<br />
Market Views<br />
UST 10y T-note Yield (%)<br />
2y/10y Spread (bp)<br />
EGB 10y Bund Yield (%)<br />
2y/10y Spread (bp)<br />
JGB 10y JGB Yield (%)<br />
Forex<br />
2y/10y Spread (bp)<br />
EUR/USD<br />
USD/JPY<br />
Current 1 Week 1 Month<br />
2.96 ↑ ↔<br />
254 ↑ ↔<br />
2.63 ↔↓ ↔↑<br />
139 ↔↓ ↔<br />
1.08 ↓ ↑<br />
92 ↓ ↑<br />
1.4305 ↓ ↑<br />
77.84 ↑ ↓<br />
IMPORTANT NOTICE. Please refer to important disclosures found at the end of<br />
this report. Some sections of this report have been written by our strategy teams<br />
(shown in blue). Such reports do not purport to be an exhaustive analysis and may<br />
be subject to conflicts of interest resulting from their interaction with sales and<br />
trading which could affect the objectivity of this report.
Market Outlook<br />
Fiscal issues remain in<br />
focus in the eurozone…<br />
…and the US<br />
Uncertainty is not helpful<br />
for growth<br />
ECB to welcome the<br />
summit agreement…<br />
As we wrote last week, the agreement at the eurozone summit was a major<br />
step forward in dealing with the debt crisis. The improved terms for the new<br />
loans to Greece are evidence of a much more constructive way of providing<br />
assistance, while the greater flexibility of the European Financial Stability<br />
Facility (EFSF) demonstrates a greater political determination to address<br />
contagion risk.<br />
So why then has some of the initial spread tightening unwound? There are<br />
various reasons for this, which we discuss in the article “Eurozone Summit:<br />
The Reaction”. One is that, while the framework is clear, some of the details<br />
need to be fleshed out.<br />
The changes to the EFSF’s scope require parliamentary approval in several<br />
participating member states. Securing support we do not see as a problem<br />
but the fact that summer recesses are upon us will extend the process.<br />
Regarding yield spreads, we see room for a stabilisation between core and<br />
peripheral eurozone markets. Liquidity spreads remain more at risk. The<br />
situation in the US is adding to tensions, with stress on USD liquidity rising.<br />
Our strategy recommendation is to pay OIS/BOR spreads.<br />
Core EGBs still have room to richen in ASW terms as well as against US<br />
Treasuries. The chances of a downgrade of the sovereign rating for the US<br />
have increased and this should keep the 10-year T-Note/Bund spread on a<br />
widening bias for some time.<br />
At the time of writing, the US political negotiations are in flux and securing a<br />
deal on the debt ceiling is proving difficult, let alone delivering a longer-term<br />
plan credible enough to allay S&P’s concerns (see US articles for more<br />
details).<br />
Against this backdrop, signs of market stress are showing up. We still<br />
believe the anticipation of a downgrade will keep the pressure on the 30-<br />
year. But, if it happens, we would be surprised if the sell-off were much more<br />
than 25bp because, for now, we think the market retains enough confidence<br />
to treat a 25-50bp sell-off as a buying opportunity.<br />
The uncertainty about the fiscal outlook is not helping the US economy,<br />
which is already battling against a number of headwinds. The latest Beige<br />
Book showed a softening of activity in half of the districts in the report, while<br />
our weakness indicator – a measure of shifts in the tone of the Beige Book –<br />
has also deteriorated markedly. That manufacturing and business<br />
investment, two of the brighter spots, are losing traction is a concern.<br />
We have been aiming low on the business surveys in the eurozone given the<br />
increase in market jitters, and the slide in sentiment continues apace. The<br />
latest Bank Lending Survey from the ECB also showed a further softening of<br />
loan demand from households.<br />
The focus of the upcoming press conference Q&A session will probably be<br />
the ECB’s attitude to the agreement on Greece and its willingness to offer<br />
further support – to Greece’s banks in the event of a selective default, or via<br />
a restart of the SMP. Mr Trichet is likely to be enthusiastic about the summit<br />
agreement, co-operative on liquidity provision but cagey on the SMP.<br />
Regarding the outlook for policy rates, markets will be scrutinising the macro<br />
assessment for evidence that the ECB is more inclined towards a wait-andsee<br />
view than pressing on with its quarter-per-quarter normalisation.<br />
Ken Wattret 28 July 2011<br />
Market Mover<br />
2<br />
www.GlobalMarkets.bnpparibas.com
…but weaker data point to<br />
a potential pause<br />
High uncertainty in the UK<br />
means the MPC will wait<br />
and see<br />
JGB yields to test the<br />
downside<br />
EUR and USD see-saw<br />
continues, with AUD, NZD<br />
and CAD favoured<br />
The flow of news suggests more emphasis on downside risks to growth and<br />
the higher level of uncertainty. This would increase the probability that the<br />
ECB skips the rate hike we had factored in for October. That the hard activity<br />
data in the eurozone will be “catching down” to the weaker surveys between<br />
now and the September/October meetings leans in the same direction. The<br />
ECB’s assessment of risks to price stability will remain to the upside,<br />
however, suggesting that the underlying bias will still be towards tightening –<br />
implying normalisation could be postponed rather than cancelled.<br />
In the UK, the GDP figures for Q2 held up a bit better than we forecast. The<br />
problem is gauging the underlying trend as there are so many distortions to<br />
the data right now. The majority of MPC members are likely to carry on with<br />
their wait-and-see strategy given uncertainty about those distortions and<br />
other matters. The key issue for the Inflation Report in August will be<br />
whether the risks to inflation are still judged as balanced over the medium<br />
term. We see grounds for a shift to the downside but the Q2 GDP data may<br />
have reduced the chances of that.<br />
In Japan, the government's policies for post-quake reconstruction will include<br />
around JPY 23trn for rebuilding over the next decade, of which JPY 19trn is<br />
to be spent in the first five years. JPY 10.5trn is to be raised via issuance of<br />
special reconstruction bonds that will supposedly be repaid by temporarily<br />
hiking household and corporate income tax rates.<br />
The JPY is back near its all-time high versus the USD amid concerns about<br />
a US downgrade, while signs of a global economic slowdown are also<br />
supporting JGBs. Domestic trading remains exceptionally thin and with latent<br />
demand for yen bonds likely to prevent any major price dips, we expect JGB<br />
yields to continue to test their downside over the coming days.<br />
The see-saw continued this week between the EUR and the USD with no<br />
currency appearing dominant. Our base-case scenario for a last-minute deal<br />
to raise the US debt ceiling would probably see the USD spike higher, albeit<br />
temporarily. The EUR has traded sideways, in line with the rise in Italian and<br />
Spanish bond yields as the market awaits more details post-Summit. Given<br />
the political will in the eurozone to move things forward, we believe that<br />
EURUSD will continue to be biased higher while the USD will continue to<br />
trend lower as markets expect the Fed to remain on hold and FX reserve<br />
diversification continues. Regarding other G10 currencies, we expect recent<br />
rallies in AUD, NZD and CAD to continue as investors seek alternatives to<br />
the G3 majors.<br />
Ken Wattret 28 July 2011<br />
Market Mover<br />
3<br />
www.GlobalMarkets.bnpparibas.com
US: Much More Adjustment Needed<br />
• We see a good chance of a US downgrade, a<br />
rising chance of the 2 August “deadline” being<br />
missed and a very small risk of a technical<br />
default.<br />
Chart 1: Federal Debt Held by Public Under<br />
CBO’s Long-Term Budget Scenarios<br />
• These are all immediate questions and are<br />
significant. We do not underestimate them, as<br />
Congress appears to.<br />
• Just as important is the fact that the US is<br />
miles away from being fiscally sustainable in the<br />
long run.<br />
• The packages that have been proposed are<br />
all based on a far too optimistic baseline. None<br />
of them go anywhere near enough toward<br />
achieving long-term sustainability.<br />
• A recent IMF study showed that to cut its<br />
debt-to-GDP ratio to 60% by 2030, the US needs<br />
to adjust its primary fiscal balance by more than<br />
Greece, Ireland or Portugal, and by over three<br />
times as much as Italy. This largely reflects a<br />
rapid run up in support programs for an aging<br />
population.<br />
• The drama over the debt ceiling gives rise to<br />
legitimate concerns that if US politicians cannot<br />
agree on something simple, how much more<br />
difficult might it be to adjust the primary fiscal<br />
balance by over 17% of GDP?<br />
• Uncertainties may well remain until after the<br />
2012 elections.<br />
There are four important questions bouncing around<br />
the markets about the US fiscal position:<br />
• Will there be a downgrade?<br />
• Will the 2 August deadline to lift the debt ceiling<br />
be met?<br />
• Will there be a technical default?<br />
• How much does the US have to do fiscally to<br />
become sustainable?<br />
Probably too much attention is being given to the first<br />
two questions and not enough to the last, where<br />
there is generally a poor appreciation of how<br />
Herculean is the task facing the US. On some<br />
reckoning, it needs to adjust its budget by more than<br />
Greece!<br />
Downgrade chances high<br />
The chances of a downgrade by at least one ratings<br />
agency have increased substantially in recent<br />
Source: Congressional Budget Office<br />
months. The IMF showed the gross debt-to-GDP<br />
ratio of general government at 91.6% of GDP last<br />
year. It is likely that this figure will pierce the 100%<br />
barrier this year. That is more significant for some<br />
agencies than others (e.g., it is a key metric for S&P,<br />
whereas Moody’s looks more at debt interest relative<br />
to tax revenues, and current low rates mean this<br />
remains low).<br />
The process of lifting the debt ceiling and negotiating<br />
a longer-term reduction in the deficit has been caught<br />
up in politics. With many politicians, ahead of<br />
primaries, playing to their core supporters rather than<br />
looking for compromise, the process has looked to<br />
be all checks and no balance. No one would argue<br />
that the process will have increased the willingness<br />
of investors to buy Treasuries (unless there is a<br />
general disaster and flight to quality, which is another<br />
kettle of fish). With S&P having put the US on<br />
negative watch, something very positive has to<br />
happen to avoid a downgrade.<br />
A notch below AAA would still be a very high rating<br />
so we do not think there will be a very big impact on<br />
the bond market, nor on other securities that would<br />
be subject to a trickle-down downgrade (e.g. munis,<br />
agencies). In net terms though, a downgrade would<br />
probably push Treasury yields up by only 25bp or so<br />
according to our strategists.<br />
The Congressional Budget Office has reckoned that<br />
a one tenth of one percent increase in Treasury<br />
yields would increase government debt interest<br />
payments over the next decade by USD 130bn<br />
(http://cboblog.cbo.gov/). So it is not exactly a matter<br />
of indifference in the Treasury building as to whether<br />
or not there is a downgrade – which could cost<br />
USD 300bn over a decade.<br />
Paul Mortimer-Lee 28 July 2011<br />
Market Mover<br />
4<br />
www.GlobalMarkets.bnpparibas.com
From a longer-term perspective, the political<br />
wrangling will have increased worries that the US<br />
could someday monetise its debt, even if it did not<br />
default, in order to square its challenging fiscal<br />
arithmetic.<br />
Missing the 2 August deadline? Chances rising<br />
The incentives are very strong for politicians to reach<br />
a compromise on the ceiling before 2 August, the<br />
date the Treasury had said was it would run out of<br />
flexibility, and cash. Much of the wrangling is still<br />
likely to be political theatrics and positioning,<br />
although it certainly feels like a closer call as the date<br />
draws near. Better than expected revenues over the<br />
past few months mean that this deadline is likely not<br />
iron-hard, and the temptation for politicians to stray<br />
beyond it is high. By our own estimates, they can<br />
probably make it into the second week of August<br />
before running out of cash, but would certainly do so<br />
before 15 August when a large interest payment is<br />
due. It looks increasingly likely that we will have to<br />
see if a compromise is thrashed out over the<br />
weekend (how very European!) to see whether or not<br />
the Tuesday deadline will be met. If it is not, we are<br />
likely to see:<br />
• Increased speculation that there will be a<br />
technical default;<br />
• More pressure on politicians to come up with at<br />
least a temporary raising of the debt ceiling;<br />
• Higher risk premia on risk assets, giving lower<br />
stock prices;<br />
• Mixed pressures on Treasuries. There would be<br />
pressure for higher yields (more worries about<br />
defaults, concerns about money market funds’<br />
and others’ reactions), but weaker risk assets<br />
would work to mitigate this.<br />
As a rough guide, an extra 50bp of risk premia on<br />
equities might cut stock prices by about 5%.<br />
Our assessment is that even if no agreement were<br />
reached by 2 August, one would be soon after, with a<br />
probability of 95%.<br />
Technical default – chances low but not zero<br />
After the US hit the debt ceiling in 1979, a limited<br />
number of cheques to pay redeeming Treasury bills<br />
did not get paid. Can we rule this out? It does not<br />
seem sensible for politicians to push things to this<br />
point, since it could create lasting damage. However,<br />
getting agreement on the short-term issue of the<br />
ceiling is entwined with the long-term issue of fiscal<br />
strategy, which is very tough (see next page).<br />
Moreover, we saw politicians in Europe push the<br />
Greek crisis far enough to do lasting damage (e.g., to<br />
liquidity in peripheral bond markets). And remember<br />
that it was not particularly sensible for the US to pull<br />
the plug on Lehman, but it happened. The fact is,<br />
when you play Russian roulette with budgetary<br />
matters, it occasionally ends with a less than optimal<br />
solution.<br />
The CBO’s views of the consequences of a default<br />
make salutary reading:<br />
“That shock could trigger large swings in stock<br />
prices, private interest rates, and the value of the<br />
dollar relative to other currencies; it might also<br />
generate massive disruptions and damage to the<br />
payments system and the flow of credit; and it would<br />
probably weaken the economy and reduce output<br />
and employment relative to what they would<br />
otherwise be. Indeed, the lack of a plan for<br />
increasing the debt ceiling may already be hurting<br />
household and business confidence, and default<br />
would reduce confidence further and increase<br />
uncertainty about future government policies, which<br />
would lower spending even apart from the effects of<br />
changes in asset prices and interest rates.”<br />
Some research suggested that the technical default<br />
in 1979 added 60bp to Treasury yields at the time<br />
and up to six months after the event. Given a bigger<br />
debt burden now, a very wide deficit and fiscal<br />
concerns more generally heightened by the eurozone<br />
crisis, there is a good chance we could see a bigger<br />
addition to yields – perhaps up to 100bp. Whether<br />
this would stick or not would depend on what<br />
happened to risk assets – Treasuries could even end<br />
up lower if there were turmoil in risk assets.<br />
With additional risk premia on stocks, we might see<br />
equity prices down by more than 10%.<br />
Growth prospects would be diminished in 2012.<br />
Given that our forecast is on the weak side of<br />
consensus, we would see a risk of falling below the<br />
“stall speed” of the economy. A technical default<br />
might knock 1% off growth.<br />
A technical default by the US would have adverse<br />
consequences globally – it would be unlikely to<br />
improve confidence in the eurozone, for example, or<br />
be good for global equities or peripheral spreads. For<br />
that reason, it might not harm the USD as much as<br />
might be thought. The extent of the damage would<br />
depend on whether there were any response from<br />
the Fed to stabilise the bond market – i.e., QE3. If<br />
there were, this would aggravate expectations that<br />
the US could address its fiscal problems by printing<br />
money.<br />
A long way from sustainability<br />
We’ve all grown used to seeing this or that budget<br />
plan in the US described as generating savings of so<br />
many trillions over a 10-year period. What we do<br />
here is put the long term position into the same<br />
Paul Mortimer-Lee 28 July 2011<br />
Market Mover<br />
5<br />
www.GlobalMarkets.bnpparibas.com
parlance as people have grown used to with the<br />
eurozone crisis – i.e. how much adjustment is<br />
required in the primary balance to achieve<br />
sustainability?<br />
One of the great difficulties in addressing this<br />
problem is deciding what the baseline is. The<br />
Congressional Budget Office provides what it calls<br />
“the extended baseline scenario” and the “alternative<br />
fiscal scenario”. The first is what CBO believes would<br />
happen according to current law.<br />
However, it is pretty clear that the rest of us should<br />
not take this as our central case, but should adopt<br />
the “alternative fiscal scenario” (see Chart 1). This,<br />
according to the CBO, “incorporates several changes<br />
to current law that are widely expected to occur or<br />
that would modify some provisions of law that might<br />
be difficult to sustain over a long period”<br />
(http://www.cbo.gov/ftpdocs/122xx/doc12253/06-23-<br />
LTBOTestimony.pdf).<br />
It is noteworthy that all the various plans with their<br />
trillions of savings are relative the baseline scenario,<br />
which is almost certainly too optimistic. In other<br />
words, there is not agreement on plans that already<br />
started off inadequate because they come from a<br />
baseline that incorporates far too optimistic<br />
assumptions. Remember also that the US fiscal<br />
debate tends to concentrate on the Federal<br />
government, whereas general government is the<br />
concept used in most international comparisons.<br />
That creates a bigger problem to address.<br />
Perhaps the best way to illustrate how much the US<br />
has to do to achieve sustainability is to take the<br />
international comparisons in the excellent IMF Fiscal<br />
Monitor, from which we take Table 1. This shows the<br />
starting point for adjustment as 2010, and the<br />
adjustment in the primary deficit necessary to bring<br />
the debt-to-GDP ratio to 60% by 2020. For Japan, a<br />
target of 80% of GDP is assumed, which<br />
corresponds to a target for gross debt of 200%.<br />
What is striking is how high the US required<br />
adjustment is, both in absolute terms and relative to<br />
other countries. If we ignore age-related spending<br />
then there is a required adjustment in the underlying<br />
primary balance of 11.3% of GDP, or five points<br />
larger than Portugal and nearly three times as much<br />
as Italy. Only Japan has a larger required<br />
adjustment. It is noteworthy that the IMF reckons the<br />
US needs more adjustment than Greece.<br />
When the IMF takes account of age-related<br />
spending, the US required adjustment increases by<br />
over 50% – to 17.5% of GDP, which is the largest of<br />
any country and a full three-and-a-half points more<br />
than Greece, three points more than Ireland and<br />
seven points more than Portugal.<br />
The sheer scale of this adjustment is staggering. The<br />
fact that it is more than in the periphery is extremely<br />
concerning. It also explains why the political battles<br />
are so intense. The OECD calculates that total US<br />
general government receipts are about 30% of GDP<br />
and that disbursements of general government are<br />
40% of GDP. So the required adjustment in the<br />
primary balance is more than 50% of current receipts<br />
and almost 50% of outlays.<br />
This is the real import of the current debt ceiling<br />
debate. If US politicians cannot agree on the simple<br />
matter of raising the debt ceiling what should markets<br />
take as being the prospect of agreeing on measures<br />
to achieve the massive scale of fiscal adjustment that<br />
the US needs to achieve? Will they, as the<br />
Europeans were over Greece, be forced to go into<br />
crisis before they act? These are legitimate questions<br />
that will keep market participants concerned for some<br />
time, probably until after the elections next year, after<br />
which, hopefully, a coherent long-term plan will<br />
emerge.<br />
Table 2: Advanced Economics: Needed Fiscal Adjustment – An Illustrative Scenario (Percent of GDP)<br />
Current WEO Projections, 2010 Illustrative Fiscal Adjustment Strategy to Achieve Debt Target in 2030<br />
Gross Debt Primary Balance<br />
Cyclically Adjusted<br />
PB<br />
Cyclically Adjusted PB in<br />
2020-30<br />
Required Adjustment<br />
between 2010 and 2020<br />
Required Adjustment and Age-<br />
Related Spending, 2010-30<br />
Austria 69.9 -1.9 -0.9 1.5 2.4 6.7<br />
Belgium 97.1 -1.3 0.4 3.4 3.1 8.7<br />
France 81.8 -4.8 -3.2 3.0 6.2 8.4<br />
Germany 80.0 -1.1 -0.3 1.9 2.2 4.4<br />
Greece 142.0 -3.2 -3.1 7.4 10.5 14.0<br />
Ireland 96.1 -29.7 -6.1 6.3 12.4 14.4<br />
Italy 119.0 -0.3 1.4 4.6 3.2 4.6<br />
Japan 220.3 -8.4 -6.7 6.6 13.3 14.0<br />
Netherlands 63.7 -3.7 -2.7 1.4 4.2 9.5<br />
Portugal 83.3 -4.6 -3.1 3.3 6.4 10.6<br />
Spain 60.1 -7.8 -6.3 1.9 8.2 10.3<br />
United Kingdom 77.2 -7.8 -5.9 3.4 9.3 13.5<br />
United States 91.6 -8.9 -6.2 5.1 11.3 17.5<br />
Average (PPP-weighted) 96.6 -5.9 -4.0 3.8 7.8 11.8<br />
G-20 102.9 -6.4 -4.5 4.1 8.6 12.8<br />
Source: IMF<br />
Paul Mortimer-Lee 28 July 2011<br />
Market Mover<br />
6<br />
www.GlobalMarkets.bnpparibas.com
Eurozone Summit: The Reaction<br />
• Our take on the EU Summit has been<br />
positive – we view it as a potential turning point<br />
in the debt crisis.<br />
• However, after an initially positive reaction,<br />
market tensions have resumed, with spreads of<br />
Italian and Spanish bonds widening again.<br />
• In this note, we look at possible factors<br />
underlying this unenthusiastic reaction.<br />
• Increased concern about the impact of a<br />
possible US debt downgrade has played an<br />
important role.<br />
• Criticism of the scale of up-front debt<br />
reduction for Greece undervalues, in our view,<br />
the relief provided by the radically modified<br />
interest rate structure.<br />
• Lingering uncertainty over some technical<br />
aspects of the deal, including the private sector<br />
involvement (PSI), has been another important<br />
factor.<br />
• Implementation is also a potential issue. In<br />
particular, the changes to the scope of the<br />
European Financial Stability Facility (EFSF)<br />
require parliamentary approval in several<br />
countries.<br />
• We do not see this as a problem but it will<br />
require time.<br />
• Meanwhile, it would be very helpful if the<br />
ECB were to resume its bond purchases<br />
through the Security Markets Programme.<br />
• Overall, some of these uncertainties are<br />
likely to persist in the short term but we are<br />
confident that, over time, the implications of the<br />
EU Summit will be properly acknowledged…<br />
• …paving the way to an easing of market<br />
tensions.<br />
In the notes “Eurozone Summit: A Major Step<br />
Forward”, 21 July 2011<br />
and “Eurozone Summit:<br />
A Yorktown Moment? ”, 25 July 2011, we argue<br />
that the outcome of the EU emergency Summit on 21<br />
July is a potential turning point in the eurozone debt<br />
crisis.<br />
Spreads over bunds of Greece, Ireland and Portugal<br />
tightened considerably but following a short-lived<br />
positive reaction, those of Italian and Spanish bonds<br />
Chart 1: Spread to Bunds (bp)<br />
Source: Reuters EcoWin Pro<br />
have widened again and are trading only a tad below<br />
their pre-Summit highs.<br />
In this note, we look at the possible factors<br />
underlying this unenthusiastic reaction. In particular,<br />
we emphasise three factors. First is the prolonged<br />
and so far fruitless, debate over the US debt ceiling.<br />
Concern has increased about a downgrade of the US<br />
sovereign debt. While we believe the impact of a<br />
possible downgrade will not be significant, the<br />
current climate of uncertainty is not beneficial for<br />
peripheral spreads.<br />
A second important factor is uncertainty about a<br />
number of technical details of the Greek deal,<br />
including the private sector involvement (PSI). A<br />
quick clarification of some of the pending issues<br />
would be beneficial, but we would argue that to focus<br />
on details would be to underestimate the bigger<br />
picture of the political commitment from the EU<br />
Summit.<br />
Finally, sceptics have expressed doubts about the<br />
ability of the EFSF potentially to deal with other<br />
countries such as Spain and Italy, should this be<br />
needed. Implementation of the changes to the<br />
EFSF’s scope is a potential issue, as it requires<br />
parliamentary approval in several countries. We do<br />
not see this is a major problem but it will require time.<br />
More generally, we believe Italy’s position is more<br />
balanced than recent market tensions would imply.<br />
A US debt downgrade?<br />
We deal with this aspect in more detail in the article<br />
“US: Much More Adjustment Needed”. In a nutshell,<br />
we see a good chance of a US downgrade, a rising<br />
chance of the 2 August deadline being missed and a<br />
very small risk of a technical default. We do not think<br />
this will have a significant impact on the bond market,<br />
Luigi Speranza/Paul Mortimer-Lee/Kenneth Wattret 28 July 2011<br />
Market Mover<br />
7<br />
www.GlobalMarkets.bnpparibas.com
nor on other securities that would experience a<br />
trickle-down downgrade, such as agencies. But the<br />
underlying problem – that a significant adjustment is<br />
required in order to bring the debt back on to a more<br />
sustainable trajectory – remains. The increased<br />
uncertainty stemming from the US has been an<br />
important factor underlying recent market dynamics<br />
in the eurozone. We suspect uncertainty on the US<br />
front will persist, probably at least until the 2012<br />
elections.<br />
Greek plan: lingering uncertainties<br />
One of the arguments used by the sceptics is that the<br />
plan agreed at the 21 July EU Summit does not<br />
tackle Greece’s main problem, which is the high level<br />
of the public debt. Implementation risk, the sceptics<br />
argue, therefore remains very high.<br />
In our view, this argument undervalues the significant<br />
debt relief coming, over time, from lower interest<br />
rates. Other things being equal, a reduction in<br />
interest rates of 100bp implies a reduction in the<br />
primary surplus needed to bring the debt back on to<br />
a sustainable path of around 1.5% of GDP. The<br />
upfront reduction in the Greek debt is limited (EUR<br />
33.5bn, or 15% of GDP) but, as we argue in more<br />
detail in the note “Greece: Improved Debt<br />
Sustainability” , 25 July 2011, the decisions<br />
taken at the EU Summit will lead to a significant<br />
improvement in Greece’s debt sustainability.<br />
Combined with the lengthening of the debt maturity,<br />
the reduction in interest rates reduces the possible<br />
implications of limited slippages in the fiscal targets.<br />
In contrast, a significant upfront reduction of the debt<br />
would have very probably reduced the government’s<br />
incentive to make structural changes in the economy.<br />
Another important factor underlying the<br />
unenthusiastic market reaction to the EU Summit is<br />
probably lingering uncertainty about a number of<br />
details of the plan including:<br />
1. The IMF’s participation. The language of the<br />
statement (“We call on the IMF to continue to<br />
contribute to the financing of the new Greek<br />
programme”) was conspicuously vague, suggesting<br />
the lack of a definitive agreement on the IMF’s share.<br />
The press has speculated about the increasing<br />
reluctance of a number of representatives in the<br />
Fund to contribute to the same extent as in the first<br />
round (which was split 73/27% between the EU and<br />
the IMF). Note, however, that the commitment to total<br />
official financing of EUR 109bn expressed in the<br />
statement is not conditional. Therefore, while a swift<br />
confirmation of IMF support would be helpful, a lower<br />
contribution than in the past would not be a major<br />
issue.<br />
2. The extent of private sector involvement (PSI).<br />
The IIF assumes the participation rate will be 90%.<br />
This would imply a contribution from the private<br />
sector of EUR 93bn, net of credit enhancement, of<br />
which EUR 37bn will be contributed in the period<br />
2011-2014. Doubts have been expressed by some<br />
about the ability to achieve such a level of<br />
participation. We would highlight such a contribution<br />
would be in line with previous experiences of similar<br />
plans such as Uruguay. As highlighted by the French<br />
Finance Minister François Baroin, the contributions<br />
from French banks will cover all EUR 15bn of their<br />
Greek exposure maturing by 2020. The 90%<br />
participation rate is feasible in our view.<br />
Stabilisation tools<br />
Together with Greece, the 21 July EU Summit dealt<br />
with the more general problem of contagion, with a<br />
number of stabilisation measures based on<br />
increased flexibility in the EFSF/European Stability<br />
Mechanism framework. The EFSF and the ESM<br />
have been allowed to:<br />
i. Finance recapitalisation of financial institutions<br />
through loans to governments including in non<br />
programme countries; and<br />
ii. Intervene in the secondary market if risks to<br />
financial stability are detected.<br />
The former is particularly important for Spain, where<br />
uncertainty about the health of the banking sector<br />
has contributed greatly to underlying concern over<br />
sovereign risk. The measure has the potential to<br />
break any adverse loop between sovereign and bank<br />
risks. The latter is potentially important for Italy.<br />
Given the size of Italy’s public debt, an escalation of<br />
the tensions in its bond market would necessarily be<br />
systemic.<br />
The decision of the EU is important in a number of<br />
ways. First, once implemented, it will relieve the ECB<br />
from the task of supporting the market. The role<br />
played by the SMP in stabilising the eurozone bond<br />
market has been crucial in our view. The ECB,<br />
however, took this role reluctantly and had recently<br />
backed away, which was one of the triggers of the<br />
escalation of market tensions. One of the motivations<br />
behind this reluctance is that the ECB viewed such<br />
interventions as interfering in the fiscal sphere, which<br />
would risk jeopardising its credibility. This risk was<br />
emphasised by the debate about a possible Greek<br />
default. Such an occurrence would have caused<br />
losses for the eurosystem, probably forcing a<br />
recapitalisation. Highlighting the cost for the taxpayer<br />
of the SMP’s market interventions, a recapitalisation<br />
would have exposed the ECB to the criticism of<br />
having gone beyond its mandate, by in effect<br />
implementing fiscal transfers without a formal political<br />
endorsement. Against this background, the EU<br />
Luigi Speranza/Paul Mortimer-Lee/Kenneth Wattret 28 July 2011<br />
Market Mover<br />
8<br />
www.GlobalMarkets.bnpparibas.com
decision was very important, as it provides the<br />
political backing. Why, then, the poor market<br />
reaction?<br />
The sceptics have highlighted potential problems in<br />
the implementation of the decision. The changes to<br />
the scope of the EFSF will have to be ratified at the<br />
national level. In most countries, this requires<br />
parliamentary approval and could take a few months,<br />
with the imminent summer recesses in national<br />
parliaments an additional complication. But, while the<br />
process may be long, we are confident that approval<br />
will eventually be gained. It must also be noted that,<br />
once approved in principle, the decision to intervene<br />
in the secondary markets will have to be taken by<br />
“mutual agreement” of EFSF/ESM member states<br />
and not by unanimity. This reduces the scope for<br />
delay caused by possible opposition in a limited<br />
number of countries.<br />
Another potential issue is the lending ability of the<br />
EFSF. The new loans to Greece leave the EFSF’s<br />
lending capacity at around EUR 323bn. This could be<br />
further reduced if Portugal and Ireland are not able to<br />
access the markets as planned and need further<br />
support over the next two years. With Italy’s yearly<br />
funding needs being in the region of EUR 225bn, the<br />
EFSF’s ammunition, some have argued, might not be<br />
sufficient. We would argue, however, that only small<br />
interventions might be needed to stabilise the<br />
markets. The EFSF can always be increased at a<br />
second stage if needed, as it already has been once.<br />
Finally, the political backing given by the EU Summit<br />
for purchases in the secondary market might allow<br />
the ECB to temporarily resume its SMP purchases,<br />
possibly under the agreement that the EFSF will buy<br />
back the bonds from the ECB at a later stage. We<br />
believe that an ECB announcement in this direction<br />
would be very beneficial. It would be evidence of a<br />
concerted effort against contagion risk and<br />
significantly reduce the risk premia attached to bonds<br />
of other countries currently under the market<br />
spotlight including Italy.<br />
Another argument used by sceptics is that, even if<br />
approved in due course, the EFSF’s ability to<br />
intervene in the secondary market would only offer a<br />
temporary relief but would not deal with the<br />
underlying problem, which is Italy’s high public debt.<br />
Under these circumstances, the argument goes, a<br />
shock to interest rates, whatever the reason,<br />
becomes a self-fulfilling prophecy, as it significantly<br />
increases the interest burden, pushing the debt on to<br />
an unsustainable trajectory.<br />
That the Italian public debt is very high is beyond<br />
doubt. But we would argue that Italy’s position is<br />
more balanced than recent market tensions would<br />
imply. While structurally low growth is an impediment<br />
to a swift reduction of the debt, especially when<br />
compounded with political fragility, Italy, unlike other<br />
so-called peripherals, can count on the sounder<br />
position of its private sector, founded on very low<br />
household indebtedness. This, in turn, is associated<br />
with a much more balanced external position than<br />
other economies currently under the market spotlight.<br />
The fiscal adjustment required to stabilise the debtto-GDP<br />
ratio is also lower – around 2% of GDP on<br />
our estimates. Finally, the argument that higher<br />
interest rates could cause a spiral underestimates<br />
the fact that the average life of Italy’s public debt, at<br />
7.8 years, is relatively high. This means that a shock<br />
would take time to fully affect the interest burden. A<br />
100bp permanent upward shift in the yield curve<br />
would, over time, increase the interest burden by<br />
around 1.2% of GDP. But in the short term the<br />
impact is much more limited – 0.2% of GDP in the<br />
first year and around 0.4% in the second.<br />
Conclusion<br />
As we have emphasised in previous notes, we saw<br />
the agreement at the Eurozone Summit as a major<br />
step forward in dealing with the debt crisis. The<br />
improved terms for the new loans to Greece are<br />
evidence of a more constructive way of providing<br />
assistance, while the greater flexibility of the EFSF<br />
demonstrates a greater political determination to<br />
address contagion risk. The market reaction to the<br />
deal has been, however, unenthusiastic.<br />
One reason for this reaction is heightened<br />
uncertainty related to the US debt ceiling debate.<br />
Uncertainty about a number of elements of the Greek<br />
plan is also playing an important role. A swift<br />
clarification of some of the pending issues would be<br />
highly beneficial.<br />
Implementation is also an issue. The changes to the<br />
EFSF’s scope require parliamentary approval in<br />
several participating member states. We do not see<br />
this as a problem, but it will require time. <br />
Meanwhile, it would be very helpful if the ECB were<br />
to resume its bond purchases through the SMP.<br />
More fundamentally, the criticism coming from<br />
sceptics that the plan does not deal with Greece’s<br />
main problem, its high debt, undervalues the debt<br />
relief that will be provided over time by lower interest<br />
rates. Similarly, we find that Italy’s position is much<br />
more balanced than recent market movements would<br />
imply.<br />
Some of these uncertainties are likely to persist in<br />
the short term but we are confident that, over time,<br />
the implications of the EU Summit will be properly<br />
acknowledged, paving the way for an easing of<br />
market tensions.<br />
Luigi Speranza/Paul Mortimer-Lee/Kenneth Wattret 28 July 2011<br />
Market Mover<br />
9<br />
www.GlobalMarkets.bnpparibas.com
France: Budget Consolidation Is On Track<br />
• The central budget is comfortably in line<br />
with its target. The deficit of other public<br />
administrations looks mixed, but adjustment<br />
measures are being taken.<br />
• The government has reduced this year's<br />
budget deficit target from 6.0% of GDP to 5.7%.<br />
• We believe the final deficit is likely to<br />
undershoot the target again this year.<br />
0<br />
-20<br />
-40<br />
-60<br />
-80<br />
-100<br />
-120<br />
Chart 1: Central Budget Balance<br />
(Cumulative, EUR bn)<br />
2011<br />
2009<br />
2010<br />
2008<br />
The central deficit is better than it looks<br />
Over the first five months of this year, the State<br />
budget deficit widened by EUR 0.5bn to EUR 68.4bn<br />
(Chart 1). But this figure is misleading, central<br />
government spending declined 3.0% y/y (the full-year<br />
target is a rise of 1.2%) and income increased by<br />
6.3% (target 5.2%) implying a reduction in the deficit<br />
of EUR 11.1bn.<br />
With spending down and revenue up, the widening of<br />
the actual budget deficit is due to the special<br />
account. This account had to pay in January and<br />
March for two tranches of the rescue package for<br />
Greece (another one is due in July). This plan is<br />
included in the French public accounts but not in the<br />
Maastricht definition of the deficit. In addition, this<br />
account transferred cash to local authorities earlier<br />
than in previous years, distorting the year-on-year<br />
comparison in the early months of the year.<br />
Looking at the breakdown of income, the picture is<br />
reassuring (Chart 2). The main gain is on corporate<br />
tax which is recovering from the recession-induced<br />
collapse. Net corporate tax income jumped 65.5% y/y<br />
and most of this impressive performance is<br />
sustainable this year. In fact, income is still 47.5%<br />
below the pre-crisis level (of January-May 2008).<br />
Meanwhile, income tax rose by 2.3% y/y in the first<br />
five months of the year, and the rise should<br />
accelerate because households this year are paying<br />
tax based on their 2010 income which rose by 2.1%<br />
and there are fewer tax breaks this year. VAT<br />
revenue is up 3.9% y/y. The increase will slow given<br />
reduced car sales following the removal of public<br />
incentives for car purchases, although some offset is<br />
provided by the removal of the cost of the incentive<br />
for the government. Altogether, the normalisation of<br />
tax income will continue and the fiscal tightening will<br />
further support tax revenues.<br />
Looking at the expenditure side, the strongest<br />
increase is for debt service, up EUR 2.4bn or<br />
-140<br />
-160<br />
EUR bn, cumulative<br />
Jan. Mar. May July Sept. Nov.<br />
Source: MoF, <strong>BNP</strong> Paribas<br />
Chart 2: Budget Revenue (% y/y)<br />
-15 0 15 30 45 60 75<br />
Source: MoF, <strong>BNP</strong> Paribas<br />
Jan-May<br />
2011 (% y/y)<br />
Net Receipts<br />
Net Tax Receipts<br />
Non Tax Receipts<br />
Other Taxes<br />
Tax on Oil Products<br />
VAT<br />
Corporate Tax<br />
Income Tax<br />
14.6% y/y. This is the result of a combination of<br />
slightly higher interest rates and rising debt. The<br />
situation will worsen in July when higher inflation<br />
(2.06% in June 2011 versus 1.43% in June 2010) will<br />
raise the value of index-linked debt (this rise is<br />
accounted as a cost, although there is no immediate<br />
disbursement). The 2011 decline in overall spending<br />
is due to a base effect, as 2010 spending included a<br />
one-off transfer to local authorities. However, since<br />
2008, expenditure has risen just 1.2% per annum, on<br />
average, showing that the stimulus policy, which is<br />
now completely over, consisted of measures that had<br />
only a transitory impact on spending. In particular,<br />
expenditure on personnel was unchanged for the<br />
third consecutive year (job cuts and wage restraint<br />
have helped to compensate for the upward drift of<br />
wages due to promotions).<br />
Overall, the central budget is clearly under control.<br />
The situation of other administrations is more difficult<br />
to assess but, again, the target is likely to be met.<br />
Dominique Barbet 28 July 2011<br />
Market Mover<br />
10<br />
www.GlobalMarkets.bnpparibas.com
... but other accounts look mixed<br />
We do not have monthly or quarterly accounts for<br />
other public administrations which are included in the<br />
Maastricht definition of the public deficit. However,<br />
INSEE provides, for each quarter, the level of debt<br />
for social security, local administrations and other<br />
central administration bodies (i.e. excluding the<br />
State). We have adjusted the data for seasonal<br />
variations (Chart 4).<br />
90<br />
80<br />
70<br />
60<br />
50<br />
40<br />
Chart 3: Public Debt Breakdown<br />
(% of GDP, NSA)<br />
60%<br />
State<br />
Total<br />
The main issue is clearly social security accounts.<br />
The debt ratio rose by 0.9pp of GDP in Q1. Health<br />
spending is recovering after a slower increase during<br />
the recession (as people postponed non-urgent and<br />
poorly compensated care, in particular for dentistry,<br />
glasses and hearing aids). With fewer people at<br />
work, compensation for work accidents have<br />
declined in recent years, but are increasing again this<br />
year. Conversely the deficit of the unemployment<br />
benefits system declined. However, a stabilisation of<br />
unemployment after the recent fall may slow the<br />
pace of this decline.<br />
The problem on the social security accounts is being<br />
addressed. Healthcare spending cuts have been<br />
agreed and more will be implemented in the coming<br />
months. Most importantly, the 2010 pension reform<br />
will start to bear fruit in Q3 and Q4 when people will<br />
delay their leaving of the labour market. This will be<br />
reflected in both lower expenditure and higher<br />
income (although the latter will depend upon how the<br />
increase in the active population is split between<br />
employment and unemployment). This reform is also<br />
a key element of 2012’s decline in the deficit.<br />
In Q1, the debt ratio of local administrations was the<br />
same as in Q1 2010. The ratio fell slightly from Q4<br />
2010 (-0.03pp), while the government had expected<br />
a 0.1pp rise per quarter in 2011. Local<br />
administrations’ debt rose during the recession for<br />
three reasons:<br />
• Lower tax income because of fewer property<br />
transactions;<br />
• Higher social expenditure because of the<br />
recession; and<br />
• Stronger investment spending, with some help<br />
from the central government, to support activity.<br />
These factors are disappearing and local<br />
administration debt is likely to continue to decline,<br />
especially if house sales continue to recover.<br />
Other public administration debt declined much more<br />
significantly, down 0.32pp of GDP versus last year,<br />
including 0.18pp over the first quarter. This trend is<br />
likely to continue but at a slower pace because of the<br />
need to increase investment in the railway network.<br />
Altogether, the debt-to-GDP ratio of social security,<br />
local authorities and other administrations rose 0.7pp<br />
30<br />
20<br />
10<br />
0<br />
Miscellaneous<br />
Local Admin.<br />
Social Security<br />
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10<br />
Source: INSEE, Reuters EcoWin Pro<br />
10<br />
9<br />
8<br />
7<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
Mar-99<br />
Chart 4: Public Debt<br />
(% of GDP, SA by <strong>BNP</strong> Paribas)<br />
Mar-00<br />
Local Admin.<br />
Mar-01<br />
Source: <strong>BNP</strong> Paribas<br />
Mar-02<br />
Mar-03<br />
Mar-04<br />
Social Security<br />
in Q1. This is less favourable than the government<br />
target of 0.4pp per quarter on average. However, the<br />
situation should improve in the second half of the<br />
year and we believe the final target will be met.<br />
2011 should be another year when the final<br />
deficit is smaller than the target<br />
The government has reduced this year's budget<br />
deficit target from 6.0% of GDP to 5.7%. We believe<br />
the final deficit is likely to be even lower than this<br />
revised goal at 5.6% of GDP. The main favourable<br />
factors are stronger than expected fiscal receipts,<br />
thanks to a cautious initial forecast as in 2010,<br />
although the extent to which the deficit is below the<br />
target is unlikely to be as large as in 2009 or 2010.<br />
For 2012, the government has already said that the<br />
central budget, which should be presented on<br />
28 September, will include more fiscal tightening than<br />
has already been announced last year. The current<br />
policy of cutting tax breaks will be continued. On the<br />
expenditure side, the cut in central administration<br />
employment will also continue. The wage freeze<br />
decided for this year will also benefit the 2012 budget<br />
thanks to the absence of a carryover. Thus France<br />
remains on track to meet its budget targets.<br />
Mar-05<br />
Mar-06<br />
Mar-07<br />
Mar-08<br />
ODAC<br />
Mar-09<br />
Mar-10<br />
Mar-11<br />
NB: ODAC = Central Administration excl. State<br />
Dominique Barbet 28 July 2011<br />
Market Mover<br />
11<br />
www.GlobalMarkets.bnpparibas.com
France: Fiscal Credibility and Debt Brake<br />
• The French version of the German ‘debt<br />
brake’ is ready for approval.<br />
• Formal implementation may have to wait for<br />
the next parliament, but it is already boosting<br />
the credibility of fiscal decisions.<br />
• Moreover, fiscal consolidation is garnering<br />
wider political support ahead of the elections.<br />
The golden rule has been prepared…<br />
The President knows he has no choice but to build<br />
his political platform around a fiscal consolidation<br />
policy. This is why he managed to get the upper and<br />
lower houses of Parliament to approve on 11 and 13<br />
July respectively, the French ‘debt brake’ rule that is<br />
aimed at being included in the Constitution (see<br />
“France: Obstinately Seeking Credibility”, Market<br />
Mover, 10 February 2011).<br />
The French version of the golden rule is different to<br />
Germany’s. In line with the stability plan, the<br />
government would have to prepare a three-year plan<br />
with a ceiling for spending and a minimum threshold<br />
for income. Any annual budget or mini-budget would<br />
have to comply with the three-year law (otherwise it<br />
would be blocked by the constitutional court). Any<br />
additional expenditure would be financed by<br />
spending cuts. Similarly, no tax cut would be allowed<br />
without offsetting measures.<br />
… but formal approval may take some time<br />
The next – and final – step required to make the rule<br />
part of the Constitution is either a referendum or a<br />
joint approval of the text by Congress (i.e. both<br />
houses) with a 60% majority.<br />
A referendum is highly unlikely as it would probably<br />
result in a ‘no’ vote, in a personal vote against the<br />
President rather than in response to the question.<br />
Similarly the timing is poor for an approval by<br />
Congress. The ruling coalition currently has a 56%<br />
majority. This should narrow after the upper house<br />
elections on 25 September (when 75k elected<br />
officials will vote in 170 of the 348 Senate members).<br />
The approval of Congress would thus require some<br />
of the left-wing opposition MPs to vote with the<br />
current majority, which is highly unlikely a few<br />
months before general elections. Calling a meeting of<br />
Congress in order to be able to win a political battle<br />
and divide the opposition or, alternatively, to stick a<br />
"pro-deficit" tag on the Socialist Party would be a<br />
dangerous game in present market conditions. We<br />
believe such a Congress is more likely to occur after<br />
the elections when the chances of getting the debt<br />
brake rule introduced in the Constitution are<br />
Chart 1: General Budget Deficit and Public Debt<br />
90<br />
85<br />
80<br />
75<br />
70<br />
65<br />
60<br />
55<br />
50<br />
General Gov't Deficit (% of GDP, RHS)<br />
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014<br />
Source: MoF, <strong>BNP</strong> Paribas<br />
Total Public Debt (% of GDP)<br />
Gov't<br />
Forecast<br />
considerably higher. The preparation work done by<br />
Parliament can still be politically useful before the<br />
elections.<br />
Politics: support for fiscal consolidation is rising<br />
The government’s determination to meet at least the<br />
target for this year's budget deficit is very high. The<br />
President knows this achievement will be published<br />
before the 2012 presidential elections and it will be<br />
important for his credibility at that time. For the same<br />
reason, the 2012 budget, which should be presented<br />
on 28 September, also has to be credible. This will<br />
be verified by European authorities. European<br />
authorities will also have to approve the next stability<br />
plan that will include a 3.0%-of-GDP maximum deficit<br />
for 2013 (as did the preceding two plans). By then,<br />
we also expect the primary budget to show a surplus.<br />
Last Wednesday, the IMF report on France<br />
highlighted that there is no other option but to stick to<br />
the stability plan. When she was MoF, Mrs Lagarde<br />
said France would do "whatever it takes" to meet the<br />
stability plan goals even if growth falls below target.<br />
The policy has not changed since then.<br />
More importantly, the markets should be reassured<br />
about the longer-term outlook. The current majority<br />
and the two main contenders for the investiture of the<br />
socialist party, Martine Aubry and François Hollande,<br />
have accepted the target of a 3%-of-GDP budget<br />
deficit in 2013. That acceptance occurred before the<br />
most recent agreement to solve the eurozone<br />
sovereign debt crisis, showing that their commitment<br />
is not a temporary position taken in reaction to<br />
Sarkozy's success in achieving a deal on this issue.<br />
The change of public opinion on the budget deficit<br />
and debt is a significant development. A majority now<br />
consider the budget deficit and debt to be excessive<br />
and see this as an important issue. That will help to<br />
ensure that economic policy is tight throughout the<br />
next parliament.<br />
9.0<br />
8.0<br />
7.0<br />
6.0<br />
5.0<br />
4.0<br />
3.0<br />
2.0<br />
1.0<br />
0.0<br />
Dominique Barbet 28 July 2011<br />
Market Mover<br />
12<br />
www.GlobalMarkets.bnpparibas.com
UK GDP: You Cannot Be Serious!<br />
• ONS estimates suggest that GDP growth<br />
would have reached 0.7% q/q in Q2 had it not<br />
been for various distortions to activity. This<br />
looks counter to other evidence of the<br />
underlying trend of the economy.<br />
Chart 1: CIPS <strong>Services</strong> and Index of Production<br />
• However, the estimate probably gives the<br />
hawks at the BoE a case for staying hawkish<br />
and for the “don’t knows” to continue sitting on<br />
the fence.<br />
ONS estimate of underlying growth looks far too<br />
high…<br />
Mark Twain was one of those who popularised the<br />
saying “There are three kinds of lies: lies; damned<br />
lies and statistics”. He might have added, “and then<br />
there’s the Q2 2011 estimate of underlying UK<br />
growth”. This came in at 0.7% q/q. Either the Q2<br />
estimate of GDP growth will be revised down, or the<br />
estimated downward distortion to growth will be<br />
revised down, or both. But when the statistics are<br />
revised and refined, we see scant chance that Q2<br />
2011 will be judged to be a quarter when underlying<br />
growth was 0.7% q/q.<br />
We struggle a bit with the ONS estimate that GDP<br />
growth was 0.2% q/q in Q2. It’s a bit stronger than<br />
we had estimated but in line with the consensus. If<br />
we accept for a moment that 0.2% is the proper<br />
figure, then we have an issue with the estimate that<br />
various distortions to the data (effects on supply of<br />
Japanese earthquake, the royal wedding and warm<br />
weather) reduced GDP by 0.5% in Q2.<br />
This estimate of the impact of distortions implies that,<br />
despite the rest of the world slowing down, the UK’s<br />
underlying rate of growth accelerated in Q2 from zero<br />
in the previous two quarters to 0.7%. Just where did<br />
this miracle renaissance of the economy come from<br />
– consumption? Have you looked at consumer<br />
confidence recently? Government consumption? Not<br />
with spending restraint beginning to bite. From<br />
exports? Not when global trade has clearly been<br />
slowing, not accelerating.<br />
If underlying Q2 growth really was 0.7% q/q, then we<br />
should presumably expect nirvana to arrive in Q3. On<br />
top of the 0.7% q/q growth the trend should lead us<br />
to expect, there should be a bounce-back of 0.5pp<br />
from the reduction to Q2 growth, giving us the<br />
expectation, if such maths is to be believed, of<br />
1.2% GDP q/q growth in Q3. If this happens then<br />
Source: Reuters EcoWin Pro<br />
expect to see Gloucester Old Spots flying over 11<br />
Downing Street.<br />
What we find very odd about the estimate is that<br />
there is little evidence of a widespread effect of the<br />
size of disruption the ONS claims in the month-tomonth<br />
data outside those coming from their own<br />
index for services. We do see it in manufacturing and<br />
foreign trade, and in the ONS’s own series “Index of<br />
<strong>Services</strong>” However, retail sales and especially the<br />
surveys show a much smoother pattern.<br />
We have long forecast that GDP would be subdued<br />
in April because of the unusual run of bank holidays.<br />
As a result of a late Easter and the royal wedding,<br />
many people used the bridging days between the<br />
holidays to have eleven consecutive days away from<br />
work while using only three days’ leave. If 10% of the<br />
population took an extra three days’ leave, and if the<br />
loss of their production was accurately recorded,<br />
then GDP would have been about 1.5% lower in April<br />
than otherwise, and Q2 GDP would have been 0.5%<br />
down on where it would otherwise have been.<br />
The problem is that this just does not show in much<br />
of the data – May and June do not look better than<br />
April in the CIPS services or in retail sales. The<br />
former is important because the Index of <strong>Services</strong><br />
from the ONS showed a 1.4% m/m rise in May after<br />
a weak April. There was a similar pattern in<br />
manufacturing. This had been flat in February and<br />
March and dropped by 1.6% in April before bouncing<br />
back by 1.8% in May. However, most of the estimate<br />
of the GDP shortfall (80% of it in fact) comes from<br />
services, which accounts for 74% of GDP. It appears<br />
to us that there is excess volatility in the monthly<br />
services index (Chart 1). We admit that some<br />
services directly linked to manufacturing output<br />
(transport and distribution, for example) should have<br />
Paul Mortimer-Lee 28 July 2011<br />
Market Mover<br />
13<br />
www.GlobalMarkets.bnpparibas.com
followed the same pattern of manufacturing<br />
production. We also see that imports and exports<br />
both fell in April, bouncing back in May. So there is<br />
definitely an effect to be seen in the data. Our bet is<br />
that the June Index of Production will come in weaker<br />
than has been factored in the Q2 release.<br />
Retail sales that give some indication of where<br />
consumption might go (retail sales comprise about<br />
40% of consumption) seem to have been boosted in<br />
April by the weather and the royal wedding – rising<br />
by 1.2% m/m in April followed by a fall of 1.3% in<br />
May and a rise of 0.7% in June induced by heavy<br />
discounting and early summer sales. We find it<br />
difficult to see that consumption in underlying terms<br />
would have been 0.75% higher in Q2 than Q1 had it<br />
not been for special effects, when retail sales were<br />
less than 0.5% higher, even though April probably<br />
benefited from distortions. Consumption is much<br />
smoother than retail sales and we expect it to have<br />
been much weaker than retail sales Q2.<br />
Chart 2: Consumption vs. Consumer<br />
Confidence<br />
Source: Reuters EcoWin Pro<br />
Chart 3: GfK Consumer Confidence and Real<br />
Earnings<br />
Given the relationship between consumer confidence<br />
and consumption in the national accounts (Chart 2) it<br />
does not make much sense to expect that, in<br />
underlying terms, consumption was strong in Q2.<br />
Real income developments (Chart 3) just do not<br />
make this a sensible assumption.<br />
Our own estimate of the downward distortion to Q2<br />
activity is lower than the ONS’s estimate – probably<br />
0.3%. Still, we have difficulty in believing what this<br />
would imply for underlying growth in Q2 – 0.5% q/q.<br />
This is because it is clear that from Q1 to Q2:<br />
• The manufacturing CIPS output index fell from<br />
58.3 to 52.7;<br />
• CIPS services fell from 57.1 to 53.9;<br />
• Government services look to have been flat; and<br />
• Retail sales rose 0.5% despite being boosted by<br />
good weather in April.<br />
So we estimate that GDP will be revised down (when<br />
is uncertain). Overall then, we do not trust the GDP<br />
figures for Q2. An underlying growth rate of 0.7% just<br />
does not tie in with where we believe the economy<br />
was during Q2, with weaker surveys, slowing global<br />
trade, with a continued squeeze on the consumer<br />
and pretty miserable consumer confidence.<br />
…but does give hawks at the BoE a case for<br />
postponing QE<br />
Unfortunately, all this matters a lot. If the BoE buys<br />
the story that underlying growth is 0.7% q/q, then<br />
QE’s chances are reduced a lot. This GDP release<br />
gives the hawks everything they could want, almost,<br />
and will avoid the Bank having to revise down its<br />
short-term growth forecast. The view that we took in<br />
Source: Reuters EcoWin Pro<br />
Table 1: UK Economic Data<br />
Feb Mar Apr May<br />
Manufacturing<br />
Production (% m/m)<br />
-0.1 0.1 -1.6 1.8<br />
Retail Sales Inc Auto<br />
Fuel (% m/m)<br />
-1.1 0.0 1.2 -1.3<br />
CIPS <strong>Services</strong> 52.6 57.1 54.3 53.8<br />
CIPS Manufacturing 60.9 56.7 54.4 52.0<br />
Real Imports (Goods exerratics,<br />
% m/m)<br />
Real Exports (Goods,<br />
ex-erratics, % m/m)<br />
Source: Reuters EcoWin Pro<br />
-2.8 -0.7 -1.7 5.6<br />
1.5 -2.8 -3.3 2.5<br />
Gilt Complex last week – that there was a good case<br />
for QE but that we did not think the BoE would be<br />
bold enough to take the opportunity until after<br />
inflation has peaked – has been reinforced. If<br />
underlying growth is above trend and inflation is still<br />
headed higher, any prudent central bank would hold<br />
its fire.<br />
Paul Mortimer-Lee 28 July 2011<br />
Market Mover<br />
14<br />
www.GlobalMarkets.bnpparibas.com
Japan: How to Finance It All<br />
• In addition to the indeterminable costs<br />
stemming from the Fukushima crisis, the<br />
authorities must procure revenue to pay for<br />
welfare/fiscal reform, reconstruction and HBV<br />
compensation.<br />
• Welfare/fiscal reform should be the top<br />
priority in our view, as a 1½-year delay in<br />
initiating reforms will generate budget deficits<br />
equal to the entire cost of reconstruction.<br />
• While higher taxes should ultimately pay for<br />
all three, the consumption tax is most<br />
appropriate when a permanent source of<br />
revenue is required e.g. for welfare reform.<br />
• Income and/or corporate taxes are<br />
theoretically more appropriate when increased<br />
revenue is needed only temporarily, e.g. for<br />
reconstruction and hepatitis B virus (HBV)<br />
compensation.<br />
• To generate the requisite JPY 16.1 trillion for<br />
reconstruction and HBV compensation, income<br />
and corporate taxes would have to be raised to<br />
prohibitive levels.<br />
• If reconstruction and HBV compensation<br />
were financed using income taxes and<br />
corporate taxes, concurrently raising the<br />
consumption tax to finance social welfare/fiscal<br />
reform would likely prove impossible.<br />
• But putting welfare/fiscal reform on hold<br />
during the time needed to finance<br />
reconstruction and HBV compensation could<br />
cause Japan’s fiscal predicament to reach<br />
critical mass before reforms can begin.<br />
• A realistic way to tackle all of these<br />
problems at once involves progressively hiking<br />
the consumption tax to 10% between FY 2013<br />
and FY 2015, and then earmarking just 0.5pp of<br />
the tax increase for financing reconstruction<br />
and HBV compensation.<br />
Authorities must come up with revenue for three<br />
pressing issues<br />
The price tag for reconstructing devastated<br />
northeastern Japan is becoming clear. According to<br />
media reports, spending during the first five years of<br />
intensive reconstruction could total roughly JPY 19<br />
trillion. While this figure accords with the high end of<br />
our own estimate (JPY 14.1-20.0trn, see “Japan: The<br />
Cost of Reconstruction”, Market Mover, 16 June), it<br />
represents the total spending package, with actual<br />
Chart 1: Trend of Consumption Tax and Social<br />
Welfare Benefits for Aged<br />
20<br />
18<br />
16<br />
14<br />
12<br />
10<br />
8<br />
6<br />
4<br />
2<br />
0<br />
Revenue shortfall<br />
Consumption tax revenue<br />
Cost of 3 expense items for aged<br />
13.3<br />
12.8<br />
11.8 12.1<br />
10.4 11.0<br />
9.6<br />
10.1<br />
8.8 9.0<br />
4.6 4.7 5.3 5.8<br />
1.5 2.1 2.4 3.2 3.8 4.3<br />
9.1 9.8<br />
7.3 6.9 7.1 6.9 6.7 6.7 7.2 7.4 7.5 7.5 7.1 6.8 7.2<br />
spending by the government amounting to roughly<br />
JPY 15trn (including JPY 6trn from the two extra<br />
budgets already enacted). The authorities intend to<br />
raise taxes to finance roughly JPY 10trn, with the<br />
remainder coming from the sale of state property and<br />
other assets as well as the tapping of surpluses in<br />
special accounts.<br />
The bill for reconstruction is not the only claim on<br />
state funding. The authorities must also find the<br />
revenue to pay for social welfare/fiscal reform as well<br />
as compensation for the victims of hepatitis B<br />
infections (caused by the reusing of syringes in group<br />
vaccinations; the government had maintained the<br />
practice was safe despite overseas evidence to the<br />
contrary).<br />
Welfare/fiscal reform requires roughly JPY 13trn<br />
each year, reconstruction will require JPY 15trn over<br />
five years, and HBV compensation will require<br />
JPY 1.1trn over five years. Needless to say, huge<br />
16.2<br />
16.6<br />
17.2<br />
99 00 01 02 03 04 05 06 07 08 09 10 11<br />
Source: MOF, <strong>BNP</strong> Paribas * FY2011 is original budget.<br />
Chart 2: Milestones on Route to Fiscal<br />
Soundness<br />
GoalMilestones (example)<br />
(1) Set medium-term spending framework<br />
for FY2011-FY2013<br />
(2) Cut primary balance deficit (as % of<br />
GDP) in half<br />
10.0<br />
Timeframe<br />
FY2013<br />
FY2015<br />
(3) Achieve primary balance surplus FY2020<br />
(4) Debt-to-GDP ratio must be steadily<br />
reduced (stock target) and the primary<br />
balance must achieve a requisite surplus<br />
(flow target)<br />
From FY2021<br />
Source: Prepared by <strong>BNP</strong> Paribas from National Policy Office's<br />
Recommendations of the “Medium-Term Fiscal Management Task Force”<br />
Ryutaro Kono 28 July 2011<br />
Market Mover<br />
15<br />
www.GlobalMarkets.bnpparibas.com
amounts of money will also be needed in connection<br />
with the Fukushima crisis (clean-up costs,<br />
compensation claims etc), but the monetary figures<br />
cannot be estimated at this juncture, Hence this<br />
issue will have to be dealt with separately. Thus, with<br />
the government being pressed to finance these three<br />
issues – welfare/fiscal reform, reconstruction and<br />
HBV compensation – the question is, can they be<br />
tackled simultaneously?<br />
Maximin principle<br />
When faced with a number of problems, the fact that<br />
decisions must be made within a limited amount of<br />
time and with limited financial resources means it is<br />
important to concentrate on minimising damage (the<br />
Maximin principle). Consequently, while it would be<br />
best if some way could be found to simultaneously<br />
deal with all three issues, reality dictates that the<br />
Japanese authorities may have to choose based on<br />
some clear order of priority.<br />
Welfare/fiscal reform should have higher priority<br />
While other nations might shelve policies if funding<br />
cannot be secured for them, this doesn’t usually<br />
happen in Japan. Consequently, if all three of these<br />
issues are to be tackled, which should receive the<br />
highest priority in securing a stable source of<br />
funding? We would argue social welfare/fiscal reform,<br />
as the amount of money involved is so large.<br />
For instance, since FY 1999, the government has<br />
exclusively used consumption tax revenue (excluding<br />
the local consumption tax and transfers to local<br />
governments) for three expense items for the aged<br />
(basic pension, health care programmes and nursing<br />
care programmes). But tax receipts from this source<br />
in FY 2010 fell JPY 10 trillion short of the amount<br />
needed; hence the current welfare system is underfunded<br />
by more than JPY 10 trillion a year.<br />
Welfare essentially operates on budget deficits<br />
Japan’s social welfare systems are essentially<br />
structured to operate on budget deficits. Thus,<br />
putting off social welfare/fiscal reform by just 1½<br />
years will generate public deficits equal to the entire<br />
cost of reconstruction. In terms of stopping the public<br />
debt from constantly swelling, it is clear that<br />
welfare/fiscal reform should be the top priority for<br />
securing stable revenue.<br />
Fiscal consolidation targets have been forgotten<br />
Japanese politicians seem to be unaware that<br />
delaying social welfare/fiscal reform will make it<br />
impossible to achieve the nation’s fiscal consolidation<br />
targets. In June 2010, the government unveiled its<br />
long-term strategy for fiscal management, setting as<br />
its targets the halving of the primary deficit by 2015<br />
and achieving a primary surplus by 2020. If nothing is<br />
Chart 3: Breakdown of National Taxes<br />
(JPY bn)<br />
Gasoline tax, 2,634<br />
Tobacco tax, 816<br />
Liquor tax, 1,348<br />
Consumption<br />
tax,<br />
10,199<br />
Others, 2,168<br />
Property tax<br />
(includes inheritance tax), 2,480<br />
Source: MOF, <strong>BNP</strong> Paribas<br />
300<br />
250<br />
200<br />
150<br />
100<br />
50<br />
Total<br />
\40.927 trillion<br />
(FY 2011<br />
budget figures)<br />
Income tax, 13,490<br />
Corporate tax,<br />
7,792<br />
Chart 4: Combined Central and Local<br />
Government Debt (% of GDP, FY)<br />
* Figures after FY2010 are our estimates.<br />
0<br />
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22<br />
Source: MOF, Cabinet Office, <strong>BNP</strong> Paribas<br />
done to stop the welfare system from generating<br />
annual shortfalls of JPY 10 trillion, halving the<br />
primary deficit by 2015 will prove impossible – even if<br />
budgetary outlays are cut. The Kan government<br />
originally wanted to raise the consumption tax to 10%<br />
“by fiscal 2015” from its current level of 5% as part of<br />
its integrated social security/fiscal reforms, but<br />
opposition within the ruling DPJ forced that plan to be<br />
watered down with the vaguer expression of raising<br />
the tax “by the middle of the 2010s.”<br />
Sticking to the fiscal consolidation targets<br />
Even if welfare/fiscal reforms are initiated, financing<br />
reconstruction could make the fiscal reform targets<br />
hard to achieve. Thus, if it is felt that the targets<br />
cannot be realised, the government should either<br />
modify them or announce that financing<br />
reconstruction will be handled separately from longterm<br />
fiscal management.<br />
Doing one or the other is probably inevitable given<br />
that the trajectory of the primary deficit has deviated<br />
so greatly from the baseline scenario due to an event<br />
beyond anyone’s control. So when the government’s<br />
fiscal management strategy comes up for periodic<br />
Ryutaro Kono 28 July 2011<br />
Market Mover<br />
16<br />
www.GlobalMarkets.bnpparibas.com
eview, whether the target dates are retained, with<br />
reconstruction costs being handled separately, or<br />
modified because of 11 March is not the real issue.<br />
The really issue would come if the targets were<br />
abandoned entirely.<br />
Which taxes should be hiked?<br />
Which taxes ought to be raised to pay for welfare<br />
reform, reconstruction and HBV compensation? Even<br />
if reconstruction is financed using special bonds,<br />
there must be a clear source of revenue for<br />
redeeming those bonds. In FY 2011, the authorities<br />
expect to receive JPY 13.492trn in income tax<br />
receipts, JPY 7.79trn in corporate tax revenue and<br />
JPY 10.199trn from the consumption tax (this<br />
excludes JPY 2.569trn from the local consumption<br />
tax and transfers to local governments). Beyond<br />
these main taxes, the tobacco tax is projected to<br />
generate JPY 816.0bn and alcohol tax JPY 1.348trn.<br />
Consumption tax should be earmarked for social<br />
welfare/fiscal reform<br />
As noted above, the government has said that the<br />
consumption tax should be raised to 10% “by the<br />
middle of the 2010s.” While this timeframe is rather<br />
vague, the main opposition party, the LDP, basically<br />
holds the same view. Hiking this tax and earmarking<br />
the revenue for financing welfare/fiscal reform is<br />
preferable in our view as the consumption tax does<br />
not distort the efficient allocation of resources.<br />
(Income taxes penalise labour – a serious issue<br />
given Japan’s shrinking productive population.)<br />
Corporate taxes, such as on capital, essentially<br />
penalise capital accumulation and thus reduce<br />
investment– another serious issue as capital<br />
accumulation is slowing as society’s rapid ageing<br />
causes the savings rate to fall. When employment<br />
and investment opportunities are impeded, a falling<br />
trend growth rate results.<br />
Temporary hikes in income and/or corporate<br />
taxes would normally be best for reconstruction<br />
and HBV compensation<br />
Which taxes would be appropriate for financing<br />
reconstruction and HBV compensation? If the tax<br />
hike is for a limited time, income and corporate taxes<br />
are in theory more appropriate than the consumption<br />
tax. While the consumption tax has the least<br />
economic impact when the rate hike is permanent, a<br />
temporary hike can cause substantial fluctuations in<br />
consumer spending. Meanwhile, income and<br />
corporate tax hikes do not distort the allocation of<br />
resources if the duration of the tax hike is strictly<br />
limited.<br />
Income and corporate tax hikes would have to be<br />
in place a long time to finance reconstruction<br />
Chart 5: Public Debt and Primary Fiscal Balance<br />
(Central government + local governments, % of<br />
nominal GDP)<br />
primary fiscal balance<br />
4<br />
2<br />
0<br />
-2<br />
-4<br />
-6<br />
-8<br />
-10<br />
1981<br />
19922002<br />
20022007<br />
40 60 80 100 120 140 160 180<br />
long-term national debt, end of previous fiscal year<br />
Source: MOF, Cabinet Office, <strong>BNP</strong> Paribas<br />
2009<br />
2010<br />
From this point of view, one can applaud those<br />
ruling-party lawmakers that called early on for<br />
income and corporate taxes to be temporarily raised<br />
to finance reconstruction, with the consumption tax<br />
being reserved for social welfare/fiscal reform. But<br />
the problem is that these taxes would have to be<br />
raised more than the maximum 10pp deemed<br />
tolerable for the rate hikes to be temporary (i.e. less<br />
than five years) and still generate the requisite<br />
revenue for financing reconstruction and HBV<br />
compensation.<br />
Do those advocating income and corporate tax hikes<br />
really know how much revenue will be required for<br />
reconstruction? There is even talk about raising the<br />
taxes on alcohol and tobacco but the meagre<br />
revenue such hikes would generate would not be<br />
enough either.<br />
Theoretically, a one-shot hike of 10pp would boost<br />
income tax revenue by about JPY 1.35 trillion a year<br />
and corporate tax revenue by JPY 780 billion. With<br />
respect to corporate taxes, if the authorities put the<br />
effective corporate tax rate deduction planned for FY<br />
2011 on hold but still abolished various special<br />
deductions as scheduled, the effect would be roughly<br />
the same as the 10pp hike mentioned above.<br />
Tax hikes lasting more than five years are not<br />
temporary<br />
Given what we have said about the revenue<br />
generated by a one-shot 10pp tax hike, how long<br />
would it take to secure the JPY 16.1trn total needed<br />
for reconstruction (JPY 15trn) and HBV<br />
compensation (JPY 1.1bn)? An income tax hike<br />
alone would take 11.9 years and a combination of<br />
income and corporate tax hikes, 7.6 years.<br />
If the authorities sell assets and drain surpluses from<br />
special accounts to cut the reconstruction bill by JPY<br />
5trn, the total remaining bill of JPY 11.1trn would<br />
require 8.2 years to finance using income taxes<br />
Ryutaro Kono 28 July 2011<br />
Market Mover<br />
17<br />
www.GlobalMarkets.bnpparibas.com
alone or 5.2 years with a combination of income and<br />
corporate tax hikes.<br />
Corporate tax hikes are inappropriate<br />
Raising corporate tax is a big problem in itself. The<br />
high level of Japan’s corporate taxes compared to<br />
other nations is the very reason the government<br />
decided to cut the effective corporate tax rate in FY<br />
2011.<br />
The disaster has not changed anything. Hiking<br />
corporate taxes would likely encourage more<br />
companies to move offshore, something already<br />
being widely considered in view of the prospects for<br />
protracted power shortages. Raising corporate<br />
taxation should thus be avoided, in our view.<br />
However, to rule out corporate tax hikes and rely only<br />
on a fixed 10pp hike in income taxes would require<br />
8.2-11.9 years to finance reconstruction and HBV<br />
compensation. Such a long period would appear as a<br />
permanent tax hike. Even so, the government must<br />
not force future generations to pick up the bill.<br />
Will the Japanese public tolerate dual tax hikes?<br />
If reconstruction and HBV compensation were<br />
financed using income taxes alone or a combination<br />
of income and corporate taxes, it could prove<br />
impossible to implement needed tax hikes for social<br />
welfare/fiscal reform for the entire time these<br />
provisional tax hikes were in place. Would Japanese<br />
households stand for such dual tax hikes (income<br />
and consumption)? Would politicians risk re-election<br />
bids to enact such tax legislation?<br />
That DPJ backbenchers have succeeded in relaxing<br />
the timeframe for hiking the consumption tax reflects<br />
the fact that Lower House elections are due not later<br />
than 2013. If welfare/fiscal reform is put oh hold for<br />
the 8.2-11.9 years needed for income tax hikes to<br />
finance reconstruction and HBV compensation (or<br />
5.2-7.6 years with a combination of income and<br />
corporate tax hikes), Japan’s fiscal predicament<br />
could reach critical mass before reforms can begin.<br />
Each year of delay in beginning these reforms leads<br />
to another JPY 10 trillion shortfall that adds to the<br />
national debt.<br />
A suggestion for hiking the consumption tax<br />
We believe there is a way of tackling all of these<br />
problems at once. It involves progressively hiking the<br />
consumption tax to 10% between FY 2013 and FY<br />
2015. For example, the rate could be raised 3pp (for<br />
JPY 7.5 trillion in increased revenue) in FY 2013,<br />
followed by an additional 2pp in FY 2015 (JPY 5<br />
trillion in new revenue). The rate hike increments<br />
could, of course, be 2.5pp each, but the ultimate<br />
target is a hike of 5pp to secure JPY 12.5 trillion in<br />
new revenue.<br />
For 10 years, direct some consumption tax<br />
receipts to reconstruction, HBV compensation <br />
While we think that the consumption tax receipts<br />
would ideally be applied only to social welfare, some<br />
of the money could be channelled toward financing<br />
reconstruction and HBV compensation. For example,<br />
if just 0.5pp (roughly JPY 1.25trn) of the consumption<br />
tax rise is earmarked for financing these other two<br />
issues, the costs involved could be settled in roughly<br />
10 years (actually 8.9-12.9 years, depending on<br />
whether state assets are sold and special accounts<br />
tapped to reduce the bill).<br />
Given that the money needed for welfare/fiscal<br />
reform is far greater, to say nothing of the urgency of<br />
fiscal restructuring, it appears logical that the lion’s<br />
share of consumption tax revenue be directed to<br />
social welfare/fiscal reform.<br />
Meanwhile, during the period that consumption tax<br />
revenue is earmarked for reconstruction, we would<br />
recommend that the government hold off on<br />
expanding the scale of social welfare benefits, such<br />
as the current plan to provide financial support to<br />
low-income households and younger households<br />
with children.<br />
Ask voters if they would prefer dual tax hikes or a<br />
more comprehensive approach <br />
The reluctance of most lawmakers to back the use of<br />
consumption tax revenue to finance anything other<br />
than social welfare is unsurprising. It took more than<br />
a decade to win public support for tax hikes to<br />
stabilise social welfare; suddenly telling everyone<br />
that the consumption tax must now be raised to<br />
finance reconstruction and HBV compensation would<br />
risk losing the hard-won support for alreadyimplemented<br />
tax hikes.<br />
But the fact remains that the authorities must secure<br />
revenue for all three of these pressing issues. The<br />
government thus needs to take the problem to the<br />
public and ask whether voters would prefer dual tax<br />
hikes or a comprehensive approach involving the<br />
consumption tax.<br />
We expect the answer would not be dual tax hikes.<br />
The comprehensive approach has the added benefit<br />
of being the least harmful to the economy (this is<br />
something that is not well understood). As things<br />
stand, the authorities might be lucky to secure the<br />
revenue for reconstruction alone, and there is a<br />
significant chance that they fail to find funding to fully<br />
cover social welfare/fiscal reform, reconstruction and<br />
HBV compensation.<br />
Ryutaro Kono 28 July 2011<br />
Market Mover<br />
18<br />
www.GlobalMarkets.bnpparibas.com
Japan: Exports to China Remain Low<br />
• Thanks to the rapid restoration of supply<br />
chains, real exports surged 9.0% m/m in June<br />
after rebounding by 5.7% in May.<br />
• As a result, real exports have recouped their<br />
big contractions of March and April to stand<br />
generally on a par with the pre-disaster level of<br />
February.<br />
7500<br />
7000<br />
6500<br />
6000<br />
5500<br />
Chart 1: Real Exports (s.a., JPY bn)<br />
• US and EU-bound exports continue to boom<br />
with the easing of Japan’s supply constraints. In<br />
contrast, shipments to China, despite growing<br />
for the first time in four months, remain at a low<br />
level, reflecting China’s economic slowdown.<br />
• It is uncertain if overall exports can remain<br />
on an upward trajectory because the global<br />
economy, led by the EMs (China, <strong>India</strong>, Brazil),<br />
has shown a pronounced deceleration.<br />
• Real imports rose 1.2% m/m in June for the<br />
third straight increase, raising them to 2.9%<br />
above the pre-disaster level.<br />
• Imports remain strong on robust efforts to<br />
make up for domestic supply constraints,<br />
coupled with increased demand for mineral<br />
fuels, as the shutdown of nuclear reactors has<br />
increased dependence on thermal power.<br />
Trade balance remains in deficit for third straight<br />
month<br />
According to the MOF’s trade statistics, nominal<br />
imports inched up 0.5% m/m in June (2.3% in May),<br />
marking a third straight increase, but nominal exports<br />
picked up the pace with solid 5.4% growth (2.2% in<br />
May). As a result, the seasonally-adjusted trade<br />
account deficit shrank sharply from JPY 450.0bn in<br />
May to JPY 191.2bn in June. The trade account has<br />
now been in deficit for three straight months. The last<br />
time the account was in the red was August 2008-<br />
March 2009, when overseas demand collapsed in<br />
the wake of the Lehman shock (prior to that, the last<br />
deficit was in December 1981). Note that media<br />
reports about the trade account returning to surplus<br />
after two months of deficit are based on the original<br />
series data that are not seasonally adjusted.<br />
Real exports return to pre-disaster level<br />
Adjusted for exchange rate and price fluctuations,<br />
our calculations show real imports rose 1.2% m/m in<br />
June (3.2% in May), which is also a third straight<br />
increase. Exports also picked up the pace in real<br />
terms, expanding a robust 9.0% m/m after<br />
5000<br />
4500<br />
4000<br />
07 08 09 10 11<br />
Source: MOF, BoJ, <strong>BNP</strong> Paribas<br />
120<br />
110<br />
100<br />
90<br />
80<br />
70<br />
60<br />
Chart 2: Real Exports to US (2005 = 100)<br />
50<br />
05 06 07 08 09 10 11<br />
Source: MOF, BoJ, <strong>BNP</strong> Paribas<br />
rebounding 5.7% in May. After plunging steeply in<br />
the wake of the Great East Japan Earthquake (–<br />
10.2% in March, –7.0% in April), real exports have<br />
rapidly recovered alongside the restoration of supply<br />
chains. As a result, real exports are generally on a<br />
par with their level before the disaster. Despite<br />
posting growth in both May and June, real exports<br />
contracted again on a quarterly basis in Q2, falling<br />
5.9% q/q (–0.4% q/q in Q1), but growth should<br />
resume from Q3 as exports fully recover.<br />
Slowdown in global economy casts doubt over<br />
continued export growth<br />
Looking ahead, domestic supply chain problems<br />
have been resolved but it is uncertain whether<br />
exports can continue an upward trajectory as the<br />
global economy, led by China, has shown a<br />
pronounced deceleration. Indicative of China’s<br />
slowing economy, the Chinese manufacturing PMI<br />
fell below the boom-bust line of 50 in July, continuing<br />
a steady downward trek that began in February.<br />
Ryutaro Kono / Azusa Kato 28 July 2011<br />
Market Mover<br />
19<br />
www.GlobalMarkets.bnpparibas.com
But the Chinese economy is not the only one that is<br />
weakening, as other big emerging nations, such as<br />
<strong>India</strong> and Brazil, are in the same boat. Against this<br />
backdrop of the G3’s super-low interest rate regimes,<br />
these emerging economies have opted to prevent<br />
local currency appreciation, with the result that<br />
monetary conditions became extremely<br />
accommodative, causing domestic demand to<br />
become red hot. This voracious demand has not only<br />
fuelled inflation but has triggered supply constraints,<br />
as demand has outstripped supply, and this is now<br />
causing these economies to slow. Making matters<br />
worse, monetary tightening was long held back out of<br />
the mistaken belief that price growth was just<br />
imported inflation (that element certainly exists but<br />
voracious EM demand, coupled with the spillover of<br />
G3 easing, is what caused the global commodity<br />
price boom in the first place). Now, emerging<br />
economies find that they must contend with rising<br />
inflation as well as slowing economic growth, making<br />
it very likely that they will have to continue monetary<br />
tightening to the detriment of growth, and Japanese<br />
exports.<br />
Export growth continued for most products<br />
Returning to June’s trade report, transport equipment<br />
(roughly 30% of total exports) was the sector that<br />
contributed the most to real export growth in June.<br />
Shipments of transport equipment rose a brisk 28.3%<br />
after robustly rebounding 31.5% in May. With<br />
automobile manufacturing virtually grinding to a halt<br />
when supply chains were ruptured by the disaster,<br />
exports by this key sector plummeted 20.0% in<br />
March and 27.5% in April. But thanks to the feverish<br />
restoration of supply chains, car production has<br />
rapidly recovered, allowing transport equipment<br />
exports to return close to their pre-disaster level<br />
quickly. Another key sector whose shipments have<br />
quickly returned to normal is ordinary machinery.<br />
After plunging 9.5% in March, ordinary machinery<br />
exports were the first to stabilise in April (0.2%),<br />
followed by solid gains of 4.5% in May and 7.2% in<br />
June. While the level is already 1.5% higher than<br />
before the disaster, the meagreness of this 1.5%<br />
margin suggests demand (especially from China)<br />
could be stalling.<br />
Meanwhile, exports of electrical machinery rose 8.0%<br />
(–0.6% in May), ending four straight months of<br />
declines that were due to severely reduced output<br />
capacity for semiconductors because the disaster<br />
knocked out numerous Tohoku factories. Although<br />
shipments of this key product seem finally to be<br />
turning around, a steady recovery from the current<br />
low level looks unlikely as the global IT/digital sector<br />
entered an adjustment phase in the spring, due to<br />
stagnant US consumer spending and the slowdown<br />
by China.<br />
Chart 3: Real Exports to China (2005 = 100)<br />
220<br />
200<br />
180<br />
160<br />
140<br />
120<br />
100<br />
80<br />
60<br />
05 06 07 08 09 10 11<br />
Source: MOF, BoJ, <strong>BNP</strong> Paribas<br />
260<br />
240<br />
220<br />
200<br />
180<br />
160<br />
140<br />
120<br />
100<br />
80<br />
Chart 4: Real Exports to China of General<br />
Machinery (2005 = 100)<br />
60<br />
05 06 07 08 09 10 11<br />
Source: MOF, BoJ, <strong>BNP</strong> Paribas<br />
On the downside, exports of chemical products still<br />
do not show any sign of recovering. After declining<br />
by 4.5% in March, shipments of chemical products<br />
revived with 2.7% growth in April only to plummet<br />
11.8% in May followed by a further 0.9% drop in<br />
June. With the level still well below the pre-disaster<br />
level, this sector may have finally recovered from<br />
domestic supply constraints but now faces the<br />
faltering of demand from China.<br />
US and EU-bound exports boom with easing of<br />
supply constraints<br />
A geographical breakdown of the June trade report<br />
(seasonally adjusted, real basis, our estimates)<br />
shows US-bound exports surging 13.1% m/m after<br />
rebounding with 12.5% growth in May. Leading the<br />
surge was transport equipment (36.6% share in<br />
2010), which expanded a brisk 31.3% after soaring<br />
46.2% in May. Even so, owing to the steep declines<br />
posted earlier (–25.9% in March, –39.0% in April),<br />
transport equipment exports are still 13.3% below the<br />
pre-disaster level. US-bound shipments also<br />
remained solid for ordinary machinery (9.4% in May,<br />
12.0% in June) and electrical machinery (3.5% in<br />
May, 5.9% in June).<br />
Ryutaro Kono / Azusa Kato 28 July 2011<br />
Market Mover<br />
20<br />
www.GlobalMarkets.bnpparibas.com
EU-bound shipments also remained firm, expanding<br />
a robust 10.0% after surging 10.1% in May, with the<br />
result that they are 0.4% above the pre-disaster level.<br />
While most product categories posted gains, the<br />
most pronounced was again transport equipment,<br />
which surged 27.7% after soaring 34.9% in May.<br />
While the economic recoveries in both the EU and<br />
US are faltering, the fact that the export numbers<br />
through June remain so robust can be attributed to<br />
the easing of Japan’s supply constraints.<br />
China-bound exports still at a low level<br />
Exports to Asia rose 8.1% m/m (–1.5% in May),<br />
ending three months of declines. Although Japanese<br />
factory activity revived from May with the restoration<br />
of supply chains, shipments to Asia (and China) did<br />
not pick up until June. Leading the recovery was<br />
transport equipment, whose shipments surged 39.9%<br />
(–2.5% in May). Asia-bound exports of electrical<br />
machinery also revived (7.6% growth following -2.3%<br />
in May) but adjustments in the global IT/digital sector<br />
make it unlikely that shipments of this product will<br />
continue to expand.<br />
Exports to China, Japan’s largest trading partner,<br />
also grew for the first time in four months, with a solid<br />
advance of 9.6% m/m (–6.3% in May). Even so, the<br />
level is still 15.3% below the average for January-<br />
February, reflecting China’s reduced economic<br />
momentum. Leading the rise in China-bound<br />
shipments was transport equipment, which soared<br />
30.5% (4.7% in May) and electrical machinery, which<br />
expanded a brisk 10.5% (–1.3% in May) for the first<br />
rise since the 11 March disaster. Meanwhile, ordinary<br />
machinery exports averted a decline in June but the<br />
modest 2.7% growth after the plunge of 14.4% in<br />
May suggests this sector, which was relatively<br />
unscathed by the disaster, remains weak owing to<br />
faltering Chinese demand (on this score, machine<br />
tool orders from China have been soft since<br />
February.). On the downside, shipments to China of<br />
chemical products declined for a fourth straight<br />
month (–3.7%, –10.2% in May), as Chinese demand<br />
is faltering just as Japanese chemical production is<br />
getting back to normal.<br />
Real imports expand for third straight month<br />
Finally, after increasing for three straight months to<br />
June, the volume of imports is 2.9% above the predisaster<br />
level. Imports’ continued strength, despite<br />
the sharp drop in the economy’s operating level after<br />
the disaster, reflects robust demand for mineral fuels<br />
(LNG, petroleum products), as the shutdown of<br />
numerous nuclear reactors has increased<br />
Chart 5: Real Exports to China of Electrical<br />
Machinery (2005 = 100)<br />
260<br />
240<br />
220<br />
200<br />
180<br />
160<br />
140<br />
120<br />
100<br />
80<br />
60<br />
05 06 07 08 09 10 11<br />
Source: MOF, BoJ, <strong>BNP</strong> Paribas<br />
Chart 6: Real Exports to China of Chemicals<br />
(2005 = 100)<br />
200<br />
180<br />
160<br />
140<br />
120<br />
100<br />
80<br />
60<br />
05 06 07 08 09 10 11<br />
Source: MOF, BoJ, <strong>BNP</strong> Paribas<br />
dependence on thermal power generation. With<br />
public disapproval making it increasingly hard to<br />
restart idle nuclear plants, dependence on thermal<br />
power is sure to increase, keeping imports of mineral<br />
fuels at very high levels. However, it is not just<br />
imports of fuel that are increasing, as shipments<br />
have increased for a wide array of products from<br />
electronics and chemicals to textiles, all of which<br />
reflects efforts to make up for domestic supply<br />
constraints.<br />
With imports expected to continue to grow more<br />
strongly than before, real GDP may not rise<br />
appreciably, even if production continues to expand<br />
(imports subtract from total GDP). On this score, we<br />
project external demand (net exports) subtracted<br />
0.9pp from the change in GDP in Q2 after subtracting<br />
0.2pp in Q1.<br />
Ryutaro Kono / Azusa Kato 28 July 2011<br />
Market Mover<br />
21<br />
www.GlobalMarkets.bnpparibas.com
Australia: Excessive Volatility<br />
• Australian rate expectations have been<br />
whipped around this year, recently switching to<br />
pricing in cuts.<br />
• The consumer lacks confidence, but other<br />
areas of the economy are holding up better.<br />
Underlying inflation pressures appear to be<br />
bubbling up.<br />
• Our forecast remains for a rate hike in Q4.<br />
The risk is that it is not delivered. But bar a<br />
significant worsening in global conditions,<br />
expectations for an RBA cut look premature.<br />
Taking a step back<br />
Australian rate expectations have been whipped<br />
around this year. At the time of writing, the futures<br />
market was pricing in some chance of a cut by the<br />
RBA from December onwards. However, at its most<br />
pessimistic (around 18 July) the market was pricing<br />
in two 25bp of cuts by around April 2012 and some<br />
probability of a third by mid-year. In late May it had<br />
been pricing in a hike by end-2011 and at the start of<br />
2011 it was looking for 50bp of hikes during the year.<br />
Our view on the RBA has been more stable. From<br />
January through to May we were forecasting no<br />
change in the cash rate during 2011. In May we<br />
changed our RBA forecast to include a 25bp in<br />
August (subsequently pushed back to October). The<br />
change largely reflected the more hawkish language<br />
of the RBA at the time. Specifically, it noted in its<br />
Quarterly Statement and the minutes to the May<br />
meeting that:<br />
“…members judged that if economic conditions<br />
continued to evolve as expected, higher interest<br />
rates were likely to be required at some point if<br />
inflation was to remain consistent with the mediumterm<br />
target.”<br />
Past behaviour suggested that having touted the idea<br />
of a rate hike, the RBA would act within a few months.<br />
However, since the RBA’s adoption of a bias to hike<br />
and since our forecast change in May, there have<br />
been a number of developments that significantly<br />
challenge our rate forecast, not least that the RBA<br />
back-tracked on its bias to hike in the July minutes. It<br />
noted that “the flow of recent information suggested<br />
both that there was more time to assess the likely<br />
strength of inflationary pressures in Australia and that<br />
it would be prudent to use that time”. Other factors<br />
affecting our forecast are discussed below.<br />
External concerns<br />
To some extent downside risks to the global<br />
economy have crystallised. Certainly, problems in<br />
Europe flared up in June and July. However, a more<br />
comprehensive approach to dealing with them,<br />
agreed at a eurozone summit on 21 July, has, in our<br />
view, improved the outlook.<br />
Just as the debt situation in the eurozone was being<br />
brought under greater control, the debate, or debacle,<br />
over raising the debt ceiling in the US came to the<br />
fore. This has helped undermine US consumer<br />
confidence at a time when the economy has already<br />
lost some momentum. Our central expectation<br />
remains that the ceiling will be raised at the eleventh<br />
hour, but there remains considerable uncertainty. It<br />
may be that the ceiling will only be upped by enough<br />
to pay the bills until early 2012. The issue would then<br />
come back onto the agenda ahead of a new round of<br />
elections. Nonetheless, providing the ceiling is raised,<br />
at least for a while the situation will be less fractious.<br />
Moreover, as the shocks from the Japanese disaster<br />
and oil price spike earlier in the year continue to fade,<br />
US growth should pick up to an albeit still-modest<br />
pace in the second half of the year.<br />
In Asia-Pacific, Chinese data have been mixed.<br />
While Q2 GDP was a little better than expected,<br />
indicators such as the manufacturing PMI have<br />
weakened further. Moreover, GDP was supported by<br />
a boost to net trade from stronger exports and<br />
weaker imports, which looks to be temporary.<br />
Domestic demand softened during the quarter. With<br />
CPI inflation jumping to 6.4% y/y in June, the<br />
authorities remain in a difficult position. Our central<br />
expectation is that they will selectively ease policy, in<br />
line with the aim to support growth outlined at the<br />
CCPCC Poliburo Summer Economic Meeting.<br />
However, high current inflation means the risk is that<br />
there is some delay or that the magnitude of easing<br />
is more limited than initially expected, at least in the<br />
near term. Overall, however, our forecast is that the<br />
economy begins to strengthen in Q4.<br />
The external situation, while precarious now, should<br />
improve in the balance of the year. The risks,<br />
however, are skewed to the downside.<br />
Dominic Bryant 28 July 2011<br />
Market Mover<br />
22<br />
www.GlobalMarkets.bnpparibas.com
Consumer caution<br />
Domestic data have been mixed, but on balance<br />
have tilted towards the disappointing side. Consumer<br />
confidence has been a particular area of weakness.<br />
It has dropped significantly below average levels and<br />
is now close to the lows seen in 2001 and during the<br />
GFC. The weakness in levels terms is driven by<br />
concerns over family finances. Sentiment, both<br />
looking back over the past 12 months and looking<br />
forward over the next 12 months, is exceptionally low<br />
(Chart 1). On a three-month moving average basis<br />
the forward-looking index is below the levels seen in<br />
the financial crisis, albeit still marginally above mid-<br />
2000 levels and still notably above early 1990 levels.<br />
Confidence in economic conditions over the next 12<br />
months and next five years, while down significantly<br />
on levels at the start of the year, is still above<br />
average. Similarly, despite significant pessimism<br />
over their own finances, on a three-month moving<br />
average basis, households appear to believe it is a<br />
better time than usual to buy a major household item.<br />
Similarly, confidence in the labour market, although<br />
down sharply in the last few months, is still around<br />
average levels. It is therefore difficult to fully<br />
understand why households are so pessimistic.<br />
One factor is the stance of policy. Interest payments<br />
on dwellings as a share of income are close to alltime<br />
highs. However, they have been stable since Q2<br />
2010 and are likely to have remained so in Q2 2011.<br />
If the RBA hikes rates again, it will only be fine tuning.<br />
The squeeze on incomes is therefore not likely to<br />
become significantly worse.<br />
Chart 1: Worried About Finances…<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Chart 2: …But Willing to Buy?<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Chart 3: Solid Employment Expectations<br />
Stock market jitters and house prices flattening off<br />
may be weighing on households’ wealth expectations.<br />
Headline inflation at 3.6% y/y is also crimping real<br />
income growth. But none of the above factors in<br />
isolation would appear to explain Australian<br />
households’ pessimism. We struggle to see that<br />
current levels of pessimism over family finances are<br />
justified by fundamentals, such as unemployment,<br />
income growth and the policy stance.<br />
It may be that a run of negative shocks, such as the<br />
Queensland floods, Japanese tsunami, commodity<br />
price increases, the debt crisis in Europe and the<br />
latest wrangling in the US, have left households<br />
feeling vulnerable despite solid Australian<br />
fundamentals. If this is the case it means that as the<br />
impact of these negative shocks unwind, which is<br />
already happening in Queensland and Japan and we<br />
expect to happen Europe and the US, Australian<br />
consumer confidence will gradually recover.<br />
Business as usual<br />
Business confidence has softened but there is little<br />
evidence of the distress that households appear to<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
be feeling at present. Business conditions are below<br />
average but far above 2000/01 and 2008/09 lows.<br />
Within this aggregate, forward orders looked sluggish<br />
in June, but are volatile month to month. For example,<br />
in August last year they fell sharply to a level notably<br />
below their current reading before recovering sharply.<br />
Employment intentions, which are more stable have<br />
held up in recent months and are consistent with<br />
solid employment growth (Chart 3).<br />
Dominic Bryant 28 July 2011<br />
Market Mover<br />
23<br />
www.GlobalMarkets.bnpparibas.com
Importantly, judged against firms’ employment<br />
expectations, the recent increase in consumers’<br />
concern over unemployment looks to be, in the main,<br />
a correction to previous excessive optimism (Chart 4).<br />
Don’t forget about inflation<br />
The Q2 inflation figure gave the market a timely<br />
reminder that expectations of a rate cut in Australia<br />
are highly premature. Measures of underlying<br />
inflation were strong. Both printed 0.9% q/q, or<br />
3.6% q/q annualised, in Q2. In Q1 the average of the<br />
weighted median and trimmed mean inflation was<br />
3.4% q/q annualised. Therefore, underlying<br />
annualised inflation over the last two quarters has<br />
been well above the RBA’s target (Chart 5).<br />
The approximately 3.5% q/q annualised pace of<br />
underlying inflation in the last two quarters means<br />
that relatively modest quarter-on-quarter increases in<br />
Q3 and Q4, for example around 2.25% annualised,<br />
will be enough to push the year-on-year underlying<br />
rate up to 2.9% by end-year. Given this is nudging<br />
the upper end of the RBA’s target range, a rate hike<br />
remains possible.<br />
While a strong AUD may weigh on inflation, there are<br />
also upside risks to inflation. For example, unit labour<br />
costs are rising quickly (Chart 6). The recent spike in<br />
labour cost growth should unwind, as it is due to the<br />
flood-induced drop in Q1 GDP. However,<br />
compensation per employee, which is not affected by<br />
the temporary drop in GDP, also highlights the<br />
potential for underlying inflation to rise from here.<br />
Chart 4: Consumer Correction<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Chart 5: Inflation Jump<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Chart 6: Unit Labour Cost Risk<br />
This is not to say Australia is on the verge of<br />
developing a significant inflation problem. But given<br />
the RBA’s mistake in the previous cycle – allowing<br />
inflation to pick up significantly above target – it may<br />
well favour a further precautionary tap on the brakes<br />
to ensure history does not repeat itself.<br />
Chance of a hike<br />
After the upside surprise to Q2 inflation, we retain our<br />
forecast of a rate hike in Q4 this year. The risk is<br />
clearly that, with policy already restrictive and<br />
consumer confidence soft, the RBA holds fire.<br />
Providing the situation in the US is resolved and the<br />
actions taken in the eurozone are successful in<br />
preventing a significant shake-out in financial<br />
markets with spillovers to the major economies,<br />
market pricing of rate cuts in Australia looks<br />
unnecessary. Moreover, the modus operandi of the<br />
RBA in the past has been to wait for clear evidence<br />
of the need to ease policy and then act aggressively.<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Since 1993 the RBA has cut rates on 17 occasions.<br />
Only five of those were 25bp moves. Bar the solitary<br />
move in December 1998, no cutting cycle has begun<br />
with a 25bp move. With underlying inflation<br />
pressures bubbling up, the Australian economy is<br />
clearly a long way from needing significant monetary<br />
loosening. The next move is more likely to be a hike.<br />
Dominic Bryant 28 July 2011<br />
Market Mover<br />
24<br />
www.GlobalMarkets.bnpparibas.com
US/EUR Spread: Impact of a US Downgrade<br />
• The probability of a downgrade of the US’s<br />
sovereign credit rating has increased and is<br />
now very high.<br />
Chart 1: US/EUR Spreads<br />
• While the impact on US yields may be<br />
limited, a downgrade would lead to a widening<br />
of the US/EUR spread.<br />
• STRATEGY: Buy 10-30y USD/EUR box<br />
spreads.<br />
Risk of a US downgrade high<br />
As the chances of a large reduction of the US federal<br />
budget deficit are fading, an agreement to raise the<br />
debt ceiling may not prevent rating agencies from<br />
downgrading the US’s sovereign credit rating. Our<br />
US strategists see the probability of such a<br />
downgrade as very high and a downgrade as the<br />
most likely scenario in the coming weeks. This may<br />
lead to the downgrade of agencies, especially in the<br />
MBS sector. However, our US strategists also<br />
consider the potential for a rise in US Treasury yields<br />
as limited (less than 25bp in the 10y area). One of<br />
the key reasons for this is that there is almost no<br />
alternative for investors. Therefore the USD 17trn of<br />
debt does not look to be at massive selling risk (for<br />
more details on the domestic impact, see article “US:<br />
Impact of a Potential US Downgrade”.<br />
Double impact on US/EUR spreads<br />
While limited, the impact of a downgrade of US debt<br />
on Treasuries’ yield would be significant, especially<br />
on US/EUR spreads. A one-notch downgrade of the<br />
current rating would put US debt under a AA+ rating.<br />
Comparison to similar ratings to asses what could be<br />
the fair spread between US T-Notes and the EUR<br />
benchmark (currently at 32bp) is difficult. By<br />
definition, there is no other USD sovereign debt. In<br />
the dollar area, New Zealand is the only AA+<br />
sovereign. The 10y New Zealand yield is close to<br />
5%, a level irrelevant for the 10y Note. In the EUR<br />
area, the only AA+ sovereign is Belgium and the 10y<br />
OLO/Bund stands around 160bp. Such a spread<br />
level for the 10y T-Note/Bund spread also looks<br />
unrealistic. In other sectors, we can make some<br />
comparisons. For instance, the 10y AA Corp<br />
US/EUR spread is slightly above 50bp, while the 10y<br />
US AA/EUR AAA Corp spread is above 100bp.<br />
All else being equal, a 20-25bp rise in the T-Note<br />
yield would push the 10y T-Note/Bund spread closer<br />
to 60bp, which is between the USD AA / EUR AA<br />
spread and the USD AA / EUR AAA spread in the<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Chart 2: US and EUR Long Ends<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
corporate sector. However, a US downgrade could<br />
also have an impact on EUR yields. Indeed, as such<br />
a downgrade would add to the current risk-off trading<br />
mode, it would further fuel the bid for safety. This<br />
may drag 10y Bund yields lower in the coming<br />
weeks. The impact may be moderate, but a further<br />
5-10bp decline in yields cannot be ruled out in such<br />
conditions. In such an event, the 10y T-Note/Bund<br />
spread may be pushed 5-10bp wider as well, into the<br />
65-70bp area, i.e. double its current level.<br />
In addition, a downgrade is expected to lead to a<br />
steepening of the 10-30y segment of the US curve.<br />
The 10-30y EUR segment looks less exposed to<br />
such a move in the near term, especially if stock<br />
markets continue to weaken. The 10-30y USD/EUR<br />
box spread is therefore also likely to widen.<br />
Strategy: Buy the 10-30y USD/EUR box spread.<br />
Currently at 58bp, the spread may widen closer to<br />
65-70bp.<br />
Patrick Jacq 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
25<br />
www.GlobalMarkets.bnpparibas.com
US: Impact of a Potential US Downgrade<br />
• A one-notch downgrade would not cause<br />
forced selling of USTs. Still, there could be a repricing,<br />
with UST rates rising by 25bp or more in<br />
long maturities.<br />
• GSEs debt would also be subject to<br />
downgrade along with USTs. Agency securities<br />
are widely held by high credit quality investors,<br />
particularly foreign Central Banks (USD 734bn),<br />
and there are likely to be very few forced sellers.<br />
Over time, we expect investors will diversify<br />
where possible to other AAA-rated paper,<br />
resulting in wider agency debt spreads to USTs,<br />
with longer-duration, less-liquid paper coming<br />
under particular pressure.<br />
• Agency MBS is likely to suffer vs. USTs, at<br />
least initially, owing to a number of factors<br />
including higher haircuts and increased market<br />
volatility.<br />
• The unsecured Fed funds market is likely to<br />
escape the downgrade unscathed, but repo<br />
rates and margin requirements are headed<br />
higher, as the large providers of cash and credit<br />
demand slightly higher haircuts for downgraded<br />
collateral. But as far as we know, the Federal<br />
Reserve is not increasing their haircuts on<br />
Treasury and Agency securities, and that should<br />
provide an anchor to the market.<br />
• Ramifications for corporate credit are<br />
modest. A few financials will experience<br />
downgrades, but the implications are expected<br />
to be mixed for banks.<br />
• Ratings for Aaa munis directly linked to the<br />
government are likely to move in tandem with<br />
the US rating, leading to some selling for<br />
liquidity purposes, but forced selling is not<br />
expected.<br />
One of the most important lessons learned over the<br />
last few years has been the need to evaluate<br />
potential “knock-on” effects from the various<br />
unprecedented developments that have transpired.<br />
Fundamental linkages such as the decline in US<br />
consumer spending subsequent to housing’s<br />
collapse or the curtailment in lending activity as<br />
banks repaired their balance sheets were not hard to<br />
envision, when the right scenario assumptions were<br />
applied. However, the technical and X-asset class<br />
linkages were harder to predict and, ultimately, more<br />
damaging to security prices and investor risk<br />
appetites. Examples such as the roll-back of SIV’s<br />
onto bank balance sheets or the pace of money fund<br />
redemptions immediately subsequent to Lehman<br />
Brothers’ bankruptcy filing come to mind. Investors<br />
who have sufficiently contemplated both unanticipated<br />
events and the possible policy responses<br />
have been best equipped to avoid land mines and<br />
add risk at opportune times.<br />
We believe it is timely to review the potential knockon<br />
effects to a possible downgrade to the US<br />
Sovereign senior debt rating. We are reviewing one<br />
possible branch of the decision tree (the one we<br />
believe to be most likely) in order to thoroughly<br />
assess the transmission effects across the major<br />
fixed-income markets. This note does not evaluate<br />
the various potential outcomes subsequent to a<br />
hypothetical debt-service breach.<br />
Since Treasury securities serve as the primary<br />
valuation benchmark and hedging tool for many other<br />
market instruments, a potential downgrade has<br />
numerous first and second order implications for key<br />
parts of the capital markets. The very political nature<br />
of the ongoing discussion in Washington and the<br />
related media reporting has resulted in a good deal<br />
of hyperbole and misinformation tied to this topic<br />
lately. Therefore, separating partisan hype from likely<br />
market developments is crucial.<br />
Key Takeaways<br />
If the US sovereign rating were downgraded to AA+<br />
by one or more of the major rating agencies, we<br />
believe there would be many small knock-on effects<br />
but no major ones. If, as we assume, the markets<br />
have largely discounted the potential for this to occur,<br />
we do not believe disorderly or panicked markets will<br />
ensue. In the near term, a number of municipal,<br />
corporate and structured finance credits will likely<br />
experience minor price adjustments as they suffer<br />
UST-linked downgrades. Some Government<br />
Securities bond funds may experience selling<br />
pressure as they lose their coveted AAA ratings. And<br />
the cost of financing and repo for a range of market<br />
participants will increase, adversely effecting both<br />
liquidity and profitability for those involved.<br />
We do not anticipate money market funds to face<br />
sizable redemptions or fund downgrades in the near<br />
term, in large part because the UST A-1+ is expected<br />
to be affirmed. We also do not expect material<br />
changes to repo lines or haircuts. The level of<br />
interest rates and the extreme level of liquidity are<br />
powerful mitigants to drastic changes in front-end<br />
behaviour.<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
26<br />
www.GlobalMarkets.bnpparibas.com
Based on discussions with a broad range of money<br />
managers, insurance companies, central banks, and<br />
other institutional investors, we believe a migration to<br />
AA+ for UST will not force asset divestitures or<br />
purchase curtailments sufficient to disrupt orderly<br />
markets. This reflects the predominant wording in<br />
most investment mandates, the absence of ratings<br />
triggers, the functioning of most benchmarks and the<br />
requirements of the NAIC, among other<br />
considerations.<br />
Longer term, UST and related downgrades will seep<br />
into nearly every aspect of the financial markets,<br />
marginally raising the cost of capital and hurdle rates.<br />
It is also expected to impinge on bank profitability as<br />
Basel 2.5 guidelines are adopted. However, there is<br />
a small chance that one or more downgrades serve<br />
as a wake-up call and spur Washington into more<br />
concerted action and a possible re-attainment of the<br />
AAA rating down the road.<br />
Central Assumptions<br />
For the purposes of this report, we have made<br />
several important assumptions. First and foremost,<br />
we do not contemplate a missed payment or default<br />
of any kind on US government securities. Were this<br />
to occur, our scenario analysis would play out quite<br />
differently. In addition to a debt-ceiling deal, we are<br />
assuming that a modest budget agreement is<br />
reached by policy makers in Washington (roughly<br />
USD 2trn). Building on these assumptions, we<br />
conclude that Standard & Poor’s would likely lower<br />
the senior debt rating of the US by one or two<br />
notches but affirm the A-1+ short-term rating.<br />
However, based on discussions and our analysis, we<br />
assume that Moody’s and Fitch would not lower their<br />
sovereign ratings under this scenario (see Tables 1-<br />
3).<br />
For the purposes of this analysis, we assume that<br />
rather than leave the UST under review, they will<br />
affirm their respective AAA ratings, albeit with<br />
negative outlooks. We have also made the implicit<br />
assumption that all of this happens against the<br />
backdrop of a tentative, but stable, near-term market<br />
context in Europe now that a new financial construct<br />
has been introduced and the bank stress tests have<br />
been disseminated. Last and importantly, we are of<br />
the belief that despite (and partly due to) the market’s<br />
focus on developments in Europe, the migration of<br />
UST ratings to AA+ will not cause a major sustained<br />
downward price move in Treasury securities. As a<br />
consequence of the debt ceiling’s multi-month<br />
headlines and the rating agencies’ numerous reports<br />
on the US government’s eroding creditworthiness,<br />
we believe sufficient hedging and portfolio repositioning<br />
has already occurred so as to limit the<br />
violence of any subsequent price action.<br />
Table 1: Standard & Poor’s Ratings<br />
current projected<br />
US Long-term AAA AA+<br />
US Short-term A-1+ A-1+<br />
Outlook Negative Negative<br />
S&P has stated if the debt ceiling is raised in time to avoid<br />
a default, but without a credible deficit reduction plan of<br />
~$4 trn, then they might lower the US long-term sovereign<br />
rating from AAA to AA+ within 3 months; possibly as soon<br />
as early Aug.<br />
Within weeks of a US downgrade, S&P would also<br />
downgrade the following government-linked institutions:<br />
current projected<br />
Fannie Mae AAA AA+<br />
Freddie Mac AAA AA+<br />
FHLBs AAA AA+<br />
FFCB AAA AA+<br />
US insurance groups AAA AA+<br />
Military govt agencies AAA AA+<br />
Source: Standard & Poor’s<br />
Table 2: Moody’s Ratings<br />
current projected<br />
US Bond rating* Aaa Aaa<br />
US Short-term P-1 P-1<br />
*On review for possible downgrade<br />
Moody's has stated that if the debt ceiling is raised in time<br />
to prevent a default, the bond rating would likely be<br />
confirmed at Aaa.<br />
Source: Moody’s<br />
Table 3: Fitch Ratings<br />
current projected<br />
US Sovereign AAA AAA<br />
US Long-term AAA AAA<br />
US Short-term F1+ F1+<br />
Outlook Stable Stable<br />
Fitch has thus far maintained a stable outlook on the<br />
US. If the debt ceiling is not raised by August 2nd,<br />
Fitch will place the US sovereign rating on RWN<br />
(ratings watch negative).<br />
Source: Fitch<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
27<br />
www.GlobalMarkets.bnpparibas.com
Treasury Market Considerations<br />
While there are some exceptions, an overwhelming<br />
majority of a broad spectrum of investors will be able<br />
to hold on to their UST holdings in the event of a<br />
downgrade, presumably to AA+. In other words,<br />
there is little reason to expect forced selling of USTs.<br />
This is true for a number of reasons:<br />
• <strong>Investment</strong> mandates typically specify the types<br />
of securities in which a portfolio can invest. In the<br />
case of US government securities (defined as<br />
securities backed by the full faith and credit of the<br />
US), very often there is no specific stipulation that<br />
they need to be AAA, so a downgrade does not<br />
automatically translate to ineligibility.<br />
• For most real money investors (central banks,<br />
money managers, insurance companies, etc.), the<br />
overall credit quality of their portfolio is the main<br />
consideration in terms of what they can and cannot<br />
hold. In the event of a downgrade, the average<br />
quality of the portfolio would suffer. Although it may<br />
at first seem counter-intuitive, this could conceivably<br />
prompt portfolio managers to sell their lower-quality<br />
assets, investing the proceeds in USTs to maintain<br />
the overall quality.<br />
• Indexed portfolios mainly need to mimic the<br />
moves in the composition of their respective<br />
benchmark – so as long as USTs remain in the<br />
benchmark, such portfolios do not need to liquidate<br />
their USTs.<br />
• In the event that a downgrade pushes UST<br />
securities outside the mandate of a portfolio, there<br />
will likely be a waiver issued as is often the case in<br />
similar situations, and then, a change in investment<br />
guidelines will be sought to maintain the holdings on<br />
an ongoing basis.<br />
For these reasons, it is widely expected that any selloff<br />
in USTs will likely be limited in magnitude.<br />
Essentially, if investors sell, they will do so not<br />
because they are forced to sell but because they<br />
want to express a view.<br />
Another factor that should help keep a lid on UST<br />
rates is that the Fed will likely maintain easy<br />
monetary policy to accommodate any ensuing fiscal<br />
tightening, encouraging investors to extend farther<br />
out on the curve. Furthermore, a preference for<br />
liquidity could bring flows into USTs, especially<br />
benchmark issues, most notably in intermediate (5-<br />
7yr) maturities.<br />
Most estimates of the rise in yields hover around<br />
25bp for long maturities – although S&P’s report “The<br />
US Debt Ceiling Standoff Could Reverberate Around<br />
the Globe – With or Without A Deal” puts the<br />
estimate in the 25-50bp range.<br />
Amount ($ billions)<br />
Chart 1: Foreign Official Holdings of USTs,<br />
Agency Debt and MBS<br />
3,500<br />
3,400<br />
3,300<br />
3,200<br />
3,100<br />
3,000<br />
2,900<br />
2,800<br />
2,700<br />
2,600<br />
May-09<br />
Jul-09<br />
Sep-09<br />
Nov-09<br />
Jan-10<br />
Mar-10<br />
May-10<br />
Among the reasons why there could be a market<br />
repricing (to the tune of 25bp or more) are the<br />
following:<br />
• USD could come under pressure, as investors<br />
call into question the status of the USD as the<br />
reserve currency (admittedly not as much as in the<br />
case of an actual default). In that case, investors<br />
would want to protect themselves against higher<br />
inflation, and this would be true especially if<br />
commodities, being denominated in USD, spiked in a<br />
mechanical reaction.<br />
• Inflation-linked securities (TIPS) may have a<br />
different treatment than USTs, in that they are not<br />
necessarily lumped in as Treasuries – sometimes<br />
with an explicit exclusion in the definition of what<br />
“Treasury Securities” mean. Therefore, TIPS may be<br />
more vulnerable to selling flows than nominal USTs.<br />
Combined with higher inflation expectations, this<br />
translates to higher nominal rates.<br />
• The cost of capital would increase – although<br />
most would expect a small change in the haircuts for<br />
USTs, if any. Still, to compensate for the loss of<br />
Jul-10<br />
Source: Federal Reserve Bank of New York<br />
Foreign Official Holdings of<br />
Treasuries, Agency Debt & MBS<br />
Table 4: Other Large AAA-Rated Sovereign<br />
Debt Markets<br />
Sep-10<br />
Public Debt<br />
Outstanding*<br />
Nov-10<br />
Jan-11<br />
Mar-11<br />
May-11<br />
Sovereign<br />
Rating<br />
Canada $1,304 AAA<br />
United Kingdom $1,796 AAA<br />
France $2,059 AAA<br />
Germany $2,288 AAA<br />
Total $7,447<br />
Japan $10,892 AA-<br />
*This total does not include foreign agency debt of the<br />
countries above.<br />
Source: The Economist<br />
Jul-11<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
28<br />
www.GlobalMarkets.bnpparibas.com
carry, UST yields would have to rise as investors<br />
require a bigger enticement to hold USTs. Under<br />
Basel 2.5, which is supposed to kick in at the end of<br />
2011, banks are required to hold capital for<br />
Incremental Risk Charge (IRC) – this is basically a<br />
credit charge to account for the risk of a downgrade<br />
on the ratings of the securities banks hold in their<br />
portfolio. Even now, with USTs being rated AAA, the<br />
IRC charge is supposed to impose a significant cost<br />
on banks as they hold significant amounts of USTs.<br />
History Lessons<br />
The lack of any historical precedent for a downgrade<br />
of the US makes it particularly challenging to<br />
handicap a market reaction with great precision.<br />
However, similar episodes in a few developed<br />
countries do provide some guidance. If we look at<br />
other developed nations that have faced potential<br />
and actual downgrades, then the results suggest that<br />
rates did indeed rise at first. The magnitude of the<br />
initial moves in the 10y rate was +50bp (UK), +80bp<br />
(Canada), and +160bp (Japan).<br />
However, the long-term impact on debt prices<br />
appears to be positive (conceivably due to austerity<br />
measures being taken in the aftermath of the<br />
downgrades). Perhaps, it takes a market reaction to<br />
really bring opposing lawmakers together in<br />
agreement, and some have expressed this view<br />
regarding the current debate in the US.<br />
The most recent event to compare this with is the UK<br />
budget battle (for a more complete summary, see our<br />
note in “UK: English Lessons”, Market Mover, 21<br />
April 2011). In May 2009, S&P came out with a<br />
negative outlook and Gilt yields rose (also widening<br />
vs Bunds). Part of this was also due to higher<br />
inflation in the UK, but when it was announced later<br />
that there was a hung parliament at the general<br />
election (causing uncertainty that policymakers could<br />
agree on a budget), this caused the Gilt/Bund spread<br />
to widen sharply. This proved to be short-lived as a<br />
coalition agreement was signed and Gilts tightened.<br />
S&P later returned its outlook on UK debt from<br />
negative to stable. If we try to capture the initial<br />
negative reaction, what we notice is that 2y yields<br />
rose +40bp, 10y +50bp, and 30y +25bp.<br />
Ratings cuts to Japan have not prevented 10y yields<br />
reaching very low levels of 1-2%, although the<br />
domestic demand base for JGBs does differ from the<br />
more diverse/international demand base for USTs.<br />
The initial downgrade from AAA status came in 1998<br />
by Moody’s. This initial warning shot sent yields<br />
sharply higher, but even though there were several<br />
more downgrades from 1998-2002 from Moody’s and<br />
S&P, JGBs recovered during this period, although<br />
with the help of lower inflation. In terms of the initial<br />
downgrade, the final score was: 2y yields +55bp, and<br />
10y +160bp (there was no 30y bond market at the<br />
time in Japan).<br />
Canada’s long-term debt was first downgraded by<br />
Moody’s from AAA status in 1994, and yields peaked<br />
soon after that. Once again, the long-term trend in<br />
yields was lower in the years after that episode. In<br />
this case however, the market initially bear-flattened<br />
with 2y yields rising 115bp, 10y by 80bp and 30y by<br />
75bp.<br />
Impact on the GSEs<br />
As S&P has stated, government-sponsored entities<br />
are meaningfully linked to the US government’s<br />
credit standing. Therefore, in the event the US longterm<br />
rating is downgraded from AAA to AA+, the<br />
GSEs will have their ratings downgraded in-line. In<br />
particular, this applies to:<br />
• Fannie Mae<br />
• Freddie Mac<br />
• Federal Home Loan Banks<br />
• Federal Farm Credit Bureau<br />
These four GSEs have combined outstanding debt of<br />
USD 2.5trn, which would all drop from AAA to AA+.<br />
The mortgage-backed securities issued by Ginnie<br />
Mae, Fannie and Freddie are not actually rated<br />
separately by S&P, but they inherit their rating from<br />
the issuing agency. A one-notch downgrade of the<br />
US will result in the approximately USD 5.4trn of<br />
AAA-rated agency MBS dropping to AA+.<br />
Agency debt and MBS are widely held. Among the<br />
largest investors are foreign central banks (USD<br />
734bn and USD 2.7 trn of UST securities – see Chart<br />
1), domestic banks, insurance companies and<br />
pension funds, as well as state and local<br />
governments – all of which have requirements or a<br />
pronounced desire to hold AAA or high-credit quality<br />
assets. As stated earlier, the number of forced sellers<br />
of these products are very few. The sheer volume of<br />
holdings of foreign central banks and their need to<br />
remain USD invested will likely prevent them from<br />
initiating large selling programs. We do expect many<br />
investors will diversify where possible to other AAArated<br />
issuers, and there may be a slowdown in<br />
buying on the margins, particularly in agency MBS<br />
due to its longer duration. Investors could move into<br />
AAA rated foreign sovereign debt, but as shown in<br />
Table 4 the amount outstanding is dwarfed by UST<br />
and Agency debt outstanding. (Note that, in the event<br />
of issuer default or receivership, senior unsecured<br />
debt is pari passu to the agency MBS guarantees;<br />
so, there is no difference in the two claims from a<br />
credit perspective.)<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
29<br />
www.GlobalMarkets.bnpparibas.com
Overall, we expect this activity will result in the<br />
following:<br />
• Wider spreads to Treasuries for agency debt.<br />
Spreads are not likely to break through the upper end<br />
of the range of the past year, except perhaps in very<br />
long-dated, off-the-run paper.<br />
• Widening of the agency MBS basis, with long<br />
cashflow CMOs under the most pressure.<br />
One noteworthy impact of the downgrade for the<br />
GSEs from AAA to AA+ is that it would activatea<br />
lowering of collateral thresholds embedded in their<br />
ISDA agreements with their derivatives<br />
counterparties. For example, if the net fair value of<br />
an entity’s OTC derivatives trades to a broker-dealer<br />
are in a USD 500 million loss position, then the entity<br />
posts cash or eligible collateral (typically Treasuries)<br />
above some threshold, say USD 100 million. So the<br />
entity posts USD 400 million of collateral to the<br />
broker-dealer. The ISDA spells out how much a<br />
ratings downgrade of the counterparty will lower that<br />
threshold. A multi-notch downgrade might lower the<br />
threshold to zero, while a single-notch downgrade<br />
might reduce it by half, to maybe USD 50 million in<br />
the example above. That means the counterparty<br />
now must post an additional USD 50 million in cash<br />
or collateral to secure the derivatives positions.<br />
Fannie, Freddie and the FHLBanks all have<br />
significant derivative portfolios that are marked to<br />
market daily, so they both pledge and accept<br />
collateral under master netting arrangements across<br />
a variety of counterparties. Although each will need<br />
to post more collateral if the threshold drops, the<br />
incremental increase is relatively small compared to<br />
both:<br />
a) The amount of collateral that they already<br />
post, and<br />
b) The daily swings in fair market value of those<br />
positions.<br />
To illustrate, Fannie Mae’s Q4 2010 annual report<br />
shows that they posted an aggregate USD 3.4bn in<br />
cash collateral as a result of their derivatives<br />
activities. We can conservatively assume that<br />
exposure is across 10-15 counterparties, each of<br />
which has current threshold of USD 100 million, that<br />
drops to USD 50 million in the event Fannie is<br />
downgraded from AAA to AA+. That would mean<br />
Fannie needs to post an additional 10 * USD 50mn =<br />
USD 500 mn or 15 * USD 50mn = $750 mn in<br />
collateral to secure their derivatives positions. That is<br />
clearly not a trivial number – on the high side, USD<br />
750/USD 3,400 = a 22% increase in collateral – but it<br />
is an amount they could easily pull from their lending<br />
in the interbank or repo markets, where they routinely<br />
park tens of billions of dollars in cash.<br />
Agency MBS<br />
Even before an actual downgrade, there has been<br />
some pressure on agency MBS (vs Treasuries) and<br />
lower liquidity, and this is likely to continue if the US<br />
were indeed downgraded, at least initially. There are<br />
several reasons for this:<br />
• Unlike USTs, which do not have an explicit credit<br />
rating requirement in most investment guidelines,<br />
Agency MBS falls in the category (“other AAA-rated<br />
securities”) where ratings do matter.<br />
• Many investors have affirmed that their<br />
guidelines are more stringent when it comes to<br />
Agency MBS vis à vis USTs.<br />
• A downgrade, and the attendant market<br />
uncertainty, should lead to higher market volatility –<br />
something that would also be captured in implied<br />
volatility. Being negatively convex, mortgages would<br />
suffer in a high volatility environment initially,<br />
widening to USTs.<br />
• The increased haircuts would be another hurdle<br />
to own Agency MBS, affecting them more severely<br />
than USTs.<br />
Looking past the initial market reaction, Agency MBS<br />
should find a bid – among portfolios that can hold<br />
them at the new rating level – since higher rates<br />
means lower prepayment risk, making them more<br />
attractive to spread buyers.<br />
Impact on Short-Term Financing Markets<br />
We can dispense with the easiest first:<br />
Fed Funds: No impact.<br />
It is a completely unsecured lending market. The<br />
GSEs are certainly among the biggest lenders in the<br />
Fed funds market right now, but as we stated above,<br />
a moderate cash drain as a result of higher collateral<br />
postings is unlikely to meaningfully raise the rate at<br />
which money that changes hands here.<br />
Repo / Margin: low-to-medium impact, higher rates.<br />
There are multiple factors that influence rates in the<br />
repo market, and the closely related margin<br />
requirements for posting collateral. Generally<br />
speaking, the weaker, more price volatile (longer<br />
duration) or more illiquid the collateral, the higher the<br />
haircut.<br />
If we assume the quality of the collateral is stable,<br />
then repo rates are driven by the dynamics of the<br />
supply of cash from the lenders (GSEs, money<br />
market funds, corporations) versus the demand for<br />
cash from the borrowers (broker-dealers, hedge<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
30<br />
www.GlobalMarkets.bnpparibas.com
funds, central banks, SecLenders) that need to<br />
finance their collateral. When the Federal Reserve<br />
implements monetary policy in a “normal”<br />
environment, it does so by conducting temporary<br />
open market operations – which it hasn’t done since<br />
late 2008, except as part of an operational readiness<br />
program. These operations with the primary dealers<br />
are done exclusively through repo/reverse repo of<br />
Treasury securities, agency debt or agency MBS.<br />
The Fed publishes a collateral schedule with haircuts<br />
as part of its discount window lending, but it applies<br />
as well to open market operations. There is no<br />
expectation at this time that the Federal Reserve is<br />
going to increase its haircuts on Treasuries and GSE<br />
securities based on a downgrade of the US and<br />
GSEs from AAA to AA+.<br />
Despite the presumed stability of haircuts from the<br />
Fed, we expect others over time will begin to adjust<br />
their haircuts higher in both repo and margin. The<br />
Chicago Mercantile Exchange (CME) – which revises<br />
its haircuts frequently – this week increased its<br />
haircuts by 0.5% to 1.0% on Treasury, agency and<br />
some foreign sovereign collateral. Although these<br />
adjustments are routine and haircuts were below<br />
historical norms, we believe the potential downgrade<br />
did influence their decision somewhat, despite their<br />
denials. We expect other exchanges, broker-dealers<br />
and SecLenders to follow in the days and weeks to<br />
come if the potential downgrade becomes a reality.<br />
Corporate Credit Impacts<br />
A downgrade of UST to AA+ by Standard & Poor’s<br />
would have some consequence on financial credits<br />
but a de-minimus impact on corporates and utilities,<br />
in our view. Of course, the USD 244 billion of FDIC<br />
guaranteed TLGP debt issued by banks and insurers<br />
would face immediate downgrade. Since all of this is<br />
short duration and predominantly backed by sound<br />
credits, we do not believe these downgrades would<br />
cause but a ripple for the affected holders. In<br />
addition, six AAA-rated insurers would face likemagnitude<br />
adjustments to their credit standings due<br />
to sovereign ceiling criteria for financial strength as<br />
well as their significant UST holdings. However,<br />
because these insurers represent roughly USD 6bn<br />
of debt outstanding and because their standalone<br />
business profiles are so strong, one or two notch<br />
downgrades should have minor, if any, knock-on<br />
effects.<br />
Standard & Poor’s has indicated that a one or two<br />
notch UST senior debt downgrade will not have<br />
immediate implications for the creditworthiness of US<br />
banks. Unlike Moody’s, S&P does not infer enough<br />
sovereign support into current bank ratings to<br />
necessitate linked downgrades under the scenarios<br />
we have assumed. Of course, if higher interest rates<br />
and lower economic growth were to occur as a<br />
consequence of a weak budget compromise and<br />
S&P’s downgrade to AA range, bank earnings and<br />
asset quality trends would most likely weaken<br />
somewhat over time, all things equal. In addition, if<br />
international banks embrace new and stricter Basel<br />
guidelines later this year or next, UST ratings<br />
downgrades would be expected to require even<br />
greater capital charges for their significant Treasury<br />
holdings.<br />
One additional knock-on for banks from an S&P<br />
downgrade of the US relates to expected<br />
downgrades for the US clearinghouses and one<br />
CSD. The rating agency believes that a sovereign<br />
downgrade may increase securities volatility, reduce<br />
prices, increase margin calls and reduce the value of<br />
clearinghouse and CSD invested capital. While these<br />
concerns are understandable in the more extreme<br />
UST-default scenario, they are much less likely to be<br />
of concern if just one rating agency applies a one or<br />
two notch downgrade of the US. Under our base<br />
case of no default and just one of three rating<br />
agencies removing the UST’s AAA rating, we do not<br />
believe a potential clearinghouse/CSD downgrade<br />
will have a material immediate spill-over influence on<br />
broader markets or banks in particular.<br />
For AAA-rated non-financial corporates, S&P (and<br />
Moody’s) has stated that sovereign downgrades to<br />
AA will not lead to corporate ratings actions. This<br />
reflects the fact that the four remaining AAA-rated<br />
firms are sufficiently strong on a standalone basis<br />
and do not have disproportionate revenue or asset<br />
exposures to UST. To the extent that the sovereign<br />
downgrade creates a near term “risk-off” reaction in<br />
the capital markets, high yield corporates would be<br />
expected to experience a knock-on effect to<br />
valuations. However, since little of a fundamental<br />
nature will have changed for these companies, we<br />
would expect this price action to be temporary.<br />
Finally with regard to corporates, there is some<br />
concern that fund managers may be required or<br />
otherwise motivated to sell corporate bonds to even<br />
out portfolio risk parameters subsequent to a UST<br />
downgrade to AA+. Based on investor discussions<br />
and prospectus reviews, we do not believe this to be<br />
a cause for concern with the majority of domestic<br />
mutual fund and money managers, nor will it be of<br />
concern to active or passive investors looking to<br />
minimize benchmark tracking errors. The one place<br />
where risk budgets may require some modification is<br />
with insurance companies. For life companies, we<br />
believe the critical variable to monitor is the UST’s<br />
NAIC rating. All likely near-term outcomes short of a<br />
default would see the UST retain its “1” rating,<br />
removing the need to adjust credit holdings. For P&C<br />
companies, some risk adjustment might seem<br />
warranted, especially since liquidity is such a critical<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
31<br />
www.GlobalMarkets.bnpparibas.com
portfolio attribute. However, given that UST debt<br />
remains the most liquid in the world, we would not<br />
expect to see major adjustments in credit allocations<br />
in response to UST downgrades, unless and until the<br />
expected future returns for credit deteriorated.<br />
Money Market and Bond Fund Implications<br />
Fortunately, the most liquidity/redemption sensitive<br />
fund products are not likely to be downgraded in the<br />
near term. Because subtle but important distinctions<br />
need to be made, one must differentiate between the<br />
creditworthiness of the underlying fund holdings from<br />
that of the fund entity. Once clarified, we believe it is<br />
instructive to look through to the end investors and<br />
their objectives and constraints. Based on this<br />
framework, we come to the following conclusions:<br />
• For money market funds, both liquidity<br />
considerations and fund credit ratings need to be<br />
evaluated. NAV stability drives individual as well as<br />
institutional behavior in money funds while fund<br />
ratings matter to a greater degree with institutional<br />
investors.<br />
• We do not expect UST money market funds<br />
to experience outsized volatility in the event of a<br />
sovereign downgrade because their investment<br />
mandates are driven by the SEC’s rule 2A-7. This<br />
edict requires “tier 1” or “tier 2” ratings on money<br />
fund holdings. In practice, the top tier is required for<br />
borrowers to have meaningful access to a broad<br />
range of money funds. Tier 1 is determined by the<br />
short-term debt ratings and would not be<br />
compromised unless 2 or more agencies lowered<br />
their senior debt ratings by 6 or more notches. Put<br />
another way, the current AAA would have to fall<br />
below A for the short term rating to drop to Tier 2.<br />
And even in this unlikely event, the funds would have<br />
some discretion over the timing of related portfolio<br />
dispositions. In the absence of forced divestiture of<br />
the underlying and in light of the absence of<br />
alternative, safe money market investments, we do<br />
not envision particular turbulence or redemption<br />
demands in these money market funds under our<br />
base case. However, in the unlikely event of a UST<br />
default event or another shock akin to the Lehman<br />
Brother bankruptcy, money market fund turbulence<br />
cannot be ruled out.<br />
• Unlike longer-term bond funds, US<br />
Government securities money market funds are<br />
unlikely to face ratings-induced downgrades which<br />
should allay concerns about large institutional<br />
redemptions. While these funds hold an estimated<br />
USD 1.3 trillion of US Government and related<br />
securities, their fund ratings are based on numerous<br />
factors, not just underlying collateral ratings. Portfolio<br />
stability, duration, liquidity and mark-to-market stress<br />
tests combined with the willingness and ability of the<br />
fund management company to support the fund are<br />
all considered when ratings are assigned.<br />
• For bond funds, where individuals are the<br />
primary holders, ratings may matter on the margin,<br />
but the nature of the product limits the scope for<br />
immediate liquidity demands. Bond fund NAV’s move<br />
in response to underlying fund holdings’ price<br />
changes, but there is no assumption of principal<br />
preservation. This greatly limits the need for fire<br />
sales of fund holdings in response to redemption<br />
requests. Therefore, if S&P downgrades the fund<br />
quality ratings on the 73 bond funds currently on<br />
CreditWatch, we do not foresee any spill-over effects<br />
to the broader fixed income marketplace.<br />
Munis<br />
In munis the main takeaway, similar to USTs, is that<br />
there would be little forced selling, for the following<br />
reasons:<br />
• For downgraded AAA credits, assuming just a<br />
single notch downgrade, muni portfolios can still<br />
typically hold them as AAs.<br />
• For lower-rated munis that would be<br />
downgraded, note that all these credits were recently<br />
optically upgraded by one to three notches when<br />
rating agencies re-mapped their muni ratings to the<br />
corporate scale. Some would just revert to or above<br />
their original rating. In other words, portfolios would<br />
not have to sell these securities since they already<br />
owned them at similar or better ratings in the past.<br />
However, some selling flows should still be expected<br />
even though muni credit quality would not change<br />
much. These would come in different waves and<br />
could have a varying degree of intensity. As a side<br />
note the outflow from munis could even benefit<br />
USTs.<br />
• Build America Bonds (BABs): Issued between<br />
February 17, 2009 and December 31, 2010, there<br />
are USD 181bn BaBs outstanding. Foreign holders<br />
may be particularly interested in unwinding their<br />
positions, not just because of the downgrade, but<br />
also because of the gains they can lock in due to<br />
appreciation since issuance.<br />
• Concurrently, high net-worth investors (mostly<br />
domestic) would sell another slice of their tax-exempt<br />
muni holdings as they did last November. Such<br />
action would not be an expression of a negative<br />
sentiment on US munis, but rather of a negative<br />
sentiment on the US itself. Some of that money could<br />
be recycled in USTs for liquidity purposes.<br />
• There could be some marginal selling from direct<br />
and indirect retail investors. While the muni market<br />
size is around USD 3.5 trillion, most of it is static,<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
32<br />
www.GlobalMarkets.bnpparibas.com
eing in retail + insurance companies + commercial<br />
bank + foreign hands, so the actual "tradeable"<br />
market is, in fact, quite thin, and it does not take<br />
much to move the market.<br />
Moody’s published a report, “Implications of a US<br />
Rating Action for Aaa-Rated US Municipal Credits”,<br />
dated 13 July 2011, addressing some aspects of the<br />
downgrade issue. Here are the important points:<br />
• 7000+ directly linked Aaa credits (USD 130bn<br />
par amount), placed on review for possible<br />
downgrade, will move in lock-step with the US rating.<br />
These include muni bonds defeased with Treasury<br />
and/or Agency securities, and certain housing bonds<br />
either secured by mortgages which are insured or<br />
guaranteed by the US government or Fannie<br />
Mae/Freddie Mac, or receive payment streams from<br />
the US government.<br />
• Indirectly linked Aaa credits have no explicit<br />
guarantees or support from the US government.<br />
Action will be taken over the next several weeks.<br />
• Vulnerable credits: subject to review for possible<br />
downgrade or negative outlook (e.g. dependence on<br />
Medicaid matching funds).<br />
• Resilient credits: will NOT be placed under<br />
review for downgrade; could be rated one to two<br />
notches above US government (e.g. low reliance on<br />
direct or indirect transfers from the federal<br />
government or low dependence on capital markets<br />
for liquidity)<br />
Note that among all Aaa-rated entities, there are:<br />
• 15 Aaa states – five of which are already on<br />
negative watch: MD, NM, SC, TN, and VA<br />
• 440 local governments<br />
• 100 Housing Finance Authorities (HFAs)<br />
• 43 higher-ed and not-for-profit<br />
There is a silver lining on the muni front: states and<br />
local governments have been cleaning up their<br />
balance sheets aggressively since the crisis. A big<br />
part of this has been achieved by cutting expenses<br />
(e.g hiring/wage freezes, furloughs, layoffs, among<br />
other things) and the creation of new revenue<br />
sources. Furthermore, unlike the Federal<br />
government, municipalities are bound by law to have<br />
a balanced budget<br />
.<br />
Bulent Baygun / Mary-Beth Fisher / Mark Howard 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
33<br />
www.GlobalMarkets.bnpparibas.com
US: Missed Payments Shocking Front USTs<br />
• T-bills maturing in August have sold off in<br />
recent days from 0.05% to around 0.15%. In<br />
terms of the math, this implies that Treasury will<br />
miss payments for over a month!<br />
• Of course, other factors such as selling<br />
flows have pressured these T-bills.<br />
• It is still very difficult to believe that<br />
Treasury would allow payment to be missed.<br />
But it’s useful to know the mathematical impact<br />
on bond yields because it can help us gauge the<br />
market’s expectation of the length of default.<br />
The mathematical impact of delayed payments<br />
It turns out that credit markets have to deal with this<br />
all the time. Corporations or other governments<br />
sometimes miss payments; the market knows about<br />
it in advance; there is some guidance as to when<br />
payments will resume; and so, bond prices adjust<br />
and reprice. It’s a similar situation in this case, just on<br />
a slightly grander scale.<br />
If a coupon payment is missed, then we assume it<br />
will eventually be paid but with no compensation for<br />
the delay. Treasury officials have not clarified this yet<br />
and maintain that 2 August is the doomsday date.<br />
Various recent analyses have suggested 10 August<br />
instead, so we will assume this cut-off date for now.<br />
The closer a bond is to maturity, the more the yield<br />
will rise to adjust for a missed payment. Therefore,<br />
the biggest payment shocks are seen in T-bills<br />
maturing in August (see Table and Chart 2).<br />
Incidentally, when we move out to 1y maturities and<br />
longer, the impact is less than 0.1bp.<br />
Is this the maximum sell-off we expect in a<br />
default? Because this makes the T-bill reaction<br />
look very scary.<br />
If there is a heightened chance of default as we<br />
approach 10 August, then the shock due to missed<br />
payments is actually the minimum reaction we would<br />
expect. There will be other factors to contend with,<br />
too, and not just selling flows. There is uncertainty<br />
about financing these assets, in terms of the repo<br />
cost and also the margin requirement having to go up<br />
if there is a downgrade or default. However small<br />
these factors might be, everything will add up.<br />
Notice in the Table that we show where T-bills are<br />
currently trading, and they are implying more than a<br />
1-month delay in payments. This is assuming that the<br />
Chart 1: Here We Go – 1M/3M Bill Curve Inverts<br />
7<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
-1<br />
-2<br />
-3<br />
Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11<br />
Table: T-Bills Repricing Under 2W or 1M Delays<br />
T-Bill<br />
Initial Yield<br />
(on July 25th)<br />
New Yield<br />
(2W Delay)<br />
Change<br />
(bp)<br />
New Yield<br />
(1M Delay)<br />
Change<br />
(bp)<br />
Current<br />
Yield<br />
11-Aug 0.05% 0.07% 2.2 0.12% 7.0 0.15%<br />
18-Aug 0.05% 0.06% 1.4 0.09% 4.4 0.12%<br />
25-Aug 0.05% 0.06% 1.0 0.08% 3.4 0.10%<br />
1-Sep 0.05% 0.06% 0.7 0.07% 2.1 0.06%<br />
8-Sep 0.05% 0.06% 0.5 0.06% 1.0 0.06%<br />
15-Sep 0.05% 0.05% 0.4 0.06% 1.3 0.06%<br />
22-Sep 0.05% 0.05% 0.5 0.07% 1.6 0.05%<br />
29-Sep 0.05% 0.05% 0.5 0.07% 1.6 0.05%<br />
Chart 2: BP Shock to Bill Yield Curve (1M Delay)<br />
8<br />
7<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
Bill 11-<br />
Aug<br />
Bill 18-<br />
Aug<br />
Bill 25-<br />
Aug<br />
Bill 1-<br />
Sep<br />
All Charts and Table Source: <strong>BNP</strong> Paribas<br />
Bill 8-<br />
Sep<br />
Bill 15-<br />
Sep<br />
Bill 22-<br />
Sep<br />
Bill 29-<br />
Sep<br />
only impact is due to bond math and not the other<br />
factors above. In this case, the sell-off since July<br />
25th would clearly be an overreaction because it’s<br />
happened in only a few days. This should underscore<br />
how much uncertainty there is over how much stress<br />
the short end could face.<br />
At the end of the day, it’s not a huge dollar impact<br />
since the duration of these bonds is minimal, but it’s<br />
interesting, nevertheless, that the T-bill market has<br />
suddenly woken up and may wake up others, too.<br />
Suvrat Prakash 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
34<br />
www.GlobalMarkets.bnpparibas.com
MBS: Staying Underweight<br />
• We maintain our underweight allocation on<br />
MBS with every passing day without a<br />
resolution on the debt ceiling.<br />
• GN/FN swaps may continue to see support<br />
as investors may question an implicit<br />
guarantee, when an explicit guarantee itself is<br />
under question. Overseas entities are the<br />
principal investors in the US sovereign credit<br />
but not in GSE credit, and their support of<br />
GNMAs may not change all that much.<br />
• GNMA 60-day delinquencies increased<br />
from 1.20% to 1.23% in June; however, the<br />
absolute level is much lower than in past<br />
years.<br />
• FRE’s retained portfolio resumed declines<br />
in June after an increase in May due to roll<br />
activity.<br />
Remain Underweight MBS<br />
We moved to an underweight position on MBS early<br />
last week due to a possible US downgrade or<br />
selective default. With the continued impasse over<br />
the debt-ceiling, we maintain that stance. Since the<br />
Obama and Boehner USD 4 trillion plan fizzled,<br />
current coupon mortgages have widened by 13 ticks,<br />
while up-in-coupon has outperformed (Chart 1).<br />
As investors assess the impact on their portfolios or<br />
wait for a resolution on the debt ceiling, liquidity<br />
should remain poor. Asset sales on the margin to<br />
keep some cash on hand to deal with a potential<br />
selective default or downgrade should continue to put<br />
pressure on the basis. Funding for MBS took a turn<br />
for the worse on Wednesday and further impacted<br />
spreads. We have also seen long-duration CMOs<br />
sales from insurance companies, which make sense<br />
given the likelihood of the long end on the curve<br />
underperforming in the current climate. Dealer MBS<br />
inventories remain around the Lehman crisis levels.<br />
While we maintain an underweight allocation, MBS<br />
underperformance is not likely to be particularly<br />
outsized. As we’ve discussed in prior notes,<br />
insurance companies should not see a significant<br />
impact as the top NAIC ratings extends down to an<br />
A- (or equivalent) rating. Risk weights for banks for<br />
conventionals and GNMA’s should remain at 20%<br />
and 0% respectively, as the weights are not tied to<br />
ratings. The impact on money managers depends on<br />
the language in individual prospectuses, but mostly,<br />
they are not likely to be forced sellers.<br />
Chart 1: Mortgage Performance (vs Swaps in<br />
Ticks as of Wednesday, 27 July)<br />
CPN 1D Since Friday 1M<br />
3.5 -0-06 2 -0-16 4 -0-13 7<br />
4.0 -0-05 4 -0-13 0 -0-11 0<br />
4.5 -0-05 5 -0-10 3 -0-10 0<br />
5.0 -0-05 3 -0-07 7 -0-05 4<br />
5.5 -0-05 0 -0-04 2 -0-02 6<br />
6.0 -0-04 6 0-01 3 -0-01 2<br />
Source: Yield Book, <strong>BNP</strong> Paribas<br />
Chart 2: REIT Balance Sheets Normalised to<br />
USD 100bn<br />
Source: <strong>BNP</strong> Paribas<br />
$ bn (USD)<br />
Assets:<br />
Agency MBS $ 94.0<br />
Cash $ 0.7<br />
Treasuries, Agencies etc $ 1.3<br />
Other $ 4.0<br />
Total $ 100.0<br />
Liabilities:<br />
Repos $ 79.9<br />
Other Liabilities $ 7.7<br />
Equity $ 12.4<br />
Total $ 100.0<br />
Chart 3: Holders of Treasury Securities as of<br />
Q1 2011 (USD 9,621bn)<br />
Insurance &<br />
Pension<br />
Funds,<br />
$1,074 , 11%<br />
State & Local<br />
Govt. , $506 ,<br />
5%<br />
Mutual Funds,<br />
$696 , 7%<br />
Rest, $1,230<br />
, 13%<br />
Banks*, $329<br />
, 3%<br />
Source: Federal Reserve<br />
Fed, $1,340 ,<br />
14%<br />
*Banks, Saving Institutions and Credit Unions<br />
Foreign<br />
Holdings,<br />
$4,445 , 47%<br />
Increase in haircuts and funding may somewhat hurt<br />
REIT and hedge fund ROEs. But we do not see an<br />
immediate selling pressure from REITs which have<br />
been a dominant supporter of MBS recently.<br />
Anish Lohokare/Timi Ajibola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
35<br />
www.GlobalMarkets.bnpparibas.com
Consider the balance sheet of some prominent<br />
REITs in Chart 2, combined and normalised to USD<br />
100bn. Assuming a typical haircut of 5%, the repo<br />
level of USD 80bn indicates that about USD 84bn in<br />
securities are encumbered. The total agency MBS<br />
size of USD 94bn indicates that USD 10bn of<br />
securities may be unencumbered. On top, if we add<br />
treasuries, agency debt, reverse repo agreements,<br />
etc, about 12% of assets may be available, should<br />
haircuts increase. This is a very generous buffer, in<br />
case haircuts increase of the order of 2% or so in a<br />
selective default scenario.<br />
Overseas investors have already diminished their<br />
purchases of conventionals since the credit crisis, but<br />
may reduce purchases further. GNMAs should be<br />
impacted to a lesser degree. Due to the overriding<br />
matter of sovereign credit for foreign investors, we<br />
think GNMAs are comparable to Treasuries and not<br />
conventionals in this context. It would be unlikely for<br />
these investors to materially weaken support for<br />
Treasuries (and GNMAs) given their sizeable<br />
holdings, but not so for GSE securities Note that<br />
foreign entities are the largest investors in the<br />
Treasury market (Chart 3) but are relatively modest<br />
investors in GSE securities (Chart 4). Their holdings<br />
of Treasuries vs Agency debt + MBS is a 4:1 ratio,<br />
which would skew further if we club GNMAs with US<br />
Treasuries and compare US vs GSE credit (due to<br />
data limitations GNMA and conventionals were<br />
clubbed together).<br />
As we’ve discussed previously, in an era where the<br />
willingness of the US to repay its own direct<br />
obligations has come under questions, investors<br />
could question the willingness to support GSEs,<br />
which should also be supportive of GN/FNs. Further,<br />
if the Treasury does not inject equity to make up<br />
GSEs loss in fair value below 0 in Q2 2011 within 60<br />
days of quarter end, GSEs would enter receivership.<br />
This “what if” scenario, while highly remote, should<br />
still help GN/FNs on the margin.<br />
High coupons had cheapened on the possibility of<br />
refi legislation, but their hedged carry has improved<br />
(Chart 5) as volatility declined. To that extent, up in<br />
coupon could do better. But valuations appear to be<br />
on the richer side for 5.5s and 6s. Also, in case of a<br />
default or a receivership, where investors would have<br />
access to collateral before further claims are made to<br />
GSEs, higher coupons would have higher credit<br />
losses. From a credit perspective, higher coupons<br />
are thus less attractive. We continue to maintain our<br />
neutral stance on the coupon stack.<br />
GNMA DLQ up, Lower than Previous Years<br />
The GNMA delinquency report for June showed an<br />
increase in 60-day delinquencies across all products<br />
from 1.20% to 1.23%. By issuer, we saw similar<br />
results. For instance, BofA 60-day delinquencies saw<br />
Chart 4: Holders of Agency and GSE securities<br />
as of Q1 2011 (USD 7,648.7bn)<br />
Insurance &<br />
Pension Funds,<br />
$970 , 13%<br />
US Govt.**, $583<br />
, 8%<br />
Rest, $925 ,<br />
12%<br />
Mutual Funds,<br />
$1,174 , 15%<br />
Source: Federal Reserve<br />
*Banks, Saving Institutions and Credit Unions<br />
**Federal, State and Local Government<br />
Foreign Holdings,<br />
$1,173 , 15%<br />
Fed, $1,070 ,<br />
14%<br />
Banks*, $1,754 ,<br />
23%<br />
Chart 5: 1M Hedged Carry in Ticks<br />
Curve Hedged Curve & Vol<br />
CPN Roll Carry Hedged Carry<br />
3.5 9.9 0.9 0.1<br />
4.0 11.0 3.0 0.6<br />
4.5 11.3 4.7 1.2<br />
5.0 11.0 5.4 2.4<br />
5.5 8.4 3.4 2.2<br />
6.0 9.0 4.7 3.5<br />
Source: Yield Book, <strong>BNP</strong> Paribas<br />
Chart 6: Monthly 60-Day GNMA<br />
Delinquencies by Vintage (Fixed and ARMs)<br />
60 day Delinquences<br />
2.3<br />
2.1<br />
1.9<br />
1.7<br />
1.5<br />
1.3<br />
1.1<br />
0.9<br />
0.7<br />
0.5<br />
Source: <strong>BNP</strong> Paribas<br />
2011 2010 2009<br />
2008 2007 2006<br />
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec<br />
an increase from 1.14% to 1.17%, Chase increased<br />
from 1.58% to 1.60%, Citi increased from 1.38% to<br />
1.46%, GMAC increased from 1.53% to 1.61%, and<br />
Wells increased from 0.88% to 0.91%, but TBW<br />
declined from 4.08% to 4.07%. In addition, 30-day<br />
delinquencies also increased from 3.43% to 3.47%.<br />
Although delinquencies picked up again, the overall<br />
level of delinquencies continues to be low when<br />
Anish Lohokare/Timi Ajibola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
36<br />
www.GlobalMarkets.bnpparibas.com
compared with the same period over the previous<br />
three years. For instance, versus 1.23% in June<br />
2011, 60-day delinquencies in June during previous<br />
years were 1.49% in 2010, 1.89% in 2009 and 1.46%<br />
in 2008. (Chart 6)<br />
Overall GNMA 90+ day delinquencies increased from<br />
1.20% to 1.27%, and CBRs increased from 2.69% to<br />
3.26%. The increase in 90+ day delinquencies was<br />
led by BofA whose 90+ day delinquencies increased<br />
from 1.14% to 1.41%. While BofA CBRs increased<br />
from 0.23% to 0.73%, the increase was substantially<br />
less than we expected. We believe that there is<br />
further room for BofA CBRs to increase next month,<br />
especially given the elevated 90+ day delinquency<br />
level, the second highest level over the past year.<br />
Overall, GNMA fixed-rate voluntary speeds (CRR)<br />
increased by 11% to 6.14; in comparison, FHLMC<br />
voluntary speeds increased by 20% to 12.47 and<br />
FNMA voluntary speeds increased by 21% to 12.49.<br />
FRE Summary: Portfolio Decline Resumes<br />
FRE’s retained portfolio was down USD 4.6bn to<br />
USD 685.03bn in June, with the declines spread<br />
across agency MBS, non-agency and whole loan<br />
holdings. Total debt outstanding declined by USD<br />
3.6bn to USD 695.22bn, and delinquencies declined<br />
by 3bp to 3.50%. The duration gap was 0, while the<br />
sensitivity of the portfolio to a 50bp shift in the level<br />
of rates, a measure of negative convexity, increased<br />
from USD 397mn to USD 469m.<br />
Anish Lohokare/Timi Ajibola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
37<br />
www.GlobalMarkets.bnpparibas.com
EUR: OIS/BOR Spreads Still Wider<br />
• The price of liquidity is pushing higher in<br />
USD and in EUR. This ascent may gather pace<br />
given rising concerns (US downgrade, EUR<br />
peripherals…).<br />
Chart 1: Limited Scope for Higher Eonias<br />
• While tensions on eonias have a limit given<br />
the full allotment at ECB tenders, euribors are<br />
more subject to pressure.<br />
• STRATEGY: Pay OIS/BOR spreads.<br />
Stress on liquidity has not eased<br />
Demand at this week’s ECB operations provided<br />
evidence that the pressure on liquidity remains high<br />
and that the risk-off mode is a key driving force.<br />
Demand for the MRO (1-week liquidity) came out at<br />
EUR 164.2bn (EUR 197.1bn expiring) and demand<br />
at the 3mth LTRO reached EUR 85.0bn (EUR 63.4bn<br />
expiring). As a result, liquidity provided to the<br />
eurosystem dropped EUR 11.3bn.<br />
At this stage of the reserve maintenance period, we<br />
should expect to see the amount of liquidity provided<br />
declining slightly as banks are well ahead of their<br />
reserve requirements. However, the drop in demand<br />
was less than in normal times. This points to some<br />
tensions. Moreover, the decrease in 1-week demand<br />
and the increase of demand for 3mth liquidity shows<br />
that term liquidity supplied in the market is drying up.<br />
While eonias are unlikely to rise sharply in the<br />
coming days and weeks, given the large frontloading,<br />
euribors remain subject to upward pressure. This is<br />
keeping OIS/BOR spreads paid.<br />
After the results of the stress tests on banks were<br />
published, one might have thought that stress on<br />
banks would have receded somewhat. But, as<br />
concerns about Greece and other peripherals persist,<br />
and given the elevated exposure of banks to<br />
sovereign risk, the risk premium on financials has not<br />
eased at all. The close correlation between financial<br />
CDS and OIS/BOR spreads leads us to see further<br />
risk of widening.<br />
In addition, USD liquidity seems likely to richen in the<br />
current context (uncertainty about an agreement to<br />
raise the debt ceiling, high risk of a downgrade of US<br />
debt). A downgrade of US debt would certainly fuel<br />
demand for liquidity. Dollar OIS/BOR spreads are<br />
therefore exposed to the risk of severe widening<br />
pressures in the near term. This can only add to the<br />
global pressure on liquidity.<br />
Source: <strong>BNP</strong> Paribas<br />
Chart 2: OIS/BOR Spreads Still Exposed to<br />
Widening<br />
Source: <strong>BNP</strong> Paribas<br />
Tensions could mount further in the near term<br />
Given the current environment, the scope for eonia to<br />
decline is clear but limited. At the very least, recent<br />
tensions will ease somewhat. But OIS/BOR spreads<br />
may rewiden further. The rise of financial CDS keeps<br />
widening pressures on OIS/BOR spreads.<br />
The situation in the US may add to current stress.<br />
The impact of a downgrade on US debt yields seems<br />
likely to be limited. But as it will intensify the search<br />
for cash, with no possibility of the Fed delivering a<br />
more accommodating liquidity policy, the risk is<br />
clearly on the upside for USD Libor spreads.<br />
Strategy: Continue to pay OIS/BOR spreads at<br />
current levels.<br />
Patrick Jacq 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
38<br />
www.GlobalMarkets.bnpparibas.com
EMU Debt Monitor: CDS Analysis<br />
Chart 1: AAA 5y CDS Basis: A Very<br />
Short-Lived Narrowing<br />
Chart 2: Wider Olo/OAT Spread and Tighter<br />
Belgium/France 5y CDS Differential<br />
115<br />
5Y CDS basis<br />
cash expensive vs CDS<br />
140<br />
120<br />
100<br />
5Y CDS and cash spreads<br />
90<br />
80<br />
60<br />
65<br />
40<br />
cash cheap vs CDS<br />
40<br />
Jan-11 Feb-11 Mar-11 Mar-11 Apr-11 May-11 Jun-11 Jun-11 Jul-11<br />
AUS FIN FRA NETH<br />
20<br />
0<br />
Jan-11 Feb-11 Mar-11 Mar-11 Apr-11 May-11 Jun-11 Jun-11 Jul-11<br />
BEL/FRA BEL/FRA cash FRA/NETH FRA/NETH cash<br />
The decline in AAA CDS from Monday 18 July’s extreme levels was short-lived and stopped on Friday. On the basis side, the<br />
swap spread widening – due to a renewed flight to quality and buying of protection – led to a sharp rewidening of AAA basis<br />
(Chart 1). AAA CDS – especially for Germany and France – not only reflect the sovereign risk but also local banks’ exposure<br />
to peripherals. The release of the second stress test results this month showed a reduction in non-core holdings but has not<br />
led so far to a protracted compression of AAA CDS basis. For instance, while the Germany and Belgium CDS basis<br />
differential used to move very closely, they have diverged since the second week of July. Chart 2 also highlights the diverging<br />
path between wider Olo/OAT spreads and the tightening of Belgium/France CDS (more than 20bp over the past week,<br />
z-scores for cash and CDS in the second table below are also quite telling). Such a decoupling – due to excessively cheap<br />
France CDS – is unsustainable and we believe will be corrected by tighter Germany and France CDS basis.<br />
All Charts Source: <strong>BNP</strong> Paribas<br />
CDS Table & Stats<br />
5y FIN NETH FRA AUS BEL ITA SPA POR IRE GRE<br />
CDS 45 48 112 86 175 272 320 1007 935 1650<br />
CDS Weekly change -1 0 2 1 -24 -31 -30 -271 -323 -900<br />
cash -34 -37 -20 -12 97 224 261 1226 1008 1343<br />
Basis 79 84 131 98 77 48 60 -219 -73 307<br />
Basis Box vs Gy -44.1 -38.5 8.3 -25.1 -45.5 -74.4 -63.1 -341.7 -195.3 184.1<br />
Average -31.1 -26.3 2.5 -14.5 0.4 -19.2 -10.7 -166.2 -203.9 37.6<br />
Max -23.8 -14.3 13.8 4.7 20.4 5.5 15.8 3.7 -1.2 885.6<br />
Min -46.4 -46.2 -10.3 -40.8 -45.5 -78.0 -64.9 -408.3 -417.4 -227.1<br />
Z score** 2.89 1.42 -1.19 1.11 3.62 3.08 2.90 1.49 -0.09 -0.47<br />
Change to 31/12/2010 CDS Cash<br />
2y 5y 10y Current Min/Max z-score Current z-score<br />
FIN 12 14 18 AUS/BEL -89 -124/-64 -0.5 -109 -2.7<br />
NETH -8 -7 -2 BEL/FRA 63 52/95 -1.1 117 2.8<br />
FRA -10 9 17 FRA/NETH 64 29/69 2.9 17 1.1<br />
AUS -10 -11 -3 FRA/FIN 67 36/71 3.1 14 0.4<br />
BEL -55 -35 -30 ITA/BEL 97 2/115 2.8 126 2.6<br />
ITA 51 36 17 AUS/FRA -26 -32/-2 -2.5 8 0.8<br />
SPA -25 -27 -39 SPA/IT 48 30/118 -1.8 37 -2.2<br />
POR 768 509 386 POR/SPA 687 166/927 1.6 965 1.5<br />
IRE 544 327 203 IRE/PO R -72 -136/181 -1.5 -219 -2.7<br />
GRE 1039 633 625 GRE/IRE 715 227/1633 0.0 336 -1.5<br />
All Charts Source: <strong>BNP</strong> Paribas<br />
** z-score measures the deviation from six-month rolling average CDS/cash basis of the country versus Germany, expressed in numbers of standard deviations. A<br />
number above 1.50 means the cash is trading historically cheap compared with its average basis level.<br />
Eric Oynoyan / Ioannis Sokos 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
39<br />
www.GlobalMarkets.bnpparibas.com
EMU Debt Monitor: Key RV Charts<br />
Chart 3: German 2y/5y/10y Fly: Observed vs. Fitted<br />
Chart 4: 2y/10y Bono Still Too Steep<br />
30<br />
20<br />
10<br />
Hedged Eur u11 OE CTD Fly<br />
5y too cheap<br />
50<br />
40<br />
30<br />
20<br />
10<br />
Phase 1: Spread widening<br />
Bono 2013 expensive<br />
Phase 2: Spread widening<br />
0<br />
0<br />
-10<br />
US QE<br />
-20<br />
Exotic desks hedging<br />
5y expensive<br />
-30<br />
May-07 Sep-08 Feb-10 Jun-11<br />
After a quick normalisation when the 5y Obl corrected half of<br />
its overvaluation in late June, renewed pressures on<br />
peripherals led to a return close to levels seen in June 2008.<br />
There is no sign of a reversal but the normalisation to come<br />
at some stage would imply a 17-18bp cheapening of the fly.<br />
-10<br />
-20<br />
-30<br />
Bono 2013 cheap<br />
-40<br />
Jan-10 Mar-10 May-10 Aug-10 Oct-10 Dec-10 Mar-11 May-11 Jul-11<br />
Bono/BTP 2013/2020 box<br />
After a quick flattening in July, the Bono 2y/10y dramatically<br />
resteepened over the past week. As Chart 4 illustrates, the<br />
box vs. BTP is still far too high, i.e. the Bono curve is too<br />
steep. Bono Oct 13/Apr 21 flatteners around 40bp above<br />
BTPs remain a very cheap option in the current context.<br />
Chart 5: Bund July 13/Jan 16 ASW: Marked 2y Cheapening Chart 6: 10y/30y Bund: Observed vs. Fitted: 30y Too Cheap<br />
DBR 3.75 4/7/13 S0302 ASW-DBR 3.5 4/1/16 05 ASW<br />
25<br />
0<br />
20<br />
10y/30y Bund too steep<br />
-5<br />
2y ASW cheapening vs 5y<br />
15<br />
10<br />
-10<br />
5<br />
0<br />
-15<br />
-5<br />
-20<br />
-10<br />
-15<br />
-25<br />
-20<br />
-30<br />
Oct-10 Dec-10 Jan-11 Feb-11 Apr-11 May-11 Jul-11<br />
DBR 3.75 4/7/13 S0302 ASW-DBR 3.5 4/1/16 05 ASW<br />
In contrast to the German 2y/5y/10y cash fly, the swap is<br />
trading on its fair value. That unusual decoupling is explained<br />
by the huge cheapening of German 2y ASW vs. 5y (Chart 5).<br />
A normalisation should imply a wider 2y/5y ASW box.<br />
Chart 7: Distribution of Bund 42 ASW Conditional to<br />
Bund Jan 21 ASW: 30y ASW Too Tight<br />
-25<br />
Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11<br />
Jan 20/July 40 Bund regressed vs. Euribor<br />
While the 10y/30y swap segment, and to a lesser extent the<br />
OAT spread, flattened over the past month, the Bund<br />
segment decoupled and remains close to its highs. The latter<br />
is clearly higher than its fair value and back to 2010’s<br />
extremes.<br />
Chart 8: Olo Curve: 2y Olo Cheapening Further<br />
40<br />
30<br />
20<br />
10<br />
0<br />
Historical Average + 2.0 st dev<br />
OLO 2013 too<br />
cheap<br />
2013 Olo<br />
richening<br />
-10<br />
-20<br />
-30<br />
-40<br />
Historical Average - 2.0 st dev<br />
OLO 2013 expensive<br />
-50<br />
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11<br />
While the Bund 10y ASW has widened by 10bp since early<br />
July, the 30y tightened, pushing the 10y/30y ASW box to<br />
extreme levels. The conditional distribution approach also<br />
underscores the cheapness of 30y Bund with the current<br />
level being on the far-right of its distribution, making the 30y<br />
Bund ASW a buy.<br />
All charts’ source: <strong>BNP</strong> Paribas<br />
Olo Sep 13/Oct 13//Sep 20/Apr 20<br />
We have stressed several times the expensive levels<br />
reached by the 2y Olo vs. BTAN in spreads and within the<br />
2y/10y Olo/OAT box. The 2y Olo has normalised within the<br />
box and is even trading a bit cheaply. Olo Sep 13/Mar 17<br />
spread is getting close to our 100/105bp target raised in Q2.<br />
Eric Oynoyan / Ioannis Sokos 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
40<br />
www.GlobalMarkets.bnpparibas.com
EMU Debt Monitor: Redemptions<br />
EGB Monthly Redemptions<br />
Bonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011<br />
ITA 0.0 18.7 30.5 0.0 14.6 12.2 0.0 20.2 46.0 0.0 15.5 0.0 157.6<br />
FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0<br />
GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3<br />
SPA 0.0 0.0 0.0 15.5 0.0 0.0 15.5 0.0 0.0 14.1 0.0 0.0 45.1<br />
GRE 0.0 0.0 8.7 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.4<br />
BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.5 27.9<br />
NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9<br />
AUS 8.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 8.4<br />
POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5<br />
IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5<br />
FIN 0.0 5.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.7<br />
Total 63 24 66 58 22 35 83 27 89 47 20 24 558<br />
EGB Monthly Redemptions<br />
T-Bill Monthly Redemptions<br />
T-Bills Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011<br />
ITA 17.4 17.3 17.3 17.3 14.6 19.3 16.3 16.2 15.7 15.7 14.9 13.0 194.8<br />
FRA 33.3 35.9 38.3 31.9 32.1 32.7 30.9 28.7 43.0 28.8 16.1 18.8 370.4<br />
GER 11.0 11.0 11.0 11.0 11.0 11.0 9.0 9.0 9.0 10.0 10.0 9.0 122.0<br />
SPA 8.7 7.9 10.2 7.3 7.9 6.3 7.3 11.9 7.3 10.0 5.4 7.7 97.9<br />
GRE 4.2 0.4 1.4 3.2 1.0 4.4 2.5 3.8 3.6 2.0 2.0 28.5<br />
BEL 5.5 6.2 6.4 6.7 7.4 6.8 5.4 5.4 5.0 6.4 3.8 3.2 68.1<br />
NET 9.7 8.3 17.4 7.0 6.9 10.9 7.7 6.2 10.6 10.2 3.8 7.6 106.2<br />
AUS 0.1 2.2 0.9 3.4 0.5 1.9 2.4 2.0 1.5 0.7 0.3 0.0 15.8<br />
POR 3.4 3.5 3.8 0.0 4.0 3.1 3.5 3.3 1.7 0.4 26.7<br />
IRE 2.1 1.2 1.6 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.2<br />
FIN 3.5 2.3 2.6 1.5 2.2 0.7 0.0 0.6 1.3 0.1 0.0 0.0 14.8<br />
Total 98.9 96.2 110.9 90.6 83.6 89.6 87.4 85.3 100.8 88.7 57.9 61.6 1051.5<br />
T-Bill Monthly Redemptions<br />
100<br />
90<br />
80<br />
70<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
0<br />
Monthly EGBs Redemptions<br />
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec<br />
120<br />
100<br />
80<br />
60<br />
40<br />
20<br />
0<br />
Monthly T-Bills Redemptions<br />
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec<br />
This Month’s EGB Redemptions<br />
Country Bond Maturity Issued Outstanding EURs (bn) CRNCY<br />
ITALY BTPS 5 1/4 08/01/11 01/08/2011 01/03/2001 20.20 20.20 EUR<br />
GREECE GGB 3.9 08/20/11 20/08/2011 24/05/2006 6.61 6.61 EUR<br />
This Month’s T-Bill Redemptions<br />
Country T-Bill Maturity CRNCY EURs<br />
AUSTRIA Various small T-Bills<br />
2.0<br />
BELGIUM BGTB 0 08/18/11 18/08/2011 EUR 5.4<br />
FINLAND RFTB 0 08/09/11 09/08/2011 EUR 0.6<br />
FRANCE BTF 0 08/04/11 04/08/2011 EUR 8.3<br />
FRANCE BTF 0 08/11/11 11/08/2011 EUR 6.1<br />
FRANCE BTF 0 08/18/11 18/08/2011 EUR 6.9<br />
FRANCE BTF 0 08/25/11 25/08/2011 EUR 7.4<br />
GERMANY BUBILL 0 08/24/11 24/08/2011 EUR 4.0<br />
GERMANY BUBILL 0 08/10/11 10/08/2011 EUR 5.0<br />
GREECE GTB 0 08/19/11 19/08/2011 EUR 2.0<br />
GREECE GTB 0 08/12/11 12/08/2011 EUR 0.5<br />
ITALY BOTS 0 08/15/11 15/08/2011 EUR 7.2<br />
ITALY BOTS 0 08/31/11 31/08/2011 EUR 9.0<br />
NETHERLANDS DTB 0 08/31/11 31/08/2011 EUR 6.2<br />
PORTUGAL PORTB 0 08/19/11 19/08/2011 EUR 3.1<br />
SPAIN SGLT 0 08/19/11<br />
Total<br />
19/08/2011 EUR 11.9<br />
85.3<br />
All charts’ source: <strong>BNP</strong> Paribas<br />
Eric Oynoyan / Ioannis Sokos 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
41<br />
www.GlobalMarkets.bnpparibas.com
UK: Trading BoE on Hold for Longer<br />
• We list a selection of interest rate strategies<br />
across assets in the sterling market against the<br />
backdrop of weak growth and stable monetary<br />
policy.<br />
• STRATEGY: Sell Z2Z3 Libor spread at 65bp.<br />
Buy Gilt 2.75% 2015 versus SONIA at 21bp. Sell<br />
the 1y1y straddle at 78bp implied volatility.<br />
Chart 1: Evolution of 6/10 Generic Libor Spread<br />
1.7<br />
1.5<br />
1.3<br />
1.1<br />
0.9<br />
0.7<br />
0.5<br />
0.3<br />
1) Front end<br />
The strip did not react to the preliminary Q2 GDP<br />
growth figures as they were roughly in line with<br />
consensus estimates. Meanwhile, front March<br />
contracts are comfortably trading above the 9900<br />
area. Curve-wise, red/green Libor spreads continue<br />
to tighten with Z2Z3 having narrowed by 26bp since<br />
early July. The spread is currently hovering around<br />
65bp and we expect it to narrow further; investors<br />
should set the first target at 59bp. The positive<br />
rolldown is worth some 7bp to the next IMM date.<br />
2) Gilt curve<br />
The benchmark curve has steepened significantly in<br />
the year to date. The bull-steepening move which<br />
has developed over the period is mainly the result of<br />
a repricing of monetary policy: the market has<br />
gradually reviewed expectations of rate hikes on the<br />
back of the dovish rhetoric of the majority of the MPC<br />
members, high inflation notwithstanding. Given the<br />
weak economic outlook, we expect the shape of the<br />
curve to remain stable in the medium term. In turn,<br />
an attractive (roll-down) strategy is to buy Gilt 2.75%<br />
2015 versus SONIA. Indeed, the bond is cheap,<br />
trading at SONIA +21bp and enjoys 8bp of roll-down<br />
to Gilt 5% 2014 in asset swap space (Chart 2).<br />
3) Volatility<br />
Chart 3 shows the evolution of the 1y and 2y swap:<br />
the 1y swap is remarkably less volatile than the 2y<br />
swap. Since the beginning of 2010, the 1y swap has<br />
traded between 0.78% and 1.24%. Again, given our<br />
expectations that the BoE will remain on hold for a<br />
long time, we expect volatility at the front end to<br />
remain subdued. Accordingly, we like monetising<br />
negative gamma positions via selling the 1y1y<br />
straddle, which is currently worth 59 cents; indeed<br />
the point looks expensive versus realised volatility.<br />
The terminal BE rates are 0.55% and 1.81% which<br />
are comfortably outside the 2010-to-date range.<br />
0.1<br />
-0.1<br />
-0.3<br />
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11<br />
Source: <strong>BNP</strong> Paribas<br />
10<br />
8<br />
6<br />
4<br />
2<br />
0<br />
-2<br />
-4<br />
-6<br />
Chart 2: SONIA ASW Curve<br />
UKT 4 22/01/60<br />
UKT 4.25 7/12/55<br />
UKT 4.25 7/12/49<br />
UKT 4.25 7/12/46<br />
UKT 4.5 7/12/42<br />
UKT 4.25 7/12/40<br />
UKT 4.25 7/9/39<br />
UKT 4.75 7/12/38<br />
UKT 4.25 7/3/36<br />
UKT 4.5 7/9/34<br />
UKT 4.25 7/6/32<br />
UKT 4.75 7/12/30<br />
UKT 4.25 7/12/27<br />
UKT 5 7/3/25<br />
UKT 4 7/3/22<br />
UKT 3.75 7/9/21<br />
UKT 3.75 7/9/20<br />
UKT 4.75 7/3/20<br />
UKT 3.75 7/9/19<br />
UKT 4.5 7/3/19<br />
UKT 5 7/3/18<br />
UKT 4 7/9/16<br />
UKT 2 22/1/16<br />
UKT 4.75 7/9/15<br />
UKT 2.75 22/1/15<br />
UKT 5 7/9/14<br />
UKT 2.25 7/3/14<br />
UKT 4.5 7/3/13<br />
UKT 5.25 7/6/12<br />
UKT 5 7/3/12<br />
UKT 3.25 7/12/11<br />
Source: <strong>BNP</strong> Paribas<br />
2.1<br />
1.9<br />
1.7<br />
1.5<br />
1.3<br />
1.1<br />
0.9<br />
0.7<br />
1y ASW rolldown (bp, LHS)<br />
SONIA ASW curve (bp)<br />
Chart 3: Evolution of 1y Swap and 2y Swap<br />
0.5<br />
Jan-10 Jul-10 Jan-11 Jul-11<br />
Source: <strong>BNP</strong> Paribas<br />
GBP 1y swap<br />
GBP 2y swap<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
0<br />
-10<br />
-20<br />
Matteo Regesta 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
42<br />
www.GlobalMarkets.bnpparibas.com
JGBs: Negative Factors to Increase<br />
• August is likely to see PM Kan announce<br />
his resignation and the DPJ elect a new leader.<br />
Debate about the magnitude of, and the<br />
resources for, the third supplementary budget<br />
would take place immediately thereafter.<br />
• Negative market factors, including not only<br />
the worsening of government finances and<br />
rising JGB issuance, but also inflation<br />
pressures are set to increase through the<br />
autumn.<br />
• While the JGB market should remain firm,<br />
in the recent high price range for some time,<br />
steepening pressure will gradually increase.<br />
Chart 1: 30-year – 10-year Yield Curve Changes<br />
in Japan, the US and Germany<br />
1.8<br />
1.6<br />
1.4<br />
1.2<br />
1<br />
0.8<br />
0.6<br />
(%)<br />
Jackson Hole<br />
speech<br />
(27-Aug)<br />
Anti-govmt<br />
demonstration<br />
in Libya (17-Feb)<br />
Germany<br />
0.4<br />
10/4 10/7 10/10 11/1 11/4 11/7<br />
US<br />
Japan<br />
Source: <strong>BNP</strong> Paribas<br />
Economic conditions are improving in Japan<br />
Although various problems grip nations everywhere,<br />
Japanese economic activity, which plunged following<br />
the March earthquake, is steadily recovering. For<br />
instance, June’s trade balance recorded a surplus of<br />
JPY 70.7bn (non-seasonally adjusted), its first in<br />
three months. The trade deficit that had persisted<br />
since April has been reversed by growing exports as<br />
the supply chain recovers. Notably, exports of<br />
transport equipment increased 28.3% m/m, a backto-back<br />
strong monthly gain, boosting total exports.<br />
Japan has scored another major victory by achieving<br />
the ‘Step 1’ in resolving the Fukushima nuclear plant<br />
accident. The nuclear reactors there are approaching<br />
stability, now that the coolant systems are working,<br />
and this will reduce the risk premium for the<br />
Japanese economy. The ‘Step 2’ targets include the<br />
purification of contaminated water and the cold<br />
shutdown of the reactors. While a plethora of<br />
problems remain, including soil decontamination and<br />
the stability of the purification system, the risk has<br />
peaked.<br />
2011 has seen an unbroken series of crises,<br />
including the US and the eurozone debt problems<br />
and March’s natural disaster in Japan. The policy<br />
response has been difficult because no perfect<br />
solutions exist, and forecasting has been further<br />
complicated because responses are linked to political<br />
situations. Even so, countries are likely to narrowly<br />
move past these crises in the coming months.<br />
Negative factors will increase through autumn<br />
An examination of yield curves in Japan, the US and<br />
Germany reveals that flattening between the short<br />
and the medium sectors (a reflection of the economic<br />
soft patch) has paused simultaneously. On the other<br />
hand, the curves have steepened between the long<br />
and the super-long sectors notably in Europe and the<br />
US. Investors are concerned about the course of<br />
deficit reduction talks in the US, while the receding of<br />
the flight to quality in the eurozone has induced a<br />
steepening in the back end of the German curve.<br />
These yield curve changes show a shift in market<br />
focus from monetary easing to fiscal easing.<br />
Even if a deficit reduction agreement is reached, we<br />
expect the US curve to continue to steepen for the<br />
following reasons: 1) S&P might still downgrade US<br />
debt, depending on the agreed deficit cuts, and<br />
Moody’s might consider downgrading, depending on<br />
subsequent progress in fiscal reform; 2) opportunities<br />
to reduce the deficit will drop ahead of the 2012<br />
presidential election; 3) finally, once the debt ceiling<br />
is raised, Treasury issuance will increase.<br />
The second supplementary budget has been passed<br />
in Japan; reports about the third supplementary<br />
budget are already appearing. Because the political<br />
situation remains confused, enactment of this third<br />
supplementary budget will be delayed but its size is<br />
likely to swell. Common sense suggests that August<br />
will probably see PM Kan announce his resignation<br />
and the DPJ elect a new leader. Debate about the<br />
magnitude of, and the resources for, the third<br />
supplementary budget would take place immediately<br />
thereafter.<br />
We expect negative market factors, including not<br />
only the worsening of government finances and rising<br />
JGB issuance, but also inflation pressures, to<br />
increase through the autumn. While the JGB market<br />
should remain firm, in the recent high price range for<br />
some time, steepening pressure will gradually rise.<br />
Koji Shimamoto 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
43<br />
www.GlobalMarkets.bnpparibas.com
Global Inflation Watch<br />
EMU Flash HICP seen stable at 2.7%<br />
The flash estimate for the eurozone July HICP, due<br />
on Friday 27, is expected to show inflation remained<br />
stable for the third month running at 2.7% y/y. Risks<br />
are tilted slightly to the upside following higher-thanexpected<br />
figures in Germany.<br />
German preliminary CPI release showed a 0.4%<br />
m/m rise (HICP 0.5%), 0.1pp higher than the<br />
consensus forecast. These monthly changes pushed<br />
the inflation rates up by 0.1pp and 0.2pp to 2.4% and<br />
2.6% for the CPI and the HICP, respectively. German<br />
inflation is back to the level reached in September<br />
2008. The main factor underlying the surprising rise<br />
appears to have been core inflation. Seasonal sales<br />
discounts were not as aggressive as last year and air<br />
transport prices soared more than usual. Looking to<br />
non-core items, weak food prices compensated the<br />
increase in heating oil and gasoline. We believe that<br />
the upward pressures on core are a specific factor in<br />
Germany and we maintain our forecast for the<br />
eurozone HICP inflation at 2.7% but risks are tilted to<br />
the upside.<br />
A point to note is the greater convergence of national<br />
developments to the EMU average, with eurozone<br />
countries that traditionally had below average<br />
inflation, such as Germany but also Austria or<br />
Finland, experiencing some upward pressure. With<br />
growth in these economies running faster and<br />
peripherals undergoing a significant fiscal<br />
adjustment, these trends are likely to continue over<br />
the next few months.<br />
In Japan, we estimate that June core CPI inflation<br />
eased 0.2pp to 0.4% y/y, reflecting slower price<br />
growth for energy. In April, the index returned to<br />
growth for the first time in 28 months with a rise of<br />
0.6% y/y. That rate of increase – the fastest since<br />
November 2008 – was maintained in May. But the<br />
price growth leader, energy, has steadily lost<br />
momentum, going from 7.3% growth in April to 5.7%<br />
in May; this reduced momentum should continue in<br />
June, resulting in the index’s slower rate of growth.<br />
Meanwhile, index rebasing (2005 to 2010), to take<br />
effect from the 26 August release of the national CPI<br />
data for July, will lower the core CPI by 0.7-0.8pp<br />
according to our estimates. The rebasing (2000 to<br />
2005) five years ago lowered the index by 0.5pp.<br />
Consequently, under the new index, the core CPI<br />
rate should hover around zero, while the US-style<br />
core-core CPI rate (0.1% y/y in May) will probably<br />
turn negative again.<br />
Chart 1: Eurozone vs. Germany (HICP, % y/y)<br />
4.0<br />
3.5<br />
3.0<br />
2.5<br />
2.0<br />
1.5<br />
1.0<br />
0.5<br />
0.0<br />
-0.5<br />
-1.0<br />
Eurozone<br />
Germany<br />
06 07 08 09 10 11<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
France<br />
Austria<br />
Chart 2: HICP (% y/y)<br />
Germany<br />
Eurozone<br />
Finland<br />
-1<br />
Jan Jul Jan Jul Jan Jul Jan Jul Jan<br />
07 08 09 10 11<br />
Source: Reuters EcoWin Pr<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
-1<br />
-2<br />
-3<br />
Eurozone<br />
Spain<br />
Chart 3: HICP (% y/y)<br />
Portugal<br />
Greece<br />
Ireland<br />
-4<br />
Jan Jul Jan Jul Jan Jul Jan Jul Jan<br />
07 08 09 10 11<br />
Source: Reuters EcoWin Pro<br />
Luigi Speranza/Gizem Kara/Dominique Barbet 28 July 2011<br />
Market Mover<br />
44<br />
www.GlobalMarkets.bnpparibas.com
Table 1: <strong>BNP</strong> Paribas' Inflation Forecasts<br />
Eurozone<br />
France<br />
US<br />
Headline HICP Ex-tobacco HICP<br />
Headline CPI<br />
Ex-tobacco CPI<br />
CPI Urban SA CPI Urban NSA<br />
Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y index % m/m % y/y Index % m/m % y/y Index % m/m % y/y<br />
2010 109.8 - 1.6 109.5 - 1.5 121.1 - 1.5 119.8 - 1.5 218.1 - 1.6 218.1 - 1.6<br />
2011 (1) 112.9 - 2.8 112.6 - 2.8 123.7 - 2.1 122.3 - 2.1 224.8 - 3.1 224.8 - 3.1<br />
2012 (1) 115.6 - 2.3 115.1 - 2.3 126.0 - 1.8 124.4 - 1.8 229.0 - 1.9 229.0 - 1.9<br />
Q1 2010 108.6 - 1.1 108.3 - 1.0 120.3 - 1.3 119.0 - 1.2 217.5 - 2.4 217.0 - 2.4<br />
Q2 2010 110.1 - 1.6 109.8 - 1.5 121.3 - 1.6 120.0 - 1.5 217.3 - 1.8 218.1 - 1.8<br />
Q3 2010 109.9 - 1.7 109.6 - 1.7 121.2 - 1.5 119.8 - 1.5 218.0 - 1.2 218.3 - 1.2<br />
Q4 2010 110.8 - 2.0 110.5 - 2.0 121.7 - 1.6 120.2 - 1.6 219.5 - 1.2 218.9 - 1.3<br />
Q1 2011 111.3 - 2.5 110.9 - 2.4 122.5 - 1.8 121.0 - 1.7 222.3 - 2.2 221.7 - 2.1<br />
Q2 2011 113.1 - 2.8 112.7 - 2.7 123.9 - 2.1 122.4 - 2.0 224.5 - 3.3 225.5 - 3.4<br />
Q3 2011 (1) 113.1 - 2.9 112.8 - 2.9 124.0 - 2.3 122.6 - 2.3 225.8 - 3.6 226.0 - 3.6<br />
Q4 2011 (1) 114.2 - 3.1 113.8 - 3.0 124.5 - 2.3 123.0 - 2.3 226.7 - 3.3 226.1 - 3.3<br />
Jul 10 109.6 -0.4 1.7 109.30 -0.4 1.7 121.0 -0.3 1.7 119.68 -0.3 1.6 217.6 0.3 1.3 218.01 0.0 1.2<br />
Aug 10 109.9 0.2 1.6 109.52 0.2 1.5 121.3 0.2 1.4 119.97 0.2 1.3 218.1 0.2 1.2 218.31 0.1 1.1<br />
Sep 10 110.2 0.3 1.9 109.86 0.3 1.8 121.2 -0.1 1.6 119.88 -0.1 1.5 218.4 0.2 1.1 218.44 0.1 1.1<br />
Oct 10 110.5 0.3 1.9 110.19 0.3 1.9 121.4 0.1 1.6 120.03 0.1 1.5 219.0 0.2 1.2 218.71 0.1 1.2<br />
Nov 10 110.6 0.1 1.9 110.28 0.1 1.8 121.5 0.1 1.6 120.09 0.0 1.5 219.2 0.1 1.1 218.80 0.0 1.1<br />
Dec 10 111.3 0.6 2.2 110.93 0.6 2.1 122.1 0.5 1.8 120.61 0.4 1.7 220.2 0.4 1.4 219.18 0.2 1.5<br />
Jan 11 110.5 -0.7 2.3 110.11 -0.7 2.2 121.8 -0.2 1.8 120.32 -0.2 1.7 221.1 0.4 1.7 220.22 0.5 1.6<br />
Feb 11 111.0 0.4 2.4 110.58 0.4 2.4 122.4 0.5 1.7 120.90 0.5 1.6 222.3 0.5 2.2 221.31 0.5 2.1<br />
Mar 11 112.5 1.4 2.7 112.11 1.4 2.6 123.4 0.8 2.0 121.90 0.8 1.9 223.5 0.5 2.7 223.47 1.0 2.7<br />
Apr 11 113.1 0.6 2.8 112.75 0.6 2.8 123.8 0.3 2.1 122.32 0.3 2.0 224.4 0.4 3.1 224.91 0.6 3.2<br />
May 11 113.1 0.0 2.7 112.74 0.0 2.7 123.9 0.1 2.0 122.40 0.1 2.0 224.8 0.2 3.4 225.96 0.5 3.6<br />
Jun 11 (1) 113.1 0.0 2.7 112.75 0.0 2.7 124.0 0.1 2.1 122.49 0.1 2.1 224.3 -0.2 3.4 225.72 -0.1 3.6<br />
Jul 11 (1) 112.6 -0.5 2.7 112.21 -0.5 2.7 123.7 -0.2 2.2 122.24 -0.2 2.1 225.4 0.5 3.6 225.76 0.0 3.6<br />
Aug 11 (1) 113.1 0.5 3.0 112.76 0.5 3.0 124.2 0.4 2.4 122.72 0.4 2.3 225.8 0.2 3.5 226.02 0.1 3.5<br />
Sep 11 (1) 113.7 0.5 3.1 113.30 0.5 3.1 124.2 0.0 2.5 122.76 0.0 2.4 226.3 0.2 3.6 226.28 0.1 3.6<br />
Oct 11 (1) 114.0 0.3 3.2 113.68 0.3 3.2 124.4 0.1 2.5 122.91 0.1 2.4 226.5 0.1 3.5 226.27 0.0 3.5<br />
Nov 11 (1) 114.1 0.1 3.2 113.76 0.1 3.2 124.5 0.1 2.4 122.97 0.0 2.4 226.5 0.0 3.3 226.07 -0.1 3.3<br />
Dec 11 (1) 114.5 0.3 2.9 114.07 0.3 2.8 124.7 0.2 2.2 123.18 0.2 2.1 227.0 0.2 3.1 225.96 0.0 3.1<br />
Updated<br />
Next<br />
Release<br />
Jul 14<br />
Jul HICP Flash (Jul 29)<br />
Jul 14<br />
Jul CPI (Aug 12)<br />
Jul 15<br />
Jul CPI (Aug 18)<br />
Source: <strong>BNP</strong> Paribas, (1) Forecasts<br />
4.0<br />
3.0<br />
2.0<br />
1.0<br />
0.0<br />
-1.0<br />
0.2<br />
0.0<br />
-0.2<br />
-0.4<br />
-0.6<br />
-0.8<br />
Chart 4: German Inflation (% y/y)<br />
HICP (% y/y)<br />
CPI (% y/y)<br />
CPI (% y/y) - HICP (% y/y)<br />
04 05 06 07 08 09 10 11<br />
Chart 5: US Core CPI (pp)<br />
Source: Reuters EcoWin Pro<br />
The domestic and harmonised measures of German inflation do<br />
not differ much, except when special factors occur, as in 2005-<br />
2006. However, the harmonised inflation is usually a little more<br />
volatile, so it is not surprising to see it above domestic inflation.<br />
Source: Reuters EcoWin Pro<br />
Core goods inflation accelerated in June on past commodity price<br />
surges. Shelter inflation also soared, due to the delayed impact of<br />
the past rise in energy prices. However, core services remained<br />
subdued, helped by the on-going wage moderation.<br />
Luigi Speranza/Gizem Kara/Dominique Barbet 28 July 2011<br />
Market Mover<br />
45<br />
www.GlobalMarkets.bnpparibas.com
Table 2: <strong>BNP</strong> Paribas' Inflation Forecasts<br />
Japan<br />
UK<br />
Sweden<br />
Core CPI SA<br />
Core CPI NSA<br />
Headline CPI<br />
RPI<br />
CPI<br />
CPIF<br />
Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y<br />
2010 99.3 - -1.0 99.3 - -1.0 114.5 - 3.3 223.6 - 4.6 302.5 - 1.2 194.6 - 2.0<br />
2011 (1) 99.9 - 0.6 99.9 - 0.6 119.5 - 4.4 235.4 - 5.3 311.7 - 3.1 197.6 - 1.6<br />
2012 (1) 100.6 - 0.7 100.6 - 0.8 122.7 - 2.5 244.8 - 4.0 318.2 - 2.1 200.4 - 1.4<br />
Q1 2010 99.8 - -1.2 99.3 - -1.2 112.9 - 3.2 219.3 - 4.0 301.2 - 0.7 193.4 - 2.3<br />
Q2 2010 99.3 - -1.2 99.3 - -1.2 114.4 - 3.4 223.5 - 5.1 302.8 - 0.9 194.3 - 1.9<br />
Q3 2010 98.8 - -1.1 99.1 - -1.0 114.7 - 3.1 224.5 - 4.7 302.9 - 1.1 194.2 - 1.7<br />
Q4 2010 99.3 - -0.5 99.4 - -0.5 115.9 - 3.4 227.0 - 4.7 307.0 - 1.9 196.4 - 2.0<br />
Q1 2011 99.6 - -0.2 99.1 - -0.2 117.6 - 4.1 230.9 - 5.3 308.1 - 2.6 196.1 - 1.4<br />
Q2 2011 (1) 99.8 - 0.5 99.8 - 0.5 119.4 - 4.4 234.9 - 5.1 311.6 - 3.3 197.5 - 1.7<br />
Q3 2011 (1) 99.8 - 1.0 100.1 - 1.0 119.9 - 4.5 236.4 - 5.3 312.1 - 3.4 197.6 - 1.7<br />
Q4 2011 (1) 100.3 - 1.0 100.4 - 1.0 121.1 - 4.5 239.5 - 5.5 315.1 - 3.0 199.3 - 1.5<br />
Jul 10 98.8 -0.4 -1.2 99.0 -0.3 -1.1 114.3 -0.3 3.1 223.6 -0.2 4.8 302.0 -0.3 1.1 193.7 -0.3 1.7<br />
Aug 10 98.8 0.0 -1.0 99.1 0.1 -1.0 114.9 0.5 3.1 224.5 0.4 4.7 302.1 0.0 0.9 193.7 0.0 1.5<br />
Sep 10 98.7 -0.1 -1.1 99.1 0.0 -1.1 114.9 0.0 3.0 225.3 0.4 4.6 304.6 0.8 1.4 195.1 0.7 1.8<br />
Oct 10 99.1 0.4 -0.6 99.5 0.4 -0.6 115.2 0.3 3.1 225.8 0.2 4.5 305.6 0.3 1.5 195.7 0.3 1.8<br />
Nov 10 99.3 0.2 -0.5 99.4 -0.1 -0.5 115.6 0.3 3.2 226.8 0.4 4.7 306.6 0.3 1.8 196.2 0.2 1.9<br />
Dec 10 99.5 0.2 -0.3 99.4 0.0 -0.4 116.8 1.0 3.7 228.4 0.7 4.8 308.7 0.7 2.3 197.3 0.6 2.3<br />
Jan 11 99.5 0.0 -0.2 99.0 -0.4 -0.2 116.9 0.1 4.0 229.0 0.3 5.1 306.2 -0.5 2.5 195.2 -1.1 1.4<br />
Feb 11 99.5 0.0 -0.3 98.9 -0.1 -0.3 117.8 0.8 4.3 231.3 1.0 5.5 308.0 0.6 2.5 196.2 0.5 1.3<br />
Mar 11 99.7 0.2 -0.1 99.4 0.5 -0.1 118.1 0.3 4.1 232.5 0.5 5.3 310.1 0.7 2.9 196.9 0.4 1.5<br />
Apr 11 99.9 0.2 0.6 99.8 0.4 0.6 119.3 1.0 4.5 234.4 0.8 5.2 311.4 0.4 3.3 197.6 0.4 1.8<br />
May 11 99.9 0.0 0.6 99.9 0.1 0.6 119.5 0.2 4.5 235.2 0.3 5.2 312.0 0.2 3.3 197.8 0.1 1.7<br />
Jun 11 (1) 99.6 -0.3 0.4 99.7 -0.2 0.4 119.4 -0.1 4.2 235.2 0.0 5.0 311.3 -0.2 3.1 197.2 -0.3 1.5<br />
Jul 11 (1) 99.7 0.1 0.9 99.9 0.2 0.9 119.1 -0.2 4.2 234.6 -0.2 4.9 311.1 -0.1 3.3 197.0 -0.1 1.7<br />
Aug 11 (1) 99.8 0.1 1.0 100.1 0.2 1.0 120.0 0.7 4.4 236.3 0.7 5.3 311.3 0.1 3.4 197.2 0.1 1.8<br />
Sep 11 (1) 99.9 0.1 1.2 100.3 0.2 1.2 120.6 0.5 4.9 238.2 0.8 5.7 313.9 0.8 3.4 198.6 0.7 1.7<br />
Oct 11 (1) 100.1 0.2 1.0 100.5 0.2 1.0 120.8 0.2 4.8 238.7 0.2 5.7 314.8 0.3 3.4 199.1 0.3 1.7<br />
Nov 11 (1) 100.3 0.2 1.0 100.4 -0.1 1.0 120.9 0.1 4.6 239.4 0.3 5.5 315.1 0.1 3.1 199.3 0.1 1.6<br />
Dec 11 (1) 100.4 0.1 0.9 100.3 -0.1 0.9 121.7 0.6 4.2 240.4 0.4 5.3 315.4 0.1 2.5 199.4 0.1 1.1<br />
Updated<br />
Next<br />
Release<br />
Jul 01<br />
Jun CPI (Jul 29)<br />
Jul 14<br />
Jul CPI (Aug 16)<br />
Jul 12<br />
Jul CPI (Aug 11)<br />
Source: <strong>BNP</strong> Paribas, (1) Forecasts<br />
Chart 6: Japanese CPI (% y/y)<br />
Chart 7: UK CPI (% y/y)<br />
Source: Reuters EcoWin Pro<br />
Japanese inflation was stable in positive territory in May. However,<br />
we expect the new rebased index to show a different picture with<br />
much lower inflation rates. Japanese deflation is not over.<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Inflation surprised to the downside in June, on slower core inflation.<br />
We still expect the headline inflation rate to go higher before the<br />
year is out given the large hikes in utility prices which are in the<br />
pipeline.<br />
Luigi Speranza/Gizem Kara/Dominique Barbet 28 July 2011<br />
Market Mover<br />
46<br />
www.GlobalMarkets.bnpparibas.com
Table 3: <strong>BNP</strong> Paribas' Inflation Forecasts<br />
Canada Norway Australia<br />
CPI Core CPI Headline CPI Core<br />
CPI<br />
Core<br />
Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y<br />
2010 116.5 1.8 115.6 1.7 128.8 2.4 120.1 1.4 172.6 2.8 - 2.6<br />
2011 (1) 119.8 2.8 117.6 1.7 130.6 1.4 121.4 1.1 178.6 3.5 - 2.7<br />
2012 (1) 122.7 2.4 120.0 2.1 133.0 1.8 123.5 1.8 183.7 2.8 - 2.7<br />
Q3 2010 116.9 2.2 1.4 116.9 0.3 1.7 128.2 -0.7 1.9 119.9 -0.3 1.2 173.3 0.7 2.8 - - 2.4<br />
Q4 2010 117.5 2.3 1.8 117.5 2.0 1.7 129.4 0.9 2.2 120.5 0.5 1.0 174.0 0.4 2.7 - - 2.2<br />
Q1 2011 119.4 3.3 2.0 119.4 0.7 1.6 130.2 0.6 1.4 120.3 -0.2 0.8 176.6 1.5 3.3 - - 2.3<br />
Q2 2011 119.8 5.6 2.5 119.8 3.4 1.5 130.9 0.6 1.4 121.5 1.0 1.0 178.0 0.8 3.6 - - 2.7<br />
Q3 2011 (1) 120.1 -0.4 2.7 120.1 1.4 1.6 129.9 -0.8 1.4 121.2 -0.3 1.0 179.3 0.7 3.6 - - 2.8<br />
Q4 2011 (1) 120.9 2.6 2.8 120.9 3.4 1.7 131.4 1.1 1.5 122.4 1.0 1.6 180.6 0.7 3.7 - - 2.9<br />
Q1 2012 (1) 122.2 3.3 2.9 122.2 2.0 2.1 131.8 0.3 1.2 122.5 0.1 1.8 182.0 0.8 3.0 - - 2.7<br />
Q2 2012 (1) 122.9 4.0 2.6 122.9 1.3 2.2 133.0 1.0 1.6 123.7 1.0 1.8 182.9 0.5 2.6 - - 2.5<br />
Updated<br />
Next<br />
Release<br />
Jul 28<br />
Jul CPI (Aug 19)<br />
Jul 12<br />
Jul CPI (Aug 10)<br />
Jul 27<br />
Q3 CPI (Oct 26)<br />
Source: <strong>BNP</strong> Paribas, (1) Forecasts<br />
Chart 8: Canadian Total versus Core CPI<br />
4.0<br />
BoC Mid-Point Inflation Target<br />
3.5<br />
3.0<br />
2.5<br />
2.0<br />
1.5<br />
1.0<br />
0.5<br />
BoC CPI Core (% y/y)<br />
0.0<br />
-0.5<br />
CPI Total (% y/y)<br />
-1.0<br />
04 05 06 07 08 09 10 11<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
In Canada, inflation surprised on the downside in June. More<br />
importantly, the move was driven by core inflation. Core inflation will<br />
increase due to the past rise in the headline CPI, but the starting<br />
point is reassuringly low.<br />
7.0<br />
6.0<br />
5.0<br />
4.0<br />
3.0<br />
2.0<br />
1.0<br />
0.0<br />
(% y/y)<br />
Chart 9: Australian CPI (% y/y)<br />
Headline CPI<br />
Underlying CPI<br />
-1.0<br />
Q193 Q195 Q197 Q199 Q101 Q103 Q105 Q107 Q109 Q111 Q113<br />
Source: Reuters EcoWin Pro, <strong>BNP</strong> Paribas<br />
Food prices should drive headline inflation sharply higher in 2011.<br />
Underlying inflation should drift higher, but remain within the target<br />
range. Risks to inflation are to the upside, particularly in the near<br />
term.<br />
CPI Data Calendar for the Coming Week<br />
Day GMT Economy Indicator Previous <strong>BNP</strong>P F’cast Consensus<br />
Thu 28/07 23:30 Japan CPI National y/y : Jun 0.3% 0.2% 0.2%<br />
23:30 Core CPI National y/y : Jun 0.6% 0.4% 0.5%<br />
23:30 CPI Tokyo y/y : Jul -0.2% 0.1% 0.0%<br />
23:30 Core CPI Tokyo y/y : Jul 0.1% 0.2% 0.2%<br />
Fri 29/07 07:00 Spain HICP Flash y/y : Jul 3.0% 2.9% 2.9%<br />
09:00 Eurozone HICP (Flash) y/y : Jul 2.7% 2.7% 2.7%<br />
Thu 04/07 07:30 Neths CPI m/m : Jul -0.5% -0.1% n/a<br />
07:30 CPI y/y : Jul 2.3% 2.4% n/a<br />
Fri 05/08 07:15 Switzerland CPI m/m : Jul -0.2% -0.6%<br />
07:15 CPI y/y : Jul 0.6% 0.7%<br />
07:15 CPI Ex-Petroleum y/y : Jul n/a<br />
Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision<br />
Source: <strong>BNP</strong> Paribas<br />
Luigi Speranza/Gizem Kara/Dominique Barbet 28 July 2011<br />
Market Mover<br />
47<br />
www.GlobalMarkets.bnpparibas.com
Inflation: Unequal In Face Of Debt<br />
• GLOBAL: Mixed.<br />
• EUR: BEs are not so immune to debt issue.<br />
• USD: 10y BEs look rich. Sell 5y5y (versus<br />
EUR/UK?).<br />
• GBP: Fall in BEs. Is it August already?<br />
Chart 1: TIPS/OATEI20 BE Spd vs. 10y UST<br />
40<br />
TIIJUL20 / OATEI20 Breakeven<br />
TIIJUL20 Nominal Rhs<br />
30<br />
20<br />
10<br />
380<br />
340<br />
300<br />
Global/mixed environment<br />
Strong food commodities, an upward surprise on<br />
German preliminary CPI data and index extensions<br />
are supportive of the inflation market. The<br />
consolidation in equities and energy commodities are<br />
not. With regard to the sovereign crisis – the impact<br />
depends. After having been resilient during most of<br />
the EGB crisis, inflation breakevens have finally<br />
fallen out of favour in Europe over the past few days,<br />
with cash underperforming swap, while TIPS seem to<br />
be benefiting from the debt ceiling saga, with cash<br />
outperforming swap. In Europe, beyond summer<br />
volatility, the Greek deal should be seen as<br />
supportive for peripherals and at least BTPei<br />
breakevens. In the US, our colleagues think that a<br />
downgrade of US debt could trigger up to 25bp of<br />
nominal sell off. That said, and as Chart 1 shows, the<br />
10y TIPS/OATei breakeven spread is already back to<br />
its high and looks wide versus the USD 10y nominal<br />
yield. Looking at 5y5y breakevens, we are close to<br />
highs on the US BE forward (Chart 2). As far as the<br />
US/EUR inflation swap spread is concerned, the<br />
current level of 90bp compares with a long-term<br />
average of 50bp and a high of 100bp. If agreement is<br />
reached in Washington over the weekend, US<br />
breakevens should underperform from next week. In<br />
any case, we do not expect the Fed to implement<br />
QE3 if (or because) there is no fiscal agreement<br />
found and the macro picture is still not very<br />
encouraging. In that context, we expect the recent<br />
range to hold and we would be a seller of the<br />
US/EUR 5y5y breakeven spread above 90bp. We<br />
would also be a seller of the US/GBP 5y5y BE<br />
spread below 20bp. The 10y area is depressed in the<br />
UK but, with the probability of QE2 having risen, we<br />
see value in the 5y5y UK breakeven.<br />
0<br />
-10<br />
-20<br />
Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11<br />
Source: <strong>BNP</strong> Paribas<br />
4.5<br />
4.2<br />
3.9<br />
3.6<br />
3.3<br />
3<br />
2.7<br />
2.4<br />
2.1<br />
Chart 2: 5y5y Inflation Swap:<br />
GBP and EUR cheap vs. US<br />
1.8<br />
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12<br />
Source: <strong>BNP</strong> Paribas<br />
10<br />
0<br />
-10<br />
-20<br />
-30<br />
Chart 3: OAT(e)I / Swap BE Spreads<br />
OATEI20 / E9.0 Breakeven<br />
OATI19 / F8.0 Breakeven Rhs<br />
GBP<br />
USD<br />
EUR<br />
260<br />
220<br />
10<br />
0<br />
-10<br />
-20<br />
-30<br />
EUR: not so resilient<br />
Italy issued EUR 0.942bn of BTPei-21 at a real yield<br />
of 4.07%, and with a bid/cover of 1.7. BTPei real<br />
yields rose around 15bp before the auction. But the<br />
paper came out with a 1.5bp premium and<br />
outperformed within the BTPei curve afterwards. RVwise,<br />
and as we said in our pre-auction desknote, we<br />
-40<br />
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 May-11 Aug-11 Nov-11<br />
Source: <strong>BNP</strong> Paribas<br />
-40<br />
Hervé Cros 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
48<br />
www.GlobalMarkets.bnpparibas.com
still like the BTPei-21 versus the BTPei-17, if not the<br />
BTPei-23. On Thursday, the BTP auction was also<br />
decent but this did not prevent BTPs from<br />
underperforming afterwards. The market remains<br />
very volatile but BTPei breakevens still represent<br />
long-term buys in our view.<br />
Cash breakevens have underperformed again versus<br />
swap (Chart 3), which makes sense given the<br />
pressure on EGBs. However, at least for OATi, the<br />
cash/swap breakeven spread is back to the low of its<br />
range. Real yields are low but this may trigger some<br />
ASW activity again.<br />
GBP: The UK DMO sold GBP 4bn of UTKI-34 at<br />
4.5bp over the UKTI32. As expected, indexers<br />
bought most of the issue. That said, as in the<br />
eurozone, it was a bad week for UK breakevens,<br />
which bear steepened (with 20y+ breakevens falling<br />
by more than 12bp) in the week of the 1.5y index<br />
extension. As seen with the performance of the<br />
UKTI16 over recent months, the market tends to<br />
price in large index events well in advance. In that<br />
respect, the UKTI17 should underperform the<br />
UKTI16 further. Looking at the long end of UK<br />
inflation, we update the chart we showed a few<br />
weeks ago (Chart 4). There was indeed too much<br />
premium embedded at the long end of the UK curve<br />
and we expect more underperformance of the<br />
10y20y BE versus 5y5y in August. Historically, UK<br />
breakevens fall in August. They started to do so a bit<br />
earlier than usual this year.<br />
JPY: JGBis have stayed under some pressure after<br />
the BoJ buy-back operation on 25 July highlighted<br />
reasonable selling interest ahead of the CPI<br />
reweighting. As a reminder, since early 2007, the<br />
MoF has bought back around JPY 5.9trn of JGBi<br />
(58% of the outstanding) while BoJ’s the Riban<br />
operations have reached JPY 858bn (8% of the<br />
indexed debt). Chart 5 shows the history of the<br />
operations. With prices back above par and<br />
breakevens close to 0%, the operations have been<br />
reduced in 2011 to JPY 50bn per month for the MoF<br />
and JPY 40bn every other month for the BoJ. The<br />
schedule for Q3 is unchanged from Q2. Today, the<br />
JGBi market is worth around JPY 34trn. There is a<br />
negative relationship (R² at 40%) between market<br />
prices and percentages of JGBi bought back. If<br />
anything, the JGBi Jun-18 should be favoured by the<br />
MoF and BoJ. As we argued in our Inflation Monitor<br />
last week, JGBi breakevens could fall by another 10<br />
to 20bp before the end of the month.<br />
Chart 4: GBP 10y20y (Rich) vs. (Cheap) 5y5y<br />
0.3<br />
0.2<br />
0.1<br />
0<br />
% %<br />
5/10y BE<br />
lhs<br />
-0.1<br />
Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11<br />
Source: <strong>BNP</strong> Paribas<br />
10/30y BE<br />
10Y20Y-5Y5Y<br />
Chart 5: JGBi Operations and JGBis<br />
Outstanding vs. Prices<br />
Source: <strong>BNP</strong> Paribas<br />
Chart 6: JGBis Outstanding and ‘Buy-Backs’<br />
300<br />
250<br />
200<br />
150<br />
100<br />
50<br />
0<br />
0<br />
Jan-2007 Jun-2008 Jun-2009 Jun-2010 Jun-2011<br />
Source: <strong>BNP</strong> Paribas<br />
MOF Buy Back + BOJ Rinban<br />
JGBI Outstanding, RHS<br />
12000<br />
10000<br />
8000<br />
6000<br />
4000<br />
2000<br />
0.7<br />
0.6<br />
0.5<br />
0.4<br />
0.3<br />
0.2<br />
0.1<br />
0<br />
Hervé Cros 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
49<br />
www.GlobalMarkets.bnpparibas.com
USDi: Sell 5y5y Forward Inflation<br />
• Forward expectations are flying high,<br />
especially via inflation swaps. 5y5y in swap is<br />
near the highs and also too high vs 5y5y cash.<br />
• July maturities look cheap vs Jan maturities<br />
in 10y sector, and we favour ‘20 maturities over<br />
‘19 which are slightly rich in the ASW.<br />
• We recap our views on potential impact of<br />
debt ceiling negotiations.<br />
• STRATEGY: Sell 5y5y fwd on CPI; stay in<br />
10s30s BE flattener into month end.<br />
Chart 1: 5y5y Fwd Inflation Too High in CPI<br />
3.30 5y5y Fwd CPI Swap<br />
%<br />
5y CPI Swap (RHS)<br />
%<br />
3.20<br />
2.60<br />
3.10<br />
3.00<br />
2.35<br />
2.90<br />
2.80<br />
2.10<br />
Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11<br />
Source: <strong>BNP</strong> Paribas<br />
TIPS had a good run since a strong 10y TIPS auction<br />
last week. 10y breakevens outperformed both tails<br />
with 5s10s30s BE fly trading around 7bp higher since<br />
the auction-day closing levels. 10s30s BE flattener<br />
that we recommended as a post-auction trade is<br />
roughly 2.5bp flatter, having given back several bp in<br />
recent correction/profit-taking. We still think there is<br />
potential for further flattening over the next several<br />
days, although we would recommend taking it off the<br />
books by the second trading session of next month<br />
since month-end related flows should be done by<br />
then.<br />
5y5y CPI<br />
bp<br />
330<br />
310<br />
290<br />
270<br />
Chart 2: …also vs 5y5y BE in cash<br />
y = 0.7008x + 121.57<br />
R 2 = 0.6893<br />
250<br />
190 210 230 250 270 290<br />
5y5y cash BE<br />
bp<br />
5y5y forward inflation expectations are running high<br />
once again, especially considering the macro<br />
outlook. 5y5y fwd inflation is near multi-year highs<br />
(Chart 1), and we recommend selling 5y5y fwd on<br />
CPI. Furthermore, 5y5y fwd in CPI swaps is also<br />
10bp too high vs equivalent in cash breakevens<br />
(Chart 2). Meanwhile, we remain bullish on nearer<br />
forwards in cash, such as 2y1y BE, which is still<br />
around 2.04% currently. 2y2y BE is now higher and<br />
near 2.2% level. Although it is still a reasonable level<br />
historically, we now prefer 2.5y1y BE (via<br />
Jan14/Jan15) which is at 2.10%. We also have<br />
recently recommended taking profit on 3y1y BE<br />
which is still at 2.35% (up approximately 20bp from<br />
recent levels).<br />
Finally, we note that July maturity TIPS look cheap<br />
vs January maturities in 10y sector (Chart 3). For this<br />
RV analysis, we build real curve using Jan maturities<br />
and find fair value of Apr and Jul maturities by<br />
applying seasonals. We prefer 2020 maturities which<br />
are also slightly cheaper in the ASW relative to 2019<br />
maturities (using ASW z-scores).<br />
Source: <strong>BNP</strong> Paribas<br />
Source: <strong>BNP</strong> Paribas<br />
Chart 3: Rich/Cheap vs Jan TIPS<br />
What Deficit Reduction Plan and Downgrade<br />
Could Mean for Rates and Inflation (repost from<br />
Inflation Monitor; see “Pondering the (Once)<br />
Unthinkable” article in previous Market Mover for a<br />
more comprehensive rates market discussion).<br />
Sergey Bondarchuk / IRS NY Team 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
50<br />
www.GlobalMarkets.bnpparibas.com
No matter how you look at it, we may be heading<br />
toward one of two outcomes – each perhaps<br />
unthinkable not too long ago: either Republicans and<br />
Democrats reach an agreement on a deficit<br />
reduction/stabilisation plan, or else the country faces<br />
a downgrade (or worse yet, a default). The two<br />
denouements have polar opposite implications for<br />
the markets, causing everyone to suffer from<br />
whiplash every time a new headline comes out, only<br />
to be negated shortly thereafter.<br />
Scenario #1:<br />
The deficit reduction package ripples its way down to<br />
the markets through multiple channels. First and<br />
foremost is a drop in GDP in the next few years.<br />
Starting with a USD 14 trillion GDP, a swing of USD<br />
140bn in the fiscal picture represents 1% of the<br />
economy. Now, there is much debate on the actual<br />
economic impact of changes on the fiscal front,<br />
depending on the source of fiscal tightening/easing,<br />
This is the age-old debate, still raging, on whether<br />
government spending or taxation has a bigger<br />
multiplier effect as it translates to economic activity. If<br />
we assume a 1-for-1 relationship for the sake of<br />
argument, then for every USD 140bn in fiscal<br />
tightening for FY 2012 (the upcoming year), we are<br />
looking at a drop of 1% in GDP. According to our<br />
macro fair value model for 30y rates, a 1% change in<br />
GDP translates to a 10bp change in 30y rates.<br />
This may not sound like much, but keep in mind that<br />
there are also knock-on effects, such as lower<br />
inflation as a result of a slower economy – there<br />
tends to be a 12-18 month lag between GDP and<br />
core inflation (Chart 4). Furthermore, another part of<br />
the proposal is to change inflation indexation to the<br />
chain-weighted CPI, which is 28bp lower than the<br />
non-chain weighted y/y CPI on average since 2001<br />
and 32bp lower for core CPI (Chart 5). This could<br />
produce a psychological impact since the main<br />
measure of inflation could read as much as 75bp<br />
lower (widest spread between chain-weighted and<br />
non-chain-weighted core CPI) than the already-tame<br />
core CPI print of 1.6% y/y, stoking deflationary<br />
concerns and weighing on self-reinforcing inflation<br />
expectations (as a side note, we don’t expect new<br />
TIPS to be indexed to chain-weighted CPI, at least<br />
initially, although it is probable in the longer run as<br />
non-chained CPI will eventually be perceived as a<br />
less relevant/accurate measure of inflation).<br />
One caveat: A proposed 15 cent gasoline tax could<br />
produce a one-time 30bp upward shock on y/y<br />
headline CPI, offsetting breakeven tightening (at<br />
least in the front end) and flattening breakeven curve.<br />
The impact on long-term inflation is a bit murkier. A<br />
higher rate of potential growth could put upward<br />
pressure on inflation, but at the same time, the USD<br />
5<br />
3<br />
1<br />
-1<br />
-3<br />
-5<br />
Chart 4: Core Inflation Tends to Follow GDP<br />
GDP y/y<br />
1994 1996 1998 2000 2002 2004 2006 2008 2010<br />
Source: <strong>BNP</strong> Paribas<br />
75<br />
bp<br />
50<br />
25<br />
0<br />
-25<br />
CPI Core y/y (Lagged 5 Quarters)<br />
Chart 5: Chain-Weighted CPI Spreads<br />
01 02 03 04 05 06 07 08 09 10 11<br />
Source: <strong>BNP</strong> Paribas<br />
would likely cement its status as the reserve<br />
currency. In other words, it would stay strong,<br />
curbing export-driven inflation pressures. Therefore,<br />
it is difficult to see long-term inflation expectations<br />
get out of hand in this scenario.<br />
Scenario #2: Downgrade, Default, and All the Bad<br />
Stuff<br />
Admittedly, we don’t have much to go on in this<br />
scenario in terms of historical precedent – certainly<br />
not in the US. So, we must use some judgement and<br />
also point to similar episodes in other developed<br />
countries. A default can easily be averted, since the<br />
US has the ability to make good on its obligations as<br />
long as the debt ceiling is raised. As a result, while<br />
we cannot totally dismiss the default scenario, we<br />
find it highly unlikely. What would happen to the<br />
markets in the event of a default? It is safe to say<br />
that the USD would come under pressure.<br />
Furthermore, rates would rise significantly in the back<br />
end, as investors would want to protect themselves<br />
against higher inflation in the long term as the USD<br />
stands to lose its reserve currency status. Once its<br />
safe-haven status disappears, US debt would carry a<br />
stigma for a long time. Being denominated in USD,<br />
commodities would spike, and TIPS breakevens<br />
would rise materially. Additionally, a downgrade is<br />
3<br />
2.5<br />
2<br />
1.5<br />
1<br />
0.5<br />
CPI - Chain-Weighted CPI<br />
Core CPI - Core Chain-Weighted CPI<br />
Sergey Bondarchuk / IRS NY Team 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
51<br />
www.GlobalMarkets.bnpparibas.com
likely to lead to higher debt-servicing costs down the<br />
road.<br />
Market implications in the event of a downgrade are<br />
likely to be similar: higher rates, steeper curve,<br />
tightening swap spreads (or in the case of the 30y,<br />
becoming more negative), much higher implied<br />
volatility, and wider TIPS breakevens especially in<br />
short maturities. If we look at other developed<br />
nations that have faced actual downgrades, then the<br />
results suggest that the eventual impact on debt is<br />
likely to be positive (perhaps due to austerity<br />
measures being taken). However, there is also a<br />
common theme here: there was initially a downtrade.<br />
Perhaps, it takes a market reaction to really bring<br />
opposing lawmakers together in agreement, and<br />
some have expressed this view regarding the current<br />
debate in the US.<br />
Sergey Bondarchuk / IRS NY Team 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
52<br />
www.GlobalMarkets.bnpparibas.com
Table 1: <strong>BNP</strong> Paribas Carry Analysis<br />
Benchmark Carry<br />
Pricing Date<br />
28-Jul-11<br />
Term 1<br />
Term 2<br />
3m<br />
6m<br />
12m<br />
Repo Rate<br />
0.42% 0.42% 0.34% 0.34% 0.56%<br />
Sett. Date<br />
29-Jul-11 01-Sep-11 01-Oct-11<br />
31-Oct-11<br />
30-Jan-12<br />
30-Jul-12<br />
Yield BE Real BE Real BE Real BE Real BE Real BE<br />
Short-end<br />
OATei Jul-12 -0.58% 1.90% -15.3 -16.4 -94.0 -92.8 -61.7 -58.0 -26.9 -6.9<br />
OATI Jul-13 -0.09% 1.60% -2.1 -3.6 -19.8 -21.3 -5.5 -7.0 -22.1 -23.1 -10.5 -10.5<br />
TIPS Jul-12 -1.38% 1.58% -22.5 -23.8 -38.1 -40.4 -45.1 -48.0 -146.9 -152.0<br />
UKTi Aug-13 -2.55% 3.23% -24.0 -24.6 -1.5 -2.7 27.3 25.6 40.6 37.4 85.6 85.8<br />
5y<br />
BUNDEI Apr-16 0.21% 1.79% -1.6 -3.1 -14.7 -17.1 -5.9 -9.4 6.7 0.1 16.7 5.4<br />
BTANI Jul-16 0.36% 2.07% 0.0 -2.4 -5.9 -10.1 0.4 -5.7 -2.2 -14.4 8.9 8.9<br />
TIPS Apr-16 -0.60% 1.89% -2.7 -5.5 -3.6 -8.9 -2.6 -10.4 -6.6 -22.3 9.4 -24.0<br />
UKTi Nov-17 -0.77% 3.03% -1.5 -4.3 -6.9 -12.2 2.7 -5.1 19.6 3.6 51.3 18.4<br />
JGBI-4 June-15 0.63% -0.35% -3.9 -4.4 2.7 1.8 9.2 8.0 25.6 23.2 42.2 37.1<br />
10y<br />
OATEI Jul-22 1.13% 2.17% 0.0 -2.1 -4.9 -8.8 -0.2 -6.2 7.5 -4.3 16.4 -6.7<br />
OATI Jul-19 0.70% 2.32% 0.3 -1.9 -3.1 -7.2 1.4 -4.9 1.0 -11.5 10.4 10.4<br />
TIPS Jan-21 0.55% 2.35% -0.2 -3.4 0.4 -5.7 2.0 -6.9 3.6 -14.4 18.8 -18.1<br />
UKTi Nov-22 0.19% 3.06% 0.0 -2.9 -2.4 -7.9 4.0 -4.1 16.1 -0.1 38.4 5.4<br />
JGBI-16 June-18 1.02% -0.42% -1.7 -2.5 2.7 1.2 6.8 4.9 15.8 11.8 28.6 20.1<br />
30y<br />
OATei Jul-40 1.41% 2.58% 0.1 -1.2 -2.0 -4.5 0.2 -3.6 3.9 -3.7 8.3 -6.4<br />
OATI Jul-29 1.26% 2.58% 0.5 -1.3 -1.0 -4.4 1.7 -3.4 2.6 -7.7 9.4 9.4<br />
TIPS Feb-41 1.62% 2.64% 0.4 -2.0 1.0 -3.5 2.0 -4.5 3.8 -9.1 12.0 -14.0<br />
UKTI Mar-40 0.55% 3.54% 0.1 -1.8 -0.7 -4.4 1.9 -3.5 6.9 -3.8 15.7 -5.5<br />
Short-end<br />
Term 1 -> Term 2 Term 2 -> 3m<br />
3m -> 6m<br />
6m -> 12m<br />
OATei Jul-12 -78.7 -76.4 30.5 32.9 34.8 51.1 26.9 6.9<br />
OATI Jul-13 -17.8 -17.7 13.1 12.9 -16.7 -16.1 11.7 12.6<br />
TIPS Jul-12 -15.7 -16.6 -7.8 -8.8 -101.8 -104.0 146.9 152.0<br />
UKTi Aug-13 22.5 21.9 28.7 28.2 13.3 11.9 45.0 48.3<br />
5y<br />
BUNDEI Apr-16 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0<br />
BTANI Jul-16 -13.0 -14.0 8.2 7.2 12.6 9.5 10.0 5.3<br />
TIPS Apr-16 -5.9 -7.7 5.8 3.9 -2.6 -8.6 11.1 23.3<br />
UKTi Nov-17 -1.0 -3.4 0.9 -1.7 -4.0 -11.9 16.0 -1.7<br />
JGBI-4 June-15 6.6 6.2 6.8 6.4 16.4 15.2 16.6 13.8<br />
10y<br />
OATEI Jul-22 -4.9 -6.7 4.4 2.5 7.7 1.9 8.9 -2.4<br />
OATI Jul-19 -3.4 -5.3 4.1 2.1 -0.4 -6.6 9.4 21.9<br />
TIPS Jan-21 0.6 -2.3 1.7 -1.4 1.5 -7.5 15.2 -3.7<br />
UKTi Nov-22 -2.4 -5.0 6.3 3.5 12.1 3.9 22.3 5.5<br />
JGBI-16 June-18 4.4 3.7 4.4 3.8 9.0 6.9 12.8 8.3<br />
30y<br />
OATei Jul-40 -2.1 -3.3 2.0 0.8 3.7 -0.1 4.4 -2.7<br />
OATI Jul-29 -1.5 -3.1 2.5 0.8 0.8 -4.3 6.8 17.1<br />
TIPS Feb-41 0.6 -1.4 1.1 -1.2 1.8 -4.6 8.1 -4.9<br />
UKTI Mar-40 -0.8 -2.5 2.6 0.7 4.9 -0.3 8.8 -1.7<br />
Source: <strong>BNP</strong> Paribas<br />
Hervé Cros 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
53<br />
www.GlobalMarkets.bnpparibas.com
Trade Reviews<br />
Options, Money Market and Bond Trades – Tactical & Strategic Trades<br />
This page summarises our main tactical (T) and strategic (S) trades. The former focus on short-term horizons (a few weeks),<br />
allowing one to play any near-term corrections within a defined trend, while the latter rely on a medium-term assumed trend.<br />
For each trade we provide the expected target and the recommended stop loss.<br />
New Strategies<br />
USD 5s10s Spread Flattener Long 5Y Spread Short 10Y Spread<br />
We like this position due to the following: (i) auction stats indicating a favourable<br />
bias going into next week; (ii) belief that Europe could deteriorate further, helping 5y<br />
spreads to outperform; (iii) belief that US downgrade fears could rise, weighing on<br />
10y and 30y spreads.<br />
Current* Targets Stop Entry<br />
-17.25<br />
(T)<br />
-25.0 -16.0 -19.25<br />
(21-Jul)<br />
Carry<br />
/ mth<br />
Risk**<br />
P/L<br />
(ccy/Bp)<br />
15k/01 USD -30k<br />
-2bp<br />
Current Strategies<br />
Yield Curves<br />
USD 2s10s Box Spread Buy 6m-fwd 2s10s Sell 1y-fwd 2s10s<br />
Flattening implied from 6m- to 1y-fwd is too little compared to history, and position<br />
has little negative roll. Will tend to work in a sell-off and risk-reward looks better than<br />
for other bearish trades.<br />
9.5<br />
(S)<br />
30.0 0.0 10.0<br />
(19-Jul)<br />
15k/01 USD -7.5k<br />
-0.5bp<br />
Money Markets<br />
Eurodollar 1-2-3 Fly Sell ED U1Z1H2<br />
It makes no macro sense for the fly to be positive given that hikes are more likely to<br />
come later rather than sooner. Strong selling flows in Z1 (for Libor protection) have<br />
pushed the fly to attractive levels.<br />
Eurodollar blues/golds fly Sell ED M5Z5M6<br />
Z5 looks quite cheap on the curve vs. surrounding contracts (same goes for 4y1y<br />
swaps). On a fly, these points look almost at all-time cheap levels, and an added<br />
feature of the trade is its lack of directionality.<br />
6.0<br />
(T)<br />
9<br />
(T)<br />
-3.0 11.0 6.0<br />
(13-Jul)<br />
-3.0 16.0 9.5<br />
(19-Jul)<br />
20k/01 USD 0k<br />
0bp<br />
30k/01 USD +15k<br />
0.5bp<br />
Options<br />
USD 7s10s15s Conditional Bear-Tightener Buy 1Y7Y Payer Sell 1Y10Y Payer -20k<br />
Buy 1Y15Y Payer<br />
(S)<br />
7s10s15s (either spot or 1y-fwd) has rarely gone above the current level of 11bp in<br />
its entire history, but using payers one can sell the fly at 17bp (due to vol advantage)<br />
if the trade is in the money at expiry.<br />
Euribor Call Spread Buy Euribor Z1 9825/50 CS<br />
11.5<br />
Upside risk with good risk/reward. ECB priced at 2% year-end, could see significant (S)<br />
retracement in between.<br />
*Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps.<br />
300k -150k 0k<br />
(14-Jun)<br />
25.0 0.0 3.25<br />
(12-Apr)<br />
1k/01 USD<br />
-20k<br />
. 12.5k/01 EUR<br />
+100k<br />
+8c<br />
Interest Rate Strategy 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
54<br />
www.GlobalMarkets.bnpparibas.com
So What if the US Loses its AAA Status?<br />
• Under a scenario of a US ratings downgrade<br />
with no default, USD may not come to any<br />
(sustained) great harm<br />
• Assuming default is avoided and the debt<br />
ceiling raised, focus may quickly turn to the<br />
scale of 2012 fiscal drag<br />
• Fiscal headwinds keeping growth subdued<br />
in 2012 plays to extension of USD downside risk<br />
through 2011.<br />
Chart 1: Japan Downgrade implications for FX<br />
and JGBs<br />
US debt downgrade shouldn’t harm USD<br />
Despite the absence as yet of any agreement on US<br />
deficit reduction, we continue to assume that the<br />
default scenario will be avoided. Even if this is so,<br />
the chances of Standard & Poor’s electing to strip the<br />
US sovereign of its AAA status remains high since<br />
the agency (in contrast to Fitch and Moody’s) has<br />
made plain that in the absence of a credible 10-yr<br />
deficit reduction agreement totalling something close<br />
to USD 4trn, a downgrade is likely. As the clock ticks<br />
down towards an August “drop-dead” date (albeit<br />
perhaps a bit beyond 2 August) so the chances of a<br />
deal that gets the debt ceiling lifted without satisfying<br />
S&P in terms of scale and substance, increases.<br />
Under “downgrade not default” and especially if a<br />
downgrade is confined to a single agency (S&P), it is<br />
not clear that major flows out of US Treasuries will<br />
necessarily result. While the knee-jerk reaction will<br />
almost certainly be USD negative, there will likely<br />
need to be evidence of large-scale physical selling of<br />
Treasuries in favour of non-dollar denominated AAA<br />
securities for there to be a sustained negative dollar<br />
impact. Our analysis and investigations suggests that<br />
across the broad spectrum of bond portfolio<br />
managers (money market funds, bond mutual funds,<br />
money managers, insurance companies, official<br />
institutions and central banks), few if any will be<br />
compelled to sell (for example many are mandated<br />
only to hold “Tier 1” assets not necessarily “AAA”<br />
assets – Tier 1 encompassing paper rated as much<br />
as 6-notches below AAA). Though we have seen<br />
evidence of money market funds starting to hoard<br />
liquidity as a precaution against redemption demand,<br />
we believe this provisioning is linked more to<br />
insurance against a debt default rather than<br />
downgrade scenario.<br />
In the case of the larger foreign holders of Treasuries<br />
(China, Japan, OPEC nations, other Asian monetary<br />
authorities), any large-scale sell-down of Treasury<br />
Source: Reuters EcoWin<br />
Source: <strong>BNP</strong> Paribas. Neither JGB yields not JPY came<br />
to any sustained harm after Japan was first stripped on its<br />
AAA rating by one agency (Moody’s) in late 1998. Limited<br />
foreign ownership of JGBs makes comparisons with the<br />
US Treasury market and the dollar specious, but the<br />
observation is nevertheless worth noting.<br />
Chart 2: US Projected Deficit Reduction under<br />
“Gang of 6” Proposals<br />
0<br />
-100<br />
-200<br />
-300<br />
-400<br />
-500<br />
-600<br />
-700<br />
-800<br />
-900<br />
Total Projected Deficit Reduction<br />
Total Ex Tax Reform<br />
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021<br />
Source: <strong>BNP</strong> Paribas: Deficit reduction/implied fiscal<br />
tightening in 2012 shown here are in addition to whatever<br />
tightening is slated to occur anyway. Much depends on<br />
the extent to which tax breaks and benefit extensions<br />
currently in place are rolled forward into 29012, but we<br />
currently assume that we will get an implied fiscal<br />
tightening of some 1.8% of GDP independent of what falls<br />
out of the current deficit/debt ceiling process.<br />
debt may be viewed by these holders as a case of<br />
“cutting off your nose to spite your face” – prone to<br />
weakening the value of existing asset holdings both<br />
directly, and indirectly via weaker USD valuations. At<br />
a time when investors – central banks and otherwise<br />
– remain hesitant to add to euro-denominated debt<br />
holdings until greater clarity is provided on the<br />
substance of the new EU agreement on Greek<br />
funding and expanded EFSF remit, it is not clear<br />
funds will flow from US Treasuries to AAA-rated<br />
eurozone debt on any significant scale. Meanwhile,<br />
Ray Attrill 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
55<br />
www.GlobalMarkets.bnpparibas.com
UK (AAA) debt is already under the ratings spotlight<br />
while non-US and European AAA-rated sovereign<br />
credit markets (Australia, Canada, Sweden and<br />
Norway) are simply too small to accommodate<br />
inflows on the scale that would make an appreciable<br />
difference to total US Treasury holdings.<br />
Comparisons with Japan’s 1998 experience of losing<br />
their AAA status, initially from just from one ratings<br />
agency (Moody’s) are not that relevant give the<br />
limited foreign ownership of the JGB market, though<br />
it is worth noting that neither JGB yields nor the JPY<br />
came to any sustained harm (see Chart 1)<br />
Also important to keep in mind are the circumstances<br />
under which S&P issues a downgrade. This will be<br />
because of the absence of an agreement to medium<br />
term deficit reduction on a sufficient scale to<br />
convince the agency that US debt is being put on a<br />
sustainable footing. However as far as 2012 is<br />
concerned, it is highly probable that this will be the<br />
first time for many years that fiscal policy is acting as<br />
a headwind rather than tailwind on the economy. As<br />
such, any growth acceleration in 2012 versus what<br />
we expect will be something close to 2% in 2011 may<br />
be modest at best and conceivably non-existent.<br />
As and when we get through the current debt ceiling<br />
debacle and assuming default is avoided but not an<br />
S&P downgrade, then markets are likely to quickly<br />
refocus on the implications of fiscal policy for the<br />
2012 growth outlook. To the extent this will play to<br />
the view that the Fed will be “easier for longer”, then<br />
even in the absence of moves to price in QE3, the<br />
more likely it is that dollar remains on a weakening<br />
trend though the remainder of 2011.<br />
Ray Attrill 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
56<br />
www.GlobalMarkets.bnpparibas.com
Little Justification For BoJ Intervention<br />
• Strength of JPY driven more by concerns<br />
over US debt-ceiling deadlock than internal<br />
factors<br />
• Odds of BoJ intervention are low unless<br />
USDJPY moves become disorderly<br />
160<br />
150<br />
140<br />
130<br />
120<br />
110<br />
Chart 1: JPY REER v. JPY REER LT Avg.<br />
JPY REER Long Term Avg<br />
Focus on the US debt ceiling has kept safe-haven<br />
currencies like the JPY and CHF very well bid<br />
against the USD. USDCHF has reached an all-time<br />
low while USDJPY is well below 80, the once<br />
perceived line in the sand for Japanese officials. As<br />
USDJPY continues to trade below 80.00, speculation<br />
of intervention from the BoJ is rising. But in our view,<br />
the likelihood of intervention is very slim, barring any<br />
disorderly moves in USDJPY. While the motive for<br />
intervention is there for Japan as it continues to<br />
recover from the devastating earthquakes earlier this<br />
year, the reasoning is rather weak.<br />
For one, the intervention in March was the result of<br />
internal factors, chiefly the Japan earthquake. With<br />
JPY flows flooding back home, JPY made significant<br />
gains against the majors: USDJPY fell from a high of<br />
79.75 to 76.25 while EURJPY dropped to 106.61<br />
from 111.27 on 17 March. The G7 countries acted in<br />
solidarity via a coordinated intervention to mitigate<br />
the strength of the currency and help allay one of<br />
Japan’s key concerns. This time around, JPY<br />
strength has been mostly against the USD on the<br />
back of the stalemate on the US debt ceiling. With<br />
the US deep in its fiscal mess and the eurozone<br />
mending its own fiscal issues, a coordinated<br />
intervention would be a hard sell. In addition, FX<br />
intervention would likely prove to be unsuccessful as<br />
it would have to be accompanied by complementary<br />
BoJ policy (further monetary easing). The last<br />
intervention had a very limited impact on the JPY<br />
because while the BoJ initially expanded its balance<br />
sheet (to new record highs), it shrank it back down<br />
once the new fiscal year began in April. This<br />
undermined efforts to weaken the JPY. With the BoJ<br />
showing little inclination to embark on fresh balancesheet<br />
expansion (let alone JGB monetisation),<br />
unilateral intervention could quickly turn into an<br />
expensive policy mistake.<br />
Second, while the JPY may look expensive in<br />
comparison to USD in nominal terms, the picture is<br />
quite different in real terms and against an average<br />
of its trading partners. The JPY remains<br />
“undervalued” versus its trading partners on a REER<br />
100<br />
90<br />
80<br />
JPY REER<br />
70<br />
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11<br />
Source: <strong>BNP</strong> Paribas<br />
95.0<br />
92.5<br />
90.0<br />
87.5<br />
85.0<br />
82.5<br />
80.0<br />
Chart 2: USDJPY v. 10yr Yield Differential<br />
77.5<br />
Nov Jan<br />
09<br />
Source: <strong>BNP</strong> Paribas<br />
USD/JPY<br />
10y UST v. JGB (RHS)<br />
Mar May Jul Sep Nov Jan<br />
10<br />
Mar May Jul<br />
11<br />
2.6<br />
2.5<br />
2.4<br />
2.3<br />
2.2<br />
2.1<br />
2.0<br />
1.9<br />
1.8<br />
1.7<br />
1.6<br />
1.5<br />
1.4<br />
basis, being well below its long term average. Since<br />
the start of 2011, the currencies of some of Japan’s<br />
key trading partners including EUR, KRW, and SGD<br />
have outperformed the JPY. Although the MYR has<br />
underperformed the JPY in recent months, it has<br />
since made a comeback. The USD has been the only<br />
big and consistent underperformer against JPY<br />
(China, Japan’s largest trading partner, has also<br />
underperformed but to a much lesser extent given<br />
the 5% drop in USDCNY in the past year.) In<br />
general, Japan maintains its competitiveness against<br />
its key trading partners on a REER basis and on a<br />
NEER basis against both Europe and some of its key<br />
Asian export competitors. The key positive spin on<br />
the strength of the currency against the USD is that<br />
raw materials and other commodities priced in USD<br />
have become markedly cheaper at a time when<br />
Japan begins its reconstruction efforts, something<br />
that Japanese officials have acknowledged as<br />
beneficial.<br />
Mary Nicola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
57<br />
www.GlobalMarkets.bnpparibas.com
Based on the JPY REER, the BoJ should not be too<br />
alarmed by the moves in USDJPY unless it begins to<br />
freefall. USDJPY will remain hostage to the progress<br />
(or lack thereof) on the US debt negotiation. Our<br />
base-case scenario is that the US comes to a twostage<br />
deal at the 11th hour which may not please<br />
S&P resulting in a downgrade. The knee-jerk<br />
reaction will likely be a sell-off in the back end of the<br />
UST curve but potentially a rally in the front end of<br />
the curve as the markets start pricing in further US<br />
economic weakness from the implied 2012 fiscal<br />
drag. Thus, the net impact on USDJPY may be<br />
limited given USDJPY is more highly correlated with<br />
yield spreads at the front end of the respective<br />
curves than at the longer end.<br />
Mary Nicola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
58<br />
www.GlobalMarkets.bnpparibas.com
AUD: The Future is Rosy<br />
• The robustness of AUD despite the<br />
diminishing of its yield advantage suggests the<br />
real drivers lie elsewhere.<br />
5.5<br />
5.0<br />
Chart 1: AU-US 2y Yield Spread<br />
1.10<br />
1.05<br />
• The key drivers appear to be robust<br />
sovereign demand, its role as a proxy for Asian<br />
FX appreciation and the terms of trade<br />
improvement.<br />
• STRATEGY: We believe that AUDUSD will<br />
appreciate further towards 1.15.<br />
4.5<br />
4.0<br />
3.5<br />
3.0<br />
2.5<br />
2.0<br />
1.5<br />
AU - US 2y Spread<br />
AUDUSD (RHS)<br />
1.00<br />
0.95<br />
0.90<br />
0.85<br />
0.80<br />
0.75<br />
0.70<br />
1.0<br />
0.65<br />
The outperformance of AUDUSD relative to expected<br />
interest rate differentials is not likely to be the<br />
catalyst for a sustained pullback on AUD. There has<br />
been much market discussion on the breakdown of<br />
this traditional relationship (Chart 1). We suggest<br />
that interest rate markets are not pricing in<br />
sufficient tightening from the RBA. Our<br />
economists are calling for a 25bp hike in Q4<br />
assuming that global downside risks do not<br />
crystallise. Further tightening is also likely in 2012 if<br />
the same conditions hold in contrast to almost flat<br />
market expectations. This week’s upside surprise to<br />
Q2’s CPI revealed an acceleration in underlying<br />
inflation to 2.7% y/y and it is likely to nudge higher<br />
over the balance of the year. In contrast, recent weak<br />
data in the US suggest little potential for a near-term<br />
increase in market expectations for Fed tightening.<br />
Accordingly, we believe there are prospects for the<br />
benchmark 2-year yield spread to move in favour of<br />
AUD over coming weeks. Still, the robustness of<br />
AUD, despite the diminishing of its yield<br />
advantage, suggests the real drivers lie<br />
elsewhere.<br />
The strong trend higher in Australia’s terms of<br />
trade appears consistent with the appreciation of<br />
AUD (Chart 2). The commodities boom continues to<br />
support the rise in prices of exports relative to<br />
imports while ongoing strong demand from<br />
Australia’s major trading partners, including China,<br />
should see this trend persist. This data series is only<br />
released quarterly but more recent CRB data is<br />
consistent with the terms of trade remaining at<br />
elevated levels. It is interesting to note that the<br />
moderation in China’s growth indicators since the<br />
second half of 2010, especially the PMI, has not<br />
produced a pullback in AUD. Such a divergence<br />
suggests that the improvement in Australia’s terms of<br />
trade is more broadly based that merely being a<br />
reflection of Chinese growth prospects.<br />
0.5<br />
Jul<br />
Nov<br />
08<br />
Mar Jul Nov<br />
09<br />
Source: Reuters EcoWin Pro<br />
130<br />
120<br />
110<br />
100<br />
90<br />
80<br />
70<br />
Mar Jul Nov<br />
10<br />
Mar<br />
11<br />
Chart 2: AUD TWI vs. Terms of Trade<br />
Term s of trade, Index, 2008-2009=100<br />
60<br />
01 02 03 04 05 06 07 08 09 10 11<br />
Source: Reuters EcoWin Pro<br />
1.15<br />
1.10<br />
1.05<br />
1.00<br />
0.95<br />
0.90<br />
0.85<br />
0.80<br />
0.75<br />
0.70<br />
0.65<br />
0.60<br />
0.55<br />
Jul<br />
AUD TW I (RHS)<br />
Chart 3: AUDUSD vs. CNY 12m NDFS<br />
Nov<br />
08<br />
Source: <strong>BNP</strong> Paribas<br />
AUDUSD<br />
USDCNY 12m NDF (RHS inverted)<br />
Mar Jul Nov<br />
09<br />
Mar Jul Nov<br />
10<br />
Mar<br />
11<br />
AUD may have become an FX proxy for general<br />
Asian currency appreciation. AUDUSD appears<br />
very closely linked to USDCNY 12-months NDFs and<br />
does not appear to have outpaced CNY appreciation<br />
(Chart 3). This link seems reasonable given<br />
Australia’s geographic location and its exposure to<br />
emerging Asian economies. Specifically, as official<br />
Jul<br />
Jul<br />
0.60<br />
80<br />
75<br />
70<br />
65<br />
60<br />
55<br />
50<br />
45<br />
6.2<br />
6.3<br />
6.4<br />
6.5<br />
6.6<br />
6.7<br />
6.8<br />
6.9<br />
7.0<br />
7.1<br />
7.2<br />
7.3<br />
7.4<br />
Steven Saywell 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
59<br />
www.GlobalMarkets.bnpparibas.com
intervention remains a significant risk from many of<br />
the region’s central banks there has been very little<br />
verbal opposition from Australian officials. The RBA<br />
has been capitalising on recent AUD strength to build<br />
official reserve assets but the rise has been<br />
moderate in recent months standing at AUD 41.1bn<br />
as at the end of June.<br />
In our opinion, the strongest rationale behind AUD<br />
appreciation remains demand form sovereign funds<br />
and central banks. In a world where both EUR and<br />
USD have faced debt market issues, alternatives<br />
such as AUD, CAD, GBP, JPY and SEK continue<br />
to benefit. Data on specific AUD demand is scarce.<br />
The official IMF COFER data for Q1 (IMF COFER Q1<br />
Update – EUR Conundrum) reveals the largest rise<br />
by category among countries that do report reserve<br />
breakdown by currency was among the non-specific<br />
“other” group of currencies at 12.6% q/q. This<br />
category relates to non-USD, EUR, JPY, CHF and<br />
GBP G10 holdings. We assume this group pertains<br />
mainly to AUD and CAD but a breakdown is<br />
unavailable and also excludes holdings from the<br />
largest foreign exchange reserve holder China.<br />
Separately, monthly data from the RBA report a<br />
sharp increase in total foreign ownership of<br />
Commonwealth Securities (Chart 4). The total has<br />
surged from AUD 57.8bn at the end of 2008 to<br />
AUD 191.3bn as at June 2011. This data series<br />
probably underreports total foreign held securities as<br />
purchases through local subsidiaries in Australia are<br />
likely excluded from the foreign total. Accordingly, the<br />
trend of rising holdings of AUD assets by foreign<br />
reserve managers appears clear.<br />
Chart 4: Foreign Ownership of Commonwealth<br />
AUS Government Securities. (AUD mn)<br />
200000<br />
180000<br />
160000<br />
140000<br />
120000<br />
100000<br />
80000<br />
60000<br />
40000<br />
Jun-94 Jun-98 Jun-02 Jun-06 Jun-10<br />
Source: RBA<br />
In summary, we do not believe the divergence<br />
between AUDUSD and relative near-term interest<br />
rate expectations will be a catalyst for a sustained<br />
AUD pullback. Indeed, the robustness of AUD<br />
despite the pullback in its yield advantage<br />
suggests the real drivers lie elsewhere. In<br />
contrast, the ongoing rise in Australia’s terms of trade<br />
supports the currency’s appreciation while the likely<br />
role of AUD as a proxy for Asian appreciation<br />
presents strong prospects for further appreciation.<br />
Finally, reserve manager demand is rising and<br />
should continue to remain strong. Strategically, we<br />
believe that AUDUSD will continue to appreciate<br />
beyond new multi-decade highs above 1.10 towards<br />
1.15.<br />
Steven Saywell 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
60<br />
www.GlobalMarkets.bnpparibas.com
Factors Behind The Soaring Bird Set to Hold<br />
• Increasing demand from China for dairy<br />
products to keep NZD on strong footing<br />
Chart 1: NZDUSD vs. NZ Terms of Trade<br />
• RBNZ to remove emergency rate cuts from<br />
March 2011; mispricing between rate hike from<br />
RBA vs. RBNZ to work in favour of AUD<br />
• STRATEGY: Buy AUDNZD on dips, targeting<br />
1.30<br />
NZDUSD continues to soar to new highs despite the<br />
recent rise in volatility in G10 FX markets, conjuring<br />
up questions as to whether such moves are<br />
overextended and whether this move is in fact<br />
warranted.<br />
First and foremost, New Zealand is experiencing a<br />
significant positive terms-of-trade shock as trade with<br />
China and emerging Asia has soared in recent years<br />
along with food prices – including those for dairy<br />
products, which account for about 22% of exports.<br />
Second, reconstruction is underway as New Zealand<br />
rebuilds after the Christchurch earthquakes. Third,<br />
NZD is gaining ground in this low-rate environment<br />
not only because of absolute rate differentials but<br />
also because markets are pricing in further rate hikes<br />
from the RBNZ as the economy rebounds.<br />
As a soft commodity exporter, New Zealand is<br />
benefiting from the surge in food prices. Earlier this<br />
year, the IMF noted that the world would have to get<br />
used to higher food prices given the rise in demand<br />
for food commensurate with global income growth<br />
and other structural factors. The IMF argues that this<br />
phenomenon is not going away anytime soon, a<br />
sentiment with which we broadly agree.<br />
But more specific to NZD is the surge in exports to<br />
China and emerging Asia. Following the 2008 milk<br />
scandals in China when some 300,000 children fell ill<br />
from drinking melamine-contaminated milk, a general<br />
distrust of Chinese-produced dairy products led to an<br />
increase in imports. New Zealand benefited greatly<br />
from this, and it is now China’s second largest<br />
trading partner (after Australia). The demand for<br />
dairy products has risen not only for this reason but<br />
also because of a rising middle class in China and<br />
emerging Asia. Demand for dairy produce in China<br />
among high-income households is twice as strong as<br />
among low-income ones. We also find that the price<br />
elasticity of export demand for dairy products is very<br />
low; this means that higher dairy prices arising from<br />
both the ongoing appreciation of the NZD and the<br />
Source: <strong>BNP</strong> Paribas<br />
Chart 2: AUDNZD v. Relative Rate Expectations<br />
Source: <strong>BNP</strong> Paribas<br />
rising trend in (NZD-constant) prices is not impacting<br />
negatively on overall demand. As such, the positive<br />
terms-of-trade shock seen in New Zealand will likely<br />
persist.<br />
The devastating earthquakes in Christchurch, New<br />
Zealand’s second largest city, in September 2010<br />
and February 2011 require enormous reconstruction,<br />
with an estimated building cost of USD 20bn.<br />
Rebuilding efforts now look to be starting to have a<br />
positive impact on the economy via a surge in<br />
construction investment, after Q1 (earthquake<br />
affected) GDP data surprised significantly to the<br />
upside with a gain of 0.8%.<br />
NZD is also benefiting in this low-rate environment as<br />
one of the higher yielding currencies in the G10<br />
space. Even at the post-earthquake emergency level<br />
of 2.5%, money market rates remain favourable with<br />
respect to most other G10 currencies. And, we<br />
should soon see RBNZ reverse its emergency rate<br />
cut. While the RBNZ left rates unchanged in July,<br />
they were optimistic on the economic recovery and<br />
noted that they see little need to maintain the<br />
emergency rate setting from back in March. This<br />
Mary Nicola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
61<br />
www.GlobalMarkets.bnpparibas.com
statement was followed by concerns over the<br />
strength of NZD and that if its strength persists, then<br />
“it is likely to reduce the need for further OCR<br />
increases in the short term”. The key phrase here is<br />
“further OCR increases”, which is interpreted to<br />
mean they would soon get rid of the emergency 50bp<br />
cut from back in March but with limited tightening<br />
thereafter assuming NZD remains so strong. After<br />
the meeting, a Reuters poll showed that the<br />
consensus now expects the RBNZ to raise rates by<br />
50bp at the next meeting on 15 September. After<br />
that, consensus is looking for rates to rise to 3.25%<br />
by March 2012 and then 3.5% by June 2012. The<br />
market is now pricing in about 111bp of rate rises<br />
over the next 12 months, a view with which we are in<br />
broad agreement.<br />
While the market is fully pricing in the removal of the<br />
RBNZ emergency cut and looking for more rate hikes<br />
from the RBNZ further down the road, we think the<br />
market is significantly under-pricing tightening risks<br />
from the RBA. Currently, the market is looking for<br />
about 19bp in cuts over the next 12 months, but a<br />
15% chance of a rate hike at the upcoming meeting.<br />
In our view, the uncomfortably high Q2 CPI outcome<br />
will, at the very least, see the RBA shifting its rhetoric<br />
at the upcoming (2 August) meeting. We expect a<br />
hike from the RBA to come in Q4. Thus, in the short<br />
term, this disconnect in rate pricing will work in favour<br />
of AUD v. NZD. AUDNZD could rally back up to 1.30<br />
on a hawkish RBA.<br />
Mary Nicola 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
62<br />
www.GlobalMarkets.bnpparibas.com
Economic Calendar: 29 Jul - 5 Aug<br />
GMT Local Previous Forecast Consensus<br />
Fri 29/07 23:01 00:01 UK GfK Consumer Survey : Jul -25 -26 -26<br />
(28/07)<br />
08:30 10:30 Mortgage Approvals : Jun 45.9k 46.0k 46.0k<br />
08:30 10:30 Net Consumer Credit : Jun GBP0.2bn GBP0.2bn GBP0.3bn<br />
23:30 08:30 Japan CPI National y/y : Jun 0.3% 0.2% 0.2%<br />
23:30 08:30 Core CPI National y/y : Jun 0.6% 0.4% 0.5%<br />
23:30 08:30 CPI Tokyo y/y : Jul -0.2% 0.1% 0.0%<br />
23:30 08:30 Core CPI Tokyo y/y : Jul 0.1% 0.2% 0.2%<br />
23:30 08:30 Household Consumption y/y : Jun -1.9% -4.3% -2.3%<br />
23:30 08:30 Unemployment Rate (sa) : Jun 4.5% 4.6% 4.6%<br />
23:50 08:50 Industrial Production (Prel, sa) m/m : Jun 6.2% 4.5% 4.5%<br />
(28/07)<br />
05:00 14:00 Housing Starts y/y : Jun 6.4% 7.8% 4.6%<br />
06:45 08:45 France Retail Sales m/m : Jun -0.8% 1.0% n/a<br />
06:45 08:45 Retail Sales y/y : Jun -1.8% 0.9% n/a<br />
06:45 08:45 PPI m/m : Jun -0.5% 0.3% -0.1%<br />
06:45 08:45 PPI y/y : Jun 6.1% 6.2% 5.9%<br />
07:00 09:00 Spain HICP Flash y/y : Jul 3.0% 2.9% 2.9%<br />
07:00 09:00 Unemployment Rate : Q2 21.3% 21.0% 20.9%<br />
07:00 09:00 Norway Unemployment Rate (nsa) : Jul 2.5% 2.7% n/a<br />
07:30 09:30 Sweden GDP (Prel, sa) q/q : Q2 0.8% 0.6% 0.6%<br />
07:30 09:30 GDP (Prel, sa) y/y : Q2 6.5% 5.0% 5.0%<br />
07:30 09:30 Eurozone Eurocoin : Jul 0.52 0.37 n/a<br />
09:00 11:00 HICP (Flash) y/y : Jul 2.7% 2.7% 2.7%<br />
09:00 11:00 Italy CPI (NIC, Prel) m/m : Jul 0.1% 0.2% 0.2%<br />
09:00 11:00 CPI (NIC, Prel) y/y : Jul 2.7% 2.6% 2.6%<br />
09:00 11:00 HICP (Prel) m/m : Jul 0.1% -1.3% -1.0%<br />
09:00 11:00 HICP (Prel) y/y : Jul 3.0% 2.6% 2.9%<br />
12:30 08:30 US GDP (Adv, saar) q/q : Q2 1.9% 1.0% 1.8%<br />
12:30 08:30 GDP Deflator (Adv, saar) q/q : Q2 2.0% 1.5% 2.0%<br />
12:30 08:30 Employment Cost Index q/q : Q2 0.6% 0.5% 0.5%<br />
12:30 08:30 Employment Cost Index y/y : Q2 2.0% 2.0% n/a<br />
13:45 09:45 Chicago PMI : Jul 61.1 58.0 60.0<br />
13:55 09:55 Michigan Sentiment (Final) : Jul 71.5 65.0 64.0<br />
19:15 15:15 Fed’s Bullard & Lockhart Speak on Monetary Policy in Wyoming<br />
12:30 08:30 Canada GDP m/m : May<br />
13:00 15:00 Belgium GDP (Flash) q/q : Q2 1.1% 0.5% 0.3%<br />
13:00 15:00 GDP (Flash) y/y : Q2 3.0% 2.4% n/a<br />
Mon 01/08 07:30 09:30 Switzerland PMI Manufacturing : Jul 53.4 52.0 52.8<br />
08:00 10:00 Eurozone PMI Manufacturing (Final) : Jul 50.4 (p) 50.4 50.4<br />
09:00 11:00 Unemployment Rate : Jun 9.9% 9.9% 9.9%<br />
08:30 09:30 UK CIPS Manufacturing : Jul 51.3 50.0 51.0<br />
Canada Public Holiday<br />
14:00 10:00 US Construction Spending m/m : Jun -0.6% -0.3% -0.1%<br />
14:00 10:00 ISM Manufacturing : Jul 55.3 54.5 55.2<br />
Tue 02/08 01:30 11:30 Australia House Price Index q/q : Q2 -1.7% -1.0% n/a<br />
04:30 14:30 RBA Rate Announcement<br />
09:00 11:00 Eurozone PPI m/m : Jun -0.2% 0.1% 0.1%<br />
09:00 11:00 PPI y/y : Jun 6.2% 6.0% 6.0%<br />
12:30 08:30 US Personal Income m/m : Jun 0.3% 0.1% 0.2%<br />
12:30 08:30 Personal Spending m/m : Jun 0.0% 0.0% 0.2%<br />
Market Economics 28 July 2011<br />
Market Mover<br />
63<br />
www.GlobalMarkets.bnpparibas.com
Economic Calendar: 29 Jul - 5 Aug (cont)<br />
GMT Local Previous Forecast Consensus<br />
Wed 03/08 01:30 11:30 Australia Trade Balance : Jun AUD2333mn AUD2000mn n/a<br />
01:30 11:30 Retail Sales m/m : Jun -0.6% 1.0% n/a<br />
01:30 11:30 Retail Sales y/y : Jun 2.2% 2.9% n/a<br />
08:00 10:00 Eurozone PMI <strong>Services</strong> (Final) : Jul 51.4 (p) 51.4 51.4<br />
08:00 10:00 PMI Composite (Final) : Jul 50.8 (p) 50.8 n/a<br />
10:00 12:00 Retail Sales (sa) m/m : Jun -1.0% 0.5% 0.5%<br />
10:00 12:00 Retail Sales (ca) y/y : Jun -1.8% -1.3% -0.9%<br />
08:30 09:30 UK CIPS <strong>Services</strong> : Jul 53.9 53.1 53.5<br />
11:30 07:30 US Challenger Layoffs : Jul<br />
12:15 08:15 ADP Labour Change : Jul 157k 100k 105k<br />
14:00 10:00 Factory Orders m/m : Jun 0.8% -1.0% -0.5%<br />
14:00 10:00 ISM Non-Manufacturing : Jul 53.3 52.5 54.0<br />
14:30 10:30 EIA Oil Inventories<br />
Thu 04/08 07:30 09:30 Neths CPI m/m : Jul -0.5% -0.1% n/a<br />
07:30 09:30 CPI y/y : Jul 2.3% 2.4% n/a<br />
08:00 10:00 Norway Unemployment Rate (sa) : May 3.4% 3.4% n/a<br />
10:00 12:00 Germany Factory Orders m/m : Jun 1.8% -2.5% -0.2%<br />
10:00 12:00 Factory Orders y/y : Jun 12.2% 5.1% 6.8%<br />
11:00 12:00 UK BoE Rate Announcement<br />
11:45 13:45 Eurozone ECB Rate Announcement<br />
12:30 14:30 ECB Press Conference<br />
12:30 08:30 US Initial Claims 398k 415k n/a<br />
Fri 05/08 Japan BoJ Rate Announcement<br />
Australia RBA Policy Statement<br />
06:45 08:45 France Trade Balance : Jun EUR-7.4bn EUR-6.9bn EUR-6.1bn<br />
07:00 09:00 Spain Industrial Production (wda) y/y : Jun -0.4% n/a<br />
07:15 09:15 Switzerland CPI m/m : Jul -0.2% -0.6% -0.6%<br />
07:15 09:15 CPI y/y : Jul 0.6% 0.7% 0.7%<br />
07:30 09:30 Neths Industrial Production m/m : Jun 0.3% -1.5% n/a<br />
07:30 09:30 Industrial Production y/y : Jun 2.6% 1.1% n/a<br />
08:00 10:00 Italy Industrial Production m/m : Jun -0.6% -0.2% n/a<br />
08:00 10:00 Industrial Production (wda) y/y : Jun 1.8% 1.2% n/a<br />
09:00 11:00 GDP (Prel) q/q : Q2 0.1% 0.2% n/a<br />
09:00 11:00 GDP (Prel) y/y : Q2 1.0% 0.7% n/a<br />
08:00 10:00 Norway Manufacturing Prod (sa) m/m : Jun 2.4% 1.0% n/a<br />
08:00 10:00 Manufacturing Prod (nsa) y/y : Jun 5.6% 2.0% n/a<br />
08:30 09:30 UK Input PPI (nsa) m/m : Jul 0.4% 0.6% 0.6%<br />
08:30 09:30 Output PPI (nsa) y/y : Jul 5.7% 5.8% 5.8%<br />
08:30 09:30 Output PPI (Ex-FDT, sa) y/y : Jul 3.2% 3.2% 3.2%<br />
10:00 12:00 Germany Industrial Production m/m : Jun 1.2% -0.5% 0.1%<br />
10:00 12:00 Industrial Production y/y : Jun 7.6% 7.8% 8.1%<br />
11:00 07:00 Canada Unemployment Rate : Jul 7.4% 7.5% 7.5%<br />
11:00 07:00 Payroll Jobs y/y : Jul 28.4k 13.0k 20.0k<br />
12:30 08:30 US Non-Farm Payrolls (Chg) : Jul 18k 50k 100k<br />
12:30 08:30 Unemployment Rate : Jul 9.2% 9.3% 9.2%<br />
12:30 08:30 Average Hourly Earnings m/m : Jul 0.0% 0.1% 0.2%<br />
19:00 15:00 Consumer Credit : Jun USD5.1bn USD5.0bn USD5.1bn<br />
During 1-5 UK Halifax House Prices m/m : Jul 1.2% 0.0% 0.0%<br />
Week Halifax House Prices y/y : Jul -3.5% -2.8% -2.8%<br />
Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision<br />
Source: <strong>BNP</strong> Paribas<br />
Market Economics 28 July 2011<br />
Market Mover<br />
64<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
3<br />
2<br />
1<br />
0<br />
-1<br />
-2<br />
-3<br />
Chart 1: Japanese CPI (% y/y)<br />
CPI excluding energy and<br />
food, but not alcohol<br />
Core CPI<br />
02 03 04 05 06 07 08 09 10 11<br />
Source: MIC, <strong>BNP</strong> Paribas<br />
% y/y Jun (f) May Apr Mar<br />
Core CPI 0.4 0.6 0.6 -0.1<br />
CPI 0.2 0.3 0.3 0.0<br />
<strong>BNP</strong> Paribas Forecast: Positive But Slower<br />
Japan: CPI (National, June)<br />
Release Date: Friday 29 July<br />
We estimate that core CPI inflation in June will stay positive<br />
but ease 0.2pp to 0.4% y/y, reflecting slower price growth<br />
for energy. In April, the index returned to growth for the first<br />
time in 28 months with a rise of 0.6% y/y. That rate of<br />
increase – the fastest since November 2008 – was<br />
maintained in May. But the price growth leader, energy, has<br />
steadily lost momentum, going from 7.3% growth in April to<br />
5.7% in May; this reduced momentum should continue in<br />
June, resulting in the index’s slower rate of growth.<br />
Meanwhile, index rebasing (2005 to 2010), to take effect<br />
from the 26 August release of the national CPI data for July,<br />
will lower the core CPI by 0.7-0.8pp (according to our<br />
estimates). The rebasing (2000 to 2005) five years ago<br />
lowered the index by 0.5pp. Consequently, under the new<br />
index, the core CPI should hover around zero, while the<br />
US-style core-core CPI (0.1% y/y in May) will probably turn<br />
negative again.<br />
Key Point:<br />
The national core index in June should stay positive<br />
but post slightly slower growth, reflecting the<br />
reduced price growth of energy.<br />
Chart 2: Japanese Unemployment Rate (% s.a.)<br />
6.0<br />
5.5<br />
5.0<br />
4.5<br />
4.0<br />
3.5<br />
00 01 02 03 04 05 06 07 08 09 10 11<br />
Source: MIC, <strong>BNP</strong> Paribas<br />
% s.a. Jun (f) May Apr Mar<br />
Unemployment Rate 4.6 4.5 4.7 4.6<br />
Key Point:<br />
Employment is starting to pick up, with the<br />
automobile industry planning on hiring more<br />
contract workers. Even so, we expect the<br />
unemployment rate in June to rise slightly.<br />
<strong>BNP</strong> Paribas Forecast: Slight Rise<br />
Japan: Unemployment Rate (June)<br />
Release Date: Friday 29 July<br />
In May, the jobless rate eased 0.2pp to 4.5%, as the<br />
jobless total declined with the continued swelling of the<br />
ranks of those categorised as not in the work force. Though<br />
job growth in May was still anaemic, we expect<br />
employment to gradually start to recover, as manufacturing<br />
activity is expected to return to pre-disaster levels by the<br />
autumn thanks to the rapid restoration of supply chains.<br />
The automobile industry, which was especially hard hit by<br />
the disaster, plans on hiring more contract workers as<br />
leading carmakers gear up for production increases from<br />
the autumn. Despite steady improvements on the job front,<br />
we expect the unemployment rate in June to deteriorate<br />
slightly to 4.6% due to an increase in the labour force<br />
participation rate.<br />
Note that the areas hit hardest by the Great East Japan<br />
Earthquake are still excluded from the data as surveying<br />
remains difficult.<br />
Market Economics 28 July 2011<br />
Market Mover<br />
65<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
Chart 3: Japanese Production and Exports<br />
120<br />
115<br />
110<br />
105<br />
100<br />
95<br />
90<br />
85<br />
80<br />
75<br />
70<br />
65<br />
(2005=100, seasonally adjusted)<br />
00 01 02 03 04 05 06 07 08 09 10 11<br />
Source: METI, <strong>BNP</strong> Paribas<br />
Production<br />
Exports (RHS)<br />
150<br />
140<br />
130<br />
120<br />
110<br />
100<br />
90<br />
80<br />
70<br />
60<br />
50<br />
Jun (f) May Apr Mar<br />
IP % m/m 4.5 6.2 1.6 -15.5<br />
Key Point:<br />
Although production is expected to continue<br />
expanding robustly in June, the slowing global<br />
economy and power shortages at home cast clouds<br />
over future factory activity.<br />
<strong>BNP</strong> Paribas Forecast: Recovering For Now<br />
Japan: Industrial Production (June)<br />
Release Date: Friday 29 July<br />
We expect production in June to expand by a solid 4.5%<br />
m/m, continuing May’s robust growth of 6.2%. While such<br />
an outturn would confirm that production activities are<br />
reviving thanks to the restoration of supply chains, the<br />
outlook is not without clouds. For one thing, power<br />
shortages are set to restrain the recovery of production<br />
over the summer. Indeed, with the growing political<br />
controversy around restarting idle nuclear reactors, power<br />
shortages have now become an issue for the entire nation,<br />
not just for the region of Japan that was directly affected by<br />
the earthquake.<br />
There are risks on the demand side too, as the global<br />
economy has been slowing. The US and Europe continue<br />
to struggle with their balance-sheet problems, while the<br />
combination of rising inflation pressure and slowing growth<br />
is posing challenges for policymakers in many emerging<br />
economies. Thus, the downside risk to external demand<br />
looks high. Given this background, the main focus of<br />
attention in the June report is the production plan survey<br />
for the summer months.<br />
Chart 4: French Retail Sales vs. Confidence<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
-1<br />
-2<br />
-3<br />
Retail Sales (% y/y, volume)<br />
Household Confid. (RHS)<br />
Commission Survey<br />
05 06 07 08 09 10 11<br />
Source: Reuters EcoWin Pro<br />
Constant Prices Jun (f) May Apr Jun 10<br />
SA-WDA<br />
Retail Sales % m/m 1.0 -0.8 -1.4 -1.8<br />
Retail Sales % y/y 0.9 -1.8 0.0 -0.7<br />
Key Point:<br />
The sharp fall seen in May reflects distortions; we<br />
forecast a strong rebound as soon as June.<br />
5<br />
0<br />
-5<br />
-10<br />
-15<br />
-20<br />
-25<br />
-30<br />
-35<br />
-40<br />
<strong>BNP</strong> Paribas Forecast: Strong Rebound<br />
France: Retail Sales (June)<br />
Release Date: Friday 29 July<br />
The recent collapse in retail sales was not consistent with<br />
the level of household confidence. Higher inflation weighed<br />
on households' purchasing power and caused a decline in<br />
retail sales. Moreover, the fall may have been amplified by<br />
the fact that there were fewer days off in May than normal.<br />
We expect a rebound in retail sales in June. Energy<br />
consumption was strong in May, and we see very little<br />
room for improvement in June despite the long weekend<br />
early in the month. Car sales were weak, but that is a<br />
legacy of past strength and we see modest potential for a<br />
rebound. Conversely, food sales were weak in May and we<br />
expect them to recover in June. More importantly, sales of<br />
other manufactured goods should be strong in June. They<br />
start from an abnormally weak level in May (possibly<br />
because of technical distortions), and seasonal sales<br />
started early this year (on 22 June). This should support<br />
retail sales for the month.<br />
Altogether, we forecast retail sales down 2.1% q/q in Q2 (if<br />
they are unchanged in June, they will be down 2.4% q/q).<br />
This implies a massive slowdown in GDP growth and a<br />
major change in its breakdown.<br />
Market Economics 28 July 2011<br />
Market Mover<br />
66<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
Source: Reuters EcoWin Pro<br />
Chart 5: Swedish Real GDP<br />
sa Q2 11 (f) Q1 11 Q4 10 Q3 10<br />
GDP % q/q 0.6 0.8 1.6 1.9<br />
GDP % y/y 5.0 6.5 7.6 6.6<br />
Key Point:<br />
Swedish GDP growth is to ease further slightly in<br />
Q2, with the quarter-on-quarter rate forecast to print<br />
0.6%, down from Q1’s 0.8%.<br />
<strong>BNP</strong> Paribas Forecast: Further Moderation<br />
Sweden: GDP (Q2)<br />
Release Date: Friday 29 July<br />
After very strong quarter-on-quarter readings in 2010,<br />
Swedish GDP growth has started to lose some momentum.<br />
Growth, at 0.8% q/q in Q1, was half of that in Q4 last year.<br />
We expect GDP growth to have eased further in Q2.<br />
On the consumer side, real retail sales, on average, have<br />
been weak so far in Q2, with strong April figures offset by a<br />
weak May outcome. Despite remaining above its long-term<br />
average, consumer confidence also continues to trend<br />
lower. Overall, these point to broadly flat private<br />
consumption in Q1.<br />
The trend in industrial production remains relatively robust.<br />
However, tight financial and monetary conditions and the<br />
downward trend in surveys, such as the manufacturing<br />
PMI, point to some moderation in investment growth over<br />
the quarter.<br />
In terms of net exports, after a 0.2pp deduction from overall<br />
quarterly growth in Q1, we expect a 0.1pp contribution in<br />
Q2.<br />
Overall, we project GDP growth in quarter-on-quarter terms<br />
to come in at 0.6% in Q2 – the lowest quarter-on-quarter<br />
reading since Q4 2009. This should take the year-on-year<br />
rate down from 6.5% to 5.0%.<br />
Chart 6: US Consumers Still Feeling the Pain<br />
Source: Reuters EcoWin Pro<br />
Q2 (a) Q1 Q4 Q3<br />
GDP % q/q AR 1.0 1.9 3.1 2.6<br />
GDP Deflator % q/q AR 1.5 2.0 0.4 2.1<br />
Key Point:<br />
GDP is expected to slow to 1.0% q/q saar in Q1 from<br />
an already lacklustre 1.9% on the back of a stalling<br />
out in consumer spending growth.<br />
<strong>BNP</strong> Paribas Forecast: A Weak Showing<br />
US: GDP (Q2a 2011)<br />
Release Date: Friday 29 July<br />
GDP is forecast to grow only 1.0% q/q saar in Q2, after a<br />
lacklustre 1.9% performance in Q1. Driving the slowing is<br />
an expected stalling out in consumer spending growth,<br />
which is expected to be unchanged after a solid 2.2% gain<br />
in Q1. Households buckled under the weight of soaring<br />
food and energy prices that sapped their purchasing<br />
power, while Japan-related supply chain disruptions dented<br />
auto sales. Construction is expected to remain subdued but<br />
to show some improvement Similarly, government<br />
spending will continue to contract but at a more modest<br />
pace. Equipment and software investment is expected to<br />
slow to a still solid 7.0% pace after an 8.8% gain. Trade<br />
should be a modest positive as imports decline with<br />
consumer spending leading to a narrowing in the trade<br />
deficit. At the same time, inventory investment should<br />
weigh on growth as supply chain disruptions lead to a<br />
slower pace of restocking. Overall the report would<br />
represent another subpar performance highlighting the<br />
difficulties that continue to plague the current expansion.<br />
The GDP deflator is expected to rise 1.5%, which would<br />
lead nominal GDP growth to slow to 2.5% from 4.0%.<br />
Market Economics 28 July 2011<br />
Market Mover<br />
67<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
Chart 7: UK CIPS Manufacturing vs. Industrial<br />
Production<br />
Source: Reuters EcoWin Pro<br />
Jul (f) Jun May Apr<br />
CIPS Manufacturing 50.0 51.3 52.0 54.4<br />
Key Point:<br />
We expect a further weakening in the PMI, with the<br />
index likely to sink to the boom/bust line of 50.0.<br />
<strong>BNP</strong> Paribas Forecast: Volatile<br />
UK: CIPS Manufacturing (July)<br />
Release Date: Monday 1 August<br />
Our manufacturing PMI forecast is based on two main<br />
factors – the dynamic in the manufacturing sector and<br />
developments abroad, particularly in the eurozone.<br />
Domestic data have been on a weakening trend. In<br />
January and February, the CIPS manufacturing index was<br />
over 60. There was a sharp weakening of 5 points in March<br />
followed by falls of 1.7, 2.5 and 0.8 points in April, May and<br />
June, respectively. That is, in the last three months, falls in<br />
the index have averaged about 1.7 points a month.<br />
The eurozone is the UK’s largest export market and the<br />
two economies’ cycles are closely intertwined (see chart).<br />
Eurozone PMIs were very weak in July, with the aggregate<br />
manufacturing PMI falling by 2.3 points after a 2.3 point fall<br />
in May. This will have affected UK manufacturing.<br />
However, as the fall in the PMIs was partly due to the<br />
eurozone crisis, the impact on the UK may be less than the<br />
impact on the mainland. Our equations suggest that the UK<br />
CIPS will show a fall smaller than in the eurozone in July<br />
but chunkier than in June.<br />
We expect the index to return to 50, with a chance it starts<br />
to show manufacturing beginning to contract.<br />
Chart 8: US PMI Manufacturing Surveys<br />
Source: Reuters EcoWin Pro<br />
Jul (f) Jun May Apr<br />
Headline Index 54.5 55.3 53.5 60.4<br />
Prices Paid 64.0 68.0 76.5 85.5<br />
Key Point:<br />
We expect the ISM manufacturing index to fall to 54.5<br />
in July affected by temporary and more lasting<br />
factors such as slowing in the global economy.<br />
<strong>BNP</strong> Paribas Forecast: Losing Ground<br />
US: ISM (July)<br />
Release Date: Monday 1 August<br />
The latest FOMC minutes highlighted that “although the<br />
effects of the Japanese disaster on U.S. motor vehicle<br />
production accounted for much of the deceleration in<br />
industrial production since March, the most recent readings<br />
from various regional manufacturing surveys suggested a<br />
slowing in the pace of manufacturing activity more<br />
broadly”. In other words, the slow down could be a result of<br />
both temporary and more long-lasting factors such as<br />
slowing in the global economy in general and less growth<br />
in China in particular.<br />
On an ISM-adjusted basis, the Philly Fed index rose from<br />
47.2 to 52.1 in July—a move out of contractionary territory;<br />
however, the Empire State index fell to 49.3 from 49.7 and<br />
Richmond Fed index also fell into contractionary mode. We<br />
interpret the movements in the regional indices as<br />
suggestive of a fall in the ISM manufacturing index to 54.5<br />
in July, remaining in expansionary territory as still-strong<br />
activity in the high-tech sector offsets the weakness in the<br />
East Coast regions.<br />
Market Economics 28 July 2011<br />
Market Mover<br />
68<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
Chart 9: US Confidence vs. Consumption<br />
Source: Reuters EcoWin Pro<br />
% m/m Jun (f) May Apr Mar<br />
Personal Income 0.1 0.3 0.3 0.4<br />
Consumption 0.0 0.0 0.3 0.6<br />
Core PCE Prices 0.3 0.3 0.2 0.2<br />
<strong>BNP</strong> Paribas Forecast: Nominal Decline<br />
US: Personal Income and Spending (June)<br />
Release Date: Tuesday 2 August<br />
Personal consumption is forecast to be flat for the second<br />
month in a row as consumers show the wear and tear of<br />
rapid inflation in H1. A decline in auto sales is expected to<br />
offset tepid gains in retail spending and a modest increase<br />
in services. On a real basis, consumer spending will also<br />
be flat after a modest decline supporting our forecast that<br />
we will see no growth in real consumption in Q2.<br />
Meanwhile, personal income is forecast to rise 0.1%. Both<br />
aggregate hours worked and average hourly earnings<br />
posted small declines in June suggesting a loss in wage<br />
and salary income. We expect this to be offset by asset<br />
and transfer income gains.<br />
The core PCE price index is expected to rise 0.3% in June.<br />
This would lead the annual pace of core inflation to jump to<br />
1.5% from 1.2%. The rapid rise in core prices over the past<br />
six months has been enough to prevent the Fed from<br />
considering further stimulus even as the unemployment<br />
rate rises.<br />
Key Point:<br />
We look for a weak report with tepid gains in income,<br />
flat spending and a jump in core inflation.<br />
Source: Reuters EcoWin Pro<br />
Chart 10: UK CIPS <strong>Services</strong><br />
Jul (f) Jun May Apr<br />
CIPS <strong>Services</strong> 53.1 53.9 53.8 54.3<br />
Key Point:<br />
Domestic demand remains weak and export orders<br />
are likely to have slipped with the global slowdown<br />
and eurozone turmoil. But our FMCI suggests the<br />
decline will be moderate.<br />
<strong>BNP</strong> Paribas Forecast: Slight Decline<br />
UK: CIPS <strong>Services</strong> (July)<br />
Release Date: Wednesday 3 August<br />
According to the ONS, growth in GDP adjusted for<br />
distortions due to unusual holiday patterns in April was<br />
0.7% in Q2. We’ve not laughed so much in ages and<br />
certainly there has been no sign of services picking up<br />
since April – the CIPS services has actually declined.<br />
June’s CIPS numbers may have reflected some delayed<br />
business and so the lack of a fall is misleading. Future<br />
business expectations were at an eight-month low.<br />
All the signs are that domestic demand remained weak in<br />
Q2. Retailers had to bring sales forward due to weak<br />
demand and many businesses seem to be struggling to<br />
keep afloat. Consumer- and government-facing businesses<br />
are doing worse that those serving other businesses.<br />
The trend in services tends to follow the trends in<br />
manufacturing in the UK and the eurozone, which are<br />
weakening, although to a lesser extent (see chart). The<br />
turmoil in the eurozone over recent months should be<br />
harming export orders for UK services.<br />
The CIPS services index has been pretty flat in the last two<br />
or three months. Our financial and monetary conditions<br />
index (FMCI) suggests that any decline will be relatively<br />
mild.<br />
Overall, we expect the CIPS services index to decline in<br />
July, by three quarters of a point.<br />
Market Economics 28 July 2011<br />
Market Mover<br />
69<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
Chart 11: US NM ISM Employment & Claims<br />
Source: Reuters EcoWin Pro<br />
<strong>BNP</strong> Paribas Forecast: Another Decline<br />
US: ISM Non Manufacturing (July)<br />
Release Date: Wednesday 3 August<br />
We look for the non-manufacturing ISM to fall slightly<br />
further in July after it declined more than a point in June.<br />
The decline in the index should reflect weakness in such<br />
economic sectors as retail, construction, and government.<br />
Indeed, retail sales momentum slowed down with core<br />
retail sales rising by a mere 0.1% m/m in June mostly on<br />
the back of higher prices rather than growth in real sales.<br />
Housing remains weak, and state and local governments<br />
layoffs are expected to accelerate. Accordingly, we think<br />
the index is set for a modest decline to 52.5. We look for<br />
the prices paid index to fall to 68.0 from 69.6 reflecting the<br />
recent broad-based decline in commodity prices.<br />
Jul (f) Jun May Apr<br />
NM Composite 52.5 53.3 54.6 52.8<br />
Prices Paid 59.0 60.9 69.6 70.1<br />
Key Point:<br />
We look for the non-manufacturing ISM to fall slightly<br />
further in July reaching 52.5 on broad-based slowing.<br />
30<br />
20<br />
10<br />
0<br />
-10<br />
-20<br />
-30<br />
-40<br />
Chart 12: German Orders and PMI<br />
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11<br />
Source: Reuters EcoWin Pro<br />
PMI Manufacturing:<br />
Orders (RHS)<br />
Manufacturing Orders (% y/y Smoothed)<br />
Jun (f) May Apr Mar<br />
Orders % m/m -2.5 1.8 2.9 -2.7<br />
Orders % y/y 5.1 12.2 10.6 10.2<br />
Output % m/m -0.5 1.2 -0.8 1.2<br />
Output % y/y 7.8 7.6 9.4 11.4<br />
Key Point:<br />
The pace of growth in the manufacturing sector is<br />
already slowing and will weaken further.<br />
75<br />
65<br />
55<br />
45<br />
35<br />
25<br />
15<br />
<strong>BNP</strong> Paribas Forecast: Catching Down<br />
Germany: Orders and Output (June)<br />
Release Date: Thursday 4 and Friday 5 August<br />
Manufacturing orders rose strongly in both April and May,<br />
implying a strong rise for Q2 as a whole (around 2% q/q),<br />
even though we expect orders to fall sharply in June.<br />
Our forecast of a decline in June relates, in part, to the<br />
slide in leading indicators, such as the manufacturing PMI,<br />
which have deteriorated markedly over recent months. The<br />
new orders sub-index of the PMI, for example, has been<br />
below the 50 expansion level since June.<br />
The composition of May’s orders data also points to a June<br />
correction. Domestic orders surged by 11% m/m in June,<br />
the largest rise in the series’ history, lifted by a 20% m/m<br />
increase in orders for capital goods.<br />
Industrial output is also on track to record a quarter-onquarter<br />
increase, though the pace of growth is likely to be<br />
around half that in the previous two quarters (2.5% q/q on<br />
average). This is supportive of our long-standing forecast<br />
of a pronounced slowdown in Q2 GDP growth after a surge<br />
in Q1.<br />
The output index of the manufacturing PMI has also been<br />
losing ground recently and ‘catch down’ for the ‘hard’ data<br />
is likely in the period ahead. We forecast a fall in output in<br />
June which will lead to a weak carry over for Q3.<br />
The softening of the survey data suggests that the y/y rate<br />
of growth in orders will fall markedly in the period ahead,<br />
exacerbated in June by unfavourable base effects.<br />
Market Economics 28 July 2011<br />
Market Mover<br />
70<br />
www.GlobalMarkets.bnpparibas.com
Key Data Preview<br />
Chart 13: US Claims, ADP, Private Payrolls<br />
Source: Reuters EcoWin Pro<br />
Jul (f) Jun May Apr<br />
Payroll Jobs k 50 18 25 217<br />
Private Payrolls k 100 57 73 241<br />
Unemployment Rate % 9.3 9.2 9.1 9.0<br />
Key Point:<br />
Public sector layoffs and tepid private hiring are<br />
expected to produce just 50k in nonfarm payrolls and<br />
another uptick in the unemployment rate to 9.3%<br />
<strong>BNP</strong> Paribas Forecast: Still Weak<br />
US: Labour Report (July)<br />
Release Date: Friday 5 August<br />
Nonfarm payrolls are expected to post another weak<br />
reading in July with a gain of 50k after just 18k in jobs were<br />
added in June. We expect private sector hiring to improve<br />
to 100k after a 57k increase a month earlier as some of the<br />
extreme weakness in private education and health care<br />
fades. Meanwhile, the large number of teacher layoffs at<br />
the end of the school year and an ongoing slowdown in<br />
federal government spending are expected to combine to<br />
shave 50k jobs from total nonfarm payrolls. Another tepid<br />
gain in jobs is expected to lead the unemployment rate to<br />
rise to 9.3%, the fourth straight month of backtracking.<br />
Average hourly earnings are expected to rise 0.1% after a<br />
flat reading as wage and salary growth remains subdued in<br />
the face of elevated unemployment. The report would be<br />
consistent a broad swath of indicators that show the<br />
economy lost significant momentum in Q2. Since<br />
employment tends to follow activity, and in light of elevated<br />
global and political uncertainties, we think firms will remain<br />
cautious early in Q3.<br />
Chart 14: Canadian Employment (thousands)<br />
150<br />
100<br />
50<br />
0<br />
-50<br />
-100<br />
-150<br />
Monthly Change<br />
Full-Time<br />
Part-Time<br />
Jan 07 Jan 08 Jan 09 Jan 10 Jan 11<br />
Source: Reuters EcoWin Pro<br />
Jul (f) Jun May Apr<br />
Unemployment Rate % 7.5 7.4 7.4 7.6<br />
Payroll Jobs k 13.0 28.4 22.3 58.3<br />
<strong>BNP</strong> Paribas Forecast: Modest Gains<br />
Canada: Labour Report (July)<br />
Release Date: Friday 5 August<br />
Canadian employment is forecast to improve by 13k in July<br />
following a below-average 28.4k increase in the previous<br />
month. The pace of employment growth has averaged an<br />
impressive 32.0k per month for the previous six months. In<br />
June, the goods sector gained 3.3k jobs (after losing 11.3k<br />
in April and another 14.9k in May), leaving the services<br />
sector with average gains of 44k jobs for the previous three<br />
months. We expect to see some pull-back in service sector<br />
jobs from the April-May-June persistence as the weak<br />
domestic demand in Q2 begins to show up in the<br />
employment reports. We forecast the unemployment rate<br />
to tick up to 7.5% as a result of a small increase in the<br />
labour force participation rate as more students than usual<br />
enter the workforce.<br />
Key Point:<br />
Some pullback as the employment report is likely to<br />
begin reflecting the weaker consumption in Q2.<br />
Market Economics 28 October 2010<br />
Market Mover<br />
71<br />
www.GlobalMarkets.bnpparibas.com
Economic Calendar: 8 Aug – 2 Sep<br />
8 Aug 9 Aug 10 Aug 11 Aug 12 Aug<br />
Japan: Current Account<br />
Jun<br />
France: BoF Survey Jul<br />
Market Economics 28 July 2011<br />
Market Mover<br />
Australia: NAB Business<br />
Survey Jul<br />
Japan: M2 Jun<br />
UK: BRC Retail Sales<br />
Monitor Jul, RICS House<br />
Price Balance Jul,<br />
Industrial Production Jun,<br />
Trade Balance Jun<br />
Germany: Trade Bal Jun<br />
France: Budget Balance<br />
Jun<br />
US: Productivity and Costs<br />
Q2, NFIB Small Business<br />
Optimism Jul, FOMC Rate<br />
Announcement<br />
Japan: BoJ Monetary<br />
Policy Meeting Minutes,<br />
CGPI Jul, Tertiary Jun<br />
Australia: Westpac<br />
Consumer Confidence<br />
Aug<br />
UK: BoE Inflation Report<br />
Germany: CPI Jul<br />
France: Current Account<br />
Jun, IP Jun<br />
Norway: CPI Jul, PPI Jul,<br />
Norges Bank Rate<br />
Announcement<br />
US: Wholesale Trade Jul,<br />
Treasury Statement<br />
Australia: Labour Jul<br />
Japan: Machinery Orders<br />
Jun<br />
Eurozone: ECB Monthly<br />
Bulletin<br />
Sweden: CPI Jul, Labour<br />
nsa Jul<br />
US: Trade Balance Jun<br />
During Week: Germany WPI Jul<br />
15 Aug 16 Aug 17 Aug 18 Aug 19 Aug<br />
Japan: GDP (Prel) Q2<br />
Holiday: France, Italy,<br />
Spain, Belgium<br />
UK: Rightmove House<br />
Prices Aug<br />
Sweden: Industrial<br />
Production Jun<br />
US: Empire State Survey<br />
Aug, TICS Data Jun,<br />
NAHB Housing Market<br />
Aug<br />
Australia: RBA MPC<br />
Minutes<br />
Eurozone: GDP (Flash)<br />
Q2, Trade Balance Jun,<br />
UK: DCLG House Prices<br />
Jun, CPI Jul<br />
Germany: GDP (Prel) Q2<br />
Spain: GDP (Flash) Q2<br />
Neths: GDP Q2, Retail<br />
Sales Jun<br />
US: New Home Starts<br />
Jul, Import Prices Jul,<br />
Industrial Production Jul<br />
Eurozone: HICP Jul,<br />
Current Account Jun<br />
UK: BoE MPC Minutes,<br />
Labour Jul<br />
US: PPI Jul<br />
Japan: Trade Balance<br />
Jul<br />
Germany: Employment<br />
Q2<br />
UK: Retail Sales Jul<br />
Neths: Consumer<br />
Confidence Aug, Labour<br />
Aug<br />
US: CPI Jul, Philly Fed<br />
Aug, Existing Home Sales<br />
Jul, Leading Indicators Jul<br />
22 Aug 23 Aug 24 Aug 25 Aug 26 Aug<br />
Eurozone: PMIs (Flash)<br />
Aug<br />
Germany: ZEW Survey<br />
Aug<br />
Norway: GDP Q2<br />
US: New Home Sales Jul<br />
Eurozone: Industrial<br />
Orders Jun<br />
Germany: Ifo Survey Aug<br />
Belgium: Business<br />
Confidence Aug<br />
Norway: Labour Jun<br />
US: Durable Goods<br />
Orders Jul, FHFA HPI Jun<br />
France: Job Seekers Jul<br />
Spain: PPI Aug<br />
Sweden: Consumer<br />
Confidence Aug, Labour<br />
Jul, PPI Jul<br />
Neths: Producer<br />
Confidence Aug<br />
During Week: Germany Import Price Index Jul, Retail Sales Jul, UK Nationwide House Prices Aug<br />
29 Aug 30 Aug 31 Aug 1 Sep 2 Sep<br />
UK: Holiday<br />
Germany: CPI (Prel) Aug<br />
Italy: ISAE Consumer<br />
Confidence Aug<br />
Spain: Retail Sales Jul<br />
Sweden: Retail Sales Jul<br />
US: Personal Income &<br />
Spending Jul, Pending<br />
Home Sales Jul<br />
Japan: Labour Jul,<br />
Household Consumption<br />
Jul, Retail Sales Jul<br />
Eurozone: Business &<br />
Consumer Survey Aug,<br />
Retail PMI Aug<br />
UK: Net Consumer Credit<br />
Jul, Mortgage Approvals<br />
Jul<br />
Germany: HICP (Flash)<br />
Aug<br />
Italy: Retail Sales Jun,<br />
ISAE Business Conf Aug<br />
Spain: HICP (Flash) Aug<br />
US: S&P/Case-Shiller<br />
Home Prices Jun,<br />
Consumer Confidence<br />
Aug, FOMC Minutes<br />
During Week: UK Halifax House Prices Aug<br />
Source: <strong>BNP</strong> Paribas<br />
Japan: IP May<br />
Eurozone: HICP (Flash)<br />
Aug, Labour Jul<br />
UK: GfK Consumer<br />
Confidence Aug<br />
Germany: Labour Jul<br />
Norway: Retail Sales Jul<br />
Italy: CPI Aug, PPI Jul<br />
US: Chicago PMI, Factory<br />
Orders Jun, ADP Labour<br />
Aug, Challenger Layoffs<br />
Aug<br />
Canada: GDP Q2 & Jun<br />
Australia: Retail Sales<br />
Jul<br />
Eurozone: PMI<br />
Manufacturing (Final) Aug<br />
UK: CIPS Manufacturing<br />
Aug<br />
Germany: GDP (Final)<br />
Q2,<br />
Italy: Wages Jul<br />
Switz: GDP Q2, PMI<br />
Manufacturing Aug<br />
US: Productivity and<br />
Costs (Final) Q2, ISM<br />
Manufacturing Aug,<br />
Construction Jul<br />
Eurozone: Industrial<br />
Production Jun<br />
France: CPI Jul, GDP<br />
(Prel) Q2, Non-Farm<br />
Payrolls (Prel) Q2, Wages<br />
(Prel) Q2<br />
Spain: CPI Jul<br />
Norway: Retail Sales Jun<br />
Italy: EU Trade Balance<br />
Jun, CPI Jul<br />
US: Retail Sales Jul,<br />
Business Inventories Jun,<br />
UoM Sentiment (Prel) Aug<br />
UK: PSNB Jul, PSNCR Jul<br />
Germany: PPI Jul<br />
Belgium: Consumer<br />
Confidence Aug<br />
Canada: CPI Jul<br />
Japan: CPI Tokyo Aug,<br />
CPI National Jul<br />
Eurozone: Monetary<br />
Developments Jul,<br />
Eurocoin Aug<br />
France: <strong>Investment</strong><br />
Survey Jul<br />
UK: GDP (Prel) Q2<br />
Germany: GfK Consumer<br />
Survey Sep<br />
Spain: GDP (Final) Q2<br />
Switz: KOF Leading<br />
Indicator Aug<br />
US: GDP (Rev) Q2,<br />
Corporate Profits Q2, UoM<br />
Sentiment (Final) Aug,<br />
Eurozone: PPI Jul,<br />
Norway: Labour nsa Aug<br />
US: Labour Aug<br />
Release dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions<br />
72<br />
www.GlobalMarkets.bnpparibas.com
Treasury and SAS Issuance Calendar<br />
In the pipeline - Treasuries:<br />
Japan: To buy back 15y floating-rate JGBs (JPY 600bn) and 10y Inflation-Indexed JGBs (JPY 150bn) in Q3<br />
France: Cancelled the auction initially planned for 4 August<br />
Italy: Still considering the launch of a new 30y syndicated BTP in the last four months of the year, subject to market conditions<br />
Italy: To issue four new securities in Q3 (BTPs Jul-14, Mar-22 & Sep-16 and CTZ Sep-13)<br />
Germany: In Q3, intends to issue inflation-linked federal securities (EUR 2 to 3bn) and reserves the right to issue foreign currency bonds<br />
Poland: Has no plans for benchmark foreign bond in Q3<br />
UK: Index-Linked Gilt Mar 2034 (tap, syndicated, GBP) scheduled for the week commencing 25 July<br />
UK: Mini-tender in the week commencing 5 September (choice of Gilt on Friday 6 August)<br />
UK: Long-dated Gilt (syndicated) in the second half of September (details around 2 weeks in advance)<br />
Finland: Planning to issue a new syndicated EUR benchmark bond (probably a 5y) in H2. To sell one more EUR benchmark bond in Q3<br />
(details one week prior to the auction). Will not issue T-bills in July<br />
Neths: Still looking to issue debt denominated in USD, depending on market conditions<br />
Czech Rep.: To launch a syndicated euro benchmark in H2<br />
In the pipeline - Agencies:<br />
EFSF: In addition to the issues for the Portuguese programme, is expected to issue two benchmark bonds in H2 2011 in support of the<br />
programme for Ireland<br />
EFSF: Expected to issue two further bonds in 2011 in support of the programme for Portugal, EUR 3-5bn per transaction<br />
During the week:<br />
FHLMC: First syndicated auction in August, details announced on Tuesday 2 August<br />
Date Day Closing Country Issues Details <strong>BNP</strong>P forecasts<br />
Local GMT<br />
29/07 Fri 11:00 15:00 US Outright Treasury Coupon Purchase (2014 -<br />
USD 2.5-3bn<br />
2015)<br />
02/08 Tue 12:00 03:00 Japan JGB 10-year JPY 2.2tn JPY 2.2tn<br />
10:30 09:30 UK Gilt 4.5% 7 Sep 2034 GBP 2bn<br />
04/08 Thu 12:00 03:00 Japan Auction for Enhanced-liquidity JPY 0.3tn JPY 0.3tn<br />
10:30 08:30 Spain Bono 3.4% 30 Apr 2014 29 Jul EUR 3-4bn<br />
11:00 15:00 US Outright Treasury Coupon Purchase (2017 -<br />
USD 2.75-3.5bn<br />
2018)<br />
08/08 Mon 11:00 15:00 US Outright TIPS Purchase (2013 - 2041) USD 0.25-0.5bn<br />
09/08 Tue 12:00 03:00 Japan JGB 40-year 2 Aug JPY 0.4tn<br />
13:00 17:00 US Notes 3-year (new) 3 Aug USD 32bn<br />
10/08 Wed 12:00 16:00 Canada CAN 3-year 4 Aug<br />
13:00 17:00 US Notes 10-year (new) 3 Aug USD 24bn<br />
11/08 Thu 12:00 03:00 Japan JGB 5-year 4 Aug JPY 2.4tn<br />
10:30 09:30 UK Index-Linked Gilt 0.625% 22 Nov 2042 2 Aug<br />
13:00 17:00 US Bond 30-year (new) 3 Aug USD 16bn<br />
16/08 Tue Denmark DGBs 11 Aug<br />
17/08 Wed 11:00 09:00 Germany Schatz 13 Sep 2013 (new) EUR 7bn<br />
12:00 16:00 Canada CAN 2-year 11 Aug<br />
18/08 Thu 10:30 08:30 Spain Obligaciones 4 Aug EUR 2.5-4bn<br />
10:30 09:30 UK Gilt 22 Jan 2017 (new) 9 Aug<br />
13:00 17:00 US TIPS 5-year 11 Aug USD 12bn<br />
22/08 Mon 12:00 10:00 Belgium OLOs 16 Aug<br />
Slovak Rep. SLOVGB 4% 27 Apr 2020 (#214)<br />
23/08 Tue 12:00 03:00 Japan Auction for Enhanced-liquidity 16 Aug JPY 0.3tn<br />
10:30 09:30 UK Index-Linked Gilt 1.875% 22 Nov 2022 16 Aug<br />
13:00 17:00 US Notes 2-year (new) 18 Aug USD 35bn<br />
24/08 Wed 11:00 09:00 Germany Bund 4 Sep 2021 (new) EUR 6bn<br />
12:00 16:00 Canada CAN 30-year (Repurchase-Switch) 18 Aug<br />
13:00 17:00 US Notes 5-year (new) 18 Aug USD 35bn<br />
25/08 Thu 12:00 03:00 Japan JGB 20-year 18 Aug JPY 1.1tn<br />
13:00 17:00 US Notes 7-year (new) 18 Aug USD 29bn<br />
Sources: Treasuries, <strong>BNP</strong> Paribas<br />
Interest Rate Strategy 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
73<br />
www.GlobalMarkets.bnpparibas.com
Next Week's T-Bills Supply<br />
Date Country Issues Details<br />
29/07 UK T-Bills Aug 2011 GBP 0.5bn<br />
T-Bills Oct 2011<br />
GBP 1bn<br />
T-Bills Jan 2012<br />
GBP 1.5bn<br />
01/08 France BTFs Oct 2011 EUR 4.5bn<br />
BTFs Jan 2012<br />
EUR 2bn<br />
BTFs Jul 2012<br />
EUR 2bn<br />
Neths DTC Oct 2011 EUR 3bn<br />
DTC Jan 2012<br />
EUR 2.5bn<br />
DTC Apr 2012<br />
EUR 2bn<br />
US T-Bills Nov 2011 USD 27bn<br />
T-Bills Feb 2012 & 26- USD 24bn<br />
week<br />
FHLMC Bills 3-month & 6-month 29 Jul<br />
02/08 Belgium TC Nov 2011 29 Jul<br />
TC Jan 2012<br />
29 Jul<br />
US T-Bills 4-week 1 Aug<br />
FHLB Discount Notes<br />
03/08 Japan T-Bills 3-month 27 Jul<br />
Portugal BT Nov 2011 EUR 0.75-1bn<br />
FNMA Bills 3-month & 6-month 1 Aug<br />
04/08 Japan T-Bills 6-month JPY 3.5tn<br />
FHLB Discount Notes<br />
05/08 UK T-Bills 29 Jul<br />
Sources: Treasuries, <strong>BNP</strong> Paribas<br />
Comments and charts<br />
• EGB gross supply is expected to fall significantly<br />
next week, from EUR 12.8bn to EUR 3.5bn. In 10y<br />
duration-adjusted terms, it is equivalent to a decrease of<br />
EUR 9bn. In addition, the week ahead will see<br />
EUR 20bn redemptions from Italian government bonds.<br />
• Spain will be the only country to issue in the primary<br />
market, with a tap of Bonos 3.4% July 2014, likely to be<br />
around EUR 3/4bn. This will be the second tap of the<br />
bond since its inception in the market in March (the<br />
current outstanding amounts to EUR 7.4bn).<br />
• Outside of the eurozone, Japan will issue a 10y<br />
bond for an expected size of JPY 2.2trn, and the UK will<br />
launch a new 15y bond for an expected size of<br />
GBP 2bn.<br />
Next Week's Eurozone Redemptions<br />
Date Country Details Amount<br />
30/07 Spain Obligacion 5.4% EUR 15.5bn<br />
01/08 Italy BTP 5.25% EUR 20.2bn<br />
Total Eurozone Long-term Redemption EUR 35.7bn<br />
04/08 France BTF EUR 8.3bn<br />
05/08 Austria ATB (EU41) EUR 0.1bn<br />
Total Eurozone Short-term Redemption EUR 8.4bn<br />
Next Week's Eurozone Coupons<br />
Country<br />
Amount<br />
Italy<br />
EUR 11.0bn<br />
Greece<br />
EUR 1.6bn<br />
Total Long-term Coupon Payments<br />
EUR 12.6bn<br />
35<br />
30<br />
25<br />
20<br />
15<br />
10<br />
5<br />
0<br />
-5<br />
-10<br />
20<br />
18<br />
16<br />
14<br />
12<br />
10<br />
8<br />
6<br />
4<br />
2<br />
0<br />
Chart 1: Investors’ Net Cash Flows<br />
(EUR bn, 10y equivalent)<br />
Net Investors' Cash Flows<br />
(EUR bn , 10y equivalent)<br />
Week of Jul 25th Week of Aug 1st Week of Aug 8th Week of Aug 15th<br />
Chart 2: EGB Gross Supply Breakdown by<br />
Country (EUR bn, 10y equivalent)<br />
Germany Italy Portugal Belgium<br />
France Spain Netherlands Austria<br />
Finland Greece Ireland<br />
Week of Jul 25th Week of Aug 1st Week of Aug 8th Week of Aug 15th<br />
Chart 3: EGB Gross Supply Breakdown by<br />
Maturity (EUR bn, 10y equivalent)<br />
10<br />
9<br />
8<br />
EGBs Gross Supply (EUR bn, 10y equivalent)<br />
2-3-YR<br />
10-YR<br />
5-7-YR<br />
>10-YR<br />
7<br />
6<br />
5<br />
4<br />
3<br />
2<br />
1<br />
0<br />
Week of Jul 25th Week of Aug 1st Week of Aug 8th Week of Aug 15th<br />
All Charts Source: <strong>BNP</strong> Paribas<br />
Interest Rate Strategy 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
74<br />
www.GlobalMarkets.bnpparibas.com
Central Bank Watch<br />
Interest Rate<br />
EUROZONE<br />
Current<br />
Rate (%)<br />
Minimum Bid Rate 1.50<br />
US<br />
Fed Funds Rate 0 to 0.25<br />
Discount Rate 0.75<br />
JAPAN<br />
Call Rate 0 to 0.10<br />
Basic Loan Rate 0.30<br />
UK<br />
Bank Rate 0.5<br />
DENMARK<br />
Lending Rate 1.55<br />
SWEDEN<br />
Repo Rate 2.00<br />
NORWAY<br />
Sight Deposit Rate 2.25<br />
SWITZERLAND<br />
3 Mth LIBOR Target<br />
Range<br />
CANADA<br />
0.0-0.75<br />
Overnight Rate 1.00<br />
Bank Rate 1.25<br />
AUSTRALIA<br />
Cash Rate 4.75<br />
CHINA<br />
1Y Bank Lending<br />
Rate<br />
BRAZIL<br />
Selic Overnight Rate<br />
6.56<br />
Date of<br />
Last<br />
Change<br />
+25bp<br />
(7/7/11)<br />
-75bp<br />
(16/12/08)<br />
+25bp<br />
(18/2/10)<br />
-10bp<br />
(5/10/10)<br />
-20bp<br />
(19/12/08)<br />
-50bp<br />
(5/3/09)<br />
+25bp<br />
(7/7/11)<br />
+25bp<br />
(5/7/11)<br />
+25bp<br />
(12/5/11)<br />
-25bp<br />
(12/3/09)<br />
+25bp<br />
(8/9/10)<br />
+25bp<br />
(8/9/10)<br />
+25bp<br />
(2/11/10)<br />
+25bp<br />
(6/7/11)<br />
12.50 +25bp<br />
(20/7/11)<br />
Next Change in<br />
Coming 6 Months<br />
+25bp (6/10/11)<br />
No Change<br />
No Change<br />
No Change<br />
No Change<br />
No Change<br />
+25bp<br />
(6/10/11)<br />
+25bp<br />
(7/9/11)<br />
+25bp<br />
(Aug/Sep 11)<br />
No Change<br />
+25bp (6/12/11)<br />
+25bp (6/12/11)<br />
+25bp<br />
(4/10/11)<br />
No Change<br />
+25bp<br />
(31/8/11)<br />
Source: <strong>BNP</strong> Paribas<br />
For the full EM Central Bank Watch, please see our Local Markets Mover.<br />
Comments<br />
Our forecast of a 25bp rise in the refinancing rate in October, after<br />
further upward revisions to staff inflation projections in September,<br />
is more uncertain given the recent weakness of activity data in the<br />
wake of financial market tensions.<br />
The FOMC is expected to maintain the Fed funds rate at 0 to<br />
0.25% until September 2012. We see the bar for another round<br />
of quantitative easing as high – requiring a further deterioration<br />
in the growth outlook and re-emergence of deflationary risks.<br />
We expect the BoJ to continue to respond to the developments<br />
surrounding the earthquake disaster by expanding liquidity.<br />
Given persistent headwinds to growth, and with inflation to fall<br />
next year, Bank Rate is forecast to stay at the current level for<br />
some time. We assume no change through 2011 and 2012.<br />
We expect the Danish central bank to follow the ECB in<br />
October, delivering a 25bp rate hike.<br />
The upward trend in inflation and wage expectations, as well as<br />
Sweden’s robust fundamentals, should lead to further rate hikes.<br />
We expect the Riksbank to deliver the next hike at its<br />
September meeting.<br />
We expect the next hike to come in August or September. The<br />
timing will depend on the flow of domestic and external news<br />
and developments in economic data.<br />
The Swiss franc has taken monetary conditions back to neutral<br />
levels rather than the SNB. Following the latest leg up in the<br />
franc to record highs, we do not expect a hike in 2011.<br />
Underlying inflation pressures remain subdued. Meanwhile, high<br />
levels of household debt tied to variable rate mortgages and the<br />
expected "temporary" inflationary pressures have left the BoC<br />
wary of normalising policy. We expect the BoC to remain on<br />
hold until at least December 2011.<br />
Stronger-than-expected underlying inflation should prompt the<br />
RBA to nudge up the cash rate by 25bp once current<br />
uncertainties in the global economy have dissipated somewhat.<br />
Inflation is set to peak in June/July and growth has lost more<br />
momentum than policymakers had anticipated. Hence we<br />
expect selective easing in H2 2011. We may have seen the last<br />
rate hike in this cycle unless July’s CPI inflation is higher than<br />
June’s.<br />
Copom again hiked by 25bp in July but dropped hawkish<br />
language saying hiking would be for a “sufficiently prolonged”<br />
period. While the central bank is keeping its options open, with a<br />
pause now possible, it still has tightening work to do in our view.<br />
Change since our last weekly in bold and italics<br />
Market Economics 28 July 2011<br />
Market Mover<br />
75<br />
www.GlobalMarkets.bnpparibas.com
Economic Forecasts<br />
GDP<br />
Year 2010<br />
2011<br />
(% y/y) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)<br />
US 2.9 2.3 2.7 2.4 3.0 3.2 2.8 2.3 2.3 2.3 2.3<br />
Eurozone 1.7 2.0 1.5 0.8 2.0 2.0 1.9 2.5 1.9 1.7 1.9<br />
Japan 4.0 -0.8 2.1 5.6 3.1 5.0 2.2 -1.0 -1.3 -1.5 0.0<br />
World (2) 5.0 4.3 4.3 5.2 5.3 5.1 4.7 4.4 4.1 4.1 4.4<br />
Industrial Production<br />
Year<br />
2010<br />
2011<br />
(% y/y) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)<br />
US 5.3 3.8 3.9 1.5 6.5 6.9 6.3 5.3 4.0 3.0 2.9<br />
Eurozone 7.4 4.4 2.2 5.1 9.3 7.3 8.1 6.6 4.6 3.8 2.5<br />
Japan 16.5 0.0 6.8 28.0 21.2 14.0 6.0 -2.6 -6.7 3.4 5.1<br />
Unemployment Rate<br />
Year<br />
2010 2011<br />
(%) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)<br />
US 9.6 9.0 8.6 9.7 9.6 9.6 9.6 8.9 9.1 9.1 8.9<br />
Eurozone 10.1 9.8 9.4 10.1 10.2 10.1 10.1 9.9 9.8 9.8 9.7<br />
Japan 5.1 4.9 4.7 5.1 5.1 5.0 5.0 4.7 4.8 5.0 5.0<br />
CPI<br />
Year<br />
2010<br />
2011<br />
(% y/y) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)<br />
US 1.6 3.1 1.9 2.4 1.8 1.2 1.3 2.1 3.4 3.6 3.3<br />
Eurozone 1.6 2.8 2.3 1.1 1.6 1.7 2.0 2.5 2.8 3.0 3.1<br />
Japan (Core) -1.0 0.6 0.7 -1.2 -1.2 -1.1 -0.5 -0.2 0.5 1.0 1.0<br />
Current Account<br />
(% GDP) ’10<br />
Year<br />
’11 (1) ’12 (1) General Government<br />
(% GDP)<br />
’10 (1) Year<br />
’11 (1) ’12 (1)<br />
US -3.2 -3.4 -3.2 US (4) -3.2 -3.4 -3.2<br />
Eurozone -0.4 -0.8 -1.1 Eurozone -0.4 -0.8 -1.1<br />
Japan 3.6 1.9 1.2 Japan 3.6 1.9 1.2<br />
Interest Rate Forecasts<br />
Year<br />
2011<br />
2012<br />
(%) ’10 ’11 (1) ’12 (1) Q1 Q2 Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)<br />
US<br />
Fed Funds Rate 0.25 0.25 0.75 0.25 0.25 0.25 0.25 0.25 0.25 0.50 0.75<br />
3-month Rate 0.30 0.45 1.15 0.30 0.25 0.30 0.45 0.75 0.90 0.90 1.15<br />
2-year yield 0.61 1.00 2.45 0.83 0.47 0.75 1.00 1.50 2.00 2.25 2.45<br />
10-year yield 3.29 3.75 4.25 3.47 3.16 3.25 3.75 3.90 4.00 4.15 4.25<br />
2y/10y Spread (bp) 268 275 180 264 269 250 275 240 200 190 180<br />
Eurozone<br />
Refinancing Rate 1.00 1.75 2.25 1.00 1.25 1.50 1.75 2.00 2.25 2.25 2.25<br />
3-month Rate 1.01 2.00 2.50 1.24 1.55 1.75 2.00 2.25 2.40 2.40 2.50<br />
2-year yield (5) 0.85 2.30 2.30 1.80 1.61 1.80 2.30 2.45 2.65 2.80 3.00<br />
10-year yield (5) 2.96 3.75 4.10 3.35 3.01 3.30 3.75 3.85 3.95 4.05 4.10<br />
2y/10y Spread (bp) (5) 211 145 180 156 140 150 145 140 130 125 110<br />
Japan<br />
O/N Call Rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10<br />
3-month Rate 0.34 0.35 0.35 0.34 0.33 0.35 0.35 0.35 0.35 0.35 0.35<br />
2-year yield 0.18 0.20 0.30 0.22 0.17 0.15 0.20 0.25 0.30 0.30 0.30<br />
10-year yield 1.12 1.40 1.50 1.26 1.14 1.30 1.40 1.40 1.40 1.50 1.50<br />
2y/10y Spread (bp) 95 120 120 104 96 115 120 115 110 120 120<br />
Footnotes: (1) Forecast (2) <strong>BNP</strong>P estimates based on country weights in the IMF World Economic Outlook Update<br />
April 2011 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated (5) German benchmark<br />
Source: <strong>BNP</strong> Paribas<br />
Market Economics / Interest Rate Strategy 28 July 2011<br />
Market Mover<br />
76<br />
www.GlobalMarkets.bnpparibas.com
FX Forecasts*<br />
USD Bloc Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14<br />
EUR/USD 1.50 1.55 1.45 1.40 1.35 1.35 1.30 1.30 1.30 1.30 1.34<br />
USD/JPY 78 83 85 90 95 95 95 95 95 95 92<br />
USD/CHF 0.83 0.83 0.90 0.93 1.00 1.00 1.04 1.04 1.04 1.04 0.97<br />
GBP/USD 1.65 1.68 1.59 1.56 1.53 1.53 1.53 1.53 1.53 1.53 1.70<br />
USD/CAD 0.98 0.93 0.95 0.97 1.01 1.01 1.04 1.04 1.04 1.04 1.00<br />
AUD/USD 1.09 1.13 1.07 1.04 0.99 0.99 0.96 0.96 0.96 0.96 0.95<br />
NZD/USD 0.82 0.84 0.81 0.80 0.76 0.76 0.74 0.74 0.74 0.74 0.76<br />
USD/SEK 5.93 5.48 5.93 6.21 6.67 6.67 6.92 6.92 6.92 6.92 6.94<br />
USD/NOK 4.98 4.77 5.07 5.26 5.56 5.56 5.77 5.77 5.77 5.77 5.07<br />
EUR Bloc Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14<br />
EUR/JPY 117 129 123 126 128 128 124 124 124 124 123<br />
EUR/GBP 0.91 0.92 0.91 0.90 0.88 0.88 0.85 0.85 0.85 0.85 0.79<br />
EUR/CHF 1.25 1.28 1.30 1.30 1.35 1.35 1.35 1.35 1.35 1.35 1.30<br />
EUR/SEK 8.90 8.50 8.60 8.70 9.00 9.00 9.00 9.00 9.00 9.00 9.30<br />
EUR/NOK 7.47 7.40 7.35 7.37 7.50 7.50 7.50 7.50 7.50 7.50 6.80<br />
EUR/DKK 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46<br />
Central Europe Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14<br />
USD/PLN 2.60 2.48 2.69 2.75 2.81 2.78 2.85 2.77 2.85 2.85 2.65<br />
EUR/CZK 24.3 24.5 24.1 23.9 23.8 23.5 23.7 24.0 23.5 23.3 23.1<br />
EUR/HUF 275 275 269 265 265 260 260 255 260 260 250<br />
USD/ZAR 6.80 6.60 6.55 6.60 6.50 6.50 7.20 7.10 7.00 6.90 6.69<br />
USD/TRY 1.52 1.50 1.56 1.59 1.63 1.65 1.65 1.67 1.69 1.69 1.54<br />
EUR/RON 4.20 4.15 4.20 4.25 4.15 4.10 4.20 4.20 4.10 3.95 3.90<br />
USD/RUB 27.51 27.25 27.86 27.97 28.08 27.65 28.19 27.75 29.07 27.75 27.75<br />
EUR/PLN 3.90 3.85 3.90 3.85 3.80 3.75 3.70 3.60 3.70 3.70 3.55<br />
USD/UAH 7.8 7.8 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.3 7.4<br />
EUR/RSD 100 100 98 97 96 95 93 92 91 90 85<br />
Asia Bloc Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14<br />
USD/SGD 1.20 1.19 1.18 1.17 1.16 1.15 1.14 1.13 1.13 1.13 -----<br />
USD/MYR 2.95 2.90 2.87 2.85 2.83 2.80 2.77 2.75 2.73 2.70 -----<br />
USD/IDR 8400 8300 8200 8100 8000 7900 7800 7700 7600 7500 -----<br />
USD/THB 29.50 29.30 29.00 28.70 28.50 28.30 28.00 27.70 27.50 27.50 -----<br />
USD/PHP 42.00 41.50 41.00 40.50 40.00 39.50 39.00 38.50 38.00 38.00 -----<br />
USD/HKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 -----<br />
USD/RMB 6.40 6.31 6.25 6.21 6.17 6.13 6.23 6.20 6.17 6.15 -----<br />
USD/TWD 28.00 27.50 27.00 26.70 26.50 26.00 26.00 26.00 26.00 26.00 -----<br />
USD/KRW 1040 1030 1020 1010 1000 990 980 970 960 950 -----<br />
USD/INR 44.00 43.50 43.00 42.50 42.00 41.50 41.00 41.00 41.00 41.00 -----<br />
USD/VND 20500 20000 20000 20000 20000 20000 20000 20000 20000 20000 -----<br />
LATAM Bloc Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14<br />
USD/ARS 4.18 4.25 4.34 4.43 4.51 4.60 4.69 4.78 4.86 4.95 -----<br />
USD/BRL 1.58 1.55 1.53 1.55 1.56 1.58 1.59 1.60 1.61 1.62 -----<br />
USD/CLP 450 435 425 430 435 440 442 445 447 450 -----<br />
USD/MXN 11.40 11.10 11.00 10.90 11.00 11.10 11.10 11.17 11.25 11.30 -----<br />
USD/COP 1730 1690 1690 1700 1710 1720 1725 1730 1740 1750 -----<br />
USD/VEF 4.29 4.29 4.29 4.29 4.29 4.29 8.80 8.80 8.80 8.80 -----<br />
USD/PEN 2.70 2.65 2.63 2.63 2.64 2.66 2.67 2.68 2.69 2.70 -----<br />
Others Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14<br />
USD Index 72.30 70.76 74.87 77.62 80.72 80.72 82.99 82.99 82.99 82.99 79.73<br />
*End Quarter<br />
Foreign Exchange Strategy 28 July 2011<br />
Market Mover, Non-Objective Research Section<br />
www.GlobalMarkets.bnpparibas.com<br />
77
Market Coverage<br />
Market Economics<br />
Paul Mortimer-Lee Global Head of Market Economics London 44 20 7595 8551 paul.mortimer-lee@uk.bnpparibas.com<br />
Ken Wattret Chief Eurozone Market Economist London 44 20 7595 8657 kenneth.wattret@uk.bnpparibas.com<br />
Luigi Speranza Head of Inflation & Fiscal Economics, London 44 20 7595 8322 luigi.speranza@uk.bnpparibas.com<br />
Eurozone, Italy<br />
Gizem Kara Scandinavia London 44 20 7595 8783 gizem.kara@uk.bnpparibas.com<br />
Dominique Barbet Eurozone, France Paris 33 1 4298 1567 dominique.barbet@bnpparibas.com<br />
Julia Coronado Chief Economist North America New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.com<br />
Yelena Shulyatyeva US New York 1 212 841 2258 yelena.shulyatyeva@americas.bnpparibas.com<br />
Bricklin Dwyer US, Canada New York 1 212 471-7996 bricklin.dwyer@americas.bnpparibas.com<br />
Ryutaro Kono Chief Economist Japan Tokyo 81 3 6377 1601 ryutaro.kono@japan.bnpparibas.com<br />
Hiroshi Shiraishi Japan Tokyo 81 3 6377 1602 hiroshi.shiraishi@japan.bnpparibas.com<br />
Azusa Kato Japan Tokyo 81 3 6377 1603 azusa.kato@japan.bnpparibas.com<br />
Makiko Fukuda Japan Tokyo 81 3 6377 1605 makiko.fukuda@japan.bnpparibas.com<br />
Richard Iley Head of Asia Economics Hong Kong 852 2108 5104 richard.iley@asia.bnpparibas.com<br />
Dominic Bryant Asia, Australia Hong Kong 852 2108 5105 dominic.bryant@asia.bnpparibas.com<br />
Mole Hau Asia Hong Kong 852 2108 5620 mole.hau@asia.bnpparibas.com<br />
Xingdong Chen Chief China Economist Beijing 86 10 6535 3327 xd.chen@asia.bnpparibas.com<br />
Chan Kok Peng Chief Economist South East Asia Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.com<br />
Marcelo Carvalho Head of Latin American Economics São Paulo 55 11 3841 3418 marcelo.carvalho@br.bnpparibas.com<br />
Italo Lombardi Latin America New York 1 212 841 6599 italo.lombardi@americas.bnpparibas.com<br />
Nader Nazmi Latin America New York 1 212 471 8216 nader.nazmi@us.bnpparibas.com<br />
Florencia Vazquez Latin American Economist Buenos Aires 54 11 4875 4363 florencia.vazquez@ar.bnpparibas.com<br />
Michal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.com<br />
Julia Tsepliaeva Russia & CIS Moscow 74 95 785 6022 julia.tsepliaeva@ru.bnpparibas.com<br />
Selim Cakir Chief Economist TEB Istanbul 90 216 635 2972 selim.cakir@teb.com.tr<br />
Emre Tekmen Economist TEB Istanbul 90 216 635 2975 emre.tekmen@teb.com.tr<br />
Interest Rate Strategy<br />
Cyril Beuzit Global Head of Interest Rate Strategy London 44 20 7595 8639 cyril.beuzit@uk.bnpparibas.com<br />
Patrick Jacq Europe Strategist Paris 33 1 4316 9718 patrick.jacq@bnpparibas.com<br />
Hervé Cros Chief Inflation Strategist London 44 20 7595 8419 herve.cros@uk.bnpparibas.com<br />
Shahid Ladha Inflation Strategist London 44 20 7 595 8573 shahid.ladha@uk.bnpparibas.com<br />
Alessandro Tentori Chief Alpha Strategy Europe London 44 20 7595 8238 alessandro.tentori@uk.bnpparibas.com<br />
Eric Oynoyan Europe Alpha Strategist London 44 20 7595 8613 eric.oynoyan@uk.bnpparibas.com<br />
Matteo Regesta Europe Alpha Strategist London 44 20 7595 8607 matteo.regesta@uk.bnpparibas.com<br />
Ioannis Sokos Europe Alpha Strategist London 44 20 7595 8671 ioannis.sokos@uk.bnpparibas.com<br />
Camille de Courcel Europe Alpha Strategist London 44 20 7595 8295 camille.decourcel@uk.bnpparibas.com<br />
Bülent Baygün Head of Interest Rate Strategy US New York 1 212 471 8043 bulent.baygun@americas.bnpparibas.com<br />
Mary-Beth Fisher US Senior Strategist New York 1 212 841 2912 mary-beth.fisher@us.bnpparibas.com<br />
Sergey Bondarchuk US Strategist New York 1 212 841 2026 sergey.bondarchuk@americas.bnpparibas.com<br />
Suvrat Prakash US Strategist New York 1 917 472 4374 suvrat.prakash@americas.bnpparibas.com<br />
Anish Lohokare MBS Strategist New York 1 212 841 2867 anish.lohokare@americas.bnpparibas.com<br />
Olurotimi Ajibola MBS Strategist New York 1 212 8413831 olurotimi.ajibola@americas.bnpparibas.com<br />
Koji Shimamoto Head of Interest Rate Strategy Japan Tokyo 81 3 6377 1700 koji.shimamoto@japan.bnpparibas.com<br />
Tomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1703 Tomohisa.fujiki@japan.bnpparibas.com<br />
Masahiro Kikuchi Japan Strategist Tokyo 81 3 6377 1703 masahiro.kikuchi@japan.bnpparibas.com<br />
Christian Séné Technical Analyst Paris 33 1 4316 9717 christian.séné@bnpparibas.com<br />
FX Strategy<br />
Ray Attrill Head of FX Strategy – North America New York 1 212 841 2492 raymond.attrill@us.bnpparibas.com<br />
Mary Nicola FX Strategist New York 1 212 841 2492 mary.nicola@americas.bnpparibas.com<br />
Steven Saywell Head of FX Strategy - Europe London 44 20 7595 8487 steven.saywell@uk.bnpparibas.com<br />
Kiran Kowshik FX Strategist London 44 20 7595 1495 kiran.kowshik@bnpparibas.com<br />
James Hellawell Quantitative Strategist London 44 20 7595 8485 james.hellawell@uk.bnpparibas.com<br />
Local Markets FX & Interest Rate Strategy<br />
Drew Brick Head of FX & IR Strategy Asia Singapore 65 6210 3262 Drew.brick@asia.bnpparibas.com<br />
Chin Loo Thio FX & IR Asia Strategist Singapore 65 6210 3263 chin.thio@asia.bnpparibas.com<br />
Robert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 robert.ryan@asia.bnpparibas.com<br />
Jasmine Poh FX & IR Asia Strategist Singapore 65 6210 3418 jasmine.j.poh@asia.bnpparibas.com<br />
Gao Qi FX & IR Asia Strategist Shanghai 86 21 2896 2876 gao.qi@asia.bnpparibas.com<br />
Bartosz Pawlowski Head of FX & IR Strategy CEEMEA London 44 20 7595 8195 Bartosz.pawlowski@uk.bnpparibas.com<br />
Dina Ahmad FX & IR CEEMEA Strategist London 44 20 7 595 8620 dina.ahmad@uk.bnpparibas.com<br />
Erkin Isik FX & IR CEEMEA Strategist Istanbul 90 (216) 635 29 87 erkin.isik@teb.com.tr<br />
Raffaele Semonella EMEA Corporates Analyst London 44 20 7 595 8813 raffaele.semonella@uk.bnpparibas.com<br />
Diego Donadio FX & IR Latin America Strategist São Paulo 55 11 3841 3421 diego.donadio@@br.bnpparibas.com<br />
78
For Production and Distribution, please contact:<br />
Ann Aston, Market Economics, London. Tel: 44 20 7595 8503 Email: ann.aston@uk.bnpparibas.com,<br />
Jessica.Bakkioui, Market Economics, London. Tel: 44 20 7595 8478 Email: jessica.bakkioui@uk.bnpparibas.com,<br />
Danielle Catananzi, Interest Rate Strategy, London. Tel: 44 20 7595 4418 Email: danielle.catananzi@uk.bnpparibas.com,<br />
Roshan Kholil, FX Strategy, London. Tel: 44 20 7595 8486 Email:roshan.kholil@uk.bnpparibas.com,<br />
Martine Borde, Market Economics/Interest Rate Strategy, Paris. Tel: 33 1 4298 4144 Email martine.borde@bnpparibas.com<br />
Editors: Amanda Grantham-Hill, Interest Rate Strategy/Market Economics, London. Tel: 44 20 7595 4107 Email: amanda.grantham-hill@bnpparibas.com;<br />
Nick Ashwell, FX/Market Economics, London. Tel: 44 20 7595 4120 Email: nick.ashwell@uk.bnpparibas.com<br />
Jeffrey Myhre, Interest Rate Strategy/Market Economics, New York. Tel: 212 471 8180 Email: jeffrey.myhre@us.bnpparibas.com<br />
<strong>BNP</strong> Paribas Global Fixed Income Website<br />
www.globalmarkets.bnpparibas.com<br />
Bloomberg<br />
Fixed Income Research BPCM Market Economics BPEC<br />
Interest Rate Strategy BPBS Forex Strategy BPFR<br />
RESEARCH DISCLAIMERS:<br />
IMPORTANT DISCLOSURES: Please see important disclosures in the text of this report.<br />
Some sections of this report have been written by our strategy teams. These sections are clearly labelled and do not purport to be an<br />
exhaustive analysis, and may be subject to conflicts of interest resulting from their interaction with sales and trading which could affect the<br />
objectivity of this report. (Please see further important disclosures in the text of this report). These sections are a marketing communication.<br />
They are not independent investment research. They have not been prepared in accordance with legal requirements designed to provide the<br />
independence of investment research, and are not subject to any prohibition on dealing ahead of the dissemination of investment research.<br />
The information and opinions contained in this report have been obtained from, or are based on, public sources believed to be reliable, but no<br />
representation or warranty, express or implied, is made that such information is accurate, complete or up to date and it should not be relied upon as such.<br />
This report does not constitute an offer or solicitation to buy or sell any securities or other investment. Information and opinions contained in the report are<br />
published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any<br />
recipient, are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any<br />
reference to past performance should not be taken as an indication of future performance. To the fullest extent permitted by law, no <strong>BNP</strong> Paribas group<br />
company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arising from any use of or reliance on material<br />
contained in this report. All estimates and opinions included in this report are made as of the date of this report. Unless otherwise indicated in this report<br />
there is no intention to update this report. <strong>BNP</strong> Paribas SA and its affiliates (collectively “<strong>BNP</strong> Paribas”) may make a market in, or may, as principal or<br />
agent, buy or sell securities of any issuer or person mentioned in this report or derivatives thereon. <strong>BNP</strong> Paribas may have a financial interest in any<br />
issuer or person mentioned in this report, including a long or short position in their securities and/or options, futures or other derivative instruments based<br />
thereon, or vice versa. <strong>BNP</strong> Paribas, including its officers and employees may serve or have served as an officer, director or in an advisory capacity for<br />
any person mentioned in this report. <strong>BNP</strong> Paribas may, from time to time, solicit, perform or have performed investment banking, underwriting or other<br />
services (including acting as adviser, manager, underwriter or lender) within the last 12 months for any person referred to in this report. <strong>BNP</strong> Paribas may<br />
be a party to an agreement with any person relating to the production of this report. <strong>BNP</strong> Paribas, may to the extent permitted by law, have acted upon or<br />
used the information contained herein, or the research or analysis on which it was based, before its publication. <strong>BNP</strong> Paribas may receive or intend to<br />
seek compensation for investment banking services in the next three months from or in relation to any person mentioned in this report. Any person<br />
mentioned in this report may have been provided with sections of this report prior to its publication in order to verify its factual accuracy.<br />
<strong>BNP</strong> Paribas is incorporated in France with limited liability. Registered Office 16 Boulevard des Italiens, 75009 Paris. This report was produced by a <strong>BNP</strong><br />
Paribas group company. This report is for the use of intended recipients and may not be reproduced (in whole or in part) or delivered or transmitted to any<br />
other person without the prior written consent of <strong>BNP</strong> Paribas. By accepting this document you agree to be bound by the foregoing limitations.<br />
Certain countries within the European Economic Area:<br />
This report is solely prepared for professional clients. It is not intended for retail clients and should not be passed on to any such persons.<br />
This report has been approved for publication in the United Kingdom by <strong>BNP</strong> Paribas London Branch. <strong>BNP</strong> Paribas London Branch is authorised and<br />
supervised by the Autorité de Contrôle Prudentiel and authorised and subject to limited regulation by the Financial <strong>Services</strong> Authority. Details of the<br />
extent of our authorisation and regulation by the Financial <strong>Services</strong> Authority are available from us on request.<br />
This report has been approved for publication in France by <strong>BNP</strong> Paribas, a credit institution licensed as an investment services provider by the Autorité de<br />
Contrôle Prudentiel whose head office is 16, Boulevard des Italiens 75009 Paris, France.<br />
This report is being distributed in Germany either by <strong>BNP</strong> Paribas London Branch or by <strong>BNP</strong> Paribas Niederlassung Frankfurt am Main, regulated by the<br />
Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin).<br />
United States: This report is being distributed to US persons by <strong>BNP</strong> Paribas Securities Corp., or by a subsidiary or affiliate of <strong>BNP</strong> Paribas that is not<br />
registered as a US broker-dealer to US major institutional investors only. <strong>BNP</strong> Paribas Securities Corp., a subsidiary of <strong>BNP</strong> Paribas, is a broker-dealer<br />
registered with the Securities and Exchange Commission and a member of the Financial Industry Regulatory Authority and other principal exchanges.<br />
<strong>BNP</strong> Paribas Securities Corp. accepts responsibility for the content of a report prepared by another non-US affiliate only when distributed to US persons<br />
by <strong>BNP</strong> Paribas Securities Corp.<br />
Japan: This report is being distributed to Japanese based firms by <strong>BNP</strong> Paribas Securities (Japan) Limited or by a subsidiary or affiliate of <strong>BNP</strong> Paribas<br />
not registered as a financial instruments firm in Japan, to certain financial institutions defined by article 17-3, item 1 of the Financial Instruments and<br />
Exchange Law Enforcement Order. <strong>BNP</strong> Paribas Securities (Japan) Limited is a financial instruments firm registered according to the Financial<br />
Instruments and Exchange Law of Japan and a member of the Japan Securities Dealers Association and the Financial Futures Association of Japan.<br />
<strong>BNP</strong> Paribas Securities (Japan) Limited accepts responsibility for the content of a report prepared by another non-Japan affiliate only when distributed to<br />
Japanese based firms by <strong>BNP</strong> Paribas Securities (Japan) Limited. Some of the foreign securities stated on this report are not disclosed according to the<br />
Financial Instruments and Exchange Law of Japan.<br />
Hong Kong: This report is being distributed in Hong Kong by <strong>BNP</strong> Paribas Hong Kong Branch, a branch of <strong>BNP</strong> Paribas whose head office is in Paris,<br />
France. <strong>BNP</strong> Paribas Hong Kong Branch is regulated as a Registered Institution by Hong Kong Monetary Authority for the conduct of Advising on<br />
Securities [Regulated Activity Type 4] under the Securities and Futures Ordinance.<br />
© <strong>BNP</strong> Paribas (2011). All rights reserved.