MARKET MOVER - BNP PARIBAS - Investment Services India

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eta, yield and commodity currencies will remain firm this year, the outlook for 2011 is less upbeat. Successful intervention? The BoJ intervening on behalf of the MOF has stabilised JPY markets. But further intervention will be needed to prevent the JPY from appreciating again. An analysis of JPY-related flows demonstrates this. While Japanese institutional investors have invested heavily in foreign bond markets, betting on the ‘Japanisation’ of Western economies, these JPY outflows have all been currency hedged. Consequently, portfolio flows have been currency neutral. Since M&A related flows have been insignificant, we believe that most of the JPY strength has been caused by commercially related JPY demand. Japanese exports have been JPY bidding and, if the semi-official Japanese Postbank had not quietly offered JPY, the USDJPY decline seen since March would have been even more dramatic. Currently, commercial JPY flows are dominant and intervention will not change Japanese exporters’ need to buy JPY. Hence, the BoJ will have to intervene in the amount roughly matching the size of Japan’s current account surplus. Given that Japan’s reserve to GDP ratio has over the past six years risen from 16% to 21%, the BoJ has ample scope to conduct JPY weakening intervention to keep USDJPY above 80.00. The coming quarter should see USDJPY slowly grinding lower, but with the BoJ in the market, the risk of a sharp move lower may have been prevented. ECB repo allocation… Hence, JPY markets should not dent risk appetite, allowing us to shift focus to the EUR. EMU economies show a split performance: Germany is surprising with its strength, while Spain and other peripheral economies face a double-dip recession. However, the market has always believed that Germany is the trend setter for the eurozone and it will continue doing so until proven wrong. Indeed, German export-oriented growth has received a big boost from booming Asian and Middle Eastern markets. With Chinese economic statistics showing domestic demand rising strongly and China allowing its currency to appreciate at a moderate pace, exporter optimism in coming surveys could be buoyed even further. Meanwhile, outstanding ECB reserves have decreased from EUR 900bn to EUR 600bn, indicating that Europe’s banking sector overall has become less dependent on ECB liquidity. Nonetheless, this is the extent of the good news. The ECB has allocated unlimited repo liquidity at the fixed 1% rate. Some 61% of reserves provided by the ECB have been absorbed by peripheral banks located in Spain, Portugal, Greece and Ireland. As long as the ECB provides unlimited access to central bank Chart 4: Japan: Current Account Surplus Drives USDJPY Source: Reuters EcoWin Pro; Current account (12mths sum) (USD), (Bln) Chart 5: Excess of Reserves Held by European Commercial Banks with the ECB Reduced Source: Reuters EcoWin Pro liquidity, the solvency of peripheral banks is almost guaranteed. Peripheral banks can even get access to short-term private funds. However, once the ECB begins to exit from the unlimited provision of liquidity, the outlook will change radically. In this case, peripheral banks will run short of funds, forcing sovereigns to step in. The creditworthiness of peripheral sovereigns has been damaged and, with bond spreads wide, it is not clear that sovereigns’ fund-raising capabilities are sound enough to deal with additional liquidity demands from its banking sector. …will be important for assessing investment risks Indeed, the weak banking sector could easily undermine EMU credit markets. The successful Spanish sovereign auctions saw little international participation, with domestic banks the main investors. Should the ECB cut banks off from unlimited liquidity, demand for local bonds will suffer – driving spreads up. Remember, in November 2009, the ECB’s Hans Redeker 23 September 2010 Market Mover, Non-Objective Research Section 46 www.GlobalMarkets.bnpparibas.com
warning to Greek banks that it might have to impose haircuts on Greek bonds used as collateral for ECB funding triggered what proved to be a significant widening of Greek bond spreads. Again, the ECB is now in a very uncomfortable position and can only hope that growth picks up quickly enough in the eurozone periphery to reduce balance sheet risks within its banking sector. As long as growth is weak, peripheral banks will remain hooked on ECB liquidity – putting the ECB between a rock and a hard place with regard to monetary policy. Providing unlimited liquidity prevents peripheral banks going down the drain, but such monetary conditions will become far too loose for core countries. The inflation-fearing German people will certainly not like the idea of inflating way peripheral countries’ problems. Alternatively, letting unlimited repos expire without replacement will send shock waves across peripheral bond markets which could easily lead to another round of EUR weakness. We expect the ECB to try to win time by keeping unlimited repos in the market well into 2011. While this implies keeping the floodgates of monetary policy open, with the ECB effectively acting as the ‘liquidity provider of last resort for the embattled peripheral banking sector, banking-related issues will not be the main focus for currency traders this year. The ECB’s accommodative monetary conditions suggest the EUR will underperform against highyielding currencies. Against the USD, the EUR is expected to make moderate gains. However, next year, things may look very different. The ECB will not be able to keep its current approach indefinitely without risking its own balance sheet. But should the ECB be forced to exit its policy of providing unlimited repos at a time when peripheral Europe still needs life support, all hell would break loose. In such a case, the EUR trend would reverse quickly. Trading themes: CAD may play catch-up Trading opportunities over the next few weeks and months will come from projected USD weakness coming on the back of the Fed preparing for another round of quantitative easing. Over the past few weeks, it has been the ‘Japanisation’ theme driving the relative performance of currencies against the USD – putting the AUD in an out-performing position. Lower bond yields globally suggested investors playing the ‘yield pick-up’ theme, putting yielding currencies into demand. Although the decline in the USD was accompanied by commodity prices breaking higher, the CAD has not benefited from the USD decline. Rather, AUDCAD has rallied by more than 15% since June. In the short term, this advance looks overstretched and will be corrected if the Japanisation theme converts into an asset theme as we expect. The CAD should receive support once the Chart 6: Sweden: Export Structure Sweden Exports by Destination Scandinavia 23% Asia incl Japan 3% UK 9% Oceania 2% Canada 2% Others 12% EU 39% US 10% Pulp & Paper 20% Sweden Exports by Type Motor 19% Pharmaceuticals 15% Basic metals 2% Machinery 29% Chemicals 14% Communication 1% Source: Statistics Sweden Exports in SEK bln, using 2009 totals (sourced via Bloomberg), Statistics Sweden Exports in SEK bln, using 2009 totals (sourced via Bloomberg) EU 56% Chart 7: UK: Export Structure UK Exports by Destination Asia Scandinavia incl Japan 7% 4% Oceania 2% Canada 4% Others 6% US 21% Food, Beverages & Tobacco 20% Finishedmanufactures 12% UK Exports by Type Basic Materials 19% All manuf 14% Fuel 18% Semimanufactures 17% Source: ONS UK Trade in goods by volume indices using 2009 totals (sourced via Bloomberg), OECD International Trade Statistics Database expressed in current USD, using 2009 totals currently dominant bond-related cross-currency flow converts into an equity flow. We showed above that central bank liquidity has determined the equity trend over the past year. With central bank liquidity being printed not only in the G4 but also Asian central banks operating looser conditions than warranted by their domestic fundamental situation, there is a good chance of seeing share prices move higher. An increasing focus on equity markets should allow the CAD to catch up with the AUD. GBPSEK shorts are the conservative way to play the China boom The other big currency trading theme is China and its increasingly important domestic market. Export opportunities to China vary significantly between countries. Generally, countries with a strong manufacturing sector stand to benefit more than countries with an underdeveloped manufacturing sector. Sweden falls into the first category. It is not only the direct trade relationship that counts. Machinery exports comprise 21% of Sweden’s total exports and are exactly what Asian economies are demanding. Globally, the machinery sector is booming and Sweden is participating in this boom. On the other hand, the UK is not known for its machinery and the financial services it exports are of little use to China, with its closed capital account. Hans Redeker 23 September 2010 Market Mover, Non-Objective Research Section 47 www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Euromoney Interest Rates Survey 201
Page 3 and 4: ECB on a different page… …but i
Page 5 and 6: developments and is prepared to pro
Page 7 and 8: and property tax payments, dropped
Page 9 and 10: directly to effect outright purchas
Page 11 and 12: Services also on the slide The ‘f
Page 13 and 14: inflation rate is calculated exclud
Page 15 and 16: closer to a more normal level” to
Page 17 and 18: point advance in the June Tankan. P
Page 19 and 20: US: Belly of the Curve is Rich, but
Page 21 and 22: US: A Carry Trade with Extra Potent
Page 23 and 24: MBS: Remain Underweight, GNM CBRs U
Page 25 and 26: EUR: Re-Enter Flatteners on 5y/10y
Page 27 and 28: EGBs: Market Update & Top Trade Ide
Page 29 and 30: EUR Covered Bonds: Market Update
Page 31 and 32: GBP Curve Opportunities Update •
Page 33 and 34: Table 1: BNP Paribas' Inflation For
Page 35 and 36: Table 3: BNP Paribas' Inflation For
Page 37 and 38: Table 1: BNP Paribas Carry Analysis
Page 39 and 40: have been happy to buy the roll to
Page 41 and 42: Technical Analysis - Interest Rates
Page 43 and 44: Trade Reviews Options, Money Market
Page 45: ond market attracted huge swathes o
Page 49 and 50: Chart 2: EUR/SEK - major support be
Page 51 and 52: Economic Calendar: 24 Sep - 1 Oct G
Page 53 and 54: Economic Calendar: 24 Sep - 1 Oct (
Page 55 and 56: Key Data Preview Chart 3: US ISM Po
Page 57 and 58: Key Data Preview Chart 7: US Consum
Page 59 and 60: Key Data Preview Chart 11: Japanese
Page 61 and 62: Key Data Preview Chart 7: UK CIPS M
Page 63 and 64: Economic Calendar: 4 - 29 October 4
Page 65 and 66: Next week's T-Bills Supply Date Cou
Page 67 and 68: Economic Forecasts GDP Year 2010 (%
Page 69 and 70: Market Coverage Market Economics Pa

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