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Market Economics | Interest Rate Strategy | Forex Strategy 20 January 2011 

Market Mover 

Market Outlook 2-3 

Fundamentals 4-30 

• Global Inflation: Ready for Takeoff? 4-9 

• US: FOMC to Hold the Line 10-12 

• Canada: Betting on Investment and 13-14 

Exports 

• Eurozone Inflation: Forecast 15-17 

Revision 

• ECB: Bark or Bite? 18-21 

• ECB Inflation Performance: A 22-23 

Review 

• Eurozone: BoP Leaves Euro 

24 

Vulnerable 

• Norway: Norges Bank Preview 25-26 

• Japan: New Cabinet and Policy 27-28 

Outlook 

• Japan: Capex Outlook 29-30 

Interest Rate Strategy 31-58 

• US/EUR Spreads: Further 31-32 

Tightening Near Term 

• US: Could the Short End Have a 33 

Pulse? 

• US: Setup for Auctions With Spread 34-35 

Curve Flatteners 

• MBS: Stay Long 36-38 

• EUR: Liquidity is No Stress 39 

• EUR: Bund ASW Risk/Reward 40 

Analysis 

• EMU Debt Monitor: Trade Ideas, 41-46 

CDS, RV Charts, Redemptions, SSA 

& Covered Bonds 

• EUR: Buy 3m5y Straddle vs 3m10y 47 

Straddle: 

• JGBs: Commodities – A Headwind 48 

• Global Inflation Watch 49-52 

• Inflation: With Supply Comes 53-55 

Opportunities 

• Technical Analysis 56-57 

• Trade Reviews 58 

FX Strategy 59-65 

• Strategy: Travelling Asia 59-62 

• Technical Strategy: EURUSD Rally 63-64 

Eyes 1.3750-1.3950 

• Trading Positions 65 

Commodities 66-68 

• Oil Update: Brent Premium the New 66-68 

Norm 

Forecasts & Calendars 69-83 

• 1 Week Economic Calendar 69-70 

• Key Data Preview 71-78 

• 4 Week Calendar 79 

• Treasury & SAS Issuance 80-81 

• Central Bank Watch 82 

• Economic & Interest Rate Forecasts 83 

• FX Forecasts 84 

Contacts 85 

www.GlobalMarkets.bnpparibas.com 

• The short-run strategy call for Treasuries remains 

neutral. With the market in a narrow range, the preference 

is to play the curve via the 5/10s flattener. 

• The FOMC meeting is a two-day affair, with the Fed to 

set out its quarterly forecasts ahead of the Chairman’s 

semi-annual testimony to Congress in February. 

• The FOMC opted for a cautious interpretation of the 

improvement in the economy in December and more of the 

same is likely in this month’s statement. 

• Positives for core EGB markets are in short supply. 

Supply is heavy and macro news flow remains strong. 

Curve wise, flattening remains the call. 

• EGB spreads have been in a trading range, albeit a wide 

one, as markets await news on amendments to the EFSF. 

This may take a while, as politicians tend to take their 

collective foot off the gas when markets calm. 

• Anxiety at the ECB over upside risks to inflation has 

increased but subdued wage pressures continue to 

suggest that there is no need to panic. 

• In the UK, in contrast, inflation worries are more 

pressing. This should be reflected in the Bank of England 

MPC minutes out next week. 

• The JGB market continues to lack direction and 10-year 

yields should remain in the existing ranges. 

Market Views 

Current 1 Week 1 Month 

UST 10y T-note Yield (%) 3.40 ↔ ↓ 

2y/10y Spread (bp) 280 ↔ ↓ 

EGB 10y Bund Yield (%) 3.15 ↔ ↓ 

2y/10y Spread (bp) 190 ↔ ↓ 

JGB 10y JGB Yield (%) 1.21 ↔ ↔ 

2y/10y Spread (bp) 102 ↔ ↔ 

Forex EUR/USD 1.3445 ↑ ↓ 

USD/JPY 82.99 ↓ ↑ 

IMPORTANT NOTICE. Please refer to important disclosures found at the end of 

this report. Some sections of this report have been written by our strategy teams 

(shown in blue). Such reports do not purport to be an exhaustive analysis and may 

be subject to conflicts of interest resulting from their interaction with sales and 

trading which could affect the objectivity of this report.

Market Outlook 

Further flattening for 

Treasuries 

The strategy call for the Treasury market remains a neutral one in the short 

run, with a bias towards recommending long positioning later in the month. 

The market remains stuck in a very narrow range and instead of directional 

trades, the preference is to play the curve via the 5/10s flattener instead. 

With regard to macro news flow, the FOMC meeting next week looms large. 

It will be a two-day meeting, with the Fed to set out its quarterly forecasts 

ahead of the Chairman’s semi-annual testimony to Congress in February. 

Data have continued to confirm that Q4 is shaping up to be a strong quarter 

for final demand growth but the labour market indicators have shown little 

benefit to date. Headline inflation has picked up but the core rate, and wage 

pressure, remains unusually low. 

Fed status quo likely… 

…despite musical chairs at 

the FOMC 

Supply problem for 

EGBs… 

At December’s meeting, the FOMC opted for a cautious interpretation of the 

improvement in the economy and this is likely to continue. Indeed, Bernanke 

reiterated that cautious stance at his Congressional testimony following the 

release of December’s employment report, saying: “though recent indicators 

of spending and production have generally been encouraging, conditions in 

the labour market have improved only modestly at best…overall, the pace of 

economic recovery seems likely to be moderately stronger in 2011 than it 

was in 2010”. Most Fed speakers have publicly supported the completion of 

QE2 and we expect little change to the tone of the policy statement to be 

released on Wednesday. 

There may be some speculation over the implications of the annual rotation 

of FOMC voters. All Governors at the Federal Reserve Board are permanent 

voting members, as is the President of the New York Fed. However, four of 

the twelve regional bank presidents serve rotating one-year terms as voters. 

The regional Fed Presidents which are rotating in as voters this year have a 

more hawkish bent than those rotating out. This is not expected to make a 

material difference to the policy stance but it does open up the possibility of 

some dissent. President Plosser is the most probable dissenter as he has 

opposed nearly all of the Fed’s unconventional policies. 

The evolution of core EGBs over the last few sessions points to the absence 

of positive factors for sovereign debt during a period of huge supply. The 

market is struggling to absorb the paper at present, with supply apparently 

far outstripping demand. There is tentative evidence to suggest that what is 

bad news for the peripheral markets will also weigh on the core as the bigger 

the fiscal difficulties in the former, the bigger the burden on the latter. 

In this context, and with the macro news flow in Germany still going strong, 

positives for core markets are in short supply. The strategy call remains a 

neutral one, therefore. Curve wise, flattening remains the call. The front end 

has, according to our assessment of the economic and fiscal outlook, moved 

too far, too fast in discounting more than one rate hike this year. However, it 

makes sense for the market to discount a less favourable ECB scenario than 

previously given the signals of increased anxiety over inflation risks. 

…as we await progress on 

EFSF changes 

Regarding EGB spreads, peripheral and core markets have also been in a 

trading range, albeit with a wide corridor. This situation is likely to persist as 

long as there is no agreement forthcoming on the proposed amendments to 

the EFSF – this could yet take a while. 

Ken Wattret 20 January 2011 


2 

www.GlobalMarkets.bnpparibas.com

The obvious focal point is the Summit on 4 February but on the basis of the 

comments from the German finance minister, amongst others, reaching an 

agreement by that time looks optimistic. More likely it will have to wait until 

March. In part, the delay reflects the differences of opinion at the national 

level on the proposals put forward. It also reflects the German government’s 

desire to secure something in exchange – a constitutional commitment to 

balanced budgets perhaps? 

More worryingly, it is also due to the tendency of the politicians to take their 

collective foot off the gas when markets calm down. A more effective way to 

bolster confidence in a lasting way would be to surprise markets positively 

with a swift, credible agreement when the markets are already in a positive 

frame of mind. We live in hope. 

4.5 

Eurozone: Pay Pressures Contained 

4.0 

Hourly Labour Costs (% y/y) 

3.5 

3.0 

2.5 

2.0 

1.5 

Negotiated Wages (% y/y) 

1.0 

Compensation per Employee (% y/y) 

0.5 

97 98 99 00 01 02 03 04 05 06 07 08 09 10 

Source: Reuters EcoWin Pro 

ECB inflation worries 

overdone… 

…given subdued pay 

pressures 

UK inflation concerns point 

to MPC shift 

JGBs in the range 

The level of anxiety at the ECB over upside risks to inflation has increased 

and the risk of an earlier start to the tightening cycle than we have forecast 

(from spring 2012) has risen accordingly. The ECB still expects inflation to 

remain in line with its definition of price stability over the medium term but it 

intends to monitor the risks to this scenario very closely – as will we. 

One of the risks to monitor is second-round effects on inflation via higher 

wage growth. As in December, the assessment of labour cost developments 

in the eurozone in this month’s ECB Monthly Bulletin was benign. To quote: 

“Labour cost indicators…continued to show subdued wage pressures…in 

line with continuously weak labour market conditions.” Growth rates in hourly 

labour costs and negotiated wages are both at their lowest on record. No 

panic required. 

In the UK, we expect the BoE MPC minutes next week to show increasing 

unease about the deterioration in inflation prospects. The MPC will have 

been made aware of the latest upward surprise in inflation (up to 3.7% y/y) 

which has reinforced our belief that inflation will exceed 4% by February – 

double the Bank's target. The market will look for clues as to how soon the 

first rate hike will be delivered. The initial focus is likely to be on whether 

arch hawk Andrew Sentance was joined by any other MPC members in 

voting for an immediate hike and to a lesser extent, whether Adam Posen 

has backed down in his bid to secure a second round of QE. Given the 

mixed picture on activity and labour market data, we suspect that the latter is 

more likely than the former at this stage. 

The JGB market continues to lack direction and 10-year yields should stay in 

a range of 1.1–1.3% for the time being as investors sit on the sidelines. Next 

week's BoJ Monetary Policy Meeting is not expected to result in any new 

action from the central bank. 



3 


Global Inflation: Ready for Takeoff? 

• The global output gap is very small and may 

have closed. We look like going well beyond 

capacity in the next couple of years. The fact 

that capacity utilisation is very uneven raises 

the global inflation threat. 

Chart 1:La Niña, El Nino and Food Prices 

• Commodity price shocks are likely to 

continue due to the lagged effects of La Niña 

and global warming, though next year some of 

these effects may ease. 

• Monetary policy on a global basis is too 

slack, especially in Asia. US policy is amongst 

the slackest. While this is appropriate for the 

US, exchange rate arrangements may mean this 

is imported into inappropriate settings such as 

EMs. 

Source: Reuters EcoWin Pro. 

Chart 2:Global Output Gap 

• Inflationary expectations are very low in 

North America. Elsewhere, they are moderate to 

high. The objective of the US is to avoid 

deflation by raising inflation expectations. 

Countries limiting the appreciation of their 

currency are importing the Fed’s objective of 

raising inflation. 

• The risks of global inflation are high. 

Capacity is tight, monetary policy is slack and 

central banks are acting weak. The discipline of 

pegging to the reserve currency is gone from 

much of the world because the reserve currency 

has an ultra-easy policy and is aiming to raise 

inflation. The risk of a surge of inflation and a 

dislocation of inflation expectations is high in 

many countries. 

• The key thing to watch is inflation 

expectations. They have declined from their 

‘scare’ levels last year but the wild swings over 

the last couple of years shows they have 

become unstable. 

Source: Reuters EcoWin Pro, IMF and BNP Paribas 

The 50bp policy hike from BCB this week is the latest 

sign of concern. 

How anxious should we be about global inflation and 

what are the main drivers? 

There are four things we would identify as important 

for inflation over coming months: 

• Supply shocks; 

On 20 th Street and Constitution Avenue, the Fed is 

worrying about disinflation, and with good reason 

given the core reading of only 0.6% y/y for 

December. 

In most of the rest of the world, however, inflation is 

increasingly bullying its way to the top of the agenda. 

Mr Trichet on 13 January showed increasing 

concern. The UK inflation rate looks likely to top 4% 

soon. We recently saw a surprise rate hike from 

South Korea on the back of inflation worries and 

concerns are prominent in China, Brazil and India. 

• The output gap; 

• Monetary policy; and 

• Inflation expectations. 

Supply shocks 

Supply shocks are generally difficult to predict 

(though in La Niña years such “shocks” could be 

expected more than they are – wet weather on the 

western side of the Pacific being a frequent 

occurrence in such years). We are suffering from 

Paul Mortimer-Lee 20 January 2011 


4 


such shocks at the moment, such as extreme 

drought in Russia last year and unusually wet 

weather in parts of Australia now, following on from 

unusually cold conditions in the northern hemisphere 

in December. Crops are being affected and so food 

prices are rising faster than underlying demand and 

supply conditions would suggest. 

The traditional approach to such shocks is to argue 

that, while such effects may last for many months, if 

next year’s crops are more normal, the food price 

shocks may diminish or reverse. Against this, some 

believe that global warming is making extreme 

conditions more likely (e.g. the melting of sea ice in 

the Barents and Kara seas due to global warming 

may be responsible, by changing local wind systems, 

for the intense cold spell in Western Europe in 

December). There is some probability of this being 

correct, so our assumption is food inflation due to 

shocks may lessen next year. But there are unlikely 

to be significant falls in food prices. 

The output gap 

The output gap is a little like virtue – it’s somewhat 

difficult to define and tougher to measure, but you 

tend to find out from consequences when it’s not 

present. 

In order to calculate the global output gap, we have 

taken figures for the past and for forecast periods 

from the IMF’s WEO. We calculated the output gap 

using a Hodrick-Prescott filter. The results are shown 

in Chart 2. 

The chart shows a number of striking things: 

• The disinflationary trend in the 1990s was 

probably greatly helped by output being below 

trend; 

• The last burst of global inflation in 2007/2008 

was associated with output above trend; 

• The financial crisis resulted in a considerable 

loss of output relative to potential – about 5% on 

a global basis. However, output was about 2½% 

above potential before the crisis and so the 

output gap that emerged was quite small; 

• On the basis of IMF forecasts, output should be 

about potential in 2011; and 

• IMF growth forecasts suggest that output will be 

significantly above potential in coming years – by 

the most since the early 1980s, in fact. 

While the relationship between the output gap and 

inflation is not particularly tight on a global basis, in 

recent years changes in the output gap have seemed 

to offer a good explanation of changes in the rate of 

Chart 3: Global Output Gap vs GDP Deflator 


increase in the global GDP deflator (see Chart 3). In 

this context, the IMF’s projection of flat inflation from 

here but an increase in output relative to potential 

seems like dreaming. 

Our perspective is that there may be some 

shortcomings with the output gap estimates. The 

method of filtering may imply a more permanent loss 

of capacity than has in fact occurred, for example. 

However, the increases we are seeing in inflationary 

pressures in a number of traded commodities and in 

some emerging markets suggest that, globally, 

capacity has closed enough to generate hotspots of 

inflation, with a threat of this spreading. 

If the IMF’s forecast for global growth is right, a 

substantial excess of global demand over supply 

looks likely to emerge. This will be spread unevenly – 

excess demand being most prevalent in emerging 

markets, persisting alongside excess supply in G10 

economies. This unevenness will reduce the level of 

output at which inflation becomes a problem (prices 

are more likely to be rigid downwards than upwards). 

The upshot from the output gap analysis is that there 

is at least a significant risk that inflation will become a 

significant problem on a global basis, even if this is 

not yet our main scenario. 

Monetary policy 

People often think of monetary policy being 

summarised by the level of interest rates. Interest 

rates are a very useful instrument of policy, but as we 

have seen with QE in the US, by no means the only 

one. Monetary policy has many aspects and 

transmission channels – the level of real and nominal 

rates today, expectations of rates tomorrow, the 

exchange rate, credit spreads and equity and other 

asset prices. We have always been partial to our 

financial and monetary conditions index (FMCI). At 



5 


this juncture, we believe that looking at the FMCI 

rather than just at interest rates has become more 

important. 

Our latest Global Outlook contained a detailed report 

on FMCIs around the world. The broad summary is 

shown in Charts 4 to 8. Financial and monetary 

conditions in the US are soft, very soft (Chart 4). Our 

FMCI is about one and half standard deviations 

below average, compared with a low since 1990 of 

two and a half standard deviations. In the eurozone, 

conditions are 0.3 standard deviations below average 

(Chart 5) with UK conditions, as in the US, one and a 

half standard deviations below average. Canada’s 

reading is similar. Japanese conditions are slightly 

tighter than average, mostly reflecting the yen. 

Overall, advanced country monetary and financial 

conditions are about a standard deviation softer than 

the long-term average (Chart 6). 

In emerging markets, our FMCI for China has 

remained accommodative, with the latest reading 

showing conditions about a standard deviation softer 

than average (Chart 7). Korean and Brazilian FMCIs 

are softer than average, India’s is about average and 

Mexico’s is above average. Overall, our latest 

readings are that, in Latin America as a whole, 

FMCIs are a bit softer than average. In Asia ex 

Japan, they are about a standard deviation below 

average (Chart 8). 

Overall, the picture is of very soft monetary 

conditions in the west, especially the US, Canada 

and the UK, less so in mainland Europe and 

restrictive in Japan. In emerging markets, conditions 

look more or less neutral in Latam but with offsetting 

pictures in Brazil (soft) and Mexico (tighter than 

average). Asia looks soft. We have to judge these 

monetary conditions relative to where they ought to 

be, given inflation and the output gap. 

US and European conditions look to us to be 

appropriate – softer than average due to low inflation 

in core terms and still excess capacity. Given some 

parts of the eurozone are softer than others, 

monetary conditions within the eurozone are 

probably too soft for Germany and too tight for 

Ireland and Spain, for example. Japanese conditions 

look too tight. 

Source: BNP Paribas 



Chart 4: US FMCI 

Chart 5: Eurozone FMCI 

Chart 6: Advanced Country FMCI 

Chart 7: China FMCI 

We would argue that monetary conditions in 

emerging markets should be tighter than average 

given the lack of spare capacity and inflation starting 

to swell. In Asia, conditions violate this the most, 

including in China, helping to explain recent 

tightening moves. Brazil is also in the ‘far too soft’ 

camp, but Latam as a whole is neutral when it should 

be restrictive. 




6 


US monetary conditions, because the USD is the 

global reserve currency, also affect countries which 

peg or dirty float against the USD. Many of these 

have output gaps and inflation dynamics that are 

hugely different from those in the US. Importing 

super-soft US monetary policy is bound to lead to 

them having an inflation and asset-price risk. It 

appears to us that very few of these countries have 

excessively tight monetary policy, which is the usual 

excuse for their intervening to hold currencies down 

or using ‘macro-prudential’ policies (aka capital 

controls) to achieve the same ends. In fact, most of 

them have monetary policies that are too soft. We 

would argue that this is their choice and that inflation 

is a very likely result. They will see their exchange 

rates appreciate in real terms against the USD 

through excess inflation. Our preference would have 

been for nominal exchange rate appreciation, which 

would contain inflation, not aggravate it. 

Overall then, monetary conditions look too soft for a 

world where inflation is developing some hotpots and 

where capacity is used up. Asia is most vulnerable, 

Latam a bit less so. 

Expectations 

Economic theory puts a big weight on inflationary 

expectations in the story of how inflation is 

propagated. Unfortunately, these are difficult to 

model and predict and they may shift in a discrete 

way. The process by which inflation expectations are 

formed is probably one where they depend upon: 

• What people experience; 

• What central banks do; and 

• What central banks say. 

This determining relationship may not be stable. For 

example, in the UK, people have been experiencing 

significantly above-target inflation for a long time. 

The longer this continues, the greater the weight is 

likely to be on what they experience and the less the 

weight will be on what the Bank of England says. 

Therefore it may have to raise rates to keep inflation 

in check. We do have measures of inflation 

expectations for various countries, but for our 

purposes here we would like a consistent measure. 

The Ifo institute provides a measure of inflation 

expectations, with Charts 9 to 14 (attached) 

summarising the picture. What we find is that, after 

the financial crisis, inflation expectations plunged. 

There was a clear danger everywhere of this 

undermining activity and leading us into deflation, at 

least in some of the most important economies. 

Aggressive monetary policy counteracted this and 

inflation expectations rose sharply in late 2009-early 

2010. These overshot – reaching levels similar to 

Chart 8: Latam and Asia Ex-Japan FMCI 


those at the peak of the cycle in 2007 – and have 

since come back, especially in North America and 

Western Europe. 

The current picture is: 

• Inflation expectations in North America are very 

low, and declining, though not as low as in late 

2008/early 2009 when deflation was being 

expected. There is no threat to inflation from 

inflation expectations in N America. 

• Inflation expectations in Western Europe have 

come back from their peak, which was the 

highest in two decades. We should not 

concentrate on the fall since then as it was 

probably an exaggeration. The level of inflation 

expectations compared with the average since 

EMU began in 1999 is moderate to strong. 

Clearly, as the ECB has shown in its recent 

press conference, they want watching. 

• Inflation expectations in the CEE countries are 

worryingly high and on a sharp upward trajectory. 

CIS expectations are also high. 

• Asian inflation expectations have not come off 

their peak very much. They are high, though not 

as high as in the early-2008 food price scare 

episode. Nonetheless, with monetary conditions 

slack, inflation expectations in Asia look 

uncomfortable and deserve very close 

monitoring, especially as food price surges look 

to have an important impact in the inflation story. 

• Latam inflation expectations are high, even 

though they are lower than the peaks at the end 

of the last cycle and the 2010 ‘QE will cause 

inflation’ scare. 

Central banks are talking about achieving price 

stability, but decisive action is not being taken (e.g. 



7 


Brazil’s 50bp rate hike this week was insufficient to 

meet the challenges of an economy well beyond 

capacity and rising inflation expectations). With 

monetary policy likely to remain soft and with global 

commodity prices under upward pressure, what 

central banks say and what they do are not 

consistent. Further, people’s experience of higher 

inflation, especially of food, is likely to push inflation 

expectations up. 

This will not be welcome in many countries. But in 

the US, higher inflation expectations are probably a 

policy goal. Clearly, inflation expectations are low 

and falling. Clearly, there is massive excess capacity, 

especially in the labour market. Clearly, wages are 

weak and so are unit labour costs. Therefore there is 

a real and present danger of disinflation and even of 

deflation. Interest rates are at their zero lower bound 

and, despite QE, there seems to have been a 

‘liquidity trap’ like behaviour of long-term yields – with 

the central bank unable to get them low enough to 

bring the economy back to full employment. 

So how is the Fed to avoid disinflation? The 

traditional means is to narrow the output gap 

sufficiently to end the threat. But the gap is too wide. 

Moreover, since the ability to lower short-term rates 

is gone and the ability to lower long-term rates 

enough is lacking, the output gap will stay wide. So 

the main means of fighting inflation is to raise 

expectations of inflation down the road. Firms and 

individuals expecting inflation at a future date, when 

spare capacity is reduced, will price differently and 

act differently today. That is what “considerable 

period” was about in 2003 and it’s what QE2 is about 

today. 

In short, to overcome deflation today, look as though 

you will create inflation tomorrow. It’s like telling 

central banks facing deflation that the responsible 

thing to do is to be irresponsible. There are plenty of 

people who think QE2 is irresponsible – the Chinese, 

for example. You can criticise the Fed for pursuing a 

policy that will create inflation the day after tomorrow. 

But if the alternative is deflation today, is that such a 

bad policy? 

While the threat of disinflation remains real in the US 

– which is to say while payroll growth remains 

insufficient to significantly lower unemployment and 

while wages and pricing power remain subdued – 

then it would be wrong for the Fed to do anything 

other than to create expectations of future inflation. 

Thus we would expect that policy to persist “for an 

extended period”. 

The Fed’s ability to create inflation in the domestic 

economy is limited by the slackness of the labour 

market. Because of this and the fact that what people 

experience is an important part of expectations 

formation, it follows that to create expectations of 

inflation, it has to create expectations of inflation in 

import prices. In other words, the Fed probably wants 

to see global inflation high at present, or a weak 

dollar, or both. We can argue that an increase in oil 

prices is the “wrong sort of inflation” since it “taxes” 

consumers, but if the choice is between the wrong 

sort of inflation and deflation, then the Fed would 

probably take the former. 

The Fed has made explicit that its aim is to raise 

inflation, because US inflation is too low. If countries 

peg or dirty float against the USD, they are implicitly 

adopting a target to raise their own inflation rates. 

Since their inflation rates are above the US and in 

some cases already too high, the implication is that 

we should expect inflation expectations in their 

economies to rise. 

Summary 

• The global output gap is very small and may 

have closed. We look like going well beyond 

capacity in the next couple of years. The fact that 

capacity utilisation is very uneven raises the 

global inflation threat; 

• Commodity price shocks are likely to continue 

due to the lagged effects of La Niña and global 

warming, though next year some of these effects 

may decline; 

• Monetary policy on a global basis is too slack, 

especially in Asia. US policy is amongst the 

slackest. While this is appropriate for the US, 

exchange rate arrangements may mean this is 

imported into inappropriate settings such as 

EMs; 

• Inflationary expectations are very low in North 

America. Elsewhere, they are moderate to high. 

The objective of the US is to avoid deflation by 

raising inflation expectations. Countries limiting 

the appreciation of their currency are importing 

the Fed’s objective of raising inflation. 

• The risks of global inflation are high. Capacity is 

tight, monetary policy is slack and central banks 

are acting weak. The discipline of pegging to the 

reserve currency is gone from much of the world 

because the reserve currency has an ultra-easy 

policy and is aiming to raise inflation. The risk of 

a surge of inflation and a dislocation of inflation 

expectations is high in many countries; and 

• The key thing to watch is inflation expectations. 

They have declined from their ‘scare’ levels last 

year but the wild swings over the last couple of 

years show they have become unstable. 



8 


Chart 9: Asia- Ifo Expected Inflation 

Chart 10: North America- Ifo Expected Inflation 



Chart 11: W, Europe- Ifo Expected Inflation 

Chart 12: CIS- Ifo Expected Inflation 



Chart 13: Eastern Europe- Ifo Expected Inflation 

Chart 14: Latam- Ifo Expected Inflation 





9 


US: FOMC to Hold the Line 

• We do not expect any change in tone at the 

January FOMC meeting. 

• While the January voter rotation brings in a 

hawkish group, there seems to be solidarity in 

the near term. 

• The more difficult debates will arise as QE2 

nears completion and the Fed has still made 

little progress on its mandates. 

The FOMC will next week set its economic 

forecasts for the monetary policy report to 

Congress. It is likely to choose a cautious 

interpretation of recent economic strength 

The Fed meets next week to evaluate the economic 

outlook and stance of monetary policy. The meeting 

will last two days as the Committee is also setting its 

quarterly forecasts ahead of the monetary policy 

testimony before Congress in mid-February. 

Not much has changed on the economic front since 

the mid-December meeting. Data have continued to 

confirm that Q4 is shaping up to be a strong quarter 

for final demand growth, yet labour market indicators 

have shown little benefits from stronger spending 

with steady but lacklustre job creation. 

Headline inflation has surged while core inflation and 

wage growth remain under pressure. The equity 

market continued to rally while house prices have 

steadily fallen and interest rates remained above 

those that prevailed for most of the year prior to the 

November FOMC meeting. 

At the December policy meeting, the FOMC chose a 

cautious interpretation of the Q4 strength and that 

seems likely to continue. Indeed, Chairman 

Bernanke reiterated that cautious stance at his 

Congressional testimony after the December 

employment report. He said “Although recent 

indicators of spending and production have generally 

been encouraging, conditions in the labor market 

have improved only modestly at best…overall, the 

pace of economic recovery seems likely to be 

moderately stronger in 2011 than it was in 2010.” 

Most Fed speakers have publicly supported the 

completion of QE2 and we expect little change to the 

tone of the policy statement released next 

Wednesday. 

A hawkish rotation of voters may actually bring 

increased near-term solidarity 

Every January brings a rotation of FOMC voters. All 

Governors at the Federal Reserve Board are 

permanent voting members, as is the President of 

the New York Fed. However, four of the 12 regional 

bank presidents serve rotating one-year terms as 

voters. Rotating out as voters are Cleveland Fed 

President Pianalto, Boston Fed President 

Rosengren, St. Louis Fed President Bullard and 

Kansas City Fed President Hoenig. 

Presidents Pianalto and Rosengren are fairly dovish 

and stood solidly behind the Fed’s QE policies. 

Dudley V Lockhart Bernanke V Bullard Fisher V Hoenig 

(New York) (Atlanta) (Chairman) (St. Louis) (Dallas) (Kansas) 

Evans V Yellen V Duke V Warsh V Kocherlakota V Lacker 

(Chicago) (Vice Chair) (Governor) (Governor) (Minneapolis) (Richmond) 

Raskin V Tarullo V Plosser V 

(Governor) (Governor) (Philadelphia) 

Rosengren V 

(Boston) 

Pianalto 

(Cleveland) 

1 2 3 4 5 6 7 8 9 10 

Dove 

Inflation forecast informed mainly by Phillips Curve 

View high unemployment as mainly cyclical 

and therefore can be helped with policy 

Hawk 

Inflation forecast informed by monetary policy stance 

View high unemployment as mainly structural 

and therefore immune to policy 

Notes: “V” indicates the FOMC member is a voter in 2011. All FOMC participants without a regional affiliation are members of the Federal Reserve Board, all of whom are voters. There are currently two 

vacancies on the Board. Participants’ views can and do change over time. 

Julia Coronado 20 January 2011 


10 


President Bullard was generally supportive of QE2 

even as he advocated normalising rates, making him 

difficult to categorise at times. Meanwhile, President 

Hoenig stood out as the hawkish curmudgeon. He 

dissented at virtually all of the FOMC meetings in 

2010, first in favour of less commitment to 

exceptionally low rates for an extended period and 

then against the initiation and continuation of QE2. 

Rotating in as voters are Chicago Fed President 

Evans, Philadelphia Fed President Plosser, Dallas 

Fed President Fisher and Minneapolis Fed President 

Kocherlakota. President Evans is a vocal backer of 

QE2. President Kocherlakota initially expressed 

scepticism about QE2, but more recently said he is 

“very comfortable with our current monetary policy 

stance”. He has also indicated he remains concerned 

about headwinds to growth from household wealth 

destruction and restructuring in the banking sector. 

The regional Fed Presidents rotating in as voters 

have a clearly more hawkish bent than those rotating 

out. However, it seems unlikely that the rotation will 

lead to a greater number of dissents in the near term. 

We may see no dissents at the January meeting. We 

think President Plosser is the most likely dissenter as 

he has opposed nearly all of the Fed’s 

unconventional policies. His core view is that 

monetary policy has very little influence on real 

economic growth. 

Dallas Fed President Fisher was one of the FOMC 

members who came out with vocal criticism of QE2 

immediately after its announcement. He said it may 

be the “wrong medicine” for the economy, that the 

Fed risked its stature and independence in initiating 

the programme and that the Fed was basically 

monetising the debt. 

More recently, President Fisher has said he doesn’t 

know if he will dissent. He indicated he “would be 

wary” about any expansion of the Fed’s balance 

sheet beyond QE2 but also that he expects the 

programme announced in November “will be carried 

through”. President Plosser has also been a critic of 

Fed policies, recently saying “the aggressiveness of 

our accommodative policy may soon backfire on us if 

we don’t begin to gradually reverse course”. 

That said, he has not made clear he wants to end the 

programme now. He has said he wants to see how 

both the economy and the policy evolve. Similarly, 

President Fisher has indicated that he expects QE2 

to be completed but would not favour any expansion. 

In the near term, the FOMC may express more 

solidarity behind the already-announced USD 600bn 

programme of Treasury purchases than we have 

seen in a while. 

The economic 

paragraph is still 

appropriate; 

while Q4 GDP is 

likely to be 

robust, ongoing 

weakness in the 

labor market 

suggests 

moderation is 

likely. The 

FOMC named 

housing, state 

and local 

government 

finances and the 

European fiscal 

crisis as 

ongoing sources 

of downside risk 

in the December 

minutes. 

The FOMC is 

likely to stay the 

course on QE2 

. with little to no 

changes in this 

paragraph. 

FOMC Statement December 14, 2010 

Information received since the Federal Open Market Committee met in November confirms 

that the economic recovery is continuing, though at a rate that has been insufficient to bring 

down unemployment. Household spending is increasing at a moderate pace, but remains 

constrained by high unemployment, modest income growth, lower housing wealth, and tight 

credit. Business spending on equipment and software is rising, though less rapidly than earlier 

in the year, while investment in nonresidential structures continues to be weak. Employers 

remain reluctant to add to payrolls. The housing sector continues to be depressed. Longerterm 

inflation expectations have remained stable, but measures of underlying inflation have 

continued to trend downward. 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment 

and price stability. Currently, the unemployment rate is elevated, and measures of underlying 

inflation are somewhat low, relative to levels that the Committee judges to be consistent, over 

the longer run, with its dual mandate. Although the Committee anticipates a gradual return to 

higher levels of resource utilization in a context of price stability, progress toward its objectives 

has been disappointingly slow. 

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, 

is at levels consistent with its mandate, the Committee decided today to continue expanding 

its holdings of securities as announced in November. The Committee will maintain its existing 

policy of reinvesting principal payments from its securities holdings. In addition, the Committee 

intends to purchase $600 billion of longer-term Treasury securities by the end of the second 

quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the 

pace of its securities purchases and the overall size of the asset-purchase program in light of 

incoming information and will adjust the program as needed to best foster maximum 

employment and price stability. 

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and 

continues to anticipate that economic conditions, including low rates of resource utilization, 

subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally 

low levels for the federal funds rate for an extended period. 

The Committee will continue to monitor the economic outlook and financial developments and 

will employ its policy tools as necessary to support the economic recovery and to help ensure 

that inflation, over time, is at levels consistent with its mandate. 

The Committee 

has seen no real 

progress on its 

mandates. 

Unemployment 

dropped, but 

mainly on 

declining labor 

force participation 

rather than strong 

job creation, and 

weakness in core 

inflation has 

rotated from 

housing to 

services. 

No changes 

needed. 



11 


The more difficult decisions will come as QE2 

nears completion and the Fed has not made 

much progress on its mandates 

The real debates will occur as we move toward 

completion of the programme. No member of the 

FOMC has indicated that he or she expects 

significant progress on the Fed’s dual mandates for 

maximum employment and stable prices, but the 

tone of the economy will set the tone of the policy 

debate. 

Should the economy continue to perform reasonably 

well, even if final demand growth moderates from 

what should be a very strong Q4, there will be strong 

opposition from the hawkish members to any further 

expansion in the balance sheet. 

At this point, it seems that further expansion of 

securities purchases would require significant 

deterioration in the economy. Such a scenario would 

also raise questions about the efficacy of Fed policy 

to date, however. There is thus certain to be 

opposition to QE3 in any case. 

The most likely path of policy would be completion of 

QE2, maintenance of the balance sheet for some 

time as progress toward the mandates will be slow in 

coming, then allowing maturing securities to 

gradually reduce the size of the Fed’s portfolio. Once 

i) the unemployment rates has fallen to 8.5% on job 

growth, rather than decline in labour force 

participation; and ii) wages have begun to stabilise, 

suggesting gradual improvement in purchasing 

power that will stabilize core inflation, the Fed will be 

ready to normalise rates to 1.0%. 

The Fed has tools in place, including the Term 

Deposit Facility and reverse repos, that it believes 

will help sterilise the trillions of dollars in excess 

reserves and give it greater control over short-term 

rates. Thus the FOMC believes it will be able to raise 

rates even as it maintains an elevated balance sheet. 

This is a shift from the last time we thought about the 

sequencing of Fed tightening. At the beginning of last 

year, we were thinking that the Fed would have to 

bring down excess reserves to a considerable 

degree before tightening could get underway, which 

could include asset sales. 

However, Chairman Bernanke stressed in a speech 

in late October 2010 that, with the liquidity absorption 

tools the Fed has developed: “I am confident that the 

FOMC will be able to tighten monetary conditions 

when warranted, even if the balance sheet remains 

considerably larger than normal at that time.” 

We continue to think that tightening is a good way off 

given the pervasive weakness in the US economy 

that remains even after a solid quarter of growth. 

While many global investors and policymakers 

believe the Fed should consider the global 

ramifications of its policies, the FOMC is likely to 

continue to focus on its domestic mandates. We are 

in a period of increasing dichotomies; global markets 

and policymakers have calibrated their policies 

based on Fed actions in prior cycles. However, the 

US is lagging global performance in the current 

recovery. This is leading to rising tensions as the Fed 

stays easy and emerging-market central banks are 

reluctant to tighten even as their economies verge on 

overheating. 



12 


Canada: Betting on Investment and Exports 

• The Bank of Canada has an optimistic 

outlook for its economy, based on a CAD at 

parity with the USD and high commodity prices. 

• We see the BoC’s outlook for the US as too 

bullish and the CAD appreciating further. 

• Risks for a hike later than our projected 

policy tightening in June lie with the CAD. 

30 

20 

10 

0 

-10 

-20 

Chart 1: Imports vs Exports (3m % y/y) 

Imports 

Optimistic 

The Bank of Canada left the policy rate at 1.00% at 

its meeting on Tuesday. While the BoC’s statement 

was slightly more hawkish than expected based on 

an improved global growth outlook, we think risks are 

building that our projected rate hike in late Q2 gets 

pushed back. The BoC focused on stronger-thanexpected 

private demand growth in the US and 

Europe. However, it also noted that continuing 

strength in the CAD poses downside risks to the 

generally stronger outlook. 

The Monetary Policy Report indicated the BoC 

expects the CAD to weaken, averaging parity with 

the USD in 2011 and 2012. In contrast, we expect 

continued appreciation in the CAD in coming months, 

suggesting downside risks to the BoC’s export 

outlook. In addition, our own view of the US outlook 

is a more subdued than the BoC’s, also suggesting 

the possibility of delay should the US hit a softer 

patch. 

The BoC statement and Monetary Policy Report 

highlighted that stretched household balance sheets 

are expected to restrain the pace of consumption 

growth and residential investment, while business 

investment should continue growing solidly. Net 

exports are also expected to contribute positively to 

growth going forward. 

Exports and investments are key 

In Q3 2010, we saw a 5.0% q/q a.r. decline in 

exports, while investment posted weak, 0.9% growth. 

The BoC expects a recovery in both going forward, 

based on a stronger external outlook. In addition, 

recall that corporate tax rates were reduced from 

18.0% to 16.5% for 2011. Since the third quarter, the 

CAD has appreciated 4.5%, and export data in 

November show a decline in the 3m y/y trend for 

exports. However, there has also been a decline in 

the 3m y/y import data (see Chart 1). The monthly 

trade balance improved in November, while the 12m 

-30 

-40 

Exports 

Jan 00 Jan 03 Jan 06 Jan 09 

Source: Haver Analytics 

90 

80 

70 

60 

50 

40 

30 

20 

10 

0 

-10 

-20 

Chart 2: Trade Balance (CAD bn) 

12m accum Trade Balance 

Jan 00 Jan 03 Jan 06 Jan 09 


Monthly Trade Balance 

Chart 3: Consumer vs Industrial Prices (% y/y) 

10 

8 

6 

4 

2 

0 

-2 

-4 

-6 

-8 

Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 


CPI 

Industrial Price Index 

accumulated trade balance continued to deteriorate 

(see Chart 2). Exports are smaller than imports in 

value so a net positive contribution to GDP growth 

would require a more significant improvement in 

exports. A rising CAD puts that scenario at risk, with 

10 

8 

6 

4 

2 

0 

-2 

-4 

Bricklin Dwyer 20 January 2011 


13 


ate hikes probably bringing further currency 

appreciation. 

Overall, the BoC revised up its GDP forecast to 2.4% 

for 2011 and 2.8% for 2012. This outlook is 

dependent on the export recovery. We forecast 2.0% 

GDP growth in 2011 and 3.1% in 2012. 

Meanwhile, overall inflation has remained subdued 

despite the relatively robust recovery, and inflation 

expectations well anchored. Canada has remained 

largely immune to the global commodity price 

pressures, with low pipeline pressures in industrial 

prices and shelter prices declining. 

Assumptions 

The Monetary Policy Report released on Wednesday 

made the following key assumptions for the 

economic outlook: i/ USDCAD at parity; ii/ energy 

prices in line with recent futures prices; iii/ relatively 

steady prices for non-energy commodities; and, iv/ 

supportive global credit conditions. 

In addition, the BoC assumes growth in the US of 

3.3% (up from 2.3%) in 2011 and 3.2% (down from 

3.3%) in 2012. Note: we expect the US to grow 2.6% 

in 2011 and 3.1% in 2012. 

A delay to hiking is in the cards… 

The BoC statement suggests further hikes are not 

imminent, but are not too far off either. We expect the 

tightening cycle to begin in late Q2 or possibly later, 

with the policy rate reaching 2.00% by the end of the 

year and 3.00% by end-2012. However, the pace of 

appreciation of the CAD and the strength and 

contour of US growth will determine the schedule for 

normalising rates. 

Bricklin Dwyer 20 January 2011 


14 


Eurozone Inflation: Forecast Revision 

• The past few months have seen an 

acceleration in the upward dynamics of oil and 

other commodity prices. 

Chart 1: Brent 1-Mth Futures & BNPP Forecast 

• In the eurozone, these trends have been 

compounded by the vibrancy of the German 

recovery. 

• We revise up our profile for inflation in the 

eurozone in response to these developments. 

• We expect headline inflation to average 2.2% 

in 2011 (from 1.8%) and 1.6% in 2012 (from 1.3%) 

• Core inflation, however, is still expected to 

remain subdued, averaging 0.9% (from 0.7%) 

and 1.1% (from 0.5%), respectively. 


Chart 2: GSCI Agriculture Spot Return Index 

Commodity shock 

The past few months have seen an acceleration in 

the upward dynamics of oil and other commodity 

prices, in particular soft commodities. A number of 

idiosyncratic factors have contributed to these trends 

including adverse weather conditions, supply 

disruptions and protectionist threats. But the shock 

was primarily due to fundamental factors including 

slack monetary policy and a closing output gap at the 

global level 1 . The risks to global inflation are high. 

In the eurozone, these trends have been 

compounded by the greater-than-expected vibrancy 

in the economic recovery in Germany and higher 

taxes in a number of countries which are undergoing 

a significant fiscal adjustment. 

Revising our food, energy profiles… 

Oil and food prices have rallied well beyond our 

forecast. At the time of the last global in December, 

BNPP Commodity Derivatives forecast that Brent oil 

would reach around USD86/Bbl at the end of 2010, 

before correcting to an average of around USD80/Bbl 

in Q1. While a correction in Q1 is still the central 

scenario, Brent oil prices have also risen 

exceptionally strongly relative to WTI. As a result, our 

Q1 forecast has been raised by around USD5/Bbl 2 . 

For the eurozone, this USD5/Bbl revision adds 

around 0.1pp to average inflation in 2011. 

1 For more on this see “Global Inflation: Ready To 

Takeoff?” in this edition of the Market Mover 

2 For more information, see “Oil Update: Brent Premium 

The New Norm” in this edition of Market Mover. 



Chart 3: GSCI & CPI Food 

The rally in soft commodity prices has also gone 

further than we expected. Prices have already risen 

above the peaks of 2008 (Chart 2) – evident in the 

GSCI agricultural spot index, for example. In 

December, we had expected a correction back to the 

Eoin O’Callaghan 20 January 2011 


15 


upward trend evident since 2005 in the first part of 

this year. But following the latest leg of the rally, 

whether you assume the price moves higher from 

here, moves flat at current levels, or declines back to 

that trend, the levels reached in recent weeks imply 

our forecast for a peak in food HICP inflation of 

around 3.5% later this year now looks conservative. 

Accordingly, we have raised our forecast, with a peak 

rate of food inflation a pp higher in the second half of 

this year. 

…with indirect implications for core… 

The latest rally in soft commodity and oil prices has 

implications for ex-food, ex-energy inflation too. 

First, it will have a lagged knock-on impact on a 

number of core categories particularly affected by 

commodity prices – so called ‘indirect effects”. For 

example, the restaurant component of core HICP 

typically reacts to a food price shock with a six month 

lag (Chart 4). Similarly, there is indirect pass-through 

from energy prices to transport prices as the cost of 

travel rises. This occurs with a fairly long lag – 

around 9 months traditionally – so has implications 

for core inflation more in the latter part of 2011, into 

2012. 

…but second round effects likely to be limited 

Second, a commodity price shock can have ‘second 

round effects’ on inflation. If a spike in commodity 

prices feeds through to inflation expectations, 

resulting in higher wages for labour, then a jump in 

commodity prices can have a far broader impact on 

prices in the economy. 

We are sceptical, however, that in the current 

environment of high unemployment and tighter fiscal 

policy, workers across the euro area as a whole have 

sufficient bargaining power to convert higher inflation 

expectations into significantly strong wage growth. 

Labour market developments typically pass-through 

to wages with a long lag in the euro area (Chart 5). 

The peak fallout on the labour market from the 

recession is still weighing heavily on labour costs. 

The subsequent slowdown in the pace of 

unemployment growth is pointing to stronger wage 

inflation on the horizon, but to relatively tame levels. 

The prospect of fiscal tightening across many 

countries in the euro area should also limit the extent 

to which the commodity price spike can be 

transmitted to the broader economy via wages. 

Germany’s economic renaissance 

The other major development since our last inflation 

update has been the vibrancy of the German 

economic recovery. 

While Germany suffered an output collapse as large 

or larger than the other principal eurozone 

Chart 4: HICP Food & Hotels/Restaurants 


Chart 5: Eurozone Labour Costs & U/R 


Chart 6: German Output Gap & Core HICP 

Inflation 


economies during the recession, it has 

disproportionately benefited from the rebound in 

world industrial activity. The strength of the industrial 

sector has spilled over into the labour market. The 

unemployment rate is now lower than at any time 

since the early 1990s, even as the unemployment 

rate across the eurozone as a whole reaches a new 

12-year high. It has also spilled over into domestic 

demand – first into investment and, we expect, 

increasingly into consumption. To reflect our 



16 


optimism on Germany, in last week’s Market Mover 3 

we revised up our growth forecast to 3.5%, the same 

rate of growth as in 2010. 

Chart 7: Core HICP – EZ & Germany 

With a smaller level of slack in the economy, closing 

at a fast rate, and being driven to a greater extent by 

domestic demand, this has implications for our 

German inflation forecast. 

Ironically, Germany has been one of the biggest 

contributors to disinflation in the euro area over the 

past two years. After a decade gaining 

competitiveness relative to other member states, 

core CPI was one of the fastest to fall in response to 

the recession, hitting 0.2% y/y in April 2010, a full 

0.6pp under the euro area’s record low. 

However, its status as a disinflationary force in the 

euro area is unlikely to last long. From nearly a half a 

percentage point under the euro area average in 

2010, we expect headline inflation in Germany to rise 

above it by early 2012, with the risk it comes earlier. 


Chart 8: EZ Core HICP & Economic Slack 

The numbers 

In response to the above mentioned factors, we have 

revised upwards our profile for inflation in the 

eurozone. We now expect headline inflation to 

average 2.2% in 2011 (from 1.8% previously) and 

1.6% in 2012 (from 1.3%). 

Core inflation, meanwhile, is expected to average 

0.9% and 1.1% (from 0.7% and 0.5%) in 2011 and 

2012 respectively. While we expect indirect passthrough 

from the soft commodity shock, and have 

adjusted our forecast to allow for stronger inflation in 

Germany – we see core inflationary pressures 

remaining contained. 


Chart 9: Core HICP – Periphery vs. Core 

First, we are sceptical that we will see significant 

second round effects across the eurozone as a 

whole in the current environment of high 

unemployment and fiscal austerity. More generally, 

slack in the euro area economy should continue to 

limit core inflationary pressure. 

Second, we continue to expect disinflationary 

pressure will resume from Ireland, Spain, Portugal 

and Greece – economies where disinflation is part of 

a structural adjustment to regain competitiveness. 

This process was interrupted in 2010 as most of 

these countries raised indirect taxes. But in 2011 we 

expect that trend to resume – indeed there is already 

evidence of that starting to happen in Greece. 


3 “Germany: Stronger for Longer”, Market Mover, 13 

January 2011 



17 


ECB: Bark or Bite? 

• The ECB has signalled increased anxiety 

over the upside risks to inflation. 

• How labour costs and inflation expectations 

evolve will be key to whether this translates into 

‘early’ increases in the refinancing rate. 

• The assessment of labour cost trends in the 

January Monthly Bulletin was similar to that in 

December, i.e. relatively benign. 

• Broad money and bank lending data do not 

signal a pressing need for rate hikes either. 

• The key risks to our call of the ECB on hold 

through 2011 are persistently high commodity 

prices and a ‘normalisation’ approach to policy. 

The ECB press conference on 13 January revealed 

increased anxiety over upside risks to inflation. 

Below we discuss the probability that this increased 

concern over inflation prospects will translate into an 

‘early’ policy tightening. 

Shifting risks 

Relevant extracts from the Introductory Statement to 

the January press conference are in Box 1. The key 

point was that inflation had turned out higher than the 

ECB had expected, largely due to energy prices. 

While this had not yet led to a change in the mediumterm 

assessment of inflation developments, the ECB 

would need to monitor developments very closely to 

ensure that this conclusion remains valid. 

The market has now fully priced in the start of the 

tightening cycle in the second half of this year. 

Whether the ECB will deliver in this timeframe will 

depend primarily on two issues. First, whether what 

is currently a short-term inflation problem driven by 

energy prices turns into a more persistent problem 

via second-round effects on core inflation. Second, 

whether inflation expectations are at risk of becoming 

unanchored. Below we look at each issue in turn. 

Ups and downs 

Chart 1 shows our forecast for inflation based on our 

‘in house’ oil price forecast: this assumes a fall in the 

price of Brent to a USD88/Bbl average in Q1. On this 

assumption, and given energy price base effects, 

headline inflation is expected to fall from 2.4% y/y in 

February to 1.9% in April. Core inflation is also set to 

remain low. 

Box 1: Extracts from ECB Introductory Statement 

“We see evidence of short-term upward pressure on 

overall inflation, mainly owing to energy prices, but this 

has not so far affected our assessment that price 

developments will remain in line with price stability over 

the policy-relevant horizon. At the same time, very close 

monitoring is warranted. 

Inflation expectations remain firmly anchored in line with 

our aim of keeping inflation rates below, but close to, 2% 

over the medium term. The firm anchoring of inflation 

expectations is of the essence. 

HICP inflation was 2.2% in December. This is somewhat 

higher than expected and largely reflects higher energy 

prices. Looking ahead to the next few months, inflation 

rates could temporarily increase further. They are likely to 

stay slightly above 2%, largely owing to commodity price 

developments, before moderating again towards the end 

of the year. 

Risks to the medium-term outlook for price developments 

are still broadly balanced but could move to the upside. 

Upside risks relate, in particular, to developments in 

energy and non-energy commodity prices.” 

13 January 2011 

Source: ECB 

The ECB is also expecting that inflation will moderate 

from the spring, as is clear from the press conference 

– again, see Box 1. 

The shorter is the deviation of headline inflation from 

the ‘below but close to 2%’ objective, the lower is the 

risk of second-round effects and an upward shift in 

inflation expectations. So, if the ECB’s expectation of 

lower inflation is borne out, anxiety over upside risks 

to inflation should recede and with it, the probability 

of early hikes in the refinancing rate. 

On the basis of our assumption of a pick up in oil 

prices subsequently, we look for inflation to rise back 

above 2% in the second half of the year, before it 

falls back again in 2012 as base effects related to 

recent energy and food price gains kick in. 

What pay pressures? 

Chart 2 shows the three key measures of pay trends 

in the eurozone. Across the board, they show low y/y 

rates of change – remarkably low, in fact. The rate of 

increase in negotiated wages fell below 2% y/y in 

early 2010 for the first time in the series’ history and 

the current growth rate, of 1.4% y/y as of Q3, is the 

lowest since the early 1990s. 



18 


On the basis of the relationship between pay trends 

and the evolution of slack in the labour market, the 

bulk of the downward pressure on labour cost growth 

in the eurozone as a whole is probably behind us 

(Chart 3). But the lags are long and the persistently 

high level of the unemployment rate does not point to 

a pick-up in wage growth any time soon. 

Chart 1: HICP Forecasts(% y/y) 

On the basis of the assessment in the latest Monthly 

Bulletin, this is a view which the ECB seems to share 

– see the extracts in Box 2. 

The view on labour cost developments expressed in 

December's ECB Monthly Bulletin was benign. It was 

liberally sprinkled with terms like 'modest', 'moderate' 

and 'contained'. We wondered whether this would 

change in January's Bulletin, in line with the greater 

concern over inflation risks expressed at the press 

conference a week before. But there was no sense of 

an increased threat of second round risks. 

Managing expectations 

Regarding inflation expectations, the ECB’s current 

view is that they remain well anchored. On the basis 

of the information available to the ECB, this is hard to 

argue against. Implied breakeven inflation rates have 

been hovering in the region of 2% recently, with no 

sign of any upward drift. 

The ECB’s quarterly Survey of Professional 

Forecasters (SPF) has also demonstrated very 

stable long-term inflation expectations (though there 

is some circularity in this as inflation expectations are 

anchored because the ECB is expected to act in 

such a way as to deliver inflation in line with its below 

but close to 2% price stability definition in the long 

run). The ECB’s next SPF will be released on 10 

February. 

There has been some upward drift in households’ 

inflation expectations. The surveys compiled by the 

European Commission, both forward and backward 

looking, have been trending higher since the autumn 

of 2009. But the current readings are not elevated in 

comparison with the past: for example, the survey of 

price perceptions over the year ahead is more than 

twenty percentage points below its average cycle 

peak since the mid-1980s. The ECB considers this 

particular measure of inflation expectations to be the 

least credible as it has a short time horizon, of just a 

year, and is therefore very sensitive to short-term 

price developments. 

No rush… 

Our assessment of second-round risks and inflation 

expectations underpins our forecast that the ECB, 

while more sensitive to upside risks to inflation and 

likely to stay that way going forward, will not raise its 

refinancing rate this year. 


4.5 

4.0 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

Chart 2: Compensation Trends 

Negotiated Wages (% y/y) 

Compensation per Employee (% y/y) 

Hourly Labour Costs (% y/y) 

97 98 99 00 01 02 03 04 05 06 07 08 09 10 


-1.5 

-1.0 

-0.5 

0.0 

0.5 

1.0 

1.5 

Chart 3: Unemployment & Labour Costs 

0.5 

2.0 

Unemployment Rate 

(1-Yr Change, 18-Mth Lag) 0.0 

2.5 

-0.5 

00 01 02 03 04 05 06 07 08 09 10 11 12 


Hourly Labour 

Costs (% y/y, RHS) 

The current circumstances are very different from 

those in summer 2008, when the ECB felt compelled 

to hike rates in what was a difficult economic and 

financial environment. Then, headline inflation 

peaked at over 4%, almost twice the current level, 

and had been well over 2% for almost a year before 

the rate hike was delivered (in July). The deviation 

from target was much bigger and much more 

persistent, so inflation expectations were much more 

at risk of becoming unanchored then than now. 

4.5 

4.0 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 



19 


The modest deviation of inflation currently relative to 

the ECB’s definition of price stability was a point 

emphasised in an interview with Governing Council 

member Orphanides on 14 January, the day after the 

‘hawkish’ press conference. He also hinted, as others 

have, that the market may have over-reacted to the 

comments in the press conference. 

…but there are risks 

There are three potential challenges to our view of no 

rate hike this year. First, that commodity prices 

remain higher for longer, outweighing the favourable 

base effects pushing down on headline inflation from 

the spring. If, as a result, inflation were to stay higher 

for longer, this would increase the risk of upward 

pressure on wages and inflation expectations. The 

‘emergency’ level of rates would be increasingly 

inappropriate in this context. 

In those circumstances, economic growth prospects 

would suffer. Commodity price rises would crimp real 

income growth for households and ECB rate hikes 

would hit confidence. This would probably limit how 

far the ECB tightening cycle would go. 

Box 2: Extracts from ECB Monthly Bulletin 

“Labour cost indicators for Q3 2010 continued to show 

subdued wage pressures. Preliminary information on 

negotiated wages for the first month of Q4 suggests that 

the pattern of moderate wage growth continued… in line 

with continuously weak labour market conditions. 

The annual rate of growth in euro area negotiated wages 

slowed to 1.4% in Q3 2010, a record low since the start 

of the series in 1991. Annual hourly labour cost growth in 

the euro area also slowed in Q3, to 0.8% from 1.6% in 

Q2. This too is the lowest growth rate observed since 

the start of this series in 2001. 

The annual growth rate of compensation per employee 

slowed to 1.5% in Q3 from 1.9% in Q2. This decline was, 

with a few exceptions, broad-based across countries. 

Sectoral developments show that the deceleration in the 

annual rate of change in the labour cost index in Q3 

2010 was broad-based across sectors.” 

Monthly Bulletin, January 2011 

Source: ECB 

Chart 4: Real Policy Rates 

The second risk to our forecast of unchanged rates 

this year is that pay pressures emerge in the core 

countries of the eurozone, most likely in Germany, 

prompting an ECB response. A recurring theme of 

our analysis for some while now has been to expect 

a pick up in wage growth in Germany. This reflects 

the obvious factors including: the low unemployment 

rate; skill shortages in some fast-growing sectors; 

and looser policy than for German needs. 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

-0.5 

Refi Rate 

As conditions in peripheral countries will be radically 

different, assessing how the Governing Council will 

respond to ‘local’ pay pressures is difficult to judge. If 

it is a problem for Germany only, it may be difficult to 

secure a consensus on the Governing Council in 

favour of hiking rates. But at the very least, we can 

expect the vocal hawks on the Governing Council to 

make a lot of noise about the upside risks to inflation 

and the need for a policy response. 

Normalisation mode 

An alternative scenario of earlier rate increases than 

we currently expect is via the ‘normalisation’ route. In 

short, the rationale would be that the level of policy 

rates has been set at an emergency level but the 

emergency is over – for the eurozone as a whole if 

not for specific member states. In this context, there 

is a case for taking rates higher whether secondround 

effects start to appear or not. 

The level of policy rates in real terms is unusually low 

(Chart 4). Measured on the basis of the headline 

inflation rate or inflation expectations, real short-term 

rates are well below zero. Measured on the basis of 

-1.0 

-1.5 

Relative to HICP (% y/y) 

EONIA 

99 00 01 02 03 04 05 06 07 08 09 10 


7 

6 

5 

4 

3 

2 

1 

0 

-1 

-2 

-3 

-4 

-5 

-6 

Chart 5: Nominal Growth & Policy 

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 


Real GDP (% y/y) + HICP (% y/y) 

ECB Refi Rate (%) 

BNPP Forecast 

core HICP inflation, real policy rates are negative still 

but less dramatically so. 



20 


The nominal policy rate and nominal growth are also 

out of whack (Chart 5). This was the case through 

most of the economic expansion from 2003 to 2008 

which the ECB, retrospectively, probably sees as an 

error. The slow pace of the rate rises from December 

2005 was a contributory factor to the decision to hike 

in July 2008 as inflation was surging and breakeven 

inflation rates were well north of 2%. 

The exceptionally low level of policy rates will be one 

of the main arguments put forward by the more 

hawkish members of the Governing Council in favour 

of a tightening sooner rather than later. We are 

already hearing from some members that the risks 

associated with tightening too late are greater than 

the risks of tightening too soon. We see this as the 

view of a very vocal minority. We doubt that there 

would be sufficient support on the Governing Council 

to justify a rise in interest rates on these grounds 

while domestically-driven inflation pressures remain 

contained, given the potential adverse effect on the 

most distressed member states’ economies and 

financial sectors. 

It is one thing for the Governing Council to reach 

agreement to deliver a warning shot over inflation 

and threaten to hike rates to make sure inflation and 

inflation expectations stay in check. It is another thing 

altogether, in the current uncertain economic and 

financial circumstances, to agree to hike rates. 

In credit 

Trends in money and credit growth will also be an 

important influence on how ECB policy evolves. The 

assessment in the most recent press conference and 

Monthly Bulletin do not point to any pressing need for 

a tightening of policy. Broad money and bank lending 

growth rates have begun to normalise but they are 

far from normal. 

As Chart 6 highlights, bank lending growth was a 

reasonably good guide to ECB policy developments 

in the first decade of EMU, albeit with a considerable 

lag between lending growth and policy changes. On 

the basis of how we expect lending growth to evolve 

from here (which is a relatively optimistic forecast), 

the lags suggest that the refinancing rates ought not 

to start rising until spring 2012. 

The relationship broke down in 2009, with the ECB 

slashing rates much earlier than would be implied by 

bank lending growth. It could be argued that this is a 

reason why the ECB might want to start increasing 

rates earlier than in the past – linked again to the 

‘normalisation’ concept. 

Chart 6: ECB Policy & Bank Lending 

13 

BNPP Fcast 

5.0 Bank Lending (% y/y, 18Mth Lag RHS) 

12 

11 

10 

4.0 

9 

8 

7 

3.0 

6 

5 

2.0 

4 

3 

2 

1.0 

ECB Refi Rate (%) 

1 

0 

0.0 

-1 

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 


Table 1: Key Forecasts 

2011 2012 

(%) 2010 2011 20122013 Q1 Q2 Q3 Q4 Q1 Q2 

GDP y/y 1.7 1.6 1.6 2.0 2.1 1.6 1.5 1.5 1.5 1.4 

HICP y/y 1.6 2.2 1.6 1.6 2.3 1.9 2.2 2.3 1.9 1.7 

Core HICP y/y 1.0 0.9 1.1 1.6 1.1 0.9 0.9 0.9 1.0 1.0 

ECB Refi Rate 1.00 1.00 1.75 2.75 1.00 1.00 1.00 1.00 1.00 1.25 


Note also that our current forecasts for the y/y growth 

rate in bank lending imply that the refinancing rate 

should rise to around 3-3½% in our forecast horizon 

out to 2013, below the 4% peak in the 2005/8 cycle. 

Bottom line 

The level of anxiety at the ECB over the upside risks 

to inflation has increased and the risk of an earlier 

start to the tightening cycle than we have forecast 

(i.e. from Q2 2012) has risen accordingly. While the 

ECB still expects inflation to remain in line with its 

definition of price stability over the medium term, it 

intends to monitor the various risks to this scenario 

very closely – as will we. Two key influences on 

whether the threat of action will actually translate into 

a higher refinancing rate this year, which markets will 

continue to price in while inflation is above target, will 

be developments relating to second round effects on 

inflation and the evolution of inflation expectations. 

On the basis of our assessment of those and other 

economic and financial developments going forward, 

we conclude, on balance, that the ECB’s bark is 

likely to be worse than its bite. 



21 


ECB Inflation Performance: A Review 

• The eurozone inflation broke above the 2.0% 

threshold in December. More importantly, 

average eurozone inflation since January 1999 

rose from 1.98% in November to 2.01% in 

December. 

• Other indicators show that inflation remains 

subdued and below headline HICP, the measure 

the ECB has chosen to target. This implies the 

ECB has chosen the most demanding target. 

• The latest inflation figure has not altered 

ECB policy, but the language was toughened. 

Jean-Claude Trichet revisited the wording of the 

ECB achievement and that of the policy outlook. 

128 

124 

120 

116 

112 

108 

104 

100 

Base 

98=100 

Chart 1: HICP vs. Ceiling 

Ceiling 2%/year 

Actual HICP 

(SA by BNP Paribas) 

96 

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 

Source: Eurostat, Reuters EcoWin Pro, BNP Paribas 

Chart 2: HICP Inflation 

The 2.2% flash estimate for eurozone inflation in 

December was described in the media as the first 

time inflation has exceeded the ECB’s target for more 

than two years. The reality and the potential 

consequences for ECB policy are more subtle. 

What is the ECB’s true target? 

As Jean-Claude Trichet usually puts it, the ECB’s 

inflation goal is ‘below 2%, but close to 2%, over the 

medium term’. This time horizon should not be 

ignored. The cumulative average inflation rate since 

January 1999 had been above the 2% ‘ceiling’ for a 

long time by the end of the tightening cycle in July 

2008 but the ECB had nonetheless refrained from 

putting in place a restrictive monetary policy. 

Mr Trichet recently insisted that, since the start of 

monetary union, average inflation had been below 

2%. He added that he felt "moved" by the EU 

Parliament applause when he said that average 

inflation was 1.97%. With the December print, the 

average has gone to 2.01%...too bad! 

Will that trigger quick policy action? This is unlikely. 

When the ECB governing council decided in June 

2008 to hike in July, it had at its fingertips the May 

inflation estimate. This stood at 3.7% y/y, compared 

with a 4% refi rate. This pushed the average inflation 

rate from January 1999 as high as 2.22%. That rate 

hike is often viewed in retrospect as a policy mistake, 

but not within the ECB. 

What do other inflation indicators say? 

The ECB focuses on the headline HICP rather than 

the ex-food and energy index; the Fed, for example, 

favours the core PCE deflator. Over the short run, 

4.0 Headline HICP (% y/y) 

3.0 

2.0 

1.0 

0.0 

-1.0 

2.0 

1.0 

0.0 

-1.0 

-2.0 

Core HICP (% y/y) 

99 00 01 02 03 04 05 06 07 08 09 10 11 

99 00 01 02 03 04 05 06 07 08 09 10 11 

Source: Eurostat, Reuters EcoWin Pro 

Headline - Core (y/y) 

Lagged 1 year 

Core Inflation y/y Change 

ignoring highly volatile factors can make sense. 

However, over the medium term, all elements need to 

be included in the index that the central bank targets 

(especially vital elements such as food and energy). 

Experience also shows that headline inflation tends to 

lead core inflation (Chart 2). Nevertheless, core 

inflation remains less volatile. 

Using one measure rather than the other does make 

a difference. In December, average inflation since 

January 1999 was 2.01% while average core inflation 

was 1.55%. This gap highlights that the main sources 

of inflation have been food and energy, items over 

which ECB interest rate policy has less influence. 

As noted above, the Fed prefers to look at the PCE 

deflator, a broader measure of inflation. However, the 

Fed favours the less volatile ex-food and energy 

definition of the deflator. Although the ECB has not 

gone down this route, looking at the eurozone PCE 

deflator would also make a lot of sense. By definition, 

this index covers all goods and services consumed by 

Dominique Barbet 20 January 2011 


22 


households. Furthermore, the statistical construction 

of the deflator captures more effectively changes in 

consumption patterns. As Chart 3 shows, this 

measure gives a result very close to that of headline 

HICP. The average inflation rate until Q3 2010 is 

marginally below the HICP measure, but the gap is 

only 4bp. 

We could also look at the total GDP deflator. By 

construction, this index is not designed to measure 

inflation for consumption but for the eurozone 

domestic economy, since imported inflation is 

eliminated. This measure shows lower inflation than 

headline HICP and is less volatile. From the start of 

monetary union to Q3 2010, average inflation on this 

measure was 1.68% (0.32pp below the official target). 

New words to back unchanged ECB policy 

In the latest press conference, Trichet presented a 

different gauge of long-term inflation, now referring to 

the average annual inflation rate over the last 12 

years. This measure allows him to still highlight a 

1.97% figure (when the inflation from January 1999 to 

December 2010 is 2.01%). The good thing about this 

wording is that the reference period and thus the 

achievement will last for a few months (possibly 

almost a year), although inflation is likely to remain at 

or above 2.2% in the next two months of published 

data. 

This issue is primarily a question of wording, since 

other indicators provide comfort on inflation’s past 

performance as well as the present underlying trend. 

We expect core inflation for the eurozone stayed at 

1.1% in December. The GDP deflator has been 

subdued: all the quarterly changes (SAAR) since Q1 

2009 have been below 1.7%; the latest y/y print is 

1.1%; and average inflation over the last three years 

stands at 1.3%. 

The ECB currently has no economic reasons to be 

concerned over the inflation outlook. Even money 

130 

125 

120 

115 

110 

105 

100 

Chart 3: Price Indices (Q1 1999=100) 

HICP Headline 

HICP Core 

PCE Deflator 

GDP Deflator 

99 00 01 02 03 04 05 06 07 08 09 10 


Chart 4: Main Inflation Indices (quarterly, % y/y) 

4.0 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

HICP Core 

GDP Deflator 

HICP Headline 

-0.5 

PCE Deflator 

-1.0 

Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 

04 05 06 07 08 09 10 


supply and credit growth, through rising, are not 

alarming. Trichet merely had a positioning problem 

since he has lost one argument he had been using 

heavily – the below 2% average inflation rate since the 

start of monetary union. The wording change solves 

this issue for the time being. 

This device can also be seen as a way for the ECB to 

avoid current inflation figures exerting too much 

pressure on the policy setting. 



23 


Eurozone: BoP Leaves Euro Vulnerable 

• Despite the worsening of the eurozone debt 

crisis last November, foreign investors turned 

net buyers of bonds and notes in that month. 

• The fact that non-eurozone capital flows 

were not the cause of the bond crisis is not 

reassuring for the euro. 

Chart 1: EMU Current Account (EUR bn/m, s.a.) 

10 

Goods 

Services 

5 

0 

-5 

-10 

Current account deficit is widening 

The eurozone’s current account deficit widened 

sharply in November, from EUR 2.1bn in October to 

EUR 6.0bn (unadjusted). While in unadjusted terms 

the eurozone posted its largest deficit for the year 

back in September (EUR 6.5bn), in seasonally 

adjusted terms the deficit rose from EUR 9.6bn in 

September to EUR 11.2bn in November – the largest 

monthly deficit since late 2008. 

The situation has been deteriorating rapidly 

(Chart 1). The main reason for the widening of the 

current account deficit is the widening of the 

merchandise trade deficit, where nominal export 

gains (22.9% y/y in November) have been outpaced 

by the increase in imports (28.2%) boosted by 

stronger inflation on imported goods. (For example, 

in Germany, import prices rose 10.0% y/y compared 

to a 4.5% increase in export prices.) The surplus on 

services, not subject to such price developments, 

remained strong in November, supported by rising 

exports (13.2% y/y). 

The deficit on income is also widening. Inflows, 

mostly interest payments, are declining, while 

outflows are rising and are likely to continue to do so 

given the impact of the financial crisis on payments. 

Capital flows show a surprising pattern 

On the capital account, foreign direct investment 

printed a monthly surplus in November, for the first 

time this year. The surplus reflected significant loans 

to eurozone subsidiaries by foreign entities and is 

likely to have disappeared in December. Net outflows 

in equities were modest in November and corrected 

part of the previous month’s inflow. 

The main surprise on the capital account in 

November came from bonds and notes (Chart 2). 

While the eurozone sovereign bond market was in 

disarray, foreign investors bought a net amount of 

EUR 10.8bn of eurozone bonds in November. This, 

combined with net sales of foreign bonds from 

eurozone investors, raised net inflows on bonds and 

notes to EUR 19.8bn. Thus foreign investors, rather 

than fleeing the Eurobond market, actually increased 

-15 

-20 

-25 

05 06 07 08 09 10 

Source: ECB, Reuters EcoWin Pro 

Total 

Chart 2: EMU BoP, Flows on Bonds and Notes 

(EUR bn/m, n.s.a.) 

75 

50 

25 

0 

-25 

-50 

-75 

Inflow 

Outflow 

2008 2009 2010 

Source: ECB, Reuters EcoWin Pro 

Balance 

their purchases during the crisis. Note the same 

occurred in April-May 2010, when Greece was 

subject to the market's scrutiny. They are also keen 

to exit the market when it is quieter, either to take 

short-term profit or, for real money investors, 

because such instruments are a more limited share 

of their total portfolio than for most eurozone 

domestic investors. Despite November’s surge, 

foreign appetite for eurozone bonds shows a trend 

decline. 

The bottom line is that, despite a large current 

account deficit, the eurozone’s basic balance (the 

current deficit and flows of long-term capital) 

registered a surplus in November of EUR 31.7bn, the 

largest for any month in 2010. With the basic balance 

in solid surplus, the euro’s decline in November 

reflected the impact on other flows of concerns over 

the debt crisis and uncertainties over the longer-term 

outlook of the eurozone. Such concerns are likely to 

persist longer than November’s capital inflow. 



24 


Norway: Norges Bank Preview 

• We continue to expect the Norges Bank to 

keep its policy rate on hold at its January 

meeting. 

Chart 1: Private Consumption & Retail Sales 

• Since the December policy decision, 

economic data, on average, have been strong, 

signalling a pick-up in growth. 

• This, together with high house prices and 

robust credit growth, is likely to be mentioned in 

the policy statement – giving it a hawkish tone. 

• However, the appreciation in the NOK is 

likely to lead to the Norges Bank remaining 

cautious. 

Stable policy rate for now 

The Norges Bank left its policy rate unchanged for a 

fifth consecutive meeting in December. But the 

statement accompanying the decision had a hawkish 

tone. The Bank’s quarterly rate projections in 

October suggested that it intended to deliver a rate 

hike, at the earliest, in summer 2011. Although we 

believe a hawkish statement in December and recent 

strong economic data have increased the chances of 

its striking sooner, we expect the Norges Bank to 

keep the policy rate at 2.00% at its meeting next 

week. 

Economic growth picking up 

There are increasing signs that economic recovery 

has gained momentum in Norway. In line with our 

long-held view, an increase in consumer spending is 

now evident. The strong retail sales print for 

November and consumer confidence in Q4 hitting its 

highest level since late 2007 signal that private 

consumption remained a key growth driver in Q4. 

With interest rates still relatively low, household 

consumption also seems to be supported by robust 

growth in credit to households. 

Another issue, likely to be mentioned by the Norges 

Bank, is the increase in house prices. Although 

posting slight q/q declines in Q3 and Q4, they are 

well above their pre-crisis levels and overall 8.3% 

higher last year than in 2009. 


Chart 2: Consumer and Manufacturing 

Confidence 


Chart 3: House Prices (Index, Q1 2005 = 100) 


On the production side, although financial and 

monetary conditions have tightened recently due to 

an appreciation relative to trend in the effective NOK 

exchange rate, they are now broadly neutral. Given 

lags, however, we should see a further improvement 

in production in the period ahead. More forwardlooking 

data, such as manufacturing surveys, support 

this view. Another positive factor, which should 

provide a boost to the economy overall, is the 

increase in oil prices. 

Gizem Kara 20 January 2011 


25 


Higher energy prices pushing up inflation 

After consistently surprising the Norges Bank to the 

downside over the previous couple of months, CPI- 

ATE inflation at 1.0% y/y in December was in line 

with the Bank’s expectations. However, higher 

electricity prices due to cold weather led to a 

significant upward surprise in headline inflation. 

Higher energy prices are likely to lead the Norges 

Bank to raise its headline inflation forecasts in its 

Monetary Policy Report in March. In terms of core, 

CPI-ATE, inflation, we expect it to start to pick up this 

year as the improving labour market leads to a 

strengthening of both demand and wages. The 

appreciation of the Norwegian krone, however, 

suggests some downside risk to inflation. Overall, 

core inflation should remain below the Norges Bank’s 

target of 2.5% throughout the year. 


Chart 4: CPI & CPI-ATE (% y/y) 

Chart 5: Import-Weighted NOK 

Policy decision 

Given the key policy rate is still low compared to 

what the neutral rate should be in Norway, we expect 

rate hikes. However, we believe the Norges Bank will 

keep the policy rate at 2.00% at its meeting next 

week. 

We expect the next hike to come in Q2. But, given 

the hawkish statement in December, we noted that 

we might see an upward revision to the Norges 

Bank’s rate projections at its March meeting. Recent 

domestic developments, which suggest a pick-up in 

growth in the quarters ahead, support this view. 

Overall, we believe the risk of rate hike in Q1 has 

increased. 

However, developments in the coming months will 

still be key for the timing of the hike. With policy rates 

generally expected to remain low for some time in 

the main advanced economies, the Norges Bank will 

not want to deviate too much from other advanced 

country central banks in terms of policy rates. 

Appreciation of the domestic currency due to higher 

rate differentials would not be welcomed by the 

Norges Bank. Since end-November, the importweighted 

NOK has appreciated by around 3%. 

Developments since the start of the year suggest the 

appreciation in January will also surprise the Norges 

Bank to the upside. As a stronger currency would 

bring downside risks to inflation and hurt export 

industries, the Norges Bank will probably wait to 

deliver a rate hike if the currency continues to 

appreciate in the coming months. 


On the other hand, high house prices, robust credit 

growth and the increase in household spending are 

other issues the Norges Bank will be looking at. As 

these had been mentioned in the previous policy 

statement, the Norges Bank will likely remain 

cautious about the risk of financial imbalances 

building up in the economy. 

Overall, if we do not see a significant appreciation in 

the currency, economic data continue to surprise to 

the upside relative to the Norges Bank’s forecasts 

and house prices increase markedly, the Bank is 

likely to deliver a rate hike in Q1. But if the krone 

appreciates significantly and still-acute tensions in 

financial markets intensify, the Bank will wait until Q2 

to strike. 

Gizem Kara 20 January 2011 


26 


Japan: New Cabinet and Policy Outlook 

• Prime Minster Kan has reshuffled his 

cabinet to avert an opposition boycott of 

parliament. But with all parties gearing up for 

the local elections in April, the going promises 

to be tough for the 2011 budget and budgetrelated 

bills. 

• That said, Kan’s tenure could prove long, 

given that no national elections are due until 

2013. Because it is politically damaging for the 

opposition to keep on blocking bills and be seen 

as the cause of political paralysis, policy 

cooperation on specific issues seems likely 

once the April local elections are over. 

• The policies most likely to garner supraparty 

support are (1) comprehensive social 

security/tax reform and (2) “opening Japan” 

(Trans-Pacific Partnership participation). 

• The appointment of Kaoru Yosano as the 

point man on social security/tax reform should 

help reconcile the ideas of the opposition and 

ruling camps. 

• Opening up Japan and TPP participation, 

however, face strong opposition from factions 

in both the DPJ and LDP. Headway on this issue 

may be blocked or could trigger political 

realignment. 

More “crises” down the road? 

Prime Minster Kan reshuffled his cabinet and the 

DPJ leadership on 14 January. With the opposition 

threatening to boycott the regular session of 

parliament set to convene on 24 January unless 

Chief Cabinet Secretary Sengoku and Land Minister 

Mabuchi were replaced (they had been censured by 

the opposition-controlled Upper House), the sacking 

of both allowed Kan to avert a “January crisis” 

(opposition boycott of parliament). 

But now the new government faces even bigger 

challenges as it lacks the two-thirds majority in the 

Lower House needed to override bills rejected by the 

Upper House (it is seven seats short). With the 

opposition gearing up to fight the ruling coalition in 

the unified nationwide local elections slated for April, 

the going promises to be rough for the 2011 budget 

and budget-related bills. These are being dubbed by 

pundits the “March crisis” and “April crisis”, 

respectively. 

We expect there will be a good deal of negotiating 

with the opposition before the budget and budgetrelated 

bills are submitted to the Diet. Negotiating on 

the specifics of any legislation is certainly 

constructive. However, political manoeuvring and 

grandstanding over how the Diet’s daily agenda is 

set could provoke public disgust at the procedural 

games parliamentarians play. Incidentally, the 

government has let it be known that it is open to 

amending the budget in parliament, something that 

would be epoch-making in its own right. 

Bigger test will be budget-related bills 

The government, by virtue of its majority in the Lower 

House, can secure passage of the budget without 

Upper House approval. Under the constitution, the 

budget is automatically enacted 30 days after 

approval by the Lower House, regardless of what the 

Upper House does. 

But the same rules do not apply to budget-related 

bills. If rejected by the Upper House, these will 

require some degree of cooperation from opposition 

lawmakers in the Lower House to achieve the twothirds 

majority needed for an override vote. While this 

process can be time-consuming, this time around 

there are no budget-related bills on tap that could 

cause the kind of confusion witnessed at the gas 

pumps in 2008. 

At that time, the provisional surcharge tax on 

gasoline could not be renewed on time due to the 

divided Diet. This led to the tax momentarily expiring, 

lowering gasoline prices, only to be reinstated one 

month later. In any event, even if the public is 

inconvenienced by the failure to promptly enact 

budget-related bills, most such bills are applied 

retroactively when they are eventually passed. 

A prime concern for market participants is a special 

law enacted each year that controls deficit-financing 

bonds. While failure to re-enact this legislation by 1 

April would not trigger chaos, government cash flow 

could be seriously impaired if the legislation is put on 

hold indefinitely. 

Increasing cooperation, once April’s election are 

over 

Ultimately, we expect the opposition New Komeito 

party to be won over to support budget-related bills, 

just as it was convinced to support the 

supplementary budget last year. Of course, in the 

run-up to the April elections, it is very likely that New 

Ryutaro Kono/ Azusa Kato 20 January 2011 


27 


Komeito will maintain its resistance to the 

government, including opposition to the budget itself. 

Nonetheless, we expect New Komeito to eventually 

back the budget-related bills in order to avoid 

adverse consequences for the public. It is even 

conceivable that New Komeito cooperation at this 

juncture could open the door to some kind of alliance 

with the DPJ, once the local elections are over. 

Some observers believe the Kan government could 

be shaken by a “June crisis”, in the event junior 

partner the People’s New Party pulls out of the ruling 

coalition, due to the failure to enact that party’s pet 

project (reversing postal privatisation). However, we 

think that, after April, the Kan government will find 

ways of working with the LDP and New Komeito so 

that key legislation can be enacted. 

If the LDP and New Komeito can change and 

cooperate with the DPJ, the anti-reformist bent of the 

People’s New Party will also have to change to some 

degree. It is our view that, once the April elections 

are over, all political parties will modify their 

approach to parliamentary affairs. 

Could Kan’s tenure be long-lived? 

Looking further ahead, there is a possibility, 

depending on the policies pursued, that Kan’s tenure 

as prime minister could be long by Japanese 

standards. One reason is that the political schedule 

is free of nationwide elections until 2013 (Upper 

House in July, Lower House in August). 

While Kan’s tenure as DPJ president (hence prime 

minister) is due to expire in September 2012, we 

expect he will be re-elected as replacing him at that 

juncture would likely mean a quick general election. 

Otherwise, the DPJ would again be slammed by the 

public and opposition for elevating its leader to the 

prime minister without the legitimacy of a Lower 

House election victory. 

Given the lengthy period without national elections, it 

would be hard for the opposition to fight the 

government on each and every issue. Accordingly, it 

is likely that some opposition parties will seek to link 

up with the Kan government on specific policies 

issues. This would allow them to build a record of 

achievement that could bolster their election 

prospects. 

Policy-wise, affinity is especially strong with New 

Komeito (one concern with a DPJ-New Kometo 

linkup is the fact that both tend to favour increased 

spending on social welfare etc). If Kan manages to 

survive the April local elections, his tenure as prime 

minister could prove long-lived provided supra-party 

cooperation is achieved on key policies. 

Non-partisan policies stand best change of 

enactment 

What kind of policies are likely to be enacted? The 

reality of a divided parliament means the DPJ’s wish 

list of programmes enshrined in its 2009 election 

manifesto must be revised, in the face of some 

internal resistance. 

Thus, the policies most likely to be enacted by a 

divided Diet are those that are truly nonpartisan in 

nature, such as: (1) comprehensive social 

security/tax reform including hiking the consumption 

tax; and (2) opening up Japan, including participation 

in the Trans-Pacific Partnership (TPP). 

These two issues were singled out by Prime Minister 

Kan in his press conference on 4 January. 

Comprehensive social security/tax reform is widely 

deemed to be the most pressing issue facing Japan 

today. In fact, the LDP and New Komeito have put 

forward similar proposals in this regard. 

The appointment of Kaoru Yosano as the minister for 

economic and fiscal policy in the new Kan 

government may be aimed at luring the LDP and 

New Komeito into cooperating on social security/tax 

reform. Yosano is an ex-LDP lawmaker who once 

served as finance minister. In that capacity, he 

helped draft plans for social welfare reform that were 

promoted by the former LDP-New Komeito coalition 

government. 

With Yosano as the point man on social security/tax 

reform, it should be easier to reconcile the ideas of 

the opposition and ruling camps. After all, if your 

ideas are accepted, continued opposition for 

opposition’s sake is absurd. Thus, if the obstacles to 

supra-party discussions can be overcome, perhaps 

real progress can be made on social security/tax 

reform. Unfortunately, at this juncture, this is 

probably still wishful thinking. 

Political realignment on TPP? 

As for the opening of Japan, the desirability of joining 

the TPP is not shared by all lawmakers. In fact, there 

is strong opposition to the TPP within both the DPJ 

and LDP, though opposition in the former case has 

more to do with Kan’s abrupt announcement than 

policy particulars. 

Given the strength of the farm lobby in Japan, 

discussions on the TPP probably won’t make much 

headway, even though “opening Japan” would be a 

good way to realise economic rejuvenation, as 

pointed out in Japan: PM Sets Out Two Key 

Challenges, Market Mover, 13 January 2011. On the 

other hand, progress in the TPP talks could lead to a 

realignment of the political landscape. 

Ryutaro Kono/ Azusa Kato 20 January 2011 


28 


Japan: Capex Outlook 

• Core machinery orders undershot 

expectations, falling 3.0% m/m in November. 

Despite this third straight drop, the net decline 

is within the range of payback for earlier gains. 

• Given the upturn in global manufacturing, 

domestic capex should pick up once exports 

and production escape their soft patch. 

• But with yen appreciation, changes in the 

demand structure and Japan’s shrinking 

workforce causing firms to focus more on 

expansion overseas, a vigorous recovery in 

domestic investment seems unlikely. 

• To arrest the effects of an ageing 

population, Japan in our view needs to 

participate in the Trans-Pacific Partnership. 

Orders fall for third straight month 

Undershooting expectations, core machinery orders 

fell 3.0% m/m in November, the third straight 

contraction. However, coming after gains of 8.8% in 

July and 10.1% in August, the net three-month drop 

is within the range of a reactionary decline. While the 

level for October-November is 6.9% lower than the 

Q3 average, it is still 2.1% above Q2, which suggests 

that orders continue to trend modestly higher. On this 

score, core orders minus mobile phones (which are 

not capital goods) posted 0.8% growth in November 

following a 0.6% advance in October. 

Capex to pick up, albeit modestly 

We believe that domestic spending on new plants 

and machinery will accelerate moving forward, 

though not to the extent of becoming a main growth 

engine for the Japanese economy anytime soon. 

Currently, the economy is in a soft patch, brought on 

by the slowdown in exports. Economic growth in Q4 

2010 is likely to turn negative due to fallout from the 

end of stimulus programmes. 

But with global manufacturing picking up again from 

autumn, exports should resume expanding shortly 

(early indications suggest real exports could revive in 

December). Thus, once statistics confirm that exports 

and production have indeed escaped the soft patch, 

domestic capex should pick up the pace – especially 

among manufacturers eager to tap into voracious 

global demand for smart phones, tablets and other 

innovative products. 

That said, due to the correcting of the yen’s super 

weak tone – which, in our view, is the proper way to 

Chart 1: Core Machinery Orders (JPY bn, s.a.) 

1300 

1200 

1100 

1000 

900 

800 

700 

600 

Monthly 

Quarterly 

03 04 05 06 07 08 09 10 

Source: Cabinet Office, BNP Paribas 

Chart 2: Machinery Orders (JPY bn, s.a.) 

700 

650 

600 

550 

500 

450 

400 

350 

300 

250 

200 

Manufacturing 

Nonmanufacturing 

03 04 05 06 07 08 09 10 


see the yen’s appreciation since the Lehman shock – 

coupled with changes in the demand structure 

(weakening of domestic demand due to population 

decline, emergence of Asian middle-class demand), 

to say nothing of Japan’s shrinking workforce, firms 

are focusing more on expansion overseas than 

investment at home. Hence, a significant 

acceleration in the domestic capex recovery looks 

unlikely. 

Manufacturers’ orders trending mildly higher 

A closer look at November’s machinery orders shows 

bookings by manufacturers jumped 10.6% m/m after 

rising 1.4% in October. Despite seesawing, orders by 

this sector are trending modestly higher. Core orders 

by non-manufacturers, meanwhile, fell sharply for a 

second straight month, plunging 10.5% in November 

(-8.7% in October). While the decline is more modest 

if mobile phones are excluded, at -4.8% in November 

(-0.2% in October), such sluggishness still suggests 

the nascent recovery in this sector has flattened out. 

Ryutaro Kono/ Hiroshi Shiraishi 20 January 2011 


29 


Orders from abroad (not part of the headline core 

figure) were down 17.8% in November, but this 

reflects negative payback for the 16.0% gain posted 

in October. When averaged out, the level for 

overseas orders in October-November is 9.1% higher 

than in Q3. While the large-lot orders posted in 

October make it hard to say with confidence that 

overseas demand is accelerating again, Asian 

demand for capital goods is likely to pick up given the 

recovery in global manufacturing. On this score, the 

latest data for machine tool orders show Asian 

demand, led by China, on the rise again. 

Domestic capital stock weakly recovering 

Meanwhile, recently released figures for capital stock 

show capital accumulation is still recovering only 

weakly. According to the Cabinet Office’s preliminary 

estimates, real gross capital investment rose 11.0% 

y/y in Q3 2010. But while this confirms that spending 

is on a recovery track, the level is still only 85% of 

the peak set in Q1 2008. The ratio of cumulative 

gross capital investment over the past year to the 

existing capital stock a year ago is 6.0%. This is on a 

par with the level in 2002, which represented the 

bottom of the previous capital investment cycle. With 

4.4% of existing capital having been scrapped over 

the past year, capital stock expanded at the modest 

rate of 1.5% y/y. 

Growth expectations falling 

In terms of the capital stock cycle, investment prior to 

2005 increased at a rate corresponding to an 

expected growth rate of slightly under 2%. However, 

the current rate of spending growth matches growth 

expectations of slightly under 1%. The change is 

most pronounced for manufacturers, whose 

investment in 2005-2006 corresponded to an 

expected growth rate of slightly more than 2%. This 

climbed to roughly 3% in 2007 but the level now 

stands at slightly under 1%. 

Non-manufacturers, on the other hand, invested prior 

to the Lehman shock at a level corresponding to an 

expected growth rate of slightly more than 1%, and 

their level now also stands at slightly under 1%. Such 

diminishing growth expectations can be attributed to 

(1) the collapse of the export boom of 2005-2007 that 

was fuelled by credit bubbles overseas and the yen’s 

super weak tone; and (2) population decline, whose 

adverse impact on domestic demand is becoming 

apparent after being concealed by the export boom. 

Stabilise growth expectations by joining the TPP 

Even if the recovery in the capital stock cycle picks 

up somewhat, it is hard to imagine domestic 

Chart 3: Capital Stock Cycle – All Industries 

(CY, from 1981) 

(Capital Investment, % y/y) 

20% 

1990 

15% 2010 

2005 

10% 

5% 

0% 

-5% 

1981 

-10% 

-15% 

-20% 

-25% 2009 

0 

1 2 3 

-30% 

5% 6% 7% 8% 9% 10% 11% 12% 

(Capital Investment in previous year/Capital Stock at end of previous year) 

Source: METI, BNP Paribas. Note: CY2010 is 2010 Q3 data. 

7.0 

6.0 

5.0 

4.0 

3.0 

2.0 

1.0 

Chart 4: Corporate Growth Expectations 

(real growth rate, %) 

0.0 

74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 


3- Year Ahead 

5- Year Ahead 

investment robustly increasing so long as the effects 

of the ageing population persist. Because population 

decline inevitably means reduced prospects for 

future sales, companies will naturally curb domestic 

business spending. If the authorities try to remedy 

this with discretionary policies designed to stimulate 

more investment, there is a risk that the result could 

be a glut of unprofitable capital stock that weighs on 

the nation’s potential to grow. 

What is needed, therefore, are new growth areas that 

can bolster the return on capital. To this end, we 

believe the authorities should consider aggressively 

tapping into overseas demand by participating in the 

Trans-Pacific Partnership. The free flow of money, 

goods and labour across state boundaries would 

inevitably bolster growth expectations, thereby 

making it possible to arrest the effects of an “ageing 

economy” and realise economic rejuvenation (see 

Japan: PM Sets Out Two Key Challenges in Market 

Mover, 13 January 2011). 

Ryutaro Kono/ Hiroshi Shiraishi 20 January 2011 


30 


US/EUR Spreads: Further Tightening Near Term 

• Eurozone factors (hawkish ECB, EFSF 

speculation, heavy supply) have – unusually – 

been the main driving forces behind the 

compression of US/EUR spreads so far this 

year. 

Chart 1: Mostly Directional…But Not Uniquely 

• Fundamentals and technicals should 

support further tightening of spreads in the 

short run. 

• The US market will continue to set the tone 

over the medium term. With the bearish bias set 

to develop during the course of 2011, this will 

lead to a gradual re-widening of US/EUR 

spreads. 

• STRATEGY: Be positioned for a return of the 

10y T-note/Bund spread to the 10bp area in the 

weeks ahead. 

Source: Reuters EcoWin 

Chart 2: The Impact of Inflation Differentials… 

US/EUR spreads remain mostly directional, 

tightening during rallies on the Treasury market 

(April-October 2010) and widening on setbacks 

(November-December 2010). However, the EMU 

crisis has distorted this relationship for short periods, 

as seen since the start of 2011 (Chart 1). 

While the Treasury market has been stuck in a 

narrow range for several weeks, US/EUR spreads 

have tightened significantly. The recent dynamic 

reflects changes in market anticipation in Europe as 

well as expectations of new measures to reinforce 

the existing EMU safety mechanisms (EFSF, ESM 

etc). 


Chart 3: …and Business Cycle Gaps 

Following the accumulation of better-than-expected 

economic data in core economies (especially 

Germany) over the past couple of months, the ECB 

‘officially’ became more hawkish at its 13 January 

meeting – triggering a sharp sell-off at the front end 

of the curve. The move has translated into a more 

pronounced inversion of short US/EUR spreads, 

pushing the 2y US/Eur spreads back close to their 

October lows both on the cash (-65bp area) and 

swap (-110bp area) curves. 

The setback has been less pronounced on 10s and 

primarily driven by the latest developments in the 

EMU sovereign debt crisis. The ‘successful’ auctions 

in several peripheral markets plus talks and 

speculation about a new shape, scope and limits for 

the EFSF (extension, possibility of buying bonds…) 

put some pressure on the benchmark curve. Unlike 

during the early stage of the crisis, when some in the 


market were questioning the future of the euro and 

buying Germany as pure flight-to-quality trades, it 

should now be clear that the political will is strong 

enough to reinforce further EMU safety nets. This 

Cyril Beuzit 20 January 2011 

Market Mover, Non-Objective Research Section 

31 


also means that, the more peripherals suffer, the 

more core will have to bear the burden. 

Chart 4: Technicals Plead for Further ST 

Tightening 

What’s next? 

While the long-term outlook is for higher yields and 

wider US/EUR spreads, the near-term picture 

remains supportive of tighter spreads, notably in the 

10y area. Regarding short spreads, there is a risk of 

re-widening / disinversion as Fed expectations have 

barely moved while both EUR and GBP front-end 

levels have significantly changed. Both the BoE and 

ECB are expected to hike rates before the FOMC, a 

situation that does not fit with previous cycles. 

Overall, the front end of the euro curve now faces 

asymmetric risks. While it may have been too quick 

to discount more than one rate hike by the end of the 

year, it makes sense for the front end to discount a 

less favourable ECB scenario than previously. Any 

further data – notably on the inflation front – 

surprising on the upside will reinforce this new bias. 

With regard to longer maturities, speculation about 

an agreement on the EFSF will remain high going 

into 4 February and the late-March EU summit, 

maintaining pressures on core EGBs during a period 

of high supply. 

In other words, as long as Treasuries remain stuck in 

the same narrow range, EMU/ECB news will set the 

tone and on balance favour additional US/EUR 

spread tightening. A more constructive tone in 

Treasuries would obviously reinforce this bias. 

Though govvies look heavy, the latest signals on 

risky assets indicate a risk of a pause/setback which 

would likely benefit the Treasury market – watch 

carefully the earnings season and behaviour of the 

S&P 500. 

Technicals (Chart 4) as well as fundamentals (Charts 

2 and 3) are also supportive of such a trend over the 

coming weeks/months. The 10y T-Note/Bund spread 

has broken below the 22.7/24.5bp area (61.8%), 

opening the way for a move towards the 4.0/6.9bp 

lows (“wave C”). The core inflation differential 

between the US and the eurozone also supports a 

further tightening in the short run. Further, our model 

(3m Euro$/Euribor spreads, inflation differential, 

business cycle expectations - ISM) also points to 

tighter spreads over the months ahead. 

The fundamental relationship (see inflation 

differential forecasts, Chart 3), however, supports a 

re-widening of US/EUR spreads later in the year. 

This is in line with our bearish views on the market, 

i.e. US yields resuming their rise in the spring. A 

likely rise in volatility later in the year (the VIX is 

currently on lows) would also support this mediumterm 

call (Chart 6). 


Chart 5: Partly Driven by Risk Appetite… 



Chart 6: …and Volatility 

Cyril Beuzit 20 January 2011 


32 


US: Could the Short End Have a Pulse? 

• With inflation concerns gaining more 

attention in Europe and UK, more investors are 

asking if the US could follow suit, sooner or 

later, despite lacklustre growth and high 

unemployment so far. 

• While an inflation-induced selloff is not our 

base case, the market could nonetheless get 

jittery – as it is prone to do – in response to any 

sign of a pick-up in headline inflation, pushing 

rates higher. 

• STRATEGY: Consider defensive bearish 

strategies using mid-curve puts on red 

Eurodollars. We recommend buying mid June 

9875/9825 put spread @ around 12 as an 

effective strategy with a 4:1 payout. 

With the ECB officially turning more hawkish in view 

of better-than-expected data (especially in Germany) 

and inflation becoming a more pressing concern in 

the UK, the question we are hearing more and more 

is, could the US be far behind? We are all familiar 

with the counter arguments: high unemployment, 

absence of wage pressures, still-deleveraging 

consumers, depressed home prices and housing 

activity, a core inflation reading a far cry from being 

anything that smells of inflation, and on and on. Yet, 

the market does sometimes get very fickle, and 

responds disproportionately if signs of a nonconsensus 

scenario begin to emerge. This is 

especially true after a period of relatively limited rate 

movements, as has been the case since mid- 

December. So, even though we are firmly in the 

camp that inflation is a non-issue in the US for the 

time being for all the reasons cited above, we should 

still be cognizant of the risk of an abrupt selloff. 

With that in mind, we canvas the spectrum of bearish 

trades. In the risk scenario we depict, where market 

sentiment moves toward inflation and prices in 

potentially aggressive Fed action against it down the 

road, we expect the 18mo to 3y part of the curve to 

take the brunt of the selloff, depending on how soon 

the market perceives the beginning of any potential 

tightening. We want limited downside, so our focus is 

on option strategies. The most obvious choice is to 

simply buy a put on red Eurodollars, but we do not 

necessarily want to spend too high a premium to 

cover a really long period to expiry. This leads us to 

mid-curve options. 

We will illustrate the idea using mid June puts. The 

red June is currently trading at 98.77. The rolldown 

Chart 1: Spread between 5 th ED and Fed Funds 

4 

3.5 

3 

2.5 

2 

1.5 

1 

0.5 

0 

-0.5 

-1 

-1.5 

Nov-90 

Nov-91 

Nov-92 

Nov-93 

Nov-94 

Nov-95 

Nov-96 

Nov-97 

Nov-98 

Nov-99 

Nov-00 

Nov-01 

Nov-02 

Nov-03 

Nov-04 

Nov-05 

Nov-06 

Nov-07 

Nov-08 

Nov-09 

Nov-10 


1200 

1000 

800 

600 

400 

200 

0 

-200 

-400 

Chart 2: PnL Chart of the Put Spread 

96.0 

96.2 

Source: BNP Paribas, Bloomberg 

1/20/2011 

3/8/2011 

4/24/2011 

6/10/2011 

96.4 

96.6 

96.8 

97.1 

97.3 

97.5 

97.7 

97.9 

98.1 

98.3 

98.5 

98.7 

98.9 

99.2 

99.4 

99.6 

99.8 

100.0 

over three months is 28bp. While hefty, this level is 

close to the median of the history of the rolldown 

over the past year. One would not gain anything in 

terms of rolldown by moving the trade to the March 

or September contract. 

We select strikes in such a way to increase the odds 

of the trade making money in a reasonable selloff. 

Chart 1 shows the historical spread between the 5 th 

Eurodollar contract and fed funds. By June 2011, at 

the expiry of the option, targeting a spread above 

100bp seems reasonable in the event of a selloff. 

This suggests that the Jun 2012 contract should be 

priced below 98.75. We prefer a put spread, rather 

than a put at 98.75, for better % returns on the 

premium spent. Specifically, we recommend buying 

the 9875/9825 put spread, paying around 12 ticks. At 

or below 98.25, the maximum payout is 4.2:1 for this 

trade. For comparison, an outright 9875 put would 

have a 2.3:1 payout ratio at the same level. To reach 

4.2:1 payout ratio with the single put, the June 2012 

should trade at 97.9 in June 2011, close to a 200bp 

spread over fed funds, which is clearly a higher 

hurdle to clear. 

Bulent Baygun 20 January 2011 


33 


US: Setup for Auctions with Spread Curve Flatteners 

• In general, 2y Tsy tends to cheapen relative 

to the long end going into the auction and 

reverse direction post auction (2s10s, 2s30s 

flatteners followed by steepeners). 

• 5y and 7y notes have a tendency to move 

almost in line with the long end going into the 

auctions and to richen relative to the long end 

post auctions (5s10s, 5s30s steepeners). 

• There is a clear trend of belly spread 

widening relative to the front end and long end 

spreads throughout the auction. 

• STRATEGY: Consider paying 5y spreads vs 

10y spreads. Also consider paying 5y spreads 

vs 2y and 10y spreads for a higher average 

move which comes with higher volatility. 

With 2y, 5y and 7y auctions taking place next week, 

we highlight auction-based systematic trades which 

we have been recommending in the past issues of 

our weekly publication. 

While doing this analysis, we look at auctions since 

Jan 2010 (total of 12 auctions) and keep the issues 

fixed through each auction (i.e. always use the 

current issue pre auction which becomes old 

post auction) so that there is no spurious roll 

effect. 

Outright treasury curve behaviour around 

auctions 

Chart 1 shows that, while the front end cheapens 

relative to the long end going into the auctions, the 

belly moves more or less along with the long end. 

Post auctions, while both the front end and belly 

richen relative to the long end, a more pronounced 

steepening effect is seen in 5s10s and 5s30s Tsy 

curve. 

Chart 1: Treasury Yield Trends Around 2y, 5y 

and 7y Auction days 

8 

7 

6 

5 

4 

3 

2 

1 

0 

(1) 

(2) 

(3) 

2s10s 

2s30s 

5s10s 

5s30s 

7s10s 

7s30s 

T-5 T-3 T-1 T T+1 T+3 T+5 


Chart 2: Spread-of-Spreads Trends Around 2y, 

5y and 7y Auction Days 

2 

1 

0 

(1) 

(2) 

(3) 

(4) 

T-5 T-3 T-1 T T+1 T+3 T+5 

2s10s 

2s30s 

5s10s 

5s30s 

7s10s 

7s30s 


Chart 3: Comparison of 5s10s Spread Flattener 

with 2s5s10s Spread Fly 

10 

8 

5s10s 

2s5s10s 

Table 1 (at the end of this article) helps us put some 

numbers in perspective for the above-mentioned 

curve trades. 5s10s Tsy curve steepener has turned 

in a profit 10 times in the past 12 auctions. The 

average movement in favour of this strategy has 

been about 5.2bp with a volatility of 3.8bp. 

6 

4 

2 

Sharpe Ratio 

for 5s10s: 

1.82 

Sharpe Ratio 

for 2s5s10s: 

1.64 

Disclosure: Given our existing structural Tsy 5s10s 

flattening view initiated at 138.5, now at 139.5, we 

will choose not to put on a tactical steepener but may 

use any potential steepening as an opportunity to 

increase our flattening position. 

0 

Jan 

Feb 

Mar 


Apr 

May 

June 

July 

Aug 

Sept 

Oct 

Nov 

Dec 

Rohit Garg 20 January 2011 


34 


Trades with higher hit ratio and Sharpe ratio in 

swap spreads 

The swap spread curve witnesses a consistent 

flattening trend around these month-end auction 

cycles. Chart 2 shows a clear trend of spread curve 

flattening going into the auction across all maturities. 

This spread-flattening trend becomes more 

pronounced post auction, especially in 5s10s. 

Based on the rankings (in Table 1, which takes into 

account average move, volatility and hit ratio), 5s10s 

spread curve flattener post 5y auction emerges as a 

clear winner. However, another strategy with a higher 

average movement at the expense of higher volatility 

is the 2-5-10 spread fly (go long 5y spreads vs 2y 

and 10y spreads) which has also worked 12 times in 

last 12 auctions (see Chart 3). 

One other important take-away from this chart is that 

on occasions when the spread curve flattener hasn’t 

worked well, the spread fly has worked very well and 

vice versa. Hence, it might be beneficial to take 

positions in both these trades simultaneously to 

increase the chances of net profit margin in terms of 

risk taken. 

Table 1: Auction Trades with Hit Ratios Adjusted for Vol and Hit Ratio (T – respective auction day) 

Average 

Move (in bp) 

Overall 

Rating 

When did it not work 

Entry Exit Hit Ratio 

Vol (in bp) 

2y Auction 

2s3s Tsy Flattener T+1 T+5 9/12 2.47 3.07 0.60 March/May/Nov 

2s5s Tsy Flattener T-1 T+5 9/12 4.70 7.14 0.49 March/May/Dec 

2s10s Tsy Flattener T-5 T 10/12 5.47 9.3 0.49 July/Oct 

2s30s Tsy Flattener T-5 T 9/12 7.03 8.74 0.60 Jan/July/Oct 

2s5s10s Tsy Fly trading lower T+1 T+5 11/12 7.41 7.19 0.94 Nov 

2s5s30s Tsy Fly trading lower T+1 T+5 11/12 7.77 10.5 0.68 Nov 

2s3s Spd Flattener T-5 T+1 9/12 1.17 2.4 0.37 July/Oct/Dec 

2s10s Spd Flattener T-3 T+5 10/12 3.66 5.4 0.56 Sept/Oct 

2s30s Spd Flattener T-3 T+5 10/12 3.76 7.5 0.42 Oct 

2s5s10s Spd Fly trading higher T+1 T+5 12/12 4.40 2.7 1.63 

2s5s30s Spd fly trading higher T+1 T+5 11/12 3.95 3.4 1.06 Nov 

5y Auction 

5s10s Tsy Steepener T T+5 10/12 5.19 3.82 1.13 June/Nov 

5s30s Tsy Steepener T T+5 11/12 6.99 8.3 0.77 Nov 

3s5s7s Tsy Fly trading lower T-3 T+5 9/12 3.68 3.67 0.75 March/May/Nov 

3s5s10s Tsy Fly trading lower T-3 T+5 11/12 6.87 6.12 1.03 Nov 

3s5s30s Tsy Fly trading lower T-3 T+5 11/12 9.41 10 0.86 Nov 

5s10s Spd Flattener T T+5 12/12 3.24 1.78 1.82 

5s30s Spd Flattener T T+5 11/12 2.95 2.66 1.02 Dec 

3s5s7s Spd Fly trading higher T-3 T+5 11/12 2.46 1.97 1.15 March 

3s5s10s Spd Fly trading higher T-3 T+5 11/12 4.91 2.74 1.64 Nov 

3s5s30s Spd Fly trading higher T-3 T+5 10/12 5.34 4.74 0.94 Nov/Dec 

5s10s30s Spd Fly trading lower T T+5 11/12 3.04 2.53 1.10 Sept 

7y Auction 

2s7s Tsy Flattener T-3 T+5 7/12 3.70 11.64 0.19 March/May/Aug/Nov/Dec 

7s10s Tsy Steepener T-3 T+5 10/12 2.39 3.25 0.61 June/Nov 

7s30s Tsy Steepener T-3 T+5 8/12 4.65 11.53 0.27 March/April/June/Nov 

3s7s10s Tsy Fly trading lower T-3 T+5 7/12 3.11 8.79 0.21 March/May/Aug/Nov/Dec 

3s7s30s Tsy Fly trading lower T-3 T+5 7/12 5.38 16.12 0.19 March/April/May/Nov/Dec 

7s10s Spd Flattener T-5 T+3 11/12 1.82 1.51 1.10 Nov 

7s30s Spd Flattener T-5 T+3 9/12 1.94 4.76 0.31 Oct/Nov/Dec 

3s7s10s Spd fly trading higher T-3 T 9/12 1.60 3.82 0.31 March/June/Nov 

3s7s30s Spd fly trading higher T-3 T 9/12 2.14 4 0.40 March/June/Nov 


Rohit Garg 20 January 2011 


35 


MBS: Stay Long 

• We recommend staying long the mortgage 

basis. Valuations remain reasonable and the 

carry in back months is attractive, fully 

reflecting the slowdown in speeds. 

• In a rally, servicer convexity costs keep 

primary rates in check and in a sell-off 

incremental extension is low. If rates remain 

range bound as we expect, the curve hedged 

carry (adding back convexity costs) remains 

formidable in this low yield environment. 

• We continue to like going up in coupon into 

5s through 6s due to the attractive carry. 

15s/30s appear to be on the richer side. 

• Investors considering front sequentials off 

CK collateral may also find value in similar 

bonds off FG collateral, given that FG 4.5s are 

trading 9 ticks below parity while CKs 4 ticks. 

• STRATEGY: Long MBS, Long UIC. 

The poor performance of mortgages on Tuesday was 

partially erased on Wednesday and, week over 

week, mortgages were tighter by 4-8 ticks depending 

on the coupon. We continue to remain overweight on 

the mortgage basis. As shown in Chart 1, the 

regression of the current coupon versus rates, curve 

and vol (to capture market rather than model 

sensitivities to these factors) indicates that 

mortgages are marginally cheap. However, we would 

argue that, considering the low rate environment we 

are in and the need for spread, the regression does 

not reflect the overall attractiveness of the product. 

Chart 1: Regression of Current Coupon versus 

Rates, Curve and Vol 

bp 

25 

20 

15 

10 

5 

- 

(5) 

(10) 

(15) 

(20) 

Jan-10 

Feb-10 


Curr Cpn Rich Cheap 

Mar-10 

Apr-10 

May-10 

Jun-10 

Jul-10 

Aug-10 

Sep-10 

Oct-10 

Cheap 

Chart 2: Mortgage Carry in Ticks 

Curve and Convexity 

Hedged Carry 

Rich 

Nov-10 

Dec-10 

Jan-11 

Curve Hedged Carry 

Cpn 1M 2M 

Back Month 

(2M-1M) 1M 2M 

Back Month 

(2M-1M) 

3.5 -1.6 -2.4 -0.9 -0.7 -0.7 0.0 

4 -1.3 -1.8 -0.5 1.0 2.8 1.8 

4.5 -1.1 -1.0 0.1 3.0 7.3 4.3 

5 -0.2 1.4 1.6 3.3 8.6 5.3 

5.5 0.3 2.4 2.1 2.2 6.3 4.0 

6 0.8 3.9 3.1 2.3 6.9 4.7 

Source: BNP Paribas, Yield Book 

Chart 3: S-Curve of the Refi Index (Refi Index 

versus Freddie Mac Survey Rate) 

5500 

For example, consider the carry of mortgages on a 1 

month and 2 month basis, both considerably 

negative for lower coupons. But the carry of 

mortgages is quite attractive in the back month, as 

the impact of low prepays is fully reflected. 

Convexity concerns in a sell-off are likely to be 

muted. As we have discussed previously, when the 

10y Treasury went beyond the 3.50% level, the bulk 

of the convexity flows were done. We have rallied 

somewhat since then but prepays haven’t picked up 

materially as reflected in the refi index since primary 

rates haven’t budged to levels where borrowers care. 

This may be due to increased convexity hedging 

costs of servicers in a rally that keeps primary rates 

in check. Thus with mortgage rates sticky in a rally 

and relatively low extension in a sell-off, mortgages 

are poised to do well in rate moves. If rates remain 

5.4 

5.2 

Source: Bloomberg 

5 

4.8 

4.6 

4.4 

4.2 

5000 

4500 

4000 

3500 

3000 

2500 

2000 

1500 

4 

Anish Lohokare / Timi Ajibola 20 January 2011 


36 


ange bound, as we expect, given that the curve 

hedged carry (without hedging convexity) is quite 

attractive helps. 

Also consider the refi index, currently hovering 

around the 2000-2500 level. Chart 3 shows that the 

refi index level in a sell-off is likely to remain sticky, 

akin to the prepay S-curve flattening out at the lower 

end of prepays. Historical data indicate that the refi 

index has not fallen below 1000 and the lows were 

reached in the later part of 2008, as mortgages rates 

soared beyond 6% even breaching 6.50% for some 

time (Chart 4). With a 4.7-5% handle on primary 

mortgage rates, we are substantially away from 

those levels. Thus the precipitous drop from 5000+ to 

2000+ levels in response to the sell-off until now 

cannot be sustained; further declines should be more 

gradual and this is yet another way of confirming the 

benign convexity picture. 

As is clear from the carry by coupon in Chart 2, up in 

coupon remains an attractive trade. 15s/30s appear 

to be on the richer side, and may see a correction. 

CMOs 

We have seen demand for front sequentials backed 

by new production (0 to 3 WALA) CK 4.5s as 

investors look to put money to work in the new year. 

While structures off CK collateral continue to look 

attractive due to the cheapness of the collateral 

around 23 ticks back to TBA, we think structures off 

Gold 4.5s also offer value. The Gold/FN 4.5 swap 

remains cheap at around -6 ticks; equal OAS 

valuation in Yield Book points to a swap level of +3 

ticks, overall a 9 tick pickup. On an equal OAS basis, 

CKs should trade 19 ticks back of TBA and current 

valuations represent a 4 tick pickup. 

Chart 5 shows analytics for FG 4.5s versus CK 4.5; it 

reflects similar OASs for both collateral, with Gold 

4.5s having a shorter duration but higher convexity. 

While models may show a higher convexity number 

per se, the s-curve over the past two years for CK 

4.5s and Gold 4.5s in Chart 6 demonstrate that Gold 

4.5s clearly have a better convexity profile. The 

WALA ramp in Chart 7 reflects the same tendency. 

In Chart 8, we show analytics for two front 

sequentials, one backed by Gold 4.5s and the other 

backed by new WALA CK 4.5s. It shows that the 

Gold 4.5 sequential looks cheaper on an OAS basis 

with a better convexity profile and a higher price. 

Thus the investor is more than compensated for the 

higher price through better convexity. In Chart 9 we 

show WAL and Yield table profiles of both front 

sequentials, which confirms that structure off gold 

4.5s has a better convexity profile. The structure off 

CK collateral currently has slower speeds than Gold 

4.5s. However the s-curve shows that CKs collateral 

Chart 4: The Refi Index Doesn’t Have All That 

Much To Fall and Should Do So Gradually 

7 

6.5 

6 

5.5 

5 

4.5 

4 

Jan- 

06 

Jul- 

06 

Jan- 

07 

Jul- 

07 

Jan- 

08 


Mortgage Rate 

Jul- 

08 

Jan- 

09 

Jul- 

09 

Refi Index 

Jan- 

10 

Jul- 

10 

Chart 5: Analytics for FG versus CK 4.5s 

(Tuesday close, indicative only) 

0 

Jan- 

11 

OAS ZV OAD OAC 

FHLG 4.5 14 74 4.9 -2.6 

FNMA 4.5 CK 13 72 5.6 -2.2 

Source: Yield Book 

1m CPRs 

70 

60 

50 

40 

30 

20 

10 

0 

Chart 6: S-Curve of CK versus FG 4.5s 


1m CPRs 

Gold 4.5s 

FN 4.5 CKs 

-75 -50 -25 0 25 50 75 100 125 150 

Moneyness 

Chart 7: WALA Ramp of CK versus FG 4.5s 

90 

80 

70 

60 

50 

40 

30 

20 

10 

0 

8000 

7000 

6000 

5000 

4000 

3000 

2000 

1000 

0 2 4 6 8 10 12 14 16 18 20 22 24 


Gold 4.5s 

FN 4.5 CKs 

WALA 



37 


is much more responsive to rates at the same level 

of moneyness and the WALA ramp is also 

considerably steeper. We would expect speeds on 

new WALA CKs to surpass that of Gold 4.5s fairly 

soon at current rate levels. 

Chart 8: Front Sequential Analytics 

(Tuesday close, indicative only) 

Price OAS OAD OAC 

PRLM PB-1566 A 103-18+ -3 3.8 -3.0 

PRLM PB-1571 A 103-05 -15 3.1 -3.3 

Source: BNP Paribas, Yield Book 

Chart 9: Front Sequential Analytics at Rate 

Shocks (Tues close, indicative only) 

WAL -300 -200 -100 0 100 200 300 

PRLM PB-1566 A 1.15 1.40 2.06 3.59 6.74 7.92 8.36 

PRLM PB-1571 A 0.98 1.08 1.54 2.40 7.22 8.32 8.72 

Yield -300 -200 -100 0 100 200 300 

PRLM PB-1566 A 1.227 1.799 2.627 3.392 3.871 3.955 3.981 

PRLM PB-1571 A 0.961 1.287 2.219 3.014 3.960 4.024 4.044 

Source: Yield Book 



38 


EUR: Liquidity is No Stress 

• The reserve maintenance period started with 

a lower level of liquidity, fuelling concerns of 

potential tension on eonia. 

Chart 1: Excess Liquidity has Declined 

• However, with no stress on liquidity given 

the ECB’s pipeline for the next few months, 

tensions will remain limited. The eonia curve will 

resteepen over the next couple of weeks. 

• STRATEGY: Take advantage of a flattening 

correction on ERs to re-enter bear steepeners. 

Lower demand at the ECB… 

Demand at this week’s ECB tenders fell slightly short 

of levels expiring. The ECB allotted EUR 247.3bn 

while EUR 248.2bn were maturing. This was a little 

surprising as demand usually increases during the 

first week of the reserve maintenance period. Indeed, 

banks usually hold more than reserve requirements 

in their current accounts during the first part of the 

reserve period, in order to avoid the risk of running 

out of cash before the period ends. In such a context 

and given lower liquidity, there was the risk of 

tensions on eonia beyond the usual rise on the last 

day of the previous reserve period. 

…as long as the ECB pipeline remains open 

The lack of stress apparent in banks’ demand at ECB 

tenders can be explained by the fact that near term, 

i.e. at least until April, the ECB will continue to 

provide liquidity on request without any cap. There is 

therefore no hurry to ask for a large excess of 

liquidity. In addition, it seems that banks adjusted 

their level of excess reserves at the start of the new 

reserve period. They currently hold EUR 222bn in 

their current accounts (EUR 9.7bn above 

requirements), while excess reserves are usually 

closer to EUR 40-50bn at the start of the period. 

Moreover, while demand at the MRO fell, demand at 

the LTRO (3 weeks) rose. This will prevent stress 

from developing. 

A gradual resteepening at the front end 

Beyond the first couple of days at the start of the 

period, it makes sense that eonia should decline. 

This will go along with a steeper spot eonia curve. 

Steepening pressures will also resume on the ER 

curve. After last week’s ECB press conference, the 

ER1-ER steepened 15bp under selling pressures. 

From a peak of 75bp, the spread tightened back to 

72.5bp. Over the next few days, the potential for a 

bull-flattening correction on ERs will fade. The 

regime at the front end has changed. For sure, the 

ECB did not want to flag up the risk of a rate hike 



Chart 2: Excess Reserves Lower 

over the next few months. But the ECB is gradually 

reassessing risks. Last year, bear-steepening 

movements at the front end offered bull-flattening 

trade opportunities. This year, the opposite is true. 

The current movement on the Euribor curve is 

temporary. A flattening below 70bp along with an 

ERH2 close to 98.25 offers an opportunity to re-enter 

bear steepeners. It is worth noting that, over the long 

run, the average spread between the refi and the 

3mth Euribor is 15-20bp in a status quo, rises to 

35bp ahead of a rate hike cycle and is close to 50bp 

when the rate hike process starts. As long as the 

market discounts a rate hike by early 2012, the 

Mar12 implied rate must be at least 1.75%. 

Strategy: Beyond a near-term correction, there is no 

scope for a bullish bias on ERs. Benefit from a bullflattening 

correction to re-enter bear steepeners. 

Patrick Jacq 20 January 2011 


39 


EUR: Bund ASW Risk/Reward Analysis 

• We combine swap spreads’ single-factor 

sensitivity into a scenario matrix. 

• STRATEGY: Buy Bund 10Y ASW at 22bp, 

target 35bp, based on risk/reward analysis. 

0 

-5 

-10 

-15 

Chart 1: Impact of Fiscal Variables 

Germany federal govt budget (EUR bn) 

Bund 10Y swap spread (RHS) 

0.70 

0.60 

0.50 

We aggregate the single drivers of Bund swap 

spreads into a scenario matrix. The idea is to provide 

scenario projections and thus minimum/maximum 

boundaries for spreads. We can then derive a 

strategy based on risk/reward arguments. 

We look at the following factors: 

• Fiscal variables (German budget); 

• ECB expectations (Eonia forwards); 

• Yield curve (EUR 2/10s); 

• Liquidity (OIS/Bor spreads); 

• Credit variables (iTraxx and SovX); and 

• Global variables (Tsy swap spread and Vix). 

Estimating swap spread sensitivity is not a trivial 

exercise, especially during the transition from a precrisis 

to a crisis environment. Nonetheless, we report 

the aggregate impact of two distinct scenarios (“risk 

on” versus “risk off”) on the Bund swap spread in the 

table below. Note how the risk/reward is tilted 

towards a spread widening strategy. 

-20 

0.40 

-25 

-30 

0.30 

-35 

0.20 

-40 

BNP 

-45 

Paribas 0.10 

f 

-50 

0.00 

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 


100 

90 

80 

70 

60 

50 

40 

30 

20 

10 

Chart 2: Impact of Liquidity 

OIS/BOR 

Bund 10Y z-spread (RHS) 

0 

10 

Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 


-90 

-80 

-70 

-60 

-50 

-40 

-30 

-20 

-10 

0 

Trade: Buy Bund 10Y ASW at 22bp, target 35bp. 

Bund 10Y Swap Spread Scenario Analysis 

Bund 10Y ASW 22 

Protracted Risk Scenario Variable Current Level E2011 level Change Weight Impact on ASW 

Government Budget (%) -3.5 -5 -2 0.125 7 

Rate expectations (bp) 0.793 0.5 -0.3 0.125 16 

EUR 2/10s yield curve (bp) 153 200 47 0.125 10 

EUR OIS/BOR (bp) 34 50 16 0.125 38 

VIX (% pts) 17 30 13 0.125 38 

EUR iTraxx Master 10Y (bp) 120 150 30 0.125 44 

SovX 5Y 190 250 60 0.125 45 

US TSY 10Y ASW 7 30 23 0.125 36 

Bund 10Y ASW projection 29 

Risk Normalisation Scenario Current Level E2011 level Change Weight Impact on ASW 

Government Budget (%) -3.5 -1.5 2 0.125 42 

Rate expectations (bp) 0.793 1.1 0.307 0.125 28 

EUR 2/10s yield curve (bp) 153 100 -53 0.125 35 

EUR OIS/BOR (bp) 34 20 -14 0.125 8 

VIX (% pts) 17 10 -7 0.125 13 

EUR iTraxx Master 10Y (bp) 120 100 -20 0.125 6 

SovX 5Y 190 150 -40 0.125 5 

US TSY 10Y ASW 7 0 -7 0.125 18 

Bund 10Y ASW projection 19 

Alessandro Tentori 20 January 2011 


40 


EMU Debt Monitor: Trade Ideas 

• Keep BTP Sep 20/Sep 40 flatteners. 

• Close 10y/20y/30y swap rec around 50bp. 

• Sell BTP Feb 37 vs. BTP Sep 40. 

• Buy Bund July 20 vs. July 39 in mid 40s. 

• Sell Bono July 40 vs. BTP Sep 40 below 40. 

Chart 1: 2020/2040 BTP, Bono, Bund Spreads 

110 

100 

90 

80 

70 

60 

We focus this week on the very long end of cash 

curves and their potential RV opportunities. 

On the 10y/30y segment and its convexity, we have 

pushed two key trades over the past month. On the 

convexity side, we recommended receiving 

10y/20y/30y swap fly in the 60/62 area in late 

November, targeting the 48/50bp level. The swap fly 

is now close to our target. On the curve itself, we 

stressed last week that 10y/30y flatteners were the 

most attractive on the BTP curve given box levels vs. 

other cash curves. We entered Sep 20/Sep 40 

flatteners at 85.5bp last Thursday, targeting 70bp 

then 60bp in Q1 2011. 

10y/30y flatteners supported by the shift in ECB’s 

policy expectations 

The main advantage of 10y/30y flatteners – 

especially on peripherals – is the optionality linked to 

a kind of a panic flattening/inversion such as that 

seen on the Greek curve and its sensitivity to a repricing 

of ECB rate hike expectations, especially after 

last week’s ECB press conference. More precisely, if 

the past is any guide, a resteepening of the Euribor 

front/red segment on a shift of market participants 

regarding future policy will have a flattening impact 

on the curve. Table 1 summarises the sensitivity of 

the main core and non-core 10y/30y segments 

(Bund, OAT, Dsl, ATS, Olo, BTP and Bono) to the 

money market curve, gauged with the 3 rd /7 th generic 

Euribor spread. The highest correlation is obtained 

for the OAT and BTP segments (above 55%) while 

Olos and especially BTP segments have the highest 

beta, with 10bp Euribor spread steepening leading to 

2bp and 2.7bp flattening respectively. Taking into 

account the relationship between the cash segment 

and the Euribor curve, the Bund with DSLs and Bono 

segments are the ones that seem too flat. Chart 2 

exhibits the residual of the regression of the Bund 

July 20/Bund July 40 vs. the money market curve 

while Chart 3 plots the DSL/OAT 10y/30y box. Both 

highlight the expensiveness of 30y Bunds and 2042 

DSL. Recurrent pension fund buying of 30y Bunds 

50 

40 

Apr-10 Jul-10 Oct-10 Jan-11 

Sep 20/ Sep 40 BTP spd Apr 2020/Jul 40 Bono spd Jul 2020/Jul 40 Bund spd 


Table 1: Cash 20/40 Spreads vs. 10y/30y Swap 

& Euribor Curve: BTP has Highest Sensitivity 

Jul 2020/Jul 40 Bund spd Oct 2019/Avr 41 OAT spd DSL July 19/Jan 37 ATS July 20/Mar 37 

Correl Eur 10y/30y 78.6% -10.3% 34.7% 84.7% 

Beta 0.80 0.42 0.82 

Alpha 44.12 44.49 26.62 

Correl Eur 3/7 -16.0% -55.9% -25.4% 33.4% 

Beta -0.10 -0.12 -0.09 0.16 

Alpha 72.10 77.56 65.71 35.71 

Olo Sep 20/Mar 41 Sep 20/ Sep 40 BTP spd Jul 2019/Jul 40 Bono spd 

Correl Eur 10y/30y 80.1% 32.3% 37.3% 

Beta 1.39 0.30 0.61 

Alpha 

Correl Eur 3/7 -21.7% -59.5% -33.8% 

Beta -0.20 -0.27 -0.19 

Alpha 71.85 104.15 91.66 


Chart 2: 10y/30y Bund vs. Euribor curve: Bund 

Curve Too Flat 

25 

20 

15 

10 

5 

0 

-5 

-10 

-15 

-20 

-25 

Apr-10 Jul-10 Oct-10 Jan-11 


Jan 2020/Jul 40 Bund spd 

Eric Oynoyan / Ioannis Sokos 20 January 2011 


41 


and DSLs maturities, which are now above 3.50%, 

could explain that temporary richening. On Bonos, 

the richening of the 30y is actually a higher premium 

over 10y Bonos, which pushed the 10y/30y 

Bono/Bund box to low levels (see Chart 4). However, 

the GGB 10y/30y inversion since April 2010 does not 

give any incentive to jump into 2020/2040 Bono 

steepeners. 

Recommended trades 

Bund July 20 / July 39 spread steepeners 

As stressed earlier, the Bund segment has 

overreacted to the shift in ECB expectations since 

October and appears more than 10bp too flat. Use 

any pullback to 44/46bp to enter steepeners, 

targeting the 55/58bp area. For HF, the safest trade 

would be to remove the money curve component 

through Euribor U1U2 steepeners (Euribor DV01 15k 

vs. 100k Bund steepeners). 1-mth profit of carry: 

1.1bp per month. 

10y/20y/30y swap fly receivers 

After a period of stabilisation in the low 60s, the 20y 

swap has finally recovered, allowing the swap fly to 

move towards the low 50s. Book profits on our 

48/50bp target. 

Sell BTP Feb 37 vs. BTP Sep 40 

As Chart 5 illustrates, this spread has dramatically 

decoupled from the 10y/30y BTP flattening since late 

November. With the 2037/40 spread almost back at 

2010 highs while the 2020/40 BTP spread has 

flattened 25bp, holders of BTP Feb 37 should take 

advantage of the current high spread level to switch 

into BTP Sep 40. The spread of around 15.5bp 

should tighten back to October lows around 

9/10bp. 

Sell Bono July 40 vs. BTP Sep 40 

After a 35bp compression since late December, the 

30y BTP/Bono spread has stabilised in a tight 

40/50bp trading range. Using the conditional 

distribution approach, any tightening to the mid 30s 

would provide very good entry levels, targeting 

December’s mid-60s (peak of Q4 2010 regime). 

Enter widening trades on a compression to the 

35/40bp area, targeting the mid 60s. 

30 

25 

20 

15 

10 

Chart 3: 10y/30y OAT/DSL Box: 30y DSL Too 

Expensive 

5 

OAT Apr 20 / DSL 42 

expensive 

OAT Apr 20/DSL 

42 cheap 

0 

May-10 Aug-10 Nov-10 Feb-11 


DSL July 20/OAT Apr 20/Jan 42/OAT Apr 41 

Chart 4: 2020/40 Cash Boxes vs. Bund: Bono 

Back at its Lows while BTP One is the Highest 

45 

35 

25 

15 

5 

-5 

-15 

-25 

Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 

2020/40 OAT/Bund 2020/40 ATS/Bund 2020/40 olo/Bund 

2020/40 BTP/Bund 2020/40 Bono/Bund 


Chart 5: 10y/30y BTP & 2037/2040 BTP Spreads 

1.1 

1.05 

1 

0.95 

0.9 

0.85 

0.8 

0.75 

0.7 

0.65 

0.6 

Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Dec-10 Jan-11 Feb-11 

BTPS 5.00 01/09/40 / BTPS 4.00 01/09/20 


BTPS 5.00 01/09/40 / BTPS 4 1/2/37 (R.H.S) 

Chart 6: 2040 BTP/Bono Distribution 

Conditional on 2020 Spread: Selling Area 

around 35/40bp 

0.18 

0.17 

0.16 

0.15 

0.14 

0.13 

0.12 

0.11 

0.1 

4.5 

4 

3.5 

December regime 

3 

2.5 

2 

Selling 

area 

1.5 

1 

0.5 

0 

0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 




42 


EMU Debt Monitor: CDS Analysis 

Chart 1: Non-core basis diff vs. Gy: 1-week richening 

Chart 2: 2y CDS basis diff vs. Germany: ATS expensive 

80 

5Y CDS basis 

30 

2Y CDS basis 

60 

40 

cash cheap vs CDS 

20 

cash cheap vs CDS 

20 

10 

0 

-20 

0 

-40 

-60 

-10 

-80 

-100 

-120 

cash expensive vs CDS 

Jul-10 Aug-10 Sep-10 Sep-10 Oct-10 Nov-10 Nov-10 Dec-10 Jan-11 

BEL SPA ITA POR 

Among non-core, the cheapness of 5y BTPs and to some 

extent Bonos vs. CDS has changed little. Both 6-month 

rolling z scores are over 2.00. As stressed last week, 5y 

BTPs were trading too cheap within the BTP curve and also 

vs. CDS. Although Italian CDS and BTP spread declined 

30bp in a week, 5y BTPs are still too cheap vs. 2y and 10y 

BTPs (see Chart 3). We expect 5y BTP to recover vs. CDS 

in coming weeks but this time with wider spreads (see Trade 

Ideas section). 

-20 

cash expensive vs CDS 

-30 

Jul-10 Aug-10 Sep-10 Sep-10 Oct-10 Nov-10 Nov-10 Dec-10 Jan-11 

FRA FIN AUS NETH 

Among core, while the Belgium/France 5y CDS is back at 

the cash level, French paper continues to trade with a high 

premium to DSLs compared to the CDS differential, even 

though that premium narrowed on a lower French CDS. The 

reduction of that premium can be played on the cash through 

wider BTAN/DSL spreads on July 14. Regarding Austria, 2y 

cash vs. France is now far too rich compared to the flat CDS 

(see chart above and Chart 8). 


CDS Table & Stats 

5y FIN NETH FRA AUS BEL ITA SPA POR IRE GRE 

CDS 37 53 97 97 190 190 280 465 625 890 

cash -36 -35 -18 -12 74 96 173 308 457 714 

Basis 73.6 88.8 115.6 109.3 116.4 93.6 106.9 156.9 167.6 175.8 

Box vs Gy 34.3 19.2 -7.7 -1.3 -8.5 14.3 1.0 -48.9 -59.7 -67.8 

Average 26.8 11.9 -11.1 -2.9 -16.4 -21.8 -25.0 -34.1 -16.5 -75.8 

Max 42.4 20.0 0.9 15.8 4.3 14.4 2.4 36.1 50.6 3.9 

Min 15.7 5.0 -24.2 -23.3 -45.4 -59.8 -52.5 -117.7 -93.1 -165.2 

Z score** 1.14 2.05 0.70 0.25 0.72 2.44 2.30 -0.35 -1.13 0.20 

Current CDS vs Germany Change to 31/12/2009 Change to 30/6 

2y 5y 10y 2y 5y 10y 2y 5y 10y 

FIN 24 37 48 24 35 46 34 20 20 

NETH 36 53 63 28 48 58 22 30 35 

FRA 71 97 113 66 93 108 23 45 60 

AUS 65 97 107 27 38 45 -9 -15 -17 

BEL 155 190 187 133 162 152 35 67 66 

ITA 135 190 190 89 116 111 -65 -26 -41 

SPA 232 280 278 178 188 181 -77 -43 -17 

POR 463 465 414 407 391 334 52 84 20 

IRE 670 625 560 552 488 423 287 199 117 

GRE 915 890 796 711 630 532 -253 -198 -252 


** z score measures the deviation from 6-mth rolling average CDS/cash basis of the country versus Germany, expressed in numbers of standard deviations. A 

number above 1.50 means that the cash is trading historically cheap compared to its average basis level. 



43 


EMU Debt Monitor: Key RV Charts 

Chart 3: Hedged Dec 12/Nov 15/Mar 20 BTP fly 

Chart 4: 2020/2040 BTP/Bono box: normalisation started 

40 

Top on BTP/bund 

5 

30 BTP 5y cheap 

spread 

0 

BTP 2040 too expensive 

20 

Sharp BTP 

-5 

10 

rally 

vs Bunds 

-10 

-15 

0 

-20 

-10 

-25 

-20 

Active CBs 

purchase 

-30 

BTP 2040 too cheap 

-30 

-35 

BTP 5y rich 

Sharp BTP sell-off -40 

-40 

Jan-10 

May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 

Mar-10 Jun-10 Sep-10 Nov-10 

Hedged Dec 12/Nov 15/Mar 20 BTP Fly 

2015 BTPs are trading again at very cheap levels on the 

BTP curve – a bit cheaper than June 2010 levels. We expect 

a rebound and recommend playing it through June 13/Nov 

15 BTP compression trades (see last week’s Trade Ideas 

section). 

Chart 5: 5y H1 ctd valuation: around 7bp too cheap 

Bono/BTP 2020/2040 box 

The normalisation has started with a 5bp box tightening. The 

latter remains 15bp from its average, however. We played 

the compression last week through Sep 20/Sep 40 BTP 

flatteners entered at 85.5, targeting 70bp then low 60s. 

Chart 6: 10y/30y DSL/OAT box: 2042 DSL too expensive 

30 

50 

Hedged Eur h11 CTD Fly 

OAT Apr 20 / DSL 42 

5y too cheap 

expensive 

40 

25 

30 

20 

20 

10 

15 

0 

-10 

10 

-20 

5y expensive 

OAT Apr 20/DSL 

5 

-30 

42 cheap 

-40 

Exotic desks hedging 

US QE 0 

-50 

May-10 Aug-10 Nov-10 Feb-11 

May-07 Dec-07 Jun-08 Jan-09 Jul-09 Feb-10 Aug-10 Mar-11 

DSL July 20/OAT Apr 20/Jan 42/OAT Apr 41 

The last sell-off following the ECB press conf led to a 

marginal cheapening of 5y ctd. Currently, 5y German H1 ctd 

is 7bp too cheap on the curve compared to only 3bp on 

swaps. Even though it is on the cheap side, it is far from 

April 2010 levels. 

Chart 7: CTZ Feb 12 too expensive on the CTZ curve 

Recurrent PF buying of 30y Bunds and DSLs has pushed 

the 10y/30y DSL/OAT box to extreme levels (i.e. DSL too 

expensive). We have the opposite situation at the short end. 

Keep July 14 DSL/BTAN widening trades. 

Chart 8: RFGB/ATS 2013, 15,17: ATS Oct 13 too expensive 

50 

-5 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Nov-10 Dec-10 Jan-11 

Sep 11/Feb 12 Feb 12/Aug 12 CTZ Feb 12/Apr 12 Apr 12/Aug 12 

CTZ Feb 12 outperformed both within the CTZ curve and 

within the CTZ/BKO box (the former is back at new lows). 

Holders of Feb 12 should either switch into Sep 11 or - for 

the most aggressive – into Aug 12, enjoying a 38/40bp pickup. 

-15 

-25 

-35 

-45 

-55 

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 

Fin July 13/ ATS Oct 13 Fin July 15/ ATS July 15 Fin Sep 17/ ATS Sep 17 

While RFGB/ATS tightened all along the curve, 2013 

spreads overshot, falling below March 2010 lows. Other 

maturities are 15/20bp above. Holders of ATS Oct 2013 

should switch back into other AAA such as OAT Oct 13, 

enjoying some pick-up. 

All Charts Source: BNP Paribas 



44 


EMU Debt Monitor: Redemptions 

• Only AAA countries face EGB redemptions in January: Germany EUR 23bn, France EUR 18bn, Netherlands EUR 14bn 

and Austria EUR 8bn. 

• T-bill redemptions will total EUR 99bn this month versus EUR 63bn of EGBs. 

EGBs Monthly Redemptions 

Bonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011 

ITA 0.0 18.7 30.5 0.0 14.6 12.2 0.0 20.2 46.0 0.0 15.5 0.0 157.6 

FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0 

GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3 

SPA 0.0 0.0 0.0 15.5 0.0 0.0 15.5 0.0 0.0 14.1 0.0 0.0 45.1 

GRE 0.0 0.0 8.7 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.4 

BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.5 27.9 

NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9 

AUS 8.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 8.4 

POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5 

IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5 

FIN 0.0 5.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.7 

Total 63 24 66 58 22 35 83 27 89 47 20 24 558 

T-Bills Monthly Redemptions 

Bonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011 

ITA 0.0 18.7 30.5 0.0 14.6 12.2 0.0 20.2 46.0 0.0 15.5 0.0 157.6 

FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0 

GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3 

SPA 0.0 0.0 0.0 15.5 0.0 0.0 15.5 0.0 0.0 14.1 0.0 0.0 45.1 

GRE 0.0 0.0 8.7 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.4 

BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.5 27.9 

NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9 

AUS 8.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 8.4 

POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5 

IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5 

FIN 0.0 5.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.7 

Total 63 24 66 58 22 35 83 27 89 47 20 24 558 

100 

90 

80 

70 

60 

50 

40 

30 

20 

10 

0 

Monthly EGBs Redemptions 

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 

120 

100 

80 

60 

40 

20 

0 

Monthly T-Bills Redemptions 

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 

This month’s EGB redemptions 

This month’s T-Bill redemptions 

Country Bond Maturity Issued EURs (bn) CRNCY 

GERMANY DBR 5 1/4 01/04/11 04/01/2011 20/10/2000 23.25 EUR 

AUSTRIA RAGB 5 1/4 01/04/11 04/01/2011 16/01/2001 8.27 EUR 

GREECE GGB 2 01/11/11 11/01/2011 11/01/2002 0.02 EUR 

FRANCE BTNS 3 01/12/11 12/01/2011 24/01/2006 17.82 EUR 

NETHERLANDS NETHER 4 01/15/11 15/01/2011 11/01/2008 13.86 EUR 

Total 63.21 

Country T-Bill Maturity CRNCY EURs 

AUSTRIA RATB 0 01/13/11 13/01/2011 EUR 0.1 

BELGIUM BGTB 0 01/20/11 20/01/2011 EUR 5.5 

FINLAND RFTB 0 01/11/11 11/01/2011 EUR 1.9 

FINLAND RFTB 0 01/19/11 19/01/2011 USD 1.7 

FRANCE BTF 0 01/13/11 13/01/2011 EUR 8.8 

FRANCE BTF 0 01/27/11 27/01/2011 EUR 8.0 

FRANCE BTF 0 01/06/11 06/01/2011 EUR 8.1 

FRANCE BTF 0 01/20/11 20/01/2011 EUR 8.5 

GERMANY BUBILL 0 01/26/11 26/01/2011 EUR 6.0 

GERMANY BUBILL 0 01/12/11 12/01/2011 EUR 5.0 

GREECE GTB 0 01/14/11 14/01/2011 EUR 1.0 

GREECE GTB 0 01/14/11 14/01/2011 EUR 2.0 

GREECE GTB 0 01/21/11 21/01/2011 EUR 1.2 

IRELAND IRTB 0 01/14/11 14/01/2011 EUR 2.1 

ITALY BOTS 0 01/31/11 31/01/2011 EUR 9.9 

ITALY BOTS 0 01/14/11 14/01/2011 EUR 7.5 

NETHERLANDS DTB 0 01/31/11 31/01/2011 EUR 9.7 

PORTUGAL PORTB 0 01/21/11 21/01/2011 EUR 3.4 

SPAIN SGLT 0 01/21/11 21/01/2011 EUR 8.7 

Total 99.0 




45 


EMU Debt Monitor: SSA & Covered Bonds 

• The recent richening of OBND, the Austrian 

agency, in the 10y area seems overrated. 

• In this segment of the curve, Dutch agencies 

offer a better yield and positive rolldown. 

• STRATEGY: Sell OBND Oct 2020 / Buy BNG 

Sep 2020 or NEDWBK Jan 2021 (yield pickup: 

7bp and 9bp resp.). 

Supply out of European SSA is not slowing. Seven 

benchmarks have been issued so far this week. 

NRW.BANK and ICO each issued a new EUR 1bn 

benchmark while KFW, CADES, EIB and NIB 

launched new bonds denominated in USD (USD 

1.5bn, 2.5bn, 4.5bn and 1bn respectively). The 

inaugural EFSF transaction is expected to be 

launched by the end of the month. The new 5y EUR 

benchmark is likely to add EUR 3-5bn to the USD 

54bn (equivalent) European SSA issued so far this 

month. This will be a key event to watch. 

In the meantime, we highlight below an attractive RV 

trade amongst Dutch and Austrian agencies. Indeed, 

the gradual richening of the Austrian agency OeBB 

Infrastruktur, in the 10y area (OBND Oct 20), seems 

excessive at current levels. That is, compared to the 

neighbouring maturity bullets of the OBND curve, to 

underlying RAGB but also its compatriot agency, 

ASFINAG (Chart 1). 

It is even more interesting to compare OBND Oct 20 

to BNG and NEDWBK, the Dutch agencies. First of 

all, let’s recall that being exposed to Austria is 

perceived as riskier than being long the Netherlands, 

as priced by the CDS and government bond markets. 

Netherlands CDS 5y is trading close to Germany and 

is 36bp tighter than Austria; in govvies space, RAGB 

Jul 20 is 21bp wider than DSL Jul 20. 

OBND Oct 20 is currently richer than BNG Sep 20 

(ASW diff: +3bp) and NEDWBK Jan 21 (ASW diff: 

+5bp) (Charts 1 & 2). However, such relative levels 

are recent (Chart 2). We do not believe that the 

current positive ASW differentials can be long lived, 

especially as fundamentals support the opposite. 

One could of course question the relative levels 

amongst EGBs. However, there is no equivalent 

richening of ATs versus DSLs in the 10y area, none 

that could explain the richening of OBND versus 

Dutch agencies. Agencies’ spreads to underlying 

govvies play in favour of the Dutch agencies. Indeed, 

if the premium BNG has to offer versus DSLs has 

been rather stable over the past 6 months, it has 

widened over the past year (from 16bp early 2010 to 

34bp today) while OBND has richened versus ATs 

over the past 6 months (from 24bp to 10bp). 

40 

30 

20 

10 

0 

Chart 1: Dutch & Austrian Agencies’ Term 

Structures (ASW) 

ASW 

OBND Oct 20 looks rich 

-10 

ASFING OBND 

NEDWBK BNG 

-20 

0y 5y 10y 15y 20y 


Chart 2: Agencies’ ASW Differentials 

8 

6 

4 

2 

0 

-2 

-4 

-6 

-8 

-10 

-12 

OBND Oct 20 vs BNG 3.875 04/11/19 

OBND Oct 20 vs BNG 2.625 01/09/20 

OBND Oct 20 vs NEDWBK 3.5 14/01/21 

-14 

Nov 09 Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 


Chart 3: Spreads to Govvies Differentials 

40 

35 

30 

25 

20 

15 

10 

5 

BOX 1: BNG/DSL 2020 vs OBND/AT 2020 

0 

BOX 2: BNG/DSL 2019 vs OBND/AT 2020 

-5 

BOX 3: NEDWBK/DSL 2021 vs OBND/AT 2020 

Nov 09 Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 


Chart 3 depicts the effects of both the richening of 

OBND versus Dutch agencies and the widening of 

the relative agencies’ premiums to govvies, also in 

favour of BNG. With the exception of June 2010 

(when ATs jumped to extreme levels), we are 

currently in the upper range. 

Dutch agencies in the 10y area currently offer great 

value vs OBND Oct 20 and DSLs. Further, the 

rolldown is positive on BNG and NEDWBK while 

negative on OBND Oct 2020. Investors long OBND 

Oct 20 should switch into BNG Sep 20 or NEDWBK 

Jan 21. 

Camille de Courcel 20 January 2011 


46 


EUR: Buy 3m5y Straddle vs 3m10y Straddle 

• The 3m5y/3m10y implied volatility ratio is 

currently hovering around 0.97, having almost 

monotonically increased from around 0.86 in 

mid- December 

• We expect the implied ratio to increase 

further. Also, we expect gamma 5y options to 

deliver more volatility in the context of 

heightened concern over inflation. 

• STRATEGY: Buy 3m5y straddle vs 3m10y 

straddle. 

Table 1: Implied/Rls vs (3M) 

1y 2y 5y 7y 10y 20y 30y 

1m 147% 115% 115% 113% 112% 112% 111% 

3m 131% 119% 103% 112% 110% 111% 109% 

6m 115% 119% 107% 108% 107% 108% 105% 

1y 115% 115% 104% 104% 101% 100% 97% 

3m5y implied volatility is hovering around 85bp 

whereas 3m10y implied volatility is around 88bp. 

Indeed, the 3m5y/3m10y implied volatility ratio is 

hovering around 0.97, having almost monotonically 

increased from around 0.86 in mid-December 

In the meantime, 3m5y volatility is currently 

delivering more than 3m10y volatility over a threemonth 

horizon (Table 1). At the ECB’s January press 

conference, there was a hawkish shift in the 

assessment of inflation risk. After some dovish 

remarks by the ECB’s Orphanides, expectations 

have stabilised at one 25bp rate hike by year-end. 

However, the debate on inflation in the eurozone is 

gradually taking centre stage. At the current level of 

rates, the risk of the market pricing in a tighter 

monetary policy in the short term is significant, in our 

view. In fact, the latest hawkish comments by ECB 

Stark on Wednesday are telling. In his view, both “the 

global economy and the Euro region recovered faster 

than thought”, and it is “important that the emergency 

measures remain temporary”. Against this backdrop, 

we expect the 5y swap to deliver more volatility than 

the 10y going forward. Accordingly, we like long 

(dynamic) gamma positions on the 3m5y point vs the 

3m10y point. 


Chart 2: 3m5y/3m10y Implied Vol Ratio vs Refi 

5 

4 

3 

2 

1 

0 

Jan- 

05 

Jul- 

05 

Refi 

Jan- 

06 


EUR 3m5y/3m10y Implied Vol Ratio (RHS) 

Jul- 

06 

Jan- 

07 

Jul- 

07 

Jan- 

08 

From a vega risk perspective, a further increase in 

the 3m5y/10y ratio is consistent with a higher interest 

rate regime and/or monetary policy normalisation by 

the ECB (Chart 1). 

Table 2 shows our preferred trade construction for a 

long position in the 3m5y/3m10y swaption spread. 

Jul- 

08 

Jan- 

09 

Jul- 

09 

Jan- 

10 

Jul- 

10 

1.4 

1.3 

1.2 

1.1 

1.0 

0.9 

0.8 

Jan- 

11 

Table 2: Trade Construction 

Notional 

Implied 

ATMF rate Premium PV PV01 Gamma Vega 

(EUR mn) 

Vol 

BE vol Theta/d Theta (EUR) 

Buy 3m5y Straddle 186 2.81 156 2,897,936 4,581 16,636 291,451 85 5.4 -1.2 -22,602 

Sell 3m10y Straddle -100 3.43 290 -2,898,583 -2,942 -15,581 -291,228 88 5.5 2.3 22,607 

-647 1,639 1,056 223 5 


Matteo Regesta 20 January 2011 


47 


JGBs: Commodities – A Headwind 

• Inflation concerns will mount if the oil price 

rises above USD 100/bbl. 

• In December, the domestic CGPI rose 

1.2% y/y, its third consecutive monthly 

advance and its biggest gain since November 

2008. Following the rise in raw material prices, 

intermediate goods prices have started to 

move up. 

• It will be some time before final Japanese 

inflation moves into positive territory. 

However, price declines are drawing to a close; 

increases in raw material prices will tend to 

spread to other goods. 

• Investors will note the halt in price declines 

in H2 this year, which will prove to be a 

persistent headwind for the bond market. 

Higher oil price should lead to inflation concerns 

Amongst international commodity prices, investors 

should probably focus on crude oil. The WTI futures 

price has risen to USD 92/bbl for the first time since 

2008, breaking through the USD 90 level, a 50% 

retracement of the plunge in prices following the 

Lehman shock. In his congressional testimony on 7 

January, Fed chairman Bernanke noted that 

economic growth would be impeded should petrol 

prices rise excessively. 

US retail gasoline prices have risen above USD 3 per 

gallon for the first time since October 2008. Inflation 

worries rapidly took centre stage when the gasoline 

price rose above USD 4 in the summer of 2008, 

pushing the Fed chairman to pause temporarily in his 

drive to cut Fed funds rates. Inflation concerns will 

increasingly mount if the oil price rises above the 

USD 100 mark. 

Input costs for corporations are rising 

Investors should pay heed to the wide range of 

surging commodity prices that include not just oil but 

precious metals and grains. Price increases are not 

only the result of expectations of tighter demand 

conditions due to the bubble-like economic growth in 

emerging economies. Industrialised nations, the US 

in particular, are also responsible because of the 

asset substitution effect generated by their monetary 

easing and currency depreciation. In other words, it 

is probable that the surge in commodity prices will be 

both broad in range and prolonged in duration. 

20 

15 

10 

5 

0 

-5 

-10 

Chart 1: Japan’s Domestic CGPI (% y/y) 

Intermediate goods 

Final goods 

-15 

05 06 07 08 09 10 11 


Raw materials 

(RHS) 

Will commodity price surges spread to final inflation? 

The December flash estimate of the corporate goods 

price index (CGPI) released by the BoJ on 14 

January showed that the domestic CGPI rose 

1.2% y/y, its third consecutive monthly advance and 

its biggest gain since November 2008. Following the 

rise in raw material prices, intermediate goods prices 

have started to move up. However, final goods prices 

continue to fall in year-on-year terms. 

Declining trend in CPI is drawing to a close 

Corporate pricing power is decidedly weak. This is 

particularly true for manufacturers, who face weak 

final demand and intense competition from abroad. 

That said, amongst commodities, even grain prices 

are advancing. These increases are the result of 1) 

growing demand in emerging economies, such as 

China, and 2) supply constraints caused by a series 

of unseasonable weather events, including droughts 

in Russia/Latin America and floods in Australia. 

Investors should note that higher raw material input 

costs for food easily translate into higher final goods 

prices. 

The base year for the Japanese CPI will be changed 

this August. We expect this to result in approximately 

a 0.5pp downward revision to the year-on-year 

change in the core CPI. In other words, it will be 

some time before final Japanese inflation moves into 

positive territory. That said, price declines are 

drawing to a close; increases in raw material prices 

will tend to spread to other goods. Investors will note 

the halt in price declines in H2 this year, which will 

prove to be a persistent headwind for the bond 

market. 

60 

45 

30 

15 

0 

-15 

-30 

-45 

Koji Shimamoto 20 January 2011 


48 


Global Inflation Watch 

Eurozone HICP: Upward Revisions 

Chart 1: GSCI & CPI Food 

The past few months have seen an acceleration in 

the upward trend in oil and other commodity prices, 

in particular soft commodities. A number of 

idiosyncratic factors have contributed to these trends 

including adverse weather conditions, supply 

disruptions and threats of protectionism. But the 

increase has been primarily due to fundamental 

factors including slack monetary policy and the 

closing of the output gap at the global level (for more 

on this see “Global Inflation: Ready To Takeoff?”). 

The risks to global inflation are high. 

In the eurozone, these trends have been 

compounded by greater-than-expected strength in 

the economic recovery in Germany and higher taxes 

in a number of countries which are undergoing a 

significant fiscal adjustment. 

Source: Reuters EcoWin Pro, BNP Paribas 

Chart 2: German Output Gap & Core HICP Inflation 

In particular, following a collapse in activity in 2009, 

the German economy has been a significant 

beneficiary of the rebound in world economic activity. 

Growth is likely to be higher than we previously 

thought (we revised up our GDP growth forecast for 

2011 from 2.7% to 3.5%) and more balanced, thanks 

to a greater contribution from domestic demand. 

Over time, this recovery will put upward pressure on 

domestically-generated inflation. 

As a result of the above-mentioned factors, we have 

revised up our forecasts for inflation in the eurozone. 

We now expect headline inflation to average 2.2% in 

2011 (from 1.8% previously) and 1.6% in 2012 (from 

1.3%). 

In the short term, the main contributors to these 

revisions are food and energy prices. Pressure on 

core prices should remain limited to those 

components for which food and energy are an 

important input, such as restaurants and transport 

services. But core inflation, forecast to average 0.9% 

and 1.1% in 2011 and 2012 respectively, is still 

expected to remain contained. 


Chart 3: Core HICP – Periphery vs. Core 

The continued low level of core inflation is predicated 

mainly on wage growth remaining subdued by high 

unemployment and tighter fiscal policies. Recent 

trends in wages support this view. 

Note that the outlook differs significantly between 

countries. In particular, beyond a temporary boost 

from higher taxes, we believe risks of deflation are 

still high in the eurozone’s periphery as a result of the 

ongoing adjustment in fiscal and external 

imbalances. 


Luigi Speranza/Eoin O’Callaghan 20 January 2011 


49 


Table 1: BNP Paribas' Inflation Forecasts 

Eurozone 

France 

US 

Headline HICP Ex-tobacco HICP 

Headline CPI 

Ex-tobacco CPI 

CPI Urban SA CPI Urban NSA 

Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y index % m/m % y/y Index % m/m % y/y Index % m/m % y/y 

2009 108.1 - 0.3 107.9 - 0.2 119.3 - 0.1 118.0 - 0.1 214.5 - -0.3 214.5 - -0.4 

2010 109.8 - 1.6 109.5 - 1.5 121.1 - 1.5 119.8 - 1.5 218.1 - 1.6 218.1 - 1.6 

2011 (1) 112.2 - 2.2 111.8 - 2.1 123.6 - 2.0 122.1 - 1.9 221.4 - 1.5 221.3 - 1.5 

Q1 2010 108.6 - 1.1 108.3 - 1.0 120.3 - 1.3 119.0 - 1.2 217.6 - 2.4 217.0 - 2.4 

Q2 2010 110.0 - 1.5 109.7 - 1.4 121.3 - 1.6 120.0 - 1.5 217.2 - 1.8 218.1 - 1.8 

Q3 2010 109.9 - 1.7 109.5 - 1.6 121.2 - 1.5 119.8 - 1.5 218.0 - 1.2 218.3 - 1.2 

Q4 2010 110.8 - 2.0 110.5 - 1.9 121.7 - 1.6 120.2 - 1.6 219.4 - 1.2 218.9 - 1.3 

Q1 2011 (1) 111.1 - 2.3 110.7 - 2.2 122.5 - 1.8 121.1 - 1.8 220.9 - 1.5 220.4 - 1.6 

Q2 2011 (1) 112.1 - 1.9 111.7 - 1.8 123.5 - 1.8 122.0 - 1.7 221.2 - 1.8 222.0 - 1.8 

Q3 2011 (1) 112.3 - 2.2 111.8 - 2.1 123.8 - 2.1 122.3 - 2.0 221.5 - 1.6 221.7 - 1.6 

Q4 2011 (1) 113.3 - 2.3 112.9 - 2.2 124.4 - 2.3 122.9 - 2.2 221.8 - 1.1 221.2 - 1.1 

Jul 10 109.7 -0.3 1.7 109.31 -0.4 1.7 121.0 -0.3 1.7 119.68 -0.3 1.6 217.6 0.3 1.3 218.01 0.0 1.2 

Aug 10 109.9 0.2 1.6 109.54 0.2 1.5 121.3 0.2 1.4 119.97 0.2 1.3 218.2 0.3 1.2 218.31 0.1 1.1 

Sep 10 110.1 0.2 1.8 109.76 0.2 1.7 121.2 -0.1 1.6 119.88 -0.1 1.5 218.4 0.1 1.1 218.44 0.1 1.1 

Oct 10 110.5 0.4 1.9 110.16 0.4 1.8 121.4 0.1 1.6 120.03 0.1 1.5 218.9 0.2 1.2 218.71 0.1 1.2 

Nov 10 110.6 0.1 1.9 110.27 0.1 1.8 121.5 0.1 1.6 120.09 0.0 1.5 219.1 0.1 1.1 218.80 0.0 1.1 

Dec 10 111.3 0.6 2.2 110.93 0.6 2.1 122.1 0.5 1.8 120.61 0.4 1.7 220.3 0.5 1.4 219.18 0.2 1.5 

Jan 11 (1) 110.6 -0.6 2.3 110.17 -0.7 2.2 122.1 0.0 2.0 120.58 0.0 1.9 220.8 0.3 1.5 219.95 0.4 1.5 

Feb 11 (1) 111.0 0.4 2.4 110.56 0.4 2.3 122.5 0.4 1.8 121.07 0.4 1.7 221.1 0.1 1.6 220.29 0.2 1.6 

Mar 11 (1) 111.7 0.6 2.1 111.27 0.6 2.0 123.0 0.4 1.7 121.53 0.4 1.6 220.9 -0.1 1.5 220.91 0.3 1.5 

Apr 11 (1) 112.0 0.3 1.9 111.56 0.3 1.8 123.3 0.3 1.7 121.85 0.3 1.6 221.1 0.1 1.6 221.50 0.3 1.6 

May 11 (1) 112.1 0.2 1.9 111.73 0.2 1.8 123.5 0.2 1.8 122.06 0.2 1.7 221.2 0.0 1.8 222.06 0.3 1.8 

Jun 11 (1) 112.2 0.1 2.0 111.79 0.1 1.9 123.6 0.1 1.8 122.13 0.1 1.8 221.3 0.0 2.0 222.38 0.1 2.0 

Jul 11 (1) 111.9 -0.2 2.1 111.49 -0.3 2.0 123.4 -0.2 2.0 121.93 -0.2 1.9 221.4 0.1 1.7 221.89 -0.2 1.8 

Aug 11 (1) 112.3 0.3 2.2 111.84 0.3 2.1 123.9 0.4 2.1 122.40 0.4 2.0 221.5 0.0 1.5 221.69 -0.1 1.5 

Sep 11 (1) 112.6 0.3 2.3 112.17 0.3 2.2 124.0 0.1 2.3 122.48 0.1 2.2 221.6 0.0 1.5 221.64 0.0 1.5 

Oct 11 (1) 113.1 0.5 2.4 112.70 0.5 2.3 124.3 0.3 2.4 122.76 0.2 2.3 221.7 0.0 1.3 221.49 -0.1 1.3 

Nov 11 (1) 113.2 0.1 2.4 112.78 0.1 2.3 124.4 0.1 2.4 122.83 0.1 2.3 221.8 0.1 1.2 221.36 -0.1 1.2 

Dec 11 (1) 113.6 0.3 2.1 113.13 0.3 2.0 124.7 0.2 2.1 123.10 0.2 2.1 222.0 0.1 0.8 220.80 -0.3 0.7 

Updated 

Next 

Release 

Jan 20 

Jan Flash HICP (Jan 31) 

Jan 20 

Jan CPI (Feb 23) 

Jan 14 


Source: BNP Paribas, (1) Forecasts 

Chart 4: Eurozone Core HICP (% y/y) 

Chart 5: US Core CPI (% y/y) 


After reaching an all-time low in April 2010, core inflation has been 

a touch stronger in recent months, mainly reflecting gains in core 

goods inflation. While we expect core services inflation to head 

lower, the rebound in core goods has further to run. We expect a 

brief interruption to the downward trend in core inflation. 


The downward trend in shelter inflation was recently interrupted. 

However, the renewed collapse in the housing market should see a 

reversion to a downward trend from early this year. 



50 



Japan 

UK 

Sweden 

Core CPI SA 

Core CPI NSA 

Headline CPI RPI 

CPI CPIF 

Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y 

2009 100.3 - -1.3 100.3 - -1.3 110.8 - 2.1 213.7 - -0.5 299.7 - -0.3 191.2 - 1.9 

2010 (1) 99.3 - -1.0 99.3 - -1.0 114.5 - 3.3 223.6 - 4.6 303.5 - 1.3 195.2 - 2.1 

2011 (1) 98.6 - -0.7 98.6 - -0.7 118.9 - 3.9 233.8 - 4.6 310.3 - 2.3 199.5 - 2.2 

Q1 2010 99.7 - -1.3 99.3 - -1.2 112.9 - 3.2 219.3 - 4.0 301.2 - 1.0 194.0 - 2.6 

Q2 2010 99.3 - -1.2 99.3 - -1.2 114.4 - 3.4 223.5 - 5.1 302.8 - 1.1 194.9 - 2.1 

Q3 2010 98.8 - -1.1 99.1 - -1.0 114.7 - 3.1 224.5 - 4.7 302.9 - 1.1 194.8 - 1.7 

Q4 2010 (1) 99.2 - -0.5 99.4 - -0.5 115.8 - 3.3 227.0 - 4.7 307.0 - 1.9 197.0 - 2.0 

Q1 2011 (1) 98.8 - -0.9 98.4 - -0.9 117.5 - 4.1 230.0 - 4.9 308.1 - 2.3 197.8 - 2.0 

Q2 2011 (1) 98.6 - -0.7 98.6 - -0.7 118.8 - 3.8 233.2 - 4.4 310.6 - 2.6 199.4 - 2.3 

Q3 2011 (1) 98.5 - -0.3 98.7 - -0.3 119.2 - 3.9 234.3 - 4.4 310.0 - 2.4 199.6 - 2.5 

Q4 2011 (1) 98.4 - -0.8 98.6 - -0.8 120.3 - 3.9 237.7 - 4.7 312.5 - 1.8 201.2 - 2.1 

Jul 10 98.9 -0.3 -1.1 99.0 -0.3 -1.1 114.3 -0.3 3.1 223.6 -0.2 4.8 302.0 -0.3 1.1 194.3 -0.3 1.7 

Aug 10 98.8 -0.1 -1.0 99.1 0.1 -1.0 114.9 0.5 3.1 224.5 0.4 4.7 302.1 0.0 0.9 194.3 0.0 1.4 

Sep 10 98.7 -0.1 -1.1 99.1 0.0 -1.1 114.9 0.0 3.0 225.3 0.4 4.6 304.6 0.8 1.4 195.8 0.8 1.8 

Oct 10 99.1 0.4 -0.6 99.5 0.4 -0.6 115.2 0.2 3.1 225.8 0.2 4.5 305.6 0.3 1.5 196.3 0.3 1.8 

Nov 10 99.3 0.2 -0.5 99.4 -0.1 -0.5 115.6 0.4 3.2 226.8 0.4 4.7 306.6 0.3 1.8 196.8 0.2 1.9 

Dec 10 (1) 99.2 -0.1 -0.5 99.3 -0.1 -0.5 116.7 1.0 3.7 228.4 0.7 4.8 308.7 0.7 2.3 197.9 0.6 2.3 

Jan 11 (1) 99.0 -0.2 -0.6 98.6 -0.7 -0.6 117.0 0.2 4.1 228.8 0.2 5.0 306.8 -0.6 2.3 197.0 -0.5 2.1 

Feb 11 (1) 98.8 -0.2 -1.0 98.2 -0.4 -1.0 117.6 0.5 4.2 230.1 0.6 5.0 308.2 0.5 2.2 197.8 0.4 1.8 

Mar 11 (1) 98.7 -0.1 -1.1 98.4 0.2 -1.1 118.0 0.3 4.0 230.9 0.3 4.6 309.3 0.3 2.3 198.7 0.4 2.0 

Apr 11 (1) 98.6 -0.1 -0.7 98.5 0.1 -0.7 118.6 0.5 3.8 232.8 0.8 4.5 310.5 0.4 2.7 199.2 0.3 2.3 

May 11 (1) 98.7 0.1 -0.6 98.7 0.2 -0.6 118.8 0.2 3.9 233.3 0.2 4.4 310.7 0.1 2.6 199.5 0.1 2.3 

Jun 11 (1) 98.5 -0.2 -0.7 98.6 -0.1 -0.7 118.9 0.1 3.7 233.5 0.1 4.2 310.4 -0.1 2.5 199.5 0.0 2.3 

Jul 11 (1) 98.5 0.0 -0.4 98.6 0.0 -0.4 118.6 -0.2 3.8 233.0 -0.2 4.2 309.5 -0.3 2.5 199.1 -0.2 2.4 

Aug 11 (1) 98.4 -0.1 -0.4 98.7 0.1 -0.4 119.1 0.4 3.7 233.9 0.4 4.2 309.6 0.0 2.5 199.2 0.1 2.5 

Sep 11 (1) 98.5 0.1 -0.2 98.9 0.2 -0.2 119.8 0.5 4.2 235.9 0.9 4.7 311.1 0.5 2.1 200.6 0.7 2.5 

Oct 11 (1) 98.4 -0.1 -0.7 98.8 -0.1 -0.7 119.9 0.2 4.2 236.7 0.3 4.8 312.7 0.5 2.3 201.1 0.3 2.4 

Nov 11 (1) 98.5 0.1 -0.8 98.6 -0.2 -0.8 120.1 0.1 3.9 237.2 0.2 4.6 312.8 0.0 2.0 201.2 0.0 2.2 

Dec 11 (1) 98.4 -0.1 -0.8 98.5 -0.1 -0.8 120.9 0.7 3.6 239.1 0.8 4.7 312.1 -0.2 1.1 201.3 0.0 1.7 

Updated 

Next 

Release 

Jan 04 

Dec CPI (Jan 27) 

Jan 20 


Jan 19 



Chart 6: Japanese CPI (% y/y) 

Chart 7: UK CPI (% y/y) 


Prices are expected to continue falling but the pace of decline is 

easing as the economy recovers. 


We expect inflation to remain above target for the remainder of the 

year, although trending down. We expect CPI inflation to hit 4% or 

above in the early months of this year. 



51 



Canada Norway Australia 

CPI Core CPI Headline CPI Core 

CPI 

Core 

Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y 

2009 114.4 0.3 113.6 1.8 125.7 2.2 118.4 2.6 167.8 - 1.8 - - 3.7 

2010 (1) 116.5 1.8 115.5 1.6 128.8 2.4 120.1 1.4 172.8 - 2.9 - - 2.7 

2011 (1) 118.6 1.8 117.1 1.4 131.1 1.9 121.8 1.4 178.9 - 3.7 - - 2.7 

Q3 2009 114.7 0.5 -0.9 113.9 1.2 1.6 125.8 0.0 1.8 118.5 0.0 2.4 168.6 1.0 1.3 - - 3.5 

Q4 2009 114.9 0.6 0.8 114.4 1.9 1.6 126.6 0.6 1.4 119.3 0.7 2.3 169.5 0.5 2.1 - - 3.4 

Q1 2010 115.4 2.0 1.6 114.9 1.6 1.9 128.4 1.4 2.9 119.4 0.1 2.0 171.0 0.9 2.9 - - 3.1 

Q2 2010 116.2 2.6 1.4 115.5 2.3 1.8 129.1 0.6 2.6 120.3 0.8 1.5 172.1 0.6 3.1 - - 2.7 

Q3 2010 116.8 2.2 1.8 115.6 0.3 1.6 128.2 -0.7 1.9 119.9 -0.3 1.2 173.3 0.7 2.8 - - 2.4 

Q4 2010 (1) 117.4 1.5 2.2 116.0 1.2 1.4 129.4 0.9 2.2 120.5 0.5 1.0 174.7 0.8 3.0 - - 2.5 

Q1 2011 (1) 117.9 1.6 2.1 116.4 1.6 1.4 131.1 1.3 2.1 120.6 0.1 1.0 176.4 1.0 3.3 - - 2.5 

Q2 2011 (1) 118.3 1.7 1.9 116.9 1.7 1.2 131.4 0.2 1.8 121.9 1.0 1.3 178.0 0.9 3.6 - - 2.7 

Updated 

Dec 21 

Jan 19 Jan 20 

Next 

Release 

Dec CPI (Jan 25) 

Jan CPI (Feb 10) Q4 CPI (Jan 25) 


Chart 8: Canadian Total versus Core CPI 

Chart 9: Australian CPI (% y/y) 

7.0 

6.0 

5.0 

4.0 

3.0 

(% y/y) 

Headline CPI 

Underlying CPI 

2.0 

1.0 

0.0 

-1.0 

Q193 Q195 Q197 Q199 Q101 Q103 Q105 Q107 Q109 Q111 Q113 


Wage pressures appear subdued, suggesting that underlying 

inflation will remain within the target range. 


Food prices should drive headline inflation sharply higher in 2011. 

Underlying inflation should drift higher, but remain within the target 

range. Risks to inflation are the upside, particularly in the near term. 

CPI Data Calendar for the Coming Week 

Day GMT Economy Indicator Previous BNPP F’cast Consensus 

Tue 25/01 00:30 Australia CPI q/q : Q4 0.7% 0.8% n/a 

00:30 CPI y/y : Q4 2.8% 3.0% n/a 

12:00 Canada CPI m/m : Dec 0.1% 0.2% 0.1% 

12:00 CPI y/y : Dec 2.0% 2.6% 2.5% 

12:00 BoC Core m/m : Dec 0.0% 0.0% -0.1% 

12:00 BoC Core y/y : Dec 1.4% 1.8% 1.7% 

Thu 27/01 10:15 Belgium CPI m/m : Jan 0.4% 0.2% n/a 

10:15 CPI y/y : Jan 3.1% 2.9% n/a 

Germany States’ Cost of Living m/m : Jan 1.0% -0.5% -0.2% 

States’ Cost of Living y/y : Jan 1.7% 1.8% 2.1% 

HICP (Prel) m/m : Jan 1.2% -0.5% -0.3% 

HICP (Prel) y/y : Jan 1.9% 2.0% 2.3% 

Fri 28/01 23:30 Japan CPI National y/y : Dec 0.1% -0.1% -0.2% 

23:30 Core CPI National y/y : Dec -0.5% -0.5% -0.5% 

23:30 CPI Tokyo y/y : Jan -0.2% 0.1% -0.2% 

23:30 

(27/01) 

Core CPI Tokyo y/y : Jan -0.4% -0.2% -0.3% 

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision 




52 


Inflation: With Supply Comes Opportunities 

• GLOBAL: Supply discount except for TIPS. 

• EUR: Long FRF/EUR BE. Watch prel. data. 

• USD: 10y TIPS a test without concession. 

• GBP: UKTi-55 – value in RY, BE and ASW. 

GLOBAL: Equities, commodities and breakevens 

are back towards local highs (Chart 1) but have yet 

to break above the post-Lehman range. Positioning 

is much less extreme on equities and rates than in 

November/December (Chart 2) while on commodities 

net speculative oil positioning remains close to multiyear 

highs (i.e. on the long side). Inflation concerns 

continue to dominate with December data showing 

inflation rates rising, albeit largely due to food and 

energy as expected. Indeed, the market’s increasing 

anticipation of monetary tightening, at least in the UK 

and eurozone, is ultimately not bullish for inflation 

especially inflation forwards. More pressing in the 

near term and potentially weighing on breakevens 

generally is the significant supply in the final week(s) 

of January – France’s EUR 3bn BTANi-16 launch on 

Thursday, BTPei supply next week, USD 13bn TIPS 

Jan-21 launch and the syndicated re-opening of 

UKTi-55 (likely to be around GBP 2.7bn notional). 

With the exception of the US where there has been 

limited (if any) cheapening ahead of supply, BTANi- 

16, UKTi-55 and probably BTPei supply offer good 

value after previous underperformance/cheapness. 

EUR: The AFT issued 2.995bn (top of the range) of 

BTANi 0.45% July 2016 at an average price of 99.48, 

i.e 12 cents above grey market levels. A bid/cover at 

2.11 is good for such a size and compares with 1.8 

for the OATi-19 launch a year ago and 1.5 for OATei- 

22 in May. The BTANi-16 is currently trading 21bp 

through the OATi-17 and still looks a bit cheap in our 

view even though the floor has already lost a third of 

its value (given the move to lower inflation volatility). 

We like the BTANi-16 in the OATi curve, in ASW and 

especially versus EUR breakevens. As written 

previously, French linkers will experience much less 

negative carry than in Europe and this does not look 

priced in at least at the front end (Chart 3). 

Admittedly, it is difficult to short EUR breakevens 

(outright) in the current market environment of rising 

headline inflation – our economists have raised their 

HICP forecasts with stronger food, energy and core 

inflation by the year-end. Nonetheless, January’s 

preliminary HICP data have surprised to the 

downside in 5 of the last 8 years and only once to the 

upside (Chart 3) – first indications in Germany from 

27 January. Meanwhile, upcoming BTPei supply 

could help the concession on ‘rich-looking’ EUR 

Ch. 1: Commodities, EQ and BEs at Local Highs 

Chart 2: Asset Positioning – Less Long than in 

November/December Except Commodities 

Chart 3: OATei-12/OATi-17 BE versus NY, Oil & 

EURUSD: Regression Residuals versus Carry 

50 

40 

30 

20 

10 

0 

-10 

-20 

-30 

-40 

OATEI12 / OATI17 Breakeven / OIL / EURUSD Residuals 

1m Carry 

Fwd Carry 

-50 

Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 

OATEI12 / OATI17 Breakeven / OIL / E Yield Move Carry Potential? 

1m 52.1 -21.4 30.7 

2m 17.5 22.2 39.7 

3m -18.9 31.2 12.3 

4: Watch Out for Downward Jan HICP Surprise 

6 

5 

4 

3 

2 

1 

0 

Jan uses to suprise 

on the downside 

jan feb mar apr may jun jul aug sep oct nov dec 

All charts source: BNP Paribas, Bloomberg 

Below In Line Above 

50 

40 

30 

20 

10 

0 

-10 

-20 

-30 

-40 

-50 

Shahid Ladha / Herve Cros / Sergey Bondarchuk 20 January 2011 


53 


eakevens. Italy should announce details of its 

scheduled 26-Jan auction on Friday (21 January). 

The 10y and 30y benchmarks (BTPei-21 and ei-41) 

are good candidates for re-opening, but there is a 

risk Italy could issue a new 5y or 15y BTPei given 

little EURxt issuance in January (only EUR 1bn from 

Germany). Reminder: BTPeis generally look cheap 

versus OATei and especially against rich DBRei 

paper which have enjoyed a scarcity premium 

suggesting the BTPei supply will offer value. 

GBP: Breakevens are little changed on the week. 

December’s CPI was very strong at 3.7% y/y (versus 

consensus at 3.4%). Food, petrol and utility bills were 

strong as expected. But core was also strong at 2.9% 

y/y (+0.2 upward surprise) on recreation/goods prices 

despite weaker clothing. Meanwhile, RPI printed 

228.4, +0.7% m/m, in line with consensus but below 

BNPP’s call. The strong CPI headline and core is not 

the ideal (policy) mix for breakevens MT given the 

risk of monetary tightening ahead, even though RPI 

does benefit directly from base rate hikes via MIPS 

ST. We continue to receive May MPC’s meeting – a 

rate hike is now 80% priced in. We continue to 

recommend taking profit on our favourite trade into 

2011, long the UKTi-13 breakeven, after its 40bp 

performance net of carry in 2011 ahead of likely 

extension activity. 

The strong 25y Gilt auction confirms the bid for 

duration and we expect next week’s UKTi-55 

syndication to meet with strong demand. The 

underperformance of the belly (10-20y) in nominal, 

real yield and breakeven space could continue at 

least in inflation space. Supportive demand 

conditions include pension funds in surplus likely LDI 

needs, coupon payments (GBP 770mn, 75% in the 

final week), 5y+ Linkers Index extension (+0.35y) 

versus a limited size (we estimate up to GBP 3bn 

notional) due to DMO Remit. Strong outright value 

and convincing RV arguments add further support. 

Our favourite trades include 10/50y real yield 

flattener and long UKTi-55 breakeven. See our 

upcoming extensive desknote, “GBPi: UKTi-55 

Syndication – Selling Note” for further details. 

USD: As we expected, the Fed concentrated 

purchases in TIPS Jul-20 (56%) and TIPS Feb-40 

(28%). The remaining 16% of the USD 1.74bn was 

scattered across the curve, with 7% (USD 179mm) 

spent on

Pricing Date 

Repo Rate 

Sett. Date 

Table 1: BNP Paribas Carry Analysis 

Benchmark Carry 

20-Jan-11 

Term 1 

Term 2 

2m 

3m 

6m 

12m 

0.42% 0.42% 0.34% 0.34% 0.34% 0.56% 

21-Jan-11 01-Feb-11 01-Mar-11 

21-Mar-11 21-Apr-11 21-Jul-11 23-Jan-12 

Yield BE Real BE Real BE Real BE Real BE Real BE Real BE 

Short-end 

OATei Jul-12 -1.09% 2.15% -0.9 -1.4 31.8 29.2 -16.3 -20.7 -20.0 -26.5 29.5 22.0 -1.8 46.4 

OATI Jul-13 -0.39% 1.87% -0.5 -1.1 14.0 10.7 10.4 4.7 21.0 12.2 48.4 33.0 48.3 23.8 

TIPS Jul-12 -1.36% 1.80% -2.3 -2.8 1.3 -0.5 12.1 9.3 20.4 15.9 63.8 52.4 -92.6 -124.4 

UKTi Aug-13 -1.66% 2.94% 0.9 -0.2 0.6 -3.3 2.3 -3.7 22.7 13.9 50.3 33.0 130.1 97.0 

5y 

OATei Jul-15 0.50% 1.81% 0.4 -0.4 14.0 10.2 1.0 -5.6 3.7 -6.5 28.2 8.8 47.0 9.7 

OATi Jul-17 0.80% 2.08% 0.2 -0.6 7.2 3.4 7.0 0.7 12.6 2.8 26.5 7.9 35.7 -0.6 

TIPS Apr-15 -0.20% 1.88% 0.1 -1.1 3.5 -0.5 8.6 2.5 13.7 4.0 32.5 12.0 22.8 -23.0 

UKTi Jul-16 -0.06% 2.81% 1.4 0.0 3.7 -1.0 6.3 -0.9 18.5 7.7 38.8 17.2 85.3 41.1 

JGBI-4 June-15 0.86% -0.42% -1.7 -1.9 -2.6 -3.5 -9.1 -10.4 -22.6 -24.6 -14.0 -18.2 -2.4 -11.5 

10y 

OATei Jul-20 1.33% 2.12% 0.4 -0.3 8.0 4.7 2.1 -3.6 4.3 -4.4 18.6 1.9 31.7 -0.8 

OATI Jul-19 1.12% 2.16% 0.2 -0.5 6.0 2.4 6.1 0.1 10.8 1.5 22.6 4.9 31.4 -3.0 

TIPS Jul-20 1.01% 2.29% 0.4 -0.7 3.1 -1.2 6.2 -0.3 9.7 -0.4 21.4 0.8 24.4 -18.9 

UKTi Nov-22 0.80% 3.09% 1.5 0.4 8.3 4.3 9.6 3.5 14.0 4.9 29.0 10.7 46.0 9.3 

JGBI-16 June-18 1.30% -0.44% -0.8 -1.2 -0.8 -2.2 -4.6 -6.4 -12.3 -15.1 -5.2 -10.8 5.6 -6.4 

30y 

OATei Jul-40 1.61% 2.40% 0.2 -0.2 3.1 1.2 1.0 -2.2 1.9 -2.9 7.3 -1.8 12.2 -5.1 

OATI Jul-29 1.58% 2.36% 0.2 -0.3 3.7 1.1 3.9 -0.4 6.8 0.1 13.9 1.3 19.9 -4.4 

TIPS Feb-40 1.97% 2.61% 0.3 -0.5 1.7 -1.2 3.2 -1.2 5.0 -1.8 10.7 -3.3 13.9 -14.6 

UKTI Mar-40 0.86% 3.58% 0.6 -0.1 3.4 0.8 3.9 0.0 5.6 -0.2 11.5 0.0 17.7 -4.8 

Short-end 

Term 1 -> Term 2 Term 1 -> Term 2 Term 2 -> 3m 

3m -> 6m 

6m -> 12m 

OATei Jul-12 32.7 30.7 -43.2 -45.4 -3.7 -5.8 49.5 48.5 -31.3 24.4 

OATI Jul-13 14.5 11.8 -1.6 -4.4 10.5 7.5 27.5 20.8 -0.1 -9.1 

TIPS Jul-12 3.6 2.3 11.7 10.4 8.3 6.6 43.4 36.5 -156.4 -176.7 

UKTi Aug-13 -0.2 -3.0 2.2 -0.6 20.4 17.7 27.7 19.1 79.8 64.0 

5y 

OATei Jul-15 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 

OATi Jul-17 13.6 10.5 -11.0 -14.2 2.7 -0.9 24.5 15.3 18.8 0.8 

TIPS Apr-15 7.0 4.0 0.8 -2.2 5.5 2.1 14.0 5.1 9.1 -8.5 

UKTi Jul-16 3.4 0.5 6.0 3.1 5.1 1.6 18.8 8.0 -9.7 -35.0 

JGBI-4 June-15 -0.9 -1.6 -8.2 -8.8 -13.5 -14.2 8.6 6.4 11.7 6.6 

10y 

OATei Jul-20 7.6 4.9 -4.8 -7.5 2.2 -0.9 14.3 6.3 13.1 -2.7 

OATI Jul-19 5.8 2.9 0.9 -2.0 4.7 1.4 11.7 3.3 8.9 -7.8 

TIPS Jul-20 2.6 -0.4 3.8 0.8 3.5 -0.1 11.7 1.2 3.0 -19.7 

UKTi Nov-22 6.8 3.9 3.2 0.4 4.4 1.3 14.9 5.8 17.0 -1.4 

JGBI-16 June-18 0.0 -1.0 -4.5 -5.4 -7.7 -8.6 7.1 4.2 10.8 4.4 

30y 

OATei Jul-40 2.9 1.4 -1.7 -3.2 0.9 -0.8 5.4 1.1 4.9 -3.3 

OATI Jul-29 3.5 1.4 0.7 -1.3 2.8 0.5 7.1 1.2 6.0 -5.7 

TIPS Feb-40 1.4 -0.7 1.9 -0.2 1.8 -0.6 5.7 -1.4 3.2 -11.3 

UKTI Mar-40 2.7 0.9 1.3 -0.5 1.7 -0.2 5.8 0.2 6.3 -4.9 


Shahid Ladha / Herve Cros / Sergey Bondarchuk 20 January 2011 


55 


Technical Analysis – Interest Rates & Commodities 

Bond & Short-Term Contracts 

• Europe 10y: Breaking slightly above key 3.09/3.12 (LT 38.2% & MT 61.8%), opening the way for 3.25 area 

• US 10y: Toppish around key 3.37 (MT 61.8%) within a ST triangle (3.25/3.44) and below 3.63 (LT falling res) 

• Short-term contracts m1: MT toppish bias on ED & Euribor, but a ST rising one on ED while Euribor is down 

Equities & Commodities 

• WTI (Cl1): Sill up MT within MT rising channel but still stalling around 91.86 wave “A” top, with risk now of 2-tops 

• Equity markets: MT positive bias persists but a ST toppish tone is developing. Larger fall is needed to turn down 

US 10y: Toppish around key 3.37 (MT 61.8%) with risk towards ST 38.2% MT Trend: Up Range: 3.20/3.45 

MT SCENARIO remains up 

Market remains up oriented MT within a MT 

rising “C of ABC” scenario which is likely to 

send it towards key 4.00/4.07 (April top & LT 

61.8%) initially and then key 4.59 (LT falling 

channel res). A break above 3.44 (daily 

triangle res) and the key 3.63 (4-year falling 

resistance) level is needed to strengthen this 

MT bearish scenario 

2.80 4.00/4.07 

ALTERNATIVE SCENARIO...ST correction 

It fails to extend the rise beyond 3.63 (LT 

falling resistance line), capped by top 

reversal, and starts a ST consolidation 

towards 3.09 (ST 38.2%) initially. First 

positive step would be a break below 3.25 

(wave “A” low & ST triangle support) 

STRATEGY 

Enter long on 3.40 area, S/L 3.46, for 

3.15/3.25 or buy stop 3.25 break, S/L 3.31, 

for 3.05/3.10 

US/EUR 10y bond: Is it now developing the main falling wave ? MT Trend: Down Range: 15/30 

MT SCENARIO is down 

After the 5 waves down move (major wave 

“A”?) which reached the key 0.2/0.6 support 

area, it has started a correction (major wave 

“B”?) above the MT falling wedge. This move 

may end close to key 56.2 (ST 61.8%) and 

the main risk now is to have started the main 

falling wave “C” towards 8.2 (wave “A” low) 

initially and then key -21.4 (LT 61.8%). ST 

bearish confirmation will come from a 

sustained break below 22.6/24.5 (61.8%) 

-21.4 4.2 => 56.2/57.0 

ALTERNATIVE SCENARIO.Wave B extends 

Rising correction (major wave “B”?) is not 

over and rise resumes from key 22.7/24.5 

area towards 45.7 top again and then towards 

critical 56.2 (ST 61.8%). A break then above it 

would call for a move towards key 85.8/85.9 

(wave “5” top & LT falling channel resistance) 

STRATEGY 

Wait for a rebound to enter short 

Christian Sené 20 January 2011 


56 


Germany 10y: MT 61.8% (3.12) break could trigger a rise towards 3.25 MT Trend: Up Range: 3.00/3.20 

MT SCENARIO is still up 

2.56

Trade Reviews 

Options, Money Market and Bond Trades – Tactical & Strategic Trades 

This 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. 

Existing Strategies 

Yield Curves 

BTP Flattener Long BTP 5% Sep 40 Short BTP 4% Sep 20 

We enter 2/3 now and the rest on any overshoot to 90bp. 

Tsy Flattener Sell UST 5Y Buy UST 10Y 

Structurally, we like the trade given QE2 purchases. PCA also shows that 10s look 

cheap while 5s look rich, which makes us comfortable with the timing of this trade. 

Also, there is a slight flattening bias beginning next week going into the following 

week's 5y auction. 

EUR Butterfly Receive EUR 2/5/10s M1 IMM 

Proxy for 2/10s flatteners with positive carry. 

Cross Markets 

USD Agency Callable Long FNMA 5nc6M 2.60 01/16 Short T 0.75 08/13 

Short-vol bullish strategies in the short end are attractive given the Fed status. 

Callables outperform in a range-bound environment, but currently tolerate a larger 

rise in rates (+115 bps) than a rally (-20 bps) before breaking even over a 6m 

horizon. 

Money Markets 

U1U2 Euribor/Eurodollar box Long Eurodollar Short Euribor 

We entered 2/3 of the position and would add at 10bp. 

GBP OIS Swap Pay May11 MPC 

Media and economists are beating on the inflation drum. The front end has been 

listening: we tactically try to ride the bearish momentum in the market via OIS swap 

at small size. 

78.5 

(S) 

138.5 

(S) 

15.5 

(T) 

-4k 

(S) 

17 

(T) 

0.71 

(T) 

70 94 85.5 

(13-Jan) 

-1.5bp 10k EUR 70k 

7bp 

130 146 138.5 

5k/01 USD 0k 

(13-Jan) 

0bp 

0.0 16.5 11.5 

(05-Jan) 

300k -150k 0k 

(06-Jan) 

30/35 7 15 

(14-Jan) 

0.75 0.64 0.67 

(11-Jan) 

Options 

Euribor Put Spread Buy ERU1 9862/50 P/S 

5.5 12.0 0.0 3.0 

Bearish long-term strategy, playing improved macro conditions, the ECB's exit 

strategy as well as the risk of a rate hike in Q2. Good entry level for shorts after 

aggressive rally at the end of 2010. 

(S) 

(04-Jan) 

*Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps. 

+1.0bp 10k/01 EUR -40k 

-4bp 

1k/01 USD 

-4k 

10k EUR 20k 

+2bp 

7.5k/01 GBP +30k 

+4bp 

12.5k/01 EUR +32k 

+2.5bp 

Interest Rate Strategy 20 January 2011 


58 


Travelling Asia 

• Inflation has emerged in Asia. Changes in 

relative competitiveness are in train, 

suggesting Asia’s surpluses will erode over 

time. 

• China’s booming economy will be most at 

risk should inflation accelerate further. But 

markets may have started with an 

inappropriate distribution of risk. 

• Asset-driven currencies such as the AUD 

are the most vulnerable. The EUR will benefit 

from the credibility of its central bank… 

• …but the ECB’s inflation-fighting 

credentials will be challenged by diverging 

monetary conditions. 

• Rising global inflation will put the JPY 

under selling pressure. 

The challenge of inflation: The example of India 

I am writing this document during a business trip to 

Asia. It has been fascinating talking to our clients and 

to policymakers. While Asia is clearly booming, the 

clouds of inflation are appearing in the blue sky; the 

outlook is no longer universally sunny. 

India, which had been hoping to become a second 

China because of its growth dynamics, is now 

hopelessly behind the curve in respect of tackling 

inflation. The RBI has allowed real rates to become 

negative, the current account deficit is taking off and 

the government is acting only slowly to reduce its 

fiscal deficit. 

Still, India is an agriculturally driven country, with the 

monsoon heavily influencing the state of the 

economic cycle. Last year’s good monsoon season 

helped push GDP growth up to 8% but industrial 

production growth has now declined to 2.7%. Rising 

inflation rates will undermine India’s competitiveness, 

not boding well for its already-weakening trade and 

current account deficits. 

Meanwhile, the RBI stands at a crossroads. Either it 

understands the inflation risks and acts accordingly, 

putting rates up aggressively or it remains behind the 

curve. 

In the first scenario, India would face a cyclical 

slowdown due to rising real rates. In the second 

case, India would be heading into troubled waters 

where rising inflation expectations kill off inward 

investment. Falling real rates would start 

undermining the INR. 

9.5 

9 

8.5 

8 

7.5 

7 

6.5 

6 

5.5 

5 

Chart 1: India Behind the Curve 

4.5 

Dec-06 Jul-07 Feb-08 Sep-08 Apr-09 Nov-09 Jun-10 

Source: Bloomberg, BNP Paribas 

0.34 

0.33 

0.32 

0.31 

0.3 

0.29 

0.28 

0.27 

0.26 

0.25 

0.24 

WPI (y/y, RHS) 

RBI CRR 

Chart 2: China Wages Relative to Output are 

Rising 

China Wages are a proportion of GDI 

China CPI (y/y, RHS) 

Mar-92 Sep-94 Mar-97 Sep-99 Mar-02 Sep-04 Mar-07 Sep-09 

Source: Reuters Ecowin Pro, BNP Paribas 

We discussed this topic with a well-respected Asianbased 

hedge fund manager. The conclusion we 

reached was that either scenario would lead to lower 

share prices. Last week, the Indonesian equity 

market moved into a higher volatility regime. In 2009 

and especially 2010, the Indonesian market saw a lot 

of inward investment and was one of the best 

performers globally. That might be changing now as 

inflation is on the rise. India is in the same boat as its 

equity market was the main destination for foreign 

inflows into the country. Since November, shares in 

Bombay have lost around 10% and we wonder when 

there will be a bigger correction in the FX market on 

the back of this development. 

China: domestically funded leverage 

The other big theme is China and its satellite 

economies. Looking out of the hotel room window, I 

5 

0 

-5 

12 

10 

8 

6 

4 

2 

0 

30 

25 

20 

15 

10 

-2 

Hans Redeker 20 January 2011 


59 


notice construction activity as far as the eye can see. 

In downtown Hong Kong, real estate is selling for 

EUR 5000 per square foot, driving house prices 

relative to income to unrealistic levels. However, 

lending restrictions have been introduced that limit 

the leverage relative to the cost of the real estate 

project to 75%; this will provide the housing market 

with a good cushion. Hence we do not envisage the 

Hong Kong real estate market undergoing a Dubaistyle 

crash. 

However, we wish to highlight the impact of a 

booming real estate market on consumer price 

inflation. Unlike Dubai, Hong Kong’s real estate 

boom is only moderately leveraged and is funded by 

Chinese real money. Nonetheless, real estate prices 

rising out of all proportion to income will squeeze 

low-income groups out of the cities. As low-income 

groups tend to be service providers, it should not be 

a surprise to see Hong Kong’s real estate boom 

leading to a period where inflation is an issue. 

Rising bills 

Each time I go to Asia, my bills are higher than on 

previous visits. There is a lot of anecdotal evidence 

suggesting Asia is inflating its relative 

competitiveness away. Official data may understate 

real inflation by a substantial margin and the Chinese 

administration’s endorsement of 20% wage 

increases may be viewed as a move to calm the 

population’s anger as real incomes are eroded by 

rising prices. 

The motivation behind the PBoC’s current policy 

mix 

Last Friday, the PBoC again increased its minimum 

reserve requirements with the aim of reducing the 

velocity of money and credit in the Chinese 

economy. This policy has become known as 

quantitative tightening. There has been a lively 

discussion on why China has largely been refraining 

from using the traditional interest rate tool to fight 

inflation. An argument often deployed is that higher 

RMB money market rates could trigger an inflow of 

unwanted hot money, pushing currency reserves up 

even up rapidly. Indeed, absorbing incoming 

reserves by selling sterilization bonds has become 

an increasingly costly business for the PBoC given 

the negative spread between the yield from foreign 

currency reserves and the yield offered by the 

sterilisation bonds. 

Nonetheless, the main reason why China is using the 

interest rate tool only reluctantly is the highly 

leveraged “state-owned” corporate sector. Here, 

higher interest rates could burst the leverage bubble. 

China’s households have on average saved 35% of 

their income on average over the past decade. As 

authorities run a closed capital account and 

50.0 

49.0 

48.0 

47.0 

46.0 

45.0 

44.0 

43.0 

Chart 3: US Wages Relative Output have 

Declined 

42.0 

Sep-75Jun-79 Mar-83 Dec-86Sep-90Jun-94 Mar-98Dec-01Sep-05Jun-09 

Source: Bloomberg, BNP Paribas 

Percent 

6 

5 

4 

3 

2 

1 

-1 

US Wages are a proportion of GDI 

US CPI (y/y, RHS) 

Chart 4: USD Vs CNY 3m Bill Rates 

USD 3m bill yield 

households have saved for pension and rainy-day 

purposes, savings were accumulated into bank 

deposits. Domestic banks have only been allowed to 

lend domestically, which in a booming economy is 

relatively unproblematic. However, Chinese bankers 

(as everywhere else in the world) are paid to ride the 

yield curve and convert deposits into vast amounts of 

credit. China’s household savings relative to GDP 

have reached 100% but state-owned corporate 

liabilities are now a multiple of that. 

China’s national accounts data are not yet as 

comprehensive enough as those provided by 

Western statistics offices. However, given the closed 

capital account and huge private household savings, 

either the corporate or sovereign sector must be 

deeply in the red. In China, it is the state-owned 

corporate sector which is highly leveraged and thus 

sensitive to changing funding costs. The Chinese 

authorities know that, explaining why they have been 

reluctant to use the interest rate tool. 

12.0 

10.0 

Nov May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb 

06 07 

08 

09 

10 11 


CNY 3m bill yield 

8.0 

6.0 

4.0 

2.0 

0.0 

-2.0 

-4.0 

-6.0 

-8.0 



60 


Capitalism requires business cycles 

There has been much admiration for the Chinese 

state-controlled economic model. We predicted that 

China in 2009 would be the anchor of stability for the 

global economy and so it turned out. However, we 

are not sure that the same can be said for the next 

12 months. Yugoslavia showed that a statecontrolled 

market economy cannot ignore the need 

for business cycles to correct wasteful investment. 

The business cycle works in the capitalist economy 

as a quality control for the efficient use of resources. 

Business cycles are necessary and useful. In its 

2006 stability report, the IMF illustrated that delaying 

cyclical downturns only makes the following 

recession deeper and more painful. In this sense, the 

absence of a Chinese business cycle is worrying and 

implicitly suggests that there must be a certain 

degree of wasteful investment in the economy which 

at one point will have to be cleared out. What should 

not be forgotten either is that wasteful investment 

reduces efficiency, turning a competitive and noninflationary 

economy slowly into a non-competitive 

and inflationary one. 

130 

120 

110 

100 

90 

80 

70 

Graph 5: USD – CNY REER gap has Widened 

by 30% 

Jan-94 

Apr-95 

J u l -96 

O c t -97 

Jan-99 

Apr-00 

Jul-01 

Oct-02 


CNY Broad BIS REER 

Jan-04 

A p r- 05 

USD Broad BIS REER 

Chart 6: Chinese Shares have Underperformed 

Jul-06 

Oct-07 

Jan-09 

Apr-10 

Does that mean the consensus has started the year 

with a wrong distribution of risk preference? Most 

think that the main risk of economic 

underperformance should be associated with the US. 

They have allocated their currency portfolios 

accordingly, using the USD as a funding currency. 

Along with a better-than-expected performance by 

the US economy, Asia’s inflation rate could 

undermine this investment strategy. 

The meaning of inflation for currency markets 

Indeed, the economic outlook for China and by 

extension Asia depends on the seriousness of the 

current inflation wave. The consensus sees inflation 

as mainly driven by commodity-driven cost-push 

effects. If this assumption proved correct, current 

prices would stabilise within a year. What we find 

disturbing is that the rhetoric has taken the same 

angle as in the early 1970s when the Yom Kippur 

war triggered the first oil price shock. Then, It was 

argued that higher oil prices would reduce real 

disposable income and would in fact prove to be 

deflationary in the long run. Hence they did not 

require attention from monetary authorities. This view 

backfired in the 1970s, a decade when inflation 

proved a real problem. Interestingly, the 1960s had 

seen a sharp expansion of the monetary base, 

exceeding GDP by a multiple. Over the past couple 

of years, the same has happened on a global scale. 

That is good enough reason in our view to discuss 

what will happen on FX markets, should inflation 

become a theme. 

Changing the way we look at FX 


First, we will have to change the way of analysing FX 

markets. During the time of the ‘Great Moderation’, 

central bank credibility advanced to ever-higher 

rates, allowing us to use nominal interest rate and 

yield differentials to predict currencies. At times of 

corporate-dominated cross-border flows, we used 

corporate bond market yields but, most of the time, 

sovereign flows dominated cross flows anyway, 

keeping the emphasis on sovereign yield 

differentials. 

When inflation comes back, it will be real yield 

differentials that tell us if currencies have upside or 

downside potential. 

The relative credibility of central banks will 

determine the value of FX 

Secondly, central banks will be differentiated 

according to their willingness to tackle inflation head 

on. In the case of Indonesia and India, markets have 

started expressing doubts, putting their asset 

markets under selling pressure. The selling pressure 



61 


will be strong for those currencies that have seen 

solid foreign inflows beforehand. 

When discussing inflation-fighting credentials, the 

ECB stands out. Only last week, the ECB’s Trichet 

expressed his unease at EMU HICP moving above 

the ECB’s 2% ceiling. Instantly, the euro rushed 

higher. However, in the case of the EUR, the 

credibility of the ECB must also be viewed in the 

context of outstanding credit risks, leading to nonhomogenous 

monetary conditions within the 

eurozone. Table 7 alongside has been constructed 

with the help of the IMF. It shows debt levels and the 

interest rate-growth differentials of selected EMU 

countries. At the start of the currency union, rates 

were way too loose for peripheral countries. The rule 

of thumb suggests that nominal GDP and rates 

should be at approximately the same level. The rule 

should particularly apply in the long term. 

Table 7: Public Debt and Interest Rate–Growth 

Rate Differential (pp) 

Country 

Debt/GDP 

2007 2009 2015 1/ Historical /2 Projected /1 

France 63.8 77.4 94.8 0.8 0.5 

Germany 65 72.5 81.5 2.6 1.5 

Greece 95.6 114.7 158.6 -1.5 2.2 

Ireland 24.9 64.5 94 -5.8 3.2 

Italy 103.4 115.8 124.7 1.4 1.7 

Portugal 63.6 77.1 98.4 -0.6 2.2 

Spain 36.1 55.2 94.4 -2.4 2.6 

Median 63.8 77.1 94.8 -0.6 2.2 

Mean 64.6 82.5 106.6 -0.8 2 

Source: IMF’s WEO database, BNP Paribas 

Interest rate-Growth rate Differential 

Chart 8: USD Liquidity vs. S&P 500, CRB 

However, before the crisis, peripheral countries 

enjoyed relative to their nominal GDP growth very 

low funding costs, which led to booming and 

consequently busting assets. The table shows that 

Ireland ran a negative interest rate-growth gap of 

5.6%. But now, as assets have tanked, peripheral 

countries are exposed to liabilities no longer covered 

by asset values. 

The funding costs of these liabilities have soared and 

will stay high if you believe the IMF numbers, leading 

to the perverse situation that monetary conditions in 

the recessionary countries of Europe’s periphery 

have tightened while booming Germany faces superloose 

monetary conditions. This environment will put 

the inflation-fighting credentials of the ECB to the 

test. 

We recall the situation from August to early 

November, when the ECB channelled 3mths Euribor 

rates up by about 60bp. At the same time, intra-EMU 

credit spreads widened, leaving us confident with our 

EURUSD 1.34 year-end call for 2010. Now as 

inflation is moving up and the ECB rhetoric is 

becoming more hawkish, we are watching credit 

spreads with interest. As long as credit does not pop 

up, the euro will strengthen, supported by 

expectations of a hawkish central bank reaction to 

rising inflation. 

However, recessionary peripheral economies facing 

already-tight monetary conditions are unlikely to cope 

well with monetary tightening. Inflation and the 

reaction of central banks must always be viewed in 

the context of credit; this is particularly the case for 

EMU. 

Inflation will kill the ‘quasi-China trade’ 


Third, the emergence of inflation might actually be 

good news for countries currently stuck in deflation or 

facing the threat of deflation (e.g. Japan and the US, 

respectively). On the other hand, inflation represents 

the biggest threat in countries where there has been 

domestically built up leverage. 

Above, we discussed the case of China, where 

inflation will either undermine the real value of 

household assets (in the case of deposit rates 

remaining below inflation) or the highly leveraged 

corporate sector faces rising funding costs (should 

the central bank take on the fight against inflation by 

increasing official lending rates). In our view, the 

inflation trade is the ‘anti quasi-China trade’ working 

against shares, commodities and last and not least 

the AUD. Inflation will bring the USD-funded carry 

trade to an abrupt halt, leading to a higher USD. 

Inflation will weaken the JPY 

Fourth, rising inflation globally will put the JPY under 

significant selling pressure. Japan has accumulated 

foreign currency hedged assets as hedging costs 

became virtually zero in a world where quantitative 

easing is a common policy tool. When inflation 

comes back and central banks tighten policy, the 

JPY will fall victim to the process. 



62 


EURUSD Rally Eyes 1.3750-1.3950 

• The EURUSD rally is poised to break out above 1.3500 sparking a larger medium-term rally toward 

1.3745-1.3980 

• Bullish weekly momentum appears strong enough to fuel a larger rise toward 1.40-1.41 over the 

next 3-5 weeks 

• However, a break above 1.40 would increase the odds of a multi-month EURUSD rally toward 

1.4335-1.4455 

• The US Dollar Index (DXY) has broken its December base favouring a deeper dive towards 76.25 

The EURUSD rally has broken above 1.3500 this 

week hitting its highest level since late November. 

By overcoming 6 weeks of resistance between 

1.3435 and 1.3500, the rise favours a medium-term 

extension towards the 1.3745/85 resistance 

including the 61.8% Fibonacci retracement point of 

November-January’s decline. 

The bullish tone of weekly momentum suggests the 

EURUSD rally may reach 1.40-1.41 in the next 3-4 

weeks. Currently, weekly momentum (51% on the 

8-week stochastic indicator) is strongly bullish, 

accelerating and just crossing the neutral zone 

(50%). This is similar to weekly momentum 

conditions in early July 2010 when EURUSD was in 

the midst of its 1.1875-1.3335 summer rally. On a 

comparative basis, this suggests the EURUSD rally 

has scope to climb another 5-6 cents towards 

1.40-1.41 by the end of February. 

A further rise above 1.40, however, would be a very 

bullish longer-term development opening scope 

toward 1.4335-1.4455. It would suggest the June 

2010 rise is continuing and will ultimately be 

comparable to the October 2008-November 2009 

rise, targeting 1.4375 (the 76.4% retracement point 

of the November 2009-June 2010 decline) and the 

July 2008 downtrend near 1.4455. Such a rise could 

persist until mid-March to early April forming a 

major EURUSD top in the process. 

In the short term, EURUSD could see a pullback 

correcting some of its recent gains. Support near 

1.3245-1.3200 should limit such losses and provide 

a EURUSD buying opportunity. 

As the mirror image of EURUSD, the US Dollar 

Index (DXY) is falling sharply off its 

November/January 81.44/31 double-top. This 

week’s break of 78.77 key support (December low) 

risks extending the sell-off to the 76.25 double-top 

objective. Such a decline would increase the 

probability of a longer-term DXY decline towards 

75.50-74 akin to a EURUSD rise towards 1.43-1.45. 

Chart 1: EURUSD – Medium-term scope to 1.3745/85 and potentially 1.3950/80 

EURUSD has cleared 

1.4280 

the 1.3500 level 

1.4160 

implying the Nov-Jan 

1.40 

decline is being 

retraced with 

1.3500 

medium-term scope 1.36 

towards 1.3745/85 

1.3335 

over the next few 

weeks. 

Bullish weekly and 

monthly momentum 

could extend the rally 

1.32 

1.28 

1.2965 

1.2870 

towards 1.3950/80 

retracing 3/4ths of the 

Nov-Jan decline. 

Short-term pullbacks 

1.24 

1.20 

1.2642 

towards 1.3245 

1.1875 

support would 

provide a buying 

1.16 

opportunity. 

31-May-10 28-Jul-10 24-Sep-10 23-Nov-10 20-Jan-11 


Andrew Chaveriat 20 January 2011 


63 


Chart 2: US Dollar Index (DXY) – Double-top targets a decline towards 76.25 

DXY posted a doubletop 

during Nov/Jan, 89 

88.35 

now favouring a 

deeper medium-term 87 

decline toward the 

76.25 double-top 85 

83.55 

objective. Accelerating 

83 

bearish weekly 

81.45 

momentum risks an 81 

even larger dive 

towards 75.50 and 79 

80.10 

potentially 74. Use 

short-term rebounds 77 

towards 79.50-80.00 

75.65 

75 

resistance to initiate 

31-May-10 28-Jul-10 24-Sep-10 23-Nov-10 

DXY short positions. 


USDMXN has 

posted a sharp 

decline during the 

past 6 weeks 

breaking long-term 

12.0440 Fibonacci 

support and trading 

at levels last seen 

during the Lehman 

crisis. 

This decline saw 

USDMXN become 

deeply oversold. We 

now expect a rebound 

off the recent 11.9440 

low towards the 

12.17-12.23 area. 


USDTRY has broken 

sharply lower through 

November’s major 

uptrend support. 

The bearish trend 

reversal has been 

validated by the further 

break below 1.5375 

key support. 

We now expect a 

multi-week decline 

towards 1.5150-1.49. 

Use short-term rallies 

towards the 1.56-1.57 

area to enter sell setup. 

Chart 3: USDMXN – Rebounding off multi-year low 

13.60 

13.40 

13.20 

13.00 

12.80 

12.60 

12.40 

12.20 

12.00 

11.80 

11.60 

13.40 

31-May-10 

12.10 

13.20 

12.45 

28-Jul-10 

13.25 

24-Sep-10 

12.15 

Chart 4: USDTRY – Breaking lower through major uptrend 

1.65 

1.60 

1.55 

1.50 

1.45 

1.40 

1.35 

1.5965 

21-May-10 

1.6065 

1.4810 

20-Jul-10 

1.5355 

16-Sep-10 

1.3830 

12.60 

23-Nov-10 

1.5920 

19-Nov-10 

81.30 

20-Jan-11 

11.95 

20-Jan-11 

1.5935 

20-Jan-11 




64 


Currency Spot Trade Recommendations Date 

NOKSEK 1.1355 Sell 1.1360, stop 1.1440, target 1.1060 20 Jan 2011 

AUDMXN 11.930 Sell 11.980, stop 12.120, target 11.600 20 Jan 2011 

AUDUSD 0.9890 Short at 1.0050, stop 1.0150, target 0.9420 19 Jan 2011 

AUDCAD 0.9900 Short at 0.9995, stop 1.0090, target 0.9460 19 Jan 2011 

USDCHF 0.9630 Long at 0.9560, stop 0.9460, target 0.9990 18 Jan 2011 

USDJPY 82.70 Long at 82.40, stop 81.40, target 85.40 17 Jan 2011 

USDKZT 146.95 Short at 147.00, stop at 149.50, target 135.00 28 May 2010 




65 


Oil Update: Brent Premium the New Norm 

• WTI has tested the top of a loose USD 80- 

90/Bbl range that we believe will be in place for 

H1 2011. Fundamentals have not tightened 

sufficiently to sustain a durable move higher in 

WTI. 

• The spread between WTI and North Sea 

Brent has widened significantly. Brent has 

developed a large premium, leading us to reassess 

the spread assumption to WTI we use to 

derive a price path for the North Sea marker. 

• Among the fundamental hurdles the market 

faces are significant spare production capacity 

in OPEC countries; still-elevated stocks in 

consuming countries; and decent y/y non-OPEC 

supply growth in Q1 and Q2 2011. 

• This year, we expect growth in world oil 

demand to slow to around 1.5 mb/d, 

commensurate with an easing of global 

economic growth from 4.7% to 4%. 

• It would not be surprising to see more funds 

diverted Brent’s way this year to minimise 

negative roll-yield, providing an additional factor 

of support for Brent relative to WTI in addition to 

the fundamentals. 

Testing our view for H1 2011 

Over the past couple of weeks, WTI has attempted 

but failed to sustain a rise above USD 92/Bbl. We 

believe that WTI will probably trade within a loose 

USD 80-90/Bbl range that will be in place for H1 

2011. Fundamentals have not yet tightened 

sufficiently to sustain a durable move higher in WTI. 

However, more noteworthy, since December, the 

spread between WTI and North Sea Brent has 

widened significantly (Chart 1). Brent has developed 

a large premium, leading us to re-assess the spread 

assumption to WTI we use to derive a price path for 

the North Sea marker. 

As we discuss further on, the persistence (against 

our initial views) of several factors contribute to 

making a Brent premium over WTI more the norm 

than the exception, at least for 2011 and potentially 

2012. As a result, we have revised up our quarterly 

profile, with Brent now averaging USD 90/Bbl in 

2011, USD 3/Bbl higher than we previously expected 

(Table 1). We make only marginal changes to our 

WTI profile, with little impact on the annual average. 

This is seen at USD 89/Bbl. 

Table 1: BNPP Crude Oil Price Forecast (18 

January 2011) 

WTI Revision (2) Brent (1) Revision (2) 

Q1 10 (actual) 78.78 .. 77.29 .. 

Q2 10 (actual) 78.04 .. 79.47 .. 

Q3 10 (actual) 76.11 .. 76.96 .. 

Q4 10 (actual) 85.19 -0.81 87.32 0.32 

Q1 11 85.00 2.00 88.00 5.00 

Q2 11 86.00 2.00 89.00 4.00 

Q3 11 90.00 1.00 91.00 3.00 

Q4 11 95.00 0.00 97.00 2.00 

2009 (actual) 61.79 .. 62.51 .. 

2010 (actual) 79.53 0.47 80.26 0.26 

2011 89.00 1.00 90.00 3.00 

2012 95.00 -1.00 97.00 2.00 

Source: BNP Paribas 1) Brent is derived from an assumed spread. * 2012 is 

based on the forward curve spreads at the time of forecast. 2) vs. 18/11/10 Issue 

Chart 1: NYMEX WTI vs. ICE Brent 

$/Bbl 

NYMEX WTI Mth1 (LHS) 

NYMEX WTI ‐ ICE Brent Mth1 (RHS) 

160 

140 

120 

100 

80 

60 

40 

20 

Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10 

Source: Bloomberg and BNP Paribas. 

Chart 2: Oil Spreads vs. Cushing Stocks 

mb 

(Inverted) 

25 

30 

35 

40 

Cushing Crude Stocks (LHS) 

NYMEX WTI ‐ ICE Brent Mth1 (RHS) 

MYMEX WTI Mth1‐Mth3 (RHS) 

Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 

Source: Bloomberg, U.S. EIA and BNP Paribas 

$/Bbl 

Market conditions not materially different 

In our previous forecast 1 , issued on 18 November 

2010, we said we expected only a level shift up in the 

trading range of WTI for the first half of 2011, rather 

1 Oil Market Comment “Past the QE sugar rush, then what? (18/11/10) 

5 

0 

‐5 

15 

10 

5 

0 

‐5 

$/Bbl 

‐10 

‐15 

‐10 

Harry Tchilinguirian 20 January 2011 

Market Mover Non-Objective Research Section 

66 


than an unrelenting rise in prices as witnessed in 

2007-2008. This view was based on the belief that 

the market’s balance would tighten progressively. As 

such, a sustained leg-up in the price appears more 

sustainable in the second half of 2011. 

Among the fundamental hurdles the market faces, 

we find: 

• Spare production capacity in OPEC 

countries of about 5.5 mb/d (most of which, unlike in 

2008, can be processed with the additions to global 

refining conversion capacity over the past two years); 

• Still-elevated stocks in consuming countries 

(on a volume and demand cover basis); and 

• Decent y/y non-OPEC supply growth in Q1 

and Q2 2011. We have not changed our point of view 

on this assessment. 

If global oil demand continues to recover in 2011, this 

will be down to emerging markets; the West 

continues to struggle. As we ended 2010, world oil 

demand had more than recouped its recession and 

financial crisis induced declines of 2008-2009. Indeed, 

it was up almost 2.7 mb/d y/y at just under 88 mb/d. 

This year, we expect growth in world oil demand to 

slow to around 1.5 mb/d, commensurate with an 

easing of global economic growth from 4.7% to 4%. 

Even if we were to assume last’s year pace of growth 

in oil demand and zero non-OPEC supply growth, 

this would not be enough to exhaust spare 

production capacity in OPEC countries in 2011. 

Equally, in our last update, we highlighted the risk to 

oil prices stemming from inflationary pressures in 

emerging markets. We stressed that subsequent 

monetary policy tightening would challenge risk 

appetite. As a result, liquidity put into risky assets, 

including commodities, might be withdrawn. But the 

impact of tightening does not end there: expectations 

for economic growth and therefore oil demand growth 

may become challenged. 

Chief among countries in this situation is China, a lead 

contributor to oil and commodity demand growth. It 

has taken gradual, repeated steps towards tightening 

monetary conditions at home through hikes in reserve 

requirement for its commercial banks (as well as 

outright interest rate hikes and other measures) 

As we highlighted in our last price update and in 

previous market comments 2 , WTI’s behaviour relative 

to Brent was contemporaneous in 2009-2010 with that 

mb/d 

4.0 

3.5 

3.0 

Chart 3: North Sea Crude Oil Production 

Crude Supply 

Diff to 5 yr avg 

North Sea Crude Production 

0.2 

0.0 

2.5 

Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 

Source: IEA Oil Market Report, BNP Paribas. 

'000 Contracts 

1600 

1500 

1400 

1300 

1200 

Chart 4: WTI vs. Brent Open Interest 

NYMEX WTI (LHS) 

ICE Brent (RHS) 

‐0.2 

‐0.4 

‐0.6 

‐0.8 

‐1.0 

‐1.2 

1000 

900 

800 

700 

1100 

600 

Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 

Source: Bloomberg, BNP Paribas. 

Chart 5: Share of WTI, Brent in the S&P GSCI* 

40% 

30% 

20% 

10% 

WTI Brent 

36.2% 

32.4% 32.7% 

12.7% 

14.3% 15.1% 

Jan 09 Jan 10 Jan 11 

Source: Index sponsor and BNP Paribas. * Indicative. 

of its contango on the short-dated portion of the 

futures curve (Chart 2). While US crude oil inventories 

have regularly declined, mainly on the Gulf Coast, 

those at Cushing bucked the trend in December by 

climbing higher. At the last count, they stood at 37 mb, 

or near their mid-March peak, when both the front 

month contango on the WTI curve and WTI’s spread 

to Brent widened considerably. 

This accumulation of stocks, driven by either weaker 

off-take of crude by refiners or excess supply trapped in 

a landlocked location, matters less than the fact that 

2 Oil Market Comment “Brent/WTI Premium the Usual Suspects 

(24/11/10) 

Oil Market Comment “Brent Premium to WTI, Live to die another day 

(23/08/10) 



67 


available capacity to store surplus crude oil is limited. 

While capacity at Cushing has been growing, some of 

this storage will be used to increase supplies of heavier 

Canadian grades. Alternatives in the form of floating 

storage will progressively fall as oil demand recovers. 

Given that we see lacklustre prospects for gasoline 

demand on the back of a jobless recovery, the scope 

for a recovery in US light crude demand seems limited, 

notably when, given the addition of conversion capacity, 

the heavier (and cheaper) barrel is likely to be favoured. 

In addition, the second phase of TransCanada’s 

Keystone pipeline expansion will reportedly begin 

service this quarter, delivering more Canadian oil 

directly to Cushing. A further extension of the pipeline to 

the Gulf Coast is still some time away, so without 

geographic ‘optionality’, the potential for episodic supply 

surpluses remains intact, as does the contango and/or 

weakness relative to Brent. 

On the Brent side, if an increase in February North 

Sea loadings eases supply tensions, the y/y declines 

in North Sea crude production (Chart 3) structurally 

favour a stronger Brent price. And as the production 

base continues to shrink, the benchmark can only 

become more upwardly sensitive to disruptions in 

comparable quality supplies (Nigerian Bonny Light 

for Brent and Angolan Cabinda for Forties, part of the 

dated Brent benchmark). 

Brent and commodity index switching 

Investors’ behaviour may finally be changing, as they 

seek to reduce the incidence of large negative rollyields 

on the WTI curve by switching to the Brent 

contract. While the trend in open interest for WTI and 

Brent over 2009-2010 has not shown clear and 

present divergence (Chart 4), this could change with 

persistence of bouts of WTI weakness tied to 

Cushing storage developments. 

Contrasting the share of WTI and Brent in the GSCI, 

a large long-only passive commodity index (Chart 5), 

the re-balancing of weightings in 2011 has been in 

Brent’s favour, though WTI still retains the lion’s 

share of oil’s contribution to the index. 

But investors are not confined to indices, and long 

positions on futures can be held independently. As 

such, it would not be surprising to see this year more 

funds diverted Brent’s way to minimise negative rollyield, 

providing an additional factor of support for 

Brent relative to WTI in addition to the fundamentals 

discussed above. 



68 


Economic Calendar: 21 - 28 January 

GMT Local Previous Forecast Consensus 

Fri 21/01 07:45 08:45 France Industry Survey (sa) : Jan 103 102 n/a 

09:00 10:00 Germany Ifo Headline : Jan 109.9 110.9 109.9 

09:00 10:00 Ifo Expectations : Jan 106.9 107.9 106.5 

09:00 10:00 Ifo Current Assessment : Jan 112.9 113.9 113.2 

09:30 09:30 UK Retail Sales (inc Autos) m/m : Dec 0.3% -2.0% -0.2% 

09:30 09:30 Retail Sales (inc Autos) y/y : Dec 1.1% -0.8% 1.1% 

14:00 15:00 Belgium Business Confidence : Dec 3.1 2.0 2.6 

Sun 23/01 Portugal Presidential Election 

Mon 24/01 00:30 11:30 Australia PPI q/q : Q4 1.3% 0.5% n/a 

00:30 11:30 PPI y/y : Q4 2.2% 3.2% n/a 

08:30 09:30 Netherlands Producer Confidence : Jan 2.5 4.0 n/a 

09:00 10:00 Eurozone PMI Manufacturing (Flash) : Jan 57.1 57.1 60.5 

09:00 10:00 PMI Services (Flash) : Jan 54.2 54.2 59.0 

09:00 10:00 PMI Composite (Flash) : Jan 55.5 55.5 n/a 

10:00 11:00 Industrial Orders m/m : Nov 1.4% 2.0% 2.4% 

Tue 25/01 00:30 11:30 Australia CPI q/q : Q4 0.7% 0.8% n/a 

00:30 11:30 CPI y/y : Q4 2.8% 3.0% n/a 

Japan BoJ Rate Announcement 

07:00 08:00 Germany GfK Consumer Confidence : Feb 5.4 5.4 5.4 

07:45 08:45 France Household Consumption m/m : Dec 2.8% -0.5% 0.3% 

07:45 08:45 Household Consumption y/y : Dec 1.5% -0.3% 0.3% 

07:45 08:45 Housing Starts (3-mths) y/y : Dec 12.1% 9.0% n/a 

07:45 08:45 Industry Survey : Q1 9 5 n/a 

08:00 09:00 Spain PPI m/m : Dec 0.3% 0.6% n/a 

08:00 09:00 PPI y/y : Dec 4.4% 5.0% n/a 

09:30 09:30 UK GDP (Prel) q/q : Q4 0.7% 0.3% 0.5% 

09:30 09:30 GDP (Prel) y/y : Q4 2.7% 2.4% 2.6% 

09:30 09:30 PSNCR : Dec GBP16.8bn GBP16.3bn GBP18.0bn 

09:30 09:30 PSNB : Dec GBP22.8bn GBP16.0bn GBP20.0bn 

12:00 07:00 Canada CPI m/m : Dec 0.1% 0.2% 0.1% 

12:00 07:00 CPI y/y : Dec 2.0% 2.6% 2.5% 

12:00 07:00 BoC Core m/m : Dec 0.0% 0.0% -0.1% 

12:00 07:00 BoC Core y/y : Dec 1.4% 1.8% 1.7% 

14:00 09:00 US S&P/Case-Shiller Home Price Index : Nov 

15:00 10:00 Consumer Confidence : Jan 52.5 54.0 54.7 

15:00 10:00 FHFA HPI : Nov 

Wed 26/01 Australia Public Holiday 

09:00 10:00 Italy Retail Sales y/y : Nov -0.6% 1.5% n/a 

09:30 09:30 UK BoE MPC Minutes 

13:00 14:00 Norway Norges Bank Rate Announcement 

15:00 10:00 US New Home Sales : Dec 290k 300k 300k 

15:30 10:30 EIA Oil Inventories 

19:15 14:15 FOMC Rate Announcement 

16:00 17:00 Eurozone ECB’s Stark Speaks in Kiel, Germany 

17:00 18:00 France Job Seekers (ILO def. sa) : Dec 21k -5k n/a 

Thu 27/01 23:50 08:50 Japan Trade Balance (nsa) : Dec JPY163bn JPY572bn JPY493bn 

(26/01) 

07:45 08:45 France Consumer Confidence : Jan -36 -38 -36 

08:00 09:00 Spain Retail Sales (Adjusted) y/y : Dec -1.5% -2.2% n/a 

08:15 09:15 Sweden Consumer Confidence : Jan 20.8 20.0 n/a 

08:30 09:30 Unemployment Rate : Dec 7.1% 7.1% n/a 

08:30 09:30 PPI m/m : Dec 0.8% 0.6% n/a 

08:30 09:30 PPI y/y : Dec 2.2% 2.6% n/a 

Market Economics 20 January 2011 


69 


Economic Calendar: 21 - 28 January (cont) 

GMT Local Previous Forecast Consensus 

Thu 27/01 10:00 11:00 Eurozone Economic Sentiment : Jan 106.2 106.4 106.9 

(cont) 10:00 11:00 Industry Sentiment : Jan 4.0 5.0 4.5 

10:00 11:00 Consumer Sentiment : Jan -11 -11 n/a 

10:30 11:30 ECB’s Bini Smaghi Speaks in Bologna 

18:00 19:00 ECB’s Tumpel Gugerell Speaks in Mainz, Germany 

10:15 11:15 Belgium CPI m/m : Jan 0.4% 0.2% n/a 

10:15 11:15 CPI y/y : Jan 3.1% 2.9% n/a 

11:00 11:00 UK CBI Distributive Trades Survey : Jan 

Germany States’ Cost of Living m/m : Jan 1.0% -0.5% -0.2% 

States’ Cost of Living y/y : Jan 1.7% 1.8% 2.1% 

HICP (Prel) m/m : Jan 1.2% -0.5% -0.3% 

HICP (Prel) y/y : Jan 1.9% 2.0% 2.3% 

13:30 08:30 US Durable Goods Orders m/m : Dec -0.3% 2.1% 1.5% 

13:30 08:30 Initial Claims 404k 425k 410k 

15:00 10:00 Pending Home Sales : Nov 

Fri 28/01 23:30 08:30 Japan CPI National y/y : Dec 0.1% -0.1% -0.2% 

23:30 08:30 Core CPI National y/y : Dec -0.5% -0.5% -0.5% 

23:30 08:30 CPI Tokyo y/y : Jan -0.2% 0.1% -0.2% 

23:30 08:30 Core CPI Tokyo y/y : Jan -0.4% -0.2% -0.3% 

23:30 08:30 Household Consumption y/y : Dec -0.4% -0.1% -0.7% 

23:30 08:30 Unemployment Rate (sa) : Dec 5.1% 5.1% 5.1% 

(27/01) 

BoJ Minutes 

08:00 09:00 Spain Unemployment Rate : Q4 19.8% 20.1% n/a 

08:00 09:00 Norway Unemployment Rate (nsa) : Jan 2.7% 2.7% n/a 

08:30 09:30 Eurozone Eurocoin : Jan 

09:00 10:00 M3 y/y : Dec 1.9% 2.0% 2.0% 

09:00 10:00 M3 y/y (3-Mth) : Dec 1.3% 1.6% 1.6% 

09:00 10:00 Bank Lending y/y : Dec 2.0% 2.3% n/a 

09:10 10:10 Retail PMI : Jan 52.9 53.2 n/a 

08:30 09:30 Sweden Retail Sales (sa) m/m : Dec 0.1% 0.3% n/a 

08:30 09:30 Retail Sales (nsa) y/y : Dec 5.3% 5.0% n/a 

08:30 09:30 Italy ISAE Consumer Confidence : Jan 109.1 108.6 108.9 

09:00 10:00 Wages m/m : Dec 0.2% 0.0% n/a 

09:00 10:00 Wages y/y : Dec 1.7% 1.6% n/a 

10:30 11:30 Switzerland KOF Leading Indicator : Jan 2.10 2.05 n/a 

13:30 08:30 US GDP (Adv, saar) q/q : Q4 2.6% 2.9% 3.4% 

13:30 08:30 GDP Deflator (Adv, saar) q/q : Q4 2.1% 1.5% 1.7% 

13:30 08:30 Employment Cost Index q/q : Q4 0.4% 0.5% 0.5% 

13:30 08:30 Employment Cost Index y/y : Q4 1.9% 2.0% n/a 

14:55 09:55 Michigan Sentiment (Final) : Jan 72.7 (p) 73.5 73.0 

During 27/1-4/2 Germany Import Prices m/m : Dec 1.2% 1.0% 1.0% 

Week Import Prices y/y : Dec 10.0% 10.6% 10.6% 

27-31 UK Nationwide House Prices Index m/m : Jan 0.4% -0.5% n/a 

Nationwide House Prices Index y/y : Jan 0.4% -1.1% n/a 

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision 




70 


Key Data Preview 

120 

115 

110 

105 

100 

95 

90 

85 

80 

Chart 1: German Ifo Business Climate 

Expectations (4-Mth Lag) 

Current Conditions 

75 

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 


Jan (f) Dec Nov Oct 

Headline 110.9 109.9 109.3 107.7 

Expectations 107.9 106.9 106.3 105.2 

Current Conditions 113.9 112.9 112.3 110.2 

Key Point: 

Sentiment will remain elevated, with the economic 

expansion broadening out. 

BNP Paribas Forecast: Stronger for Longer 

Germany: Ifo Business Climate (January) 

Release Date: Friday 21 January 

Ifo’s business climate index climbed for the seventh month 

in succession in December, rising above its high point 

during the previous expansion of 2005-2008. 

The sub-indices measuring current business conditions 

and future expectations both improved, with the former at 

an exceptionally elevated level (see chart). 

The assessment of current business conditions in Germany 

is still a little short of its cycle high in 2006 (115.5) and we 

expect a further improvement in December. 

The improvement in Ifo’s sentiment surveys was initially 

due to the exceptional strength in the manufacturing and 

export sectors but domestic sectors, including retail, have 

also shown a pronounced improvement more recently. The 

business climate index for the retail sector has risen to its 

strongest level since the early 1990s. Survey participants 

have signalled a moderation in the rate of externally driven 

growth relative to the spring peaks but domestic demand is 

taking up the baton. 

The latest round of hard activity data has been strong in 

Germany, with industrial orders recording one of the largest 

increases on record in November. This points to a further 

pick-up in expectations. 

Chart 2: UK Retail Sales vs RICS Sales to Stocks 


Dec (f) Nov Oct Sep 

% m/m -2.0 0.3 0.7 -0.5 

% y/y -0.8 1.1 0.4 0.3 

% 3m/3m -0.1 0.2 0.5 1.1 

% 3m/yr 0.2 0.6 0.6 0.8 

Key Point: 

We expect retail sales to show an initial fall of 2% 

m/m, with the risk of a downward revision at a later 

stage. 

BNP Paribas Forecast: Sharp Fall 

UK: Retail Sales (December) 


We expect UK retail sales to fall by 2% m/m in December, 

largely due to snow-related disruption. The coldest 

December on record and widespread snow prevented 

shoppers from getting to the high street and deliveries to 

stores. As a guide, the last time there was disruption of this 

nature (January 2010), the initial estimate of retail sales 

was for a 1.2% m/m fall. This was subsequently revised 

down to a decline of over 3% m/m. We suspect a similar 

outcome is likely this time round. 

Within the breakdown, clothing sales are likely to perform 

well given the experience of January 2010 and anecdotal 

reports – not least from the BRC retail sales monitor. 

Meanwhile, the headline measure also includes auto fuel 

sales. These plunged by 8.5% m/m in January 2010 as 

fewer road journeys were made. Given the proximity to 

Christmas and the likelihood that travel plans were 

abandoned, we expect this component to fall by at least as 

much. 

The bottom line is there is likely to be a sizeable fall that 

will be vulnerable to revision. Further, the fall is likely to be 

temporary and a bounce back to some extent the following 

month is likely. We suspect that the VAT hike in January 

will mean the bounce is rather muted. 



71 



65 

60 

55 

50 

45 

40 

35 

30 

Chart 3: Eurozone PMI by Sector 

Services 

Manufacturing 

99 00 01 02 03 04 05 06 07 08 09 10 



Manufacturing 57.1 57.1 55.3 54.6 

Services 54.2 54.2 55.4 53.3 

Composite 55.5 55.5 55.5 53.8 

Key Point: 

PMI data will again highlight divergence between the 

core and peripheral economies. 

BNP Paribas Forecast: Internal Divergence 

Eurozone: ‘Flash’ PMIs (January) 

Release Date: Monday 24 January 

Activity in manufacturing has re-accelerated since autumn 

last year, with the eurozone PMI for the sector increasing 

in each of the three months to December. 

The levels of the headline index and the main sub-indices 

for orders and output have risen back towards their cycle 

highs of spring 2009. The employment sub-index has also 

improved markedly, rising to its highest level in more than 

a decade (to 53.8 in December). 

This strength, however, has been driven largely by robust 

activity in the ‘core’ countries and in Germany in particular. 

The latter’s headline, output and orders sub-indices have 

all risen back above the 60 level, consistent with unusually 

strong growth rates in the manufacturing sector. 

The growth rates signalled by the peripheral countries’ PMI 

data, while improving, have been much less elevated. The 

service sector PMIs in the peripheral countries have been 

deteriorating, consistent with weak consumer demand, in 

turn due to fiscal austerity programmes. 

In Germany, in contrast, the service sector has been doing 

well, as the expansion becomes more broad based. This 

has been insufficient to prevent the service sector PMI for 

the eurozone as a whole from losing ground. 

The input price sub-index for the manufacturing PMI in the 

eurozone has risen sharply, due to commodity price rises. 

Output prices have also been rising, but by less. 

Chart 4: UK GDP vs Composite CIPS 

Source: INSEE, Reuters EcoWin Pro 

Q4 (f) Q3 Q2 Q1 

GDP % q/q 0.3 0.7 1.1 0.3 

GDP % y/y 2.4 2.7 1.6 -0.3 

Ind Prod % q/q 0.4 0.6 1.1 1.0 

Services % q/q 0.2 0.5 0.6 0.3 

Key Point: 

We expect a sluggish 0.3% q/q pace of expansion, 

held back to a large extent by snow-related 

disruption. 

BNP Paribas Forecast: Sluggish 

UK: GDP (Prel Q4) 

Release Date: Tuesday 25 January 

We expect GDP growth to decelerate to 0.3% q/q during 

Q4, held back by snow-related disruption. Industrial 

production growth had been solid in the first two months of 

the quarter. However, we expect a weak December 

reading for manufacturing to dampen the quarterly 

average. Business services output growth ground to a halt 

during Q3, consistent with the dip in the services sector 

CIPS. We expect a slight improvement during Q4, though 

again a weak December is likely to hold back the quarterly 

average. 

Manufacturing and business services accounted for only 

0.1% point of the 0.7% q/q expansion during Q3. The bulk 

of the growth was accounted for by construction and 

government output. We expect construction to continue to 

decelerate from the super-strong pace recorded in mid- 

2010. Similarly, distribution output is likely to have suffered, 

not least given the poor performance of retail sales during 

Q4. 

Overall, we expect a sluggish pace of expansion though 

dampened to a large extent by temporary weather related 

influences. These should reverse during Q1 helping growth 

to reaccelerate. However, at that stage the impact of fiscal 

tightening should prevent growth from rebounding 

drastically. 



72 



Chart 5: French Sales of Manuf. Goods (3m avg) 

16 

12 

8 

4 

0 

-4 

-8 

Total (% 3m/3m annualised) 

Sales excl. autos (% 3m/3m annualised) 

-12 

Jan May Sep Jan May Sep Jan May Sep Jan May Sep 

07 08 09 10 


Volume index Dec (f) Nov Oct Dec 09 

SA-WDA 

% m/m -0.5 2.8 -0.6 1.4 

% y/y -0.3 1.5 -0.3 5.4 

Key Point: 

The surge in sales seen in November should be 

partly corrected in December, despite very strong 

car sales. 

BNP Paribas Forecast: Correction 

France: Hh Consumption of Manuf. Goods (December) 


Retail sales of manufactured goods were extremely strong 

in November, rising 2.8% m/m. This was due to a 

combination of favourable factors. Christmas shopping 

started early, cold weather favoured sales of winter clothes 

and shoes (+2.9% m/m) and, most importantly, car sales 

soared 14.9% m/m. Since that gain was triggered by the 

prospect of the end of the car sales incentive (EUR 500 per 

car), car sales will increase further in December. However 

sales will remain below end-2009 levels as the incentive 

was twice that amount at the time. 

The decline in sales of other items should outweigh the 

positive impact of car sales in December. Sales of 

electronic items seem to have lost momentum in the last 

few months. The cold weather may have maintained 

demand for clothes and shoes, but the level of sales has 

probably eased. In any case, snowy and icy weather surely 

curbed sales in the week leading up to Christmas, with little 

prospect of catch-up thereafter. This slower pace of sales 

in the second half of December likely continued into early 

January, in particular because of the late official starting 

date for the seasonal sales. 

The correction of the November surge is thus likely to be 

split over the following two months. 

Chart 6: US Consumer Confidence 


Jan (f) Jan 2H Jan p Dec 

Conference Board 54.0 - - 52.5 

Michigan Sentiment 73.5 74.3 72.7 74.5 

BNP Paribas Forecast: Up 

US: Consumer Confidence (January) 


The Conference Board Index of Consumer Confidence 

dropped to 52.5 from 54.3 in December. In January, we 

expect a partial rebound in the index to 54.0. While 

consumer confidence measures have struggled to find a 

consistent upward path lately, it should continue trending 

upward as the economy continues to expand and the 

labour market gradually improves. Indeed, according to the 

latest Beige Book, “Labor markets in most Districts appear 

to be firming somewhat”. In addition, earlier this month, the 

latest weekly index of consumer sentiment by Langer 

Research Associates (formerly known as the ABC News 

Consumer Confidence Index), increased to the highest 

level since 2008. However, certain factors such as surging 

gasoline prices and high unemployment rates should 

continue to limit confidence from accelerating above the 

recent trend. 

Key Point: 

In January, we expect a partial rebound in the 

Conference Board index to 54.0 after the previous 

month’s decline. 



73 



Chart 7: Canadian Inflation 

BNP Paribas Forecast: Short-lived Pressure 

Canada: CPI (December) 



m/m % Dec (f) Nov Oct Sep 

CPI 0.2 0.1 0.4 0.2 

Bank of Canada Core 0.0 0.0 0.4 0.2 

Key Point: 

Energy prices are likely to push prices higher in 

December, but this looks like a bump in y/y inflation. 

We expect Canadian headline CPI to increase by 0.2% in 

November, as higher energy prices continue to pressure 

the headline inflation index. Consequently, headline 

inflation should pick up to 2.6% y/y in December from 2.0% 

in November. This high y/y reading is likely just a one-off 

as we expect the y/y inflation to be limited moving forward 

as a result of base effects. 

The Bank of Canada core CPI is expected to be flat at 

0.0% m/m in December. Shelter costs are likely to be a 

significant factor in November’s reading. Note that food, 

shelter and transportation prices make up 63.5% of the 

headline inflation index. 

Looking forward, the main upside risks to the inflation 

outlook are higher commodity prices and more energy 

price pressures. On the other hand, a deceleration in the 

growth of unit labour costs and a more pronounced 

correction in the housing market should limit core inflation 

growth. 

Chart 8: Japan Trade Balance (JPY bn, s.a.) 

1400 

1200 

1000 

800 

600 

400 

200 

0 

-200 

-400 

-600 

-800 

00 01 02 03 04 05 06 07 08 09 10 


JPYbn Dec (f) Nov Oct Sep 

Trade balance (nsa) 571.8 162.8 821.3 788.5 

Trade balance (sa) 677.0 425.7 575.7 626.8 

Key Point: 

Real export growth should stabilise shortly and 

return to pronounced expansion from the spring. 

BNP Paribas Forecast: Larger Surplus 

Japan: Trade Data (December) 

Release Date: Thursday 27 January 

Based on trade data through mid-December, we expect 

exports (both nominal and real) to have expanded in 

December and imports (both nominal and real) to have 

been flat. The seasonally adjusted trade surplus should 

thus expand over November. 

In November, nominal exports rose on rebounding export 

prices but real exports fell for a fourth straight month, 

reflecting the fading impact of overseas inventory 

restocking and fiscal stimulus, coupled with moderate 

adjustments of worldwide inventory levels for IT/high-tech 

products. Even so, with exports to China, Japan’s top 

trading partner, again accelerating, there are signs that real 

exports are set to revive. Such strength dovetails with 

recent Chinese indicators showing domestic demand is 

expanding and the Chinese manufacturing cycle has 

recovered (manufacturing PMI has been soaring since 

bottoming out in July). What is more, the manufacturing 

cycles in the US and EU are belatedly following China’s 

lead, showing signs of improvement from October. 

Accordingly, we expect real export growth will stabilise 

shortly and return to pronounced expansion from the 

spring. 



74 



10 

5 

0 

-5 

-10 

-15 

-20 

-25 

-30 

-35 

-40 

Chart 9: Eurozone Sentiment by Sector 

Consumer 

Industry 

Construction 

99 00 01 02 03 04 05 06 07 08 09 10 11 



Economic Sentiment 106.4 106.2 105.1 103.8 

Industry 5 4 1 0 

Services 9 10 10 8 

Consumer -11 -11 -9 -11 

Key Point: 

Sentiment remains elevated but divergence persists 

at the sectoral and national level. 

BNP Paribas Forecast: Internal Divergence 

Eurozone: Economic Sentiment (January) 

Release Date: Thursday 27 September 

The eurozone economic sentiment index improved in eight 

of the nine months to December, reaching its highest level 

since October 2007 prior to the financial crisis. 

The key driver of the improvement in sentiment has been 

the industrial sector, which has the highest weighting of the 

five main sub-sectors (at 40% of the total). Other leading 

indicators for the sector, including the manufacturing PMI, 

remain elevated, implying that sentiment will continue to do 

well, supported by strong global demand. 

The domestically-driven sentiment sub-surveys, like retail 

and consumer confidence, have fared less well. This is due 

in part to austerity programmes in the economies with their 

public finances in worst shape. 

In the core countries, and Germany in particular, the overall 

level of sentiment is much more elevated and domesticallydriven 

sub-surveys have done comparatively well. The gap 

between the level of consumer sentiment in Germany and 

for the eurozone as a whole is at a record high. 

Surveys of price expectations in the household sector have 

risen sharply from 2009’s lows, as have pricing intentions 

of industrial firms, linked to commodity price trends. They 

remain well below past peaks, however. 

Chart 10: Germany Preliminary CoL 



CoL m/m -0.5 1.0 0.1 0.1 

CoL y/y 1.8 1.7 1.5 1.3 

HICP m/m -0.5 1.2 0.1 0.1 

HICP y/y 2.0 1.9 1.6 1.3 

Key Point: 

We expect a further acceleration, led by food and 

core prices. 

BNP Paribas Forecast: Further Acceleration 

Germany: Preliminary Cost of Living (January) 


We expect headline CPI inflation to accelerate further in 

January, up by 0.1pp point to 1.8% y/y – the highest since 

October 2008. We expect the HICP measure to rise by the 

same margin, to 2.0% y/y. 

The acceleration is likely to be largely due to a combination 

of higher core inflation and food prices while energy 

inflation ticks lower. More specifically, food prices are likely 

to continue accelerating in y/y terms as the CPI catches up 

with the jump in soft commodities during late 2010. 

Rising core inflation is likely to be driven by the clothing 

and household goods components. Clothing should 

accelerate mainly due to base effects related to a 

substantial drop last January that we don’t expect to be 

repeated this January. It is a similar story for household 

goods. 

Energy inflation is likely to reflect two opposing forces. 

Rising utility bills should add to inflation but be more than 

offset by the fall in transport prices as fuel costs rose by 

less than they did during the same month a year earlier. 



75 



Chart 11: French Household Confidence Vs. CPI 

-1.0 

-0.5 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

Inflation Rate (%y/y, inverted) 

3.5 

4.0 

02 03 04 05 06 07 08 09 10 


EU Commission Index (RHS) 

New INSEE Index (RHS) 

Diffusion Index, SA Jan 11 (f) Dec Nov Jan 10 

INSEE indices: 

Overall -38 -36 -33 -30 

Buying opportunity -22 -21 -20 -21 

EU Commis. Index: 

Headline -18.5 -17.5 -16.6 -16.0 

Key Point: 

Higher food and energy prices are exerting 

downward pressure on wage earners' purchasing 

power and confidence. 

5 

0 

-5 

-10 

-15 

-20 

-25 

-30 

-35 

-40 

-45 

-50 

BNP Paribas Forecast: Under Pressure 

France: Household Confidence (January) 


French household confidence fell heavily in December. 

According to INSEE, the headline index lost 3 points, 

pushing it down to its lowest level since July. This fall is 

clearly due to accelerating inflation; in particular, food and 

energy prices, to which households are highly sensitive, 

have been rising sharply. 

This caused a sharp drop in the personal financial situation 

as well as living standards, both present and future. 

Spending plans as well as expected savings fell as a result. 

Since food and energy prices have increased further since 

the December survey was carried out, January confidence 

is unlikely to post any recovery. The improvement in the 

labour market has been very slow recently, which does not 

help. We forecast further deterioration of confidence, for 

the same reasons as in December, though at a slower 

pace. 

What matters for economic growth is the impact on actual 

private consumption. The INSEE indicators have 

underestimated the level of consumption for several years, 

and the situation is not as bad as it looks. However, the 

deterioration is undeniable as the EU Commission index 

shows. 

Chart 12: US: Investment to Slow in Q4 


BNP Paribas Forecast: Increase on Aircraft 

US: Durable Goods (December) 


Durable goods orders are expected to increase 2.1% m/m 

in December, reflecting a solid increase in orders for 

Boeing aircraft. Meanwhile, we look for orders ex 

transportation to increase by 0.5% m/m after surging 3.6% 

a month prior. The November ex-transportation reading 

was the second-strongest monthly increase in 2010, largely 

driven by defence orders and expected to reverse in 

December. However, consistent with a similar dynamic in 

other manufacturing indicators, we expect core capital 

goods orders to improve by 1.5% m/m. We look for 

equipment and software investment to moderate from 

15.4% q/q a.r. in Q3, but still grow by a solid 5.0% in Q4. 

% m/m Dec (f) Nov Oct Sep 

Durable Goods 2.1 -0.3 -3.1 4.9 

Ex-Transport 0.5 3.6 -2.0 1.1 

Key Point: 

Durable goods orders are expected to increase 2.1% 

m/m in December, reflecting a solid increase in 

orders for Boeing aircraft. 



76 



3 

2 

1 

0 

-1 

Chart 13: Japanese CPI (% y/y) 

Core CPI 

BNP Paribas Forecast: Same Rate of Decline 

Japan: CPI (National, December) 


In November, the rate of decline in the national core CPI 

eased 0.1pp from October to -0.5% y/y on higher prices for 

petroleum products and food (prices for both components 

were unchanged m/m). Excluding energy and food (but not 

alcohol), the US-like core CPI fell 0.1pp faster than 

October, coming in at -0.9% y/y. 

-2 

-3 

CPI excluding energy and food, but not alcohol 

02 03 04 05 06 07 08 09 10 


% y/y Dec (f) Nov Oct Sep 

Core CPI -0.5 -0.5 -0.6 -1.1 

CPI -0.1 0.1 0.2 -0.6 

Based on the Tokyo CPI numbers for December (after 

making allowances for differences with the national index), 

we estimate that the national core CPI should be 

unchanged from November at -0.5% y/y. While deflationary 

pressures are easing, the rate of improvement is being 

tempered by downward pressures from the yen’s 

appreciation in the summer, coupled with the stalling of 

improvements in the output gap. In this respect, slowing 

exports and fallout from the end of green car subsidies are 

likely to cause the economy to contract in Q4. 

Key Point: 

While deflationary pressures are easing, 

improvements in the national core CPI will likely 

stall in December. 

Chart 14: Japanese Unemployment Rate (% s.a.) 

6.0 

5.5 

5.0 

4.5 

4.0 

3.5 

00 01 02 03 04 05 06 07 08 09 10 


% s.a. Dec (f) Nov Oct Sep 

Unemployment rate 5.1 5.1 5.1 5.0 

Key Point: 

With the economy expected to contract in Q4, 

improvements on the job front will probably remain 

stalled for the time being. 

BNP Paribas Forecast: Flat 

Japan: Unemployment Rate (December) 


We expect the unemployment rate in December to remain 

at 5.1% for the third straight month. After rapidly improving 

from a record-high of 5.6% in July 2009 to 4.9% in 

January-February 2010, the jobless rate has subsequently 

seesawed in the low 5% range, as improvements on the 

job front have stalled. 

While job losses from downsizing/business failures has 

declined, individuals seeking new jobs or better working 

conditions are finding few opportunities. Corporations are 

reluctant to aggressively hire owing to lingering perceptions 

of over-staffing, as labour adjustments during the last 

recession focused on working hours, thereby leaving 

payrolls relatively intact. 

Although perceptions of excessive employment are steadily 

waning, it will be some time before job growth clearly picks 

up, especially since the economy looks headed for a 

momentary contraction in Q4 due to the winding down of 

stimulus programmes. 



77 



Chart 15: Eurozone M3 & Bank Lending (% y/y) 

12.5 

10.0 

7.5 

5.0 

2.5 

0.0 

Private Sector 

Bank Lending 

M3 

-2.5 

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 


% y/y Dec (f) Nov Oct Sep 

M3 2.0 1.9 0.9 1.1 

M3 (3-mth Avg.) 1.6 1.3 1.0 0.8 

Private Sector Loans 2.3 2.0 1.5 1.3 

Key Point: 

Rates of growth in M3 and bank lending are low by 

past standards but are trending higher. 

BNP Paribas Forecast: Low But Rising 

Eurozone: Monetary Developments (December) 


The y/y growth rate in M3 accelerated to its strongest level 

in fifteen months in November, rising from 0.9% to 1.9%. 

This was driven, in part, by base effects. The three-month 

average y/y rate of growth rose for the seventh successive 

month but to a less elevated 1.3%. 

The y/y growth rate in private sector bank lending rose to a 

20-month high in November, from 1.5% to 2.0%. The m/m 

rise of 0.7% was the biggest since before the intensification 

of the financial crisis (March 2008 to be precise). The y/y 

rate of change is almost three percentage points above its 

trough in October 2009 (of -0.8%). 

Loans to households have been the main driver of the pickup, 

though the rate of growth has lost some momentum in 

recent months. The y/y rate of increase slipped to 2.7% in 

November and has been going sideways for the past three 

quarters. Lending for mortgages has been robust, rising by 

over 3% y/y since May 2010, while consumer credit has 

continued to contract on a y/y basis. 

Lending to the non-financial corporate sector is lagging that 

for households, as is typically the case. The rate of decline 

has moderated, however, to -0.1% y/y in November. 

Looking beyond special factors, the ECB continues to view 

M3 and lending growth rates as “low”. 


Chart 16: US: Final Demand 

Q4 (a) Q3 Q2 Q1 

GDP % q/q AR 2.9 2.6 1.7 3.7 

GDP Deflator % q/q AR 1.5 2.1 1.9 1.0 

Key Point: 

The moderate 2.9% q/q saar gain in overall GDP we 

expect would reflect a 4.4% surge in final demand 

and a 1.5pp drag from inventories. 

BNP Paribas Forecast: Strong Final Demand 

US: GDP (Q3a 2010) 

Release Date: Friday 29 October 

GDP is forecast to grow 2.9% q/q saar in Q4, up from 2.6% 

in Q3. The tone of the report should be much stronger than 

the headline suggests, however, as inventories are 

expected to subtract 1.5pp from growth while final demand 

is forecast to surge 4.4%. The reading would represent the 

first time since the recovery began that final demand grew 

at a pace above the economy’s potential (see chart). 

For the year as a whole, final demand will have risen 1.9%. 

Trade is expected to contribute 1.7pp to growth after 

subtracting an average 2.6pp over the prior two quarters. 

Consumer spending is also expected to surge 3.5%, on 

strong holiday spending. Meanwhile, government should 

be subdued as contraction in state and local government 

spending nearly offsets surging federal outlays on defence. 

Equipment and software spending is expected to grow at a 

more moderate pace while both commercial and residential 

real estate should post modest declines. The GDP deflator 

is expected to rise 1.5%, which would lead to reasonably 

healthy nominal GDP growth of 4.4%, similar to the prior 

quarter. 



78 


Economic Calendar: 31 Jan – 25 Feb 

31 January 1 February 2 February 3 February 4 February 

Japan: IP Dec, Housing 

Starts Dec 

Eurozone: HICP (Flash) 

Jan 

UK: GfK Consumer 

Confidence Jan 

Italy: PPI Dec 

Spain: HICP (Flash) Jan 

Norway: Retail Sales Dec 

US: Personal Income & 

Spending Dec, Chicago 

PMI Jan 

Canada: GDP Nov 



Australia: RBA Rate 

Announcement, NAB 

Business Conditions Dec 

Eurozone: Labour Dec, 

Manufacturing PMI (Final) 

Jan 

UK: CIPS Manu Jan, Net 

Consumer Credit Dec, 

Mortgage Approvals Dec 

Germany: Labour Dec 

France: PPI Dec 

US: Construction Dec, 

ISM Manufacturing Jan 

Eurozone: PPI Dec 

Norway: Labour Nov 

US: Challenger Job 

Losses Jan, ADP Labour 

Jan 

Australia: Trade Balance 

Dec 

Eurozone: ECB Rate 

Announcement & Press 

Conference, Retail Sales 

Dec, Services PMI (Final) 

Jan 

UK: CIPS Services (Final) 

Jan 

US: Productivity & Costs 

(Prel) Q4, Factory Orders 

Dec, ISM Services Jan 

Italy: CPI (Prel) Feb 

Spain: Industrial 

Production Dec 

US: Labour Jan 

Canada: Labour Jan 

During Week: Germany Retail Sales Dec, UK Halifax House Prices Jan 

7 February 8 February 9 February 10 February 11 February 

Australia: Retail Sales 

Dec 

Japan: Leading Indicator 

Dec 

Germany: Factory Orders 

Dec 

Norway: Industrial 


US: Consumer Credit 

Dec 

Japan: M2 Jan, Current 

Account Dec 

UK: BRC Retail Sales 

Monitor Jan, RICS House 

Prices Jan 

Germany: Industrial 


France: BoF Survey Jan, 

Trade Balance Dec, 

Budget Balance Dec 

Neths: IP Dec 

US: NFIB Small Business 

Optimism Jan 

Australia: Westpac 

Consumer Confidence 

Feb 

UK: Trade Balance Dec 

Germany: Trade Balance 

Dec 

France: Investment 

Survey Jan 

Australia: Labour Jan 

Japan: CGPI Jan, 

Machinery Orders Dec 

Eurozone: ECB Bulletin 

UK: BoE Rate Ann, IP Dec 

France: IP Dec 

Italy: IP Dec 

Sweden: IP Dec 

Norway: CPI Jan, PPI Jan 

Neths: CPI Jan 

Switz: CPI Jan 

US: Wholesale Inv Dec, 

Treasury Statement Jan 

UK: PPI Jan 

Germany: HICP Jan 

France: Current Account 

Dec, Non-Farm Payrolls 

(Prel) Q4, Wages (Prel) 

Q4 

Spain: GDP (Flash) Q4 

Sweden: AMV Labour 

Jan 

US: Trade Balance Dec, 

UoM Sentiment (Prel) 

Feb 

During Week: Germany WPI Jan 


Eurozone: Industrial 


Australia: NAB Business 

Conditions Jan 

Eurozone: GDP (Flash) 

Q4, Trade Balance Dec 

UK: DCLG House Prices 

Dec, CPI Jan 

Germany: GDP (Flash) 

Q4, ZEW Survey Feb 

France: GDP (Prel) Q4 

Italy: Trade Balance Dec 

Spain: HICP Jan 

Sweden: Rate Ann 

Neths: GDP (Prel) Q4, 

Retail Sales Dec 

US: Empire State Survey 

Feb, Retail Sales Jan, 

Import Prices Jan, TICS 

Data Dec, Business 

Inventories Dec, NAHB 

Housing Market Feb 

UK: Labour Dec, BoE 

Inflation Report 

Spain: GDP (Final) Q4 

Belgium: GDP (Flash) Q4 

US: New Home Starts 

Jan, PPI Jan, Industrial 

Production Jan, FOMC 

Minutes 

Eurozone: Current 

Account Dec, ECB 

Governing Council 

Meeting (No Rate 

Announcement) 

Sweden: CPI Jan, Labour 

Jan 

Norway: GDP Q4 

Neths: Labour Jan 

US: CPI Jan, Philly Fed 

Feb, Leading Indicators 

Jan 

UK: Retail Sales Jan 

Germany: PPI Jan 

Italy: Non-EU Trade 

Balance Jan 

Belgium: Consumer 

Confidence Feb 

Neths: Consumer 


Canada: CPI Jan 


UK: Rightmove House 

Prices Feb, PSNB Jan, 

PSNCR Jan 

Eurozone: PMIs (Flash) 

Feb 

Germany: Ifo Survey Jan 

Neths: Producer 


US: Public Holiday 

Japan: BoJ Monetary 

Policy Meeting Minutes 

France: Housing Starts 

Jan, Industry Survey Feb 

Belgium: Business 


US: S&P/Case-Shiller 

House Prices Dec, 

Consumer Confidence 

Feb 

Japan: Trade Balance 

Jan 

Australia: Wage Cost 

Index Q4 

Eurozone: Industrial 

Orders Dec 

UK: BoE Minutes 

France: CPI Jan 

Italy: CPI Jan 

Norway: Labour Dec 

US: Existing Home Sales 

Jan 

During Week: Germany Import Price Index Jan, GfK Consumer Confidence Mar 


Eurozone: Business & 

Consumer Survey Feb 

Germany: GDP (Final) 

Q4 

France: Consumer 

Confidence Feb, Job 

Seekers Jan 

Italy: Retail Sales Dec 

Sweden: Consumer 


US: Durable Goods 

Orders Jan, FHFA House 

Prices Dec, New Home 

Sales Jan 

Release dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions 

79 

Japan: CPI Tokyo Feb, 

CPI National Jan 

Eurozone: Monetary 

Developments Jan, 

Eurocoin Feb 

UK: GDP (Prel) Q4 

Germany: HICP (Prel) 

Feb 

France: Retail Sales Jan 

Spain: PPI Jan 

Belgium: CPI Feb 

Switz: KOF Leading 

Indicator Feb 

US: GDP (2 nd Est) Q4, 

UoM Sentiment (Final) 

Feb 


Treasury and SAS Issuance Calendar 

0Global Markets, Home Page 

just one click on “Market Calendar” for more details 

In the pipeline - Treasuries: 

Ireland: To resume borrowing as soon as market conditions permit 

Italy: BTP Sep 2021 (new) to be issued in Q1 

Poland: Plans to issue dollar-denominated bonds in H1. Is also considering issuing bonds denominated in yen and euros 

Portugal: Expects to launch a new bond via a syndicate in Q1. Another new bond issue is possible at a later date 

UK: Two mini tenders, one in February and another in March 

Belgium: Cancelled its bond auction scheduled for 31 January 

Finland: To launch two new euro-denominated benchmark bonds in 2011, a new 10y in H1 

Czech Rep.: May sell up to EUR 2bn of bonds in May 

Denmark: In 2011, to issue a 5-year EUR loan (EUR 1-2bn); EUR or USD loans may be issued in the 2-5y maturity segment 

Slovak Rep.: Plans to raise as much as EUR 4bn through syndicated sales 

During the week: 

UK: Index-Linked Gilt 1.25% Nov 2055 (re-opening, syndicated, GBP) 

FNMA: Second syndicated auction in January, details announced on 27 January 

Date Day Closing Country Issues Details BNPP forecasts 

Local GMT 

21/01 Fri 11:00 16:00 US Outright Treasury Coupon Purchase (2018 - 2020) USD 7-9bn 

24/01 Mon 12:00 03:00 Japan JGBs 10y Auction for Enhanced-liquidity issue 208-309 

JGBs 20y Auction for Enhanced-liquidity issue 59-88 

JPY 0.3tn 

Slovak Rep. SLOVGB 14 Oct 2013 (#215 - floating rate) 

EUR 0.2bn 

11:00 16:00 US Outright Treasury Coupon Purchase (2016 - 2017) USD 7-9bn 

25/01 Tue Neths DSL 5% 15 Jul 2012 (Off-the-run facility) 

DSL 4.5% 15 Jul 2017 (Off-the-run facility) 

EUR 2-3bn 

Denmark DGB 5% 15 Nov 2013 

DGB 3% 15 Nov 2021 

12:00 17:00 Canada Repurchase of 10 Cash Mgt Bonds (Jun11 - Jun12) CAD 0.5bn 


13:00 18:00 US Notes 0.5% 31 Jan 2013 (new) USD 35bn 

26/01 Wed 10:55 09:55 Italy CTZ 21 Jan 

11:00 10:00 Germany Bund 3.25% 4 Jul 2042 EUR 2bn 

11:00 10:00 Sweden T-bonds 5% 1 Dec 2020 (# 1047) SEK 2bn 

12:00 17:00 Canada CAN 2-year 20 Jan 

13:00 18:00 US Notes 2% 31 Jan 2016 (new) USD 35bn 

27/01 Thu 12:00 03:00 Japan JGB 15 Feb 2013 JPY 2.6tn 

10:55 09:55 Italy BTPeis 21 Jan EUR 2-3bn 


13:00 18:00 US Notes 2.75% 31 Jan 2018 (new) USD 29bn 

28/01 Fri 10:55 09:55 Italy 3 & 10y BTPs and CCT 21 Jan EUR 7-9bn 


31/01 Mon 11:00 16:00 US Outright Treasury Coupon Purchase (2013 - 2014) USD 6-8bn 

01/02 Tue 12:00 03:00 Japan JGB 10-year 25 Jan JPY 2.2tn 

11:00 10:00 Austria RAGBs 25 Jan EUR1.5-2.5bn 

10:30 10:30 UK Gilt 2% 22 Jan 2016 25 Jan 

11:00 16:00 US Outright TIPS Purchase (2013 - 2040) USD 1-2bn 

02/02 Wed 12:00 17:00 Canada CAN 10-year 27 Jan 

11:00 16:00 US Outright Treasury Coupon Purchase (2021 - 2027) USD 1.5-2.5bn 

03/02 Thu 12:00 03:00 Japan Auction for Enhanced-liquidity 27 Jan JPY 0.3tn 

10:30 09:30 Spain Bono 2.5% 31 Oct 2013 31 Jan EUR 3-4bn 

10:50 09:50 France OATs 28 Jan EUR 7-9bn 

11:00 10:00 Sweden ILBs 27 Jan 

10:30 10:30 UK Gilt 4.25% 7 Dec 2040 25 Jan 


04/02 Fri 11:00 16:00 US Outright Treasury Coupon Purchase (2013 - 2015) USD 6-8bn 

Sources: Treasuries, BNP Paribas 



80 


Next Week's T-Bills Supply 

Date Country Issues Details 

21/01 UK T-Bills Feb 2011 GBP 0.5bn 

T-Bills Apr 2011 

GBP 1bn 

T-Bills Jul 2011 

GBP 1.5bn 

24/01 France BTF Apr 2011 EUR 4bn 

BTF Jul 2011 

EUR 2bn 

BTF Jan 2012 

EUR 1.5bn 

Germany Bubills Jan 2012 (new) EUR 3bn 

US T-Bills Apr 2011 USD 29bn 

T-Bills Jul 2011 

USD 28bn 

FHLMC Bills 3-month & 6-month 21 Jan 

25/01 Spain Letras Apr 2011 24 Jan 

Letras Jul 2011 

24 Jan 

US T-Bills 4-week 24 Jan 

FHLB Discount Notes 

26/01 Japan T-Bills Apr 2011 JPY 4.8tn 

Italy BOT Jul 2011 21 Jan 

FNMA Bills 3-month & 6-month 24 Jan 

27/01 FHLB Discount Notes 

28/01 UK T-Bills 21 Jan 

Denmark T-Bills 

Sources: Treasuries, BNP Paribas 

Comments and charts 

• EGB gross supply will fall to EUR 13.5bn (ex-CTZ) 

in the week ahead from EUR 28.5bn in the past week. In 

10y duration-adjusted terms, it falls to EUR 10.3bn from 

EUR 15bn in the past week. 

• The Netherlands will conduct its first off-the-run taps 

for 2011 on Tuesday under the new schedule of a 

quarterly instead of a monthly frequency and with a 

bigger size. DSLs Jul-12 and Jul-17 will be tapped for a 

total amount of EUR 2-3bn. Italy will tap CTZ on 

Wednesday while, on the same day, Germany will tap 

30y Bund Jul-42 for EUR 2bn. On Thursday there will be 

BTPeis auction in Italy and on Friday the usual 3y and 

10y BTPs and CCT auctions. The inaugural EFSF bond 

issuance is expected to take place in the week ahead as 

the end of January has been suggested as the most 

likely timing of this issuance. 

• Outside of the eurozone, US will issue USD 99bn of 

2y, 5y and 7y notes. Denmark, Canada and Japan will 

also issue paper in the week ahead. 

Next Week's Eurozone Redemptions 

Date Country Details Amount 

26/01 Germany Bubills EUR 6.0bn 

27/01 France BTF EUR 8.0bn 

Total Eurozone Short-term Redemption 

EUR 14bn 

Next Week's Eurozone Coupons 

Country 

Amount 

Italy 

EUR 0.1bn 

Austria 

EUR 0.0bn 

Total Long-term Coupon Payments 

EUR 0.1bn 

30 

25 

20 

15 

10 

5 

0 

-5 

-10 

-15 

-20 

25 

20 

15 

10 

5 

0 

Chart 1: Investors’ Net Cash Flows 

(EUR bn, 10y equivalent) 

Net Investors' Cash Flows 

(EUR bn , 10y equivalent) 

Week of Jan 10th Week of Jan 17th Week of Jan 24th Week of Jan 31st 

Chart 2: EGB Gross Supply Breakdown by 

Country (EUR bn, 10y equivalent) 

Germany Italy Portugal Belgium 

France Spain Netherlands Austria 

Finland Greece Ireland 


Chart 3: EGB Gross Supply Breakdown by 

Maturity (EUR bn, 10y equivalent) 

20 

18 

16 

14 

12 

10 

8 

6 

4 

2 

0 

EGBs Gross Supply (EUR bn, 10y equivalent) 

2-3-YR 5-7-YR 10-YR >10-YR 





81 


Central Bank Watch 

Interest Rate 

EUROZONE 

Current 

Rate (%) 

Minimum Bid Rate 1.00 

US 

Fed Funds Rate 0 to 0.25 

Discount Rate 0.75 

JAPAN 

Call Rate 0 to 0.10 

Basic Loan Rate 0.30 

UK 

Bank Rate 0.5 

DENMARK 

Lending Rate 1.05 

SWEDEN 

Repo Rate 1.25 

NORWAY 

Sight Deposit Rate 2.00 

SWITZERLAND 

3 Mth LIBOR Target 

Range 

CANADA 

0.0-0.75 

Overnight Rate 1.00 

Bank Rate 1.25 

AUSTRALIA 

Cash Rate 4.75 

CHINA 

1Y Bank Lending 

Rate 

BRAZIL 

5.81% 

Selic Overnight Rate 11.25 

Date of 

Last 

Change 

-25bp 

(7/5/09) 

-75bp 

(16/12/08) 

+25bp 

(18/2/10) 

-10bp 

(5/10/10) 

-20bp 

(19/12/08) 

-50bp 

(5/3/09) 

-10bp 

(14/1/10) 

+25bp 

(15/12/10) 

+25bp 

(5/5/10) 

-25bp 

(12/3/09) 

+25bp 

(8/9/10) 

+25bp 

(8/9/10) 

+25bp 

(2/11/10) 

+25bp 

(25/12/10) 

+50bp 

(19/1/11) 

Next Change in 

Coming 6 Months 

No Change 

No Change 

No Change 

No Change 

No Change 

No Change 

No Change 

+25bp 

(15/2/11) 

+25bp 

(12/5/11) 

No Change 

+25bp 

(1/6/11) 

+25bp 

(1/6/11) 

No change 

+25bp 

(Feb 11) 

+50bp 

(2/3/11) 


For the full EMK Central Bank Watch please see our Local Markets Mover 

Comments 

Doubts about the sustainability of the recovery and low inflation 

pressures imply no rise in the refinancing rate for a considerable 

period of time: we expect the first increase only in H2 2012. 

The FOMC is expected to maintain the funds rate at 0 to 0.25% 

for an extended period. It will execute its QE2 programme through 

H1 2011, with a high probability of an extension through H2 2011. 

We expect the BoJ to maintain its overnight call rate at 0 to 

0.1% for an extended period. It could well expand its asset 

purchase programme, depending mainly on moves in the yen. 

Despite sluggish growth, we expect persistent upward surprises 

on inflation and rising inflation expectations to provoke an 

interest rate hike in Q3 – with the risk of an earlier move. 

Higher money market rates in the eurozone are likely to 

continue to put pressure on the krone. Thus, further increases in 

the interest rate on certificates of deposit are on the agenda. 

Strong domestic economic growth should lead to further rate 

hikes. We expect the Riksbank to deliver the next rate hike at 

February’s meeting. 

We expect the Norges Bank to raise rates in Q2 2011. Given the 

Bank’s hawkish statement in December, the risk is that the rate 

hike comes in Q1 if economic data surprise to the upside and 

the krone does not appreciate significantly. 

The rally in the franc is delivering a tightening of monetary 

conditions independent of SNB policy. The timing of the first hike 

remains dependent on exchange rate developments. 

In light of developments in global financial markets and the US 

economic outlook in particular, the BoC is pausing to allow 

further progress in the recovery. Rate hikes should resume in 

June 2011, with 75bp of increases delivered by the end of the 

year. 

The effective cash rate is moderately restrictive while financial 

and monetary conditions are outright tight. Below-trend growth 

is likely this year, especially given the impact of the Queensland 

floods. Underlying inflation is contained, albeit with upside risks. 

There is limited need for further tightening in the near term. 

Inflation pressure remains strong and the property market 

continues to overheat. We thus expect RRR to be hiked to 23% to 

slow M2 and lending growth to a 16-17% y/y pace. Further, we 

expect at least two 25bp hikes in H1 2011, supplemented by strict 

liquidity controls and tight money market rates. 

After being on hold since a hike in July 2011, the BCB resumed 

hiking in January 2011. In light of a worrisome inflation picture, 

the monetary authority is likely to continue tightening monetary 

policy in coming months. 

Change since our last weekly in bold and italics 



82 


Economic Forecasts 

GDP 

Year 2010 

2011 

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -2.6 2.8 2.4 2.4 3.0 3.2 2.6 2.2 2.4 2.5 2.5 

Eurozone -4.0 1.7 1.6 0.8 2.0 1.9 2.0 2.1 1.5 1.5 1.5 

Japan -5.2 3.6 1.4 5.0 2.7 4.4 2.6 1.4 1.4 1.0 1.9 

World (2) -0.6 4.8 4.1 4.8 5.0 4.8 4.5 4.1 4.0 4.1 4.2 

Industrial Production 

Year 

2010 

2011 

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -9.3 5.5 3.0 2.7 7.4 6.6 5.3 4.2 3.0 2.4 2.5 

Eurozone -14.6 6.8 2.8 4.6 9.0 6.9 6.6 4.6 2.6 2.2 1.8 

Japan -21.9 15.0 1.2 27.4 21.0 13.4 2.6 -1.3 -1.6 1.2 6.2 

Unemployment Rate 

Year 

2010 2011 

(%) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US 9.3 9.7 9.5 9.7 9.7 9.6 9.7 9.7 9.7 9.5 9.3 

Eurozone 9.4 10.0 10.2 9.9 10.0 10.0 10.1 10.1 10.2 10.2 10.2 

Japan 5.1 5.1 4.6 4.9 5.2 5.1 5.0 4.8 4.7 4.5 4.5 

CPI 

Year 

2010 

2011 

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -0.4 1.6 1.5 2.4 1.8 1.2 1.3 1.6 1.8 1.6 1.1 

Eurozone 0.3 1.6 2.2 1.1 1.5 1.7 2.0 2.3 1.9 2.2 2.3 

Japan -1.4 -0.7 -0.9 -1.2 -0.9 -0.8 0.0 -0.9 -1.0 -0.7 -1.1 

Current Account 

(% GDP) ’09 

Year 

’10 (1) ’11 (1) General Government 

(% GDP) 

’09 

Year 

’10 (1) ’11 (1) 

US -2.7 -3.4 -3.3 US (4) -10.0 -8.9 -9.9 

Eurozone -0.6 -0.5 -0.2 Eurozone -6.3 -6.2 -4.7 

Japan 2.8 3.5 3.5 Japan -10.2 -8.2 -6.8 

Interest Rate Forecasts 

Interest Rate (3) 

Year 

2011 

2012 

(%) ’09 ’10 ’11 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US 

Fed Funds Rate 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50 

3-month Rate 0.25 0.30 0.30 0.30 0.30 0.30 0.30 0.30 0.45 0.75 0.90 

2-year yield 1.14 0.61 1.00 0.50 0.75 0.85 1.00 1.10 1.50 2.15 2.40 

10-year yield 3.84 3.29 3.75 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.60 

2y/10y Spread (bp) 269 268 275 250 250 265 275 290 275 235 220 

Eurozone 

Refinancing Rate 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75 


2-year yield 1.37 0.85 1.50 1.00 1.20 1.30 1.50 1.70 2.05 2.30 2.45 

10-year yield 3.40 2.96 3.35 2.75 2.90 3.15 3.35 3.50 3.75 3.90 4.10 

2y/10y Spread (bp) 203 211 185 175 170 185 185 180 170 160 165 

Japan 

O/N Call Rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 


2-year yield 0.15 0.18 0.25 0.25 0.25 0.25 0.25 0.25 0.30 0.30 0.30 

10-year yield 1.30 1.12 1.40 1.20 1.30 1.40 1.40 1.40 1.40 1.50 1.50 

2y/10y Spread (bp) 115 95 115 95 105 115 115 115 110 120 120 

Footnotes: (1) Forecast (2) Country weights used to construct world growth are those in the IMF World Economic Outlook Update 

April 2010 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated 


Market Economics / Interest Rate Strategy 20 January 2011 


83 


FX Forecasts* 

USD Bloc Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 

EUR/USD 1.27 1.25 1.20 1.23 1.25 1.30 1.32 1.32 1.33 1.34 1.35 

USD/JPY 85 84 88 92 95 100 110 120 119 118 116 

USD/CHF 1.01 1.05 1.11 1.09 1.08 1.05 1.05 1.06 1.06 1.07 1.07 

GBP/USD 1.55 1.51 1.46 1.45 1.52 1.55 1.57 1.61 1.66 1.70 1.73 

USD/CAD 0.95 0.96 0.93 0.95 0.95 1.00 1.02 1.09 1.11 1.14 1.16 

AUD/USD 1.02 0.99 0.92 0.93 0.92 0.93 0.92 0.90 0.87 0.85 0.83 

NZD/USD 0.79 0.78 0.74 0.73 0.72 0.69 0.67 0.66 0.64 0.62 0.60 

USD/SEK 7.09 7.04 7.58 7.56 7.36 7.08 6.89 6.89 6.99 6.94 6.96 

USD/NOK 6.22 6.16 6.33 6.10 5.92 5.77 5.76 5.68 5.49 5.30 5.19 

EUR Bloc Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 

EUR/JPY 108 105 106 113 119 130 145 158 158 158 157 

EUR/GBP 0.82 0.83 0.82 0.85 0.82 0.84 0.84 0.82 0.80 0.79 0.78 

EUR/CHF 1.28 1.31 1.33 1.34 1.35 1.36 1.38 1.40 1.41 1.44 1.44 

EUR/SEK 9.00 8.80 9.10 9.30 9.20 9.20 9.10 9.10 9.30 9.30 9.40 

EUR/NOK 7.90 7.70 7.60 7.50 7.40 7.50 7.60 7.50 7.30 7.10 7.00 

EUR/DKK 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 

Central Europe Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 

USD/PLN 3.07 3.16 3.25 3.09 3.12 2.96 2.88 2.84 2.78 2.69 2.74 

EUR/CZK 24.7 24.5 24.3 24.5 24.3 24.0 23.9 23.8 24.0 23.8 23.5 

EUR/HUF 290 285 280 275 270 270 270 265 260 255 260 

USD/ZAR 7.30 7.50 7.40 7.30 7.40 7.30 7.30 7.50 7.20 7.10 7.00 

USD/TRY 1.50 1.52 1.48 1.47 1.49 1.46 1.47 1.46 1.45 1.43 1.42 

EUR/RON 4.35 4.50 4.50 4.40 4.20 4.30 4.20 4.20 4.20 4.20 4.10 

USD/RUB 30.32 30.11 31.19 29.90 30.11 29.07 28.85 28.41 27.86 27.32 28.51 

EUR/PLN 3.90 3.95 3.90 3.80 3.90 3.85 3.80 3.75 3.70 3.60 3.70 

USD/UAH 7.9 7.9 7.8 7.8 7.5 7.5 7.5 7.5 7.5 7.5 7.5 

EUR/RSD 105 115 105 100 98 97 96 95 93 92 91 

Asia Bloc Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 

USD/SGD 1.25 1.23 1.22 1.21 1.21 1.20 1.19 1.18 1.17 1.16 1.15 

USD/MYR 3.03 3.00 2.95 2.90 2.87 2.85 2.83 2.80 2.77 2.75 2.73 

USD/IDR 8800 8600 8500 8400 8300 8200 8100 8000 7900 7800 7800 

USD/THB 29.50 29.00 28.70 28.50 28.30 28.00 27.70 27.50 27.30 27.00 27.00 

USD/PHP 43.00 42.50 42.00 41.50 41.00 40.50 40.00 39.50 39.00 39.00 39.00 

USD/HKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 

USD/RMB 6.58 6.52 6.49 6.45 6.40 6.35 6.30 6.26 6.23 6.20 6.17 

USD/TWD 28.70 28.00 27.70 27.30 27.00 26.70 26.50 26.00 26.00 26.00 26.00 

USD/KRW 1100 1070 1060 1050 1040 1030 1020 1010 1000 1000 1000 

USD/INR 44.50 44.30 44.00 43.70 43.50 43.00 42.50 42.00 41.50 41.00 40.50 

USD/VND 20500 20500 20500 20500 20500 20500 20500 20500 20500 20500 20500 

LATAM Bloc Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 

USD/ARS 4.00 4.09 4.19 4.28 4.36 4.44 4.52 4.60 4.68 4.75 4.83 

USD/BRL 1.68 1.66 1.65 1.63 1.63 1.65 1.67 1.70 1.71 1.73 1.74 

USD/CLP 529 516 500 485 480 475 473 471 473 475 478 

USD/MXN 12.00 11.70 11.45 11.30 11.30 11.50 11.80 12.00 12.08 12.15 12.24 

USD/COP 1800 1750 1720 1700 1705 1730 1745 1760 1770 1780 1790 

USD/VEF 4.29 4.29 4.29 4.29 4.29 4.29 4.29 4.29 8.80 8.80 8.80 

USD/PEN 2.76 2.73 2.68 2.67 2.70 2.70 2.71 2.72 2.73 2.74 2.75 

Others Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13 Q3 '13 

USD Index 82.04 83.11 86.11 85.63 84.56 83.26 83.51 84.81 84.22 83.77 83.14 

*End Quarter 

Foreign Exchange Strategy 20 January 2011 

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com 

84

Market Coverage 

Market Economics 

Paul Mortimer-Lee Global Head of Market Economics London 44 20 7595 8551 paul.mortimer-lee@uk.bnpparibas.com 

Ken Wattret Chief Eurozone Market Economist London 44 20 7595 8657 kenneth.wattret@uk.bnpparibas.com 

Luigi Speranza Head of Inflation Economics, Eurozone, Italy London 44 20 7595 8322 luigi.speranza@uk.bnpparibas.com 

Alan Clarke UK London 44 20 7595 8476 alan.clarke@uk.bnpparibas.com 

Eoin O’Callaghan Inflation, Eurozone, Switzerland, Ireland London 44 20 7595 8226 eoin.ocallaghan@uk.bnpparibas.com 

Gizem Kara Scandinavia London 44 20 7595 8783 gizem.kara@uk.bnpparibas.com 

Dominique Barbet Eurozone, France Paris 33 1 4298 1567 dominique.barbet@bnpparibas.com 

Julia Coronado Chief US Economist New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.com 

Yelena Shulyatyeva US, Canada New York 1 212 841 2258 yelena.shulyatyeva@americas.bnpparibas.com 

Bricklin Dwyer US, Canada New York 1 212 471-7996 bricklin.dwyer@americas.bnpparibas.com 

Ryutaro Kono Chief Economist Japan Tokyo 81 3 6377 1601 ryutaro.kono@japan.bnpparibas.com 

Hiroshi Shiraishi Japan Tokyo 81 3 6377 1602 hiroshi.shiraishi@japan.bnpparibas.com 

Azusa Kato Japan Tokyo 81 3 6377 1603 azusa.kato@japan.bnpparibas.com 

Makiko Fukuda Japan Tokyo 81 3 6377 1605 makiko.fukuda@japan.bnpparibas.com 

Richard Iley Head of Asia Economics Hong Kong 852 2108 5104 richard.iley@asia.bnpparibas.com 

Dominic Bryant Asia, Australia Hong Kong 852 2108 5105 dominic.bryant@asia.bnpparibas.com 

Mole Hau Asia Hong Kong 852 2108 5620 mole.hau@asia.bnpparibas.com 

Xingdong Chen Chief China Economist Beijing 86 10 6561 1118 xd.chen@asia.bnpparibas.com 

Isaac Y Meng China Beijing 86 10 6561 1118 isaac.y.meng@asia.bnpparibas.com 

Chan Kok Peng Chief Economist South East Asia Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.com 

Marcelo Carvalho Head of Latin American Economics São Paulo 55 11 3841 3418 marcelo.carvalho@br.bnpparibas.com 

Italo Lombardi Latin America New York 1 212 841 6599 italo.lombardi@americas.bnpparibas.com 

Florencia Vazquez Latin American Economist Buenos Aires 54 11 4875 4363 florencia.vazquez@ar.bnpparibas.com 

Michal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.com 

Julia Tsepliaeva Russia & CIS Moscow 74 95 785 6022 julia.tsepliaeva@ru.bnpparibas.com 

Interest Rate Strategy 

Cyril Beuzit Global Head of Interest Rate Strategy London 44 20 7595 8639 cyril.beuzit@uk.bnpparibas.com 

Patrick Jacq Europe Strategist Paris 33 1 4316 9718 patrick.jacq@bnpparibas.com 

Hervé Cros Chief Inflation Strategist London 44 20 7595 8419 herve.cros@uk.bnpparibas.com 

Shahid Ladha Inflation Strategist London 44 20 7 595 8573 shahid.ladha@uk.bnpparibas.com 

Alessandro Tentori Chief Alpha Strategy Europe London 44 20 7595 8238 alessandro.tentori@uk.bnpparibas.com 

Eric Oynoyan Europe Alpha Strategist London 44 20 7595 8613 eric.oynoyan@uk.bnpparibas.com 

Matteo Regesta Europe Alpha Strategist London 44 20 7595 8607 matteo.regesta@uk.bnpparibas.com 

Ioannis Sokos Europe Alpha Strategist London 44 20 7595 8671 ioannis.sokos@uk.bnpparibas.com 

Camille de Courcel Europe Alpha Strategist London 44 20 7595 8295 camille.decourcel@uk.bnpparibas.com 

Bülent Baygün Head of Interest Rate Strategy US New York 1 212 471 8043 bulent.baygun@americas.bnpparibas.com 

Mary-Beth Fisher US Senior Strategist New York 1 212 841 2912 mary-beth.fisher@us.bnpparibas.com 

Sergey Bondarchuk US Strategist New York 1 212 841 2026 sergey.bondarchuk@americas.bnpparibas.com 

Suvrat Prakash US Strategist New York 1 917 472 4374 suvrat.prakash@americas.bnpparibas.com 

Rohit Garg US Strategist New York 1212 841 3937 rohit.k.garg@americas.bnpparibas.com 

Anish Lohokare MBS Strategist New York 1 212 841 2867 anish.lohokare@americas.bnpparibas.com 

Olurotimi Ajibola MBS Strategist New York 1 212 8413831 olurotimi.ajibola@americas.bnpparibas.com 

Koji Shimamoto Head of Interest Rate Strategy Japan Tokyo 81 3 6377 1700 koji.shimamoto@japan.bnpparibas.com 

Tomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1703 Tomohisa.fujiki@japan.bnpparibas.com 

Masahiro Kikuchi Japan Strategist Tokyo 81 3 6377 1703 masahiro.kikuchi@japan.bnpparibas.com 

Christian Séné Technical Analyst Paris 33 1 4316 9717 christian.séné@bnpparibas.com 

FX Strategy 

Hans Redeker Global Head of FX Strategy London 44 20 7595 8086 hans-guenter.redeker@uk.bnpparibas.com 

Ian Stannard FX Strategist London 44 20 7595 8086 ian.stannard@uk.bnpparibas.com 

James Hellawell Quantitative Strategist London 44 20 7595 8485 james.hellawell@uk.bnpparibas.com 

Kiran Kowshik FX Strategist Singapore 65 6210 3264 kiran.kowshik@bnpparibas.com 

Mary Nicola FX Strategist New York 1 212 841 2492 mary.nicola@americas.bnpparibas.com 

Andy Chaveriat Technical Analyst New York 1 212 841 2408 andrew.chaveriat@americas.bnpparibas.com 

Local Markets FX & Interest Rate Strategy 

Drew Brick Head of FX & IR Strategy Asia Singapore 65 6210 3262 Drew.brick@asia.bnpparibas.com 

Chin Loo Thio FX & IR Asia Strategist Singapore 65 6210 3263 chin.thio@asia.bnpparibas.com 

Robert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 robert.ryan@asia.bnpparibas.com 

Jasmine Poh FX & IR Asia Strategist Singapore 65 6210 3418 jasmine.j.poh@asia.bnpparibas.com 

Gao Qi FX & IR Asia Strategist Shanghai 86 21 2896 2876 gao.qi@asia.bnpparibas.com 

Bartosz Pawlowski Head of FX & IR Strategy CEEMEA London 44 20 7595 8195 Bartosz.pawlowski@uk.bnpparibas.com 

Elisabeth Gruié FX & IR CEEMEA Strategist London 44 20 7595 8492 elisabeth.gruie@uk.bnpparibas.com 

Dina Ahmad FX & IR CEEMEA Strategist London 44 20 7 595 8620 dina.ahmad@uk.bnpparibas.com 

Diego Donadio FX & IR Latin America Strategist São Paulo 55 11 3841 3421 diego.donadio@@br.bnpparibas.com 

85

For Production and Distribution, please contact: 

Ann Aston, Market Economics, London. Tel: 44 20 7595 8503 Email: 0Hann.aston@uk.bnpparibas.com, 

Danielle Catananzi, Interest Rate Strategy, London. Tel: 44 20 7595 4418 Email: 1Hdanielle.catananzi@uk.bnpparibas.com, 

Derek Allassani, FX Strategy, London. Tel: 44 20 7595 8486 Email: 2Hderek.allassani@uk.bnpparibas.com, 

Martine Borde, Market Economics/Interest Rate Strategy, Paris. Tel: 33 1 4298 4144 Email 3Hmartine.borde@bnpparibas.com 

Editors: Amanda Grantham-Hill, Interest Rate Strategy/Market Economics, London. Tel: 44 20 7595 4107 Email: 4Hamanda.grantham-hill@bnpparibas.com; 

Nick Ashwell, FX/Market Economics, London. Tel: 44 20 7595 4120 Email: 5Hnick.ashwell@uk.bnpparibas.com 

BNP Paribas Global Fixed Income Website 

6Hwww.globalmarkets.bnpparibas.com 

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Interest Rate Strategy BPBS Forex Strategy BPFR 

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