Market Mover - BNP PARIBAS - Investment Services India

Market Economics | Interest Rate Strategy | Forex Strategy 27 October 2011Market MoverMarket Outlook 2-3Fundamentals 4-29• US FOMC: Rise of the Aggressive 4-7Doves• HARP – Phase II – Another Baby Step 8-9• US: The Fiscal Clock is Ticking… 10-11• Canada: Lowering Expectations 12-13• France: Time for Tightening 14-15• UK: Still Raining 16-17• Sweden: Rate Hikes Postponed 18• Japan: Exports Slow on End of Catch- 19-20Up• Japan: Lessons from a ‘Lewis Turning 21-24Point’• Australia: Not Yet 25-27• China: Undertaking Selective Easing 28-29Interest Rate Strategy 30-62• US Bonds: Treasury Quarterly Funding 31Review• Impacts of HARP 2.0 on Agency Debt 32-33• MBS: HARP 2.0? OMG, INBD! 34-36• Greece: “Deeper” PSI After the EU 37-38Summit• EUR: Receive OIS/BOR Spreads 39• EUR: Update on the 50y Point 40• EMU Debt Monitor: CDS, RV Charts, 41-46Redemptions, Trade Ideas, SSA &Covered Bonds• EUR Gamma: Yet One More Carry47Trade• GBP: Long-End Linkers and Gilts in 48-50Demand• JGBs: No Impact from the BoJ’s51Decision• Global Inflation Watch 52-55• Inflation: Sentiment to Support56Breakevens• TIPS: A Pause before a New Jump? 57-59• Technical Analysis 60-61• Trade Reviews 62FX Strategy 63-69• EURUSD: New Upside Risk 63-65• Oil Implications for FX 66-67• Looks to Sell USDCAD 68-69Forecasts & Calendars 70-85• 1 Week Economic Calendar 70-71• Key Data Preview 72-79• 4 Week Calendar 80• Treasury & SAS Issuance 81-82• Central Bank Watch 83• Economic & Interest Rate Forecasts 84• FX Forecasts 85Contacts 86www.GlobalMarkets.bnpparibas.com• Though some implementation risks remain, theoutcome of the EU Summit will help the market regainsome confidence.• The rally in risky assets will hopefully help sentiment tostabilise, although more details are needed for asustainable normalisation trend to develop.• Political acceptance of further fiscal measures,particularly in Italy, will be crucial to help reduce volatilityin EGBs and attract investors.• We favoured normalisation trades going into the EUSummits and maintain this call for the weeks ahead, i.e. weexpect further bear steepening on the benchmark curveand tighter EMU spreads.• The outlines of the recent agreements have beenenough to push EURUSD decisively through 1.39 and toabove 1.41.• The move lower in the USD remains very much part of abroader improvement in risk sentiment. This improvementhas been driven by better US data, and expectations thatan upcoming change to Fed policy objectives could meanUS rates are lower for even longer.• Treasuries remain driven by EMU news for the momentand we expect further bear steepening going into theFOMC meeting.• We look for further near-term USD weakness and nowprefer to express this via the AUD and JPY.• After the latest BoJ easing measurers failed to softenthe JPY and the BoJ acknowledged the risk of further neartermyen strength, we stay short USDJPY.Market ViewsUST 10y T-note Yield (%)2y/10y Spread (bp)EGB 10y Bund Yield (%)2y/10y Spread (bp)JGB 10y JGB Yield (%)2y/10y Spread (bp)Forex EUR/USDUSD/JPYCurrent 1 Week 1 Month2.29 ↑ ↑200 ↑ ↑2.19 ↑ ↑155 ↑ ↑1.01 ↔↑ ↑87 ↔↑ ↑1.4132 ↔ ↑75.83 ↓ ↓IMPORTANT NOTICE. Please refer to important disclosures found at the end ofthis report. Some sections of this report have been written by our strategy teams.Such reports do not purport to be an exhaustive analysis and may be subject toconflicts of interest resulting from their interaction with sales and trading whichcould affect the objectivity of this report.

Market OutlookPositive outcome of the EUSummit, althoughimplementation details arelackingFinancial markets continue to be primarily driven by swings in eurozonesovereign risk premia. There was a period of consolidation going into the EUsummits, but the risk-on mode is back after EU leaders’ proposals toaddress the crisis. The most positive aspects of the announcement include:the multidimensional nature of the measures agreed; the agreement inprinciple to 'leverage' the EFSF four to five times the amount still available;the agreement on banks’ capital (bank recapitalisation needs amount toEUR 106.4bn according to the EBA: EUR 5.2bn in Germany, 7.8bn inPortugal, 8.8bn in France, 14.8bn in Italy, 26.2bn in Spain and 30bn inGreece for major recapitalisations); the attempts to settle the Greek issue(on the PSI, the nominal discount on Greek debt will be 50% and theobjective is to reduce the debt/GDP ratio to 120% by 2020); and anotherround of fiscal consolidation measures from Italy.There is still work to do. In particular, the mechanics of the EFSF leverageschemes need to be fleshed out; the ECB is not involved in EFSF leverage;the revision of the July 21 PSI for Greece may encourage more defensivebehaviour by investors; and the proposed reduction in the Greek debt/GDPratio may not be adequate.EMU AAA: Further Normalisation AheadIs this just a post-EUSummit relief rally orsomething more decisive?We continue to favournormalisation tradesSource: BNP ParibasThe measures announced are partly political and some details about theirimplementation are still lacking. However, although these measures may notyet be seen as the final solution (ECB involvement, stronger fiscal union,Eurobonds…) they are clearly a step in the right direction, which should helprestore some confidence in the market. The political acceptance of furtherfiscal measures, particularly in Italy, will be crucial to reduce volatility inEGBs, which remains a pre-condition for investors’ appetite in peripheralmarkets to return.The market reaction so far can be seen as a relief rally on risky assets, witha setback in benchmark papers and a tightening of intra-EMU spreads.Governments need to quickly deliver the missing details (G20 meeting3-4 November) and to implement further fiscal reforms to sustain the moves.We favoured normalisation trades going into the Summits and we maintainthis call for the weeks ahead – expecting further bear steepening on thebenchmark curve and tighter EMU spreads. A more defensive way to bepositioned on AAA curves after the post-EU Summit’s sharp move onspreads could be 2/10s OATs flatteners versus 5/30s DSL steepeners as2/10y OAT/AAA boxes have reached extreme levels.Beyond the coming weeks and our call for further normalisation, bear inmind that although EMU news has set the tone for several weeks, the otherCyril Beuzit 27 October 2011Market Mover2www.GlobalMarkets.bnpparibas.com

ECB to remain active onliquidity measures and thesecondary marketUS markets driven by EMUnews until 2 NovemberFOMC meetingFurther upside on EURUSDJPY’s upward trend todevelop furtherkey driving force going into the turn of the year will remain the fundamentalpicture. Within the eurozone, leading indicators have already deterioratedand hard data will follow their fall. This week, PMIs fell further below 50, withforward-looking sub-indices, such as new orders, still sliding. This favours anECB rate cut: the macro-economic background sets a compelling case for acut straight away, although the fact that November will be Draghi’s firstmeeting may be a complication. We still see the ECB moving in Decemberas the most likely scenario, in tandem with the release of new economicprojections, with a 50bp cut aimed at boosting confidence. In other words,the macro environment will remain bond supportive for a while and the‘japanisation’ theme is likely to resurface once EMU stress has easedsignificantly.Regarding liquidity, the latest measures could have a negative impact onliquidity and bank lending as banks have to commit to raise EUR 106bn inorder to show Core Tier 1 capital of 9% by June 2012. The ECB will have toremain active on the liquidity front. The 12mth tender conducted this weekattracted reasonable, but not that strong, demand. However, both liquidityand its duration were increased. In addition, the latest EU decisions arelikely to improve the credit quality assessment on banks. Thus CDS haveroom to decline. We recommend receiving OIS/BOR spreads.In the US, economic data continue to surprise to the upside and equitiesremain well bid, so the near-term momentum for rates continues to be to theupside in our opinion. We have preferred to express this view via 5s30ssteepeners, given that the market could run with the idea of UER/inflationtargeting or an MBS purchase programme at next week’s FOMC meeting(both of which should support the 5y sector). We may not carry this positionthrough the actual meeting, but if the market prices a meaningful chance ofthis in the days before, then we believe this gives an added kicker to 5s30ssteepeners.In the FX market, the outline of the latest eurozone rescue deal has beensufficient to push EURUSD decisively through 1.39 and to above 1.40. Thefall in the USD remains very much part of a broader improvement in risksentiment. This improvement has been driven by better US data, alongsideexpectations that upcoming changes to the Fed’s policy could mean USrates are lower for even longer, and some easing of fears of a China hardlanding.The fact that the euro is weakening – not strengthening – against commoditycurrencies in particular is testimony to the above argument. We see the USDhas continuing to have downward potential and we marginally prefer toexpress this via the likes of the AUD and JPY than the EUR. The comingweek's RBA meeting will be the key focus for the former; the market is fairlyfully priced for a 25bp rate cut, meaning the AUD’s upside risk is significantif, as we expect, the RBA stands pat. But we do look for a cut in December.The ECB and Fed meetings now loom large as the next key drivers for themajors. A rate cut from the ECB, or strong hint thereof at Mr. Draghi’sinaugural press conference, could take some of the heat out of the euro butprobably not for long. Language from the FOMC meeting that suggests ratescould be kept low for an even longer “extended period” has the potential todrive a more lasting weakening in the USD.The Bank of Japan increased the size of the Asset Purchase Program byJPY 5trn to JPY 55trn, directed at JGB purchases. However, the decisiondisappointed some market participants, which had strongly expected theextension of maturities of JGBs subject to purchases.This latest easing has been accompanied by an acknowledgement that theJPY could strengthen further in the short term. We continue to expectUSDJPY to head lower, all the more so if US treasury yields do fall after theFOMC meeting.Cyril Beuzit 27 October 2011Market Mover 3 www.GlobalMarkets.bnpparibas.com

US FOMC: Rise of the Aggressive Doves• Disappointing H1 economic performance,downward revisions to GDP over the past threeyears, and rising financial market volatility ledthe Fed to downgrade its outlook not just in thenear term, but also over a longer horizon.Chart 1: Retail Mortgage Spread a Worry to Fed• November FOMC meeting is the first timesince June that economic forecasts will bepublished.• Financial markets have been pleasantlysurprised over the past month by incoming dataconsistent with the 2.5% q/q saar reading on Q3GDP growth. However, the performance hasbeen less of a surprise to the FOMC whosemembers generally anticipated a strongergrowth performance in H2 2011 as some of thetemporary factors restraining growth eased.Source: Reuters EcoWin ProChart 2: Financial market volatility can take a tollon hiring• Most FOMC participants indicated they sawadvantages in being more transparent about theconditionality in the Committee’s forwardguidance by providing more information aboutthe economic conditions to which the guidancerefers. The November meeting with its forecastand post-meeting press conference is ideallysuited to roll out such a new policy framework.• While it may have appeared in recent monthsthat the Fed was becoming less aggressive, itnow appears that they were simply steppingback and reformulating their reaction function.A weaker outlook for longerSomething momentous happened at the Fed inAugust. A disappointing H1 economic performance,downward revisions to GDP over the past threeyears, and rising financial market volatility led theFed to downgrade its outlook not just in the nearterm, but also over a longer horizon. In June, theFOMC statement said, “the slower pace of therecovery reflects in part factors that are likely to betemporary”. However, the statement released afterthe August meeting acknowledged that “temporaryfactors…appear to account for only some of therecent weakness in economic activity”.Much of the Fedspeak in recent months has cited thefiscal adjustment taking place at the state and locallevel and likely to take place in coming years at thefederal level, and refocused attention on the specialrole the ongoing housing correction plays inrestraining the recovery.Source: Reuters EcoWin ProChart 3: Aggressive policy has helped avert worseeconomic outcomesSource: Reuters EcoWin ProThus began a recalibration of the Fed’s reactionfunction. A lower growth outlook means lessprogress on their mandates. Policies in place may,therefore, not be strong enough to produce desiredresults as they were based on a forecast for animmediate return to self-sustaining above-trendgrowth. In addition, emerging downside risks to theoutlook suggested a more aggressive stance.Julia Coronado 27 October 2011Market Mover4www.GlobalMarkets.bnpparibas.com

The November FOMC meeting is the first time sinceJune that economic forecasts will be published. Asshown in Chart 1, we expect a significant markdownto 2011 growth projections that factor in a rebound toa 2.0% to 2.5% annualised rate of growth in H2.However in addition, we expect them to mark downtheir growth expectations through 2013 inacknowledgement of what Vice Chair Janet Yellenrecently referred to as “persistent restraints on theeconomic recovery”.While the growth estimates are lower, they will stillbe for activity above the FOMC’s own estimate of thelonger-term trend of 2.5% to 2.8%. After all, theforecasts are conditional on appropriate monetarypolicy, and if growth isn’t above trend, theunemployment rate won’t be declining and the Fedwill be failing on one of its mandates. The Fed neverforecasts its own failure.Chart 4: Unemployment and Underemployment area National “Crisis”Source: Reuters EcoWin ProChart 5: The Fed’s Policies Have SupportedAs with GDP growth, the Fed has been too optimisticon progress on the unemployment rate, and weexpect these forecasts to be marked up throughoutthe forecast horizon. These will serve as a keycalibrating point for their new communicationstrategy as will be discussed in more detail below.The FOMC has done a better job forecasting bothheadline and core inflation, and we look for onlyminor adjustments to its forecasts. Particularly in lightof the downgrade to their growth and unemploymentrate forecasts, the FOMC is likely to continue toanticipate that inflation will settle “at levels at orbelow those consistent with the Committee's dualmandate as the effects of past energy and othercommodity price increases dissipate further.”Downside risks remainFinancial markets have been pleasantly surprisedover the past month by incoming data consistent withthe 2.5% q/q saar reading on Q3 GDP growth.However, the performance has been less of asurprise to the FOMC whose members generallyanticipated a stronger growth performance in H22011 as some of the temporary factors restraininggrowth eased. Supply chain disruptions following theJapan earthquake held back Q2 and boosted Q3; theaverage of the two quarters is 1.9%, a pace notstrong enough to consistently generate job growth orstrong enough to reduce unemployment over time.A number of recent speeches from FOMC membershave reinforced the message from the Septemberstatement that “there are significant downside risksto the economic outlook, including strains in globalfinancial markets”. Vice Chair Janet Yellen in arecent speech cited “the potential for such adversefinancial developments to derail the recovery”.Source: Reuters EcoWin ProIn particular, she noted that “U.S. financialinstitutions facing earnings and fundingpressures…could cut back on lending, tighten creditterms, or attempt to delever by rapidly selling offassets”. This is, of course, a problem not unique to,or even centred in, the US as European banks arefacing the same situation. This has been andcontinues to be a credit cycle, and an intensificationof deleveraging threatens to derail the fragilerecoveries in the US and Europe.The financial market turbulence has also led todepressed levels of consumer and businessconfidence. While the transmission of weakconfidence to activity was not apparent in theSeptember data, it is only one month, and thepersistence of low levels of confidence has beenfrequently cited by Fed speakers as anotherdownside risk to the outlook.A new reaction functionThe Fed has not stood idly by as the outlook hasdeteriorated. They eased at each of the last twomeetings first by pushing rate hike expectations backwith a conditional promise to maintain “exceptionallylow levels for the federal funds rate at least throughmid-2013” and, in September, by extending theJulia Coronado 27 October 2011Market Mover5www.GlobalMarkets.bnpparibas.com

duration of their securities portfolio through operationtwist.Operation twist was recognised in the minutes fromSeptember FOMC meeting as being “necessarilylimited by the amount of shorter-term securities in theSOMA portfolio” and “a number of participants sawlarge-scale asset purchases as potentially a morepotent tool that should be retained as an option in theevent that further policy action to support a strongereconomy was warranted”.A number of Fed speakers including Chicago FedPresident Evans, Boston Fed President Rosengren,New York Fed President Dudley, Governor Tarullo,Vice Chair Yellen, and Chairman Bernanke himselfhave all confirmed that QE3 is very much still anoption they are willing to turn to. This puts to rest thenotion that the Fed is being held back by a potentialpolitical backlash domestically and abroad. Many ofthese speakers have specifically emphasised theindependent nature of the Fed.In the meantime, the September minutes alsoindicated that “most participants indicated that theyfavoured taking steps to increase further thetransparency of monetary policy”. Indeed “mostparticipants also indicated they saw advantages inbeing more transparent about the conditionality in theCommittee’s forward guidance by providing moreinformation about the economic conditions to whichthe guidance refers”.Last week, Chicago Fed President Evans proposed apolicy rule in which the Fed “commit[ed] to keepshort-term rates at zero until either theunemployment rate goes below 7 percent or theoutlook for inflation over the medium term goesabove 3 percent”, Without endorsing the specificrule, Vice Chair Yellen referred to President Evans’proposal as “potentially promising” as it would“facilitat[e] public understanding of how various shiftsin the economic outlook would be likely to affect theanticipated timing of future policy”.Chairman Bernanke recently gave a speechdescribing the global paradigm of monetary policy as“flexible inflation targeting” or “constraineddiscretion.” This is a policy characterised by explicitguidance on long-term inflation goals combined withnear-term flexibility to deviate from these targets and“respond to economic shocks as needed to moderatedeviations of output from its potential”. However, healso noted that, in contrast to many central banks,the Fed has a dual mandate for “maximumemployment and price stability, on an equal footing”.Thus, it would appear that the Chairman issympathetic to providing more explicit guidance onthe longer-term goals for both inflation andunemployment. Indeed, the September FOMCminutes highlighted that the Committee would like tocouch its current policy in the context of mediumtermgoals for employment and inflation while, at thesame time, confirming its commitment to longer termgoals. The minutes noted that this was a complicatedtask and that the post-meeting statement as “not wellsuited to communicate fully the Committee’s thinkingabout its objectives and its policy framework”. TheNovember meeting with its forecast and postmeetingpress conference is, therefore, ideally suitedto roll out such a new policy framework.There are a number of ways the FOMC couldprovide more concrete medium-term markers for itspolicy. It could maintain the time commitment put inplace in August but be clear about the conditionsthey expect to prevail at that time. Marketparticipants could then adjust their expectationsaccording to their own forecasts and changes ineconomic conditions. Alternatively, they could go theroute suggested by President Evans in which theyeschew the time frame altogether and make thecurrent policy stance explicitly contingent oneconomic conditions. Even their prior forecasts forthe unemployment rate suggest that a policytightening would not be likely before “at least throughmid-2013” and very likely after that under newforecasts. Therefore, the new communication policywill also be a policy easing as it will push rate hikeexpectations back even further.The new framework will also provide guidance aboutwhat the triggers for further easing will be. Consistentwith prior communication, we think that the triggerwould be failure to make progress on their mandates.That is, if inflation decelerates and unemploymentfails to decline, the Fed would be ready to expand itsbalance sheet. In particular, recent Fedspeak hasindicated a shift toward a renewed focus onmortgage purchases along with Treasury purchases.Such a policy has the advantage of targeting themost distressed sector of the economy, and it alsohelps accommodate some of the blow to mortgagemarkets of recent mortgage refinancing proposalsthat will inflict losses on mortgage investors. Weexpect QE3 as early as December just as themortgage refinancing program is kicking into gear.If at first you don’t succeed…While it may have appeared in recent months thatthe Fed was becoming less aggressive, it nowappears that they were simply stepping back andreformulating their reaction function. As PresidentEvans acknowledged “more than once the FOMC’sprojections have proved too optimistic, and the U.S.economy has been unable to achieve escapevelocity for returning to stronger, self-sustaininggrowth. But instead of doing nothing, the FOMC tookJulia Coronado 27 October 2011Market Mover6www.GlobalMarkets.bnpparibas.com

further actions to support stronger growth in thecontext of continued price stability”.Indeed if the transmission of monetary policy to theeconomy is weaker than in the past, and/or fiscalpolicies are not taking the desired direction, theimplication is that monetary policy has to be more,not less aggressive. Such an argument was maderecently by Governor Tarullo who said “ we have totake the world as we find it and adjust our actionsaccordingly. Sometimes this will mean tightermonetary policy to offset the inflationary effects ofother policies. Sometimes, as at present, it will meanmore accommodative policies, even when we knowthat monetary policy alone cannot solve all theeconomy’s problems.”While President Evans and Governor Tarullo mightbest be characterised as aggressive doves, ViceChair Yellen effectively endorsed the type of policyproposed by President Evans, and like GovernorTarullo, Chairman Bernanke characterised thecurrent state of the labour market as a “crisis”. Thus,it would appear the Fed will continue to beaggressive and flexibly respond to economicdevelopments.Table 1: FOMC Economic Projections 1Central Tendencies 2011 2012 2013 2014 Longer RunReal GDP GrowthNov 2011 1.5 to 1.8 2.8 to 3.3 3.3 to 4.0 3.5 to 4.2 2.5 to 2.8Jun 2011 2.7 to 2.9 3.3 to 3.7 3.5 to 4.2 - 2.5 to 2.8Apr 2011 3.1 to 3.3 3.5 to 4.2 3.5 to 4.3 - 2.5 to 2.8Jan 2011 3.4 to 3.9 3.5 to 4.4 3.7 to 4.6 - 2.5 to 2.8Unemployment RateNov 2011 9.0 to 9.1 8.4 to 8.6 7.2 to 7.7 6.5 to 7.0 5.2 to 5.6Jun 2011 8.6 to 8.9 7.8 to 8.2 7.0 to 7.5 - 5.2 to 5.6Apr 2011 8.4 to 8.7 7.6 to 7.9 6.8 to 7.2 - 5.2 to 5.6Jan 2011 8.8 to 9.0 7.6 to 8.1 6.8 to 7.2 - 5.0 to 6.0PCE InflationNov 2011 2.4 to 2.6 1.5 to 2.0 1.5 to 2.0 1.5 to 2.0 1.7 to 2.0Jun 2011 2.3 to 2.5 1.5 to 2.0 1.5 to 2.0 - 1.7 to 2.0Apr 2011 2.1 to 2.8 1.2 to 2.0 1.4 to 2.0 - 1.7 to 2.0Jan 2011 1.3 to 1.7 1.0 to 1.9 1.2 to 2.0 - 1.6 to 2.0Core PCE InflationNov 2011 1.5 to 1.7 1.2 to 2.0 1.4 to 2.0 1.5 to 2.0Jun 2011 1.5 to 1.8 1.4 to 2.0 1.4 to 2.0 -Apr 2011 1.3 to 1.6 1.3 to 1.8 1.4 to 2.0 - -Jan 2011 1.0 to 1.3 1.0 to 1.5 1.2 to 2.0 - -Source: Federal Reserve1. Projections of real GDP growth, PCE inflation, and core PCE inflation are Q4/Q4 growth rates. Projections for the unemployment rateare the average for Q4 in the respective year. Each participant's projections are conditional on his or her assessment of appropriatemonetary policy. The central tendencies exclude the three highest and three lowest projections for each variable in each year.Julia Coronado 27 October 2011Market Mover7www.GlobalMarkets.bnpparibas.com

HARP - Phase II – Another Baby Step• While fewer than 1 million borrowers wereable to refinance through the initial HARP, theFed estimates that 4 million borrowers appear tomeet the basic eligibility for HARP refinancingunder changes announced 24 October 2011.Chart 1: Share of Borrowers with NegativeEquity by Mortgage Rate Segment• FHFA is providing incentives for borrowersto refinance into shorter-term loans by“eliminating certain risk-based fees forborrowers who refinance into shorter-termmortgages”.• We estimate the maximum number ofeligible households to be around 4.5mn, theactual increase is likely to be far lower, around800,000 to 1mn.• HARP reforms could be more beneficial inthose cities and states where the proportion ofdeeply underwater borrowers is much largerthan the national average.• Overall, we consider the FHFA initiative tobe a positive, albeit small, step in the directionof reducing the structural problems in the UShousing sector. But other policy initiatives arealso clearly neededOn 24 October 2011, the Federal Housing FinanceAgency (FHFA), along with Fannie Mae and FreddieMac, announced changes to the Home AffordableRefinance Program (HARP) that are designed tomake it easier for underwater homeowners torefinance their mortgages at current, lower interestrates. The original HARP programme, which waslaunched in 2009, targeted borrowers with LTVsbetween 105% and 125% and has enabled justunder 900,000 borrowers to refinance their loans.Addressing existing impedimentsWhile fewer than 1 million borrowers were able torefinance through the initial HARP, the Fed estimatesthat 4 million borrowers appear to meet the basiceligibility for HARP refinancing. At a recent FederalReserve housing market forum, Governor Duke listedfour possible impediments to greater penetration byHARP: (i) upfront fees that are added to therefinancing costs of loans that are judged to havehigher risk characteristics, such as high loan-to-valueratios; (ii) put-back risk that the loan originator willhave to repurchase the loan from the GSEs becausethe underwriting violated GSE guidelines; (iii) holdersof junior liens refusing to allow their loans to remainsubordinate to a proposed new refinance loan; andSource: CoreLogic, Market Rate = 5.1% as of Q2(iv) mortgage insurers not agreeing to re-underwritetheir policies.The reforms to HARP will increase the reach of theprogram by directly addressing the first twoimpediments: risk-based fees should be reduced oreliminated, and mortgage originators will be relievedof put-back risk. Eligibility will also be extended tohouseholds with LTVs above 125%. To qualify forrefinancing, borrowers must have their loans sold toeither Fannie Mae or Freddie Mac on or before 31May 2009, be current on their mortgages (no latepayments in the past six months and nor more thanone late payment in the past twelve), and haveadequate income.Encouraging borrowers to shorten the termFHFA is providing incentives for borrowersto refinance into shorter-term loans by “eliminatingcertain risk-based fees for borrowers who refinanceinto shorter-term mortgages”. Mortgage rates tend tobe less for shorter-term mortgages. In fact, thespread between 30 Year and 15 Year Freddie Macfixed rate has widened significantly this year and isabout 2 standard deviations above the historicalmean (Chart 2). However, reducing the term of theloan to get a lower mortgage rate will result in asignificantly higher monthly payment. For manyunderwater borrowers, that might not be a viableoption, regardless of attractive incentives.Macroeconomic effects are not materialPrecisely estimating the rise in refinancing that thereformed HARP will unleash is difficult. However, wecan identify realistic upper and lower bounds forrefinancing. We estimate the maximum number ofeligible households to be around 4.5mn. We arrive atYelena Shulyatyeva 27 October 20111Market Mover8www.GlobalMarkets.bnpparibas.com

this figure by starting with CoreLogic’s Q2 2011estimate for the number of borrowers in negativeequity who are also paying above-market mortgagerates - 8mn (Chart 1). We then discount this numberby the share of agency mortgages in totaloutstanding mortgages (62%) and the MortgageBankers’ Association’ (MBA) estimate for theproportion of outstanding mortgages that are current- 91%; comprised of a 6% delinquency rate and a 3%foreclosure rate.Assuming an average loan size of USD 250,000 anda 1.5pp reduction in mortgage rates (from 6% to4.5%), each borrower would save around USD 230per month; thus, a 4.5mn increase in refinancingwould raise personal disposable income by USD13bn, or 0.1%.However, the actual increase is likely to be far lower.Not all eligible borrowers will apply for refinancing,while the proportion of households with negativeequity that are also current on their mortgages islikely to be below 91%. The FHFA, in what we regardto be the lower bound, estimates that between800,000 and 1mn borrowers will take advantage ofthe HARP reforms. Combining this lower figure withthe same assumptions about mortgage sizes andrates yields an estimate of USD 2.75bn in overallsavings, or just 0.02% of disposable income. Thus,while the households that are able to refinance couldsee disposable income increases of up to 5%, in theaggregate the direct impact of the programme onhousehold incomes will not be material from amacroeconomic point of view, regardless of whetherthe eventual uptake is on the low or high side.Regional impact of removing 125% LTV ceilingSo far, our analysis has made use of only nationalmortgage statistics. However, the severity of thehousing crisis varies significantly across the US.Consequently, HARP reforms could be morebeneficial in those cities and states where theproportion of deeply underwater borrowers is muchlarger than the national average. For example,borrowers with large negative equity positions aremore likely to strategically default; that is, they aremore likely to voluntarily default despite having themeans to meet their payment obligations. In Q22011, Nevada had the highest percentage of homeswith negative equity at 60% (unsurprisingly, Nevadaalso has also experienced the largest house pricefalls since 2006), followed by Arizona (49%), Florida(45%), Michigan (36%), and California (30%)according to CoreLogic. The situation is particularlygloomy for those with severe negative equity. Themost recent report also indicated that out of morethan half a million mortgage loans in Nevada almost45% are severely underwater. For Arizona, thisshare is just slightly below 30% out of 1.3mnChart 2: 15-Year Rates More AttractiveSource: Reuters Ecowin Pro, BloombergChart 3: Negative Equity of 25% or MoreSource: CoreLogicproperties; Florida has a similar percentage of its4.4mn mortgages, which are in negative equity bymore than 25%. Out of 6.8mn loans in California 17%are severely underwater, while this share forMichigan is 17% of 1.4mn mortgages loans (Chart 3).Adding estimates for just these five states yields anestimate of 3.25mn homeowners, who can potentiallybenefit from the enhanced HARP. Therefore, the newprogramme has the most potential and could help toput the floor under plunging housing prices in theseparticular regions.Overall, we consider the FHFA initiative to be apositive, albeit small, step in the direction of reducingthe structural problems in the US housing sector. Butother policy initiatives are also clearly needed. Forexample, we think that it is important to place agreater emphasis on the rapid conversion offoreclosed homes into rental properties. Such anapproach would involve encouraging privateinvestment by converting some of the real estateowned (REO) by the GSEs into rental structures. Ifwell-designed, the Obama plan could shift asignificant number vacant properties from theownership to the rental market alleviating bothdownward pressure on home prices and upwardpressure on rents.Yelena Shulyatyeva 27 October 20111Market Mover9www.GlobalMarkets.bnpparibas.com

US: The Fiscal Clock is Ticking…• The Supercommittee in charge of proposinga USD 1.2trn fiscal deficit reduction plan by 23November is “running short on time”, accordingto one of the Supercommittee’s co-chairs.• Wednesday, Democrats on the Committeesubmitted a USD 3bn deficit reduction plan thatwas quickly shot down by Republicans due to itsheavy reliance on tax increases.• If the Supercommittee does not come upwith a plan in time, then it could risk anotherratings downgrade.• We are cautiously optimistic that theSupercommittee will come forward with abipartisan proposal that will be approved byCongress and signed into law.420-2-4-6-8-10-12Chart 1: Federal Deficit: BNP Paribas vs CBO(% of GDP)1992 1997 2002 2007 2012 2017Source: Haver Analytics, CBO, BNP ParibasForecast -->CBOBNP ParibasChart 2: Federal Government Debt (% of GDP)• As battles in Congress drag on, PresidentObama is now turning to his executive powers toprovide stimulus.1059585Forecast -->Time is not on their sideThe Supercommittee in charge of proposing a USD1.2trn fiscal deficit reduction plan by 23 November is“running short on time”, according to one of theSupercommittee’s co-chairs. In fact, a plan, whichwill need to be run by the CBO for official “scoring”,or unbiased measuring, will need to be submitted tothe CBO a few days prior to the 23 Novemberdeadline in order to allow adequate time for thescoring. However, the parties still appear to be a longway from an agreement.Democrats move firstOn Wednesday, Democrats on the Committeesubmitted a USD 3bn deficit reduction plan thatlargely mirrored President Obama’s “Grand Bargain”which was debated this summer. Republicans werequick to refute this proposal as it included asignificant tax increase component. Disagreementsover tax increases continue to hinder negotiations,and we foresee that it will take some compromisefrom Republicans in order to get a deal done. TheDemocrats do not believe that they can give in onthis; otherwise, Republicans are likely to get fullcredit for the deficit reduction. Nevertheless, theRepublicans have some room to eliminate some taxloopholes, which would not actually raise the taxrate, allowing both parties to claim victory.75655545352008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020Source: Haver Analytics, BNP ParibasRisking another downgradeAs we have written before, coming up with USD1.2trn in deficit reduction is not the difficult part. Thedifficulty is striking an agreement that allows bothparties to claim credit for any deal as we enter anelection year. If the Supercommittee does not comeup with a plan before the deadline, then it could riskanother ratings downgrade. We see two likelyscenarios: i/ the Supercommittee puts together apackage which is approved by Congress by 23December, Republican’ compromise and everyoneclaims victory; or, ii/ the Supercommittee cannotcome to a compromise over taxes and the plan fails.If the second outcome is the case, Congress still hasanother year before the forced sequestration wouldtake effect. Thus, Congress would have time to enactUSD 1.2trn worth of deficit reduction after theelections and before the sequestration takes effect,although this added time could come at the cost of aFitch or Moody’s downgrade (see Box 1).Bricklin Dwyer 27 October 2011Market Mover10www.GlobalMarkets.bnpparibas.com

While a downgrade would not have a material impacton our fiscal projections, it is likely to have a markedimpact on consumer and business confidence whichcould have a substantive impact on the elections.Thus, while the second option would be morerepresentative of Congress’ past inaction, we believethat the impact of a second (and possibly third)downgrade and Congress’ ability to adopt a“package”, without deliberation, will allow Congressto emphasise the greater good and discount thecompromises as necessary to take a small steptowards putting public finances on a sounder footing.Indeed, at the time of writing, the Republican Partypresented a USD 2.2trn deficit reduction packagewhich highlighted USD 600bn in Medicare and otherhealthcare entitlement cuts, USD 250bn indiscretionary spending cuts, and USD 640bn in newrevenue without increasing taxes. While Democratsquickly dismissed the Republican proposal, theinclusion of revenue increasing measures is a step inthe right direction.Executive powerAs battles in Congress drag on, President Obama isnow turning to his executive powers to providestimulus. Despite the President’s American Jobs Actincluding many components supported by bothpolitical parties, it has been held up by theDemocrats’ insistence on offsetting the tax cuts andstimulus spending with tax increases on the wealthy,as well as Republican opposition to key parts of theplan. After a failed vote on the Act two weeks ago,President Obama announced in recent days his new“We can’t wait” campaign of executive action tocombat Congressional inaction.Housing, education, and more…On Monday, the President kicked off his plan toaddress housing, education, and more, throughexecutive orders by announcing a refinanceprogramme for underwater homeowners. In addition,on Wednesday President Obama announcedchanges to the repayment terms of federal loans forcollege graduates. Unsurprisingly, bothannouncements were held in key election battlegrounds—Nevada and Colorado. President Obamaplans to announce a new initiative each weekthrough the end of the year.Another shutdown?Meanwhile, there is less than three weeks before 18November when the government could potentiallyrun out of money if a third continuing resolution is notpassed for FY 2012 spending. We do anticipateanother stop-gap measure to be passed in time;however, this highlights, once again, that Congresshas been unable to pass a budget since 2010. In theBox 1: The Rating Agencies5 August 2011: S&P downgraded the US to AA+(negative outlook) from AAA (negative outlook)reflecting: “S&P’s opinion that the fiscal consolidationplan that Congress and the Administration recentlyagreed to falls short of what …would be necessary tostabilise the government’s medium-term debtdynamics”; “S&P’s view that the effectiveness, stability,and predictability of American policymaking andpolitical institutions have weakened at a time ofongoing fiscal and economic challenges to a degreemore than previously envisioned”.2 August 2011: Moody’s confirmed US’ Aaa Ratingand assigned a negative outlook which indicated thatthere would be a risk of downgrade if: “There is aweakening in fiscal discipline in the coming year;further fiscal consolidation measures are not adopted in2013; the economic outlook deteriorates significantly;or there is an appreciable rise in the US government’sfunding costs over and above what is currentlyexpected”.2 August 2011: Fitch confirmed US AAA rating warningthat the US "must also confront tough choices on taxand spending against a weak economic backdrop if thebudget deficit and government debt is to be cut to saferlevels over the medium term". The agency said,however, that it will revisit its decision to keep theOutlook Stable at the end of the year. Their view iscurrently, "In terms of the joint select committee, whyprejudge the outcome of that when we'll know theoutcome in three-and-a-half or four-month time?" Anoutright one-notch downgrade is not ruled out, but lesslikely, the agency said in a statement. A negativeoutlook usually means a downgrade is possible in twoyears.Source: BNP Paribas, Standard & Poors, Moody’s & Fitchend, we are likely to get individual appropriation billswhich will provide the authority to spend, althoughthis takes time as it requires many individual bills tobe voted on.Cautiously optimisticIn all, we are cautiously optimistic that theSupercommittee will come forward with a bipartisanproposal that will be approved by Congress andsigned into law. A downgrade by Fitch and Moody’spotentially hangs in the balance, and it will be muchmore politically appetising to accept the bipartisanSupercommittee’s bill than risk the political falloutotherwise—we would expect the events of August toprovide a sober warning to lawmakers who refuse toplay ball. In addition, we expect the tax cuts andunemployment insurance components of theAmerican Jobs Act to be passed while PresidentObama uses his executive power to try to provideadditional stimulus.Bricklin Dwyer 27 October 2011Market Mover11www.GlobalMarkets.bnpparibas.com

Canada: Lowering Expectations• The BoC shifted its expectations for policytightening out significantly as it revised down itsgrowth forecasts. The BoC also left the dooropen to cut rates in the first quarter of 2012 if theUS were to fall into recession as we expect.• The BoC’s downward revision to theCanadian growth outlook also prompted cuts tothe inflation outlook. The BoC now judges therisks to their forecasts to be roughly balanced.• The BoC zeroed in on financial market risks,which we think are likely to be formallyincorporated into their mandate in the comingdays.• We see two likely scenarios for policy: i/growth evolves in line with the BoC’sexpectations, and thus, the Bank remains onhold until at least mid-2013; or ii/ growthdisappoints, and the BoC cuts rates early nextyear and remains on hold until at least mid-2013.We think the latter is more likely.A significant shiftThe Bank of Canada (BoC) kept its overnight rateunchanged in its 25 October policy statement whilelowering expectations for domestic economic growthciting several downside risks to the global economythat have been realised since the last meeting. TheBank of Canada shifted its expectations for policytightening out significantly as it revised down itsglobal and domestic growth expectations.The BoC also left the door open to cut its policy ratein the first quarter of 2012 if the US were to fall intorecession, as we expect. The quarterly MonetaryPolicy Report (MPR) highlighted the significantrevisions to the growth outlook with Q4 growthrevised from 2.9% q/q ar to 0.8% q/q ar—in line withour expectations for the quarter. The revision cameon the back of weaker expectations for both personalconsumption and net exports. This is consistent withthe Conference Board’s consumer confidence indexfor October, which fell to its lowest level since March2009 (see Chart 2).Downside risksThe BoC anticipates a brief recession in the euroarea. Although they expect the euro crisis to becontained, the danger of failing to contain the crisis is“the most serious risk facing the global and Canadian3210-1-2-3-4Chart 1: A Slow Closing of the Output Gap (%)Q1 1995 Q1 1998 Q1 2001 Q1 2004 Q1 2007 Q1 2010Source: Reuters EcoWin Pro1101051009590858075706560Chart 2: Consumer confidence is weakJun 06 Jun 07 Jun 08 Jun 09 Jun 10 Jun 11Source: Conference Boardeconomies”. Meanwhile, they forecast weak growthin the US through the first half of 2012 before theAmerican economy gradually gains strengththereafter. However, in the MPR, the BoC noted that“a US recession would have material consequencesfor growth and inflation in Canada”. In addition, highlevels of household debt “could lead to a sharperthan-expecteddeceleration in household spending.Relatedly, if there were a sudden weakening in theCanadian housing sector, it could have sizeablespillover effects on other areas of the economy”.Upside risksThe upside risks relate to possible unexpectedinflationary pressures on the back of either morepersistent growth in emerging market economies,stronger-than-expected momentum in householdborrowing, and/or more decisive global policy actionwhich “could lift confidence more rapidly thancurrently projected”.Bricklin Dwyer 27 October 2011Market Mover12www.GlobalMarkets.bnpparibas.com

Low for longAs a result of the aforementioned risks and generalweakness in the domestic economy, expectations forCanadian growth were revised down 0.7pp for both2011 and 2012 to 2.1% and 1.9%, respectively.Meanwhile, the BoC’s growth forecast for 2013 wasrevised up to 2.9% from 2.1% previously. Thisimplies a very slow closing of the output gap with theeconomy not expected to return to full capacity untilthe end of 2013 (see Chart 1).The downward revision to the growth outlook alsoprompted downward revisions to the inflation outlook.Core inflation is projected to be “slightly softer thanpreviously expected, declining through 2012 beforereturning to 2 percent by the end of 2013”. Headlineinflation “is expected to trough around 1 percent bythe middle of 2012 before rising with core inflation tothe two percent target by the end of 2013”. Weinterpret the lowering of growth and inflationexpectations to mean that the overnight rate willlikely remain at low levels for some time.Leaving the door open for cutsAfter lowering their expectations, the BoC nowjudges risks to their forecast to be roughly balanced.However, the overall tone of the Policy Statementwas dovish. In particular, the BoC removed the line“some of the considerable monetary policy stimuluswill be eventually withdrawn”.With regard to the policy outlook, there are two likelyscenarios: i/ the global and Canadian economiesgrow in line with the BOC’s current expectations—and thus the Bank would be expected to remain onhold until at least mid-2013; or ii/ the global andCanadian economies grow more slowly than currentBoC expectations (including a US recession)—inwhich case, we would see policy easing in the nearterm, and rates would remain on hold until at leastmid-2013. Of the two, we think the latter is morelikely.We expect that a rate cut would come in early 2012on the back of the implementation of QE3 in the USand have, therefore, moved back our call for the BoCto cut rates from December 2011 to early 2012 onthe back of a delay in our expectations for theimplementation of QE3 and an upward revision to oursecond half of 2011 US growth outlook. In addition,we have pushed back our expectations for theremoval of policy accommodation until mid-2013.Changing the mandateImportantly, the BoC focused a large portion of thestatement on financial market risks. We think there isa good chance that this will become an explicitcomponent of the upcoming changes to their officialmandate. In addition, we could see a move towardtargeting core inflation versus the current mandate oftargeting headline inflation. Both of these outcomeswould give the BoC more wiggle room at times wheninflationary pressures are deemed to be temporary.Bricklin Dwyer 27 October 2011Market Mover13www.GlobalMarkets.bnpparibas.com

France: Time for Tightening• The French government will have to reducethe 2012 GDP growth forecast from 1.75% to1.0% at most. This should be accompanied by afiscal tightening package of close to EUR 8bn.• The budget deficit should not overshoot thetarget of 4.6% of GDP in 2012 which has been inall the previous stability plans.• The bulk of the new measures should, onceagain, raise taxes and social contributionincome.50%40%30%20%Chart 1: Distribution of2012 GDP Growth Forecasts for France10%Aug0%Oct0.0 0.5 1.0 1.5 2.0The 2012 budget was built using an economicgrowth estimate of 1.75% for 2012, the same level asin 2011. When these hypotheses were adopted, inAugust, they were in line with market consensusestimates, which were 1.9% for 2011 and 1.7% for2012 according to Consensus Economics. Howeverthe economic situation has dramatically worsenedsince then. The consensus estimate for 2011 growtheased to 1.6% y/y, but for 2012 was revised downsharply, losing four-tenths in September and anotherfour-tenths in October. Consensus Economicscollected more data over time (15 forecasters inAugust, 18 in September and 21 in October) and therange of the forecasts widened, whereas it normallydeclines over time (Chart 1). This shows a strongincrease in uncertainty about the growth outlook. Thesituation is very different for inflation, where theconsensus remained stable and the range narrowedmarginally.Revising growth downThe growth rate for this year has not been revisedmuch since August/September when the governmentestimated the 2011 deficit target would be met. Harddata published since then do not threaten Q3 growthmuch, but business and household surveys clearlyshow there is a growing risk that GDP will contract inthe last quarter of 2011. This would have limitedimpact on the 2011 average growth rate and an evensmaller effect on the budget, given the delay incollecting taxes.The main risk for the current year affects receiptsfrom corporate tax. Consequently we will have to payspecial attention to the September and Decemberfiscal outcomes, when quarterly payments ofcorporate tax are due. The reduction of the deficit,compared to the year before, is developing asexpected in the later part of the year (Chart 2, inSource: Consensus Economics0-20-40-60-80-100-120-140-160Source: MoFChart 2: Central Budget Balance20092011EUR bn, cumulative 20102008Jan. Mar. May July Sept. Nov.particular in August, September and December).Chart 2 shows that the cumulative deficit over thefirst eight months of the year narrowed byEUR 19.4bn to EUR 102.8bn. Social security andlocal government deficits should be smaller thaninitially expected, so that the government has someleeway to face the declining growth. It also has sometime left to cancel some expenditure, currently frozenuntil the end of the fiscal year, in order to deal withthis risk.The October consensus forecast for 2012 GDPgrowth is 0.9%, so a revision by the government toits own growth forecast seems likely. The consensus2012 growth forecast for Germany has fallen from1.9% in August to 1.0% in October. The Germangovernment thus reduced its growth forecast to1.0%. In practice, it will difficult for the Frenchgovernment to come up with a forecast much abovethe German growth level. The government shouldrather cut the growth rate aggressively now, in orderto be sure that no further forecast cut, and no morefiscal tightening, are required until the elections areover.Dominique Barbet 27 October 2011Market Mover14www.GlobalMarkets.bnpparibas.com

In September, we estimated 2012 French growtharound 1.0% (see "French 2012 Deficit: In Control",in Market Mover, 29 September 2011). We also saidthen the government would not only have to reduceits growth forecast, but would also have to implementnew austerity measures to keep the deficit, as ashare of GDP, at the same level. We estimated thenthat around EUR 8bn of new measures would berequired. At present the risks to our growth forecastare on the downside.The measures to stabilise the deficitConsensus Economics also shows that, despite thelower growth, the deficit forecast remained extremelyflat (Chart 3). Economists clearly share our view thatthe government will toughen its fiscal policy to copewith slower growth, as the president and governmentmembers have already said loud and clear. Thisbudgetary policy may also explain why lower growth,which goes hand in hand with a higherunemployment rate forecast and lower wageincrease expectations, does not result in modificationof the inflation forecast. Most analysts probablyexpect fiscal measures to push prices a little higher.However, we can't say whether this refers to thefiscal measures already announced late August andin the draft budget late September, or whetheranalysts expect more adverse fiscal news in thefuture.The government has already announced the easiestand most obvious measures, so the new austeritypackage will be more difficult to put together. Thefact that 2012 is the main election year naturallycomplicates the decision-making process. Thepolitical factor is the main reason we are notexpecting a hike in VAT, although this wouldgenerate the highest income gain (theoreticallyEUR 6bn for 1pp hike in the standard rate andEUR 3bn for the same increase in the reduced rate).A VAT hike, six months before the elections, wouldbe very risky politically. The election factor also limitsthe potential for further indirect tax hikes onconsumption.Opinion polls also indicate that people are lesswilling to accept spending cuts than tax hikes;probably because most people also want tax rises tohit the wealthy, i.e. not them. Potential savings onspending are limited, and these should be usedpreferably around year-end as a last minute lifeline incase of unexpected bad news at that time.We believe the bulk of fiscal tightening will, onceagain, come from a reduction in breaks on taxes andsocial charges (known as "niches fiscales etsociales"). An interesting insight of what could beannounced is provided by the MoF report, prepared1.91.71.51.31.10.90.7Chart 3: Major Consensus Forecastsfor France in 2012 (mean)15 forecasters 18 forecasters 21 forecastersAugust September OctoberSource: Consensus EconomicsCPI (% y/y)GDP (% y/y)Budget Def(% of GDP, RHS)in June 2011, which analysed 385 different schemes,amounting to a total of EUR 96bn. The report gaveeach of them an efficiency (or inefficiency) rating(see "France: The Deficit Target is the Priority", inMarket Mover, 1 September 2011). As much asEUR 10.7bn of the tax breaks were deemedeconomically inefficient and another EUR 27.1bnwere not efficient enough.A large part (EUR 9.8bn) of the least effectivemeasures affect income tax: a modification decidednow would only affect 2013 fiscal income, not the2012 fiscal year. Some of the least efficientmeasures were already reduced or cancelled earlierthis year. Consequently the main source of incomefor 2012 lies with social contributions. The reportmentions EUR 3.1bn of inefficient cuts in socialcontribution and another EUR 9.4bn have a poorefficiency rating. This is where the bulk of theausterity measures can be found.Asset salesThe government may also be willing to increaseasset sales, although the financial context does notlook favourable for restarting the privatisationprogramme. However, the government may try to sellreal estate, buildings and land, since these priceshave not declined much. More immaterial assetsmay also be sold; the current budget includes theproceeds of the sale of radio bands for mobilephones.Since August, the tax increases already announcedamount to EUR 10.5bn or 0.5% of GDP. Another0.3pp to 0.4pp should be presented by the year-end.Given the measures announced in 2010, for thefiscal year 2012, the total tightening from incomeshould reach 1.0pp of GDP. Expenditure restraintswould also reduce the structural deficit by about0.6pp of GDP. With low growth mechanically adding0.5% to the deficit, the 2012 initial target of 4.6% ofGDP should be respected.5.45.25.04.84.64.44.2Dominique Barbet 27 October 2011Market Mover15www.GlobalMarkets.bnpparibas.com

UK: Still Raining• The UK’s past income and savings behaviourhas been revised by the ONS. Real disposableincome is now estimated to have risen in 2010, ifonly just. And the UK savings rate has beenrevised up significantly.• Combined with weak but positive realincome growth in 2012, scope for households toease back on their rate of saving should providesome room for consumption growth in thesecond half of 2012.Chart 1: Household Disposable Income Growth(% y/y)20151050Impact of inflationOtherTaxes and benefitsNet property incomeCompensation of employees• Still, there are lots of bridges to cross beforethen and the near-term outlook is bleak. Weexpect GDP to contract in Q4 2011.-5-102006 2007 2008 2009 2010More revisions to economic historyThis week saw the Office for National Statistics(ONS) release further information on the UK’sfinancial and economic accounts, followingsignificant methodological changes put in place inthe context of the ONS ‘Bluebook 2011’ revisionexercise. We have already seen some impact fromthese changes in downward revisions to the Q2 2011growth estimate, to 0.1%, and also the revision to theoverall level of GDP which saw the fall in output overthe 2008/9 recession revised to 7.1% rather than theprevious estimate of 6.4%.But in contrast to the fairly negative news from theearlier release of the revised series, this week’s datacontained some more positive reinterpretations ofhistory.The revised data provide new estimates forhousehold’s real disposable income growth in recentyears. While these continue to show that growth inreal disposable income has been depressed, thesituation is not so severe as previously estimated. Sothe previous estimate suggested that real disposableincome had fallen by 0.8% in 2010, which wouldhave been the first annual fall in more than 30 years.Now, however, in a reminder never to place toomuch credence on any particular set of statistics, thatdecline has been revised. Upward revisions to theestimate of net property income and a downwardrevision to the estimate of the deflator over theperiod now shows the annual change in realdisposable income as having grown 0.1% in 2010.The 2009 real disposable income figures have alsobeen revised up to show growth of 1.6%, up from1.1% in the previous estimate. In the latest quarter,Q2 2011, the data show a surprising 1.2% q/q rise inSource: Office for National Statistics1086420Chart 2: Savings Rate (%)Latest DataPrevious Estimates-22005 2006 2007 2008 2009 2010 2011Source: Office for National Statisticsreal disposable income. But that does not reflect amarked pick-up in wages and salaries, which rose0.5%. Rather, it appears a 2.8% rise in socialbenefits is partly responsible.In the bigger picture the data does not really changethe story that household disposable income growth isbeing held back by high inflation. In the year to Q22011, total household real income growth has fallenby 1.2%. Within that, while nominal income hasgrown by 3.2%, high inflation has eroded the realvalue of that increase.A higher savings rate may give more upside toconsumption next yearThe earlier release of the Q2 2011 GDP datashowed a downward revision to the level ofconsumption over the last few years. And whencombined with the new income release, the result isDavid Tinsley 27 October 2011Market Mover16www.GlobalMarkets.bnpparibas.com

a fairly significant change in the estimate of thehousehold savings ratio in recent years. The averagerevision to the savings ratio since 2008 is 1.6pp, withthe savings rate in Q2 2011 at 7.4%.Next year the outlook is for slow nominal incomegrowth, with a continuation of sluggish wage growthand the growth in other sources of income likely tofall back. But with inflation easing, the picture may bebetter for real disposable income than in 2010. Andsince the current savings rate probably reflects ahigher than usual precautionary ‘rainy day’ level ofsavings given economic uncertainty, there is somescope for households to augment their spending bylowering their rate of saving if current economicuncertainty eases.In consequence, there may be some scope for somepositive rates of consumption growth next year,particularly in the second half.For now though the news flow remains weakHowever, there are several bridges to cross betweennow and then, many of them not of the UK’s making.And the near-term outlook remains pretty bleak. Thisweek’s CBI Industrial Trends survey saw a slump innew orders and business optimism, suggestingmanufacturing is contracting. And in the comingweek the first release of UK third quarter GDP islikely to be an estimated 0.4% on the quarter. It couldhave been worse, but the evidence from the surveyssuggests activity was sliding towards the end of thequarter and we agree with MPC member MartinWeale that output is likely to contract in Q4.David Tinsley 27 October 2011Market Mover17www.GlobalMarkets.bnpparibas.com

Sweden: Rate Hikes Postponed• The Riksbank left the policy rate at 2.0% atits October meeting.Table 1: Riksbank’s Latest Forecasts (% y/y)2011 2012 2013 2014• The Bank cut its growth and inflationforecasts further, which paved the way for adownward revision to the repo rate profile.• Given the increased uncertainty about theeconomic outlook, we expect the Bank to keepits policy rate on hold for the rest of this year,and deliver a 25bp cut in Q1 2012.CPICPIFGDPRepo Rate (%,annual avg.)3.0(3.0)1.5(1.5)4.2(4.5)1.8(1.8)1.9(2.1)1.3(1.5)1.5(1.7)2.2(2.4)2.4(2.6)1.8(2.0)2.4(2.4)2.7(2.9)2.62.02.53.3The Riksbank kept its policy rate at 2.0% at itsOctober meeting, in line with our and the market’sexpectations.Source: The Riksbank. September 2011 forecasts in bracketsChart 1: Policy Rate (%)The rationale of the decision was that uncertaintyabout the economic outlook has increased mainlydue to the eurozone debt crisis, growth is expectedto be slightly weaker in the coming period andinflation pressures are low.The policy statement was broadly balanced. TheBank noted that so far the main impact ofdevelopments abroad on Sweden was via a declinein household and business confidence. Whenuncertainty declines and confidence returns, theeconomy is expected to grow at a more normal rate.On inflation, although underlying inflationary pressureis currently low, the Bank expects it to increase asresource utilisation rises.Riksbank’s forecast revisionsIn terms of economic forecasts, because recentevidence suggests economic growth is slowing, theBank revised down its GDP forecast from 4.5% to4.2% in 2011 and 1.7% to 1.5% in 2012. This, in turn,led to a downward revision in the inflation forecast.The Bank now expects 2012 headline inflation at1.9%, down from 2.1% previously (the 2013 inflationforecast was also revised down, from 2.6% to 2.4%).The CPIF inflation forecast for 2012, meanwhile, wasrevised down from 1.5% to 1.3% (2013 inflation wasalso revised lower, from 2.0% to 1.8%). There wereno changes to the Bank’s 2011 inflation forecasts.In all, these downward revisions have paved the wayfor a lower repo rate profile. The new profile suggeststhe Riksbank is to postpone continued increases inthe repo rate. The Bank’s forecast for the quarterlyaverage of the repo rate suggests it will average2.00% in Q4 this year and 2.34% in Q4 2012. This isdown from the Bank’s September forecast of 2.05%for Q4 2011 and 2.57% for Q4 2012. TheseSource: Reuters EcoWin Proprojections suggest the Bank intends to deliver thenext rate hike in Q2 next year.The decision to keep the repo rate unchanged wasnot unanimous. Deputy governors Ekholm andSvensson preferred to lower the repo rate by 25bp to1.75% and wanted to see a lower repo rate path thatstays at 1.5% from Q1 2012 through Q1 2013, andthen rises to just above 3% by end-2014.Policy outlookWe believe risks to the Riksbank’s policy profile areto the downside. The next move of the Bank will becut, rather than a hike, in our view. Over the comingperiod, the Riksbank’s focus is likely to shift to afurther loss of momentum in the economy, whichshould pave the way for further downward revisionsto the policy rate profile. Furthermore, the Bank willbe unwilling to deviate too much from otheradvanced country central banks in terms of policyrates, as a significant appreciation of the krona willput downside risks to inflation. Overall, we expect thepolicy rate to remain unchanged at 2.00% this year,before being cut to 1.75% in Q1 2012.Gizem Kara 27 October 2011Market Mover18www.GlobalMarkets.bnpparibas.com

Japan: Exports Slow on End of Catch-Up• Japan’s trade account was in deficit for asixth straight month but the scale of the shortfallplunged sharply, as nominal exports surged inSeptember while nominal imports contracted.• Real exports, which have been on the mendsince May, rose 1.3% m/m but the pace ofincrease has dropped recently, reflecting the endof the post-disaster catch-up phase for mostproducts.• US-bound shipments fell 1.5%, while EUboundexports rose 2.3%. But exports to bothhave been losing steam since July, as demandhas weakened with fiscal/financial turmoilweighing on sentiment. • Exports to China rose 2.9% but the level isstill below normal, due largely to the slowdownof the Chinese economy. On this score, generalmachinery exports remain more than 24% belowtheir pre-disaster level, indicative of theweakness of investment demand.• Although real imports fell 2.8%, the firstsetback in six months, the tone remains firmthanks to yen appreciation, resurgent demandfrom normalised factory activity and briskdemand for fuel for thermal power generation.Trade account deficit continues for sixth straightmonthAccording to the MOF’s trade statistics forSeptember, Japan’s seasonally-adjusted tradeaccount remained in deficit for a sixth straight month,but the scale of the shortfall plunged sharply to justJPY 21.8bn from JPY 265.2bn in August, as nominalexports surged 2.0% m/m but nominal importscontracted 2.2%.Exports lose much steamAdjusted for exchange rate and price fluctuations,our calculations show real exports rose 1.3% m/m,for a second straight, albeit slower, gain (2.7% inAugust). Trend-wise, real exports have been on themend since May, thanks to production recoveringalongside the restoration of supply chains. For thequarter ending in September, real exports rose arobust 9.5% q/q after contracting 6.0% q/q in Q2(real imports rose 0.1% q/q in Q2 and 2.8% q/q inQ3). Even so, with the exception of transportequipment, where output is still being ramped up,production growth and exports have significantlymoderated recently, as activity has largely returned7,5007,0006,5006,0005,5005,0004,5004,000Chart 1: Real Exports (sa, JPY bn)totalTransport equipment (RHS)05 06 07 08 09 10 11Source: MOF, BOJ, BNP Paribas1,6001,5001,4001,3001,2001,1001,000900800700600Chart 2: Real Exports to China (sa, JPY bn)05 06 07 08 09 10 11Source: MOF, BOJ, BNP Paribas2,0001,8001,6001,4001,2001,000to normal (to the pre-disaster levels of February).Consequently, the main determinant of export growthfrom now on will be foreign demand, not domesticsupply capability. With developed and emergingeconomies showing signs of losing momentum,Japan’s exports look likely to shift into a lower gearor even stall.Except for transport equipment, exports aregenerally weakLooking at the breakdown of real exports by productcategory, the sector contributing most to real exportgrowth in September was again transport equipmentat roughly 30% of total exports: shipments rose 4.3%m/m (12.1% in August). Exports of this key productplunged in March-April as the disaster threwautomotive supply chains into chaos, but reboundedsharply from May as damaged plants were broughtback online and electricity rationing ended. As ofSeptember, the index level for this product was14.3% higher than in pre-quake February.800600Ryutaro Kono/ Azusa Kato 27 October 2011Market Mover19www.GlobalMarkets.bnpparibas.com

Another key product, electrical machinery alsocontributed to overall export growth, with shipmentsreviving 1.3% after contracting 1.1% in August. Butthe level remains 3.9% below pre-disaster Februaryand is likely to stay weak as the global IT/digitalsector adjusts to slowing private demand in Chinaand stalling consumer spending in the US andEurope.On the downside, general machinery exports fell0.6% (–2.9% in August), marking a third straightdecline. Having suffered relatively little damagecompared to other sectors, general machineryexports stopped falling in April and by June the levelwas already 1.3% higher than in February. But thedeepening slowdown in the global manufacturingcycle has caused shipments of this key exportproduct to turn down. Exports of chemical productsalso remain weak, falling 0.2% (–0.1% in August).US-bound exports: First decline in five monthsA geographical breakdown of the September tradereport (seasonally adjusted, real basis, ourestimates) has US-bound exports turning sour for thefirst time in five months with a 1.5% m/m decline(4.1% in August). Even so, exports for Q3 overall areup a huge 20.3% q/q (compared with -5.4% q/q in Q1and -11.4% q/q in Q2), with quarterly gains beingposted by most products, except chemical productsand nonferrous metals. In addition to pronouncedquarterly recoveries by electrical machinery (12.6%q/q in Q3 from -9.8% q/q in Q2) and generalmachinery (8.3% from -3.9% in Q2), shipments oftransport equipment surged a phenomenal 56.6%(-14.1% in Q1, -25.1% in Q2), reflecting inventoryreplenishment. With monthly trade figures from Julyshowing exports to the US have lost momentum, itseems that the catch-up phase following the 11March disaster is over for most products, excepttransport equipment. With financial turmoil furtherundermining sentiment in American households andbusinesses, this year’s Christmas sales could drop,leading to a less bright outlook for Japanese exports.EU-bound exports: first decline in five monthsEU-bound shipments rose 2.3% m/m in September(0.0% in August) and grew 13.4% q/q in Q3 overall(-3.9% q/q in Q2). Products contributing to thequarterly gain include transport equipment (43.5%from -24.2% in Q2), electrical machinery (8.5% from0.0% in Q2), and general machinery (9.1%from -2.5% in Q2). But like shipments to the US, EUboundexports have lost momentum with the end ofthe post-disaster catch-up process. Making mattersworse, the eurozone’s deepening sovereign debtwoes have shaken the financial markets andsubstantially eroded growth expectations. It wouldnot be unexpected for exports to start trending lower.Asia-bound exports: Shipments to China stillbeing adjustedExports to Asia rose 2.5% m/m in September afterfalling 0.5% in August, and shipments in Q3 overallare up 5.8% q/q after plunging 8.4% q/q in Q2.Exports to China, Japan’s largest trading partner,rose 2.9% m/m in September after dropping 1.6% inAugust, and exports in Q3 overall recovered 8.6%q/q after plummeting 14.5% q/q in Q2. But comparedto pre-disaster January-February (we take a twomonthaverage because the February level isboosted by the Chinese New Year effect), exports toAsia and exports to China are still down 4.7% and10.3%, respectively. Trend-wise, exports to Chinahave been basically flat since July, a sluggishnessthat reflects the slowdown in the Chinese economythat began before Japan’s March disaster.Regarding products in Q3, China-bound shipmentsof transport equipment soared 63.4% q/q (-37.0% q/qin Q2) and electrical machinery shipments rose 8.8%q/q (-14.3% in Q2). While transport equipmentshipments have roughly returned to the normalJanuary-February average, electrical machineryshipments are still down by more than 10%. Generalmachinery exports to China posted a second straightquarterly decline (-10.4% q/q in Q2, -7.5% q/q in Q3):24.4% below normal, a grim indication of theweakness of Chinese domestic demand. Japanesedata for machine tool orders shows demand fromChina has yet to stabilise and is still trending lowerafter cresting at the start of the year.Real imports remain firm, as strong yen takesrootFinally turning to imports, real imports fell 2.8% m/m(2.5% in August), for the first setback in six months.Even so, real imports rose 2.8% q/q in Q3 (0.1% q/qin Q2), for a third straight quarterly advance. Thelevel as of September is 2.8% higher than predisasterFebruary. Such strong imports reflect threethings: the effect of yen appreciation (includingreverse imports by some companies), resurgentdemand for materials now that production hasrecovered and brisk demand for mineral fuel forthermal power generation, reflecting reduceddependence on nuclear power. In terms of products,mineral fuel imports rose 4.2% q/q (-3.4% q/q in Q2),transport equipment shipments surged 9.0% (-3.4%in Q2), electrical machinery shipments increased3.4% (-4.0% in Q2) and general machinery importspicked up the pace with 6.7% gains (2.0% in Q2).Ryutaro Kono/ Azusa Kato 27 October 2011Market Mover20www.GlobalMarkets.bnpparibas.com

Japan: Lessons from a ‘Lewis Turning Point’• Japan’s era of rapid economic expansioncoincided with massive internal migration. Butwhen the supply of surplus rural labour forurban industries was fully absorbed, the era ofrapid growth ended. This is the ‘Lewis turningpoint,’ where wages rise as the labour supplyfrom the countryside tapers off: a modeldescribing the industrial revolution in Europethat applies surprisingly well to Japan.• Looking back, Japan’s trend growth ratestarted falling in the early 1970s after internalmigration began tapering off a decade earlier.But the authorities at the time misunderstoodthis and adopted stimulative policies to shore upgrowth, resulting in rampant real estatespeculation and soaring inflation of 25% y/y.• Conditions in China today resemble Japanwhen its era of robust growth ended. With wageshaving risen for several years in China’s coastalregions, surplus labour from the countrysidecould be tapering off (the Lewis turning point). Ifso, Chinese trend growth could be shiftinglower, and the authorities ought to adjust to anew cruising speed in order to avoid a hardlanding.• While it is just a risk scenario, prematurelyshifting to stimulative policies could put Chinaon the same path as Japan in the 1970s.65605550Chart 1: Manufacturing PMI –China, Brazil and India45China40BrazilIndia3508 09 10 11Source: Markit Group Limited, EcoWin, BNP paribas1612840-4-8Chart 2: Japan’s Real GDP (% y/y)195719739.4197419904.2 199120081.2-1257 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11Source: Cabinet Office, BNP Paribas *Note: Trend calculated using HP filter.The global economy is slowing these days in largepart because the emerging market economies(EMEs) like China, Brazil and India, which havespearheaded growth since the Lehman shock, arelosing momentum. Developed economies like the USand eurozone have until recently somehow continueda modest expansion on the back of exports to theEMEs, while their own internal demand has stayedsluggish because of unresolved balance-sheets. Butwith the EMEs losing steam since the spring,recovery in the US and Europe has also stalled. Thishas aggravated structural problems in the US andEurope, including the sovereign debt woes insouthern Europe. That the US and Europe shouldsuccumb to economic soft patches, or even outrightrecession, whenever the global economy turns souris very much like the Japanese business cycle overthe past 20 years. Increasingly the EMEs are callingthe tune for the developed economies.EMEs look for early end to tighteningIn China and the other EMEs, economic growth isdecelerating alongside accelerating inflation. In otherwords, the economies are slowing not because ofweak aggregate demand but because aggregatedemand has expanded so briskly in the past threeyears that it has outstripped generating capacity.This has resulted in supply constraints that aredampening economic growth and pushing priceshigher. As such, to ensure sustainable growth,continued tightening policies are now needed to coolthe red-hot aggregate demand so inflationarypressures can be adequately neutralised.Unfortunately, concerns about slowing growth haveprompted many EMEs to start looking for an earlyend to tightening policies. In fact, Brazil has alreadyreversed course and slashed its policy rate in lateAugust and again in October.Ryutaro Kono 27 October 2011Market Mover21www.GlobalMarkets.bnpparibas.com

Premature end to tightening could riskaccelerated inflationOf course, an end to tightening now might limit neartermEME economic deterioration, somethingpossibly responsible for the upbeat sentimenttemporarily evident in the financial markets. But thereis also a risk that supply constraints could becomegreater. This could cause inflation to rise even faster,making future tightening so drastic that the economicconsequences could be much more severe. Thesharp drop in commodity prices since the springcould be a trap for EME policymakers. Led by thesofter tone of prices for food and gasoline, pricessuperficially seem to be falling, and a subduedheadline inflation rate could increase the pressure onpolicymakers to switch from tightening to stimulus(this is especially true when share prices are alsoweak). But with wages on the rise in many EMEs,there is a risk that home-made inflationary pressurescould be aggravated. EME policymakers,consequently, could become unable to fine tunemacro-stabilisation policies.Japan’s misguided macro policies in the late1970sWhile all EMEs have seen inflation pick up alongsiderobust economic growth in the last three years, theChinese economy is particularly worrying. Conditionsin China today closely resemble Japan in the secondhalf of the 1970s when the era of robust growthended. At that time, Japan was undergoing a changein its trend growth rate (potential growth rate) but thegovernment and BOJ misunderstood this andadopted macro-economic stimulative policies thatresulted in rampant real estate speculation andsoaring inflation. In the hope that the Chineseauthorities do not make the mistakes Japan made,this report will be devoted to describing Japan’sexperience in the late 1970s.Japan’s ‘Lewis turning point’Japan’s era of robust economic growth lastedroughly 20 years, from the middle of the 1950s to themiddle of the 1970s. At this time, the economy onaverage spanned good times and bad and enjoyedgrowth well over 9% (average growth in 1957-1973was 9.4%). We thus came to expect double-digitgrowth during recovery phases. However, inhindsight, an analysis of economic indicators showsJapan’s trend growth rate started falling in the early1970s as internal migration, its primary growthengine, was tapering off. In a typical example of the‘Lewis turning point’, Japan’s period of rapideconomic growth ended when the supply of surplusrural labour for urban industries was fully absorbed.This model has been used to describe the age ofrobust growth in Europe after the industrialrevolution, but it applies surprisingly well to Japan.Chart 3: Japan: Rural to Urban Migration Trends(net immigration rate = net immigration total/totalpopulation of area)2.5%2.0%1.5%1.0%0.5%0.0%-0.5%-1.0%-1.5%55 60 65 70 75 80 85 90 95 00 05 10Source: MIC, BNP Paribas30252015105Tokyo areaOsaka areaNagoya areaothersNet in-migrationNet out-migrationChart 4: Japan and US Consumer Price in 1970s(% y/y)071 72 73 74 75 76 77 78 79 80 81 82 83 84 85Source: EcoWin, BNP ParibasJapanJapan’s era of robust growth was the heyday ofinternal migrationStatistics confirm that there was intense internalmigration in Japan between the mid 1950s and thefirst half of the 1970s, as the surplus offspring offarming families (second and third sons withsecondary education) left the countryside in favour ofjobs in the three big metropolitan areas of Tokyo,Osaka and Nagoya. With urban factories and serviceindustries absorbing this surplus labour from thecountryside, Japan’s era of robust growth wascertainly the heyday of internal migration.Demand-side aspect of Japan’s rapid growthWhile this describes the era of rapid growth from asupply-side perspective, there is also the demandsideas the population influx into cities swelled thenumber of urban households, making higherstandards of living possible. The expansion of urbanlifestyles fuelled demand in the 1950s for TVs,washing machines and refrigerators (the original socalled‘three holy durables’ or must-have products)and this was followed in the 1960s by demand forcolour TVs, cars and air conditioning units – the new‘three holy durables'. The speed at which theseUSRyutaro Kono 27 October 2011Market Mover22www.GlobalMarkets.bnpparibas.com

durable consumer goods became commonplacethroughout the country contributed to the nation’srapid growth.Japan’s trend growth was shifting lower in theearly 1970sLooking back, we know that Japan’s trend growthrate started falling in the early 1970s after internalmigration started tapering off a decade earlier. Hadan omniscient authority overseen macro policy, itmight have been possible to maintain price stabilitywhile gradually steering growth down to a newcruising speed of around 4%, but most Japanese atthat time still believed trend growth was in the 9%range. So when GDP growth slipped below 8%, theJapanese authorities thought the economy wasfalling into recession and they resorted toexpansionary fiscal policies and monetary easing topush growth back to 9% to prevent the output gapfrom deteriorating.Misunderstanding of drop in trend growth led tothe Great InflationWhat happens when the trend growth declines butpolicymakers misunderstand this and repeatedly tryto shore the economy up? While it might be possibleto elevate growth above trend for a period of time,continually trying to do so will result in variousimbalances. Excessive liquidity can cause rampantspeculation in real estate and can ultimately triggersoaring inflation. When the return of capital (naturalrate of interest) is down sharply, continued monetaryeasing can facility a property bubble. And ifbottlenecks develop in the labour supply after robustaggregate demand, rising wages can trigger homemadeinflation. When Japan’s growth abruptly fellfrom the 9% range to the 4% range in the early1970s, there was a nationwide boom in speculativereal estate dealings and consumer prices surged to25% y/y, resulting in what came to be called the‘Great Inflation’.Impact of 1973 oil shock and Tanaka’s ‘balanceddevelopment’ policyThe direct cause of this ‘Great Inflation’ was the firstoil shock in 1973. At the same time, soaring realestate prices were fuelled by speculation triggered bya plan by the 1972-74 Kakue Tanaka government to‘remodel’ the Japanese archipelago, by curbing anurban concentration in favour of ‘balanceddevelopment’. Even so, these were just theimmediate catalysts and the underlying cause wasthe maintenance of expansionary fiscal andmonetary policies because it was not understood thatthe economy’s slowdown was due to a drop in trendgrowth. Meanwhile, US inflation at this time peakedin the 12% range, surging to double-digit proportionson the mistaken anti-inflation policies (such as pricecontrols) of the Nixon Administration as well as the353025201510Chart 5: Japan’s Manufacturing Sector Wages(Firms with over 30 employees, % y/y, quarterly)5060 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85Source: MHLW, BNP Paribas302520151050-5-10Chart 6: Japan’s Land Prices(Land for commercial use, % y/y)-1571 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11Source: Cabinet Office, MIC, BNP ParibasFed’s mistaken continuation of monetary easing.(The Fed thought rising US unemployment was dueto weak aggregate demand but the real cause wasan increase in NAIRU from the influx of babyboomers into the labour force.) That Japan’s inflationrate was more than twice was as bad as America’sreflects the policy mistakes Japan made.Successful forbearance policiesIncidentally, when this speculative real estate boomcollapsed in the mid 1970s Japan did not experiencesevere balance-sheet troubles (non-performing loansin the banking sector and excessive debt in othersectors). Trend growth was still in the relativelystrong range of 4% so Japan could grow out of itsproblems without resorting to drastic measures. Inother words, a forbearance policy approachsucceeded at that time. Unfortunately, that successprobably contributed to the adoption of forbearancepolicies after Japan’s 1980s credit bubble burst. Buteconomic growth in the 1990s was too weak toresolve the resulting balance-sheet problems, whichfestered until the authorities imposed stricter assetassessments, adequate loan-loss reserves, andpublic fund bailouts.Ryutaro Kono 27 October 2011Market Mover23www.GlobalMarkets.bnpparibas.com

China’s ‘Lewis turning point’Returning to the parallels with China, the fact thatwages are on the rise in China’s urban coastalregions suggests surplus labour from the countrysideis tapering off – the Lewis turning point. Mediareports state that some companies have hiked wages200 or 300% in the last two to three years in order toretain workers from the countryside, althoughstatistics put the rate of increase at about 15%annually. Of course, the labour shortage in thecoastal areas also reflects curbs on internal migrationand increased industrialisation in China’s interior.Some argue, therefore, that China can maintain itsrobust trend growth as long as labour continues toflow to growth industries, wherever they mighthappen to be.China’s ‘harmonious society,’ a local version ofJapan’s ‘balanced national development?’Even so, it seems that China has adopted drasticpolicies to develop its interior much like Tanaka’smisguided vision for ‘remodelling’ Japan. In thispolicy, governments led by the LDP tried to preventoverpopulation in the cities and depopulation in thecountryside, by aggressively transferring income toreinvigorate Japan’s rural communities. Tanaka’s‘remodelling’ plan aimed to achieve ‘balancednational development.’ Needless to say, policiessuch as this, that prioritised curbing the free flow oflabour to cities probably impaired Japan’s trendgrowth. Could the same be happening in Chinatoday? The ‘harmonious society’ policy advocated byPresident Hu Jintao seems to entail a Chineseversion of ‘balanced national development.’ What ismore, China today is also starting to build up itssocial welfare systems, much like Japan did at thestart of the 1970s. In Japan, 1973 is known as the‘first year’ of social welfare, as free medical servicesfor the elderly and the index-linked pension wereintroduced under the Tanaka Cabinet.Allowing Chinese growth to shift lower is key toavoiding hard landingWe fear that because of supply-side constraintsChina will soon become unable to maintain 8% rangegrowth without soaring inflation. If our comparisonwith Japan is correct, and Chinese trend growth isstarting to shift lower, then China should be able toavoid a Japanese-style hard landing if it quicklyallows the economy to cool to a new cruising speedof under 8%. But most Chinese still see growthbelow 8% as a serious economic problem anddanger to employment. Consequently, they feel theauthorities should quickly shift to stimulative policiesto avert such a slowdown. If Beijing does this, though,121086420-2Chart 7: China’s GDP Deflator (% y/y)-400 01 02 03 04 05 06 07 08 09 10 11Source: EcoWin, BNP Paribaswe fear they could follow the same path that Japantook. If that were to happen, the global economycould be severely impacted as many nations dependon the Chinese economy. This and contagion fromthe eurozone sovereign debt crisis are our top riskscenarios for 2012.Could the Chinese regime survive an experiencelike Japan’s?Japan was able to maintain social stability after itstrend growth halved, its inflation surged to 25% andits real estate bubble burst. However, there are fearsthat similar events in China could severely shake thecurrent political regime with broad geopoliticalramifications.Another Japanese policy mistakeJapan also made another policy mistake in the 1970sthat Beijing should heed, and that involves currencypolicy. During the two decades of rapid economicgrowth, Japan maintained a fixed exchange underthe old Bretton Woods Agreements, with the yen setat a weak 360yen per dollar. Such an exchange ratecaused significant inflationary pressures. Unliketoday, capital flows were strictly controlled, so a fixedexchange rate did not necessarily hamper monetarypolicy. Even so, keeping the yen at such a weaklevel relative to Japan’s economic fundamentalsmade it hard for monetary tightening to adequatelyrein in inflation.Delayed yen revaluationIf inflation is rising due to supply constraints and anoverly weak fixed exchange rate, the best course ofaction is a package of monetary tightening andcurrency revaluation. Japan in the 1970s, however,did not do this out of concern for damage toexporters, and so the 360 yen/dollar fixed ratecontinued until the 1971 Nixon Shock, the end of thedollar’s convertibility into gold. This mistakenadherence to an overly weak exchange rate alsocontributed to Japan’s Great Inflation.Ryutaro Kono 27 October 2011Market Mover24www.GlobalMarkets.bnpparibas.com

Australia: Not Yet• Having been forecasting no change in ratesthrough to end-2012, the consensus has swungto expect a 25bp rate cut on 1 November.6.0Chart 1: Inflation ContainedUnderlying Inflation• Better inflation data mean the RBA now hasthe capacity to ease policy. However, recentofficial commentary suggests November is toosoon to expect a move.• Our forecast is for a 25bp cut in Decemberas insurance against downside news betweenthen and the next RBA meeting in February.5.04.03.0% q/q annualised% y/y2.01.0• Contrary to the market’s perception, wejudge the greater risk is for easing to be delayeduntil 2012.Underlying Inflation = average of trimmed mean and weighted median0.0Q103 Q104 Q105 Q106 Q107 Q108 Q109 Q110 Q111Source: ABS, BNP ParibasChart 2: Ex-Food and Energy Inflation EasingShift in consensusThere are two key and related events in Australiaover the coming week, the RBA policy meeting on1 November and the release of the Statement onMonetary Policy on 4 November. At the time ofwriting, the market was pricing in almost a 25bp cutat the upcoming meeting. The consensus amongeconomists has also swung in favour of a 25bp ratecut, although only by a slim margin (12 for a cutversus eight for no change). Our forecast remains fora rate cut at the December meeting.While the market has long been pricing in aggressiverate cuts, which are unlikely to be delivered on thescale expected, the change in the economists’consensus is marked. Last week the median forecastwas for an unchanged cash rate throughout theremainder of 2011 and all of 2012. Now the majorityof economists expect one imminently, which raisesthe question: what has changed?76543210-1% y/y-2Q191 Q194 Q197 Q100 Q103 Q106 Q109Source: ABS, BNP ParibasCPI ex-food & energyHeadline CPIIt’s inflation, stupidThe obvious potential game changer was the Q3inflation release. Headline CPI inflation was in linewith market expectations at 3.5% y/y, down from3.6% in Q2. However, the measures of underlyinginflation – the trimmed mean and weighted median –both surprised significantly to the downside, eachrising by 0.3% q/q against expectations for a 0.6%increase. On a y/y basis, trimmed mean inflationeased to 2.3% from 2.6% and weighted medianinflation fell to 2.6% from 2.9%. The ABS alsointroduced a new CPI ex-food and energy figure (ameasure of underlying or core inflation commonlyused in other countries). It, too, eased on a year-onyearbasis to 2.1% from 2.5% and is at its lowestsince Q4 2009.The sharp reduction in quarter-on-quarter underlyinginflation (as measured by the average of the trimmedmean and weighted median) to 0.3% q/q from 0.6%q/q is important. On an annualised basis, the figure isonly 1.2%, well below the bottom end of the RBA’starget range and the weakest since Q4 1998. Ittherefore unwinds some of the 3.2% annualisedaverage quarter-on-quarter increase seen in H1 2011,which itself has been revised down from 3.5% q/qannualised.Overall, on a year-on-year basis, two out of threemeasures of underlying inflation (the trimmed meanand ex-food and energy) are running in the lower halfof the 2-3% target range while the other (theweighted median) is running at only 2.6%.Dominic Bryant 27 October 2011Market Mover25www.GlobalMarkets.bnpparibas.com

Forward lookingThe Q3 inflation data help to re-affirm the RBA’smore relaxed stance on inflation that has emergedover the past month or two. However, to concludethat it will therefore deliver a cut on 1 November ispremature. Certainly, on a quarter-on-quarterannualised basis, underlying inflation was weak. Butthat followed two unexpectedly strong quarters, solooks like a correction. The big picture is that the datahave helped remove concerns about upside risks toinflation, but they are unlikely to have given rise toconcerns that inflation will be too low in the future.The factors underlying this judgment are that:• Surveys of costs are close to their average;• The unemployment rate is close to trend;• Compensation growth is robust; and• The AUD remains strong by historical standards.Chart 3: Around Trend – ISource: Reuters EcoWin Pro, BNP ParibasChart 4: Around Trend – IIThis should show through in the RBA’s inflationforecast, released in the Statement on MonetaryPolicy. We expect it to be consistent with the 2-3%target over the forecast horizon, compared with theprevious forecast, in which underlying inflation roseabove 3.0%.The key point is that better news on inflation hasremoved an obstacle to a rate cut, but it has notmade a cut in November a done deal. If anything, weview the risk that the RBA delays cutting rates tobeyond our December forecast as greater than therisk it cuts in November.Source: Reuters EcoWin Pro, BNP ParibasChart 5: Bias to Ease…Talking deputy-headDeputy governor Ric Battellino’s speech on25 October – the day before the CPI data werereleased – highlights that while the RBA is mindfulthat some policy easing might be necessary at somepoint, it does not sound like a central bank ready topull the trigger imminently.Mr Battellino reiterated the sentiment from theOctober statement, namely that, “the downwardrevisions to recent estimates of underlying inflationand the softer global economic outlook have madethe outlook for inflation less concerning, providingscope for monetary policy to be supportive ofeconomic activity, if needed”.However, if anything, Mr Battellino, and possibly byimplication, the RBA, appears more relaxed aboutglobal conditions than one month ago.He noted: “It remains to be seen how the Australianeconomy will respond to the recent financial volatilityand the consequent fall in confidence and the loss ofwealth. To date, however, as in the United States,the flow of monthly data in Australia has been a littleSource: Reuters EcoWin Pro, BNP Paribasbetter than might have been expected given thevolatile financial environment”.Certainly, since the last meeting NAB businessconfidence has improved, consumer confidence hasrisen, employment growth has picked up and retailsales growth has recovered somewhat. This is not tosay that a rate cut will not prove necessary.Mr Battellino himself acknowledged, “job vacanciesand advertisements are lower than their peak aroundDominic Bryant 27 October 2011Market Mover26www.GlobalMarkets.bnpparibas.com

the start of the year, overall credit growth remainssubdued and the housing market remains soft”.Nonetheless, he did not sound like a man arguing fora rate cut at the next RBA meeting.We would, however, add a number of other points toMr Battellino’s list of weak areas of the economy,which could be used to justify a rate cut beyondNovember. For example, consumer confidence is stillwell below average, business confidence is on thesoft side, and, while the US is doing a little betterthan expected, European growth looks notably worse.Insurance policyWhile recent debt-related developments in Europeand some better news on US growth have led tostronger sentiment in markets, it is worthremembering that the global economy has suffered anegative shock from financial market volatility, whichis still likely to be feeding through to the realeconomy. Aggressive RBA rate cuts, as priced in bythe market, continue to look inappropriate. But in lightof improved Australian inflation data some modestpolicy easing to guard against downside global riskswould seem sensible.Deputy Governor Battellino’s commentary suggests amove at the 1 November meeting is not the mostlikely scenario. We therefore continue to expect a25bp cut in December. Why would the RBA cut inDecember but not in November? Because it isanother month in which we expect to see below-paractivity data in the US, Europe and to some extentAustralia in response to the shock to financial9.008.007.006.005.004.003.00%Chart 6: …And Scope to CutRBA Cash Rate2.001993 1995 1997 1999 2001 2003 2005 2007 2009 2011Source: Reuters EcoWin Pro, BNP ParibasAverage Cash Rate1993-2007Effective Cash Ratemarkets in recent months. And, perhaps moreimportantly, failure to act in December will mean theRBA would have to wait until February to react to anynegative surprises. The now benign outlook forinflation gives the RBA the ability to take outinsurance against such a scenario by moving thepolicy rate back towards neutral from its current,mildly restrictive, stance (Chart 6, the effective cashrate takes into account the wider spread on mortgagerates since the crisis, and is above its average level).In sum, having been one of the first houses toforecast an RBA rate cut, we are now in the oddposition of arguing that it will come later than themarket and the consensus expected. Moreover, thegreater risk to our forecast is that policy easing isdelayed into 2012, rather than delivered on1 November.Dominic Bryant 27 October 2011Market Mover27www.GlobalMarkets.bnpparibas.com

China: Undertaking Selective Easing• On 25 October, Chinese Premier Wen calledfor a pre-emptive and subtle adjustment tocurrent macro policy.• This policy call was probably in response tothe recent blow-up in the underground bankingsystem, risks building in the shadow bankingsystem, and growth momentum weakening.• However, we do not expect general andoverall easing. Rather, we see selective andtargeted easing in credit loans and taxation.• In our view, the beneficiaries would be publichousing, ordinary housing, businesses providingdaily necessities, small and mini businesses,high-tech, new energy and environmentalprotection.Premier Wen calls for a timely macro policyadjustmentAfter two major economic reviews, the Chinesepremier, Wen Jiabao, made an official policystatement that it is time for China to make a preemptiveand subtle macro policy adjustment in orderto cope with the changed economic situation andtrends. He made this statement on 25 October inTianjin.In addition to Premier Wen's policy statement, theCBRC announced a supplementary guidelineyesterday (26 October) requiring all commercialbanks to improve their financial services to small andmini businesses. The MOC, MOF and PBOC jointlychose one month from next year as “ConsumptionPromoting Month”.Why now?In our view, there are two reasons for the change:• The underground banking system blowing up inWenzhou in the region of Zhejiang, Erdos inInner Mongolia, and Sishui in Jiangsu, and risksin the shadow banking system building up (oneA-share listed company offered total borrowingguarantees at 69 times its net assets). The StateCouncil seems to have agreed that the majorreason for the rapid and chaotic growth inunderground banking was the over-controlledofficial credit lending market. Financialspeculation surging and collapsing not onlydamages manufacturing and increases financialrisks, but also greatly threatens social stability.Table 1: Official Financing Falling(RMB bn)9M 11(% share) (%y/y)Aggregate financing 9800 100.0 -11.41. RMB loans 5680 58.0 -9.52. Forex loans 477 4.9 63.33. Designated loans 1070 10.9 11.84. Trust loans 84.8 0.9 -82.25. Bankers' acceptance 982.5 10.0 -50.06. Corporate bond 839.7 8.6 -14.17. Non-Financial corporateequity 3515 3.6 -3.1Source: PBOC, BNP Paribas70656055504540Chart 1: Economic Confidence Weakening(%)PMI-outputHeadline PMI35Jan-05 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11Source: PBOC and BNP Paribas• The State Council is worried that growthmomentum, which has been hit, is not strongenough to support the high growth that isnecessary for the 18th Party Congress. There isalso a risk of a sharp slowing and a hard landing.The GDP growth rate remains at 9.1% in Q3, butslowed from 9.5% in Q2 and 9.7% in Q1.Potential recessions in the US, EU and Japan,and rising trade conflicts, would weaken China’sexports greatly. Consumption growth is alsoslowing due to a slowdown in economic growthand income, high inflation, and the withdrawal ofthe consumption promotion policy. Moreimportantly, FAI growth should definitely be on adownward trend because of the slowing ininfrastructure construction, and greater efforts tocontrol property prices.Implications and benefitsFrom Premier Wen's policy statement, we don'texpect a general or overall policy easing immediately,but selective and targeted easing. The easing isexpected in two areas: lending and taxation.Chen Xingdong 27 October 2011Market Mover28www.GlobalMarkets.bnpparibas.com

Restrictive lending conditions could be revisedsomewhat. For instance, the CBRC now allowscommercial banks to exclude loans to small and minibusiness from their calculations of their lending-todeposits(L/D) ratio. The CBRC has also becomemore tolerant of higher non-performing loan ratios forlending to small and mini businesses. With therectification of the problems in the underground andshadow banking systems, deposits should return tothe banking system. It is also possible for the PBOCto allow small and medium-sized banks to offerhigher-than-benchmark interest rates in order toattract more deposits. That would help small andmedium banks lower their L/D ratios or increase theirnew-lending capability. It is also possible for thePBOC to cut RRR for small and medium-sized banks(but we do not see that as likely in the immediatefuture).In our view, the targeted easing would benefit thefollowing six areas:1. Public housing: the Ministry of Urban-RuralConstruction reported to the National People’sCongress two days ago that building has begunfor 98% of the planned ten million units of publichousing, but many of the projects are short offunding;2. Ordinary housing: Premier Wen, for the first timesince the State Council launched a policy tocontrol property prices in April 2010, requiredlocal governments to increase land supply forordinary housing construction. We believe he isworried the growth in property investment couldfall too much;3. Small and mini businesses;4. Investments and businesses that are essentialfor people’s daily life;5. New technology, new energy and environmentalprotection; and6. Exports. Export-oriented companies havesuffered from weakening demand in theinternational market and large cost increases(wages, energy and materials, interest rates, theRMB exchange rate). They are also short offunding due to the difficulty of accessing bankloans.Taxation wise, the premier has called for a structuralcut in taxes. Measures could include:• Increasing the tax threshold, and extending tosmall and mini businesse the halving of thecorporate tax rate until 2015;• Removing the 3% stamp duty from commercialbanks’ lending contracts made with small andmini businesses;• Extending to 2013 the policy that allows lossesincurred on small loans (below RMB 5mn for asingle borrower) to be deducted from profitsbefore tax;• Extending to 2015 the policy that has cut to 3%the operation tax on revenues from insuranceactivities generated by rural financial institutions;The MOF has indicated that the Chinese governmenthas chosen Shanghai as the place to trial VATreform and replace turnover tax with VAT in serviceindustries, in order to lighten service providers’ taxburden and to promote service consumption from thebeginning of 2012.China’s stock market has been ignited by the news.From the point of view that policy matters, it is clearthe stock market is bottoming out. But the degree ofupside would depend on real growth, the differencein investors’ expectations and changes ininternational peers.Chen Xingdong 27 October 2011Market Mover29www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchUS: Treasury Quarterly Refunding Preview• The refunding announcement on 2November provides long-term guidance onTreasury issuance and the auction calendar.• Many investors have been expectingissuance cuts this year, due to Treasury’sprevious guidance. However, since BNPP hashad more pessimistic econ/budget forecasts,we have not expected issuance cuts any timesoon. This time is no different.• Is Treasury timing the market? They shortedthe long end two years ago. Now, they’reconsidering switching from fixed to floating!There are a range of budget forecasts that Treasurycan use when deciding how to manage the auctioncalendar. We show a few different forecasts in Table 1:- Baseline scenario: This comes from the CBO(Congressional Budget Office), and generally assumesthat current law remains in place. It also assumes thatthe Budget Super-Committee will follow through withidentifying USD 1.2tn in future savings.- Alternate scenario: Here, the CBO assumes thatmost of the Bush tax cuts are extended, the AMT isindexed for inflation (both political parties seeminglyfavour this), and a few other “likely-to-happen” factors.- Bloomberg median forecast: In the two scenariosabove, CBO assumes 3.6% GDP growth in the 2013-2016 period, along with a sharp decline in U/E from8.5% to 5.3%. Let’s face it, this is over-optimistic, sothe Street’s expectations provide a useful reality check.- Net Treasury issuance: This is how much money israised if auction sizes are left unchanged. In ouropinion, a prudent long-term financing strategy wouldbe to hold off on auction size cuts until 2013, based onthe comparison shown in Chart 1.Is Treasury timing the market?Two years ago, Treasury began to actively extend theduration of its issuance, so as to “lock in” historicallylow rates. Rates have not sold off as expected, so thecost of this strategy might be coming under scrutiny.After all, T-bill issuance has come down at the sametime. So, Treasury has switched from issuing bills at0.00% to issuing 10yrs and 30yrs at a greater cost (fornow). One sign that Treasury is looking to hedge thisstrategy is that it is exploring floating rate notes(FRNs), which reduce the cost of issuance when theyield curve is fairly steep.Table 1: Annual Budget Deficits (USD bn)2012 2013 2014CBO Baseline Scenario 970 510 270CBO Alternate Scenario 1,000 770 640Bloomberg Median Forecast 1,100 850 n/aNet Treasury Issuance (current path) 900 850 700Source: BNP Paribas. Figures rounded to nearest 10bn.201220132014Chart 1: Annual Budget Deficits (USD bn)0 200 400 600 800 1000 1200Source: BNP ParibasCBO Baseline ScenarioCBO Alternate ScenarioBloomberg Median ForecastNet Treasury Issuance (current path)There appears to beroom to cut issuanceonly in 2013Chart 2: Treasury Issuance Should Remain Steady3002502001501005002-3Y5-7Y10-30YQ1 06Q2 06Q3 06Q4 06Q1 07Q2 07Q3 07Q4 07Q1 08Q2 08Q3 08Q4 08Q1 09Q2 09Q3 09Q4 09Q1 10Q2 10Q3 10Q4 10Q1 11Q2 11Q3 11Q4 11Q1 12Q2 12Source: BNP ParibasForecastWe think the chances of actually seeing TreasuryissuedFRNs are quite low because there would haveto be compelling evidence that this reduces financingcosts. FRNs would surely attract additional buyers intothe market, as there is less interest rate risk. However,the big downside is that if Treasury's offerings arespread into more diverse products, then the liquidity inthose products goes down and can affect the ability ofdealers to effectively market these products.Suvrat Prakash 27 October 2011Market Mover30www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchUS: Impacts of HARP 2.0 on Agency Debt• Though we do not expect HARP 2.0 toproduce a “nuclear” refinance wave, ourmortgage analysts are predicting a moderateprojected pick-up in prepay speeds of highercoupon, older vintage MBS. These high coupon,seasoned mortgages are heavily represented inFannie and Freddie’s retained mortgageportfolios.• One impact of this targeted increase inprepays is that it will accelerate the contractionof Fannie and Freddie’s retained portfolios. As aresult, their overall funding needs will bereduced as these assets shrink.• This should intensify the trends in theagency debt market of the past 2 years - furthershifting Fannie and Freddie’s debt compositiontowards longer term, non-callable debt to matchthe longer duration, lower convexity profile ofthe retained portfolio.A re-focusing of Fannie and FreddieThe HARP program was not introduced to changethe structure or market impact of Fannie andFreddie’s business model, but it may accelerate theirtransition or wind-down from mortgage investmentcompanies to more streamlined, single-purposemortgage guarantors.When Fannie and Freddie were originally placed intoconservatorship in September 2008, the preferredstock purchase agreement that the GSEs enteredinto with the Treasury required that the organisationsshrink their retained mortgage portfolios until theywere below UDS 250bn. The mechanism thatTreasury chose to implement this provision was toput a “hard cap” on the year-end size of the portfoliosthat declined by 10% per year.The 2008 year-end cap for each GSE was UDS 900billion (shown in Chart 1, along with Fannie Mae’smortgage portfolio and debt outstanding). At thattime, Fannie’s retained portfolio was below UDS800bn so the cap was not constraining. Setting the2008 cap at UDS 900bn, implied a 2009 cap of UDS810bn (90% * UDS 900bn), a year-end 2010 cap ofUDS 729bn (90% * UDS 810bn) and so on. In fact, in2009 the Treasury adjusted the agreement, keepingthe year-end 2009 cap at UDS 900bn so the GSEshad ample “room” to buy-out delinquent loans fromtheir securitized pools. The spike in Chart 1 thatAmount (in billions)Chart 1: FNMA Mortgage & Debt Portfolios920900880860840820800780760740720700680660640Jan‐08Mar‐08Jun‐08Sep‐08Source:bnP ParibasDebt Outstanding (in billions)440420400380360340320300280260240220200180160140120Jan‐08Dec‐08Mar‐09Jun‐09Sep‐09Dec‐09Mar‐10shows the quick increase in the portfolio from UDS725bn to UDS 820bn is a result of those buyouts.Therefore, 2010 became the first year of the forcedshrinking with the year-end cap of UDS 810bn. Thisyear’s cap is UDS 729bn, which Freddie is wellbelow but which Fannie just dropped under in JulyJun‐10Sep‐10Dec‐10Mar‐11Total Debt OutstandingGross Mortgage PortfolioYE 08 capYE 09 capYE 10 capYE 11 capYE 12 capJun‐11Sep‐11Dec‐11Chart 2: FNMA Debt CompositionApr‐08Jul‐08Source:bnP ParibasOct‐08Jan‐09Apr‐09Jul‐09Oct‐09Jan‐10Apr‐10Jul‐10Oct‐10Mar‐12Jan‐11Jun‐12Short term debtCallable long term debtNoncallable long term debtTable 1: FNMA Debt YTD Changes(amounts in millions)YTDDec-09 Dec-10 Aug-11 changeShort term debt 200,567 152,013 189,371 37,358Callable debt 210,181 219,804 150,710 (69,094)Noncallable debt 375,027 422,061 402,218 (19,843)Short term debt % 26% 19% 26% 6.4%Callable debt % 27% 28% 20% -7.4%Noncallable debt % 48% 53% 54% 1.0%Total Debt Outstanding 785,775 793,878 742,299 (51,579)Source:bnP ParibasApr‐11Sep‐12Jul‐11Mary-Beth Fisher 27 October 2011Market Mover31www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective research(most recent reporting is as of August 2011).Through a combination of run-off and possibly somesales, Fannie has managed throughout the year tosteadily shrink their retained mortgage portfolio, andwe expect that will continue into year-end.Debt Composition Shifts as WellAs shown in Chart 1, as the mortgage portfolio hasdeclined, so has aggregate debt outstanding. Chart 2breaks down the debt portfolio into short term(original maturity < 1 year) debt, and callable andnon-callable long term debt. Noncallable long termdebt is actually growing outright, while both shortterm and callable debt outstanding has sharplydeclined.The drop in callable debt is material, particularlyconsidering the sequence of callable redemptionwaves of the past year given the low rateenvironment. Callable issuance has been highacross all of the GSEs due to the redemptions, butas we’ve noted in prior research and we show inTable 1, the GSEs have been aggressivelyrestructuring their debt portfolios and reducingcallable debt. Fannie’s callable debt outstanding hasdropped by UDS 69bn year-to-date, while their shorttermdebt has climbed by UDS 37bn. Overall theirdebt portfolio has shrunk UDS 52bn and we expectthat trend to continue into year-end, and in-line withthe UDS 81bn required drop in their retained portfolioyear-over-year.As a percentage of their debt outstanding (lastcolumn in Table 1), callables have been reduced by7.4% while noncallable and short term debt hasrisen. Although noncallable debt has grown only 1%this year, it actually jumped from 48% to 53% of totaldebt outstanding YOY in 2010. This is almostcertainly a reflection of the longer duration and lowerconvexity in the mortgage portfolio, which results inless needs to buy vol (issue callables) on the liabilityside.Further prepays of high coupon mortgages will onlyintensify this trend. Going forward, we expect that netcallable issuance from Fannie and Freddie will shrinkmaterially next year, though some of those fundingneeds will shift to bullets and discount notes. Overall,the continued contraction of the portfolio may keepcallable financing levels rich and put pressure onagency debt spreads due to the low supply.Mary-Beth Fisher 27 October 2011Market Mover32www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchMBS: HARP 2.0? OMG, INBD!• A change to the nature of reps and warrantrelief offered by FNM does not seem likely. Onlyan improvement in the usage of automatedappraisal is apparently targeted. FRE isexpected to match the rep and warranty reliefoffered by FNM.• There do not appear to be any newagreement or understandings on MI and secondlien issues.• Decreased LLPAs and expanding HARP to125+ LTV borrowers should have a marginalimpact.• Prepay differences between FNM and FREindicate that the effect of HARP enhancementsmay be marginal at best. We expect 2008 FN 6swhich paid at 24 CPR last month, to possiblymove to the 30 CPR area. Final details areawaited and are expected to be available on Nov15 th .• The excessive pickup in September GNII 4%speeds was driven by buyouts rather than refi’s.• FRE’s September summary indicates that itsnegative convexity exposure appears to havedeclined in the rally, as higher coupons arealready beyond their points of maximumnegative convexity.Much ado…When details about enhancements to HARP startedinitially emerging on Monday, it appeared that thechanges were significant and would include a waiverfrom repurchases. It also appeared that second lienand MI issues that have held back HARP refinancingwere being newly addressed as well.But as the day progressed, further clarificationsindicated that changes might in fact be fairlymarginal. Indeed, there does not appear to be anychange as such to the nature of FNM’s requiredrepresentations and warranties. Regulatory agenciesprobably viewed that the existing rep and warrantyrelief was already substantial but that the awarenessaround it wasn’t. Specifically, FNM’s underwritingreps and warranties are not expected to change at allbut the GSE would be more efficiently usingautomated appraisals. FNM’s use of the automatedappraisal is reportedly at 30%, while that of FRE’s at80%. Freddie would begin offering the underwritingrep and warranty relief on current loans that FannieChart 1: Loans and Securities Held by theBanking System$ bnFN/FG Passhroughs $ 857CMOs $ 457US Treasuries $ 163Other Securities $ 1,245Real Estate Loans $ 4,122C&I Loans $ 1,239Loans to individuals $ 1,290Other Loans & leases $ 455Source: FDICChart 2: % MI by Coupon and Vintage – FG 30yLoan LevelCpnVintage2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20114 21% 6% 9% 12% 8% 10% 2% 34% 6% 8% 10%4.5 27% 12% 10% 7% 8% 6% 9% 12% 8% 9% 12%5 26% 16% 17% 19% 11% 8% 10% 17% 11% 8% 11%5.5 23% 17% 19% 21% 13% 12% 18% 28% 10% 11% 15%6 38% 22% 19% 21% 21% 18% 31% 36% 11% 23% 76%Source: BNP ParibasChart 3: % Second Liens by Coupon and Vintage– FG 30y Loan LevelCpnVintage2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20114 0% 0% 4% 14% 23% 17% 11% 2% 16% 15% 16%4.5 10% 4% 16% 14% 12% 19% 18% 18% 16% 16% 16%5 7% 8% 10% 10% 13% 12% 18% 14% 13% 21% 23%5.5 13% 9% 6% 10% 14% 17% 20% 10% 11% 23% 23%6 9% 6% 4% 7% 12% 16% 15% 6% 3% 11% 10%Source: BNP Paribasoffers. The criteria for being current was relaxedsomewhat. Previously, a borrower had to be 12months current for the servicer to obtain anunderwriting rep and warranty relief from FNM; thatnow changes to current over six months with onedelinquency over the past 12 months. Verbalverification of employment for FNM was and shouldcontinue to be the norm, (no change there) andshould be matched by FRE. Of course, this rep andwarranty relief is available only for same servicerrefi's; for refinancing through a different servicer, theborrower is re-qualified, and an entirely new loan withnew reps and warranties is created. There was talkof a fee for rep and warranty waiver, which may bemore applicable to different servicer refinancing. Butif there were underwriting issues with the loan backwhen the economy was doing well, the probability ofthat being corrected now is unlikely (income is acommon issue).Anish Lohokare / Timi Ajibola / Bo Peng 27 October 2011Market Mover33www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchLiar liarFraud and misrepresentation (the latter, a particularlygrey area) still present an issue and are not likely tobe addressed. Cases where second liens were notreported or were originated after the first lien may notbe relieved from underwriting rep and warrantyclaims. Several loans may have the same borrowerlisted as an owner-occupant, and such cases maynot get rep and warranty relief either. Lenders are notbeing relieved of charter violations; cases with creditenhancement issues on 80+ LTV loans would fallunder that category for example.Can you put it in writing?Other than the general rep and warranty waiverscovering underwriting and automated appraisals thathave always been part of FNM’s HARP guidelines, itappears that explicit language protecting lendersfrom repurchases may not be forthcoming. Duringthe pre-crisis period, underwriting accuracy took abackseat in an effort to meet volumes. However, thatdid not absolve lenders from representation andwarranty risk. As was clear from recent bankearnings, lenders were surprised at the GSEsincreasingly pursuing repurchases of seasonedloans.The recently released report by FHFA criticizedFreddie Mac’s settlement with BoA, particularly thefact that the GSE had not pursued claims onseasoned collateral.http://www.fhfaoig.gov/Content/Files/EVL-2011-006.pdfThe report provides deep insights into FHFA’sperspectives on this issue and text from the reportthat highlights this subject is reviewed below.“The FHFA senior examiner also observed that,despite the apparently changed foreclosure patternsassociated with housing boom era mortgages,Freddie Mac had not adjusted its process foridentifying loans that might be candidates forrepurchase claims. Freddie Mac reviews intensivelyfor repurchase claims only those loans that go intoforeclosure or experience payment problems duringthe first two years following origination”.“Freddie Mac management has advised FHFA-OIGthat they also believe that higher rates of loandefaults in later years do not necessarily equate tohigher defect rates.” [defect = underwriting defect]“…demonstrates the extent to which Freddie Machas not reviewed housing boom era mortgages thatwent into foreclosure during the third through fifthyears after their origination. It shows that by choosingto review intensively only those loans that defaultedwithin two years of origination, Freddie Mac did notexamine close to 100,000 2006 vintage loans.”“Freddie Mac data further show that for allEnterprise-owned foreclosed loans originatedbetween 2004 and 2007, Freddie Mac has notreviewed over 300,000 loans for possible repurchaseclaims. Those loans that were not reviewed(hereafter referred to as “out-of-sample” loans) havea combined unpaid principal balance exceeding $50billion. Many of these loans are likely not candidatesfor repurchase. For instance, a portion of the loansnot reviewed are lower-risk prime loans, whichprobably have a lower incidence of representationand warranty defects. On the other hand, FreddieMac’s portfolio of housing boom loans includes asubstantial number of Interest Only and Alt-Amortgages, which have a high incidence of defects”.Given the risk averse current environment, verbalassurances may not be enough to entice lenders tolend. In Chart 1, we show the overall balance sheetof the banking system. Clearly, banks are heavilyloaded with mortgages and a refi wave would mean aconsiderable loss of NIM. Without an offset such astronger rep and warranty relief, banks would nothave an incentive to increase lending capacity.MI and second liens: nothing new hereIt had initially seemed that new ground had beenbroken on the MI and second lien front, but that maynot be the case. The aim seems to be towardsimproved operational efficiency of MI and second lientransfers to the new loan, but no material newagreements or understandings seem to have takenplace. Large lenders are already part of a second lienre-subordination consortium. Charts 2 and 3demonstrate the considerable presence of MI andsecond liens in higher coupon collateral.LLPA changes do not appear to be a game changereither. Note that the considerable rally in mortgagerates failed to elevate prepays for higher coupons,and thus, it is not clear what increased moneyness atthese low levels of rates would achieve. In fact,prepays on even 5s came in below expectations inSeptember. Chart 4 shows that the effect of including125+ LTVs is expected to be fairly limited. And thispart of the HARP puzzle is not expected to beattacked until next year. 125+ LTV loans would likelytrade as specified pools but different from FNM’sCQs and FRE’s U6 pools which cover 105-125%LTV.Unless details emerge that indicate enhancementsthat are materially better than what appear to be onthe cards right now, we expect do not expect prepayson higher coupons to exceed the 30 CPR area ('086s are currently at 24CPR).Anish Lohokare / Timi Ajibola / Bo Peng 27 October 2011Market Mover34www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchPrepays on FN 2008 6s are about 1.5 CPR fasterrelative to FGs at present, after being about 2.5 CPRslower before HARP was introduced. Some of the 4CPR flip is due to higher FN delinquencies whichbecame apparent after buyouts were introduced.Thus, the impact of limited rep and warrant relief isnot outsized.Final details are awaited at this point, and should beavailable on 15 November. Our expectations couldbe revised if final details depart materially fromcurrent indications. Also, efficiency enhancementscould be an ongoing process if the focus onrefinancing is maintained.GNMA DLQ updateIn September prepays, GNII 4s sped up a whooping117%, but the increase in GNI 4s was much moremuted at 28%. GNII 4% speeds (9.1 CPR) thusovertook GNI 4% speeds (6.4 CPR) by a significantmargin. However, the substantial speed increase inGNII 4s was due to buyouts (led primarily by WellsFargo) rather than refinancing. GNII 4% CRRs(voluntary prepays) increased from 1.99 to 2.68 andGNI 4% CRRs from from 2.68 to 4.49. CBRs(buyouts) for GNII 4s increased from 2.14 to 6.30,while for GNI 4s declined from 2.40 to 1.97; WellsGNII 4s CBRs increased from 1.93 to 6.94 and inGNI 4s increased from 3.63 to 4.02. In Chart 5, weshow the voluntary speed increase for 4 through 5sin GNI, GNII and FG. Clearly, once buyouts werestripped out, the call protection afforded by GNs isclear.Overall, the GNMA Delinquency report forSeptember showed a decline in 60-daydelinquencies across all products from 1.36% to1.33%. By Issuer, we saw somewhat similar results.For instance, BofA 60-day delinquencies declinedfrom 1.26% to 1.23%, Chase declined from 1.88% to1.82%, Citi declined from 1.69% to 1.58%, GMACwas flat at 1.73%, Wells declined from 1.08% to1.05% and TBW declined from 4.20% to 3.83%. Inaddition, 30-day delinquencies declined from 3.77%to 3.55%.The overall level of delinquencies continues to be lowwhen compared with the same period over theprevious three years. For instance, versus 1.33% inSeptember 2011, 60-day delinquencies in Septemberduring previous years were 1.54% in 2010, 2.11% in2009 and 1.77% in 2008.Chart 4: 125+ LTV Population by Coupon andVintage – FG 30y Loan LevelCpnVintage2003 2004 2005 2006 2007 2008 2009 2010 20114 2% 1% 1% 6% 11% 5% 0% 0% 0%4.5 1% 2% 2% 8% 17% 4% 0% 0% 0%5 0% 1% 5% 10% 12% 5% 0% 0% 0%5.5 0% 1% 7% 11% 11% 6% 1% 0%6 0% 1% 8% 11% 12% 7% 0%Source: BNP ParibasChart 5: GNMA Voluntary Speeds vs FGsCpnGNI GNII FRESep-11 Aug-11 % Change Sep-11 Aug-11 % Change Sep-11 Aug-11 % Change4 4.49 2.67 68% 2.68 1.99 35% 16.89 7.2 135%4.5 10.23 6.25 64% 7.52 4.17 80% 23.66 12.50 89%5 12.79 9.36 37% 12.01 8.35 44% 21.14 17.32 22%Source: BNP ParibasOverall GNMA 90+ day delinquencies increased from1.46% to 1.54%, and CBRs increased from 3.87 to3.97. The increase in 90+ day delinquencies was,once again, led by BofA whose 90+ daydelinquencies increased from 2.02% to 2.38%, andCBRs declined from 0.74 to 0.51 in September. Aswe mentioned last month, with BofA's 90+ daydelinquency level significantly below GNMA’s 5%threshold it might be focusing on using resourceselsewhere as opposed to delinquent loan buyouts.This delinquency reports seems to confirm thisassumption.FRE MVS – Negative convexity declines in therallyFRE’s retained portfolio was down USD 1.4bn toUSD 679.13bn in September and continues to bewell below the year-end cap of USD 729bn. AgencyMBS declined by USD 2.1bn, non-agency MBSdeclined by USD 1.2bn and whole loans increasedby USD 1.9bn. Total debt outstanding declined byUSD 3.1bn to USD 689.92bn, and delinquenciesincreased by 2bp to 3.51%. The duration gap was 0.The sensitivity of the portfolio to a 50 bp shift in thelevel of rates, a measure of negative convexity,declined substantially from USD 335 mn to USD 152mn. This makes sense given that the portfolio iscomposed primarily of higher coupons which arealready beyond their point of maximum negativeconvexity. A rally only causes higher coupons tomove further away from that point and become lessnegatively convex.Anish Lohokare / Timi Ajibola / Bo Peng 27 October 2011Market Mover35www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchGreece: “Deeper” PSI After the EU Summit• The long awaited deeper PSI is now officialafter the conclusion of the EU Summit. Amongthe things we know, it remains a voluntaryoperation, it involves a 50% nominal discounton notional of GGBs held by private investorsand it includes a EUR 30bn contribution fromEU member states.• There are several things we still don’t knowsuch as the GGB eligibility pool, the requiredparticipation rate, the characteristics of thecollateral and the characteristics of the new PSIbonds.• The official sector will provide an additionalEUR 100bn programme financing until 2014. Thenew programme should be agreed by the end of2011 and the exchange of bonds should beimplemented at the beginning of 2012.Table 1: NPV Estimation Under 100%Collateralisation via AAA BondsNew PSI Bonds (100% Collateral)Discount RateNPV Estimation9% 12%4.5% 39.3% 34.3%Coupon6.0% 47.0% 40.4%Source: BNP ParibasTable 2: NPV Estimation under 30bn CashInstead of AAA BondsNew PSI Bonds (0% Collateral) + CashDiscount RateNPV9% 12%4.5% 43.1% 36.0%Coupon6.0% 50.8% 42.0%Source: BNP ParibasWhat we knowIn our recent piece “Greece: PSI Revisited, 19October” we explained why the original PSI had tochange and how it could be tweaked to lead todifferent NPV reductions. In particular, we analysedthe impact of each factor (coupon, discounting rate,haircut on the notional, collateralisation percentage)on the NPV of the new bonds. We also highlightedthe importance of some form of collateral in the PSIexchange in order to help facilitate a higherparticipation rate.The EU Summit statement which was released in theearly hours of 27 October sheds some light on thenew form of the PSI (twelfth paragraph). In moredetail, we know the following facts:• There is still a discussion between Greece andits private investors to find a solution for a deeperPSI. This means that there has yet to be a finalagreement.• The PSI aims at reducing the debt/GDP ratio to120% by 2020. We still need to find out if thismetric refers to gross or net debt.• It remains a voluntary operation.• There will be a nominal discount of 50% onnotional Greek debt held by private investors.• EU member states would contribute to the PSIpackage up to EUR 30bn.• The official sector will provide additional financingof up to EUR 100bn until 2014 including therequired recapitalisation of Greek banks.• This new programme should be agreed by theend of 2011 and the exchange of bonds shouldbe implemented at the beginning of 2012.What we don’t knowThere are still many important details missing withrespect to the new deeper PSI. In more detail:• What is the expected and required participationrate in this new PSI (it was 90% on 21 July)?• What is the sample of eligible GGBs forparticipation in this new PSI? In the 21 Julydescription, the eligible pool included almost allGGBs maturing up to 2020. According to thepress, this has been extended to include alloutstanding GGBs except for ECB holdings. TheEU Summit statements refers to “Greek debtheld by private investors” and hints at the wholeoutstanding of GGBs, excluding the ECBholdings. We still do not know what is going tohappen to the GGBs maturing in December andto those which matured in August which were stilleligible for the original PSI. The new pool isestimated at around EUR 206bn versus 150bnon 21 July. This implies that the debt buybackoperation might no longer be on the table sincethe targeted bonds were supposed to be thelong-end bonds (after 2020) which were not PSIeligible on 21 July. The fact that all GGBs (exECB holdings) could be PSI eligible now meansthat there are no GGBs left for buybacks (unlessthe ECB is willing to sell some of its GGBholdings, of course).Ioannis Sokos 27 October 2011Market Mover36www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective research• What will be the form of the EUR 30bncontribution from EU member states? Back on 21July, the collateral was expected to be 30y EFSFzero coupon bonds for the first 3 options and 15yamortising EFSF floating rate bonds for option 4(the official announcement did not specify whichkind of AAA bonds would be used but there wasa wide consensus in the market about EFSFbeing the issuer of these defeasance assets).There have been various market rumours thatthis new deeper PSI might involve cashpayments to GGB holders instead of AAA bonds.However, paragraph 14 in the EU Summitstatement says that “credit enhancements will beprovided to underpin the quality of collateral soas to allow its continued use for access toEurosystem liquidity by Greek banks”. On top ofthat, there was a statement by Hung Tran, theIIF’s deputy managing director, that thisEUR 30bn of official funding will be used tocollateralise the new bonds with AAA rated zerocoupon bond securities. Of course, we are stillmissing all the pricing details with respect tothese AAA bonds, i.e. maturity, coupon, yield.• What are the characteristics of the new PSIbonds? Back on 21 July, there were 4 optionswith different characteristics among them. Theconsensus now is that there is going to be only 1option. For all NPV considerations we need toknow the maturity profile, coupon and discountrate of these new PSI bonds.What makes senseAfter having noted what we know and what we don’tknow, we can start thinking of various scenarios thatmake sense to us given the numbers that we doactually know. First of all, it is very interesting that theEU members’ contribution to the PSI is now specifiedin EUR and not in NPV terms. The limit of EUR 30bnis a signal that the EU authorities learned the lessonof the 21 July deal where collateral turned out to bemuch more expensive than initially thought. Backthen, it was agreed that AAA bonds would guaranteethe notional repayment of the new Greek PSI bonds.In the meantime, AAA rates fall massively and theAAA collateral became much more expensive.A scenario of 90% participation over a PSI pool ofEUR 206bn, leads to a figure of EUR 185.4bn. Whenapplying a 50% haircut on this amount we end upwith a new notional of Greek PSI bonds ofEUR 92.7bn. The EUR 30bn collateral is 32.4% ofthe EUR 92.7bn of notional of the new PSI bondswhich is almost identical to the price of the 30y AAAzero coupon bonds that was used on the 21 Julydeal. In simple terms, you can spend EUR 30bntoday to buy such an amount of 30y AAA zerocoupon bonds that will guarantee the repayment ofthe new notional of the EUR 92.7bn PSI bonds after30 years.Of course, as explained before, this is based on aseries of assumptions and can only be used as amathematical calculation that makes sense with thefigures that we do know from the EU Summitstatement.Under the alternative scenario where the 30bn iscash and not AAA bonds, the investors will end upwith a new PSI bond which will carry only Greek risk.Thus it will have a lower NPV compared to theprevious case where the notional is guaranteed byAAA bonds. This shortfall in NPV terms will becompensated for with cash delivery at the time of theexchange. In the case where the notional repaymentis not guaranteed by the AAA bonds but will have tobe paid by Greece, there is a possibility of using anamortising bond in order to smooth out theredemption profile and avoid a 30y bullet bond whichwould create a huge spike in the redemption profileof Greece. This would have NPV implications toosince the cash flows will change substantially.NPV considerationsIn this last section we try to get a feeling of where theNPV of this new PSI package will stand. As notedabove, this can only be done under a combination ofassumptions. Here we examine both the 30y AAAzero coupon bonds (worth EUR 30bn) scenario andthe EUR 30bn cash scenario that were describedabove. We use a combination of coupon of 4.5% and6% and discount rate of 9% and 12%. Tables 1 and 2show the results of these NPV estimates.Starting with Table 1, the notional of the new 30y PSIbonds is guaranteed by AAA zero coupon bonds(which are priced at 32.4% NPV). The NPV of thePSI deal (as a percentage of the original GGBsnotional) in this case varies from 34.3% in the lowcoupon/high discount rate case to 47% in the highcoupon/low discount rate case. Table 2 shows theresults under a no AAA collateral scenario, whereinvestors are given EUR 30bn of cash, or(30bn/185.4bn) 16.2% NPV under a 90%participation scenario. Bear in mind that this NPVpercentage will vary according to the participationand the PSI eligible pool of GGBs since the onlyconstant is the EUR 30bn figure. The NPV of thisoption ranges from 36% to 50.8%.The reason that the NPV is a bit higher in this case isbecause investors will receive the principalredemption in 30y by Greece and still receive 16.2%of NPV in cash while in the AAA bonds caseinvestors receive only a coupon stream by Greeceand the AAA bonds which are worth 16.2% of NPV,i.e. there is no principal repayment by Greece (in linewith original PSI terms). The principal redemption willtake place via the AAA bonds in this case.Ioannis Sokos 27 October 2011Market Mover37www.GlobalMarkets.bnpparibas.com

EUR: Receive OIS/BOR SpreadsThis section is classified as non-objective research• The 12mth tender conducted this weekattracted reasonable demand but it was not thatstrong. However, both the amount of liquidityand its duration have increased.• In addition, EU decisions on Greece, theEFSF and banks, are likely to improve the creditquality assessment on banks. CDS have roomto fall.• STRATEGY: receive OIS/BOR spreads. Onthe Mar12, target 45bp (versus 58.5 currently).Chart 1: Cost of Carry Weighed onDemand for 12mth (EUR bn)Reasonable demand, but not that strong, for12mthAt its LTRO, the ECB allotted EUR 56.9bn for12 months. The number of bidders (181) was lowerthan at previous 12mth tenders conducted in 2009(even if we exclude the spectacular demand at thefirst one). Demand for 12mth liquidity was very closeto the lower bound of the range of expectations(EUR 50-200bn). We were expecting strongerdemand accompanied by lower demand for 3mthliquidity. However, demand at the 3mth tenderremained high, at EUR 44.6bn, while EUR 85bn wasexpiring. To summarise, more than a half of positionsrolled for another 3mth period and the rest for 12mth,while an additional EUR 16.5bn jumped into the12mth tender.The cost of carry prevented demand from being verystrong, although there were advantages to shiftingmore significantly from the 3mth to 12mth. Indeed,the rate on the 12mth tender will benefit from theECB’s rate cuts if the central bank delivers. Going forthe 3mth to benefit from potential rate cuts thereforemakes little sense. In addition, rolling from 3mth to3mth for a year is exposed to the risk of aninterruption of non-standard procedures for tendersnext year, even though this risk is now very small.However, although demand was lower than expectedat the 12mth tender, both the amount and theduration of liquidity provided by the ECB increasedafter this week’s operations. Liquidity is now muchmore than EUR 200bn above needs, and theduration of liquidity increased from 30 to 71 days.This is significant enough to allow stress on liquidityto ease somewhat. Banks’ funding is improving andthere is more certainty thanks to the extension of theduration of liquidity. Thus OIS/BOR spreads haveroom to tighten.Source: BNP ParibasChart 2: OIS/BOR Spreads are TighteningSource: BNP ParibasRisk assessment on banks to improveDecisions taken at the EU summit have majorimplications for banks. As the situation looks, to alarge extent, addressed, and the implications forbanks are largely manageable, the creditassessment on banks is likely to improve in the nearterm. The early market reaction is clear in stocks andCDS. The decline in banks’ CDS will beaccompanied by tighter short-term credit spreads.OIS/BOR spreads therefore have room to narrowmore significantly.Strategy: receive OIS/BOR spreads. On the Mar12,target 45bp (versus 58.5 currently).Patrick Jacq 27 October 2011Market Mover38www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchEUR: Update on the 50y Point• We review the decoupling between volatility,term premium and the 30/50s yield curve.• TRADE: Buy OAT55 versus OAT35 @11bppick-up, target flat, stop/loss 15bp.Valuation models continue to suggest that the levelof convexity implied by the ultra-long end of the yieldcurve is significant. For example, by decomposingthe reference OAT35/55 spread into its rateanticipation, term premium and convexity premium(Chart 1), we get about 10bp of convexity RV. Thisresults primarily from a dislocation between the bullflattening of 10/30s, the rally in 30Y volatility and thesteepening of the 30/50s segment.Anecdotal information suggests that significantpaying flows in the 40Y and 50Y buckets areresponsible for this decoupling. We suspect thatsome investors are trying to position themselvesahead of a rumoured change in the Dutch pensionregulation (nFTK). Nonetheless, the appetite forduration from investors in negative convexity shouldcontinue to prevail in the environment of low yieldsand dull equity performance.Interestingly, when we further analyse the ultra-longend of the OAT curve we note an outperformance ofOAT55 in ASW-terms relative to OAT35 (same foron-the-run OAT41 and OAT60). The ASW-box hascompressed by some 15bp after briefly scratchinglevels in excess of 30bp.We do not put too much weight on credit-relatedarguments when valuing 50Y bonds. In the currentregime, we still have a well-behaved curve anddefault probabilities are discounted so heavily atultra-long maturities that the impact of durationextension on credit premia is negligible. Given recentOAT price dynamics, we cannot fully dismiss thecredit argument either (Chart 3). As we have seen inprevious episodes (e.g. Italy and Spain), yield curvestend to flatten when spreads to Bunds enter a new‘high yield’ regime (investors start hedging notionalexposure rather than dv01). This is not yet the casefor France, though!TRADE: Buy OAT55 versus OAT35 @11bp pick-up,target flat, stop/loss 15bp.Chart 1: Modelling the OAT 30/50s40residuals (LHS)35OAT35/55 yield spread30model2520151050-5-102005 2006 2007 2008 2009 2010 2011Source: BNP Paribas50403020100-10Chart 2: OAT55 Outperforming in ASWSpread of z-spreads (LHS)OAT35 z-spreadOAT55 z-spread2005 2006 2007 2008 2009 2010 2011Source: BNP Paribas35030025020015010050Chart 3: Contagion Risk in AAA02007 2008 2009 2010 2011Source: BNP ParibasiTrax SenFin 10YOAT/Bund 10Y (RHS)0.150.100.050.00-0.05-0.10-0.15-0.20-0.25-0.301501301109070503010-10-30-50120100806040200Alessandro Tentori 27 October 2011Market Mover39www.GlobalMarkets.bnpparibas.com

EMU Debt Monitor: Key RV ChartsThis section is classified as non-objective researchChart 5: 2y/5y OAT/Bund box: 5y OATs havestabilised on their cheapest levelsChart 6: OFR/OTR OBL ASW –Obl 161 back on the cheap side3025Oct 13 Bund cheap/OAT Apr 16 cheapSMP 2.0131192071553105OAT Apr 16 expensiveBTAN 5y cheapening1-10Apr-11 Jun-11 Aug-11 Oct-11 Dec-11OAT/Bund Oct 13/Apr 165y French papers have stabilised at their cheapest levelswithin the 2y/5y OAT/Bund box for a few days. Those whoconsider the recommended 2y/10y OAT as too risky couldplay flatteners through the OAT Oct 13/Apr 16 spread.Chart 7: 10y/30y DSL/OAT box back to its widest levels-31 16 31 46 61 76 91 106 121 136 151 166 181 196Av 5 OFR/OTR asw obl 159/160 obl 158/159obl 157/158 obl 156/157 obl 155/156obl 160/161If the past is any guide, Obl 161 seems to be trading atcheap levels vs. Obl 160 in ASW terms around 3.5bp (roll13bp). In contrast, Obl 159 recently richened on the Oblcurve. We advise holders of Obl 159 to switch into Obl 161.Chart 8: 10y/15y Fin/DSL: 15y Fin is normalising504540OAT Apr 20 / DSL 42 expensive1510FIN July 25 expensive353052502015-5105OAT Apr 20/DSL 42 cheap0May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11DSL July 20/OAT Apr 20/Jan 42/OAT Apr 41After a brief setback due to the cheapening of 10y OATs, the10y/30y DSL/OAT box finally retraced close to its widestlevels (i.e. 30y DSL still too expensive). A safe way to play a‘normalisation’ is to enter 5y/30y DSL stepeeners.Chart 9: France/Netherlands CDS & 5y BTAN/Oblspread diverging-10FIN July 25 cheap-15Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11Fin Apr 20/July 20/July 25/ DSL Jan 28Last week we highlighted the extreme cheapness of 15y Finvs. DSL. The former has started to recover but remains verycheap with the 10y/15y box, still trading 10bp from itshistorical average. Fin July 15 is still a buy on the 15y area.Chart 10: 10y/15y/30y Bund fly: massive 15y Bundcheapening since mid-September1605Y CDS and cash spreads0.750.715y Bund cheapening1400.651200.61000.5580600.50.450.4400.35200Apr-11 May-11 Jun-11 Jun-11 Jul-11 Aug-11 Sep-11 Sep-11 Oct-11BEL/FRA BEL/FRA cash FRA/NETH FRA/NETH cashAs Chart 9 shows, the France/Netherlands CDS differentialhas decoupled from the cash spread. The sharp divergencein CDS basis is unsustainable and a normalisation will lead toFrance CDS richening versus the cash (the OAT supply nextweek argues for a tighter France CDS basis).All charts source: BNP Paribas0.3Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11DBR 2.50 01/21DBR 5.625 1/28 DBR 3.25 07/42 FLYDBR 2.50 01/21 DBR 6.5 7/27 DBR 3.25 07/42 FLYEven though the 10y/30y Bund segment has almost fullynormalised, most of the move has come from the 15y/30ysegment, which pushed 15y Bunds back to very cheap levelsin the 10y/15y/25y Bund fly. The most conservative tradewould be for holders of 10y Bund to switch into Jan 2024.Eric Oynoyan / Ioannis Sokos 27 October 2011Market Mover41www.GlobalMarkets.bnpparibas.com

EMU Debt Monitor: Trade IdeasThis section is classified as non-objective research• Play 5y/10y Bono flatteners• Olo 2y/5y flatteners are still attractive.• Buy Bono July 40 versus BTP Sep 40 / sellBono Apr 21 versus Bono July 266040Chart 1: Short-Lived Normalisation of 2y/10yBono versus BTP SegmentBono 2013 expensive20Relative value switches updateFollowing the EU summit announcement, we providea quick update on recent non-core relative valuerecommendations.3y/10y Bono flattenersIn early September we stressed the excessivesteepening of the Bono 2y/10y segment comparedwith the BTP one, underscored by the very high levelof the 2y/10y Bono/BTP box at around 50bp. Werecommended selling the expensive 3y Bono (i.e.Oct 14) versus 10y, expecting around 25bpflattening. As Chart 1 illustrates, the Bono segmentflattened by more than 20bp until recent days, as thebox fully normalised before rewidening. Theexpensive Bono Oct 14 also disinverted by 10bpversus Apr 14.What about now? Actually, the pullback on the Bonocurve in recent days has been particularlypronounced on the 2016/2020 segment as Oct 16richened versus Apr 16 (see Chart 2). Meanwhile,the Oct 20/Apr 21 spread has been flattening formore than a month. Such micro moves on OFR/OTR5y and 10y Bonos led to new highs on the Bono Oct16/Oct 20 segment, while the BTP one has beenfairly unchanged. Very tight repo conditions on BonoOct 16 incline us to be more conservative on theentry level to take into account the additional carry ona two to three week horizon. Moreover, the nextBono supply will be on Bono Oct 16 next Thursday,which should reverse the recent richening move andimprove repo conditions.Strategy: enter flatteners on Bono Oct 16/BonoOct 20 segment on a further overshooting to the69/71bp area, expecting a return to low 50s.2y/5y olo flattenersIn early October, we underscored the extremevaluation reached by 2y olos within 2y/10y olo boxesversus AAA and pushed for Sep 13/Sep 16 oloflatteners.0-20SMP 2.0-40Jan-10 Mar-10 Jun-10 Sep-10 Nov-10 Feb-11 May-11 Jul-11 Oct-11Bono/BTP 2013/20 boxSource: BNP ParibasChart 2: Bono Oct 16/Sep 20 Segment: BonoOct 16 Richened versus Both OFR 5y and 10y0.70.60.50.40.30.20.10-0.1-0.2Sep-11 Sep-11 Oct-11 Oct-11Source: BNP Paribas3020100-10-20-30Bono Oct 16 ASW richeningBTPS 4.00 09/20 BTPS 4.75 09/16SPGB 4.85 10/20 SPGB 4.25 10/16SPGB 4.25 10/16 ASW SPGB 3.25 04/16 ASW (RHS)Chart 3: Olo/ATS 2y/5y Box: 2y Olo StillExpensiveHistorical Average + 2.0 st devHistorical Average - 2.0 st devOLO 2013-40Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11Source: BNP ParibasOlo Sep 13/Oct 13/Mar 17/Feb 17OLO 2013 toocheapThe Sep 13/Sep 16 olo spread is a few basis pointssteeper from where we recommended it but we donot see reasons to question that flattening call for thetime being. Indeed, while the 2y/10y olo/AAA box25201510502013 OloricheningEric Oynoyan / Ioannis Sokos 27 October 2011Market Mover42www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchstarted to normalise, 2y/5y ones versus AAA curveslike ATS or BTANs are still hovering at their lows, i.e.2y olos too rich (see Charts 3 and 4). Moreover,within the local curve the 2y/5y/10y olo fly is trading10/12bp above its fair value, i.e. 5y olo too cheap(the fly went up to 20bp+ too high ten days ago).Keep in mind that in mid-September the belly of theolo curve traded up to 35bp too expensive.Strategy: Enter or keep Sep 13/Sep 16 olo spread(monthly carry 2.5bp for one month). Thesegment should flatten back to the mid 90s.10y/30y Bono segmentAt the very long end of the non-curves, most of 30ymaturities recovered versus the 10y maturity after aninitial spike after the start of the SMP 2.0. However,the flattening of the 10y/30y segment has been muchmore pronounced on BTPs than Bonos. As Chart 5highlights, that lag on the Bono segment has pushedthe 10y/30y Bono/BTP box to new highs. Anotherindicator of the cheapness of the very long end of thebono curve is the differential between the observedand the fitted spread. The times series of the residualis plotted on Chart 6. The differential is around +20bpcompared with -12bp for the BTP curve.Strategy: we would recommend two kinds oftrades. The aggressive one would be to buy BonoJuly 40 versus BTP Sep 40. With thenormalisation of the 30y Bono and BTP, thespread in the low 50s should widen to the high70s.For the most conservative ones, the alternativetrade would be to sell Bono Apr 21 into BonoJuly 26, targeting a return to the low 40s.Chart 4: Olo/Btan 2y/5y box: 2y Olo Cheapened aBit But Remains Expensive155-5-15-25Historical Average + 2.0 st dev-35OLO 2013 expensive-45Historical Average - 2.0 st dev2013 Olo richening-55Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11Source: BNP ParibasOlo Sep 13/Oct 13/Mar 17/Apr 17OLO 2013 too cheapChart 5: 10y/30y Bono/BTP Box: Bono SegmentToo Steep20100-10-20-30-40Bono 10y/30y too steepBono 10y/30y too flat-50Jan-10 Mar-10 Jun-10 Sep-10 Nov-10 Feb-11 May-11 Jul-11 Oct-11Source: BNP ParibasBono/BTP 2020/2040 boxChart 6: Observed versus Fitted Bono 10y/30ySegment: 30y Normalising But Still Cheap5545Bono 10y tooexpensive3525155-5-15-25SMP2.0-35May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11Source: BNP ParibasJul 2019/Jul 40 Bono spreadEric Oynoyan / Ioannis Sokos 27 October 2011Market Mover43www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchEMU Debt Monitor: SSA and Covered Bonds• Significant movements in spreads in coreEGBs and SSA have opened the door tointeresting trade opportunities.• In particular, the massive steepeningdeveloped in French OATs contrasts markedlywith the lesser dynamics observed within theCADES curve.• We recommend playing this dislocationthrough a box trade CADES/OAT 5/10y orthrough a compression trade CADES/OAT 5y(April 2016). Target 25bp profit over the nextthree months.Opportunities arise from spillover into core SSARecent comments from rating agencies havepressured French OATs lately, driving themsignificantly wider in ASW terms. The impact on coreSSA was twofold, with a noticeableunderperformance from CADES, EIB, EU and EFSFon the one hand, while KFW remained quite resilientin this nervous environment (Chart 1).Significant movements in spreads in core EGBs andSSA have opened the door to interestingopportunities that are worth considering.In particular, in the sell-off, French OATs havesteepened massively, a dynamic not observed withinthe CADES curve (Chart 2). According to our inhousegeneric indices, the box CADES/OAT 5/10y istherefore back at the all-time high seen during theLehman crisis. This observation comes despite thismorning’s price action in French OATs, which haveoutperformed significantly since the EU Summit.Indeed, whereas CADES/OAT 10y is back to levelsclose to the long-term average, after having peaked,CADES/OAT 5y is back at the all-time high seenduring the Lehman crisis (Chart 3). Therefore, werecommend playing this strong dislocation, eitherthrough a box trade CADES/OAT 5/10y (enter aflattener in OAT 5/10y combined with a steepener inCADES 5/10y), or through a compression tradeCADES/OAT 5y (buy CADES Apr-16 versus shortOAT Apr-16). Target 25bp profit over the next threemonths.As far as EIB and KFW are concerned, it isnoteworthy that EIB remains fairly priced relatively toboth CADES and KFW taken together. However, EIBsteepened significantly over the past month, while302520151050-5-10Chart 1: Spillover into Core SSA –Performance in ASW btw 17 Oct and 26 Oct2y 5y 10yKFW CADES EIB EU EFSFSource: BNP Paribas50403020100Chart 2: CADES 5/10y vs OAT 5/10y –Strong Dislocation-102006 2007 2008 2009 2010 2011Source: BNP ParibasCADES 5/10y FRTR 5/10yChart 3: CADES/OAT 5y – Back to All-Time Highs706050403020100-102006 2007 2008 2009 2010 2011Source: BNP ParibasLEHCADES/OAT 5yKFW lagged strongly behind. As a result, KFW looksexcessively flat compared with EIB and other peers.A box trade EIB/KFW (enter a flattener in EIBcombined with a steepener in KFW) can be enteredto profit from this recent decoupling. It works in both2y/5y and 2y/10y. Target 15bp profit in the shortterm.Camille de Courcel 27 October 2011Market Mover44www.GlobalMarkets.bnpparibas.com

EMU Debt Monitor: RedemptionsThis section is classified as non-objective researchEGB Monthly RedemptionsBonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011ITA 0.0 18.7 30.5 0.0 14.6 12.2 0.0 20.2 46.0 0.0 15.5 0.0 157.6FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3SPA 0.0 0.0 0.0 15.5 0.0 0.0 15.5 0.0 0.0 14.1 0.0 0.0 45.1GRE 0.0 0.0 8.7 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.4BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.5 27.9NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9AUS 8.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 8.4POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5FIN 0.0 5.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.7Total 63 24 66 58 22 35 83 27 89 47 20 24 558EGB Monthly RedemptionsT-Bill Monthly RedemptionsT-Bills Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011ITA 17.4 17.3 17.3 17.3 14.6 19.3 16.3 16.2 15.7 15.7 14.9 20.0 201.8FRA 33.3 35.9 38.3 31.9 32.1 32.7 30.9 28.7 36.4 36.1 34.8 37.1 408.2GER 11.0 11.0 11.0 11.0 11.0 11.0 9.0 9.0 9.0 10.0 10.0 9.0 122.0SPA 8.7 7.9 10.2 7.3 7.9 6.3 7.3 11.9 7.3 10.0 6.2 9.3 100.3GRE 4.2 0.4 1.4 3.2 1.0 4.4 2.5 4.0 3.6 3.3 3.6 31.6BEL 5.5 6.2 6.4 6.7 7.4 6.8 5.4 5.4 5.0 6.4 6.4 6.8 74.4NET 9.7 8.3 17.4 7.0 6.9 10.9 7.7 6.2 7.8 12.7 7.1 10.1 111.6AUS 0.1 2.2 0.9 3.4 0.5 1.9 2.4 2.0 0.2 0.7 1.2 0.3 15.8POR 3.4 3.5 3.8 0.0 4.0 3.1 3.5 3.3 3.6 2.3 30.4IRE 2.1 1.2 1.6 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.2FIN 3.5 2.3 2.6 1.5 2.2 0.7 0.6 1.1 0.1 0.0 0.0 14.6Total 98.9 96.2 110.9 90.6 83.6 89.6 87.4 85.3 90.0 98.5 87.5 98.3 1116.8T-Bill Monthly Redemptions1009080706050403020100Monthly EGBs RedemptionsJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec120100806040200Monthly T-Bills RedemptionsJan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecThis Month’s EGB RedemptionsCountry Bond Maturity Issued EURs (bn) CRNCYFRANCE FRTR 5 10/25/11 25/10/2011 11/09/2001 15.65 EURGERMANY OBL 3 1/2 10/14/11 14/10/2011 29/09/2006 17.00 EURSPAIN SPGB 5.35 10/31/11 31/10/2011 12/06/2001 14.09 EURThis Month’s T-Bill RedemptionsCountry T-Bill Maturity CRNCY EURsAUSTRIA Various small T-bills1.31BELGIUM BGTB 0 10/20/11 20/10/2011 EUR 6.41FINLAND RFTB 0 10/11/11 11/10/2011 EUR 0.07FRANCE BTF 0 10/06/11 06/10/2011 EUR 9.56FRANCE BTF 0 10/13/11 13/10/2011 EUR 8.09FRANCE BTF 0 10/20/11 20/10/2011 EUR 8.60FRANCE BTF 0 10/27/11 27/10/2011 EUR 9.86GERMANY BUBILL 0 10/12/1112/10/2011 EUR 5.00GERMANY BUBILL 0 10/26/1126/10/2011 EUR 5.00GREECE GTB 0 10/14/11 14/10/2011 EUR 2.00GREECE GTB 0 10/21/11 21/10/2011 EUR 1.63ITALY BOTS 0 10/14/11 14/10/2011 EUR 7.15ITALY BOTS 0 10/31/11 31/10/2011 EUR 8.53NETHERLANDS DTB 0 10/31/11 31/10/2011 EUR 12.66PORTUGAL PORTB 0 10/21/1121/10/2011 EUR 3.27SPAIN SGLT 0 10/21/11 21/10/2011 EUR 10.04All charts sources: BNP ParibasEric Oynoyan / Ioannis Sokos 27 October 2011Market Mover45www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchEUR Gamma: Yet One More Carry Trade• In this environment, we still like bullishstrategies as leading indicators point to furtherweakness of the economic landscape.• Strategy: Buy 1x1.5 2.30% - 1.79 1y5yReceiver Spread versus 1x 4% 1y10y Payer, atzero cost.The upper-left corner of the swaption implied volatilitysurface currently looks rich versus delivered volatility(Chart 1). In particular, 1m2y and 1m30y straddlesare now trading respectively at 120% and 137% ofdelivered vol (one month window). Note though that,in the recent past, delta hedged long straddlepositions at the front end have been profitabledespite implied/realised ratios above unity: forinstance, in early August 3m2y implied volatility wastrading at a premium versus delivered volatility butlong convexity trading was profitable over a onemonthhorizon (Chart 2). In fact, at this point, volatilitydelivered more than what was priced in by impliedvolatility quoted one month prior. What happenedwas that given the backdrop of downside risk togrowth with CPI inflation significantly above the ECBtarget, increased uncertainty regarding monetarypolicy supported long vol positions at the front end.With the eurozone crisis still ongoing and the difficultposition in which Mario Draghi, the newly appointedgovernor of the ECB finds himself, we expect suchdynamics to re-emerge soon.In this environment, we still like bullish strategies asleading indicators point to further weakness of theeconomic landscape. In particular, we recommendclients enter the following carry trade:Buy 100m 2.30% 1y5y Receiver SwaptionSell 150m 1.79% 1y5y Receiver SwaptionSell 100m 4.00% 1y10y Payer Swaptionat zero cost.At the time of writing, the 5y swap is 2.02%, the 1y5yswap is 2.30%, the 10y swap is 2.63%, and the1y10y is 2.82%.The idea is simply to finance a long position in a 1y5yreceiver spread with short OTM 1y10y payer.Assuming the payer expires worthless, the followingholds: the maximum terminal profit is 1.83m if the 5yrate settles at 1.79%. Assuming unchanged 5y rate,the terminal profit is 840k. Finally the trade startsgenerating losses if the 5y swap settles below 1.01%Chart 1: Impl/Rls Ratios (1m)1y 2y 5y 7y 10y 20y 30y1m 127% 120% 117% 118% 121% 129% 137%3m 118% 113% 103% 105% 104% 110% 114%6m 106% 106% 99% 99% 99% 102% 103%1y 95% 99% 90% 90% 91% 92% 92%2y 100% 94% 83% 83% 84% 83% 83%Source: BNP ParibasChart 2: Evolution of 3m2y Impl/ForwardRls Vol versus Impl/Backward Rls Vol1.61.5Implied/Forward Rls Vol (1m)Implied/Backward Rls Vol (1m)1.41.31.21.11.00.90.80.70.6Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11Source: BNP ParibasChart 3: Mark to Market Valuation TodayAssuming Instantaneous ParallelShifts of the Curve500,0000-500,000-1,000,000-1,500,000-2,000,000-2,500,000Source: BNP Paribas-100 -75 -50 -25 0 25 50 75 100(the historical low being 1.70% seen in August lastyear).Six month carry P&L is worth 596k.The mark to market valuation today assuminginstantaneous parallel shifts of the curve is shown inChart 3.Matteo Regesta 27 October 2011Market Mover46www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchGBP: Long-End Linkers and Gilts in Demand• Huge demand for UKTi-62 syndication.• APF shows risk of 20y+ UKT gilt squeeze.• STRATEGY: Keep 10/30y real yield and giltflatteners, and long 10y gilts versus Bunds.Chart 1: Huge Demand for UKTi-62 SyndicationMassive demand for UKTi-62 launchThere was incredible demand for the GBP 4.5bnlaunch of the new 50y index-linked benchmark with“a very large book of high-quality demand ofGBP 10bn in 90 minutes and at a time of persistingglobal market volatility”, according to the UK DMOpress release. The UKTi 0.375% 22-March-62 cameat a real yield of 0.49% and a spread of +2bp versusUKTi-55, the tight (or rich) end of the range. Despiteoffering the lowest real yield for an ultra syndicationand the longest duration linker (or sovereign bond)around, the UKTi-62 saw the largest order book forany linker transaction ever! Both LDI and extensiondemand were significant, as we expected, and theconcession was enough.We like real yield flatteners via ultras, especiallyversus the 12-20y sector given Novembersyndication intentions. Long ultra breakevens (at 3%)and breakeven steepeners remain very attractive inboth a historical and risk premia context, butTuesday’s APF operation highlights the risk of asqueeze on long-end conventionals. It seemssensible to wait until after early December’s couponpayments (on conventionals) to re-consider beingshort 15y+ conventionals in any capacity. Thecoupons will see GBP 5bn of cash coming back intogilts (DMO and BoE adjusted) or close to GBP 9bn of10y equivalent. After the 0.50y duration extension ofthe 5y+ UKTi index extension on 26 October, the 1y+UKTi index will extend by +0.45y at the end of themonth. We prefer to express our bullish long-endbreakeven via swaps at this stage, despite relativelywide ASW discounts. At the front-end, we stay bullishon UKTi-13 breakevens, with UKTi breakevenshaving fallen too much versus EUR and USDbreakevens since the end of July. Remember, UKlinkers offer the best 3/6month carry.Focus back on APF and supplyWeek three of the Bank of England’s APF operationssuggests it is becoming increasingly difficult for theBank of England to source conventional gilts forreverse auctions. In Table 1, we show averageoffer/cover ratios, discounts and duration of APFoperations over the last three weeks. Discounts andSource: BNP Paribas12.0010.008.006.004.002.000.00Chart 2: UK Conventional Gilt Coupon Flows(BoE/DMO and duration adjusted)GBP bn1.490.23offer/coverage ratios are, on average, much lowerthan at the end of week one. Furthermore, discountsand cover ratios are lower for the higher maturitysectors. Indeed, last week’s 25y+ sector reverseauction saw a coverage ratio of only 1.06 andvirtually no discount. In fact, some stocks were9.097.437.436.65 6.654.91Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecSource: BNP ParibasCoupon FlowsBoE & DMO AdjustedTable 1: Summary Statistics of APF (3 weeks)SectorOffersReceivedOffersAcceptedOffer/CoverRatioDiscount1.490.237.374.919.09Availiable freefloafloatof RA£25bn RA / free-Duration(y)3-10y 19,620 5,101 3.85 1.1 142,268 18% 5.0010-25y 12,877 5,099 2.53 0.5 59,174 42% 11.6925y+ 7,515 5,100 1.47 0.4 82,360 30% 19.73Average 2.62 0.7 12.14Source: BNP ParibasShahid Ladha 27 October 2011Market Mover47www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchbought by the BoE at a premium of up to 2bp to14.45 GEMM price snapshot.We have repeatedly mentioned the risk of a potentialsqueeze on long-dated conventionals, given thesharply net negative supply due to BoE buying. Theresults of APF operations give some indication as topositioning and potential squeezes in the gilt curve.We find support for our call for a flatter gilt curve –and target 75bp on 10/30 benchmark gilt curve.In terms of RV on the gilt curve, we keep ourtraditional gilt relative-value methods but add freefloatof individual gilt stock to our analysis. InCharts 3 to 6, we plot updated rich/cheap analyses(versus a fitted gilt spread to SONIA curve) by eachsector with updated free-floats (%). In the 3-10ysector, we find 2015 maturities and UKT 4 16 lookrich, while the UKT 4T 20 looks better valued after itsrecent richening.In the 10-25y sector, we find the UKT 4Q 32 stilllooks the most attractive, with little premium given afree-float close to 50%, although it is exempt from thenext two 10-25y sector purchase operations that willbe re-opened for GBP 2bn on Thursday 3 November.While the stock could cheapen further into supply,demand remains strong for longer-dated gilts so theauction should be well received. We see strong valuein the UKT 4Q 32 and expect it to outperform in thesector by the start of December.At the long-end, the 30y area remains our favourite,especially the 4T 38 and 4Q 39, which are notreflecting any premium relative to free-float.Meanwhile, ultras look rich relative to free-float, giventhe likely premium on conventional gilt duration withlimited supply. Note this statement from the UKDMO: “As a result of the larger than originallyanticipated size of today’s syndication, the DMO isalso announcing today that the gilt mini-tenderpreviously scheduled for the week commencing28 November is being cancelled”.50-5-10Chart 3: 3-10y Sector – RV versus Free-Float2t 15 4t 15 8 15 2 16 4 16 1t 17 8t 17 5 18 4h 19 3t 19 4t 20 3t 20 8 21 3t 21Source: BNP Paribas50-5-10-15Rich/Cheap bp Free-float (%)Chart 4: 10-25y Sector – RV versus Free-Float4 22 5 25 4q 27 6 28 4t 30 4q 32 4h 34 4q 36Source: BNP Paribas1050-5-10Rich/Cheap bp Free-float (%)Chart 5: 25y+ Sector – RV versus Free-Float4t 38 4q 39 4q 40 4h 42 4q 46 4q 49 3t 52 4q 55 4 60Source: BNP ParibasRich/Cheap bp Free-float (%)Chart 6: 10y Gilt/Bunds versus UK/GER CDSSpread120%100%80%60%40%20%0%90%80%70%60%50%40%30%20%110%100%90%80%70%60%50%Good entry point for long gilt/BundFollowing the supportive outcome of the EuropeanSummit, we still like long 10y gilt/Bund plays. Therecent underperformance of gilts into the highduration UKTi-62 syndication events leaves the 10ygilt/Bunds spread attractive in the 40bp area giventhe strongly net negative supply on conventionals inQ4.Source: BNP ParibasShahid Ladha 27 October 2011Market Mover48www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchTable 2: Results from Week Three of the BoE’s APF Reverse Auction OperationBond (3-10y)OffersReceivedOffersAcceptedWAAPHighest AAPDiscount(cents)Discount(bp)14.45 DMODMO Close(t-1)Change onDay (cents)Change onDay (bp)2t 15 623 287 105.68 105.70 0.7 0.2 105.69 105.67 2 -0.6 3.10 92%4t 15 406 109 113.80 113.80 0.3 0.1 113.80 113.77 3 -0.8 3.58 54%8 15 84 57 127.43 127.43 7.0 2.0 127.50 127.47 3 -0.8 3.57 38%2 16 809 285 103.00 103.02 1.9 0.5 103.02 102.98 4 -1.0 4.07 98%4 16 124 0 0.00 0.00 112.22 112.18 4 -0.9 4.47 71%1t 17 0.0 0.0 5.01 99%8t 17 353 0 0.00 0.00 4.84 61%5 18 514 0 0.00 0.00 5.58 41%4h 19 535 239 116.67 116.68 116.67 116.55 12 -1.9 6.41 69%3t 19 569 240 111.23 111.27 3.7 0.5 111.27 111.14 13 -1.9 6.91 89%4t 20 75 16 118.84 118.84 -1.1 -0.2 118.83 118.70 13 -1.8 7.10 61%3t 20 301 223 110.79 110.80 5.5 0.7 110.84 110.71 13 -1.7 7.66 97%3t 21 995 245 110.64 110.65 110.66 110.57 9 -1.1 8.39 99%DV01Free float(%)24-Oct-11 5387 1701 Cover Ratio 3.17 Avg discount 0.4 Avg Duration 5.71Bond (25y+)OffersReceivedOffersAcceptedWAAPHighest AAPDiscount(cents)Discount(bp)14.45 DMODMO Close(t-1)Change onDay (cents)Change onDay (bp)4t 38 132 132 124.25 124.65 -56.0 -3.4 123.69 123.15 54 -3.3 16.55 66%4q 39 356 298 114.54 115.05 -12.0 -0.7 114.42 113.89 53 -3.1 17.34 82%4q 40 757 711 114.36 114.40 4.0 0.2 114.40 113.82 58 -3.3 17.62 93%4h 42 134 134 119.82 121.05 36.0 2.0 120.18 119.52 66 -3.6 18.12 88%4q 46 78 78 116.03 116.30 3.0 0.2 116.06 115.31 75 -3.8 19.56 84%4q 49 154 154 116.10 116.90 35.0 1.7 116.45 115.52 93 -4.6 20.39 85%3t 52 106 106 105.73 105.92 10.0 0.5 105.83 104.92 91 -4.2 21.81 85%4q 55 36 36 117.04 117.05 27.0 1.2 117.31 116.11 120 -5.5 21.84 71%4 60 51 51 112.23 112.89 -24.0 -1.0 111.99 110.66 133 -5.8 23.05 85%DV01Free float(%)25-Oct-11 1804 1700 Cover Ratio 1.06 Avg discount 0.1 Avg Duration 18.38Bond (10-25y)OffersReceivedOffersAcceptedWAAPHighest AAPDiscount(cents)Discount(bp)14.45 DMODMO Close(t-1)Change onDay (cents)Change onDay (bp)4 22 1,648 484 113.56 113.58 3.6 0.4 113.60 113.41 19 -2.2 8.67 52%5 25 559 320 124.86 124.89 5.9 0.6 124.92 124.67 25 -2.4 10.26 57%4q 27 403 118 116.00 116.00 4.0 0.3 116.04 115.81 23 -1.9 12.01 54%6 28 459 144 140.29 140.34 5.0 0.4 140.34 140.08 26 -2.2 11.77 52%4t 30 384 237 123.52 123.64 11.0 0.8 123.63 123.30 33 -2.5 13.27 64%4q 32 313 134 115.72 115.74 4.1 0.3 115.76 115.42 34 -2.4 14.24 53%4h 34 356 141 119.71 119.75 1.3 0.1 119.72 119.30 42 -2.8 15.20 82%4q 36 480 122 115.95 116.03 7.6 0.5 116.03 115.62 41 -2.6 16.01 86%DV01Free float(%)26-Oct-11 4604 1700 Cover Ratio 2.71 Avg discount 0.5 Avg Duration 11.61Source: BNP ParibasShahid Ladha 27 October 2011Market Mover49www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchJGBs: No Impact from the BoJ’s Decision• The BoJ increased the size of the AssetPurchase Program by JPY 5trn, aiming at JGBpurchases.• STRATEGY: Take profit in the JGB 2y/5y/10ybutterfly.No impactThe BoJ has increased the size of the Asset PurchaseProgram by JPY 5trn to JPY 55trn, directed at JGBpurchases. However, the decision disappointed somemarket participants, who had strongly expected anextension of maturities of JGBs subject to purchases.The USDJPY exchange rate dropped to a new post-WWII low of 75.73 on 26 October, which resulted in theadditional easing measures by the BoJ. However,aggressive action was difficult this time, with the policyrate already at just 0–10bp, and a further increase inoutright JGB purchases impossible without violatingthe BoJ's self-imposed ‘banknote rule’ – which statesthat the central bank's long-term JGB holdings shouldnot exceed the total value of banknotes in circulation –in the relatively near term. As the JGB buyingoperation via the Asset Purchase Program is notincluded in the banknote rule, the BoJ’s decision toincrease its size was widely expected by the market. Inthe future, the BoJ may consider the extension ofmaturities of JGBs to 3-5 years from 2 years, or couldcut its Complementary Deposit Facility (excessreserves) rate. However, while these measures mayhave some success in lowering short-end interest rates,we see little prospect of them reversing the yen's rise.The BoJ’s latest Outlook for Economic Activity andPrices still expects a gradual economic expansiondespite a lowering of growth forecasts. CPI inflationforecasts have also been lowered to around zero toreflect the impact of August's index rebasing, leavingmarket participants with a strong expectation thatmonetary policy will remain highly accommodative.Range boundThe 10y yield continues to hover around 1% as theJGB market remains extremely insensitive toexogenous factors such as the European sovereigndebt crisis and fluctuations in US Treasury yields.However, we expect JGB market participants to moveout of wait-and-see mode now that the second half ofFY 2011 is well under way. If US Treasury yields risefurther, we may see JGB yields follow the trend. In themeantime, we recommend taking profit in the JGB2y/5y/10y butterfly (long 5y) which has a bullish bias,Chart 1: Asset Purchase Program (JPY trn)Program sizebeforethe increaseAmount ofincreaseProgram sizeafterthe increaseTotal size About 50 About +5 About 55Asset purchases 15.0 +5.0 20.0JGB* 4.0 +5.0 9.0T-Bill 4.5 -- 4.5CP 2.1 -- 2.1CB 2.9 -- 2.9ETFs 1.4 -- 1.4J-REITs 0.11 -- 0.11Fixed-rate funds-supplying operationagainst pooled collateral35.0 -- 35.03-month term 20.0 -- 20.06-month term 15.0 -- 15.0* = In addition to purchases under the Asset Purchase Program, the Bankregularly purchases JGBs at the pace of JPY 21.6trn per annum.Source: BoJ, BNP ParibasSell JPY →←Buy JPY543210-1-2-3Chart 2: USD/JPY and FX Intervention(¥trn)95 97 99 01 03 05 07 09 11 CYSource: MoF, BNP Paribas8070605040FX intervention¥4.5trn (4-Aug)USD/JPY(RHS)Chart 3: Banknote Rule (JPY trn)30CY 99 01 03 05 07 09 11Source: BoJ, BNP ParibasBoJ notes in circulationCurrent depo.(RHS)QuantitativeeasingBoJ holdingsof JGBs150140130120110100and performed well after our recommendation ahead ofthe 5y auction last week. Also, today’s BoJ decisionmay support the 2y sector, against our position.908070403020100Tomohisa Fujiki 27 October 2011Market Mover50www.GlobalMarkets.bnpparibas.com

Global Inflation WatchEurozone inflation seen easing in OctoberChart 1: Eurozone Inflation, Main ContributorsWe forecast eurozone October flash inflation (dueout Monday 31 October) at 2.9% y/y, down slightlyfrom the level of 2.95% reached in September. Thedata already published support our view that theindex rose by 0.2% m/m.3.02.52.01.5EnergyOctober’s preliminary inflation rate in Germany wasbelow market expectations at 0.0% m/m. Theexception came from the region of North-RhineWestphalia Land where the scrapping of student feespushed the regional CPI down 0.3% m/m. Withoutthis, national CPI would have been stronger. Thepreliminary CPI inflation slowed to 2.5% y/y, from2.6% in September. Meanwhile, HICP inflationprinted 2.8% y/y, down from 2.9%.Belgian’s CPI rose 0.15% m/m in October leavingthe annual inflation rate unchanged at 3.6% y/y. Thiswas in line with our forecast (no consensus forecastwas available). Belgian inflation is very sensitive toenergy prices and much more volatile than theeurozone average (Chart 2). When the base effect onenergy declines throughout the winter, Belgianinflation will converge with the eurozone average.Spanish preliminary HICP inflation, due on Friday28, is forecast to fall slightly in October to 2.9% y/yfrom September’s 3.0%. This is consistent with ourglobal view that inflation should start to ease indeveloped markets in October or November,because of a less adverse base effect on energy anddue to the global economic slowdown. Exceptionsremain possible, especially where tax hikes hitconsumers.The Italian CPI, due out on the same day as theeurozone flash estimate, is expected to print 3.1%y/y. September’s VAT increase was not entirelycaptured in September’s price index, the remainingimpact should appear in October’s data. Uncertaintyabout how much of the tax hike will be passed on toconsumers remains high: the weakness of economicactivity and particularly private consumption shouldcap price increases. Retailers, manufacturers andproviders of services will bear part of the fiscalburden through lower profit margins.1.00.50.0-0.5FoodCore01/10 07/10 01/11 07/11Source: Eurostat, BNP ParibasChart 2: Belgian versus Eurozone Inflation (% y/y)654CPI Belgium321HICP Eurozone0-1-206 07 08 09 10 11Source: Reuters EcoWin ProChart 3: Inflation Rates in Spain and Italy (% y/y)6Spain5432Italy10-1-205 06 07 08 09 10 11Source: Reuters EcoWin ProLuigi Speranza/Gizem Kara/Dominique Barbet 27 October 2011Market Mover51www.GlobalMarkets.bnpparibas.com

Table 1: BNP Paribas' Inflation ForecastsEurozoneFranceUSHeadline HICPEx-tobacco HICPHeadline CPIEx-tobacco CPICPI Urban SA CPI Urban NSAIndex % 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/y2010 109.8 - 1.6 109.5 - 1.5 121.1 - 1.5 119.8 - 1.5 218.1 - 1.6 218.1 - 1.62011 (1) 112.8 - 2.7 112.4 - 2.6 123.6 - 2.1 122.1 - 2.0 225.0 - 3.2 225.0 - 3.22012 (1) 114.8 - 1.8 114.3 - 1.7 125.7 - 1.6 124.0 - 1.6 229.0 - 1.8 229.0 - 1.8Q1 2011 111.3 - 2.5 110.9 - 2.4 122.5 - 1.8 121.0 - 1.7 222.3 - 2.2 221.7 - 2.1Q2 2011 113.1 - 2.8 112.8 - 2.7 123.9 - 2.1 122.4 - 2.0 224.5 - 3.3 225.5 - 3.4Q3 2011 (1) 112.8 - 2.7 112.4 - 2.6 123.8 - 2.1 122.3 - 2.1 226.2 - 3.8 226.5 - 3.8Q4 2011 (1) 113.9 - 2.8 113.5 - 2.7 124.3 - 2.2 122.8 - 2.1 226.9 - 3.4 226.4 - 3.4Q1 2012 (1) 113.8 - 2.3 113.3 - 2.2 124.6 - 1.7 123.0 - 1.6 227.5 - 2.3 226.9 - 2.3Q2 2012 (1) 115.1 - 1.7 114.6 - 1.6 125.5 - 1.3 123.9 - 1.3 228.5 - 1.8 229.5 - 1.8Q3 2012 (1) 114.7 - 1.7 114.2 - 1.6 126.0 - 1.8 124.3 - 1.6 229.6 - 1.5 229.8 - 1.5Q4 2012 (1) 115.7 - 1.5 115.1 - 1.4 126.5 - 1.8 124.9 - 1.7 230.6 - 1.6 230.0 - 1.6Jan 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 1.6Feb 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 2.1Mar 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 2.7Apr 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 3.2May 11 113.1 0.0 2.7 112.75 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 3.6Jun 11 113.1 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 3.6Jul 11 112.4 -0.6 2.5 112.03 -0.6 2.5 123.4 -0.4 1.9 121.94 -0.4 1.9 225.4 0.5 3.6 225.92 0.1 3.6Aug 11 112.6 0.2 2.5 112.23 0.2 2.5 124.0 0.5 2.2 122.59 0.5 2.2 226.3 0.4 3.8 226.55 0.3 3.8Sep 11 113.5 0.8 3.0 113.08 0.8 2.9 124.0 -0.1 2.2 122.49 -0.1 2.2 227.0 0.3 3.9 226.89 0.2 3.9Oct 11 (1) 113.7 0.2 2.9 113.34 0.2 2.9 124.2 0.2 2.3 122.64 0.1 2.2 226.7 -0.1 3.5 226.42 -0.2 3.5Nov 11 (1) 113.8 0.1 2.9 113.38 0.0 2.8 124.3 0.0 2.3 122.68 0.0 2.2 227.0 0.1 3.5 226.52 0.0 3.5Dec 11 (1) 114.2 0.3 2.6 113.73 0.3 2.5 124.6 0.2 2.0 122.97 0.2 2.0 227.2 0.1 3.2 226.13 -0.2 3.2Jan 12 (1) 113.1 -0.9 2.4 112.65 -0.9 2.3 124.3 -0.2 2.0 122.67 -0.2 1.9 227.2 0.0 2.8 226.35 0.1 2.8Feb 12 (1) 113.5 0.4 2.3 113.07 0.4 2.2 124.5 0.2 1.8 122.91 0.2 1.7 227.4 0.1 2.3 226.45 0.0 2.3Mar 12 (1) 114.8 1.1 2.0 114.30 1.1 2.0 125.1 0.5 1.4 123.50 0.5 1.3 227.8 0.2 1.9 227.79 0.6 1.9Apr 12 (1) 114.9 0.1 1.6 114.41 0.1 1.5 125.3 0.2 1.3 123.74 0.2 1.2 228.1 0.1 1.6 228.60 0.4 1.6May 12 (1) 115.1 0.2 1.8 114.66 0.2 1.7 125.6 0.2 1.4 123.98 0.2 1.3 228.5 0.2 1.7 229.70 0.5 1.7Jun 12 (1) 115.2 0.0 1.8 114.68 0.0 1.7 125.7 0.1 1.4 124.10 0.1 1.3 228.9 0.1 2.0 230.31 0.3 2.0UpdatedNextReleaseOct 14Oct Flash HICP (Oct 31)Oct 14Oct CPI (Nov 10)Oct 19Oct CPI (Nov 16)Source: BNP Paribas, (1) ForecastsChart 4: Eurozone HICP (% y/y)654321Chart 5: US CPICPI % y/y - Contribution to GrowthEnergyFood0-1Core (ex-food & energy)-2Source: Reuters EcoWin ProSeptember’s sharp rebound in inflation was mainly due tomethodological factors. The contribution of energy to headlineinflation was 1.3pp in September. However, this should declinesharply from October onwards.-3Jan May Sep Jan May Sep Jan May Sep Jan May08 09 10 11Source: Reuters EcoWin ProThe core CPI gained only 0.05% m/m in September thanks to pricefalls on cars and apparel. However, core inflation has risen to2.0% y/y, and should continue to rise until the year-end, thuscontributing more to headline inflation. However, the expecteddecline in the energy contribution should outweigh thisdevelopment.Luigi Speranza/Gizem Kara/Dominique Barbet 27 October 2011Market Mover52www.GlobalMarkets.bnpparibas.com

Table 2: BNP Paribas' Inflation ForecastsJapanUKSwedenCore CPI SACore CPI NSAHeadline CPIRPICPICPIFIndex % 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/y2010 100.0 - -1.0 100.0 - -1.0 114.5 - 3.3 223.6 - 4.6 302.5 - 1.2 194.6 - 2.02011 (1) 99.8 - -0.2 99.8 - -0.2 119.6 - 4.5 235.3 - 5.3 311.5 - 3.0 197.4 - 1.52012 (1) 99.5 - -0.3 99.5 - -0.3 122.7 - 2.4 243.7 - 3.6 316.0 - 1.4 200.0 - 1.3Q1 2011 99.8 - -0.8 99.5 - -0.8 117.6 - 4.1 230.9 - 5.3 308.1 - 2.6 196.1 - 1.4Q2 2011 99.9 - -0.3 100.0 - -0.3 119.4 - 4.4 234.9 - 5.1 311.6 - 3.3 197.5 - 1.7Q3 2011 (1) 99.7 - 0.2 99.9 - 0.2 120.1 - 4.7 236.2 - 5.2 311.9 - 3.3 197.2 - 1.6Q4 2011 (1) 99.6 - -0.1 99.7 - -0.1 121.4 - 4.8 239.1 - 5.3 314.6 - 2.8 198.9 - 1.3Q1 2012 (1) 99.4 - -0.4 99.1 - -0.4 121.6 - 3.4 240.3 - 4.1 0.0 - 0.0 0.0 - 0.0Q2 2012 (1) 99.5 - -0.4 99.5 - -0.4 122.7 - 2.8 243.7 - 3.7 0.0 - 0.0 0.0 - 0.0Q3 2012 (1) 99.4 - -0.3 99.5 - -0.3 122.8 - 2.3 244.3 - 3.4 0.0 - 0.0 0.0 - 0.0Q4 2012 (1) 99.5 - -0.1 99.6 - -0.1 123.8 - 2.0 246.4 - 3.1 0.0 - 0.0 0.0 - 0.0Jul 10 99.7 -0.3 -1.0 99.7 -0.4 -1.1 114.3 -0.2 3.1 223.6 -0.2 4.8 302.0 -0.3 1.1 193.7 -0.3 1.7Aug 10 99.5 -0.2 -1.1 99.7 0.0 -1.1 114.9 0.5 3.1 224.5 0.4 4.7 302.1 0.0 0.9 193.7 0.0 1.5Sep 10 99.4 -0.1 -1.2 99.7 0.0 -1.2 114.9 0.0 3.1 225.3 0.4 4.6 304.6 0.8 1.4 195.1 0.7 1.8Oct 10 99.7 0.3 -0.8 100.0 0.3 -0.8 115.2 0.3 3.2 225.8 0.2 4.5 305.6 0.3 1.5 195.7 0.3 1.8Nov 10 99.7 0.0 -0.8 99.8 -0.2 -0.8 115.6 0.4 3.3 226.8 0.4 4.7 306.6 0.3 1.8 196.2 0.2 1.9Dec 10 99.8 0.1 -0.8 99.7 -0.1 -0.8 116.8 1.0 3.7 228.4 0.7 4.8 308.7 0.7 2.3 197.3 0.6 2.3Jan 11 99.8 0.0 -0.8 99.4 -0.3 -0.8 116.9 0.1 4.0 229.0 0.3 5.1 306.2 -0.5 2.5 195.2 -1.1 1.4Feb 11 99.8 0.0 -0.9 99.4 0.0 -0.8 117.8 0.7 4.4 231.3 1.0 5.5 308.0 0.6 2.5 196.2 0.5 1.3Mar 11 99.8 0.0 -0.7 99.7 0.3 -0.7 118.1 0.3 4.0 232.5 0.5 5.3 310.1 0.7 2.9 196.9 0.4 1.5Apr 11 100.0 0.2 -0.3 100.0 0.3 -0.3 119.3 1.0 4.5 234.4 0.8 5.2 311.4 0.4 3.3 197.6 0.4 1.8May 11 100.0 0.0 -0.2 100.1 0.1 -0.2 119.5 0.2 4.5 235.2 0.3 5.2 312.0 0.2 3.3 197.8 0.1 1.7Jun 11 99.7 -0.3 -0.3 99.8 -0.3 -0.3 119.4 -0.1 4.2 235.2 0.0 5.0 311.3 -0.2 3.1 197.2 -0.3 1.5Jul 11 99.8 0.1 0.1 99.8 0.0 0.1 119.4 0.0 4.4 234.7 -0.2 5.0 311.1 0.0 3.3 196.8 -0.2 1.6Aug 11 99.8 0.0 0.3 99.9 0.1 0.2 120.1 0.6 4.5 236.1 0.6 5.2 311.2 0.0 3.4 196.8 0.0 1.6Sep 11 (1) 99.6 -0.2 0.2 99.9 0.0 0.2 120.9 0.6 5.2 237.9 0.8 5.6 313.4 0.7 3.2 198.1 0.7 1.5Oct 11 (1) 99.6 0.0 -0.1 99.9 0.0 -0.1 121.0 0.1 5.1 238.3 0.2 5.5 314.6 0.4 3.3 198.9 0.4 1.6Nov 11 (1) 99.6 0.0 -0.1 99.7 -0.2 -0.1 121.3 0.2 4.9 239.1 0.3 5.4 314.6 0.0 3.0 198.9 0.0 1.4Dec 11 (1) 99.6 0.0 -0.2 99.5 -0.2 -0.2 121.9 0.5 4.4 240.0 0.4 5.1 314.6 0.0 2.2 199.0 0.0 0.8UpdatedNextReleaseSep 30Sep CPI (Oct 28)Oct 19Oct CPI (Nov 15)Oct 11Oct CPI (Nov 10)Source: BNP Paribas, (1) ForecastsChart 6: Japanese CPI (% y/y)Chart 7: UK CPI (% y/y)Source: Reuters EcoWin ProWe expect CPI inflation to return to negative territory as early asOctober, as two special factors that are boosting the annual changeby a combined 0.3pp – a tobacco tax hike and higher non-lifeinsurance premiums – will fall out of the annual comparison.Source: Reuters EcoWin Pro, BNP ParibasCPI inflation reached its highest level in three years at 5.2% y/y inSeptember, exceeding expectations. We forecast inflation will starteasing in October, with the decline gaining pace over the followingmonths, when the energy contribution diminishes and the baseeffect due to VAT disappears. This will change the inflation pictureand explains why the MPC unanimously approved quantitativeeasing.Luigi Speranza/Gizem Kara/Dominique Barbet 27 October 2011Market Mover53www.GlobalMarkets.bnpparibas.com

Table 3: BNP Paribas' Inflation ForecastsCanada Norway AustraliaCPI Core CPI Headline CPI CoreCPICoreIndex % 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/y2010 116.5 1.8 115.6 1.7 128.8 2.4 120.1 1.4 172.6 2.8 - 2.82011 (1) 119.9 3.0 117.6 1.8 130.5 1.3 121.4 1.1 178.7 3.5 - 2.62012 (1) 123.2 2.7 120.1 2.1 132.4 1.5 123.6 1.8 183.5 2.7 - 2.6Q1 2011 119.4 3.3 2.0 117.0 0.7 1.6 130.2 0.6 1.4 120.3 -0.2 0.8 176.7 1.6 3.3 - - 2.4Q2 2011 119.8 5.6 2.5 117.1 3.4 1.5 130.9 0.6 1.4 121.5 1.0 1.0 178.3 0.9 3.6 - - 2.8Q3 2011 120.6 0.8 2.8 118.4 1.6 1.6 130.1 -0.7 1.5 121.2 -0.3 1.1 179.4 0.6 3.5 - - 2.5Q4 2011 (1) 121.1 2.2 3.0 118.9 3.2 1.8 130.7 0.5 1.0 122.6 1.1 1.7 180.2 0.4 3.6 - - 2.6Q1 2012 (1) 122.4 3.1 3.1 119.5 1.6 2.0 131.2 0.4 0.8 122.6 0.0 1.9 181.5 0.7 2.7 - - 2.5Q2 2012 (1) 123.6 4.8 2.9 119.8 1.7 2.1 132.5 1.0 1.2 123.8 1.0 1.9 182.4 0.5 2.3 - - 2.4Q3 2012 (1) 123.6 1.2 2.9 120.6 2.3 2.2 132.5 0.0 1.9 123.6 -0.2 2.0 184.3 1.1 2.8 - - 2.8Q4 2012 (1) 124.2 0.8 2.7 121.1 1.9 2.1 133.4 0.7 2.1 124.5 0.7 1.6 185.5 0.6 2.9 - - 2.8UpdatedNextReleaseOct 21Oct CPI (Nov 18)Oct 10Oct CPI (Nov 10)Oct 26Q4 CPI (Jan 25)Source: BNP Paribas, (1) ForecastsChart 8: Canadian Headline vs. Core CPI (% y/y)4.03.53.02.52.01.51.00.50.0-0.5-1.0BoC CPI Core (% y/y)BoC Mid-Point Inflation TargetCPI Total (% y/y)04 05 06 07 08 09 10 11Source: Reuters EcoWin Pro, BNP ParibasWage pressures appear subdued, suggesting that underlyinginflation will soon move back within the BoC's target range.7.06.05.04.03.02.01.00.0(% y/y)Chart 9: Australian CPI (% y/y)Headline CPIUnderlying CPIBNPPFcast-1.0Q193 Q195 Q197 Q199 Q101 Q103 Q105 Q107 Q109 Q111 Q113Source: Reuters EcoWin Pro, BNP ParibasUnderlying inflation is forecast to tick slightly higher in Q4, from2.5% y/y to 2.6%. This should push headline inflation 0.1pp up to3.6% y/y.CPI Data Calendar for the Coming WeekDay GMT Economy Indicator Previous BNPP F’cast ConsensusFri 28/10 23:30 Japan CPI National y/y : Sep 0.2% 0.0% 0.1%23:30 Core CPI National y/y : Sep 0.2% 0.2% 0.2%23:30 CPI Tokyo y/y : Oct -0.2% -0.5% -0.5%23:30 Core CPI Tokyo y/y : Oct -0.1% -0.4% -0.4%07:00 Spain HICP Flash y/y : Oct 3.0% 2.9% 2.9%Mon 31/10 10:00 Eurozone HICP (Flash) y/y : Oct 3.0% 2.9% 2.8%10:00 Italy CPI (NIC, Prel) m/m : Oct 0.0% 0.3% n/a10:00 CPI (NIC, Prel) y/y : Oct 3.0% 3.1% n/a10:00 HICP (Prel) m/m : Oct 2.0% 0.8% n/a10:00 HICP (Prel) y/y : Oct 3.6% 3.6% n/aRelease dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revisionSource: BNP ParibasLuigi Speranza/Gizem Kara/Dominique Barbet 27 October 2011Market Mover54www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchInflation: Sentiment to Support Breakevens• EU Summit and carry to support front-endBE• Linker supply is very well received• Consider long 5y5y USD/EUR BE fwd spreadChart 1: Risky Assets Supporting BreakevensAsset markets’ very positive response to theoutcome of the EU Summit will support breakevens.Still, details remain uncertain, especially over themechanics of EFSF leverage, and there is work to bedone in resolving the crisis. Nonetheless, relativelydepressed breakevens offer tactical value here. Thecarry environment remains very positive in the UKand Europe, while it is flattish for FRF and negativein the US. Chart 1 shows 2y cash breakevens acrossregions and we favour front-end UK, then EURbreakevens, while FRF continues to look rich,especially at 2/3m forwards. Still, the most recentdata from Germany – preliminary HICP was flatmonth on month versus +0.1% expected – may resultin a slight downward revision to October HICPforecasts from our economists. Despite a largeincrease in crude (but not gasoline) inventories, oil isback to USD 92/bbl – above its 90.52 neckline,technically opening up a potential move to 99.20 first,then the 106 target area. Consequently, the recoveryin front-end USD breakevens is likely to continue. Wecontinue to favour breakeven flatteners in EUR, whilewe find the inflation curve too steep at 10y+maturities in the UK.Beyond the European political sphere, the inflationmarket has been focused on supply. Attractivevaluations and structural forces saw the largest bookever for a linker syndication. The new 50y indexlinkedbenchmark, UKTi-62, saw GBP 10bn of ordersin the 90 minutes it was open. The EUR 750mnBTPei-21 was also very strong, coming with apremium of 75 cents and bid/cover of 2.13. Improvingsentiment after the European Summit will allowBTPei breakevens to move closer to fair value, fromcheap levels.Source: BNP Paribas28026024022020018016014012010080Chart 2 Carry and Value Favour Front-EndUK/EUR Breakevens versus FRF2602402202001801601401201008060TIIJUL13 Breakeven Lhs1UKTI13 Breakeven Rhs240Jan-11 May-11 Aug-11 Nov-11 Feb-12Source: BNP ParibasBOBLEI13 BreakevenLhs2OATI13 Breakeven Rhs1Chart 3: 5y5y USD/EUR BE Forward Spread(cash and swap)2402202001801601401201008060350340330320310300290280270260250In Chart 3, we show 5y5y USD/EUR breakevenforward spread. Both are very volatile, quite rangeboundand close to the bottom of the range. With 10yTIPS supply in November and potential support forthe cash product in Europe after the EU Summit, weprefer playing the spread in swap. Next week will seethe November FOMC meeting, which could open thedoor for further QE, especially after weak consumerconfidence and the Richmond survey. This wouldSource: BNP Paribassupport higher 5y5y inflation forwards in the US andversus the EUR, given the more accommodative USmonetary policy stance.Shahid Ladha / Herve Cros 27 October 2011Market Mover55www.GlobalMarkets.bnpparibas.com

TIPS: A Pause Before a New Jump?This section is classified as non-objective research• Heading into month-end, TIPS have thus farturned in a stellar performance, beatingmatched duration USTs by approximately 1.98%since 1 October. They are likely to pause atcurrent levels.• The European bailout’s initial details are in,but the market still faces choppiness in themonths ahead.• Energy markets have provided a bit ofturbulence lately, leaving gasoline, crude, andfront-end breakevens a bit fractured.• We look at the efficacy of our 10s-30sbreakeven steepener thus far and maintain it forthe time being.• The Fed’s schedule will be out near monthend,and we look at the sales as anotherliquidity generating event for the TIPS market.TIPS have had a stellar month, thus far, with the CitiInflation Linked Bonds Index beating durationequivalent Treasuries by nearly 1.98% through 25October (before the European news). Rounding outthe month should still leave TIPS ahead, but whatremains to be seen is whether such a margin willshrink in the coming days. We doubt it, as the lastday of the month is likely to bring in more extensionneeds with a very large duration extension of +0.18yrs according to BNP estimates.The big event in the week ahead is the FOMCmeeting, which has the potential to move the nominaland TIPS market materially. Our economists believethat the Fed will introduce expanded communicationlanguage at this event, which will potentially set themup for an eventual bout of further quantitative easing.Much will depend on whether and what levels theFed ends up targeting. A 3% headline inflation targetwould certainly be bullish, but a lesser level or arange may leave a more mixed reaction. We wouldlean bullish on TIPS on the introduction of anytargeting communication. The damage from recentEuropean uncertainty raises our conviction that theFed would like to head off any economic weaknessat the pass, all of which is positive for the TIPSmarket. The actual mention of employment as atarget should be accretive from a sentimentperspective, even if it does highlight a known Fedobjective.340330320310300290280270260Chart 1: 5yr forward 5yr Inflation Swap25001/11 02/1103/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11Source: BNP ParibasChart 2: Front-end breakevens have been a bitsluggish in following WTI’s rally1.5%1.4%1.3%1.2%1.1%1.0%0.9%1YR BECrude0.8%10/1/11 10/8/11 10/15/11 10/22/11Source: BNP Paribas, BloombergChart 3: 10-30 Breakevens curve runs into someheadwinds45352515501/11 02/1103/11 04/11 05/11 06/11 07/11 08/11 09/11 10/11Source: BNP Paribas10s-30s BreakevensThe second element, unemployment targeting, mayhave a more negative impact on sentiment if it servesto codify a higher NAIRU. If participants, perceive anunemployment level that is too high, they may beginto suspect that the Fed has significantly revised up$93$91$89$87$85$83$81$79$77$75Aaron Kohli 27 October 2011Market Mover56www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchits long-run NAIRU, and some disappointment couldresult from such inferences. Still, we believe that tobe a very unlikely outcome and are bullish TIPSheading into the event. The direct result on TIPSbreakevens should also be a continued steepening ofthe curve at the long-end and a potential selloff inUST nominal yields at the long-end along with somefurther “risk-on” response.Looking now at the front-end of the TIPS curve, it hasbeen a bit of an enigma of late, responding moreslowly to WTI oil prices than expected, especiallygiven the recent upswing in WTI crude prices (seechart) which have given the price moves a decidedlypositive technical character. This is likely due to areversal in the Brent WTI crack-spread and thecloser tracking of gasoline with Brent crude ratherthan WTI. Additionally, the backwardation of the WTIcurve after several months in contango cannot betaken as a bullish sign according to our energystrategists, given the temporary and technical natureof the correction and the fact that it could be prone toquick reversal. Front-end breakevens could simplybe anticipating this correction and paying less heedto WTI prices than they might have during priorperiods. We’ll be watching this spread closely,though our view is that for the moment, the structuralchange in the WTI curve is temporary. Our front-endbreakeven steepener with an energy hedge is still upslightly with gasoline prices down since initiation.Turning now to another recent trade idea, we take alook at our 10s-30s BE steepener. After a sharpmove in our favour, the trade has run into sometemporary headwinds, chopping sideways for most ofthe week. From a technicals perspective, the 200-day moving average at 21.5bp (and falling) remainsan impediment to the curve’s further steepening.Leaving that aside for the moment, however, webelieve that 10s-30s still offers the best value(especially heading into month-end), but it also has agreater amount of volatility than the 20s-30s BEsteepener. In fact, the volatility over the last year hasbeen roughly double in the 10s-30s vs the 20s-30sBE curves, which isn’t unexpected. Those wishing toprotect profits in the 10s-30s may switch to the 20s-30s BE steepener as a way to safeguard gains whileretaining the same basic curve view. 20s-30s mayalso offer a closer psychological floor, with the 0bound of the curve only about 3.5bp away. Thecaveat to this, however, is the Fed’s fondness for the20yr sector, which sports very high index ratios andmay be a quick way for the central bank to introducea much greater amount of cash into the system atbuybacks.Another indicator worth watching is 5yr forward 5yrzero coupon inflation swaps, which have retracedfrom their recent lows near 256bp and bounded closeto current levels of 286bp. Here again, we believe arespite might be in the offing, given the sharpness ofthe recent move, but the general trend should bemaintained, and we will likely move higher. This tradeallows another potential way to play the expectedsteepening of the breakeven curve coming out of theFOMC meeting next week.The schedule for November’s purchases and saleswill be released near month-end, and we suspectthat the Fed will once again choose to place thepurchase early in the month and the sell-back closerto the CPI fixing date. We believe this stems from theFed’s desire to schedule the sale as close to a highactivity point for the front-end as possible to allow formore liquidity in the market and perhaps betterdemand. Such a placement should suffice, however,the moving of this sale further away from the CPIfixing is also unlikely to significantly impact demandwhile creating another period of good trade executionfor TIPS. Supply creates its own demand, and a saleoperation by the Fed, as long as it doesn’t coincidewith another major headline event (G20 summit,FOMC meeting, etc) should retain significant demandand provide a more consistent number of liquidityevents in the month rather than focusing most of themonthly activity into a single week. The first TIPSevent saw aggressive buyers, and with CPI only aweek later, we’re likely to see similarly solid demand.We caution that if certain front-end TIPS continue torichen (April and July 12s specifically), they maybecome targets for sale at the next operation. We’lltake another look at those securities once we knowthe schedule and as we get closer to the date. Thebuyback in TIPS should still remain early in themonth, and the Fed is likely to go after its oldfavourites again (April 28s, Apr 29s and Feb 32s)while excluding the July 21s (they now own a smallamount from a SOMA auction purchase).Aaron Kohli 27 October 2011Market Mover57www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchCarry TablePricing Date27-Oct-11Term 1Benchmark CarryTerm 23m6m12mSett. Date28-Oct-11 01-Dec-11 01-Jan-1230-Jan-12 30-Apr-12 29-Oct-12Yield BE Real BE Real BE Real BE Real BE Real BEShort-endOATei Jul-12 -2.12% 2.88% 75.8 79.0 80.4 87.7 50.5 60.6 -367.6 -334.4OATI Jul-13 -0.60% 1.53% -13.1 -12.9 -14.9 -14.4 -21.4 -21.5 -38.1 -40.1 2.5 2.5TIPS Jul-12 -1.19% 1.34% 10.6 10.2 -47.8 -48.5 -70.1 -70.7 -333.1 -331.7UKTi Aug-13 -2.10% 2.63% -3.4 -3.0 3.9 4.6 12.8 14.4 9.5 14.3 38.4 64.55yBUNDEI Apr-16 -0.42% 1.55% 15.1 14.8 18.0 17.3 16.6 15.4 -0.5 -3.8 14.7 7.9BTANI Jul-16 0.35% 1.55% -3.0 -4.8 -1.6 -5.5 -1.7 -7.9 0.3 -13.5 26.5 26.5TIPS Apr-16 -0.77% 1.73% 2.4 0.5 -4.2 -7.8 -5.0 -10.3 -12.1 -22.8 14.5 -8.2UKTi Nov-17 -0.93% 2.63% 12.0 10.1 12.8 9.1 16.5 11.1 20.2 9.4 39.0 15.7JGBI-4 June-15 0.61% -0.36% -5.7 -6.1 2.8 2.0 0.7 -0.3 -21.3 -23.4 3.0 -1.610yOATEI Jul-22 1.22% 1.80% 7.8 5.7 10.3 6.0 11.2 4.3 8.4 -5.9 23.8 -6.2OATI Jul-19 0.87% 1.82% -1.3 -3.5 0.2 -4.4 0.8 -6.4 4.0 -11.2 23.5 23.5TIPS Jan-21 0.14% 2.00% 2.2 -0.2 -0.2 -4.8 0.3 -6.3 -0.2 -13.5 18.1 -9.1UKTi Nov-22 -0.02% 2.48% 7.8 5.7 9.0 5.0 11.8 6.0 16.2 4.6 30.9 6.9JGBI-16 June-18 0.93% -0.40% -9.5 -10.2 2.5 1.2 1.6 0.0 -8.8 -12.3 7.2 -0.230yOATei Jul-40 1.58% 2.25% 3.6 2.2 4.9 2.0 5.3 1.0 4.5 -4.5 11.7 -6.4OATI Jul-29 1.46% 2.23% -0.3 -2.2 0.8 -3.1 1.5 -4.5 4.2 -8.1 16.0 16.0TIPS Feb-41 0.98% 2.29% 1.2 -0.5 0.6 -2.7 1.0 -3.6 1.8 -7.4 10.3 -8.2UKTI Mar-40 0.42% 2.93% 3.2 1.7 3.8 0.9 5.0 0.9 6.9 -1.1 13.0 -3.2Short-endTerm 1 -> Term 2 Term 2 -> 3m3m -> 6m6m -> 12mOATei Jul-12 4.7 8.7 -29.5 -26.2 -418.2 -395.0 367.6 334.4OATI Jul-13 -1.8 -1.5 -7.0 -7.3 -16.6 -18.6 40.5 42.6TIPS Jul-12 -58.5 -58.7 -30.7 -30.8 -263.0 -261.0 333.1 331.7UKTi Aug-13 7.3 7.6 9.1 10.0 -3.3 -0.1 28.8 50.25yBUNDEI Apr-16 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0BTANI Jul-16 2.9 2.5 -1.3 -1.9 -17.2 -19.2 15.3 11.7TIPS Apr-16 1.4 -0.6 -0.3 -2.5 2.0 -5.6 26.2 39.9UKTi Nov-17 -6.6 -8.3 -1.7 -3.5 -7.1 -12.5 26.6 14.6JGBI-4 June-15 8.5 8.1 -1.8 -2.1 -22.0 -23.1 24.3 21.810yOATEI Jul-22 2.6 0.3 0.8 -1.6 -2.8 -10.2 15.4 -0.2OATI Jul-19 1.5 -0.9 0.4 -2.1 3.2 -4.9 19.5 34.7TIPS Jan-21 -2.4 -4.6 0.2 -2.2 -0.5 -7.2 18.3 4.4UKTi Nov-22 1.2 -0.7 3.0 0.9 4.3 -1.4 14.7 2.3JGBI-16 June-18 12.0 11.5 -0.6 -1.2 -10.4 -12.2 16.0 12.030yOATei Jul-40 1.3 -0.2 0.4 -1.0 -0.9 -5.5 7.2 -1.9OATI Jul-29 1.1 -0.8 0.6 -1.4 2.7 -3.6 11.8 24.2TIPS Feb-41 -0.6 -2.2 0.4 -1.2 0.8 -3.8 8.5 -0.8UKTI Mar-40 0.6 -0.7 1.3 -0.1 2.0 -2.0 6.1 -2.1Source: BNP ParibasShahid Ladha / Herve Cros 27 October 2011Market Mover58www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchTechnical Analysis – Interest Rates & CommoditiesBond & Short-Term Contracts• Europe 10y: Still a ST bottoming/up bias above 2.06 (H&S neckline) for 2.41 target• US 10y: Still a ST bottoming/up bias and a rising wave “5” scenario developing towards 2.40/47 targets• Short-term contracts h2: Toppish/weak bias on Euribor (2-top) and weak one on ED within MT falling channelEquities & Commodities• WTI (Cl1): Now up ST above falling channel and now 90.52 (2-dip neckline) for 99 area first and then 106 target• Equity markets: ST bottoming/up bias developing from Sept/Oct lows with new tops printedUS 10y: Breaks above ST falling channel/triangle call for 2.40/47 target MT Trend: Down Range: 2.20/2.40MT SCENARIO remains downThe breaks below 2.50 (LT triangle support),2.33 (2010 low) and then 2.03 (2008 low),above which we are back, strengthened theMT falling bias to reach MT 138.2% extensionof 2010/2011 rise at 1.78. Main risk if fallresumes and breaks below 1.93 (61.8%) toextend fall towards 1.67 low and then 1.50(LT falling channel support).1.93 2.72ALTERNATIVE SCENARIO…Rise extendsST bottoming/up bias is under way, sustainedby rising divergences on weekly RSI, andbreak above daily ST falling channel and nowST triangle for a move first towards 2.40/ 2.47(channel & triangle breaks target). Note alsoon daily chart the risk of a rising wave “5”scenario developing towards 2.47 target also.STRATEGYKeep short if you are above 2.06 for2.40/2.47. Could add above 2.26/2.29WTI: Break above ST falling channel & 2-dip neckline opened way up for 99 MT Trend: Weak Range: 90.0/98.0MT SCENARIO is still down83.57

This section is classified as non-objective researchGermany 10y: Bottoming/up ST above 2.06 (H&S neckline) for 2.41 target MT Trend: Down Range: 2.10/2.30MT SCENARIO is still slightly down1.64 2.57The sharp fall seen from the 3.50 top sent itsharply below 2.09 (2010 low), close to 1.55/1.57 (MT falling support line+ LT 138.2extension). Despite current ST bottoming biasand return above 2.09 (2010 low), MT bias isstill slightly down oriented but would berekindled by a move below 2.06 (H&Sneckline) initially and then 1.87 (61.8%).ALTERNATIVE SCENARIO...ST rise extendsThe ST bottoming/up bias since the breakabove ST falling wedge and 2.06 (invertedHead and Shoulders neckline) persists withrisk of developing a further ST rising biastowards 2.41 target, but now needs toovercome 2.25 top to strengthen rising bias.STRATEGYRe-entered short on 2.00/2.05, S/L 2.10 now,for 2.40UK 10y: ST bottoming/up bias after ST falling wedge break for 2.96 target MT Trend: Down Range: 2.48/2.70MT SCENARIO is still down orientedLarge down move below 2009 and 2010 lows2.18

This section is classified as non-objective researchTrade ReviewsOptions, Money Market and Bond Trades – Tactical & Strategic TradesThis page summarises our main tactical (T) and strategic (S) trades. The former focus on short-term horizons (a few weeks),allowing one to play any near-term corrections within a defined trend, while the latter rely on a medium-term assumed trend.For each trade we provide the expected target and the recommended stop loss.Current StrategiesYield CurvesEur 1y fwd 2y/5y/10y swap fly REC 1y fwd swap fly50% entered at 16.1 we would add the rest at 20bp. Observed fwd fly is still trading13.5bp above its fair value and the spot/fwd differential is very high.USD Box Spread : buy 6mth fwd vs 1y fwd BUY 2s10s . 6M-fwd vs 1Y-fwdFlattening implied from 6m- to 1y-fwd is too little compared to history, and positionhas little negative roll. Will tend to work in a selloff, and risk-reward lookscomparitively better compared to other bearish trades.LinkersUSD TIPS Swap BE : Long 10y Inflation swap Short TIPS BE 0.625% July 2021BUY . . 10yMarket is long TIPS and TIPS BE look rich vs swap, especially taking into accountlevel of stress on libor and upcoming 10y TIPS supplyMoney MarketsSell M5Z5M6 Eurodollar fly SELL M5Z5M6 . .Z5 looks quite cheap on the curve vs surrounding contracts (same goes for 4y1yswaps). On a fly, these points look almost at all-time cheap levels, and an addedfeature of the trade is its lack of directionality.May 2012 MPC gap PAY Sonia MPC . May 2012Position closed on 7th Oct at 0.4875. P&L: Eur +101k.Current* Targets Stop Entry10.0(T)0(S)33(S)7(T)0.49(S)2/3 23 16.1(26-Sep)30 -8 10(19-Jul)48 33 38.25(09-Sep)-3 16 9.5(21-Sep).53 .35 .43(11-Aug)OptionsZ1 Euribor 99.50 Call BUY Euribor 99.50 Call Z11.0Nuke option on the ECB.(S)USD Swaption Payer 7y/10y15y Fly BUY . . 1y payer-257s10s15s (either spot or 1y-fwd) has rarely gone above the current level of 11bp in (S)its entire history, but using payers one can sell the fly at 17bp (due to vol advantage)if the trade is in the money at expiry.*Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps.10 0 1(10-Aug)300 -150 0(14-Jun)Carry/ mthRisk**10K15KP/L(ccy/Bp)EUR+61kUSD-150K+1 40K USD-160k30k10KUSD+75KGBP+87.5k12.5K EUR0K1k USD-25kInterest Rate Strategy 27 October 2011Market Mover61www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchEURUSD: New Upside Risks• Our 1.50 2012 EURUSD forecast remainsintact• FOMC likely to drive next leg of the movehigher• Eurozone banking sector deleveraging entailsadditional upside euro risksRegular readers of our FX commentary will know thatour call for EURUSD to head to the 1.50 area next yearis predicated on a combination of alleviation (for thetime being at least) of a significant amount of currenteurozone stress based on a conclusive outcome fromthe latest machinations by eurozone policy makers andfurther policy easing from the Fed. We had originallycouched the Fed policy component of this viewexclusively in terms of a decision to launch QE3.However, it now seems possible that the dollar couldfall towards our targeted levels if potential upcomingchanges to the Fed's communications policy produce asignificant fall in yields in the belly of the Treasurycurve. See Chart 1. In particular, this might occur ifthe FOMC say that any move away from its ultra-lowrates policy will be tied to the achievement of someintermediate macro-economic policy objectives,notably the unemployment rate. Either way, weremain comfortable re-stating the 1.50 call.In recent weeks, some potentially significant newvariables have entered the EURUSD equation. Theserelate to firstly, the potential for repatriation flows backto the eurozone as European financial institutionsshrink their overseas balance sheets. This is partly inresponse to the increased costs (less so the reducedavailability) of dollar funding and hence the profitabilityof activities contingent on dollar funding. Secondly,and much less discussed, is the potential for a creditcrunch in Europe as banks attempt to scale back theirdomestic balance sheets, retreating from or reducingsome of their traditional lending activities. This couldbe partly motivated by an attempt to achieve highermandatory Tier 1 capital levels by shrinking thedenominator of the capital ratio calculation (and whichis also relevant to the shrinkage in overseas balancesheets) and partly because some area of bank lendingactivity may no longer be deemed sufficiently profitablein the context of a reduction in the higher-margincorporate and investment banking business thatcorporate lending is in some cases partly designed toattract. The regulatory and fiscal authorities mayattempt to thwart efforts by banks to achieve highercapital ratios by June 2012 through balance sheet1.11.00.90.80.70.60.50.40.30.2OctEURUSD vs. 2-5-10 EU-US swap spreadSwap Diff 2,5,10 year weighted average (bp)Feb Apr Jun Aug Oct10 11Source: Reuters Ecowin0.630.620.610.600.590.580.570.560.55EURUSD (RHS)EURUSD vs. relative US/EZ bank credit0.5498 00 02 04 06 08 10Source: Reuters EcowinRatio of US/Eurozone credit (lhs)EURUSD1.5001.4751.4501.4251.4001.3751.3501.3251.3001.275Chart 3 : Intl. Investment Position : EZ vs. Japan0.25Japan net intl. investment position (rhs, EURtrn.)0.00-0.25-0.50-0.75-1.00-1.25-1.50Eurozone net intl. investment position (lhs, JPYtrn.)-1.7586 88 90 92 94 96 98 00 02 04 06 08 10Source: Reuters Ecowin1.71.61.51.41.31.21.11.00.90.8275250225200175150125100755025FX Strategy / Ray Attrill 27 October 2011Market Mover62www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchshrinkage but may be less able to impede thepermanent retreat from some types of lending activity.The agreement struck this week in Brussels regardingbank recapitalisation talks only of banks not engagingin ”excessive” balance sheet reduction.The repatriation argument may or may not provesignificant. Where eurozone banks fund overseasassets through euro liabilities, then a decision todispose of those assets may entail cross-bordercurrency flow into euros. However for the most parteurozone banks are seen running either currencymatchedoverseas balance sheets (e.g. dollar assetsfunded via dollar liabilities) or fund these assets viacross currency basis swaps (out of euros). Disposal ofassets in these cases will not entail any subsequentcurrency flow.That said, where enterprise value exists in foreigncurrency assets (and so realised value exceeds thecost of funding the asset) asset disposals could entail arepatriation with EUR-positive impact. In practice, thepotential scale of banking sector repatriation flows thatcould impact on FX rates looks to be modest. BIS dataon the external position of reporting banks as of Q12011 shows eurozone banks holding some USD 3trnworth of non-euro denominated assets and USD 2.6trnof liabilities, so net free foreign assets of some USD400bn. Not trivial by any means, but suggesting that avery big axe will need to be taken to the overseasactivities of many eurozone banks to have a materialFX impact.We do see some evidence of repatriation flows acrossthe eurozone financial system (not just from bankingflows) in the latest (August) Balance of payments data.See: Eurozone: Capital Repatriation by DominiqueBarbet from 20 October. Foreign direct investmentabroad by eurozone residents was -EUR6.5bn inAugust (i.e. net repatriation), though admittedly thenumbers are too noisy on a month-to-month basis todraw firm conclusions. We also saw significant netportfolio inflows to the eurozone. Eurozone residentswere heavy net sellers of overseas equities and bonds,and while foreign residents were also significant sellersof eurozone stocks and bonds, there was a net inflowof EUR43.5bn. With the current account deficit atEUR5.0bn, the eurozone ran a broad basic balancesurplus of EUR38bn. This goes some way toexplaining the relative strength of the euro in August.That’s said, we should stress that the eurozone is notJapan. Parallels with the early 1990s’ Japanesefinancial crisis and the large scale repatriation ofoverseas assets across the financial sector and whichhelped drive USDJPY lower are inappropriate. Thoughmuch less so than today, Japan was still a majorinternational investment creditor at the time of its crisis;the eurozone is a net international debtor (-EUR1.19tnas of 2010). See Chart 3. If a new phase of globalEurozone domestic credit growth y/y111098765432 Credit to Euro area residents y/y growth103 04 05 06 07 08 09 10 11Source: Reuters Ecowindeleveraging is underway (and there is plenty ofevidence from the Q2 2010 US Balance of Paymentsdata that there is) there are a lot more eurodenominatedassets that can flee the eurozone thanthere are to bring back into the euro area.So, we see some potential euro positive impact fromoverseas balance sheet deleveraging by eurozonebanks, and if this occurs on a larger scale than in otherparts of the world, a bigger potential impact could comefrom significant shrinkage in domestic balance sheetsand the implied contraction in credit availability.Remember it was the extreme contraction in theavailability of dollar credit in the immediate aftermath ofLehman’s collapse that drove the dollar sharply higher(greatly amplified by the need to buy dollars that couldnot be borrowed as lenders refused to roll over shorttermloans as they fell due). Fed QE (v.1.0 and v.2.0)TARP, PPIP and the (eventual) creation and utilisationof central bank dollar swap lines eased the dollarfunding squeeze, and the dollar resumed its downtrendas bank credit contraction eased and eventuallyreversed.We are not suggesting that we are in for a re-run of2008, this time centered on the euro area, and ofcourse the ECB’s liquidity spigots are currently wideopen, but over lengthy time periods, there is a decentrelationship between the relative pace of creditexpansion in the United States and the eurozone andthe evolution of the EURUSD rate. See Chart 2. Amonetary theory of exchange rate determination, usingbroader measures of credit rather than high poweredbase money, holds some water. The relationship hasevidently been much less reliable in the past 18 monthsor so, and where it would seem that the direct impact ofQE2 in supporting risk sentiment and driving yielddifferentials against the dollar, has been the dominantinfluences on FX. Nevertheless, were we to startseeing signs of tighter credit conditions across theFX Strategy / Ray Attrill 27 October 2011Market Mover63www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researcheurozone and a reversal of the (very modest) pace ofoutright credit expansion evident in the past year or soas eurozone banks delever (and for which there isalready some evidence in the latest ECB lendingsurvey), it would flag some potential additional upsideeuro risk on top of that which we expect to emanatefrom the Fed from upcoming FOMC meetings.in eurozone credit and broad money supply growth,then the ensuing macro economic implications (adeepening recession and attendant deflation risk)could well mandate the ECB eventually adoptingunconventional policy measures (quantative easing).But the road from here to there could well be via a stillstrongereuro.Of course, were a full-blown eurozone credit crunch tomaterialise and be reflected in an outright contractionFX Strategy / Ray Attrill 27 October 2011Market Mover64www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchOil Implications for FX• Fundamentals, technical picture, and Fedpolicy supportive for oil• The rebound in oil prices should support AUD,CAD, and NOK• Correlations between AUD, CAD, NOK and oilremain strongChart 1 : WTI technical pictureNYMEX WTI prices soared in the last three weeks,bouncing off the year’s low of USD 75.67/bbl to overUSD 90/bbl. The earlier downtrend in oil could be partlyattributed to the fears of a sharp decline in demand dueto the grim global economic outlook as well as sheerrisk aversion from an unsettling situation in theeurozone. With the recent rebound in risk and oilrallying, commodity currencies like AUD, CAD, NOK –the three with the strongest correlation to oil – shouldfind ongoing support. While risk appetite remains a keydriver of oil prices, underlying oil fundamentals coupledwith our Fed view should be sufficient to carry oil andcommodity currencies higher.NYMEX WTI suffered a significant drop in October asmarkets were repricing global growth. But, the recentupside surprise in the US data led the price of WTI backup. The technical trading picture for WTI has turnedconstructive. While WTI has been subject to such starkfluctuations, Brent, which is the oil price used for theEuropean oil market, remained steady because oildemand from European countries tends to be relativelyinelastic. As such, Brent is insulated from fluctuations inrisk appetite. In addition, the supply constraints fromLibya directly affect the price of Brent unlike WTI giventhat nearly 85% of Libyan oil exports are sold toEurope.Source: Reuters Ecowin, Bloomberg, BNP ParibasChart 2 : USDCAD vs. WTISource: Reuters Ecowin, Bloomberg, BNP ParibasChart 1 : NOK TWI vs. WTIHeading into Q4 2011, our oil analysts expect oil pricesto remain at current high levels (year-end forecast ofUSD 92/bbl) due to the following fundamental factors:(1) oil demand holding up in local markets, (2) aseasonal increase in demand as we move into thenorthern hemisphere’s winter, (3) growth of non-OPECsupply delayed into next year, (4) OPEC cutting backon production as Libya oil eventually returns to themarket, and (5) consequent reduction in oil inventoriesin consuming countries.A positive outlook on oil implies that commoditycurrencies with the strongest correlation to oil – NOK,CAD, and AUD – should rally. While Norway andCanada may be the only oil producing/exportingcountries of the three, AUD’s relationship with oil is aSource: BNP ParibasFX Strategy / Mary Nicola 27 October 2011Market Mover65www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchfunction of risk appetite and global growth. The 6-monthand 1-year rolling correlation between oil and NOK,CAD and AUD have been consistently strong since2008. However, there were intervals when thecorrelation broke down. In 2011, the correlationbetween WTI and NOK weakened from the end ofFebruary to the beginning of May while the correlationbetween WTI and both CAD and AUD weakened fromthe end of February until July.The end of February corresponds with the onset of theArab spring in Bahrain. Concerns that instability couldcross the borders into Saudi Arabia raised concern thatsupply constraints were foreseeable. In the meantime,FX markets were still well-supported by ample liquidityconditions thanks to accommodative Fed policy.Meanwhile, USDCAD, USDNOK, AUDUSD, and oilwere all in consolidation mode up until the beginning ofAugust when sentiment turned negative. With thecorrelation currently strong and the markets moving asa function of risk appetite, a risk-on mode from thepotential change in Fed communication at the FOMCmeeting next week would spark a move higher in oiland boost commodity currencies.Based on recent Fedspeak, we expect the Fed toimpose an unemployment target (of let’s say 7%) in itscommuniqué, which would signal not only loosemonetary policy for longer but also place a lower barChart 2 : Fed Balance sheet vs. WTISource: Reuters Ecowin, Bloomberg, BNP Paribasfor QE3. With unemployment a lagging indicator, adecline in unemployment would take at least 3 years tofall to 7% from the current level of 9.1%. Our ratesstrategists expect that this change would leadTreasuries to rally in the front end, which would benegative for USD. As such, with a potentialcomprehensive solution on the eurozone debt crisis inthe works, risk appetite should improve and restore theimpact of the ”Bernanke put” under risky assets, drivingcommodities and commodity currencies higher.FX Strategy / Mary Nicola 27 October 2011Market Mover66www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchLook to Sell USDCAD• Recent CAD underperformance shouldreverse with oil prices firm and rate spreadssupportive despite the recent dovish BoCstatement• A move by the FOMC to signal ratesremaining low for longer with US dataoutperforming should help the CAD• We would look at opportunities to sellUSDCAD on any reboundsWe continue to remain constructive on the Canadiandollar given higher oil prices, relative rate spreads andcontinued inflows. Moreover, with the Fed likely to setthe stage for policy being ‘accommodative for longer’ atthe FOMC meeting next week just when incominggrowth indicators in the US are outperformingexpectations, the CAD seems well-positioned tobenefit. As such, we believe that the recent set back inCAD following this week’s admittedly dovish Bank ofCanada statement offers opportunities to take on freshlong CAD exposure. We like to position short USDCADon expectations that spot should revisit 0.9600.The Canadian dollar has been recentlyunderperforming, losing well over 3% against mostG10 currencies over the past month. Given that eventhe oil sensitive Norwegian Krone, too, hasconsiderably outpaced the Loonie over the sameperiod, idiosyncratic factors seem at play. Expectationsthat the US economy – on which the Canadianeconomy is highly dependent – could be heading for ahard landing weighed negatively on CAD. While BNPPeconomics currently looks for modestly negativegrowth in the US in Q4 2011 and Q1 2012, so farforward looking indicators for Q4 on the manufacturingside (in particular on new orders) have been strong. Itseems plausible that this continues with potentialupside surprises on both October Chicago and ISMPMI’s releases into next week, especially after thesharp rebound seen in the corresponding Philly Fedindex last week. Chart 1, comparing the Chicago PMInew orders sub-index alongside the 3-monthannualised appreciation of CADUSD, also suggests thepotential for CAD to catch up.Despite this week’s rather dovish BoC monetary policyreport, we argue that relative rate spreads shouldcontinue to favour USDCAD downside. While the Bankof Canada revised down their forecasts for 2011 and2012 by 0.7pp (to 2.1% and 1.9% respectively), oureconomists expect only limited easing. Indeed, ifChart 1: CAD outperforms when US manufacturingindicators hold in well82.572.562.552.542.532.522.5USDCAD 3m Changeannualised (RHS Inverse)Chicago PMI New OrdersJan-00 Jul-01 Jan-03 Jul-04 Jan-06 Jul-07 Jan-09 Jul-10 Jan-12Source: Reuters Ecowin, Bloomberg, BNP ParibasChart 2: Tighter rate spreads to weigh on USDCAD200150100500-50-100-150-200-250Mar-03 Aug-04 Jan-06 Jun-07 Nov-08 Apr-10 Sep-115Y swap spreadSource: Reuters Ecowin, Bloomberg, BNP Paribas20.0015.0010.00-5.00-10.00-15.00-20.00Fed-BoC OCR spread1Y fwd on swap spreadChart 3: Strong inflows have driven the CAD5.000.00Mar-80 Jun-84 Sep-88 Dec-92 Mar-97 Jun-01 Sep-05 Dec-09Canada Financial Account (CAD bn)Source: Reuters Ecowin, Bloomberg, BNP ParibasUSDCAD Inverse (RHS)-75-55-35-155254565850.880.981.081.181.281.381.481.581.68FX Strategy / Kiran Kowshik 27 October 2011Market Mover67www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchanything, the improvement in the near term US growthoutlook has prompted our economists to postpone theirtiming for a 25bps BoC rate cut from December to thebeginning of 2012. In contrast, our US economics teambelieves the Fed is on the verge of embarking on anew forward looking guidance based on acceptableranges for CPI and the jobless rate to peg expectationsof zero interest rate policy (ZIRP). Should this come topass as early as next week’s FOMC meeting, our fixedincomecolleagues point out the potential for a sharp50+bp rally in the belly of the US treasury curve. Chart3 suggests that USD-CAD 5Y spreads are rather wideeven if we allow for a 25bp rate cut from the BoC inearly 2012.However, another factor that would indirectly supportthe CAD is the continued demand for Canadian bonds,an inflow that has picked up ever since the Fedembarked on QE. Canada has healthy fiscal metricsjust as the universe of AAA rated sovereigns isdiminishing. Just recently, S&P affirmed its “AAA/A-1+”long- and short-term sovereign credit ratings onCanada. Given our assumption that the Fed iseventually forced to pull the trigger on QE3, theseinflows could be re-invigorated, suggesting anotherpillar supporting CAD strength (Chart 3).CAD long positioning has been almost completelyeliminated with IMM positioning now net short for thepast couple of weeks. However, unfortunately, thesharp risk rally after the EU Summit has seen spotmove substantially, and we would look for a pull backbetween 1.00 and 1.01 to consider short USDCAD spotpositions looking for an eventual move down to 0.9600on a one-to-two month horizon. Meanwhile, given stillelevated risk reversals, the options market offersattractive opportunities to put on short USDCADpositions.Options Structures for Short USDCADRecommendationSpot Ref: 0.9950Idea 1: Ratio Risk Reversal 3mth USDCAD (sell 2 xUSD 1.0400 call buy 0.9930 USD Put) - Zero CostThis strategy takes advantage of the relatively high riskreversal which is still trading around 3.00% (mid) atpresent. In the 12 months until the recent Euro-zonecrisis this traded between a 0.50% -1.50% range. Thescenario that this trade plays is spot moving lower withoil higher into the winter months accompanied by aquelling of market fears on the Euro-zone. Thisstrategy should benefit from both with the risk reversalselling off as risk premiums fall and CAD appreciatingwith Oil.Risk: This strategy is predicated on the crisis fearsabating over the next few months. If we see similarevents to those of September both spot and the riskreversal are going to rally rapidly.Idea 2: Buy a 2mth USDCAD RKI put 1.0150 KI 0.9400- Cost: 1.51% USD Notional (TV: 1.76% / Vanilla:3.18%)The payout at KI is approximately 5 x, with potential forfurther gain.As noted above the skew is trading at high levelscheapening down side barriers meaning this is tradingat a 0.25% discount to TV. The strategy looks to getinto the USDCAD move at yesterday's spot (1.0150)should we see our Q4 target of 0.9400 come to fruition.The two month horizon encompasses a lot ofdata/events increasing the chance of at least a spikedown to 0.9400. We expect next week's FOMC (Nov2nd) to be quite dovish- bullish for US bonds andbearish the USD. Events further down the road suchas Nov-22 FOMC minutes, could be USD negative andthere is the Dec-13 FOMC decision too.Risk: As with the above if the Euro-zone crisis isn'tsatisfactorily resolved then it is unlikely we'll see0.9400 in the next two months.Joe Nash+44 (0)20 7595 8384Chart 4: IMM PositioningSource: Reuters Ecowin, Bloomberg, BNP Paribas, CFTCFX Strategy / Kiran Kowshik 27 October 2011Market Mover68www.GlobalMarkets.bnpparibas.com

Economic Calendar: 28 Oct - 4 NovGMT Local Previous Forecast ConsensusFri 28/10 23:01 00:01 UK Gfk Consumer Confidence : Oct23:30 08:30 Japan CPI National y/y : Sep 0.2% 0.0% 0.1%23:30 08:30 Core CPI National y/y : Sep 0.2% 0.2% 0.2%23:30 08:30 CPI Tokyo y/y : Oct -0.2% -0.5% -0.5%23:30 08:30 Core CPI Tokyo y/y : Oct -0.1% -0.4% -0.4%23:30 08:30 Household Consumption y/y : Sep -4.1% -4.0% -3.5%23:30 08:30 Unemployment Rate (sa) : Sep 4.3% 4.4% 4.5%23:50 08:50 Industrial Production (Prel, sa) m/m : Sep 0.8% -2.0% -2.1%(27/10)06:45 08:45 France Retail Sales m/m : Sep 0.2 -0.7 0.0%06:45 08:45 Retail Sales y/y : Sep 0.3 -1.3 -0.7%07:00 09:00 Norway Unemployment Rate : Oct 2.5% 2.7% 2.5%07:00 09:00 Spain HICP Flash y/y : Oct 3.0% 2.9% 2.9%07:00 09:00 Unemployment Rate : Q3 20.9% 20.8% 20.9%07:15 09:15 Sweden Consumer Confidence (sa) : Oct -5.8 -6.4 -6.407:30 09:30 Retail Sales (sa) m/m : Sep -0.3% 0.3% 0.3%07:30 09:30 Retail Sales (nsa) y/y : Sep 0.2% 0.3% -0.2%07:30 09:30 Eurozone Eurocoin : Oct 0.0 -0.1 n/a08:10 10:10 Retail PMI : Oct 49.6 49.3 n/a08:00 10:00 Italy Wages m/m : Sep08:00 10:00 Wages y/y : Sep09:30 11:30 Switzerland KoF Leading Indicator : Oct 1.2 0.9 1.012:30 08:30 US Personal Income m/m : Sep -0.1% 0.5% 0.3%12:30 08:30 Personal Spending m/m : Sep 0.2% 0.4% 0.6%12:30 08:30 Employment Cost Index q/q : Q3 0.7% 0.6% 0.6%12:30 08:30 Employment Cost Index y/y : Q3 2.2% 2.3% n/a13:55 09:55 Michigan Sentiment (Final) : Oct 57.5 58.5 58.013:00 15:00 Belgium GDP (Flash) q/q : Q3 0.5% 0.2% n/a13:00 15:00 GDP (Flash) y/y : Q3 2.3% 2.1% n/aSun 30/10 Europe Clocks Go Back by One HourMon 31/10 05:00 14:00 Japan Housing Starts y/y : Sep 14.0% 15.0% 7.6%07:45 08:45 France PPI m/m : Sep 0.0% 0.0% n/a07:45 08:45 PPI y/y : Sep 6.3% 5.9% n/a09:00 10:00 Norway Retail Sales (sa) m/m : Sep 1.3% 0.2% n/a09:00 10:00 Retail Sales (sa) y/y : Sep 7.6% 4.3% n/a09:30 09:30 UK Mortgage Approvals : Sep 52.4k 50k 50.5k09:30 09:30 Net Consumer Credit : Sep GBP0.5bn GBP0.5bn GBP0.4bn10:00 11:00 Eurozone HICP (Flash) y/y : Oct 3.0% 2.9% 2.8%10:00 11:00 Unemployment Rate : Sep10:00 11:00 Italy CPI (NIC, Prel) m/m : Oct 0.0% 0.3% n/a10:00 11:00 CPI (NIC, Prel) y/y : Oct 3.0% 3.1% n/a10:00 11:00 HICP (Prel) m/m : Oct 2.0% 0.8% n/a10:00 11:00 HICP (Prel) y/y : Oct 3.6% 3.6% n/a11:00 12:00 PPI m/m : Sep11:00 12:00 PPI y/y : Sep12:30 08:30 Canada GDP m/m : Aug 0.3% 0.2% 0.2%12:30 08:30 GDP y/y : Aug 2.3% 2.2% n/a13:45 09:45 US Chicago PMI : Oct 60.4 59.5 59.0Market Economics 27 October 2011Market Mover69www.GlobalMarkets.bnpparibas.com

Economic Calendar: 28 Oct - 4 Nov (cont)GMT Local Previous Forecast ConsensusTue 01/11 21:30 08:30 Australia House Price Index q/q -0.1% -0.7% n/a21:30 08:30 House Price Index y/y -1.9% -1.4% n/a(31/10)03:30 14:30 RBA Rate AnnouncementJapan BoJ MinutesFrance Public Holiday07:00 07:00 UK Nationwide House Price Index m/m : Oct07:00 07:00 Nationwide House Price Index y/y : Oct09:30 09:30 CIPS Manufacturing : Oct 51.1 50.0 50.009:30 09:30 GDP (Adv) q/q : Q3 0.1% 0.4% 0.3%09:30 09:30 GDP (Adv) y/y : Q3 0.6% 0.4% 0.3%08:30 09:30 Switzerland PMI Manufacturing : Oct 48.2 48.0 n/a14:00 10:00 US Construction Spending m/m : Sep 1.4% 0.3% 0.2%14:00 10:00 ISM Manufacturing : Oct 51.6 52.0 52.2Wed 02/11 08:55 09:55 Germany Unemployment (Chg, sa) : Oct -26k -8k -10k08:55 09:55 Unemployment Rate : Oct 6.9% 6.9% 6.9%09:00 10:00 Eurozone PMI Manufacturing (Final) : Oct 47.3 (p) 47.3 47.309:00 10:00 Norway Unemployment Rate AKU : Aug 3.2% 3.2% n/a11:30 07:30 US Challenger Layoffs y/y : Oct12:15 08:15 ADP Labour Change : Oct 91k 100k 103k14:30 10:30 EIA Oil Inventories16:30 12:30 FOMC Rate Announcement18:15 14:15 Bernanke Speaks at Fed Press ConferenceThu 03/11 Japan Public HolidayG20 Summit in Cannes, France00:30 11:30 Australia Retail Sales m/m : Sep 0.6% 0.6% n/a08:28 08:28 UK CIPS Services : Oct 52.9 52.0 52.012:30 08:30 US Non-Farm Productivity (Prel, saar) q/q : Q3 -0.7% 3.8% 2.5%12:30 08:30 Initial Claims 402k 405k n/a12:30 08:30 Unit Labour Costs (Prel, saar) q/q : Q3 3.3% -2.5% -0.5%14:00 10:00 Factory Orders m/m : Sep -0.2% 0.1% 0.0%14:00 10:00 ISM Non-Manufacturing : Oct 53.0 54.0 54.012:45 13:45 Eurozone ECB Rate Announcement13:30 14:30 ECB Press ConferenceFri 04/11 00:30 11:30 Australia RBA Monetary Policy StatementG20 Summit in Cannes, France08:00 09:00 Spain Industrial Production y/y : Sep 0.3% -3.0% n/a09:00 10:00 Eurozone PMI Services (Final) : Oct 47.2 (p) 47.2 47.210:00 11:00 PPI m/m : Sep10:00 11:00 PPI y/y : Sep10:00 11:00 Germany Factory Orders m/m : Sep -1.4% -2.2% 0.0%10:00 11:00 Factory Orders y/y : Sep 3.9% 5.0% 7.9%11:00 07:00 Canada Unemployment Rate : Oct 7.1% 7.1% 7.2%11:00 07:00 Payroll Jobs : Oct 60.9k 20.0k 20.0k12:30 08:30 US Non-Farm Payrolls (Chg) : Oct 103k 75k 100k12:30 08:30 Unemployment Rate : Oct 9.1% 9.1% 9.1%12:30 08:30 Average Hourly Earnings m/m : Oct 0.2% 0.1% 0.2%Sun 06/11 US Clocks Go Back by One HourDuring 1-4 UK Halifax House Prices m/m : OctWeek 31/10-Germany Retail Sales (BBK, Real, sa) m/m : Sep -2.7% 0.2% 1.0%2/11Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revisionSource: BNP ParibasMarket Economics 27 October 2011Market Mover70www.GlobalMarkets.bnpparibas.com

Key Data Preview3210-1-2-3Chart 1: Japanese Core CPI (% y/y)CPI excluding energy andfood, but not alcoholCore CPI05 06 07 08 09 10 11Sources: MIC, BNP paribas% y/y Sep (f) Aug Jul JunCore CPI 0.2 0.2 0.1 -0.2CPI 0.0 0.2 0.2 -0.4BNP Paribas Forecast: Slight Positive Price GrowthJapan: CPI (National, September)Release Date: Friday 28 OctoberBased on the Tokyo CPI numbers for September (whichprecede the national figures by a month), we expect thenational core CPI to rise 0.2% y/y in September, the samerate of increase as in August. If so, the index will register athird straight advance, due largely to surging energy prices –in August, energy prices rose 7.1% and elevated the coreCPI by 0.5pp. Were it not for energy prices, the core CPIwould still be falling, as evident from the US-style core-coreCPI (which excludes energy and food but not alcohol), inwhich prices fell 0.5% y/y in August, marking 32 straightmonths below zero. In any event, positive CPI growth is likelyto end in October, when two special factors that are elevatingthe core index by a combined 0.3pp – tobacco tax hike,higher non-life insurance premiums – will be stripped away,returning price growth to negative territory.Key Point:The national core CPI should remain slightly positive inSeptember, but prices are expected to turn negativeagain from October when special factors (tobacco taxhike, higher non-life insurance premiums) are strippedfrom the index.Chart 2: Japanese Unemployment Rate (% sa)6.05.55.04.54.03.500 01 02 03 04 05 06 07 08 09 10 11Sources: MIC, BNP parobas% sa Sep (f) Aug Jul JunUnemployment rate 4.4 4.3 4.7 4.6Key Point:We expect the jobless rate will deteriorate slightly to4.4% in September owing to fallout from the slowingglobal economy and a statistical reaction to August’sbig improvement.BNP Paribas Forecast: Higher Jobless RateJapan: Unemployment Rate (September)Release Date: Friday 28 OctoberWe expect the jobless rate will deteriorate slightly to 4.4% inSeptember. In August, the unemployment rate improved byits largest margin ever, falling 0.4pp to 4.3%. But with thejobless and employed totals both dropping sharply in August,the improvement in the jobless rate is said largely to reflect aplunge in the labour force itself: immigration statistics showforeign labourers (mostly second or third-generationJapanese from Latin America) have left Japan in droves afterlosing their jobs in the wake of the 11 March earthquake. It isnot enough to suggest the jobless rate reduced becauseemployment conditions improved, although the job offer ratiorose. In September, we expect the jobless rate will resume itsdeterioration because of fallout from the slowing globaleconomy and a statistical reaction to the big improvement inAugust. Even so, deterioration will be limited because theageing of society is still steadily reducing the labour force asretirees and those not looking for work enter the non-labourforce.Market Economics 27 October 2011Market Mover71www.GlobalMarkets.bnpparibas.com

Key Data PreviewChart 3: Japanese Production and Exports120(2005=100, seasonally adjusted)150115140110Production1301051201001109510090859080Exports (RHS)8075707060655000 01 02 03 04 05 06 07 08 09 10 11Sources: METI. MOF, BNP ParibasSep (f) Aug Jul Jun% m/m -2.0 0.6 0.4 3.8BNP Paribas Forecast: First Decline in Six MonthsJapan: Industrial Production (September)Release Date: Friday 28 OctoberWe expect industrial production in September to fall by 2.0%m/m, marking the first setback in six months. Productionlevels in July have largely returned to normal (i.e., predisasterlevel of February), but if distortions in the seasonaladjustments are excluded, the pace of production growth hasbeen moderating of late. On this score, the productionforecast index also projects a pause in the recovery inSeptember (-2.5%) followed by resumed growth (3.8%) inOctober. Factory activity continues to be underpinned byreconstruction and ramped-up production by car makers whoare making up for lost production after the disaster. However,the outlook is not entirely bright, as downside risks for theglobal economy have increased, with both developed andemerging economies losing momentum. We expect slowingexports to cause factory recovery to stall around year-end.Key Point:Output should decline in September and then resumerecovery on reconstruction demand and catch-upproduction by car makers. But the slowing globaleconomy will be likely to cause the factory recovery tostall around year-end.543210-1-2-3Chart 4: French Retail Sales vs. ConfidenceRetail Sales (% y/y, volume)Household Confid.(EU Survey, RHS)04 05 06 07 08 09 10 11Source: INSEE, Reuters EcoWin ProVolume (sa-wda) Sep (f) Aug Jul Sep 10% m/m -0.7 0.2 -0.2 0.9% y/y -1.3 0.3 -1.4 1.9Key Point:Poor household confidence points towards a drop insales after the holiday period.50-5-10-15-20-25-30-35-40BNP Paribas Forecast: DecliningFrance: Retail Sales (September)Release Date: Friday 28 OctoberReal retail sales were fairly stable in July and August afterthe June 0.9% m/m gain. The sharp decline of householdconfidence, when the fears of economic downturn werespreading, and the intensification of the financial crisisapparently failed to hit consumption.The breakdown shows a slightly different picture. Sales ofdurable goods diminished as consumers restrainedexpenditure. During the summer, relatively strong activity intourism, despite adverse weather, compensated for this.Sales of miscellaneous goods and energy (petrol and diesel)were up and we believe activity in services was robust. Thismay change in September. Sales of energy should declinefrom their previous peak. Because of poor confidence, we donot expect a rebound in sales of manufactured goods,especially durable goods. The exception may be car saleswhere manufacturers’ discounts have probably helped, butthe y/y change is sure to decline rapidly over the comingmonths because of a strong base effect.The only sector where there is potential for a recovery is foodsales. These should rebound from an abnormally low level.However, the German experience where retail sales in realterms declined continuously for years after reunification,shows a rebound is not guaranteed. The poor economicsituation may result in a similar situation in France, wherepeople abandon traditional brands, shops and supermarketsin favour of hard discounters, showing up in the data in theform of a continuous sales decline in real terms.Market Economics 27 October 2011Market Mover72www.GlobalMarkets.bnpparibas.com

Key Data PreviewChart 5: US Confidence vs. ConsumptionSources: Reuters EcoWin Pro% m/m Sep (f) Aug Jul JunPersonal Income 0.5 -0.1 0.3 0.2Consumption 0.4 0.2 0.8 -0.1Core PCE Prices 0.0 0.1 0.2 0.2BNP Paribas Forecast: Flat to DownUS: Personal Income & Spending (September)Release Date: Friday 28 OctoberPersonal consumption is forecast to rise 0.4% in Septemberafter a 0.2% gain in August. Nominal core retail sales rose arobust 0.6%, and auto sales jumped 4.9%. However, adecline in utility spending should weigh on service spending,which comprises 2/3 of all personal spending. Overall, thegain would be consistent with a moderate rebound inconsumption growth in Q3.Meanwhile, personal income is forecast to rise a solid 0.5%after a decline of 0.1% reflecting the rise in both aggregatehours worked and average hourly earnings. Income appearsto have grown notably more slowly in Q3 than spending,suggesting a decline in the personal saving rate.The core PCE price index is expected to be flat inSeptember, down from a 0.1% m/m rise in September. Themoderation in core inflation momentum should come fromlower OER and core goods price inflation. This would leavethe annual pace of core PCE inflation at 1.6%.Key Point:A jump in auto sales is expected to lead to robustpersonal spending in September.Chart 6: Eurozone Inflation Breakdown (% y/y)3.02.52.01.51.00.50.0EnergyFood-0.5Core01/10 07/10 01/11 07/11Source: Reuters EcoWin Pronsa Oct (f) Sep Aug JulFlash estimate (% y/y) 2.9 3.0 2.5 2.5Key Point:Food, energy and core are forecast marginally lower inOctober, which should allow a one-tenth decline inheadline inflation.BNP Paribas Forecast: Marginal EasingEurozone: Flash HICP Inflation (October)Release Date: Monday 31 OctoberThe eurozone inflation rebound in September was primarilythe correction of abnormally low data in the preceding twomonths, which affected the contribution of core items (seeChart). Things returned to normal in September and weexpect this to prevail until the end of the year.The main source of volatility has been the energy componentfor the last few years. We forecast this item to be fairly stablein October, printing a modest increase on the month around0.4%, but allowing for a modest decline, by about two-tenths,of the y/y inflation of that item (from 12.4% in September).The favourable base effect will be particularly significant inDecember, January and March; three months during whichenergy prices rose between 2% and 3% m/m last winter.The trend increase in food prices should continue. However,the mild weather in September may have caused fresh foodprices to ease temporarily; this should compensate for risingprices in manufactured foods.Finally, core inflation reached 1.64% in September, slightlyabove the June level, 1.57%. We expect core inflation to stayaround this level until year-end. The inflationary impact ofpast increases in crude goods prices has not been entirelypassed on to consumers. However, declining privateconsumption, evident throughout the eurozone, should makeit difficult for manufacturers and retailers to hike pricessignificantly. We forecast headline inflation at 2.9%.Market Economics 27 October 2011Market Mover73www.GlobalMarkets.bnpparibas.com

Key Data PreviewChart 7: UK Manufacturing PMI80Future Business Expectations757065Business Activity6055504540Incoming New Business3505 06 07 08 09 10 11Sources: Reuters EcoWin ProOct (f) Sep Aug JulPMI manufacturing 50.0 51.1 49.4 49.4BNP Paribas Forecast: Down To EarthUK: Manufacturing PMI (October)Release Date: Tuesday 1 NovemberThe UK manufacturing PMI showed a surprising bounceabove 50 in September. The headline index rose to 51.1, upfrom a revised 49.4 in August. The manufacturing outputindex rose to 53.3, also the highest level since April.Backlogs of reported work fell further, suggesting that someof the bounce in output came from firms running down theirexisting order books. Still, total new orders rose to 50.5,which was also the highest level since April.We are not optimistic that last month’s strong reading can besustained in October. Certainly the CBI Industrial Trendssurvey for October slumped, and the BCC QuarterlyEconomic Survey looked weak. The October eurozone PMI(flash) has already shown a further fall below 50. And while itwould be nice to believe the UK data could follow moreclosely the US ISM than the eurozone PMI, the proportion ofthe UK export market that depends on the EU makes that nottoo likely. So we look for a fall in the UK PMI to around 50.Key Point:Last month’s resilience is likely to be short-lived.2.52.01.51.00.50.0-0.5-1.0-1.5-2.0Chart 8: UK GDP% y/y (RHS)% q/q-2.580 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10Sources: Reuters EcoWin ProQ3 (f) Q2 2011 Q1 Q4GDP q/q 0.4 0.1 0.4 -0.5GDP y/y 0.4 0.6 1.6 1.3Key Point:Little bounce back from stagnation in Q2. We expect a0.4% expansion on the quarter.12.510.07.55.02.50.0-2.5-5.0-7.5-10.0-12.5BNP Paribas Forecast: Another Weak Growth ReadUK: GDP (Q3 Advance 2011)Release Date: Tuesday 1 NovemberUK GDP expanded by just 0.1% in Q2. A number of specialfactors downwardly affected growth in that quarter. Theseincluded the additional bank holiday for the royal wedding,the impact of the Japanese tsunami and record warmweather in April. The ONS estimate these effects could haveshaved 0.5pp off Q1 growth, though the methodology used toarrive at this figure is broad brush.There is little guarantee that the lost output will be made upin future quarters in any case and the first estimate of Q3GDP looks likely to be fairly weak again. Looking at thepartial components received so far, the level of industrialproduction over July and August is around 0.2% higher thanQ2, while construction output is up 2.0% over the samemonths. Over Q3 as a whole, the volume of retail sales isdown 0.2%. The rest of the service sector is not very wellcovered by official data on a monthly basis, but the index ofservices data for July and the services PMI would suggestsomething like a 0.5% expansion in overall service sectoroutput. That would equate to a 0.4% rise in GDP in Q3, asimilar 0.4% rise on the year.Market Economics 27 October 2011Market Mover74www.GlobalMarkets.bnpparibas.com

Key Data PreviewChart 9: German Unemployment and the PMISources: Reuters EcoWin ProOct (f) Sept Aug JulUnempl. Change (‘000) -8 -26 -9 -10Unemployment Rate (%) 6.9 6.9 7.0 7.0BNP Paribas Forecast: Slower DeclineGermany: Unemployment Change and Rate (October)Release Date: Wednesday 2 NovemberThe German labour market surprised market consensus witha decrease of 26,000 in the total number of unemployed inSeptember – around five times larger than expected. Theunemployment rate decreased to 6.9%. This is the lowestrate measured in the series which started with reunification(9.6% on average).Meanwhile, the number of vacancies slightly rose to 478 000,up by 7,000: a slower pace than previous months.The employment component of survey indicators such as theIfo or PMI still indicate that companies are willing to hire, butmore slowly. The PMI flash index signals a decline in theemployment subcomponent by 1.3 points to 54.4. This levelwas, in the past, equivalent to a decline in unemployment ofaround 8,000.The unemployment rate itself is likely to remain unchanged inOctober.Key Point:Unemployment will decline further, but at a slower pace.Chart 10: UK Service Sector PMI65.062.560.0UK57.555.052.550.047.5Eurozone45.042.540.037.597 98 99 00 01 02 03 04 05 06 07 08 09 10 11Sources: Reuters EcoWin ProOct (f) Sep Aug JulPMI services 52.0 52.9 51.1 55.4BNP Paribas Forecast: Easing in OctoberUK: Services PMI (October)Release Date: Thursday 3 NovemberThe UK service sector PMI rose to 52.9 in September, upfrom 51.1 in August. Within the data, incoming new workrose, as did the employment series. The long-run seriesaverage of the headline PMI services series is around 55, sothe September release is consistent with positive but subtrendservice sector growth. The link between the officialservice sector data and the PMI appears fairly loose in anycase.There weren’t any particular reasons for the strength of theservice sector, but it seems plausible that the momentum inthe sector will fade somewhat over the next quarter,particularly as the manufacturing slowdown continues. Boththe CBI and BCC services surveys have fallen sharply in theirmost recent releases.Overall we expect a decline in the headline services PMI to52.0 in October.Key Point:Service sector momentum is fading and the PMI is likelyto fall in October.Market Economics 27 October 2011Market Mover75www.GlobalMarkets.bnpparibas.com

Key Data PreviewChart 11: US Non-Farm ProductivityBNP Paribas Forecast: Strong ReboundUS: Non-Farm Productivity & ULC (Q3, preliminary)Release Date: Thursday 3 NovemberNon-farm productivity is forecast to surge by 3.8% q/q AR inQ3 following a 0.7% q/q saar drop in Q2 as output grewmuch stronger than aggregate hours worked. Non-farmbusiness output grew sharply rising 3.8% saar in Q3following a 1.8% pace in Q2. Meanwhile, aggregate hoursworked growth was flat in Q3. Unit labour costs growthshould fall into a negative territory posting -2.5% q/q saar inQ3 following a 3.3% clip in Q2. Compensation grew muchslower than output during the forecast period. Going forward,the odds are high that productivity gains will slow to a moremoderate pace.Sources: Reuters EcoWin Pro% q/q, AR Q3 (p) Q2 Q1 Q4NF Productivity 3.8 -0.7 -0.6 2.2ULC -2.5 3.3 6.2 -1.6Key Point:Non-farm productivity is forecast to rebound strongly inQ3 as non-farm output grew much stronger thanaggregate hours worked.Chart 12: US NM ISM Employment & PayrollsSources: Reuters EcoWin ProOct (f) Sep Aug JulNM Composite 54.0 53.0 53.3 52.7Prices Paid 60.0 61.9 64.2 56.6BNP Paribas Forecast: IncreaseUS: ISM Non Manufacturing (October)Release Date: Thursday 3 NovemberWe look for the non-manufacturing ISM to increase to 54.0 inOctober from 53.0 in September. The increase in the indexshould reflect a recent pick up in the retail and nonresidentialconstruction sectors, while the government sectorcontinues to shrink. The index also includes a sentimentcomponent that we think will rise on the back of better-thanexpectedeconomic data as of late. Our forecast would beconsistent with growth in the non-manufacturing sector, albeitat a moderate pace. We expect a retrenchment on the part ofconsumers in Q4 and for the non-manufacturing ISM to fallbelow 50 by the end of the year. We look for the Octoberreading on the prices paid index to fall to 60.0 from 61.9reflecting the recent broad-based decline in commodityprices.Key Point:An estimated increase to 54.0 in the NM ISM indexshould reflect a recent pick up in the retail and nonresidentialconstruction sectors, while the governmentsector continues to shrink.Market Economics 27 October 2011Market Mover76www.GlobalMarkets.bnpparibas.com

Key Data PreviewChart 13: German: Industrial Orders and OutputSources: Reuters EcoWin Pro(sa) Sept (f) Aug Jul JunOrders % m/m -2.2 -1.4 -2.6 1.8Orders % y/y 5.0 3.6 8..9 9.4Output % m/m -3.3 -1.0 3.9 -1.1Output % y/y 4.7 7.9 10.4 7.0BNP Paribas Forecast: Falling OutputGermany: Industrial Orders and Output (September)Release Date: Friday 4 and Monday 7 NovemberIndustrial production in August declined by 1.0% m/m,essentially due to a sharp contraction in durable consumergoods production. A large part of the decline was a bounceback following a major rise in durable goods production inJuly.The trend in industrial production generally follows neworders with a delay of two to three months. However, overthe past few months, industrial production outperformedorders, generating a significant gap in the level of productionin comparison to the level of orders. This gap is likely toaffect industrial production in addition to weaker orders overthe next few months.Industrial orders started to decline in July. The Septemberdecline amounted to 2.2% m/m. All sub-componentsdeclined, especially consumer goods orders. The new orderssub-component in the PMI is below 50 and has beenfollowing a downward trend since July. In September, theindex declined to 46.4 and flash estimates signal that theslowdown is likely to accelerate even further in October. Thedecline can be expected to be most pronounced in exportorders.Key Point:Activity is likely to fall in the last quarter of the year.Chart 14: US Unemployment Rate-6011-5010-40-30Jobs Plentiful Less JobsHard to Get (Inverted)9-20-1087010203065Unemployment Rate 440(%, RHS)Bars Mark Recessions50376 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12Sources: Reuters EcoWin ProOct (f) Sep Aug JulPayroll Jobs k 75 103 57 127Private Payrolls k 100 137 42 173Unemployment Rate % 9.1 9.1 9.1 9.1Key Point:We expect a moderate increase in nonfarm payrolls andthe unemployment rate to remain at current levels inOctober.BNP Paribas Forecast: Modest GrowthUS: Labour Report (October)Release Date: Friday 4 NovemberNonfarm payrolls are expected to post a 75k increase inOctober after posting 103k growth in September. We forecastprivate sector hiring to grow 100k. Meanwhile, an ongoingslowdown in state and local government spending isexpected to shave 25k government jobs from total nonfarmpayrolls. The claims data do not suggest deterioration inlabour market conditions, neither do they indicate that therecent wave of layoff announcements has begun to filter intojobless claims filings. Meanwhile, the latest business surveysindicated increased doubts about the strength of therecovery noting restraint in hiring. Consumer surveyspainted a similar picture. The Conference Board’s labourdifferential index, which measures the percent ofrespondents saying jobs are plentiful and subtracts thepercent saying jobs are hard to get, remained athistorically depressed levels in October (see chart). Weforecast the unemployment rate to remain at 9.1% assumingstable labour force participation. Average hourly earnings areexpected to rise 0.1% after 0.2% a month prior as wage andsalary growth remains subdued in the face of elevatedunemployment.Market Economics 27 October 2011Market Mover77www.GlobalMarkets.bnpparibas.com

Key Data Preview150100500-50-100-150Chart 15: Canadian Employment (thousands)Monthly ChangeFull-TimeJan 07 Jan 08 Jan 09 Jan 10 Jan 11Sources: Reuters EcoWin ProPart-TimeOct (f) Sep Aug JulUnemployment rate % 7.1 7.1 7.3 7.2Payroll jobs (k) 20.0 60.9 -5.5 7.1BNP Paribas Forecast: ModeratingCanada: Labour Report (October)Release Date: Friday 4 NovemberCanadian employment is forecast to improve by 20k inOctober following a whopping 60.9k increase in the previousmonth. The volatility in employment growth has beenexacerbated over the past four months. We have seenanywhere from the positive surprise in September toAugust’s contraction of 5.5k jobs. Nevertheless, the 6maverage pace of employment growth is now running at 28.6kper month, up from the recent trough of 18.2k in August.Despite the improvement, we saw a spike in public sectoremployment (up 36.9k) in September while the private sectorlost 14.9k and self-employment rose 38.9k. Overall, whilethe report suggested some ongoing strength in the(public) services sector, it is unlikely to last while theprivate sector and goods producing industries struggle togenerate employment. On balance, we forecast theunemployment rate to remain at 7.1% as a result of a smalldecrease in the labour force participation rate.Key Point:We expect the pace of employment growth to slow inOctober after a spike in September showed labourmarket imbalances with strength in public services andthe private and manufacturing employment lagging.Market Economics 27 October 2011Market Mover78www.GlobalMarkets.bnpparibas.com

Economic Calendar: 7 Nov – 2 Dec7 Nov 8 Nov 9 Nov 10 Nov 11 NovJapan: Leading IndicatorSepEurozone: Retail SalesSepGermany: IndustrialProduction SepNorway: IndustrialProduction SepSwitz: CPI OctUS: Consumer CreditSepMarket Economics 27 October 2011Market MoverAustralia: NAB BusinessSurvey OctUK: BRC Retail SalesMonitor Oct, RICS HousePrices Oct, IndustrialProduction SepGermany: Trade BalanceSepFrance: Trade BalanceSepNeths: IndustrialProduction SepUS: NFIB Small BusinessOptimism OctAustralia: WestpacConsumer ConfidenceNovJapan: Current AccountSepUK: Trade Balance SepFrance: BoF Survey Oct,Investment Survey Oct,Budget Balance SepSweden: IndustrialProduction Sep, RiksbankMonetary Policy MinutesUS: Wholesale Trade SepAustralia: Labour OctJapan: M2 Oct,Machinery Orders SepEurozone: ECB BulletinUK: BoE RateAnnouncementGermany: CPI OctFrance: CPI Oct, IP SepItaly: IP SepNeths: CPI OctSweden: CPI OctNorway: CPI Oct, PPI OctUS: Trade Balance Sep,Import Prices Oct, UoMSentiment (Prel) Nov,Treasury Statement OctDuring Week: Germany WPI Oct14 Nov 15 Nov 16 Nov 17 Nov 18 NovJapan: GDP (Prel) Q3Eurozone: IndustrialProduction SepFrance: Current AccountSepAustralia: MPC MinutesEurozone: Trade BalanceSep, GDP (Flash) Q3UK: CPI OctGermany: GDP (Prel)Q3, ZEW Survey NovFrance: GDP (Prel) Q3,NF Payrolls (Prel) Q3,Wages (Prel) Q3Spain: CPI OctItaly: EU Trade Bal SepNeths: GDP Q3, RetailSales SepUS: Empire State SurveyNov, Retail Sales Oct,PPI Oct, Bus Inv SepJapan: BoJ RateAnnouncementEurozone: HICP Oct,EU15 New CarRegistrations OctUK: BoE Inflation Report,Labour OctSpain: GDP (Final) Q3Italy: CPI OctUS: CPI Oct, IndustrialProduction Oct, TICSData Sep, NAHB HMI NovEurozone: GoverningCouncil Meeting (No RateAnnouncement)UK: Retail Sales OctSweden: Labour OctNeths: Labour OctUS: New Home StartsOct, Philly Fed SurveyNov21 Nov 22 Nov 23 Nov 24 Nov 25 NovJapan: BoJ MonetaryPolicy Meeting Minutes,Trade Balance OctEurozone: CurrentAccount SepItaly: Non-EU TradeBalance OctUS: Existing Home SalesOctUK: PPI Oct, PSNB Oct,PSNCR OctNorway: GDP Q3US: GDP (Final) Q3,Corporate Profits Q3Japan: HolidayEurozone: Ind OrdersSep, PMIs (Flash) NovUK: BoE MPC MinutesFrance: Industry SurveyNovNorway: Labour SepUS: Durable GoodsOrders Oct, PICE Oct,UoM Sentiment (Final)Nov, FOMC MinutesUK: GDP (Prel) Q3Germany: GDP (Final)Q3, Ifo Survey NovItaly: Cons Conf NovSweden: ConsumerConfidence Nov, PPI OctNeths: ProducerConfidence NovBelgium: BusinessConfidence NovUS: HolidayDuring Week: Germany GfK Consumer Confidence Survey Dec, Retail Sales Oct, Import Price Index Oct28 Nov 29 Nov 30 Nov 1 Dec 2 DecEurozone: MonetaryDevelopments OctGermany: CPI (Prel) NovFrance: Job Seekers OctSweden: Retail SalesOct, Trade Balance OctUS: New Home Sales OctJapan: Labour Oct,Household ConsumptionOct, Retail Sales OctEurozone: Business &Consumer Survey (Nov),EU Finance MinistersMeet in BrusselsFrance: Housing StartsOctItaly: Wages OctSpain: HICP (Flash) Nov,Retail Sales OctBelgium: CPI NovSweden: GDP Q3US: S&P/Case-ShillerHome Prices Sep, FHFAHPI Sep, ConsumerConfidence NovJapan: IP Oct, HousingStarts OctEurozone: HICP (Flash)Nov, Labour OctUK: GfK Cons Conf NovGermany: Labour OctFrance: Retail Sales Oct,PPI OctSweden: CA Q3Norway: Retail Sales OctItaly: CPI (Prel) Nov, PPIOct, Labour OctSwitzerland: KoF NovUS: ADP Labour Nov, Prod& Costs (Final) Q3, BeigeBook, Chicago PMI Nov,Pending Home Sales Oct,Challenger Layoffs Nov,Canada: GDP SepAustralia: Retail SalesOctEurozone: ManufacturingPMI (Final) NovUK: BoE PressConference & FinancialPolicy StatementSwitzerland: GDP Q3,PMI NovUS: ISM ManufacturingNov, Construction OctJapan: CGPI Oct, TertiaryIndex SepUK: PPI OctSpain: GDP (Flash) Q3Sweden: PES Labour OctHoliday: France, USGermany: PPI OctItaly: Industrial Orders SepNeths: ConsumerConfidence NovBelgium: ConsumerConfidence NovUS: Leading Indicators OctCanada: CPI OctJapan: CPI Tokyo Nov, CPINational OctFrance: ConsumerConfidence NovItaly: Retail Sales SepSpain: PPI OctEurozone: PPI OctNorway: UnemploymentNovUS: Labour NovCanada: Labour NovDuring Week: UK Nationwide House Prices Nov, Halifax House Prices NovSource: BNP ParibasRelease dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions79www.GlobalMarkets.bnpparibas.com

Treasury and SAS Issuance CalendarThis section is classified as non-objective researchIn the pipeline - Treasuries:Japan: 15y Floating-rate JGB buy-backs for JPY 0.6trn and 10y Inflation-Indexed JGB buy-backs for JPY 0.15trn in Q4Italy: BTP Nov 2014 (new) to be issued in Q4Germany: In Q4, intends to issue inflation-linked federal securities (EUR 2-3bn) and reserves the right to issue foreign currency bondsUK: Gilt Purchase Programme has resumed; to be conducted for a 4mth period; the size of the programme will be kept under review; dates orfrequency may change depending on hols and market conditionsUK: Cancelled the mini-tender scheduled for the week commencing 28 NovemberUK: Mini-tender in the week commencing 12 December (choice of gilt on Fri 2 Dec)UK: Plans to offer, via syndication, a new index-linked gilt (12-20y area) in H2 of NovemberFinland: Plans to arrange a EUR benchmark bond auction in Q4 (details one week prior to the auction)Czech Rep.: May delay plans to sell Eurobonds this yearHungary: May sell foreign-currency denominated bonds this year to prefinance 2012, depending on the international situationIn the pipeline - Agencies:EFSF: Issues initially scheduled in Q4 2011 in support of Portugal could now be issued in early 2012EFSF: Plans to issue one benchmark bond for Ireland (EUR 3bn) before year endDate Day Closing Country Issues Details BNPP forecastsLocal GMT28/10 Fri 10:55 08:55 Italy BTP 4.25% 1 Jul 2014 EUR 2.5-3.25bnCCTeu 15 Oct 2017EUR 0.5-1bnBTP 4.25% 1 Sep 2019EUR 0.5-1.25bnBTP 5% 1 Mar 2022EUR 2-3bn13:00 17:00 US Outright T. Coupon Sales (Oct 2013 - Feb 2014) USD 8-9bnFHLMC Notes 27 Nov 2013 (new, syndicated)31/10 Mon 14:45 14:45 UK Gilt Purchase (13 Gilts 2015-2021) GBP 1.7bn12:00 11:00 Belgium OLO 4% 28 Mar 2014 (OLO 54)OLO 3.5% 28 Jun 2017 (OLO 63)28 Oct EUR 1-2bnOLO 4.25% 28 Sep 2021 (OLO 61)Slovak Rep. SLOVGB 3.5% 24 Feb 2016 (#213)EUR 0.1bn01/11 Tue 12:00 03:00 Japan JGB 20 Sep 2021 JPY 2.2tn14:45 14:45 UK Gilt Purchase (9 Gilts 2038-2060) GBP 1.7bnDenmark DGB 2.5% 15 Nov 2016DGB 3% 15 Nov 202112:00 16:00 Canada Repurchase of 7 Cash Mgt Bonds (Dec11 to Dec12) CAD 0.5bn02/11 Wed 11:00 10:00 Germany OBL 1.25% 14 Oct 2016 (Series 161) EUR 5bn14:45 14:45 UK Gilt Purchase (7 Gilts 2022-2036) GBP 1.7bn12:00 16:00 Canada CAN 3-year 27 Oct03/11 Thu 10:30 09:30 Spain Bono 4.25% 31 Oct 2016 31 Oct EUR 3-4bn10:50 09:50 France OATs 28 Oct EUR 7-9bn10:30 10:30 UK Gilt 4.25% 7 Jun 2032 GBP 2bn07/11 Mon 14:45 14:45 UK Gilt Purchase 3 Nov08/11 Tue 12:00 03:00 Japan Auction for Enhanced-liquidity 1 Nov JPY 0.3tn11:00 10:00 Austria RAGBs 1 Nov EUR 1-2bn10:30 10:30 UK Index-Linked Gilt 0.625% 22 Mar 2040 1 Nov14:45 14:45 UK Gilt Purchase 3 NovNeths DSL 3.25% 15 Jul 2021 EUR 1.5-2.5bn13:00 18:00 US Notes 3-year (new) 2 Nov USD 32bn09/11 Wed 14:45 14:45 UK Gilt Purchase 3 Nov12:00 17:00 Canada CAN 2-year 3 Nov13:00 18:00 US Notes 10-year (new) 2 Nov USD 24bn10/11 Thu 12:00 03:00 Japan JGB 40-year 3 Nov JPY 0.4tn13:00 18:00 US Bond 30-year (new) 2 Nov USD 16bn14/11 Mon 10:55 09:55 Italy 5-year BTP and possibly 15- or 30-year BTP 7 Nov EUR 6-9bn11:00 10:00 Norway NGBs 7 Nov14:45 14:45 UK Gilt Purchase 10 NovSlovak Rep. SLOVGB (For decision)15/11 Tue 12:00 03:00 Japan JGB 5-year 8 Nov JPY 2.5tn14:45 14:45 UK Gilt Purchase 10 NovDenmark DGBs 10 Nov16/11 Wed 11:00 10:00 Germany Schatz 13 Dec 2013 (new) EUR 6bn11:00 10:00 Sweden T-bonds 9 Nov SEK 2bn14:45 14:45 UK Gilt Purchase 10 Nov12:00 17:00 Canada CAN 30-year 10 Nov17/11 Thu 12:00 03:00 Japan Auction for Enhanced-liquidity 10 Nov JPY 0.3tn10:30 09:30 Spain Obligaciones 3 Nov EUR 3-5bn10:50 09:50 France BTANs 2- &/or 5-year 11 Nov EUR 7-9bn11:50 10:50 France OATis , OATeis, BTANeis 11 Nov EUR 1.5-2bn10:30 10:30 UK Gilt 5% 7 Mar 2018 8 Nov13:00 18:00 US TIPS 10-year 10 Nov USD 11bnSources: Treasuries, BNP ParibasInterest Rate Strategy 27 October 2011Market Mover80www.GlobalMarkets.bnpparibas.com

This section is classified as non-objective researchNext Week's T-Bill SupplyDate Country Issues Details28/10 UK T-Bills Nov 2011 GBP 0.5bnT-Bills Jan 2012GBP 1bnT-Bills Apr 2012GBP 1.5bnDenmark T-Bills Dec11 (SKBV 2011-IV)T-Bills Mar12 (SKBV 2012-I)T-Bills Jun12 (SKBV 2012-II)31/10 France BTF Feb 2012 EUR 4.5bnBTF Mar 2012EUR 1bnBTF May 2012EUR 2bnGermany Bubills Oct 2012 (new) EUR 2bnUS T-Bills Feb 2012 USD 29bnT-Bills May 2012USD 27bnFHLMC Bills 3-month & 6-month 28 Oct01/11 Japan T-Bills Feb 2012 JPY 5.1tnUS T-Bills 4-week 31 OctFHLB Discount Notes02/11 Portugal BT Feb 2012 EUR 0.75-1.25bnFNMA Bills 3-month & 6-month 31 Oct03/11 FHLB Discount Notes04/11 UK T-Bills 28 OctSources: Treasuries, BNP ParibasNext Week's Eurozone RedemptionsDate Country Details Amount31/10 Spain Obligacion 5.35% EUR 14.1bn01/11 Italy BTP 1.9% EUR 0.0bn01/11 Italy CCT EUR 15.5bnTotal Eurozone Long-term Redemption EUR 29.6bn31/10 Italy BOT (6m) EUR 8.5bn31/10 Neths DTC EUR 12.7bn01/11 Austria ATB (EU46) EUR 0.0bn03/11 France BTF EUR 8.3bnTotal Eurozone Short-term Redemption EUR 29.5bn2520Next Week's Eurozone CouponsCountrySpainGreeceTotal Long-term Coupon PaymentsChart 1: Investors’ Net Cash Flows(EUR bn, 10y equivalent)AmountEUR 3.3bnEUR 0.9bnEUR 4.2bnNet Investors' Cash Flows(EUR bn , 10y equivalent)151050-5Comments and charts• EGB gross supply is expected to increase toEUR 18bn in the week ahead, up from EUR 14bn thisweek. In 10y duration-adjusted terms, this would beequivalent to EUR 13bn. As EUR 30bn bonds willmature, net supply will be negative again in the comingweek.• Belgium will kick off on Monday with the reopeningof OLO Mar-14, OLO Jun-17 and OLO Sep-21 for anestimated amount of EUR 1-2bn. Germany will follow onWednesday with a 5y tap for EUR 5bn. Then, onThursday, Spain and France will close the week with atap of SPGB 5y for about EUR 3-4bn (estimated) andOATs for EUR 7-9bn (estimated).• Outside of the eurozone, the UK will issue GBP 2bnof Gilt 2032, and Japan will raise JPY 2.2trn in the10y.-10-151614121086420Week of Oct 31st Week of Nov 7th Week of Nov 14th Week of Nov 21thChart 2: EGB Gross Supply Breakdown byCountry (EUR bn, 10y equivalent)Germany Italy Portugal BelgiumFrance Spain Netherlands AustriaFinland Greece IrelandWeek of Oct 31st Week of Nov 7th Week of Nov 14th Week of Nov 21thChart 3: EGB Gross Supply Breakdown byMaturity (EUR bn, 10y equivalent)141210EGBs Gross Supply (EUR bn, 10y equivalent)2-3-YR 5-7-YR10-YR >10-YR86420Week of Oct 31st Week of Nov 7th Week of Nov 14th Week of Nov 21thAll Charts Source: BNP ParibasInterest Rate Strategy 27 October 2011Market Mover81www.GlobalMarkets.bnpparibas.com

Central Bank WatchInterest RateEUROZONECurrentRate (%)Minimum Bid Rate 1.50USFed Funds Rate 0 to 0.25Discount Rate 0.75JAPANCall Rate 0 to 0.10Basic Loan Rate 0.30UKBank Rate 0.5DENMARKLending Rate 1.55SWEDENRepo Rate 2.00NORWAYSight Deposit Rate 2.25SWITZERLAND3 Mth LIBOR TargetRangeCANADA0 to 0.25Overnight Rate 1.00Bank Rate 1.25AUSTRALIACash Rate 4.75CHINA1Y Bank LendingRateBRAZIL6.56Selic Overnight Rate 11.50Date ofLastChange+25bp(7/7/11)-75bp(16/12/08)+25bp(18/2/10)-10bp(5/10/10)-20bp(19/12/08)-50bp(5/3/09)+25bp(7/7/11)+25bp(5/7/11)+25bp(12/5/11)-50bp(3/8/11)+25bp(8/9/10)+25bp(8/9/10)+25bp(2/11/10)+25bp(6/7/11)-50bp(19/10/11)Next Change inComing 6 Months-50bp (8/12/11)No ChangeNo ChangeNo ChangeNo ChangeNo Change-50bp (8/12/11)-25bp (16/2/12)+25bp(14/3/12)No Change-25bp (17/1/11)-25bp (17/1/11)-25bp (6/12/11)No Change-50bp(30/11/11)Source: BNP ParibasFor the full EM Central Bank Watch, please see our Local Markets Mover.CommentsThe ECB focused on unconventional measures at its Octobermeeting but left the door open to a future reduction in policy rates.We forecast a 50bp rate cut in December in tandem with the nextround of staff projections.The FOMC is expected to keep the Fed funds rate at 0-0.25%for at least the next couple of years and the Fed launchedOperation Twist in September. In light of the deterioration in thegrowth outlook and financial market conditions, we expect athird round of quantitative easing to be announced at or beforethe end of the year.Economic activity has been picking up steadily on an easing ofthe supply-side constraints caused by the 11 March earthquake.However, should the yen appreciate sharply again, the BoJ mayonce more be forced to ease policy.QE was increased by GBP 75bn in October. We look for anotherGBP 50bn by February.We expect the central bank to deliver a rate cut in line with theECB. But if the krone continues to appreciate, further cuts in theinterest rate on certificates of deposit are likely.We expect the Riksbank to remain on hold this year and delivera rate cut in February, as growth slows and inflation moderates.Due to increased uncertainty regarding the economic outlookand low inflation, the next rate hike is to come in Q1 next year inour view, with a risk of it coming later than Q1.The SNB has implemented a peg to the euro. A minimumexchange rate of 1.20 against the euro will be enforced. The pegis the response to the appreciation of the franc and its risks toprice stability and growth outlook.The BoC has lowered its global and domestic growthexpectations sharply. This suggests that rates will remain low fora long time and that the BoC will probably cut its policy rate ifour expectations of a downturn in the US are realised.With global growth conditions set to deteriorate through to theend of the year and Australian business confidence alreadybelow trend, the RBA is likely to take out some insuranceagainst building downside risks by easing policy in Q4.The deterioration in the global growth outlook has reduced theodds of further rate hikes in China. However, because CPIinflation remains high, the authorities still have an incentive tonarrow the negative gap between the deposit rate and inflationto address a source of social discontent. The impact oneconomic growth should be limited.The central bank is cutting rates, aiming to mitigate the impact ofthe global slowdown on the domestic economy. We foresee afull cutting cycle of 300bp (if not more), with rates down to 9.5%by mid-2012, at a pace of (at least) 50bp per meeting.Change since our last weekly in bold and italicsMarket Economics 27 October 2011Market Mover82www.GlobalMarkets.bnpparibas.com

Economic ForecastsGDPYear 20112012(% y/y) ’11 (1) ’12 (1) ’13 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)US 1.6 0.7 2.4 2.2 1.6 1.6 0.8 0.4 0.5 0.5 1.4Eurozone 1.5 0.7 1.2 2.4 1.6 1.3 0.9 0.3 0.5 0.7 1.3Japan -0.6 1.3 1.1 -1.0 -1.1 -1.0 -0.1 1.0 1.9 1.1 1.1World (2) 3.9 3.3 4.1 4.4 3.9 3.8 3.4 3.1 3.1 3.2 3.7Industrial ProductionYear20112012(% y/y) ’11 (1) ’12 (1) ’13 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)US 3.6 0.7 2.9 5.4 3.7 3.3 1.9 0.2 0.6 0.3 1.7Eurozone 3.0 -0.7 1.6 6.6 4.1 3.0 -0.4 -1.1 -0.9 -0.3 1.8Japan -2.1 3.8 2.5 -2.6 -6.8 -0.4 1.0 3.1 8.0 2.6 1.9Unemployment RateYear2011 2012(%) ’11 (1) ’12 (1) ’13 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)US 9.1 9.2 8.6 8.9 9.1 9.1 9.2 9.2 9.3 9.2 9.2Eurozone 10.1 10.3 10.0 10.0 10.0 10.1 10.2 10.4 10.3 10.3 10.2Japan 4.7 4.6 4.3 4.7 4.6 4.7 4.7 4.7 4.6 4.5 4.5CPIYear20112012(% y/y) ’11 (1) ’12 (1) ’13 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1)US 3.2 1.8 1.8 2.1 3.4 3.8 3.4 2.3 1.8 1.5 1.6Eurozone 2.7 1.8 1.7 2.5 2.8 2.7 2.8 2.3 1.7 1.7 1.5Japan (Core) -0.2 -0.3 0.1 -0.8 -0.3 0.2 -0.1 -0.4 -0.4 -0.3 -0.1Current Account(% GDP) ’11 (1) Year’12 (1) ’13 (1) General Government(% GDP)’11 (1) Year’12 (1) ’13 (1)US -3.1 -2.9 -2.5 US (4) -8.5 -9.3 -7.6Eurozone -0.8 -0.6 -0.6 Eurozone -4.1 -3.1 -2.0Japan 2.1 1.3 1.0 Japan -11.1 -8.2 -8.0Interest Rate ForecastsYear20112012(%) ’11 (1) ’12 (1) ’13 (1) Q1 Q2 Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)USFed Funds Rate 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.253-month Rate 0.35 0.30 0.25 0.30 0.25 0.36 0.35 0.30 0.30 0.30 0.302-year yield 0.20 0.35 0.75 0.83 0.47 0.20 0.20 0.20 0.25 0.30 0.3510-year yield 2.20 3.00 3.25 3.47 3.16 1.72 2.20 2.50 2.60 2.75 3.002y/10y Spread (bp) 200 265 250 264 269 152 200 230 235 245 265EurozoneRefinancing Rate 1.00 1.00 1.00 1.00 1.25 1.50 1.00 1.00 1.00 1.00 1.003-month Rate 1.00 1.10 1.30 1.24 1.55 1.54 1.00 1.00 1.00 1.05 1.102-year yield (5) 0.40 1.00 1.75 1.80 1.61 0.41 0.40 0.50 0.70 0.85 1.0010-year yield (5) 2.00 3.00 3.25 3.35 3.01 1.67 2.00 2.25 2.50 2.75 3.002y/10y Spread (bp) (5) 160 200 150 156 140 127 160 175 180 190 200JapanO/N Call Rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.103-month Rate 0.35 0.35 0.35 0.34 0.33 0.33 0.35 0.35 0.35 0.35 0.352-year yield 0.15 0.20 0.25 0.22 0.17 0.13 0.15 0.15 0.15 0.15 0.2010-year yield 0.90 1.15 1.30 1.26 1.14 0.99 0.90 1.00 1.10 1.10 1.152y/10y Spread (bp) 75 95 105 104 96 85 75 85 95 95 95Footnotes: (1) Forecast (2) BNPP estimates based on country weights in the IMF World Economic Outlook UpdateApril 2011 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated (5) German benchmarkSource: BNP ParibasMarket Economics 27 October 2011Market Mover83www.GlobalMarkets.bnpparibas.com

This publication is classified as non-objective researchFX Forecasts*USD Bloc Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14EUR/USD 1.45 1.48 1.50 1.50 1.48 1.45 1.40 1.40 1.40 1.34 1.31USD/JPY 75 73 70 70 75 80 90 90 90 88 90USD/CHF 0.83 0.84 0.83 0.87 0.88 0.90 0.93 0.93 0.93 0.97 0.99GBP/USD 1.58 1.61 1.60 1.60 1.61 1.61 1.57 1.59 1.59 1.70 1.60USD/CAD 0.94 0.91 0.90 0.90 0.90 0.91 0.94 0.96 0.98 1.00 1.00AUD/USD 1.12 1.15 1.18 1.18 1.15 1.10 1.05 1.02 1.00 0.95 0.95NZD/USD 0.86 0.87 0.87 0.91 0.92 0.90 0.88 0.85 0.83 0.76 0.76USD/SEK 6.34 6.22 6.07 6.07 6.08 6.14 6.29 6.29 6.29 6.94 7.02USD/NOK 5.20 5.05 4.85 4.85 4.86 5.03 5.33 5.46 5.46 5.07 5.34EUR Bloc Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14EUR/JPY 109 108 105 105 111 116 126 126 126 118 118EUR/GBP 0.92 0.92 0.94 0.94 0.92 0.90 0.89 0.88 0.88 0.79 0.82EUR/CHF 1.20 1.25 1.25 1.30 1.30 1.30 1.30 1.30 1.30 1.30 1.30EUR/SEK 9.20 9.20 9.10 9.10 9.00 8.90 8.80 8.80 8.80 9.30 9.20EUR/NOK 7.54 7.48 7.28 7.28 7.20 7.30 7.46 7.65 7.65 6.80 7.00EUR/DKK 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46Central Europe Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14USD/PLN 2.93 3.11 3.00 2.93 2.84 2.83 2.86 2.79 2.71 2.65 2.67EUR/CZK 25.0 24.3 24.1 23.8 23.5 23.7 24.0 23.5 23.3 23.1 23.0EUR/HUF 292 290 285 280 280 270 265 260 260 250 245USD/ZAR 7.60 7.25 7.00 6.80 6.70 7.20 7.10 7.00 6.90 7.21 7.37USD/TRY 1.78 1.75 1.68 1.72 1.73 1.72 1.70 1.69 1.69 1.54 1.55EUR/RON 4.29 4.25 4.20 4.05 4.10 4.20 4.20 4.10 3.95 3.90 3.80USD/RUB 30.27 29.61 28.98 27.76 27.14 27.44 28.39 27.97 28.81 28.19 28.96EUR/PLN 4.25 4.60 4.50 4.40 4.20 4.10 4.00 3.90 3.80 3.55 3.50USD/UAH 8.0 8.0 8.0 8.0 8.0 7.8 7.7 7.5 7.3 7.4 7.4EUR/RSD 100 98 97 96 95 93 92 91 90 85 84Asia Bloc Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14USD/SGD 1.20 1.18 1.17 1.16 1.15 1.14 1.13 1.12 1.11 ----- -----USD/MYR 2.96 2.93 2.87 2.83 2.80 2.77 2.75 2.73 2.70 ----- -----USD/IDR 8500 8300 8100 8000 7900 7800 7700 7600 7500 ----- -----USD/THB 29.70 29.30 28.70 28.50 28.30 28.00 27.70 27.50 27.50 ----- -----USD/PHP 42.50 41.80 41.00 40.50 40.00 39.50 39.00 38.50 38.00 ----- -----USD/HKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 ----- -----USD/RMB 6.31 6.28 6.24 6.18 6.12 6.05 5.98 5.93 5.89 ----- -----USD/TWD 29.30 28.70 28.30 27.80 27.30 27.00 26.70 26.50 26.00 ----- -----USD/KRW 1080 1040 1010 1000 990 980 970 960 950 ----- -----USD/INR 46.00 45.50 45.00 44.50 44.00 43.50 43.00 42.50 42.00 ----- -----USD/VND 20800 20700 20600 20500 20400 20300 20200 20100 20000 ----- -----LATAM Bloc Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14USD/ARS 4.45 4.54 4.68 4.79 4.95 5.10 5.20 5.35 5.55 5.70 5.85USD/BRL 1.85 1.80 1.75 1.72 1.67 1.68 1.69 1.70 1.71 1.72 1.73USD/CLP 470 460 440 450 455 458 462 466 470 473 475USD/MXN 12.70 12.40 12.10 11.70 11.40 11.43 11.48 11.55 11.60 11.61 11.63USD/COP 1780 1760 1735 1729 1720 1700 1715 1725 1735 1740 1745USD/VEF 4.29 4.29 4.29 4.29 4.29 8.80 8.80 8.80 8.80 8.80 8.80USD/PEN 2.68 2.66 2.65 2.63 2.62 2.62 2.63 2.64 2.64 2.65 2.66Others Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14USD Index 73.63 72.10 71.03 71.13 72.33 73.98 77.33 77.37 77.52 79.25 81.22*End QuarterForeign Exchange Strategy 27 October 2011Market Moverwww.GlobalMarkets.bnpparibas.com84

Market CoverageMarket EconomicsPaul Mortimer-Lee Global Head of Market Economics London 44 20 7595 8551 paul.mortimer-lee@uk.bnpparibas.comKen Wattret Chief Eurozone Market Economist London 44 20 7595 8657 kenneth.wattret@uk.bnpparibas.comLuigi Speranza Head of Inflation & Fiscal Economics, London 44 20 7595 8322 luigi.speranza@uk.bnpparibas.comEurozone, ItalyDavid Tinsley UK, Ireland London 4420 7595 8150 david.tinsley@uk.bnpparibas.comGizem Kara Scandinavia London 44 20 7595 8783 gizem.kara@uk.bnpparibas.comEvelyn Herrmann Europe London 44 20 7595 8476 evelyn.herrmann@uk.bnpparibas.comDominique Barbet Eurozone, France Paris 33 1 4298 1567 dominique.barbet@bnpparibas.comJulia Coronado Chief Economist North America New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.comJeremy Lawson US New York 1 212 471-8180 Jeremy.lawson@ americas.bnpparibas.comYelena Shulyatyeva US New York 1 212 841 2258 yelena.shulyatyeva@americas.bnpparibas.comBricklin Dwyer US, Canada New York 1 212 471-7996 bricklin.dwyer@americas.bnpparibas.comRyutaro Kono Chief Economist Japan Tokyo 81 3 6377 1601 ryutaro.kono@japan.bnpparibas.comHiroshi Shiraishi Japan Tokyo 81 3 6377 1602 hiroshi.shiraishi@japan.bnpparibas.comAzusa Kato Japan Tokyo 81 3 6377 1603 azusa.kato@japan.bnpparibas.comMakiko Fukuda Japan Tokyo 81 3 6377 1605 makiko.fukuda@japan.bnpparibas.comRichard Iley Head of Asia Economics Hong Kong 852 2108 5104 richard.iley@asia.bnpparibas.comDominic Bryant Asia, Australia Hong Kong 852 2108 5105 dominic.bryant@asia.bnpparibas.comMole Hau Asia Hong Kong 852 2108 5620 mole.hau@asia.bnpparibas.comXingdong Chen Chief China Economist Beijing 86 10 6535 3327 xd.chen@asia.bnpparibas.comKen Peng Senior Economist , China China 86 10 6535 3380 ken.peng@asia.bnpparibas.comChan Kok Peng Chief Economist South East Asia Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.comMarcelo Carvalho Head of Latin American Economics São Paulo 55 11 3841 3418 marcelo.carvalho@br.bnpparibas.comGustavo Aruda Latin American Economist São Paulo +1-212-471-6599 gustavo.arruda@amecias.bnpparibas.comNader Nazmi Latin America New York 1 212 471 8216 nader.nazmi@us.bnpparibas.comFlorencia Vazquez Latin American Economist Buenos Aires 54 11 4875 4363 florencia.vazquez@ar.bnpparibas.comMichal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.comJulia Tsepliaeva Russia & CIS Moscow 74 95 785 6022 julia.tsepliaeva@ru.bnpparibas.comSelim Cakir Chief Economist Turkey, GCC, South Africa Istanbul 90 216 635 2972 selim.cakir@teb.com.trEmre Tekmen Economist Turkey, GCC and South Africa Istanbul 90 216 635 2975 emre.tekmen@teb.com.trNazli Toragan Economist Turkey, GCC and South Africa IIstanbul 90 216 635 2986 lnazli.toraganli@teb.com.trInterest Rate StrategyCyril Beuzit Global Head of Interest Rate Strategy London 44 20 7595 8639 cyril.beuzit@uk.bnpparibas.comPatrick Jacq Europe Strategist Paris 33 1 4316 9718 patrick.jacq@bnpparibas.comHervé Cros Chief Inflation Strategist London 44 20 7595 8419 herve.cros@uk.bnpparibas.comShahid Ladha Inflation & UK Strategist London 44 20 7 595 8573 shahid.ladha@uk.bnpparibas.comAlessandro Tentori Chief Alpha Strategy Europe London 44 20 7595 8238 alessandro.tentori@uk.bnpparibas.comEric Oynoyan Europe Strategist London 44 20 7595 8613 eric.oynoyan@uk.bnpparibas.comMatteo Regesta Europe Strategist London 44 20 7595 8607 matteo.regesta@uk.bnpparibas.comIoannis Sokos Europe Strategist London 44 20 7595 8671 ioannis.sokos@uk.bnpparibas.comCamille de Courcel Europe Strategist London 44 20 7595 8295 camille.decourcel@uk.bnpparibas.comBülent Baygün Head of Interest Rate Strategy US New York 1 212 471 8043 bulent.baygun@americas.bnpparibas.comMary-Beth Fisher US Strategist New York 1 212 841 2912 mary-beth.fisher@us.bnpparibas.comAaron Kohli US Strategist New York 1 212 841 2026 aaron.kohli@americas.bnpparibas.comSuvrat Prakash US Strategist New York 1 917 472 4374 suvrat.prakash@americas.bnpparibas.comAnish Lohokare MBS Strategist New York 1 212 841 2867 anish.lohokare@americas.bnpparibas.comOlurotimi Ajibola MBS Strategist New York 1 212 8413831 olurotimi.ajibola@americas.bnpparibas.comBo Peng US Strategist New York 1 212 8412241 bo.peng@americas.bnpparibas.comTomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1703 Tomohisa.fujiki@japan.bnpparibas.comHidehiko Maejima Japan Strategist Tokyo 81 3 6377 1701 Hidehiko.maejima@japan.bnpparibas.comChristian Séné Technical Analyst Paris 33 1 4316 9717 christian.séné@bnpparibas.comFX StrategyRay Attrill Head of FX Strategy – North America New York 1 212 841 2492 raymond.attrill@us.bnpparibas.comMary Nicola FX Strategist New York 1 212 841 2492 mary.nicola@americas.bnpparibas.comSteven Saywell Head of FX Strategy - Europe London 44 20 7595 8487 steven.saywell@uk.bnpparibas.comKiran Kowshik FX Strategist London 44 20 7595 1495 kiran.kowshik@bnpparibas.comJames Hellawell Quantitative Strategist London 44 20 7595 8485 james.hellawell@uk.bnpparibas.comLocal Markets FX & Interest Rate StrategyDrew Brick Head of FX & IR Strategy Asia Singapore 65 6210 3262 Drew.brick@asia.bnpparibas.comChin Loo Thio FX & IR Asia Strategist Singapore 65 6210 3263 chin.thio@asia.bnpparibas.comRobert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 robert.ryan@asia.bnpparibas.comJasmine Poh FX & IR Asia Strategist Singapore 65 6210 3418 jasmine.j.poh@asia.bnpparibas.comGao Qi FX & IR Asia Strategist Shanghai 86 21 2896 2876 gao.qi@asia.bnpparibas.comBartosz Pawlowski Head of FX & IR Strategy CEEMEA London 44 20 7595 8195 Bartosz.pawlowski@uk.bnpparibas.comDina Ahmad FX & IR CEEMEA Strategist London 44 20 7 595 8620 dina.ahmad@uk.bnpparibas.comErkin Isik FX & IR CEEMEA Strategist Istanbul 90 (216) 635 29 87 erkin.isik@teb.com.trDiego Donadio FX & IR Latin America Strategist São Paulo 55 11 3841 3421 diego.donadio@@br.bnpparibas.com85

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