Market Outlook - BNP PARIBAS - Investment Services India

Market Economics | Interest Rate Strategy | Forex Strategy 29 January 2010 

Market Mover 

Market Outlook 2-3 

Fundamentals 4-26 

• US FOMC: A More Hawkish Tone 4-6 

• US: Get It While You Can 7-10 

• France: Roaring Consumption 11 

• UK: BoE Meeting Preview 12-14 

• UK Inflation: Bridging the Gap 15-17 

• Norway: To Pause for Now 18-19 

• Japan: Vetting Budget Spending 20-22 

Requests 

• Japan: Polarisation in Machine Tool 23-24 

Orders 

• Australia: The Next Step 25-26 

Interest Rate Strategy 27-46 

• US: Post-FOMC Treasury Market 27 

Overview 

• US: After FOMC, Favour Calls on 28 

Front End 

• US: Rolling Down the Agency 29-30 

Spread Curve 

• US: Poor Housing Underscores 31-33 

MBS Support 

• EUR: Eonias Bet on July Jump 34 

• EUR: Timing the 20Y Point 35 

• EUR: EUR: Peripheral EGBs Under 36-37 

Pressure 

• Gilts : Equilibrium at Higher Rates 38 

• JGBs: Supply Continues to Weigh 39 

• Global Inflation Watch 40-43 

• Inflation: BEs Collapsing in Europe 44 

• Technical Analysis 45 

• Trade Reviews 46 

FX Strategy 47-53 

• Strategy: CNY: Revaluation and FX 47-50 

Reserves 

• Technical Strategy: USD Bullish 51-52 

Signals 

• Trading Positions 53 

Forecasts & Calendars 54-70 

• 1 Week Economic Calendar 54-55 

• Key Data Preview 56-64 

• 4 Week Calendar 65 

• Treasury & SAS Issuance 66-67 

• Central Bank Watch 68 

• Economic Forecasts 69 

• FX Forecasts 70 

Contacts 71 

www.GlobalMarkets.bnpparibas.com 

• The FOMC was less dovish in its latest statement. 

Assessments of inflation and growth prospects were 

generally more upbeat, although the Fed continues to see 

an extended period of very low rates. The statement 

favours a moderate rebound in stock markets as well as 

limited bear-steepening pressures at the front end of the 

US curve. 

• Upcoming first-tier data are critical as they will confirm 

or challenge the Fed’s assessment. With Q4 GDP, ISM and 

NFP data in the pipeline, nervousness is likely ahead of the 

releases. 

• In the eurozone, markets are focused on sovereign 

credit risk. Peripherals, above all Greece but also Portugal, 

are under strong selling pressure, primarily as a result of 

their fiscal situations. But recent developments have been 

intensified by factors such as speculative selling in the 

face of weak potential demand from real accounts. 

Peripherals may remain under pressure in the near term. 

• These circumstances offer core EGBs robust support 

but, as yields are already low, there is little scope for an 

extension of the recent rally. 

• In Japan, the current weakness in the stock market is 

offering JGBs robust support. 

• Inflation and related interest rate divergences have 

become the dominant theme on FX markets. The 

acceleration in China’s inflation rate to 1.9% y/y in 

December has put financial markets on alert, with fears 

mounting that China will have to withdraw its monetary 

stimulus. Selling pressures on the USD are expected to 

fade slightly, while the GBP is set to remain weak. 

Market Views 

Current 1 Week 1 Month 

UST 10y T-note Yield (%) 3.66 ↔↑ ↔↓ 

2y/10y Spread (bp) 279 ↑ ↔↓ 

EGB 10y Bund Yield (%) 3.20 ↔ ↔↓ 

2y/10y Spread (bp) 208 ↔↑ ↔↓ 

JGB 10y JGB Yield (%) 1.34 ↔ ↓ 

2y/10y Spread (bp) 119 ↔ ↓ 

Forex EUR/USD 1.3975 ↓ ↓ 

USD/JPY 89.78 ↑ ↑ 

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 

The Fed is less dovish… 

…although recent data 

have been mixed 

The context turns less 

favourable for Treasuries 

Nest week’s NFP data may 

be a turning point 

In the EMU, it’s all about 

sovereign credit quality 

The FOMC was less dovish in its latest statement. On inflation, instead of saying 

that resource slack is “likely to continue to dampen” cost pressures, it said 

“continuing to restrain” cost pressures. This suggests that resource slack is no 

longer a downward force on inflation as much as it is a constraint on it going 

higher. In addition, the statement included a few upgrades on growth. Housing 

spending is “expanding” instead of “appears to be expanding”. Business 

spending "appears to be picking up" instead of companies "cutting back on fixed 

investment". The overall assessment on growth is that the recovery will be 

"moderate", rather than economic activity will remain weak. The only downgrade 

in the statement appears to be that instead of saying that "financial market 

conditions have become supportive of economic growth", it acknowledges that 

"bank lending continues to contract" in a new reference. While the FOMC kept 

open the option of extending the duration and size of the MBS purchase 

programme, it may now be starting to close the door on this by removing the 

statement about evaluating the "timing and overall amount" of its purchases. 

Finally, there was a dissenter for the first time since the Fed started its rescue 

policy. Hoenig, a regular hawk, felt that the “extended period” language was no 

longer warranted. This does not represent strong dissent but added to the 

hawkish signal. All in all, while the statement did not change the near-term 

outlook as far as the Fed’s liquidity policy is concerned, it led markets to expect 

monetary policy tightening sooner than recently discounted. 

The statement was delivered following mixed US economic data. Although 

consumer confidence improved slightly (albeit still close to its lows), some hard 

data pointed to signs of weakness, in particular in the housing sector. Housing 

starts, home sales and house prices suffered setbacks. In business activity, the 

Philadelphia Fed index fell more than expected. With regard to inflation, recent 

core PPI and CPI figures suggest that core inflation is easing further. 

The FOMC’s assessment of the US economy therefore looks more optimistic 

than recent data have suggested and this triggered a positive reaction on stock 

markets after several days of setback. The recent sell-off in equities was not only 

linked to disappointment on economic data, however. US President Obama’s 

comments on banks hammered financial stocks, which were at the heart of the 

recent stock market weakness. Risk reassessment was also key to the recent 

downward pressure on stock prices. The rebound seen on the back of the FOMC 

statement thus looks vulnerable and is unlikely to lead to a massive bear market 

in Treasuries. Given the ever so slight change in stance, there will be a negative 

tone for Treasuries, while the short end is under steepening pressure. 

In that context, upcoming data will be key. Q4 GDP (likely to be well above 4% at 

an annualised rate) may add to the heavy tone. ISM indexes are not expected to 

strengthen much. Finally, the consensus is for a decent NFP increase, the first 

(except the anecdotal 4k rise in November) since 2007. We are less optimistic, 

however, expecting no change in payrolls and a 0.1pp rise to 10.1% in the 

unemployment rate. The range of expectations, volatility of data and potential 

impact from winter weather conditions on seasonally adjusted figures leave the 

door for surprises wide open. In that respect, nervousness will prevail in US 

bond markets early next week. 

In the EMU, the focus is less on economics than on sovereign debt, with 

peripheral countries coming under strong pressure. Greek government paper 

has suffered the strongest deterioration since Greece joined EMU. A significant 

reassessment on GGB spreads and CDS was driven by severe concerns on the 

country’s fiscal situation as well as major criticisms from the European 

Commission on the quality of Greece’s data. The initial rises in yields and 

spreads were significant. This is also true for Portuguese bonds, for example, 

which are suffering following material upward revisions in deficits as well as 

disappointment over the likely size of this year’s budget shortfall. What has 

happened recently to GGBs was driven by other factors, however. There is 

Patrick Jacq 29 January 2010 


2 

www.GlobalMarkets.bnpparibas.com

GGBs and other 

peripherals will remain 

under pressure 

The deterioration in stock 

markets offers robust 

support to JGBs 

FX trades mainly driven by 

interest rate differentials 

Selling pressures to 

develop on GBP 

growing speculation against GGBs while real accounts have no capacity to bid. 

The rise in GGB yields and volatility has extended risks to levels where real 

accounts cannot go. With no demand in the face of speculation, yields and 

spreads are flying. In that respect, the EUR 25.0bn demand for the 5y 

syndicated GGB looks suspect. Bids were probably well beyond real demand. 

When speculative accounts know their allocation will be limited, they bid very 

aggressively. In this context, bidding was unrealistic and supply (EUR 8.0bn) 

looks very high. In addition, the PDMA announced its intention to issue a new 

syndicated 10y GGB next month, fuelling selling pressures in this area. 

This situation may persist, and GGB spreads are exposed to further deterioration 

near term. But levels reached are out of line with the fundamentals. Some ECB 

and EU officials have backed recent decisions taken by Greece. The next step is 

the Excessive Deficit Procedure, which the EC will launch before end-February. 

The EC will also have to assess the recent plan submitted by Greece to curb the 

deficit and debt, and is likely to back it. In the meantime, volatility will prevail and 

peripheral markets will likely see further deterioration. In such circumstances, 

core EGBs remain relatively healthy. Demand for safety is likely to remain a key 

driving force, with benchmarks benefiting from this support. Recent low levels on 

yields are likely to offer strong support too. The tone should be more positive 

than in the US, but a strong bullish tone seems unlikely. 

In Asia, stock markets have been rocked by talk of stricter US financial 

regulation and a tightening of Chinese lending policy. The Nikkei is likely to face 

increased upside resistance as domestic investors are forced to hedge their 

existing positions, and we therefore expect to see a certain amount of indirect 

support for the JGB market from this direction. Japanese exporters saw strong 

demand from the rest of Asia in the October–December quarter, but it remains to 

be seen how exports might be affected by this month's tightening of Chinese 

lending policy. With domestic demand still weak, any decline in exports would be 

likely to raise significant concerns over the risk of a renewed economic 

downturn. 

JGB market participants apparently remain focused on Asian stocks, US 

financial reforms and exchange rate movements. That said, with supply/demand 

conditions in the yen bond market set to remain benign in the near term, we see 

very little risk of exogenous factors triggering a significant rise in JGB yields. 

Inflation and related interest rate divergence has become the top theme on FX 

markets. The rise in China annual inflation rate to 1.9% in December has put 

financial markets on alert, with concern mounting that China will have to 

withdraw its monetary stimulus. The first increase in minimum reserve 

requirements came into force this week, but with inflation likely to reach 3% in 

January, further tightening of monetary conditions is just a question of time. 

Meanwhile, China’s Deputy Commerce Minister admitted that currency 

appreciation pressure has increased, supporting our view that the RMB will be 

allowed to appreciate in Q3. Financial market consequences will be far-reaching 

as changes in the valuation of the RMB in tandem with likely restrictions on hot 

money inflows will reduce currency reserve growth. Strong currency reserve 

growth has been supplying markets with excess dollars, an important reason 

why the USD has been under selling pressure since 2002. Declining currency 

reserve growth will supply fewer dollars into the market, allowing the USD to 

rebound. 

The BoE, ECB and Fed have all adopted more hawkish rhetoric. On Thursday, 

the BoE is likely to confirm it is pausing its QE efforts, suggesting that the pubic 

sector deficit must be funded via domestic private or foreign flows. Gilt spreads 

have increased ahead of the event, lending sterling support. However, the UK 

and Japan have gross debt levels of 460% and 480% of GDP respectively, 

compared to 300% in the US. Hence, the UK is after Japan the most yieldsensitive 

economy. The highly leveraged UK economy is unlikely to cope too 

well with higher bond yields and it could be argued that the similar levels of gross 

debts in the UK and Japan suggest both economies operate similar rate levels. 

We remain convinced that an autonomous UK yield increase is unsustainable 

and likely to be reversed, causing sterling to trade sharply lower. 



3 


US FOMC: A More Hawkish Tone 

• In its statement, the FOMC reaffirmed its 

commitment to keep rates exceptionally low for 

an extended period. 

Chart 1: Fall in New and Existing Home Sales 

Ignored 

• However, the FOMC began to subtly alter its 

description of economic and inflation 

conditions, signalling more confidence in the 

economy and slightly less conviction that 

inflation would be subdued for some time. 

• The FOMC removed its reference to the 

housing sector, where recent data have been 

very disappointing, and restated its commitment 

to end purchases of mortgage-backed securities 

by 31 March without any reference to housing 

market conditions. 

• It also allowed a dissent instead of reflecting 

on disagreement in the meeting’s minutes. 

• The FOMC also stated that the liquidity 

measures will run off in the next few weeks and 

therefore open the door to a probable rise in the 

discount rate. 

Source: Reuters EcoWin Pro 

Chart 2: The Fed’s Support to the Mortgage 

Market Ends 31 March 

• All of these subtle changes in tone make us 

far less comfortable with our view that the first 

hike in the Federal funds rate would occur in the 

second half of 2011. 

• It seems that the FOMC is growing more 

confident that extreme policy ease is 

increasingly less needed. 

• It now seems more likely that the first hike in 

the Fed funds rate will be brought forward to the 

turn of the year with an earlier hike of the 

discount rate, possibly as soon as March. 


While the FOMC reaffirmed its commitment to 

keep the Federal funds rate exceptionally low for 

an extended period, the tone of the statement 

became more hawkish and there was even a 

dissent 

The FOMC kept its commitment to leave the policy 

rate for the federal funds rate at 0 to ¼% and 

continues to anticipate that economic conditions, 

including the low rates of resource utilisation, 

subdued inflation trends and stable inflation 

expectations, are likely to “warrant exceptionally low 

levels of the federal funds rate for an extended 

period”. While that important point is clearly made by 

the Committee, there was a dissent this time. It is the 

first time since the emergency conditions were set in 

place that a formal dissent has been made. In past 

meetings, the differences of opinion were left to be 

aired in the meetings’ minutes rather than appearing 

as part of policy. 

The more confident view of the economic 

recovery expressed in the policy statement is 

intended to signal that policy changes are being 

considered 

Moreover, the text of the policy statement exposed 

some important nods in the direction of a more 

confident view of the economic recovery than in 

recent statements. While the wording changes are 

subtle, they do reflect well thought through changes 

in the FOMC’s collective view and are intended to 

provide a glacial shift in policy intention. 

Brian Fabbri 29 January 2010 


4 


The subtle changes in the wording of the 

statement include a more confident belief that 

consumption growth is accelerating, inventories 

are under control and economic activity is 

strengthening 

One of the most prominent of these text changes has 

to do with household spending. In December the 

FOMC stated, “Household spending appears to be 

expanding at a moderate rate” whereas, in January, 

the FOMC believe that “Household spending is 

expanding at a moderate rate”. Another, not so 

subtle, change in view concerns the inventory 

correction. In December the FOMC wrote that, “Firms 

continue to make progress in bringing inventory 

stocks into better alignment with sales” whereas now 

they believe that “Firms have brought inventory 

stocks into better alignment with sales”. As a result, 

the FOMC now thinks that, “Information received 

since the Federal Open Market Committee met in 

December suggests that economic activity has 

continued to strengthen”. In contrast, in December, 

the FOMC wrote that, “Information received since the 

Federal Open Market Committee met in November 

suggests that economic activity has continued to pick 

up”. 

The FOMC removed all references to the housing 

sector, despite the disappointing flow of data 

The most significant window into the FOMC’s 

thinking is that it removed any reference to the 

housing sector. In December it was concerned about 

this sector’s recovery and wrote: “The housing sector 

has shown some signs of improvement over recent 

months”. Since then, all the news on the housing 

sector has been extremely disappointing. In 

December, new and existing home sales crashed 

7.6% and 16.7% m/m respectively and housing starts 

fell 4%. All were well below the consensus forecasts. 

Thus, the depressing housing data must have also 

surprised the FOMC members and yet they chose to 

avoid any reference to this disturbing reversal of the 

housing market’s recovery. 

The FOMC apparently did not want to disrupt its 

plan to end its purchases of mortgage-backed 

securities by 31 March 

The lack of reference to the housing market’s 

reversal is an important omission in light of its goal to 

stop purchasing agency issues and agency 

mortgage-backed securities by the end of March. 

Despite the very obvious deterioration in the housing 

sector’s recovery, the FOMC remains adamant that it 

will end its support of the mortgage market. We had 

previously thought that, given the reversal of the 

recovery in the housing sector, the FOMC would 

make the end of purchases more conditional on the 

housing sector’s recovery. Clearly the FOMC was not 

as concerned about the dependence of the housing 

Chart 3: The Liquidity Initiatives are Winding 

Down 


Chart 4: Time for a Rise in the Discount Rate 


sector’s recovery on its mortgage market support. 

The FOMC will therefore purchase an additional 

USD 279bn of agency mortgage-backed securities 

between now and 31 March, which will continue to 

enlarge its balance sheet. 

The FOMC was also slightly less emphatic that 

inflation will be subdued for some time 

There were also two subtle changes to the brief 

remarks on inflation from the previous policy 

statement. First, the FOMC substituted the term 

“restrain” for “dampen” in their statement that, “With 

substantial resource slack continuing to restrain cost 

pressures and with longer-term inflation expectations 

stable, inflation is likely to be subdued for some 

time”. The nuance here is that dampen means to 

deaden or depress while restrain means to hold 

back. This is a significant difference in meaning. The 

second tiny nuance was that they currently believe 

that inflation is “likely” to be subdued instead of “will 

remain” subdued for some time. 



5 


The shift in tone makes us considerably less 

comfortable with our forecast for an initial hike of 

the Fed funds rate in the second half of 2011 

All of this shifting in the tone of the policy statement 

makes us considerably less comfortable with our 

forecast that monetary policy tightening will begin in 

Q3 2011. Our forecast for a relatively subdued 

economic recovery in 2010; for inflation to continue 

to decelerate throughout the year; for the 

unemployment rate to rise irregularly through most of 

this year; and for banks to continue restraining credit 

to households and small businesses and to further 

de-leverage their balance sheet remains, and this 

combination led us to believe that the FOMC would 

not change policy (raise the Fed funds rate) until the 

second half of 2011. 

The need for extremely accommodative policy 

seems to be past as economic and financial 

market conditions improve 

However, we must take into account that monetary 

accommodation remains substantially greater than 

ever before and that the immediate liquidity crisis is 

now behind us. Moreover, the FOMC now believes 

that. For example, it said in the latest policy 

statement that, “While bank lending continues to 

contract, financial market conditions remain 

supportive of economic growth”. 

The first policy instrument to change will probably 

be the discount rate which will be increased as the 

liquidity initiatives all unwind in February 

Probably the first policy instrument to change will be 

the discount rate. As the liquidity crisis deepened in 

2008, the discount rate was one of the first 

instruments to be changed. It was reduced to just 

25bp above the funds rate and later a host of new 

liquidity initiatives were created. As a result 

borrowing at the discount window rose from trivial 

levels before the crisis to nearly USD 300bn in the 

midst of it. As the FOMC’s major liquidity initiatives 

run off over the next few weeks, discount window 

borrowing will return to more normal levels, a true 

reminder that the liquidity crisis is over. Historically, 

the discount rate was always considered a penalty 

rate (100bp over the Fed funds rate) and we expect 

the Federal Reserve to return it to that status with the 

first move possibly coming as early as March 2010. It 

is presently set at 50bp, 25bp over the upper end of 

the funds rate target. The FOMC is expected to raise 

it back to 100bp over the funds rate probably in two 

steps, of first 25bp and then 50bp. 

We think that a change in the funds rate will be 

signalled by incremental changes in the FOMC’s 

policy commitment for rates as was the case in 

the 2003-2004 tightening period 

The last time the FOMC began to tighten policy, it 

informed markets of its intent in incremental steps. 

For example, it had a commitment to leave the target 

funds rate low (at 1%) for a considerable period. The 

FOMC adopted this language in August 2003 and 

changed it in January 2004 to a much milder 

commitment of: “With inflation quite low and resource 

use slack, the Committee believes that it can be 

patient in removing its policy accommodation”. It 

was, and it kept rates unchanged through May 2004 

when the FOMC again changed the policy statement 

to: “With inflation low and resource use slack, the 

Committee believes that policy accommodation can 

be removed at a pace that is likely to be measured”. 

It raised rates for the first time at its next FOMC 

meeting at the end of June 2004, five months after it 

changed its commitment. 



6 


US: Get It While You Can 

• As the first-time homebuyers’ tax credit 

expiry date grew close, existing home sales 

plummeted by 16.7% m/m in December, giving 

up almost 60% of the gain recorded over the 

previous six months. 

Chart 1: Reality Check 

• The rebound in housing demand observed 

so far appears to have been largely supported 

by government programmes, suggesting the 

recovery is far from becoming self-sustaining. 

• Given that the tax credit has largely 

supported activity at the lower end of the 

market, it is not surprising that inventories of 

higher-price homes remain excessive. 

• With the tax credit now extended until April, 

housing demand should rebound in early 2010. 

Nevertheless, prospects for H2 2010 appear 

sluggish and risks are tilted to the downside. 


Chart 2: Sales Remained Strong in the West 

Still on life support 

After hovering around an annualised level of 4.63 

million units between November 2008 and May 2009, 

existing home sales surged over the second half of 

last year, reaching a 33-month high of 6.54 million in 

November as prospective home buyers rushed into 

the market to take advantage of the tax credit before 

it expired 1 (Chart 1). Indeed, a survey conducted by 

the National Association of Realtors (NAR) reported 

that first-time buyers accounted for around half of 

total existing home sales in the three months to 

November. Despite this healthy start, as the tax 

credit’s expiry date grew close, prospective home 

buyers left the market en masse, suggesting that the 

rebound in housing demand observed so far has 

been largely supported by government programmes 

and therefore that the recovery is far from becoming 

self-sustaining. Indeed, existing home sales 

plummeted by 16.7% m/m in December, giving up 

almost 60% of the gain recorded over the previous 

six months. 

Tax dollars at work 

According to the NAR, 2 million resale properties 

benefited from the tax credit in 2009. Given that 

existing home sales totalled 4.7 million (in nonseasonally 

adjusted, non-annualised terms) over the 

first 11 months of last year, we conclude that 42% of 

buyers purchasing a resale home took advantage of 

1 

The 2009 first-time homebuyers’ tax credit was initially set to expire at the end 

of November. 


this programme. While it is likely that some of these 

sales would have taken place even without the tax 

credit, the government programme likely borrowed 

strength from the future as prospective buyers 

rushed into the market before the credit expired. As 

such, the future path of home sales is likely to be 

weaker than it would have been without the tax 

credit. 

Regionally, existing home sales declined across 

most of the country in December, dropping sharply in 

the Northeast (-19.5%), the Midwest (-25.8%) and 

the South (-16.3%) (Chart 2). In contrast, sales 

eased by a more moderate 4.8% m/m in the West, as 

high foreclosures rates in this region likely supported 

demand. Indeed, according to the NAR, sales of 

distressed properties accounted for 32% of total 

resale volumes in December, while data from 

RealtyTrak indicate that around 40% of foreclosures 

are concentrated in the West. 

Anna Piretti 29 January 2010 


7 


Given that the plunge in existing home sales virtually 

matched the 16% m/m decline in pending home 

sales recorded in November, it appears that 

disruptions to resale volumes stemming from the 

looming end of the tax credit have already trickled 

through into the data 2 (Chart 3). As such, barring an 

unexpected downward correction in pending home 

sales in December, the extensions to the tax credit 

programme suggest existing home sales should 

rebound in January. 

Who benefited from the tax credit? 

While the home-buyer tax credit is available for 

homes costing up to USD 800,000 (income limits 

also apply), the programme has disproportionately 

benefited homes in the lower price range of the 

market. This is likely because the version of the 

programme introduced in early 2009 was specifically 

restricted to first-time home buyers, who accounted 

for 40-50% of total resale volumes in 2009 and who 

tend to purchase cheaper properties. According to 

the NAR, the typical first-time homebuyer earned a 

median income of USD 61,600 in 2009 and bought a 

home costing USD 156,000. In contrast, the typical 

repeat buyer earned a median income of USD 

88,100 and purchased a home costing USD 224,500. 

To put this in context, the nationwide median income 

of homeowners was USD 77,000 in 2008 (data for 

2009 are not yet available), while median home 

prices for existing homes hovered around USD 

173,000 in 2009, down from a median level of USD 

197,000 in 2008. While USD 8,000 might appear a 

negligible incentive for some buyers, it actually 

represents 4.5% of median home sale prices; as 

such, the tax credit is enough to cover the 3.5% 

down-payment required on first-time homebuyer FHA 

loans. Given that 55% of entry-level buyers took 

advantage of the FHA loans in 2009, the home buyer 

tax credit clearly had a substantial impact in drawing 

prospective buyers into the market by helping to 

partially offset the negative impact of tight credit 

conditions and labour market uncertainty. 

As the homebuyers’ tax credit available between 

January and November 2009 was restricted to firsttime 

homeowners, it is not surprising to find that 

buying activity in recent months has been largely 

concentrated in the lower end of the market. Indeed, 

according to the NAR, nearly 70% of homes sold in 

September were priced below USD 250,000. In 

addition, among existing properties, sales of homes 

priced below USD 100,000 are up 22.5% from a year 

2 

Existing home sales are recorded at the end of the escrow period, when a 

mortgage contract is closed. Because it takes around two months from the time a 

purchase contract is signed to the time the mortgage is actually closed, existing 

home sales reflect buying conditions with a one to two months lag. Therefore, the 

strong resale volumes recorded in November reflected sales contracts which 

were likely signed in September and October. Similarly, the December reading 

relates to contracts signed in October and November. 


Chart 3: Fully Corrected 

Chart 4: Working Off the Excesses 


ago, while sales in the upper end of the market 

remain very slow. Sales of homes priced USD 

500,000 and above rose by a meagre 4% y/y. 

Inventories are easing 

While housing demand is likely to remain subdued 

over most of H2 2010, inventories of existing homes 

available for sale eased further in December, falling 

by 6.6% m/m to a non-annualised level of 3.289 

million, the lowest level since early 2006. However, 

due to the sharp drop in demand, the month-supply 

of inventories actually increased to 7.2 from 6.5 

previously (Chart 4). While the steady decline in 

available inventories suggest supply and demand are 

being brought back into balance, official statistics of 

inventories are unlikely to capture the full spectrum of 

the housing stock, as discouraged homeowners 

trying to sell a house likely stopped advertising their 

property. They are expected to come back to the 

market as conditions continue to improve. 

Given that the tax credit has largely supported 

activity at the lower end of the market, it is not 

surprising that the months-supply for homes costing 

USD 100,000 or less has dropped to around five 

months, while for homes costing above USD 



8 


500,000, the months-supply level of inventories 

remains 14, double the industry standard of seven 

months considered necessary for prices to stabilise. 

Therefore, while high-end prices are likely to correct 

further, prices are likely to increase at the lower end 

of the market, consistent with NAR reports of multiple 

bids for lower priced homes in certain areas of the 

country. The overall effect of these cross-currents is 

likely to be an increase in median house prices over 

the short term, as the sample of available inventories 

has shifted slightly to the higher end of the market. 

This is because, unlike the S&P Case-Shriller house 

price index, the median price for existing home sales 

is not adjusted for changes in the housing sample. 

Indeed, median existing home sale prices have so far 

rebounded at a faster pace than the S&P/Case- 

Shiller house price indexes or the LoanPerformance 

HPI 3 , rising by 1.5% y/y in December. In contrast, 

both the S&P/Case-Shiller 20-cities index and the 

LoanPerformance HPI indicate that house prices 

were still below last year’s levels, falling by 5.3% y/y 

and 5.7% y/y respectively in November. In addition, 

both these indexes, which are based on a “repeatsale” 

method and therefore better adjust for changes 

in the home sales sample, suggest the growth 

momentum has moderated since the summer. For 

example, on a 3-month annualised basis, the 20- 

cities index rose by 2.4% in the three months to 

November, easing from an average growth rate of 

9% recorded between July and September (Chart 5). 

The post-credit world 

Going forward, housing demand should rebound in 

the short term but is likely to stagnate over the 

second half of this year. The homebuyers' tax credit 

has now been extended until April (for contracts that 

close in June) and expanded to include more affluent 

and existing home buyers, suggesting resale 

volumes should benefit from a new influx of buyers 

over the next few months. 

The NAR expects around 900k first-time homebuyers 

and 1.5 million existing homeowners to take 

advantage of the extended programme. However, 

these estimates appear rather optimistic, as they 

imply that the second “segment” of the tax credit 

(December 2009 to April 2010 for contracts that 

close by June 2010) is even more successful than 

the first segment (January 2009 to November 2009), 

when 2 million homebuyers took advantage of the 

government programme. Supporting the argument of 

a slower pace of housing demand is the fact that the 

second segment will be in effect for a shorter time 

3 

The LoanPerformance HPI is a repeat-sales index that tracks increases and 

decreases in sales prices for the same homes over time, which provides a more 

accurate "constant-quality" view of pricing trends than basing analysis on all 

home sales. This index is used by the Federal Reserve to calculate the value of 

real estate assets in the Flow of Funds accounts. 

Chart 5: House Prices Compared 


Chart 6: The Tax Credit Effect 


than the first; in addition, the January-to-November 

2009 programme likely borrowed some strength from 

the future, arguing for a moderation in the pace of 

home sales. On the upside, however, the extended 

programme also covers existing home buyers (who 

can qualify for a credit of USD 6,500) and will 

therefore tap into a section of the market that was 

previously excluded. Given these arguments, we 

assume that the extended programme will benefit 

between 1.8 and 2.0 million homebuyers. Assuming 

that around 50% of buyers purchasing a resale home 

will qualify for the tax credit, we estimate that raw 

existing home sales will total around 3.4 million 

between December 2009 and June 2010. Given 

average developments in seasonal patterns, we 

conclude that existing home sales will rebound 

sharply over the next few months and peak at 6.7 

million (seasonally adjusted, annualised units) in 

June, before ending the year at around 5.9 million 

units. Had the tax credit programme not been 

introduced (both the first and second segments), we 

assume existing home sales would have eased to a 

cycle trough of 4.3 million annualised units in March 

2009 before rebounding modestly over the second 

half of last year and into this year, ending 2010 at 

around 5.3 million units (Chart 6). 



9 


Fewer sales = higher inventories = lower prices 

Estimates of the tax credit’s impact on house prices 

are complicated by the interaction of demand and 

supply. In particular, as buying conditions worsened, 

prospective home sellers likely grew discouraged 

and stopped advertising for their properties, 

preferring to wait for better times. Therefore, as 

home sales increase, inventories are likely to 

increase as well, as properties which had been 

previously removed from the market are put back up 

for sale. While we do not have specific information 

regarding prospective sellers’ intentions, we estimate 

that the tax credit accounted for an additional 690k 

existing home sales in 2009. Assuming that these 

homes had remained unsold (and thus available) 

suggests the uptrend in existing housing inventories 

observed over the first half of 2009 would have 

extended over the rest of the year, pushing the 

number of unsold available properties towards 4.39 

million units, well above the 3.29 million units 

reached in December (Chart 7). 

Given the inverse relationship between house price 

inflation and existing inventories, the steady decline 

in inventories recorded in 2009 clearly contributed to 

support house prices in recent months (Chart 8). 

However, given our estimate for lower home sales 

and higher inventories in the absence of government 

support, it appears that home prices would have 

likely eased further in early 2009 and would still be 

languishing near their cycle lows (Chart 9). 

Conclusion 

Given that the homebuyers’ tax credit has now been 

extended and expanded, we expect the plunge in 

existing home sales recorded in December to be 

temporary, suggesting housing demand should 

rebound in January. 

Nevertheless, recent volatility in sales dovetails with 

our view that the housing market recovery remains 

fragile. In particular, tight credit conditions, ongoing 

deleveraging, a likely increase in mortgage rates and 

an unemployment rate at or above 10% all point to 

sluggish housing demand after the tax credit 

programme expires in mid-2010. 

Chart 7: Fewer Sales Higher Inventories 


Chart 8: Lower Inventories Higher Prices 


Chart 9: Higher Inventories Lower Prices 




10 


France: Roaring Consumption 

• Retail sales rocketed in Q4, partly driven by 

auto sales, with the surge pushing PCE higher. 

• However, the positive impact on Q4 GDP will 

be mitigated by higher imports. Moreover, these 

factors should unwind in Q1. 

1.2 

1.0 

0.8 

0.6 

Chart 1: Retail sales vs. PCE (3m % change) 

Retail Sales of Manuf. 

Goods (% q/q, RHS) 

Ex Autos Total 

4 

3 

2 

1 

French retail sales of manufactured goods rose 2.1% 

m/m in December (way above the consensus of a 

0.6% rise). This pushed the y/y change up to 5.9%, 

the highest level since July 2007. More importantly, 

the quarterly gain reached 3.0% q/q (12.7% 

annualised) – the strongest gain since Q3 1999, 

when a previous car purchase incentive ended. 

New car sales…and other stuff 

As widely expected, the main driver was car sales 

(up 9.1% m/m and 31.8% y/y) as households rushed 

to benefit from the full amount of the car purchase 

incentive and the bonus for low carbon-emitting cars. 

In 2009, the car purchase scheme attracted 600k 

clients for a direct cost of EUR 0.6bn; this was 

probably entirely covered by extra VAT receipts (with 

c. 300k to 400k additional new car sales and 200k to 

300k being opportunistic buying). However, 

consumption of other goods was also strong. 

Sales of clothes and shoes also did very well, up 

2.0% m/m, favoured by cold weather and solid 

Christmas trading. Other items also printed gains on 

the month, as the car sales boom had little adverse 

impact on the sales of other items. Ex-auto sales 

rose 1.5% q/q in Q4. Car sales have been primarily 

financed by a decline in savings or via bank loans 

(see France: Misleading Credit Data, Market Mover, 

15 January 2010). The rise in the savings ratio to 

17% in Q3 (the second-highest quarterly figure since 

1983) was partly due to tax cuts and should suffer a 

massive correction in Q4. 

Mitigated impact on GDP 

A 3.0% jump for manufactured goods sales is usually 

consistent with a 1.2-1.5% q/q increase for total 

personal consumption expenditure (as defined in 

GDP, Chart 1). However, car sales were driven up by 

specific factors, so consumption of other services is 

more likely to replicate the pattern of ex-auto sales. 

The PCE gain consistent with a 1.5% q/q retail sales 

rise is thus likely to be in the 0.6% to 0.9% range, 

according to the long-term historical relationship; our 

forecast is +0.8%. 

This will of course push GDP higher in Q4, but part of 

this contribution to GDP will result in further auto 

inventory decline (although the contraction of 

0.4 

0.2 

0.0 

-0.2 

PCE (% q/q) 

-0.4 

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 

05 06 07 08 09 

Sources: INSEE, Reuters EcoWin Pro 

Chart 2: Trade Balance - Cars (EUR bn/month) 

11.5 

11.0 

10.5 

10.0 

9.5 

9.0 

8.5 

8.0 

7.5 

7.0 

01 02 03 04 05 06 07 08 09 


Imports 

Exports 

inventories of other items should slow in Q4) and an 

increase in imports. The trade deficit for the first two 

months of Q4 jumped to EUR 4.8bn per month vs. a 

EUR 2.5bn average monthly deficit in Q3. Car 

imports soared (Chart 2), with most new cars bought 

under the incentive programme small cars which are 

most often produced outside France (except 

Toyotas). We thus forecast GDP growth of 0.6% q/q 

in Q4, with a strong negative contribution from net 

exports. 

Since the jump of car sales will progressively unwind 

over the next three months, the reverse impact is 

likely to arise in Q1. Already, anecdotal evidence 

points to a decline in seasonal sales vs. last year, not 

only because of heavy snow. We expect a 

contraction of retail sales ex-autos as early as 

January (and new car registrations due for release 

on 1 February are also likely to decline). While net 

exports should recover, we expect a negative PCE 

figure in Q1, cutting GDP growth to 0.4%. 

0 

-1 

-2 

-3 

-4 

Dominique Barbet 29 January 2010 


11 


UK: BoE Meeting Preview 

• We expect the BoE to announce a pause in 

its asset purchase programme at the February 

MPC meeting. 

Chart 1: BoE Inflation Projection November-09 

(Market Rate Expectations) 

• The Inflation Report is likely to show a 

moderate upward revision to its two year ahead 

inflation projection. 

• Though we expect the new inflation 

projections to entertain speculation of an 

interest rate hike later this year, we believe that 

would be misleading. 

Pause for Thought 

The highlight of next week’s UK economic calendar 

will be the crucial February Bank of England MPC 

decision. The decision will have been made in light of 

the latest BoE Inflation Report (released 10 

February) which will update the committee’s outlook 

for growth and inflation. The market and consensus 

expectation is overwhelmingly that the Bank will 

pause its purchases of gilts. We agree. 

Incremental news since November 

A tried and tested way of gauging future BoE 

decisions is to make a judgement about how 

incremental news has evolved since the latest 

Inflation Report and what revisions this implies for 

the BoE inflation projections. Charts 1 and 2 show 

the latest BoE inflation projections published in the 

November Inflation Report. On the basis of market 

expectations at the time (which assumed around 

100bp of interest rate hikes), the centre point of the 

inflation projection two years ahead was 1.65% and 

only returned to target three quarters later. Based on 

no change in Bank Rate, the projection at the two 

year ahead horizon was 2.35% and rising at that 

point. 

To summarise, the incremental news on the key 

influences on the CPI projection since November has 

been: 

• Although the price of oil denominated in USD 

has moved sideways, in GBP terms the price 

is 2.5% higher. This implies a small add to 

the near term inflation projection; 

• Equities are around 5% stronger, implying an 

upward bias on the growth and inflation 

projections; 

• The effective GBP exchange rate is 

unchanged over the period as a whole; 


Chart 2: BoE Inflation Projection November-09 

(Unchanged Bank Rate) 


• The Q4 GDP data were much weaker than 

expected, but survey indicators suggest 

upward revisions are likely and the Q1 2010 

forecast is on track; 

• CPI inflation was slightly higher than 

expected in Q4, but is likely to be 

substantially higher than expected during Q1 

2010; 

• Market interest rate expectations have 

scaled back the extent of hikes in Bank Rate 

over the next two years; and 

• Gilt yields have risen in both level terms and 

relative to Germany or OIS contracts of 

corresponding maturities. 

Dealing firstly with the projection based on 

unchanged Bank Rate, on balance we suspect that 

the combination of the news flow points to a small 

upward revision to the inflation projection. This 

Alan Clarke 29 January 2010 


12 


should be particularly true for the immediate quarter 

or two. 

Further ahead, the revisions to the projections are a 

little less obvious. In the past, an upward revision of 

1 percentage points to the first three quarters of the 

inflation projection tends to translate into an upward 

revision of 0.3pp two years ahead. This would 

suggest that the likely 0.5pp upward revision to the 

Q1 2010 projection will probably add around 0.15pp 

to the two year ahead projection (which was trending 

up quite sharply at that point anyway). 

That said, sharp increases in inflation around the 

start of 2010 due to the VAT hike will drop out of the 

y/y calculation in early 2011. This may dilute the 

extent of the upward revision two years out. 

The other major news has been the disappointing 

GDP data. We suspect that the BoE will take the 

view that the initial print of 0.1% q/q expansion in Q4 

GDP will be revised higher. Furthermore, the 

evolution of the survey indicators suggest the nearterm 

GDP projection is largely on track. We therefore 

doubt that there will be a significant revision to the 

growth outlook, though this may be an excuse to 

moderate the upward revision to the inflation 

forecast. 

In sum, we suspect that the two year ahead inflation 

projection on the basis of unchanged Bank Rate will 

be moved upwards to around 2.5% y/y – mainly due 

to the fact that the projection was trending sharply 

higher at the two year ahead horizon last time 

around. 

The inflation projection based on market interest rate 

expectations will take account of the above, plus 

changes in the interest rate outlook. Last time, the 

two year and one quarter ahead projection was 

1.8%. Since November, expectations for hikes in 

Bank Rate have been scaled back by around 50bp. 

However, gilt yields have risen by around 20bp. We 

judge that the net result is there should be a modest 

additional upward revision to the two year ahead. In 

sum, that projection should be around 1.9%, but 

could be as high as 2%. 

A word of caution is warranted here. In the past this 

kind of mechanical calculation has been very 

effective. However, there was an element of fudge in 

November 2009. Mechanically, the Bank could easily 

have revised up its two year ahead inflation 

projection by 0.5pp. Yet the Bank revised up the 

projection by just 0.15pp. This suggests uncertainty 

about what impact spare capacity will have on 

inflation further ahead exerted some restraint on the 

revisions. This could be evident again in the 

February projections. It also highlights that the Bank 

lacks faith in its prior assumption that inflation will 

reaccelerate in late 2011, despite a persistent output 

gap. 

Secondly, the Bank has warned a number of times 

that given the uncertainty facing data around the turn 

of the year – not least the VAT hike which the Bank 

said it will look through – the MPC is not likely to read 

too much into the recent upward surprises. To some 

extent there is also an element of weather-related 

distortion, which should prove temporary. Both 

suggest a risk of some restraint in revising up the two 

year ahead projection. 

Wait and see mode 

The combination of the two inflation projections make 

a strong case for the committee announcing a pause 

in its purchases of gilts. This adds to the hints in the 

minutes and recent MPC commentary that suggested 

a further expansion in purchases was unlikely. 

In particular, the minutes failed to mention the 

widening spread between gilt yields and OIS 

contracts of corresponding maturities. The December 

MPC minutes explicitly stated that the prior narrowing 

in this spread had been used by the committee “as 

an indicator of the positive impact from the asset 

purchase programme”. The narrowing in this spread 

unwound further ahead of the January MPC, yet 

there was no mention of this in the minutes. We 

suspect the committee did not want to entertain 

hopes of a further expansion in QE only to 

disappoint. 

Furthermore, the discussion of developments in 

adjusted broad money growth refrained from talking 

about the depressed growth rate of headline broad 

money growth. Instead, the minutes highlighted the 

change in GBP levels and referred to one component 

of broad money that had been bouncing back. 

We interpret these as tactical hints that the 

committee is not keen on expanding the asset 

purchase programme further. There was good 

reason for the minutes to emphasise the positives. 

The latest data on lending have shown tangible signs 

of improvement. In particular, lending to non-financial 

corporations (although volatile) has been on an 

improving trend since mid-2009. Moreover, smaller 

firms (who should be finding it harder to source 

credit) also saw lending growth reaccelerate in the 

final portion of 2009 (Chart 3). 

All considered, we expect this week’s MPC decision 

to announce a pause in the asset purchase 

programme. The Bank is likely to say that the effects 

of past purchases are still working through the 

system and it would be wise to observe the effects of 

past easing. This decision is unlikely to be presented 

as the end of QE. Rather, the MPC stands ready to 



13 


esume purchases should market conditions or the 

recovery in the macro economy take a turn for the 

worse. 

When will the first hike be? 

In the past, extrapolating the BoE’s inflation 

projection and judging when it will exceed target has 

been a good guide to when the first hike will arrive. 

Typically, the first rate hike should be expected to be 

roughly two years before inflation is projected to 

exceed target. On the basis of the likely projection in 

the upcoming Inflation Report, one could argue that 

the first rate hike is not very far off. That point could 

be as early as Q3 2010, since extrapolating the 

Bank’s projection will probably see inflation above 

target by Q3 2012. 

However, this overlooks one crucial factor. The 

Bank’s projections take no account of the fiscal 

tightening that is likely to be announced in the 

aftermath of the general election. This is normal 

practice for the BoE. If the projections did include 

such tightening, the Bank’s GDP growth projection 

wouldn’t be anywhere near 4% in 2011 and the 

inflation projection would be somewhat lower. 

We judge that this means the first rate hike is unlikely 

to be delivered until at least early 2011. However, by 

that point we expect GDP growth to be significantly 

weaker than the Bank is expecting and for inflation to 

be on a steady downward trend below target. We 

believe these will contribute towards an even longer 

delay before hikes begin. 

Emergency rates no longer necessary? 

We are often asked whether the BoE may consider 

moving Bank Rate from an “emergency level” to a 

level that is just “very low”. After all, the emergency 

appears to have passed. However, 0.5% Bank Rate 

is not what it seems. Very few borrowers are 

fortunate enough to be paying interest on borrowing 

anywhere near Bank Rate. 

Chart 4 shows the average mortgage rate paid by 

households (which takes account of how many 

borrowers are on fixed rates and which maturities as 

well as variable rates etc) against Bank Rate. When 

Bank Rate peaked at 5.75% during 2007, the 

average effective mortgage rate was a mere 20bp 

above Bank Rate. Since the financial crisis began, 

that spread has blown out to around 300bp such that 

the average mortgage rate paid is just above 3½% 

despite Bank Rate being only 0.5%. 

Similarly, although the spread between corporate 

bond yields and gilts has compressed since the 

height of the financial crisis, the spread remains 

around 160bp wider than pre-crisis levels (which 

were on average around 100bp). 

Chart 3: Lending to Corporations 


Chart 4: Bank Rate vs Average Effective 

Mortgage Rate 


The deputy Governor of the RBA in a recent speech 

noted the RBA may not have to raise the policy rate 

by as much for this very reason. The spread between 

market rates and the policy rate meant that the 

current policy setting was around 100bp tighter than 

would otherwise have been the case. 

Furthermore, since potential GDP growth in the UK is 

now around 100bp lower than before the crisis, this 

means that neutral interest rates are that much lower 

than they used to be (3.5-3.75% instead of 4.75%). 

The point is, in isolation, Bank Rate at 0.5% looks 

incredibly low. However, taking on board the 

tightening delivered by the market, the policy setting 

is much less accommodative. Add to that the likely 

rise in gilt yields once QE ends and the policy setting 

will tighten even without the help of BoE hikes. 

Conclusion 

We expect the BoE to pause its asset purchases at 

the February meeting. While the Inflation Report 

projections may entertain speculation that the first 

rate hike is not that far off, we believe that would be 

the wrong interpretation and the first rate hike is still 

a long way away. 



14 


UK Inflation: Bridging the Gap 

• In the past year, core inflation rates in the 

UK and eurozone have diverged significantly. 

Chart 1: Headline CPI – Eurozone & UK 

• Core inflation in the eurozone is close to its 

all-time low – in the UK it is at an all-time high. 

• The sharp rise in UK inflation has been a 

core goods phenomenon. 

• Sterling’s weakness appears to be playing a 

role, although it is second-hand car prices that 

have driven the bulk of the increase. 

• In contrast, and comfortingly for 

policymakers, services prices do appear to be 

responding to the weakness of economic 

activity in the UK. 


Chart 2: Core CPI – Eurozone & UK 

Core divergence 

The contrast between the inflation data in the UK and 

eurozone over the past twelve months has been 

stark. Not so much at a headline level – both have 

been pulled down and then up by exceptionally large 

commodity price base effects (Chart 1). Rather, the 

real divergence has been in core inflation (Chart 2). 

Despite the sharp economic downturn, and a pretty 

tepid recovery to date, core inflation has been 

trending higher in the UK. Over the past year, it has 

risen by nearly 2pp, reaching 2.8% y/y in December. 

That increase is exaggerated by a VAT cut at the end 

of 2008. But December 2009’s 2.8% core print still 

compares unfavourably with the near 2% inflation 

rates that existed in the months before the VAT cut. 


Chart 3: Core Goods Inflation 

In contrast, core inflation in the euro area has been 

trending down. Having started 2009 at nearly 2% y/y, 

eurozone core inflation finished the year at 1.1%, just 

0.2pp shy of its previous all time low. The result has 

been a widening of the core inflation spread between 

the two economies to its widest level since the data 

began in 1997. 

The extent of the slowdown in core inflation in the 

eurozone is noteworthy in its own right – it has 

occurred despite a sizeable increase in unit labour 

costs over the past year as firing failed to keep pace 

with the fall-off in output. But given that we would 

expect core inflation to trend down in response to a 

slowdown in growth, the strength of UK ex-food, exenergy 

inflation is more the anomaly to explain. 


Breaking down core inflation 

First, slicing core inflation into its two big components 

– core services and core goods – helps to explain 

Eoin O’Callaghan & Alan Clarke 29 January 2010 


15 


why core inflation has been rising in the UK but 

falling in the eurozone (Charts 3 and 4). We can 

make two observations: 

Chart 4: Core Services Inflation 

• The rise in core inflation in the UK over the past 

year has been a core goods phenomenon. Core 

goods inflation has spiked higher in the UK even 

as it has declined in the euro area. 

• Services inflation, in contrast, has been trending 

down in both economies, though its decline has 

been faster in the UK. 

These dynamics are important for a number of 

reasons. First, the rise in goods inflation, as services 

inflation has declined, is consistent with the 

exchange rate playing a major role in core inflation’s 

ascent in the UK. Goods are far more import 

intensive than services which are largely nontradable. 

Second, it should be encouraging for policymakers 

that services inflation is declining in the UK because 

the prices of services arguably represent a far better 

gauge of domestic price pressures than the price of 

goods. In addition to being largely sold into the 

domestic economy, wage costs make up a very 

important part of the price (the other two components 

are non-wage costs and mark up). Service inflation’s 

descent therefore suggests the decline in wage 

inflation in the UK is passing through to prices – if 

anything quicker than you might expect given usual 

lags (Chart 5). 


Chart 5: UK Services Inflation & Earnings 


Chart 6: Main Contribution to UK Core Goods 

CPI Inflation 

Third, services inflation is not just declining, it has 

already reached its lowest level since the data 

started in 1997 and its premium to the eurozone has 

fallen by two thirds over that period. Again, there are 

distortions created by the VAT cut, but the December 

level of services inflation – at 2.5% - is well below 

November 2008’s 4.3% y/y. 

Explaining core goods inflation’s rise 

So what has been driving core goods inflation’s 

ascent in the UK? Three series stand out from the 

rest. The first and most important is vehicle prices 

whose rate of inflation has risen from a pre-VAT cut 

level of -3.3% in November 2008 to 9.0% in the most 

recent December 2009 release. That alone has 

added nearly 0.8pp to core inflation over that period. 

At first glance, this is a little puzzling: as across the 

rest of Europe, there is a subsidy scheme in 

operation in the UK which should, all else being 

equal, be cutting the prices paid by car buyers. 

Under the scheme, car buyers who trade in a car that 

is over 10 years old for scrapping, receive £1000 

from the government and a further £1000 of 

discounts from the manufacturer. 


However, the CPI does not take account of the 

discount. Moreover, car manufacturers have raised 

their list prices in response to having to pay half of 

the car scrappage subsidy. Since it is the list price 

that the ONS captures, the car scrappage scheme 

has actually been inflationary as far as the CPI is 

concerned. 

Furthermore, the ‘purchases of vehicles’ component 

is made up of new and second-hand cars – which 



16 


eceive roughly 60/40 weight within the category. 

While both are contributing to the increase, it is the 

second-hand car market that appears to be adding 

the most. From November 2008 to December 2009, 

second-hand car inflation rose from -12.5% y/y to 

+15.8% y/y - a swing of nearly 30pp! New car 

inflation increased by just over 2.5pp to 4.4% y/y 

over the same period. 

We spoke to the Office of National Statistics which 

suggested that an important explanation is, ironically, 

the impact of cost cutting by businesses. As 

companies choose to keep their current fleet of 

company vehicles rather than change them, a major 

source of supply for the second-hand car market has 

shrunk. We should not discount the impact of a weak 

sterling, however, particularly for the new car market, 

given the large proportion of foreign car marques in 

the UK. 

Crucially, the month-on-month change in secondhand 

car prices has slumped recently, suggesting 

this boost to headline inflation has been temporary. 

Assuming this series reverts to around the seasonal 

norm, and even after taking into account the January 

VAT hike and a likely further VAT hike to 20%, we 

estimate that car prices will subtract ½pp from 

headline inflation over the next twelve months. 

The exchange rate also appears likely to have played 

an important part in explaining the strength of the 

other two main contributors to core goods inflation 

over the past year – clothing and audio-visual 

equipment inflation – given their high import content. 

Audio-visual equipment inflation has increased from 

-13.5% y/y in November 2008 to -6.9% in the most 

recent December release. That 7pp increase has 

added a further 0.3pp to core inflation. Clothing price 

inflation has risen by 3.6pp since November 2008 to 

reach -3.5% in December, also adding 0.3pp to core 

inflation over that period. However, unless the GBP 

exchange rate resumes its fall (it has been largely 

stable over the past six months) this boost will also 

fade. 

Conclusion 

Persistent upward surprises in the CPI for at least the 

last year raise genuine concerns about the prospects 

for UK inflation. However, when we consider exactly 

what has been driving inflation higher, the outlook is 

less worrisome. It is tricky to distinguish, for example, 

between a rise in clothing inflation because of the 

exchange rate or an independent increase, say, 

because retailers are increasing their margins. 

Nonetheless, our analysis highlights a number of 

useful observations that reduce the perniciousness of 

the rise in core inflation. Core goods have driven the 

rise in core inflation – something disproportionately 

attributable to vehicle prices with the exchange 

rates’s influence consistent with the strength in 

clothing and audio visual equipment inflation. 

Services inflation, in contrast, appears to be 

responding to the downturn and should continue to 

do so ahead. 



17 


Norway: To Pause for Now 

• There has been evidence since the Norges 

Bank’s last policy meeting that bank lending 

rates are rising, showing the impact of the 

policy rate increases. 

Chart 1: Policy Rates (%) 

• Economic data have been broadly in line 

with market and the Norges Bank’s expectations 

while the imported weighted NOK has 

appreciated somewhat. 

• Overall, the chances of a policy rate 

increase next week have therefore diminished. 

We expect the next rate hike to be delivered in 

March. 

• That said, a rate hike next week can still not 

be ruled out, given that rates are much lower 

than what current levels of growth and inflation 

would normally require. 


Chart 2: Unemployment Rate (%) 

Surprise rate hike in December 

At its December meeting, the Norges Bank delivered 

its second rate hike in this cycle, rising the policy rate 

by 25bp to 1.75% (Chart 1). The market was 

expecting no change. The Norges Bank signalled in 

its rate projections in October that it will deliver rate 

hikes gradually. But it seemed to be more certain on 

its growth outlook for both Norway and globally in 

December. The statement noted that the recovery at 

home and abroad had “gained a firmer foothold” and 

“the outlook for next year seems less uncertain”. It 

was thus sufficiently confident to deliver a further rate 

hike in December. 

The Norges Bank also acknowledged that the policy 

rate is low (the neutral level is around 5.0%). Hence, 

further rate hikes are to come to slow the economy. 

We believe, however, the main reason behind this 

earlier than expected rate hike was that the first 

policy rate increase in October “had a limited impact 

on bank lending rates” and therefore on consumers. 

Developments in bank lending rates, as well as the 

macroeconomic data and performance of the krone 

since the last policy meeting, should therefore give 

an indication of whether the Norges Bank will 

increase its policy rate next week or pause, given the 

move in December. 

Developments in the economic data and krone 

The developments in macroeconomic data since the 

last rate hike were broadly in line with market and the 

Norges Bank’s expectations. On the labour market 


front, the seasonally adjusted unemployment rate 

was unchanged at 3.2% in October (the figure for 

September was revised up from 3.1% to 3.2%). At 

this level, unemployment rate is still just 0.9pp higher 

than its low in March 2008 (Chart 2) and 1.1pp higher 

than its all-time low in late 1980s. This limited 

increase in unemployment is clearly one of the 

reasons why the Norges Bank started increasing its 

policy rate well ahead of most other advanced 

country central banks. 

In terms of inflation, both headline and core inflation 

ticked up in December, coming in only slightly higher 

than the consensus estimates. Core, CPI-ATE, 

inflation at 2.4% was in line with the Norges Bank’s 

most recent forecast, which was presented in the 

October Monetary Policy Report. Thus it should not 

warrant a significant change in the Norges Bank’s 

assessment. 

With regard to activity, the improvement in sales has 

lost some momentum in recent months. Sales fell by 

Gizem Kara 29 January 2010 


18 


1.2% m/m in November, partly offsetting an increase 

in October. On a 3m/3m basis, sales are now up 

0.7%, a deceleration from 1.0% in October and 

below the recent peak of 1.8% in July. Manufacturing 

production, on the other hand, is on an upward trend. 

The 3m/3m rate has risen consistently over the past 

five months. In November, production was up 2.3% 

from 2.2% in October, well above the trough of 

-3.4% in February. In terms of surveys, 

manufacturing PMI in December nudged up into 

expansion territory, the first time it had been above 

50 since July. However, the index was revised down 

recently from 50.4 to 47.2, back to signalling 

contraction in the sector. 

Overall, as economic data since the last policy 

meeting have not been stronger than the market and 

the Norges Bank were expecting, they should not, 

alone, warrant a change in the Norges Bank’s initial 

intention to deliver rate hikes gradually. Also, the 

import weighted NOK has strengthened somewhat 

since the last policy meeting. It was up as much as 

2% in mid-January, while on Wednesday it closed 

around 0.4% higher than its level in mid-December 

(Chart 4). 

Lending rates, credit growth and house prices 

Since December, there has been survey evidence 

that bank lending rates have increased further. In 

particular, the country’s biggest lender said in mid- 

January that it will raise interest rates on home loans 

by 25bp, effective March 10. Given this move comes 

from the biggest lender, the smaller lenders are likely 

to raise their lending rates accordingly. We believe 

this gives a reason to the Norges Bank to pause in 

February, as the increase in rates shows that the 

policy rate hikes are having an impact. 

The recent data on credit, on the other hand, showed 

that credit to households continued to grow in 

November. On house prices, the Norges Bank had 

already mentioned its concern in the previous 

statement that “house prices are rising sharply”. In 

Q4, house prices were actually flat q/q in Q4, while 

because of base effects, they were up 11.6% y/y 

(Chart 5). 

What next? 

We highlighted after the December meeting that 

whether or not the Norges Bank will deliver a rate 

hike at its next meeting in February will depend on 

developments in bank lending rates, economic data 

and the krone (see Norway: Need for Higher Rates, 

Market Mover, 18 December 2009). We noted that if 

bank lending rates increase, showing an impact from 

October and December’s rate hikes, the chances of 

further monetary tightening in February will diminish. 

The evidence since then suggests the Norges Bank 

is likely to keep rates on hold at its meeting next 

week. The fact that bank lending rates are increasing 

Chart 3: Manufacturing Production & FMCI 

Source: Reuters EcoWin Pro, BNP Paribas 

Chart 4: Import Weighted NOK 


Chart 5: Household Credit Growth & House 

Prices (% y/y) 


should give comfort to the Norges Bank that its policy 

rate increases are now being passed onto 

consumers, as strong growth in private consumption 

was one of the points flagged up in the December 

policy statement. 

We therefore believe the next rate hike will come in 

March. That said, we believe a rate hike at the 

February meeting can still not be ruled out, given the 

policy rate is much lower than what current levels of 

growth and inflation would normally require. 

Gizem Kara 29 January 2010 


19 


Japan: Vetting Budget Spending Requests 

• Since spending programmes initially 

deemed top priority lose urgency over time, it is 

important to constantly review spending items. 

• In November, the Government Revitalisation 

Unit under took the epoch-making reform of 

publicly vetting budget expenditure requests, 

something previously decided in private by the 

‘iron triangle’ of bureaucrats, special interests 

and lawmakers. 

• The vetting process may have only cut a 

modest amount of wasteful spending, but the 

process did create the framework for micro-level 

fiscal discipline. Achieving results on a larger 

level is the responsibility of the National Policy 

Unit, which has the role of creating a scheme for 

guaranteeing macro-level fiscal discipline. 

• Combining the “bug’s eye” micro-level 

discipline of the Government Revitalisation Unit 

with the “bird’s eye” macro-level discipline of 

the National Policy Unit could result in much 

improved fiscal management. 

• Although spending measures should 

constantly be under review, it will be politically 

hard to reassess the spending programmes 

earmarked in the budgets for FY 2010 and 2011. 

The coming year may thus be the last chance to 

secure a far-reaching budget overhaul. 

Epoch-making reform 

In November, we had the privilege of briefly 

participating in the nine-day process of vetting 

budget expenditure requests that was undertaken by 

the Government Revitalisation Unit. Whenever we at 

BNPP take part in such government-related activities, 

we usually report on them as soon as possible. 

However, this time round, we refrained from doing 

because the screening was so micro in nature that it 

would necessarily require the naming of names. 

However, with the entire budget-screening process 

currently extremely prominent in the media, we have 

decided to lay out our overall impressions. 

The process as a whole was truly an epoch-making 

achievement in that it was the first time such 

screening was done in full view of the public. It goes 

without saying that, even if spending programmes 

were entirely appropriate when they were first 

implemented, such needs and urgency inevitably 

fade with the changing times, and some projects will 

outlive their usefulness. However, the private sector 

agents benefiting from these programmes become 

vested interests that vehemently oppose cutting such 

spending, while the bureaucrats pushing to fund the 

programmes are adamant about their maintenance 

owing to the power that holding the budget’s purse 

strings allows them to wield over the private sector. 

Thus, spending measures that should constantly be 

up for review have become entrenched owing to 

Japan’s iron triangle of bureaucrats, special interests 

and interest-driven lawmakers that has been fostered 

by more than half a century of single-party rule. 

We participated in screening activities involving 

remuneration for medical services and the pricing of 

generic drugs. Thus, rather than studying whether or 

not specific outlays should be terminated, as was the 

main concern of other budget-vetting operations, our 

working group (consisting of lawmakers, researchers, 

fiscal experts etc) explored how best to repair defects 

in the make-up of the systems concerned. 

Background of Japan’s doctor shortage 

For example, the pressing issue of a shortage of 

doctors is not just a problem of headcount but also a 

matter of uneven distribution of doctors by region and 

by type of care due to defects in the remuneration 

system (mispricing). On this score, the fact that 

private practitioners can make far more money per 

hour than hospital-employed physicians very likely 

causes a shift from the latter to the former. This shift, 

in turn, is a big reason why many regional hospitals 

have been forced to close, as their members of staff 

have defected to the greener pastures of private 

practice. What is more, when hospital-based doctors 

leave for the higher pay and predictable hours of 

private clinics, they tend to give up their past 

specialised skills, ending up treating general ailments 

such colds and the flu – thereby further reducing the 

nation’s pool of specialists. In other nations, 

specialists earn greater wages than general 

practitioners, but that is not the case in Japan owing 

to the distorted remuneration system. The dwindling 

number of specialists not only robs Japan’s medical 

profession of the power to grow, but it also adversely 

impacts the economic wellbeing of the Japanese 

people, who otherwise would benefit from that growth. 

Mispricing and uneven distribution of doctors 

When opting for private practice, the fact that Japan 

does not limit the doctor’s freedom to choose what 

type of medicine to practice and where to practice it 

means the selection is largely determined by income 

and workday considerations (of course, the presence 

Ryutaro Kono 29 January 2010 


20 


or absence of competitors in a specific area is also a 

factor). The result is that fields with the harshest 

working conditions (such as obstetrics/gynaecology, 

surgery and paediatrics) are avoided in favour of 

easier areas (e.g. ophthalmology, orthopaedics). This 

gives rise to shortages in specific fields and 

geographic locations. In other words, the fact that the 

remuneration system is fixed for all medical services 

down to the smallest detail means continued 

mispricing causes doctors to favour certain practices 

over others. 

Until recently, the Central Social Insurance Council 

(CSIC) of the Ministry of Health, Labour and Welfare, 

which effectively controls Japan’s medical 

remuneration system, had not set prices in a way 

that appropriately balances supply and demand after 

considering the interests of all parties concerned. 

(Owing to problems including asymmetrical 

information, the medical profession is heavily 

regulated. But while some degree of price control is 

needed given the absence of a market mechanism, 

the problem is that price-setting has not been done 

appropriately.) Experts have long complained about 

this, but the problem was not widely known until the 

budget-vetting process exposed it to the public. This 

led to an overhaul of both the CSIC itself (a 

membership shake-up has given a stronger voice to 

hospital-based doctors) and the remuneration system, 

with the latter focusing on rectifying the income 

disparities between private practice doctors and 

hospital-based physicians. 

Is one hour per review sufficient time? 

There has been some criticism that the time 

constrains on the vetting process – one hour each for 

some 450 projects – did not allow for adequate 

assessments. Since the government-assigned 

reviewers included accountants, authorities on fiscal 

affairs and experts in regional policy matters, all of 

whom came prepared for the specialised subjects 

involved, an hour was enough to cover the issues in 

question. In our particular working group, when 

asked if outlays on their project warranted urgency in 

the face of the many other priority issues raised in 

the DPJ’s manifesto, some bureaucrats were at a 

loss as to what to say, leaving reviewers with the 

impression that the request for funding was just 

routine, something that was also done last year and 

the year(s) before that. 

Given the clout of interest-driven lawmakers, these 

officials probably assumed that, barring some 

emergency, their pet projects would always continue, 

even if fiscal conditions got tight, because that is the 

way things had always always done. But the public 

does not see it that way. Faced with severe 

budgetary constraints, voters naturally want spending 

projects to be selected on the basis of priority. 

Vetting process creates micro-level fiscal 

discipline 

To ensure that limited tax revenues are wisely spent 

on programmes required today means there must be 

a constant review of the urgency of all spending 

programmes so that an order of priority can be 

determined. By establishing the programmes-vetting 

process, the government has created micro-level 

fiscal discipline. Of course, spending on areas 

including science and the arts might require a longterm 

perspective such as a 100-year plan. Further, if 

certain science projects are weeded out during the 

vetting process, lawmakers can always re-approve 

them at later date. Even here, it is important that 

efforts be made to ensure that limited resources yield 

the maximum output. In this sense, the objective of 

the vetting process is to promote efficiency. 

Vetting process may have had little real effect 

Another common complaint is that the vetting 

process did little to actually reduce spending. 

According to the Government Revitalisation Unit’s 

final report, the process only pared JPY 969.2 billion 

from the budget requests (we note that planned new 

bond issuance in FY 2010 totals JPY 44 trillion). But 

it is wrong to expect the vetting of individual spending 

projects to yield huge spending cuts. For that to 

happen, you have to either put a ceiling on the 

overall budget or target areas for specific curtailment. 

(Alternatively, you could overhaul the tax system to 

secure increased revenue via higher taxes.) The job 

in this situation is that of the National Policy Unit, not 

the Government Revitalisation Unit. The National 

Policy Unit has the role of creating a scheme for 

guaranteeing macro-level fiscal discipline, such as a 

long-term fiscal reconstruction plan, medium-term 

framework or single-year budgetary ceiling. It could 

be argued that the new DPJ-led government was 

unable to address macro-level fiscal discipline this 

time around owing to time constraints. However, if it 

had at least imposed a single-year ceiling on 

spending, then the FY 2010 draft budget probably 

would not have swollen to record proportions. 

While on the issue of macro-level fiscal discipline, we 

have pointed out in previous reports that the aim of 

bolstering economic activity always lures the powers 

that be into raising fiscal spending. The DPJ-led 

government is no exception. On the one hand, it vets 

public works projects to eliminate waste; but, on the 

other hand, it designs a package of emergency 

economic stimulus (second extra budget for FY 

2009) that is full of expansionary spending in order to 

avert an economic “soft patch.” While the additional 

spending might yield a momentary jump in GDP, it 

nullifies all of the waste-cutting efforts of the budgetvetting 

reform. It is extremely unfortunate that 



21 


coalition governments are so prone to boosting 

spending. 

“Bug’s eye” micro fiscal discipline and “bird’s 

eye” macro fiscal discipline 

The temptation to adopt expansionary fiscal policies 

is, of course, largely being driven by this summer’s 

Upper House election. Since politicians will revert to 

being ordinary citizens in the event of an electoral 

loss, the preference for expansionary spending is the 

natural way to maximise their own interests. To nip 

this temptation in the bud requires the government to 

commit to controlling its actions. In other words, the 

government needs to introduce at an early date a 

long-term fiscal reconstruction plan (or something 

similar) to guarantee macro-level fiscal discipline. 

Because fiscal policy is so prone to expansionary 

pressures, as the democratic process harmonises 

the interests of diverse parties, it is crucial that there 

is a rule that binds budget formulation into the future, 

rather than just a single year. We absolutely must 

avoid an extra FY 2010 budget full of additional 

economic stimulus, which may happen in the 

absence of such a rule as the summer’s Upper 

House election draws near. 

Combining the “bug’s eye” micro-level discipline of 

the Government Revitalisation Unit with the “bird’s 

eye” macro-level discipline of the National Policy Unit 

could result in much improved fiscal management. 

Issues for next year 

In closing, we will lay out some recommendations for 

next year’s vetting process. It appears that quite a 

few spending programmes overlap with other 

programmes. Bureaucrats in one area do not seem 

to know what sort of programmes are going on 

elsewhere. If the government first completely 

investigates the regional public corporations charged 

with actually implementing programmes, it should be 

possible to eliminate such wasteful duplication. 

Additionally, the vetting process next year should be 

started earlier to allow for more thorough waste 

reduction. While we believe that spending measures 

should constantly be under review, it will be politically 

hard for the Hatoyama government to 

comprehensively reassess the spending programmes 

that it has approved for implementation in the budgets 

for fiscal 2010 and 2011. Next year might be the last 

chance for the change of government to produce a farreaching 

budget overhaul. 



22 


Japan: Polarisation in Machine Tool Orders 

• Japan’s data on machine tool orders 

confirm the growing polarisation between the 

rate of growth in the newly emerging economies 

and that in developed nations. 

• The drivers of overseas demand for tools 

are the emerging economies of Asia, especially 

China. Indeed, Chinese orders in December 

were above the former peak. 

• Orders from the US and Europe, as well as 

within Japan, remain so lacklustre that the level 

in all three cases remains under 30% of their 

former peaks. 

• Despite concerns that fund flows into the 

EMKs could be adversely impacted by 

Washington’s plans to tighten banking 

regulations, the fact that the US and Europe will 

have to maintain their super-low interest rate 

regimes argues against any drying up of these 

flows. 

Pronounced global polarisation 

It is widely recognised that the economies of Asia ex- 

Japan, led by China, are booming, while domestic 

demand in the US and Europe is weak owing to 

persistent balance sheet troubles. This dichotomy 

between the newly emerging economies and the 

developed nations is also clearly evident in Japan’s 

data on machine tool orders, for which a country 

breakdown is available (something that suggests the 

direction of capital investment in each nation). 

Weak domestically, strong overseas 

According to our seasonally adjusted estimates, the 

sum total of machine tool orders bottomed out in 

March 2009 at just 14% of the former peak (October 

2007), but the subsequent recovery pushed that 

figure up to 43% in December. The driver of this 

recovery has been overseas demand, which in 

December surged 29.2% m/m, causing this category 

to reach 55% of its former peak. Domestic demand in 

December also rose sharply, by 21.6%, the first 

increase in three months. However, the trend of this 

recovery remains weak, so the level as of December 

is still only 27% of its former peak, below the bottom 

of the recession following the burst IT bubble. Even 

though Japan is not saddled with balance sheet 

troubles, its domestic demand (demand for capital 

investment) remains weak. 

Chart 1: Domestic Orders (sa, CY 2005=100) 

120 

Monthly 

110 

100 

90 

80 

70 

60 

50 

40 

Quarterly 

30 

20 

10 

03 04 05 06 07 08 09 

Source: JMTBA, BNP Paribas 

160 

140 

120 

100 

Chart 2: Foreign Orders (sa, CY 2005=100) 

80 

60 

40 

Monthly 

Quarterly 

20 

03 04 05 06 07 08 09 


160 

140 

120 

100 

80 

60 

40 

20 

Chart 3: Asia ex-Japan Orders (sa, CY 

2005=100) 

Quarterly 

Monthly 

0 

03 04 05 06 07 08 09 


Ryutaro Kono/ Hiroshi Shiraishi 29 January 2010 


23 


China leads recovery in overseas demand 

A closer look at the country breakdown of machine 

tool orders confirms that the drivers of overseas 

demand are the emerging economies of Asia. In fact, 

orders from Asia ex-Japan have been so brisk that 

December’s level was in line with the previous peak. 

Naturally, the most conspicuous strength is shown by 

China (whose economy in Q4 2009 surged 10.7% 

q/q, returning to double-digit growth for the first time 

in six quarters). Chinese orders began reviving at the 

start of 2009, with the tempo accelerating sharply 

from the autumn. By December, the level was well 

above its past peak. Orders from South Korea and 

Taiwan are also solid, though the magnitude is less 

than China’s. As is widely known, domestic demand 

in China and the other Asian EMKs is expanding 

briskly thanks to (1) very aggressive domestic 

stimulus programmes, coupled with the lack of 

balance sheet problems, and (2) very 

accommodative monetary conditions from the influx 

of capital via escalating dollar carry trades. 

US and European demand remain weak 

Meanwhile, orders from the US and Europe are as 

lacklustre as Japan’s. Orders for the EU are 

especially weak, with the recovery (if it can be called 

that) so anaemic that the level in December is still 

just 20% of its former peak. Orders coming from the 

US stood in December at 28% of their former peak, 

and the pace of recovery there also remains slow. 

Polarisation unlikely to end soon 

Recently, concerns have emerged about fund flows 

into the EMKs being substantially reduced by 

Washington’s latest plans to rein in the banking 

sector, something that could reduce risk taking by US 

financial institutions. What is more, in China the 

authorities are also starting to tighten monetary 

policy. Nevertheless, as long as the US and Europe 

face balance sheet troubles, they will have to 

maintain their super-low interest rate regimes, and 

this argues against any drying up of the fund flows 

from the developed nations to the EMKs. (Of course, 

over the long run, the strengthening of banking 

regulations may greatly affect global fund flows as 

well as the pace of global growth.) Furthermore, 

given the political risks involved, Beijing is unlikely to 

tighten monetary policies to the extent that it 

appreciably dampens growth in the near future. Thus, 

the current global polarisation is unlikely to end 

anytime soon. 

Chart 4: China Orders (sa, CY 2005=100) 

300 

Monthly 

250 

200 

150 

100 

Quarterly 

50 

0 

03 04 05 06 07 08 09 


Chart 5: US Orders (sa, CY 2005=100) 

140 

Monthly 

120 

100 

80 

60 

Quarterly 

40 

20 

0 

03 04 05 06 07 08 09 


Chart 6: EU Orders (sa, CY 2005=100) 

250 

Monthly 

200 

150 

100 

Quarterly 

50 

0 

03 04 05 06 07 08 09 


Ryutaro Kono/ Hiroshi Shiraishi 29 January 2010 


24 


Australia: The Next Step 

• Data released since the disappointing Q3 

GDP number have generally been robust. 

Chart 1: Employment Growth 

• The labour market is turning out stronger 

than many expected. Underlying inflation 

remains on the high side. 

• These factors should convince the RBA that 

further policy normalisation is warranted at its 

February meeting. 

Hike odds on 

The RBA has moved well ahead of most central 

banks in hiking its policy rate at the past three 

consecutive meetings. This reflects the fact that 

Australia is in a very different place economically 

relative to the likes of the US, eurozone and UK. With 

the Australian economy normalising and policy rates 

at exceptionally low levels, beginning to withdraw the 

excess of accommodation was entirely sensible and, 

therefore, not a difficult decision. However, with the 

policy rate less accommodative than it once was, the 

RBA’s decisions are set to become a closer call. 

For the 2 February meeting, we remain in the rate 

hike camp – expecting the RBA to raise the cash rate 

by 25bp to 4.00%. This is now very much the 

consensus view. But when Q3 GDP data 

disappointed late last year, the December minutes 

were more dovish than expected and Deputy 

Governor Battelino suggested policy was less 

accommodative than the cash rate suggested, it 

would have been easy to think that a February rate 

hike was beginning to look unlikely. This raises the 

question: what has happened since these events to 

make the market so convinced that a hike will be 

delivered? After all, at the time of writing, only one 

out of 21 economists in the Bloomberg survey 

expects rates to be left unchanged. 

Hard labour 

One key swing factor for the RBA is likely to be the 

labour market data. The market has been surprised 

significantly on the upside for the past four months 

running. On average, employment has increased by 

35k, or 0.3%, per month more than the consensus 

forecast. Employment is now rising at 1.0% y/y. But 

this figure is sure to increase given the three- and 

six-month changes (Chart 1) and the positive tone of 

employment indicators, such as the NAB survey, job 

adverts and vacancies. 


Chart 2: Unemployment & the NAIRU 


Strong employment growth has pushed the 

unemployment rate down by a total of 0.3pp since 

October. At 5.5%, it is not that far above the OECD 

estimate of the NAIRU (Chart 2). Certainly, the 

amount of slack in the labour market is far less than 

seen at the beginning of previous recoveries, which 

argues for policy to be more pre-emptive, especially 

given the policy rate is coming from a very low level. 

The improvement in the labour market is likely to be 

one factor supporting consumer confidence. 

Confidence surged through 2009 and, after two 

months of decline, bounced back in January (Chart 

3). The January bounce should give the RBA some 

confidence that the rate hikes delivered thus far have 

not been detrimental to the recovery. 

General strength 

Other data related to the consumer have also been 

firm since the December RBA meeting. Passenger 

and SUV sales rose by over 7.0% q/q in Q4, the third 

strongest q/q increase (excluding a tax-related spike 

Dominic Bryant 29 January 2010 


25 


in 2000) since at least 1994. Retail sales jumped 

1.4% m/m in November, well above expectations. 

Data releases for other sectors of the economy since 

the December RBA meeting have been fewer in 

number, particularly in recent weeks. Monthly NAB 

business confidence, released before Christmas, 

improved to its highest level since May 2002. 

Housing starts and building approvals have also 

been strong. In sum, survey data have been robust 

and point to an acceleration in growth. The hard data 

have also been positive and do not give much reason 

to doubt that the economy is continuing to recover 

from the sharp slowdown seen in late 2008 and early 

2009. It is also worth remembering that the Q3 GDP 

data, which put growth at a disappointing 0.2% q/q, 

were not as weak as the headline number suggests. 

Most of the downside came from a surge in imports – 

the drag from net trade was the largest since 1974. 

Final domestic demand contributed 0.6pp to q/q 

growth while inventories added a further 0.8pp. 

Looking beyond Australia, we have also seen 

generally strong data, particularly in Asia. Chinese 

GDP grew by an estimated 10.2% q/q ar in Q4 while 

industrial production across a number of Asian 

economies has continued to surge. Given that China, 

India, South Korea and other Asian economies 

together account for about 45% of Australian exports, 

continued strength in Asia should provide some 

further support for Australia’s recovery. 

Asymmetric inflation risks 

On the prices side, Q4 inflation was a little stronger 

than the market expected, at 2.1% y/y compared with 

1.3% in Q3. From the RBA’s perspective, there were 

a few points to note. First, headline inflation has now 

moved back into the 2-3% y/y target range. Second, 

underlying measures of inflation remained on the 

high side with trimmed mean inflation stable at 3.2% 

and weighted median inflation showing a minimal 

decline to 3.6% from 3.7%. 

The measures of underlying inflation are likely to 

moderate in the coming quarters as a result of lags 

from the sharp slowdown earlier in 2009 and the 

spare capacity within the economy. However, with 

the unemployment rate falling and capacity utilisation 

rising, whatever slack there might be is being eroded 

quickly. Hence, there seems little risk that underlying 

inflation will end up being too low. In other words, the 

risks on inflation seem asymmetric – underlying 

inflation is currently above the target range and is 

unlikely to drop below it. 

The next step 

Overall, since the soft headline Q3 GDP reading and 

the dovish RBA minutes/comments from Deputy 

Governor Battellino were released, the data on the 

Chart 3: Confidence & Consumption 




Chart 4: GDP & NAB Survey 

Chart 5: Inflation Measures 

Australian economy have generally favoured a 

further rate hike at the February RBA meeting. Of 

particular importance has been the strength of the 

labour market. But, more widely, the economy 

appears to be continuing to recover from the sharp 

slowdown seen in late 2008/early 2009. At the same 

time, while underlying inflation will likely moderate, at 

present it remains on the high side with little risk that 

it ends up slowing too much. Further removal of 

policy accommodation therefore looks warranted. We 

expect a 25bp rate hike. However, we not regard it 

as the near certainty that the economist polls suggest. 

Dominic Bryant 29 January 2010 


26 


US: Post-FOMC Treasury Market Overview 

• The FOMC struck a more hawkish tone at 

its latest meeting, which should arrest the rally 

in Treasuries. 

• We expect the 1y sector to remain more or 

less anchored but the 2 to 5y to come under 

pressure. 

• STRATEGY: Put on 1s2s steepeners. Sell 

the 1s2s3s butterfly (short the belly). 

The FOMC statement arguably turned more hawkish 

on inflation, with resource slack no longer being 

viewed as a downward force on inflation as much as 

a constraint to it going higher. The overall 

assessment on growth was that the recovery will be 

"moderate", replacing the previous prognosis that 

economic activity will remain weak. Even the 

“extended period” language was called into question 

by Hoenig, who dissented. 

With these developments, it was no surprise to see 

selling pressure on the Treasury curve. The very 

front end (0-2yrs) steepened while the curve was 

flatter 2yrs and out, and we would expect these 

trends to persist for now. The expected bumper GDP 

print on Friday and next week’s possibly positive 

NFP print (consensus is +27k) could spook markets 

and further the sentiment that hikes are closer than 

we think. Still, even in that scenario, we expect the 

1y sector to remain more or less pegged as it’s 

unlikely for more tightening to be priced in for 2010 

than 2011. As a result, we favour front-end 

steepeners in the form of 1s2s (see Chart 1 for the 

close relationship between the direction of rates and 

1s2s spread). 

We also recommend selling the 2y sector in view of 

its sub-par rolldown prospects within the front end. 

Chart 2 shows the 6m total return of 1-3y Treasuries 

due to rolldown alone (i.e. in an unchanged yield 

Chart 1: 3-Month Change of 2y Tsys and 1s2s 

200 

150 

100 

50 

0 

-50 

-100 

-150 

-200 

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 

Source: BNP Paribas, Yield Book 

3m Chg in 2y 

3m Chg in 1s2s (RHS) 

curve scenario). Clearly a barbell of 1s and 3s should 

outperform the 2y sector in this scenario. This 

suggests an RV opportunity, but we should also 

incorporate other scenarios to make a full 

assessment, most importantly a bear-steepening in 

the front end, consistent with our expectations. When 

we run a multi-scenario optimisation along these 

lines, we find that – with proper weightings – a 

barbell of 1y and 3y is indeed likely to outperform the 

2y. Trade details are shown in Table 1. 

150 

100 

50 

0 

-50 

-100 

Chart 2: 6-Month Total RoR of 1-3y Treasuries 

1.8 

1.6 

1.4 

1.2 

1 

0.8 

0.6 

0.4 

0.2 

Buy April 2011s 

& Jan 2013s 

Barbell 

Return 

0 

1 1.5 2 2.5 3 3.5 

Source: Yield Book, BNP Paribas 

Sell Dec 2011s 

Effective Duration 

Table: Trade Details – Sell 2y, Buy 1y and 3y Sectors 

Security Price Yield Duration Par Amount ($) Market Amount ($) 

Buy T 4.875 04/30/2011 105.541 0.430 1.22 66,561 71,055 

T 1.375 01/15/2013 99.870 1.420 2.91 28,967 28,945 

Sell Cash 0.169 10,843 10,834 

T 14.625 12/31/2011 107.196 0.838 1.85 82,894 89,166 

Net -2.536 -0.049 0.00 1,791 0 

Source: BNP Paribas 

Bulent Baygun 29 January 2010 

Market Mover, Non-Objective Research Section 

27 


US: After FOMC, Favour Calls on Front End 

• In light of the FOMC statement, outright 

front-end carry positions no longer look as 

attractive since the market could be spooked 

by strong data and aggressively push frontend 

rates higher. 

• We still feel the Fed won’t hike any time 

soon and have long recommended playing the 

base-case scenario of a Fed on hold using 

options. This takes advantage of the outsized 

rolldown in the short end. 

• STRATEGY: Buy 6m1y and sell 6m10y 

receivers in a costless structure to take 

advantage of a highly attractive entry point due 

to the flatter forward curve and historically 

cheap vol ratio. 

Chart 1: 6m1y/6m10y 50bp OTM Vol Ratio 

160% 

140% 

120% 

100% 

80% 

60% 

40% 

Jan-04 May-05 Sep-06 Feb-08 Jun-09 

Chart 2: Entry Level Compared to Spot 1y10y 

350 

The trade is a conditional bull-steepener although the 

outsized carry at the front end is the main impetus for 

the trade. We sell the 6m10y receiver around 75bp 

out of the money so as to strike it at 3.30%, some 

50bp below spot and the lowest level on the 10y rate 

in recent months. While we expect this to fall out of 

the money, the 6m1y receiver can be expected to 

end up in the money. To make it costless, the 6m1y 

receiver can be struck at around 0.64%, which 

compares favourably with the spot 1y range of 0.43- 

0.67% in recent months. 

From a curve perspective, the credentials are very 

strong, since the effective curve strike is 266bp. The 

spot 1y10y is currently trading at 330bp and has 

been above the entry level since May last year (see 

Chart 2 for 3m and 6m breakeven floors). The risk to 

the position is deflation concerns or a number of 

economic setbacks which could bull-flatten the curve. 

Chart 3 shows the expect P/L under curve 

movements in 1y10y which are led by the 10y (as per 

current market dynamics, the 1y is relatively pegged 

while the 10y leads). In a sell-off, the position can 

actually be expected to be in the black. The current 

market environment suggests that the 10y will lead 

the sell-off, so the receiver we are short will 

depreciate faster than the receiver we are long. In a 

300 

250 

200 

150 

3m Floor 

6m Floor 

100 

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 

Chart 3: Expected P/L Under Curve Movements 

400,000 

300,000 

200,000 

100,000 

- 

(100,000) 

(200,000) 

(300,000) 

6m Holding 

(400,000) 

3m Holding 

(500,000) 

-75 -50 -25 0 25 50 75 

All Charts Source: BNP Paribas 

1y10y Curve Changes 

bear-flattening scenario, the receivers simply fall out 

of the money. 

Table 1: Trade Details for 6m1y vs 6m10y Conditional Bull-Steepener 

Structure Strike Notional ($) PV ($) PV01 ($) Vega ($) Gamma ($) Theta ($) 

Buy 6m1y Rec F - 43bp 200,000,000 125,000 5,133 31,829 1,149 (1,197) 

Sell 6m10y Rec F - 75bp (24,000,000) (125,000) (3,494) (39,456) (651) 1,566 

Net 0 1,639 (7,627) 498 369 


Suvrat Prakash 29 January 2010 


28 


US: Rolling Down the Agency Spread Curve 

• Short maturity agencies are attractive on 

forward basis vs Tsys and OIS swap due to the 

steep agy spread curve and carry advantage. 

• Establishing long agency position vs short 

Treasury or OIS swap protects the investor in a 

sell-off and offers a decent cushion against 

agency underperformance. 

• STRATEGY: Buy agency bullet around 2y 

sector vs short Treasury position or against 

paying fixed in a matched maturity OIS swap. 

We find agency bullets in the front end of the curve 

attractive on the forward basis vs Tsys or vs paying 

fixed in OIS swap for two reasons: due to the 

steepness of agency spread curve and the carry 

advantage. The agency/OIS spread curve is 

particularly steep in the 1y to 2y sector (Chart 1), 

which makes for an attractive rolldown profile for 

agency bullets around the 2y maturity point. 

Furthermore, agency/OIS spreads for short maturities 

have stabilised in a tight range since mid-2009 (Chart 

2), improving the basis risk profile. Lastly, agencies' 

carry advantage means that they look even cheaper 

vs OIS or Treasuries on a forward basis (Table 1). 

In Table 1, we present a sample of three agency 

bullets ranging in maturities from 23 to 29 months. 

For instance, FHLMC 1.125 12/11 which currently 

trades at 10bp spread to 2y OTR Tsy, 12bp spread to 

OIS and around 16bp spread to similar maturity 

Treasury note (adjusted for the curve). By going long 

this bullet vs paying fixed in matched maturity OIS 

swap, in 1y time the position should end up at around 

19bp spread to OIS using rolling o/n financing 

(assuming o/n financing doesn’t blow out) or at 

around 16bp spread to OIS using term financing. 

Relative to Tsy, the position should end up at a 33- 

36bp spread on 1y forward basis. This compares 

favourably to Agy/OIS spread of around 3bp and 

Agy/Tsy spread of around 2bp in 11m maturities 

(23m bullet will roll down to the 11m horizon maturity 

in 1y time). In other words, long Agy/short Tsy 

position will build 33-36bp of spread in 1y time, 

whereas the horizon (11m) Tsy spread is currently 

around 4bp, implying a profit of 29-32bp. Similarly, 

long Agy/pay OIS position will build 16-19bp of 

20 

bp 

15 

10 

5 

0 

15 

bp 

10 

5 

-5 

-10 

Chart 1: Agency/OIS Spreads 

Agy / OIS Spreads (First 2 Years of the Curve) 

0 

2/10 5/10 8/10 11/10 2/11 5/11 8/11 11/11 

Chart 2: 1y CM Agy/OIS Spread History 

Breakeven 

1y Const Maturity Agency / OIS Spread 

-5 

Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 

40 

bp 

35 

30 

25 

20 

15 

10 

5 

0 

Chart 3: 1y CM Agy/CMT Spread History 

-5 

Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 

Source: BNP Paribas (All Charts and Table) 

Breakeven 

1y Const Maturity Agency / Tsy Spread 

spread over 1y, implying 12-15bp profit considering 

that horizon maturity (11m) trades at just 4bp spread 

to OIS. Charts 2 and 3 also show that over the last 

seven months, forward Agy/OIS and Agy/Tsy 

spreads have been comfortably under our forward 

level, implying a decent cushion against agency 

underperformance. 

Maturity 

Sergey Bondarchuk 29 January 2010 


29 


Table 1: Sample of Agencies in 2y Sector vs OIS and Tsy Spot and Forward 

SPOT 6M FORWARD 1Y FORWARD 

OIS 

Spread 

Tsy 

Curve 

Spread 

OIS 

Spread 

Curnt OIS Spd 

at Horizon 

Maturity 

Tsy 

Curve 

Spread 

Curnt Tsy Spd 

at Horizon 

Maturity 

OIS 

Spread 

Curnt OIS Spd 

at Horizon 

Maturity 

Tsy 

Curve 

Spread 

Curnt Tsy Spd 

at Horizon 

Maturity 

Spot 

Issue 

Yield 

FHLMC 1.125 12/15/2011 1.011 11 18 14 6 23 11 19 4 36 4 

FNMA 1.875 04/20/2012 1.171 4 13 5 6 17 11 6 4 23 5 

FHLMC 1.75 06/15/2012 1.301 8 18 10 11 23 18 12 6 31 11 

Sergey Bondarchuk 29 January 2010 


30 


US: Poor Housing Underscores MBS Support 

• Housing data in coming months should 

continue to deteriorate as the purchase index 

remains depressed. This underscores 

continued government support for mortgages, 

especially during the typically positive spring 

seasonals. Spreads at the wider end of the 

recent range and carry in higher coupons 

should help mortgages outperform in the near 

term. 

• We continue to favour up in coupon, 

particularly 6s as we approach prepayments. 

Additionally, the 15Y sector looks rich vs 30Ys 

and we like selling 15Y 5.5s vs 30Y 6s. 

Mortgages have seemed to break their widening 

fever seen since the beginning of the year. Money 

manager interest at the wides this week particularly 

helped. But the second leg in mortgage widening that 

started around 12 January may have been aided by 

the overall increase in risk premium as reflected in 

corporate and ABX indices for example (Chart 1). It 

is this backdrop of an overall increase in risk 

premium that presents some risk for the mortgage 

basis as the Fed exit looms. As mortgages richened 

due to Fed purchases last year, investors likely sold 

mortgages and moved to riskier asset classes. 

Creation of excess reserves may have also helped 

money make its way there. As Fed purchases end, 

we could thus see an overall increase in the risk 

premium. Money managers are likely to be the key 

supporters of mortgages after the Fed exit given their 

underweight positioning. As mortgages widened 

considerably through the credit crisis, money 

managers increased their allocation to agency MBS, 

but were unable to shield them from an overall 

increase in risk premia. 

We had a considerably bearish outlook on mortgages 

as a response to the MBSPP end (though positive in 

the short term), and given that outlook we had placed 

a high probability of the Fed extending the 

purchases. The FOMC meeting this week continued 

to leave the door open for that possibility. But given 

the fails occurring in 5.5s, the largest coupon, it 

would be difficult for the Fed to extend the purchase 

programme without some retooling, perhaps buying 

more GNs or moving into specified pools. There is 

only a limited supply of higher coupons. As 

discussed previously, there appear to be more than 

enough bonds to deliver to the Fed, but that it’s 

cheaper to fail than deliver is the likely underlying 

Chart 1: Risky Assets Suffered since mid-Jan; 

Mortgages May have Acted in Sympathy 

100 

95 

90 

85 

80 

75 

70 

12/28/09 

12/31/09 

Source: Bloomberg 

1/3/10 

1/6/10 

Corp CDX 5Y Spd 

ABX - 061- Px (rhs 

- reverse) 

1/9/10 

1/12/10 

1/15/10 

1/18/10 

1/21/10 

1/24/10 

1/27/10 

Chart 2: Mortgage Current Coupon OAS vs the 

5Y Agency (FN) Debt Spread 

100 

80 

60 

40 

20 

0 

-20 

-40 

Curr Cpn LOAS - 5Y Agcy Debt Spd to Lib 

-60 

05 06 07 08 09 10 

Source: BNP Paribas, Yield Book 

Chart 3: Large Bank MBS portfolios vs FNCL 5 

Px 

$ bn 

720 

710 

700 

690 

680 

670 

660 

650 

640 

630 

620 

Jan-09 

Feb-09 

Mar-09 


Apr-09 

Large Bnk Holdings (lhs) 

FNCL 5 Px (rhs, rev) 

May-09 

Jun-09 

Jul-09 

cause of fails. In the event a fail penalty is imposed 

on mortgages, this problem may however diminish. 

Aug-09 

Sep-09 

Oct-09 

Nov-09 

Dec-09 

Jan-10 

99 

100 

101 

102 

103 

104 

105 

78 

79 

80 

81 

82 

83 

84 

85 

86 

$ Px 

Sergey Bondarchuk / Suvrat Prakash / Bulent Baygun / Anish Lohokare 29 January 2010 


31 


After the announcement concerning the GSEs in late 

December, our outlook on spreads is much milder, 

around 15-20 bps of widening. With the 

announcement, agencies in total have about USD 

100 bn in purchasing power for the year, and can act 

as a backstop bid. But we underscore that our milder 

outlook particularly hinges on the GSEs. As shown in 

Chart 2, the spread to agency debt is fairly attractive 

on a historical basis and a small widening could go a 

long way in improving the economics further. 

Past two H.8 reports have shown banks decreasing 

their MBS portfolios (Chart 3: latest release covered 

the week ending 13 January). As shown in Chart 4, 

cash assets of banks have been highly correlated 

with the level of excess reserves in the market. As 

excess reserves reduced over the past few weeks, 

bank cash reduced as well, initially. 

Banks seemed to have then sold mortgages and 

improved their cash position. While this trend is only 

recent, there is a reasonable chance that banks do 

not step in to buy mortgages in size unless they 

cheapen materially. Banks are typically total 

spread/USD price players rather than OAS, and buy 

mortgages when they have a benign outlook on 

volatility. But with vol (gamma) already so depressed, 

they may be reluctant to buy mortgages (though the 

mortgage exposure to vol has technically reduced 

given the burnout seen in the refi index). The winding 

down of liquidity programmes may cause excess 

reserves to decline further. 

Housing data released this week are indicative of the 

need for the government to keep mortgage rates low. 

Both existing and new home sales for December 

came in well below market expectations. The Case- 

Shiller Index was only slightly disappointing, but 

covered November and not December, which should 

be worse. As shown in Chart 5, despite the extension 

of tax credits, the purchase index has not recovered. 

If mortgage rates increase substantially, they may 

hurt the typical housing market improvements due to 

seasonality seen in spring. 

Overall, with the attractive carry in the short term (for 

higher coupons), and the necessity of government 

support in the intermediate term, whether through the 

Fed or GSEs, we continue to favour mortgages. 

Since spreads are at the wider end, it also provides 

investors with an attractive point to initiate new longs. 

In terms of the coupon stack, we continue to like up 

in coupon, particularly 6s. As shown in Chart 5, the 

actual completion of loan mods remains quite low. 

December prepayments may have been influenced 

by faster completion of the origination and 

securitisation process, with banks looking to 

conserve capital, rather than a secular increase (see 

Dec Prepay Commentary). We particularly like up in 

Chart 4: Bank Cash Assets vs Excess Reserves 

1400 

1300 

1200 

1100 

1000 

900 

800 

700 

600 

500 

Dec-08 

Jan-09 

Feb-09 


Mar-09 

Excess Reserves 

Total Bank Cash 

Apr-09 

May-09 

Jun-09 

Chart 5: Purchase Index hasn’t Recovered 

despite Extension of Homebuyer Credits. Refi 

Index had Already Burnt Out 

8000 

7000 

6000 

5000 

4000 

3000 

2000 

1000 

0 

Feb- 

09 

Mar- 

09 

Apr- 

09 


Refi Index 

May- 

09 

coupon as we near January prepayments, since 

prepays may surprise to the downside for this 

reason. We also think that the likelihood of FAS 

166/167 having a measurable impact on 

prepayments is quite low. 

Jul-09 

Aug-09 

Purchase vs Refi Index 

Jun- 

09 

Prch Index (rhs) 

Jul- 

09 

Aug- 

09 

Sep- 

09 

Oct- 

09 

Sep-09 

Nov- 

09 

Oct-09 

Dec- 

09 

Nov-09 

Jan- 

10 

Chart 6: Completion of Loan Mods Poor 

HAMP Total (Dec 09) 

Trial Plan Offers 1,164,507 

# of Trial Mods started 902,620 

Active mods 853,696 

Active Trial Mods 787,231 

Perm Mods Approved by Serv 112,521 

(Perm Mods done 66,465 

Perm Mods awaiting borrower acceptance) 46,056 

Source: financialstability.gov 

Dec-09 

320 

300 

280 

260 

240 

220 

200 

180 



32 


Fannie Mae has not discussed the interpretation of 

not marking loans to market; nor has it provided 

delinquencies by coupon, as Freddie Mac did. 

Neither agency has amended its MBS prospectus yet 

to discuss FAS 166/167 as a risk scenario for 

prepayments as they had done with the Home 

Affordable programme (this is however not required). 

In our view, agencies are more likely to reserve their 

portfolios for acting as a backstop bid, rather than 

using them up for buyouts. 

Given the richness of the 15Y sector, we also like 

selling 15Y 5.5s vs 30Y 6s. Despite 15Y 5.5s 

cheapening vs 30Y 6s over the past couple of days, 

there continues to be value in the trade. In Chart 7, 

we compare prepayment changes from November to 

December for 2007 and 2008 FN 6s. The increases 

in prepayments were fairly similar for the vintages. 

The chart shows delinquencies by vintage for FG 6s 

as discussed in the FRE Q3 10Q (FN 6s should 

show similar relative trends between vintages, 

though overall delinquencies should be much 

higher). If buyouts due to mods were the primary 

cause, we should have seen 2007s increase more 

relative to 2008. 

Chart 7: Prepays vs Dlq 

2007 2008 

Dec FN 30Y 6s 27.7 28.9 

Nov FN 30Y 6s 20.0 22.5 

Chg 7.8 6.4 

Dlq (Q3, FG 6s) 6.65% 3.66% 

Source: Bloomberg, Freddie Mac 

We think that more than one month of mortgage 

applications may have been fitted into December in 

an effort by banks to convert loans to agency MBS to 

save capital. The 2008 vintage has proved to be the 

most callable and, given the better availability of 

HARP now than in April, borrowers may have taken 

advantage of all time rate lows in early December. To 

the extent Janiary prepayments could surprise to the 

downside, and since the increases in December 

were primarily in 30Ys, 30Ys may benefit 

disproportionately from the declines in January. For 

instance, 2008 15Y 5.5s increased by 2 CPR, while 

30Y 6s by 6.4 CPR. 2007 5Y 5.5s slowed marginally, 

but 30Y 6s picked up 7.8 CPR. 



33 


EUR: Eonias Bet on July Jump 

• After having eased from levels seen at the 

start of the year, ECB meetings are gradually 

gaining ground. 

• The biggest step remains between June and 

July, as the prospect of the EUR 442bn expiry 

weighs significantly. 

• STRATEGY: Receive May-July gap, pay Aug- 

Oct gap. 

ECB’s focus is on EUR liquidity 

The ECB is stopping temporary swap lines with the 

Fed, as well as stopping USD liquidity operations 

with EMU banks. At the prospect of the end of these 

operations, demand for dollars at the ECB’s weekly 

tenders has plunged in recent weeks, reaching zero 

this week. What we have seen over the past few 

weeks is less demand at the ECB’s USD tenders and 

more at the MRO. The ECB allotted EUR 63.4bn at 

this week’s MRO, with EUR 58.0bn maturing. 

Demand for 1-week liquidity remained close to levels 

seen in previous weeks. The number of bidders (83) 

was significantly down from last week (101). The 

decrease in the number of bidders is a sign of 

normalisation for most banks but also indicates that 

there is no significant improvement at struggling 

banks. After this week’s tender, liquidity provided to 

the eurosystem with open market operations was 

almost unchanged and remained very high – close to 

EUR 760.0bn (EUR 725bn through OMOs and EUR 

33bn from the covered bond purchase programme). 

This is around EUR 190bn above current needs. In 

other words, excess liquidity increased slightly and 

this prevented any tension on fixing from developing. 

Liquidity expected to remain excessive until June 

Current excess liquidity conditions will persist for a 

while. Even if demand at the MRO collapses in 

coming months, liquidity provided by the three 1y 

tender accounts for EUR 614.4bn, still above 

expected daily requirements (in the EUR 580-610bn 

area). This will continue until the end of June. At this 

stage, there are two major uncertainties. What will 

the ECB decide with regard to short-term open 

market operations while it is gradually removing the 

1y and 6mth tenders? And how to deal with the 

collapse in liquidity at the end of June? 

It is worth bearing in mind that the ECB wants to 

drive the “exit strategy” in order to 1/ drain the excess 

liquidity and 2/ change the structure of funding – 

currently, open market operations at 9% with MROs 

and 91% with LTROs – to the structure prevailing 

before the crisis, i.e. 60-65% with MROs and 35-40% 

billions 

350 

300 

250 

200 

150 

100 

50 

0 

Chart 1: Liquidity Remains High 

Liquidity provided by Open Market operations - 

(reserve requirements + autonomous factors) 

-50 

O/N rate (RHS) 

-100 

Jun Jul Aug Sep Oct Nov Dec Jan 

09 

10 


Chart 2: Forward OIS-Refi Spreads 

10 

0 

-10 

-20 

-30 

-40 

-50 

-60 

-70 

1st 

ECB 

2nd 

ECB 


3rd 

ECB 

4th 

ECB 

5th 

ECB 

6th 

ECB 

7th 

ECB 

8th 

ECB 

9th 

ECB 

0.70 

0.65 

0.60 

0.55 

0.50 

0.45 

0.40 

0.35 

0.30 

0.25 

10th 

ECB 

with 3mth LTROs. In other words, the ECB should 

keep MROs attractive from a relative standpoint. 

Fixed rate and full allotment conditions at the MRO 

could therefore prevail beyond June. In the 

meantime, the last 6m tender at the end of March 

should benefit from the same conditions as the last 

1y tender, i.e. full allotment and post determined rate. 

However, as the tender expires in early October, the 

probability of a rate above 1% is even lower than the 

same probability for the last 1y tender. In such 

conditions, excess liquidity could prevail beyond the 

end of June, leading to lower Eonias in July and 

August. 

Strategy: The probability of excess liquidity 

persisting beyond June is high enough to 

recommend receiving the ECB’s May-Jul gap and to 

pay the ECB’s Aug-Oct gap. 

Percent 



34 


EUR: Timing the 20Y Point 

• The long end of the EUR curve and, more 

specifically, the 20y point offers a relatively 

cheap alternative to outright 2/10s flattener 

strategies that bank on a full normalisation of 

excess liquidity conditions in the Eurosystem. 

• STRATEGY: We suggest receiving the EUR 

10/20/30y butterfly at slightly higher levels (entry 

target in the 58/60bp region). Alternatively, we 

propose looking at 20/30y steepeners on the 

cash curve, looking to enter the trade on a 

consolidation of the current widening trend in 

20y-Fwd 10y ASW. 

0.90 

0.80 

0.70 

0.60 

0.50 

0.40 

0.30 

0.20 

0.10 

Chart 1: Monetary Policy and the Long End 

EUR 10/20/30Y 

EUR 2Y (RHS) 

Reversion to 2Y 

rate implied levels 

0.00 

1999 2001 2003 2005 2007 2009 2011 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

4.5 

5.0 

5.5 

6.0 


Chart 1 plots the EUR 10/20/30y butterfly against the 

level of 2y rates. Aside from a minor RV correction 

(5bp max), there does not seem to be any particular 

dislocation according to our models. 

However, the fly’s directional link with the level of 

short-term interest rates (i.e. the link to ECB policy), 

the relatively high correlation between the fly and the 

2/10s spread (R2: 0.85), as well as the limited cost of 

carry (10bp for 10/20/30s versus 45bp for 2/10s), 

make receiving the fly an attractive strategy for those 

investors looking for: a) a normalisation of Eonia and 

b) an increase in rate hike anticipation (currently 

12x24 Eonia is at 1.60%). 

To substantiate our argument, we present a basic 

model of the EUR curve that reflects the correlation 

structure between the 2y rate and other points alone. 

The results in Table 1 highlight the compression of 

the 10/20/30y fly as a function of a higher 2y rate 

(this argument is also valid for a flatter 2/10s curve). 

Similar arguments can also be made in cash space, 

where the cheapness of 20y government bonds is 

even more evident. As for the swap curve, the 10/20y 

cash curve is relatively steep, while the 20/30y curve 

is still relatively flat. Another way to show the 

cheapness of the 20y point is to compute the implied 

20y-forward 10y cash yield and compare it to the 

20y10y swap rate. Chart 2 plots this 20y-fwd 10y 

ASW for Bunds, OATs and BTPs. 

STRATEGY: The EUR 10/20/30y butterfly has been 

quoted in a 55/62bp range for the past nine months. 

Currently, the fly is at the bottom of this range. With 

excess liquidity likely to persist in Q2, we suggest 

waiting for a better level before receiving the 20y 

rates versus the wings. We are targeting the 58/60bp 

Table 1: Curve Correlation Analysis 

Bump 

Response 

2Y 10Y 20Y 30Y 10/20/30Y 

-100 0.69 2.58 3.22 3.22 63 

-50 1.19 3.02 3.58 3.54 60 

Live 1.69 3.46 3.94 3.86 56 

50 2.19 3.89 4.29 4.18 52 

100 2.69 4.33 4.65 4.50 49 

200 3.69 5.20 5.37 5.14 41 


3.50 

3.00 

2.50 

2.00 

1.50 

1.00 

0.50 

0.00 

Chart 2: Implied 20Y-Fwd 10Y ASW 

20Y10Y ASW 

-0.50 

May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 

region. Similarly, we prefer to wait for a consolidation 

of the 20y-fwd 10y ASW widening trend at slightly 

wider levels before buying 20y bonds versus 30y. 

OAT 

Bund 

BTP 

BTP Curve Fwd Cash Fwd Swap Fwd Zspread 

9/19 vs 5/31 0.85 5.56 4.64 0.93 

9/19 vs 8/39 0.86 5.29 4.28 1.01 

5/31 vs 8/39 0.01 4.91 3.50 1.41 

5/31 vs 9/40 0.06 5.07 3.46 1.61 


Alessandro Tentori 29 January 2010 


35 


EUR: Peripheral EGBs Under Pressure 

• The EUR 8bn syndication of the new 5y GGB 

was not enough to change the climate for Greek 

spreads, which are continuing to hit new highs. 

The Greek PDMA announced a second 

syndication to take place in February (new 10y) 

for EUR 3-5bn… 

• …thereby leaving no breathing space for 

GGBs after the heavy supply of this week. The 

Greek MinFin also announced a roadshow to the 

US and Asia next month in order to drum up 

foreign investors’ interest in GGBs. 

• Contagion to other eurozone countries, 

especially Portugal, is growing fast, thus making 

a default scenario even more unlikely. Ireland 

has been outperforming so far, and we believe 

that this cannot be sustained. Underweight 

Ireland and Portugal. 

Chart 1: GGB/Bund Spread & vs Average EGBs 

5.0 

4.5 

4.0 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 


Ratio of Greek Spreads vs Average EGB Spread 

Ratio of Greek Spreads vs Average Peripherals 

10y GGB/Bund (ASW) RHS 

Chart 2: % of 2010 Total Issuance Completed 

40% 

35% 

30% 

% of Forecast 2010 Supply Completed 

800 

700 

600 

500 

400 

300 

200 

100 

0 

25% 

Greece: EUR 8bn Syndication was not enough 

The first big syndicated GGB (new 5y) issuance 

came earlier than we expected as the Greek PDMA 

completely changed its stance and moved from the 

uncertainty of whether or not to make a second 

private placement or not to the first GGB syndication 

(EUR 8bn with the order book reaching EUR 25bn!) 

and the announcement of a second one in February 

(new 10y). First, we believe that this change in tone 

by the Greek PDMA is a good thing, since it 

demonstrates some confidence that the country is 

able to fund itself. Private placements very often 

send a wrong signal to investors as they indicate that 

the country is reluctant to go to the primary market to 

borrow. What is even worse than actually doing a 

private placement though is to show uncertainty on 

whether you will do it or not; from this perspective 

also, the change in the PDMA’s tone is considered a 

positive development. 

Once the order book had reached EUR 25bn, 

Greece decided to issue EUR 8bn instead of EUR 3- 

5bn initially targeted, at a spread of midswaps 

+350bp from initial guidance of +375bp. Common 

sense was that this would buy at least some time for 

Greece and, if anything, could create some 

downward pressure on spreads. Of course, as 

Moody’s correctly put it, this does not change the big 

picture and the structural fiscal problems of Greece 

are here to stay, but nevertheless it could have 

erased some of the risk related to doubts on 

Greece’s ability to fund its debt that must have been 

incorporated into the extremely wide levels of Greek 

spreads. However, spread compression did not occur 

20% 

15% 

10% 

5% 

0% 


Greece Ireland Italy Portugal Spain 

Chart 3: Contagion to Other EGBs (ex-GGBs) 

55 

40 

25 

10 

-5 

Year-to-Date 

Since Nov 17th 

AUS BEL ITA POR SPA NETH FRA IRE FIN 


Iberian Contagion 

Irish Outperformance 

and the new 5y GGB yield rose 40bp in its first day of 

trading, while the 10y GGB/Bund spread is more 

than 70bp wider this week alone. Chart 1 shows the 

new historical wides of the 10y GGB/Bund spread, 

along with the increasing ratios of Greek spreads 

over average EGBs (now at 5x) and over average 

peripherals (now at 3x). 

The next reasonable questions to ask are what 

happened to the EUR 17bn that was not allocated 

during the syndication and why did the Greek PDMA 

not leave some breathing space to GGBs before 

announcing its plans for a second syndicated deal of 

Ioannis Sokos 29 January 2010 


36 


EUR 3-5bn (new 10y) in February? Compared to last 

week, the situation looks better since Greece has 

already completed 22% of its total 2010 funding 

needs (Chart 2), while some supportive statements 

by EU and ECB officials hit the headlines this week. 

Mr. Trichet said that he trusts that the Greek plan is 

realistic and also necessary, and Mr. Juncker said 

that the Greek plan is a step in the right direction. Mr. 

Soros and Mr. Pryce (Fitch Ratings) were also 

positive on Greece, in sharp contrast to Mr. Roubini’s 

statement that “Greece is already bankrupt”. Despite 

all these comments, Greek spreads exploded once 

again and the Greek PDMA may need a coupon of 

7% in its upcoming 10y syndication. 

Chart 4 shows the bond and T-bills redemptions plus 

the coupon payments that lie ahead for Greece, 

making it obvious that April and May will be the 

heaviest months. This explains why the Greek 

FinMin said that he plans 50% of 2010 issuance to 

take place in Q2. When looking at the maths of it, the 

Greek government has debt obligations of EUR 

27.2bn in the period from 1 Jan until end-May, and it 

has issued EUR 13.6bn so far (EUR 2bn private 

placement, EUR 3.6bn of T-bills and EUR 8bn of new 

5y GGB), meaning there is a need for a further EUR 

13.5bn before the end of May. Of this EUR 27.2bn, 

EUR 16.7bn corresponds to bond redemptions, EUR 

4.8bn to coupon payments and EUR 5.7bn to T-bill 

payments, which are expected to be rolled forward 

with new T-bills. Therefore, under a rough 

approximation, we could say that a further EUR 

11.5bn in GGB issuance is needed before the end of 

May. 

As spreads keep widening, the scenario of some 

form of external help (bailout plan) will gain publicity, 

and the whole subject usually ends up with the 

standard debate between the no bailout clause of the 

Maastricht Treaty and the window for some form of 

financial aid that is allowed for countries in trouble 

due to crises. Both Greece and the EU will continue 

to say that there is no need for a bailout and that 

Greece will find its own way out of the current 

situation through the implementation of the Growth 

and Stability Plan that will be judged at the EcoFin 

meeting on 16 February. Before that though, at the 

beginning of February there will be a report by the 

European Commission on the Greek Growth and 

Stability plan. 

EGBs: Contagion from Greece weighs on Iberia 

What we’ve seen in the last weeks is an acceleration 

of the contagion effects from Greece to other 

peripheral countries. Chart 3 shows the year-to-date 

and 17 November (i.e when the Greek story started) 

to date widening in all EGB spreads except for 

GGBs. Portugal and Spain have seen their spreads 

to Bunds widen aggressively in 2010, by 35bp and 

Chart 4:Greek Debt Expiring in 2010 & Coupons 

9 

7.5 

6 

4.5 

3 

1.5 

0 

Bond Redemptions 

Coupon Payments 

T-bills Redemptions 

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


120 

110 

100 

90 

80 

70 

Chart 5: 10y IRE/POR/SPA/ITA vs Bunds 

10y Yield Spreads vs Bunds 

60 

ITA 

POR 

50 

SPA IRE (RHS) 

40 

Oct-09 Nov-09 Dec-09 Jan-10 


24bp respectively. BTPs have been more resilient 

with a 15bp widening, while the biggest surprise 

comes from Irish bonds, which have stretched by 

only 7bp. Ireland was praised by the EU and ECB for 

the harshness and decisiveness of its fiscal 

measures after deciding to cut spending by EUR 4bn 

in 2010. While this is certainly a step to the right 

direction, it does not justify such an outperformance 

versus other peripherals. We thus choose to 

underweight Irish bonds at these levels. 

Portugal has been the main underperformer, and 

from Wednesday this week it has an extra reason to 

be so as the government announced a higher than 

expected deficit of 9.3% for 2009, with a plan to 

reduce it only to 8.3% this year. PGBs widened by 

11bp the following day, while Portugal has only 

borrowed EUR 1bn so far in 2010, putting more 

pressure on PGBs. We therefore choose to 

underweight PGBs too. Chart 5 shows the 10y 

spreads to Bund of Spain, Portugal, Ireland and Italy. 

The accelerating contagion of the Greek fiscal 

problems to other countries with significant deficits 

and high debt/GDP ratios is one more reason why a 

default in Greece is an extremely unlikely scenario. 

Greece might represent only 2.7% of the eurozone’s 

GDP, but the nature of its problem allow the 

aforementioned contagion to other peripheral 

countries to grow. The upcoming assessment of the 

Growth and Stability plan by the European 

Commission and the EcoFin will be crucial. 

200 

190 

180 

170 

160 

150 

140 

130 

120 

110 

100 

Ioannis Sokos 29 January 2010 


37 


Gilts : Equilibrium at Higher Rates 

• One year projection of aggregate Gilts 

demand paints the potential risk of GBP 50bn of 

excess supply. Equilibrium will be restored with 

gradually increasing rates 

• STRATEGY: Expect investors to add to 

short Gilt positions. In relative value terms 

selling the Gilt 5s10s z-spread box is attractive. 

Moreover the Greek experience suggests that it 

should operate as insurance vs the sovereign 

credit risk. 

Jean-Baptiste Say has been apocryphally attributed 

the thesis according to which in a free market there 

never can be a general glut. This theory will be nicely 

put to test soon by the Gilt auction schedule if the 

BoE announces the suspension of the APF program 

at the February MPC meeting as we expect. In fact, 

where do we stand in terms of aggregate demand? 

Chart 1 plots the evolution of Gilt holdings of main 

investor categories. Overseas investors have shown 

to be quite steadfast investors during the crisis in the 

face of a weak currency. We presume that relatively 

cheap Gilts benefited during the crisis from 

diversification from Dollar assets in global portfolios. 

Holdings by insurance companies and pension funds 

have also been firm during the crisis. We note that 

building societies have not meaningfully increased 

their holdings during the crisis. 

275,000 

225,000 

175,000 

125,000 

75,000 

25,000 

-25,000 

Chart 1: Evolution of Gilts’ Holdings 

1987 Q1 

1990 Q1 


5 

4 

3 

2 

1 

0 

-1 

-2 

-3 

-4 

Oct-08 

Nov-08 

Banks (including BoE) 

Overseas 

Insurance companies & PFs 

Building societies 

Other financial institutions 

Households 

1993 Q1 

1996 Q1 

Chart 2: 10y z-spread FV model 

Dec-08 

Jan-09 


Feb-09 

Mar-09 

Apr-09 

May-09 

Chart 3: Gilt vs GGB 5s10s z-spread 

Jun-09 

Jul-09 

1999 Q1 

Aug-09 

Sep-09 

2002 Q1 

Oct-09 

Nov-09 

2005 Q1 

Dec-09 

Jan-10 

2008 Q1 

We now run the following exercise: we project Gilt 

holdings of the main investors over a year horizon 

assuming a mean growth rate in line with 2008/09 

flows. We apply however some exceptions: we adjust 

banks’ growth for the assumption that BoE will cease 

to purchase Gilts. As they stand, reserve balances 

held at the BoE are GBP 159bn. Since FSA definition 

of liquidity buffer includes them we expect Gilt 

demand by banks and building societies to remain 

subdued this year. We assume further that overseas 

will continue to purchase Gilts, however at half the 

mean growth rate to correct for the increasing 

sovereign downgrade risk. We finally estimate gross 

Gilt supply for FY 2010/11 at GBP 220bn. As a result 

the Gilt market is left with GBP 51bn of supply 

overhang over the next year. We nevertheless agree 

with Say’s theory that auction failures are unlikely 

(Gilt 2049 failure in March 2009 was a timing 

mishap): the market will clear but only gradually 

increasing level of rates will restore the 

demand/supply imbalance. Expect the market to add 

to continue to underweight Gilts across the term 

structure. Being short Gilts will be the “pain trade” 

this year. 

80 

60 

40 

20 

0 

-20 

-40 

-60 

-80 

Jan- 

07 

Apr- 

07 

Jul- 

07 


Gilt 5s10s z-spread box 

GGB 5s10s z-spread box 

Oct- 

07 

Jan- 

08 

Apr- 

08 

Jul- 

08 

In terms of strategy, we find little value in taking 

positions in asset swap space on the 10 year sector 

given that our model suggests that it is currently 

trading at fair value (chart 2). Chart 3 plots the 

evolution of the GGB 5s10s z-spread box vs Gilt 

5s10s z-spread. In our view the Gilt z-spread curve is 

still too steep. In addition a short position is attractive 

as insurance policy vs sovereign credit risk. The 

premium you pay is the (small) negative carry to the 

position. 

Oct- 

08 

Jan- 

09 

Apr- 

09 

Jul- 

09 

Oct- 

09 

Jan- 

10 

Matteo Regesta 29 January 2010 


38 


JGBs: Supply Continues to Weigh 

• The impact of the Ozawa scandal on the 

Japanese economy and equity market is likely 

to be limited. 

• The supply-demand situation for JGBs is 

far more important to the bond market and JGB 

issuance will soar as tax revenues fall. 

• If uncertainties retreat and equity prices 

rise, institutional investors’ dependency on the 

benefits of carry will ease somewhat. 

• This would be a destabilising development 

for the medium sector of the curve where 

banks have increased their long positions. 

Table 1: Outlook for JGB Supply and Demand 

(JPY trn) 

Issued to 

market 

(A) 

Redeemed 

from market 

(B) 

Bought back 

by MoF 

(C) 

Outright 

purchase by 

BoJ (D) 

Jan-2010 9.2 1.6 0.3 1.8 5.5 

Feb-2010 9.5 1.5 0.3 1.8 5.9 

Mar-2010 9.5 11.3 0.3 1.8 -3.8 

Net supply 

(A – B – C – D) 

(Y/Y) 

Apr-2010 9.5 1.6 0.25 1.8 5.8 (+1.9) 

May-2010 9.2 1.6 0.25 1.8 5.6 (+2.0) 

Jun-2010 9.5 9.6 0.25 1.8 -2.2 (+3.0) 


Impact of political scandal is likely to be limited 

Currently, the political situation is complicated in 

Japan. The first regular Diet session since the 

inauguration of the Hatoyama Cabinet was convened 

on 18 January. It was a difficult launch for the DPJ: 

opinion polls show that the popularity of the 

government has fallen below 50% due to the arrest 

of close associates of Secretary General Ozawa, the 

DPJ’s top dog. The opposition will fiercely pursue the 

nexus between politics and money that has 

enmeshed both Ozawa and Hatoyama, seizing this 

golden opportunity to target an abrupt reversal of 

power. 

However, the impact of the Ozawa scandal on the 

Japanese economy and equity market will probably 

be limited for two reasons. First, budgets will be 

enacted. Following Ozawa’s testimony during a 

voluntary hearing conducted by special investigators 

from the Tokyo District Public Prosecutor’s Office, 

the Budget Committee voted on the supplementary 

budget on 25 January. The DPJ had the Lower 

House pass it that same day and its overwhelming 

strength in the Upper House points to the 

supplementary budget’s eventual passage. The 

same holds true for the main government budget for 

2010. 

Second, public support for the DPJ continues to far 

outstrip that for the LDP. Support for the LDP has 

continued to wither since ex-PM Koizumi retired; 

even now, the scandals rocking the DPJ have not 

become tailwinds for the LDP. Within the LDP, 

opinion is split over the compulsory retirement at 70 

for candidates standing for those Upper House seats 

determined by proportional representation. This 

disagreement, together with a lack of funds, suggests 

that the LDP cannot target a reversal of power in this 

summer’s Upper House elections. 

Supply continues to weigh 

Japanese demographics and the view that the LDP’s 

age has passed lie behind the continued dominance 

of the DPJ. Public support for the DPJ first surpassed 

that for the LDP in 2007, the year that Japan’s baby 

boomers turned 60 and began to retire. As the 

average age of the population rises, the proportion of 

the economically disadvantaged will increase and 

public demands to rectify economic disparities and 

perfect the social welfare system will intensify. These 

developments underpin support for the DPJ. 

Even though it is not as interesting as political 

scandals, the supply-demand situation for JGBs is far 

more important to the bond market,. When the FY09 

second supplementary budget was approved on 25 

January, estimates for FY09 tax revenues were 

revised down to JPY 36.9trn and the issuance of new 

financial resource bonds was revised up to 

JPY 53.5trn. Although the MOF, in deference to PM 

Hatoyama, has held down issuance of these bonds 

to JPY 44trn in FY2010, final issuance will, in fact, 

soar as tax revenues fall. 

The short end will continue to find support, since the 

BoJ has intensified its quantitative easing stance. 

The JGB market will probably continue to lack 

direction in the short term. However, if uncertainties 

overseas and in the domestic political situation 

retreat and equity prices rise, institutional investors’ 

dependency on the benefit of carry will ease 

somewhat. This would be a destabilising 

development for the medium sector of the curve 

where banks have increased their long positions. 

Koji Shimamoto 29 January 2010 


39 


Global Inflation Watch 

Very Weak German CPI Data 

Wednesday’s large downward surprise to German 

inflation constituted the latest piece of evidence that 

policymakers should be far more worried about 

deflation rather than inflation in the euro area. The 

national headline CPI fell by 0.6% m/m in January, 

double the -0.3% m/m print expected by the market 

and weaker than our own -0.5% m/m estimate. That 

left the y/y rate flat at 0.8% y/y after three straight 

months of big gains. The HICP numbers were even 

weaker at -0.7% m/m, 0.7% y/y. 

There were two key drivers of the downward surprise 

relative to consensus. First, the increase in energy 

prices in January was weaker than the country’s fuel 

data had implied. Second, and much more 

importantly, there was a very weak core inflation 

print. Based on the five states’ data, we estimate 

core inflation decelerated to 0.8% y/y in January from 

1.1% in December at the national level – its lowest 

level since October 2006. 

Chart 1: German Clothing CPI (% m/m), Sliced* 

Source: Reuters EcoWin Pro, BNP Paribas *Lines show past 5 years %m/m 

changes between January and December. 

Chart 2: Eurozone HICP (% y/y) 

The cut in VAT on restaurants that took effect this 

month played a small part in this fall. Rather, the 

softness of core was relatively widespread, with 

evidence of particularly aggressive discounting in 

clothing prices – which dropped by double their 

previous record fall (Chart 1). That alone sliced 0.2pp 

from core inflation over the month. 

Following the German data, we have revised our 

estimate for today’s eurozone flash HICP release. 

We now expect headline inflation to print 1.1% y/y, 

still up 0.2pp from December thanks to upward 

pressures from food (cold weather) and energy (oil 

price rises in January). We had core inflation ticking 

0.1pp lower to 1.0% on strong seasonal discounting, 

but following the larger than expected decline in 

German core inflation, our estimates suggest we 

should see a 0.9% y/y – which would equal the 

series’ all-time low recorded in 2000. 

This week’s data calendar includes the Japanese 

CPI for December. The rate of decline in the national 

core CPI has steadily moderated for three straight 

months, coming in at -1.7% y/y in November from a 

low of -2.4% in August. We expect this trend to 

continue with the inflation rate forecast at -1.4% y/y in 

December. But the moderation in the decline in the 

CPI does not reflect the easing of deflationary 

pressures, rather it is just a technical reaction to 

falling petroleum product prices a year earlier. This 

factor should continue to temper the CPI’s rate of 

decline in January, after which the fall in the CPI will 

re-accelerate as base effects fade. 


Chart 3: Japanese CPI (% y/y) 

3 

Core CPI 

2 

1 

0 

-1 

CPI excluding energy and food, but not alcohol 

-2 

-3 

02 03 04 05 06 07 08 09 

Source: MIC, BNP Paribas 

Luigi Speranza/Eoin O’Callaghan 29 January 2010 


40 


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 - 0.1 214.6 - -0.3 214.5 - -0.4 

2010 (1) 109.5 - 1.3 109.1 - 1.1 120.9 - 1.3 119.5 - 1.3 219.9 - 2.5 219.9 - 2.5 

2011 (1) 110.2 - 0.7 109.7 - 0.6 122.1 - 1.0 120.6 - 0.9 222.2 - 1.1 222.2 - 1.1 

Q3 2009 108.0 - -0.4 107.8 - -0.5 119.4 - -0.4 118.1 - -0.4 215.2 - -1.6 215.7 - -1.6 

Q4 2009 108.6 - 0.4 108.4 - 0.3 119.7 - 0.4 118.4 - 0.3 217.1 - 1.5 216.2 - 1.4 

Q1 2010 (1) 108.7 - 1.2 108.4 - 1.1 120.3 - 1.3 118.9 - 1.2 218.6 - 2.8 217.9 - 2.8 

Q2 2010 (1) 109.5 - 1.1 109.2 - 1.0 120.8 - 1.1 119.4 - 1.1 219.4 - 2.8 220.5 - 2.9 

Q3 2010 (1) 109.4 - 1.3 109.0 - 1.1 121.1 - 1.5 119.8 - 1.4 220.3 - 2.4 220.8 - 2.4 

Q4 2010 (1) 110.3 - 1.5 109.8 - 1.4 121.4 - 1.4 120.1 - 1.4 221.3 - 1.9 220.3 - 1.9 

Q1 2011 (1) 109.7 - 0.9 109.2 - 0.8 121.6 - 1.1 120.2 - 1.1 221.7 - 1.5 221.1 - 1.5 

Q2 2011 (1) 110.4 - 0.9 109.9 - 0.7 122.2 - 1.2 120.8 - 1.1 222.1 - 1.2 223.1 - 1.2 

Jul 09 107.8 -0.7 -0.7 107.51 -0.7 -0.8 119.1 -0.4 -0.7 117.80 -0.4 -0.7 214.5 0.0 -1.9 215.35 -0.2 -2.1 

Aug 09 108.1 0.3 -0.2 107.89 0.4 -0.3 119.7 0.5 -0.2 118.41 0.5 -0.2 215.4 0.4 -1.4 215.83 0.2 -1.5 

Sep 09 108.2 0.0 -0.3 107.91 0.0 -0.5 119.4 -0.2 -0.4 118.12 -0.2 -0.4 215.8 0.2 -1.3 215.97 0.1 -1.3 

Oct 09 108.4 0.2 -0.1 108.16 0.2 -0.3 119.5 0.1 -0.2 118.23 0.1 -0.2 216.4 0.3 -0.2 216.18 0.1 -0.2 

Nov 09 108.5 0.1 0.5 108.28 0.1 0.4 119.6 0.1 0.4 118.31 0.1 0.3 217.3 0.4 1.9 216.33 0.1 1.8 

Dec 09 108.9 0.3 0.9 108.61 0.3 0.8 120.0 0.3 0.9 118.60 0.2 0.8 217.5 0.1 2.8 215.95 -0.2 2.7 

Jan 10 (1) 108.2 -0.6 1.1 107.88 -0.7 1.0 119.9 -0.1 1.3 118.51 -0.1 1.2 218.1 0.3 2.8 216.98 0.5 2.8 

Feb 10 (1) 108.7 0.4 1.2 108.35 0.4 1.0 120.4 0.4 1.3 119.00 0.4 1.2 218.6 0.2 2.6 217.77 0.4 2.6 

Mar 10 (1) 109.2 0.5 1.3 108.94 0.5 1.2 120.5 0.1 1.2 119.16 0.1 1.1 218.9 0.1 2.9 218.93 0.5 2.9 

Apr 10 (1) 109.5 0.2 1.2 109.16 0.2 1.0 120.7 0.1 1.2 119.32 0.1 1.1 219.2 0.1 3.1 219.93 0.5 3.1 

May 10 (1) 109.5 0.0 1.2 109.21 0.0 1.0 120.8 0.1 1.2 119.46 0.1 1.1 219.4 0.1 3.1 220.59 0.3 3.1 

Jun 10 (1) 109.5 0.0 1.0 109.14 -0.1 0.8 120.9 0.0 1.1 119.50 0.0 1.0 219.6 0.1 2.4 220.88 0.1 2.4 

Jul 10 (1) 109.1 -0.4 1.2 108.66 -0.4 1.1 120.8 0.0 1.5 119.48 0.0 1.4 219.9 0.2 2.5 220.83 0.0 2.5 

Aug 10 (1) 109.3 0.3 1.1 108.94 0.3 1.0 121.3 0.4 1.4 119.93 0.4 1.3 220.3 0.2 2.3 220.72 -0.1 2.3 

Sep 10 (1) 109.7 0.3 1.4 109.32 0.3 1.3 121.3 0.0 1.6 119.95 0.0 1.6 220.7 0.2 2.3 220.84 0.1 2.3 

Oct 10 (1) 110.1 0.3 1.5 109.69 0.3 1.4 121.4 0.1 1.6 120.05 0.1 1.5 221.0 0.1 2.1 220.84 0.0 2.2 

Nov 10 (1) 110.2 0.1 1.5 109.77 0.1 1.4 121.4 0.0 1.4 120.02 0.0 1.4 221.3 0.1 1.9 220.32 -0.2 1.8 

Dec 10 (1) 110.5 0.3 1.5 110.08 0.3 1.4 121.5 0.1 1.3 120.12 0.1 1.3 221.5 0.1 1.8 219.80 -0.2 1.8 

Updated 

Next 

Release 

Jan 28 

Jan Flash HICP (Jan 29) 

Jan 15 

Jan CPI (Feb 23) 

Jan 15 


Source: BNP Paribas, (1) Forecasts 

Chart 4: Eurozone HICP (% y/y) 

Chart 5: US Shelter Prices Drive Core CPI Lower 


While headline inflation troughed in July, core inflation is forecast 

to continue grinding lower, as the output gap weighs on ex-food, 

ex-energy prices. 


The plunge in shelter inflation remains the driver of the underlying 

trend in the CPI. Inflation in core goods has eased, however, 

following a temporary boost from a series of tobacco tax hikes and 

a sharp contraction in vehicle inventories. 



41 



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 (1) 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) 98.9 - -1.4 98.9 - -1.4 113.8 - 2.7 221.6 - 3.7 302.8 - 1.0 194.3 - 1.6 

2011 (1) 98.5 - -0.4 98.5 - -0.4 115.0 - 1.0 227.9 - 2.8 311.9 - 3.0 197.7 - 1.7 

Q3 2009 100.0 - -2.3 100.1 - -2.3 111.3 - 1.5 214.4 - -1.4 299.5 - -1.2 191.6 - 1.6 

Q4 2009 (1) 99.7 - -1.8 99.9 - -1.8 112.1 - 2.1 216.9 - 0.6 301.3 - -0.4 193.2 - 2.3 

Q1 2010 (1) 99.5 - -1.4 99.1 - -1.4 112.8 - 3.2 218.5 - 3.6 299.8 - 0.5 192.7 - 1.9 

Q2 2010 (1) 98.6 - -1.8 98.7 - -1.8 113.7 - 2.8 221.3 - 4.1 301.5 - 0.6 193.7 - 1.4 

Q3 2010 (1) 98.5 - -1.5 98.6 - -1.5 113.9 - 2.4 222.3 - 3.7 302.5 - 1.0 194.3 - 1.4 

Q4 2010 (1) 98.9 - -0.8 99.1 - -0.8 114.7 - 2.3 224.4 - 3.4 307.5 - 2.1 196.7 - 1.8 

Q1 2011 (1) 98.9 - -0.6 98.5 - -0.6 114.5 - 1.5 225.3 - 3.1 306.7 - 2.3 195.8 - 1.6 

Q2 2011 (1) 98.6 - 0.0 98.7 - 0.0 115.2 - 1.3 227.7 - 2.9 310.0 - 2.8 197.0 - 1.7 

Jul 09 100.1 -0.1 -2.2 100.1 -0.2 -2.2 110.9 -0.1 1.8 213.40 0.0 -1.4 298.8 -0.5 -0.9 191.1 -0.2 1.8 

Aug 09 99.9 -0.2 -2.4 100.1 0.0 -2.4 111.4 0.5 1.6 214.40 0.5 -1.3 299.4 0.2 -0.8 191.5 0.2 1.9 

Sep 09 100.0 0.1 -2.2 100.2 0.1 -2.3 111.5 0.1 1.1 215.30 0.4 -1.4 300.4 0.3 -1.6 192.3 0.4 1.4 

Oct 09 99.8 -0.2 -2.3 100.1 -0.1 -2.2 111.7 0.2 1.5 216.00 0.3 -0.8 301.1 0.3 -1.5 193.0 0.3 1.9 

Nov 09 99.8 0.0 -1.7 99.9 -0.2 -1.7 112.0 0.3 1.9 216.60 0.3 0.3 301.0 0.0 -0.7 193.0 0.0 2.3 

Dec 09 (1) 99.6 -0.2 -1.4 99.7 -0.2 -1.4 112.6 0.6 2.9 218.01 0.7 2.4 301.7 0.2 0.9 193.5 0.2 2.7 

Jan 10 (1) 99.6 0.0 -1.2 99.3 -0.4 -1.2 112.5 -0.1 3.5 217.36 -0.3 3.5 299.1 -0.9 0.4 192.2 -0.6 2.2 

Feb 10 (1) 99.5 -0.1 -1.5 98.9 -0.4 -1.5 112.8 0.3 3.0 218.44 0.5 3.3 299.7 0.2 0.6 192.6 0.2 1.9 

Mar 10 (1) 99.4 -0.1 -1.6 99.1 0.2 -1.6 113.2 0.3 3.1 219.83 0.6 4.0 300.6 0.3 0.6 193.1 0.2 1.6 

Apr 10 (1) 98.6 -0.8 -2.1 98.6 -0.5 -2.1 113.4 0.2 3.0 220.76 0.4 4.4 301.4 0.3 0.7 193.7 0.3 1.6 

May 10 (1) 98.6 0.0 -1.8 98.7 0.1 -1.8 113.7 0.3 2.7 221.32 0.3 4.0 301.3 0.0 0.6 193.6 0.0 1.4 

Jun 10 (1) 98.6 0.0 -1.6 98.7 0.0 -1.6 113.8 0.1 2.6 221.95 0.3 4.0 301.7 0.1 0.5 193.8 0.1 1.2 

Jul 10 (1) 98.5 -0.1 -1.6 98.5 -0.2 -1.6 113.3 -0.4 2.2 221.45 -0.2 3.8 300.8 -0.3 0.7 193.3 -0.3 1.2 

Aug 10 (1) 98.4 -0.1 -1.5 98.6 0.1 -1.5 114.3 0.8 2.6 222.56 0.5 3.8 301.7 0.3 0.8 193.9 0.3 1.3 

Sep 10 (1) 98.5 0.1 -1.5 98.7 0.1 -1.5 114.2 -0.1 2.4 222.93 0.2 3.5 305.2 1.2 1.6 195.8 0.9 1.8 

Oct 10 (1) 98.8 0.3 -1.0 99.1 0.4 -1.0 114.6 0.3 2.6 223.98 0.5 3.7 307.1 0.6 2.0 196.6 0.4 1.9 

Nov 10 (1) 99.0 0.2 -0.8 99.1 0.0 -0.8 114.6 0.0 2.3 224.16 0.1 3.5 307.2 0.0 2.0 196.7 0.1 1.9 

Dec 10 (1) 98.9 -0.1 -0.7 99.0 -0.1 -0.7 114.9 0.3 2.0 224.97 0.4 3.2 308.4 0.4 2.2 196.6 -0.1 1.6 

Updated 

Next 

Release 

Dec 25 

Dec CPI (Jan 28) 

Jan 19 


Jan 12 




Chart 7: UK CPI (% y/y) 


Inflation is likely to remain heavily in negative territory for the 

foreseeable future. 


Inflation surprised to the upside in December for the 16 th time in the 

past 21 months. We expect CPI inflation to breach the 3% y/y 

threshold in January but to moderate subsequently. 



42 



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) 116.1 1.5 115.2 1.4 128.1 1.9 120.6 1.8 172.8 - 3.0 - - 2.8 

2011 (1) 117.7 1.4 116.6 1.2 131.1 2.3 122.9 2.0 178.5 - 3.3 - - 2.9 

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 (1) 115.2 1.2 1.4 114.6 0.6 1.7 127.1 0.4 1.9 119.8 0.4 2.3 170.5 0.6 2.6 - - 3.1 

Q2 2010 (1) 115.8 2.2 1.1 115.1 1.7 1.3 128.2 0.9 1.9 120.8 0.9 1.9 171.9 0.8 2.9 - - 2.7 

Q3 2010 (1) 116.5 2.2 1.5 115.5 1.4 1.4 128.2 0.0 1.9 120.6 -0.2 1.7 173.7 1.0 3.0 - - 2.5 

Q4 2010 (1) 116.9 1.6 1.8 115.8 1.2 1.2 129.1 0.7 2.0 121.1 0.4 1.5 175.0 0.8 3.3 - - 2.8 

Q1 2011 (1) 117.3 1.2 1.8 116.2 1.2 1.4 129.6 0.4 2.0 121.4 0.3 1.4 176.2 0.7 3.4 - - 2.9 

Q2 2011 (1) 117.6 0.9 1.5 116.4 1.0 1.2 131.0 1.1 2.2 122.9 1.2 1.7 177.8 0.9 3.4 - - 2.9 

Updated 

Jan 22 

Jan 11 Jan 27 

Next 

Release 


Jan CPI (Feb 10) Q1 CPI (Apr 28) 


Chart 8: Canadian Total vs. Core CPI 

Chart 9: Australian CPI (% y/y) 


After plunging to a 56-year low last July, headline inflation is already 

back into positive territory. However, the large amount of spare 

capacity and the strong CAD suggest core inflation will continue to 

ease well into this year. 


Inflation is slowing, broadly in line with the RBA’s forecast. However, 

we believe inflation will be higher than the RBA expects at the two 

year ahead horizon, given the improving outlook for growth. 

CPI Data Calendar for the Coming Week 

Day GMT Economy Indicator Previous 

BNPP 

F’cast 

Consensus Comment 

Fri 29/01 23:30 Japan CPI National y/y : Dec -1.9% -1.8% -1.7% Cosmetic 

23:30 Core CPI National y/y : Dec -1.7% -1.4% -1.3% rise 

23:30 CPI Tokyo y/y : Jan -2.3% -2.0% -2.1% 

23:30 

Core CPI Tokyo y/y : Jan -1.9% -1.8% -1.8% 

(28/01) 

08:00 Spain HICP Flash y/y : Jan 0.9% 1.3% 1.2% 

10:00 Euroland HICP (Flash) y/y : Jan 0.9% 1.1% 1.2% Rebound continues 

Fri 05/02 10:00 Italy CPI (NIC, Prel) m/m : Jan 0.2% 0.0% n/a 

10:00 CPI (NIC, Prel) y/y : Jan 1.0% 1.2% n/a 

10:00 HICP (Prel) m/m : Jan 0.2% -1.4% n/a 

10:00 HICP (Prel) y/y : Jan 1.1% 1.4% n/a 

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision 




43 


Inflation: BEs Collapsing in Europe 

• GLOBAL: Weak but key data looming. 

• EUR: Bearish. 2/10y BE Steepener. 

• USD: Favour 10y TIPS (BE) into month-end. 

• GBP: Further BE curve post UKTi-40. 

Chart 1: Jan Surprising to Downside in Europe 

0.60% 

Richen Jul 

2009 2008 2007 2006 2005 

0.40% 

2004 2003 2002 2001 

0.20% 

0.00% 

-0.20% 

-0.40% 

Cheapen Apr & Sep 

GLOBAL: Equities and commodities are lower as the 

-1.00% 

Maturities 

flight to quality intensifies on weak economic data 

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

(US new home sales and UK GDP), unprecedented 

Chart 2: 2/10y BE Curve Too Flat at Fwds 

widening of Greek bond spreads and further inflation 

120 

80 

supply. Breakevens are down everywhere with 

BTPEI12 / OATI17 Breakeven 

100 

100 

OATI17 Breakeven Rhs 

Europe underperforming sharply following very weak 

120 

80 

German preliminary CPI data. Oil fell to USD 73/bbl, 

140 

60 

shrugging off bullish DoE inventory data. After a less 

160 

dovish FOMC, the State of Union address triggered a 

40 

180 

mild consolidation in risky assets. We maintain our 

200 

20 

negative call on rich EUR breakevens, and still 

220 

0 

favour GBP and USD breakevens at least up to 10y 

240 

-20 

1-Apr Fwd Not 

maturities. Focus on key economic data next week 

Priced! 260 

including US Q4 GDP, NFP, ISM. 

-40 

280 

Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 

EUR: Collapsing breakevens across maturities. 

German preliminary HICP printed -0.7% m/m vs. 

Charts source: Bloomberg, BNP Paribas 

-0.4% consensus due to very weak core inflation and 

despite higher food inflation. The trend of increased 

EUR 650mn BTPei-41 re-opening was better 

January discounting (Chart 1) intensified – German 

received (premium of 38 cents, bid/cover at 1.84). 

discounts were nearly twice those of recent years. USD: 7y+ breakevens have been remarkably 

We expect the deceleration in core to materialise in resilient given the broader flight to quality. The front 

other countries in Jan due to similar discount end may remain volatile – we stay bearish. The TIPS 

practices and limited ability to increase administered Jan-11 is not suffering from its drop out of the TIPS 

prices (unlike most years) but to be less pronounced Index. Historically, this is usually priced in advance – 

than the surprise in Germany. We now expect Jan the Jan-11 has looked the cheapest front TIPS vs. 

HICP Ex-tob at 107.88, -0.67% m/m implying very our forecasts for some months. That said, any 

negative carry in the month of March. At the 2y point, significant concession would represent a buying 

1-April BE forwards are close to the top of their 9m opportunity. 10y TIPS should benefit from index 

range when upcoming negative carry, deflationary extension bid (+0.20y) and inflows into the product at 

news, widening of peripherals and risk averse asset end-January, particularly ahead of new 30y TIPS 

markets suggest they should be closer to their 9m issuance in February which should keep 15y+ TIPS 

lows. This is typically priced in February and frontend 

suppressed. Whilst TIPS Jan-20/Jan-25 BE spread 

(2-5y) BEs have exhibited negative total returns looks quite flat at +5bp, it could invert into the 30y 

in both Jan and Feb in four of the past five years. We supply. 

stay negative on front-end EUR BEs. Meanwhile, the 

10y remains depressed in the cash inflation curve 

GBP: Breakevens under pressure as UKTi-40 

with the EUR 1.052bn BTPei-17 tap weighing. It 

syndication failed to impress triggering volatility at the 

came with a premium of only 3 cents, bid/cover of 

long end. The size of the book was just above GBP 

1.58). The 2/10y BE curve remains way too flat esp. 4bn – less than half that of 2009’s linker syndications 

on a forward basis – we keep our BTPei-12/OATi-19 

and GBP 3.5bn was issued compared to GBP 5bn 

BE steepener. The trade has 10-20bp further 

for both UKTi-42 and -50 in Q3 2009. The UKTi-40 

potential (1-Apr in negative territory!). The negative 

came at UKTi-37 RY – 3bp, in the middle of our fair 

Jan surprise is worth 5-10bp in itself and the recent 

value range but not rich. Investors seem concerned 

widening in peripheral/core nominal spreads has not 

by the prospect of increased linker issuance in FY 

yet been fully reflected in real spreads, leaving BTPei 10/11 whilst the lack of a RY concession since the 

BEs richer across the curve. Long-end breakevens 

coupon fixing did not help. We continue to favour 

also suffered early in the week although the smaller 

shorter maturities (up to 10y) and favour a flatter 

inflation curve ahead. 

Shahid Ladha / Herve Cros 29 January 2010 


44 


-0.60% 

-0.80%

Pricing Date 

Repo Rate 

EUR DRI 

FRF DRI 

Sett. Date 

Table 1: BNP Paribas Carry Analysis 

Real BE Real BE Real BE Real BE Real BE Real BE 

BTANEI Jul-10 -1.65% 2.02% 35.0 35.5 -218.4 -216.0 -180.3 -173.9 - 

BTPEI Sep-10 -0.78% 1.57% 38.2 33.5 -124.7 -135.6 -55.6 -74.9 168.9 111.8 - - 

OATEI Jul-12 -0.23% 1.52% 10.7 7.3 -21.4 -28.7 -3.2 -14.9 25.0 1.3 23.4 -18.0 

BTPEI Sep-12 0.45% 1.76% 12.1 6.6 -15.5 -27.6 4.3 -15.0 39.2 -1.6 64.0 -23.9 

BOBLEI Apr-13 0.32% 1.26% 9.7 6.4 -13.5 -20.6 2.2 -9.1 28.2 5.1 40.9 -1.5 

BTPEI Sep-14 1.10% 1.67% 8.1 3.7 -6.4 -15.9 6.2 -8.9 29.0 -2.3 48.4 -13.5 

OATEI Jul-15 0.80% 1.69% 6.3 2.9 -6.3 -13.5 3.7 -7.7 20.8 -1.9 31.9 -11.7 

BUNDEI Apr-16 0.92% 1.59% 5.8 2.8 -5.2 -11.6 3.8 -6.3 19.2 -1.1 29.9 -8.6 

BTPEI Sep-17 1.75% 1.78% 5.8 2.0 -2.4 -10.6 6.2 -6.6 22.3 -3.8 38.1 -12.5 

BTPEI Sep-19 2.10% 1.92% 5.0 1.5 -1.3 -8.8 6.1 -5.6 20.2 -3.3 34.9 -11.3 

BUNDEI Apr-20 1.42% 1.77% 4.1 1.6 -2.4 -7.7 3.7 -4.6 14.6 -2.1 23.6 -8.1 

OATEI Jul-20 1.51% 1.94% 4.1 1.3 -2.3 -8.3 4.0 -5.5 15.2 -3.8 24.6 -11.7 

BTPEI Sep-23 2.39% 2.08% 4.0 0.9 -0.6 -7.2 5.2 -5.2 16.2 -4.8 28.1 -12.2 

GGBEI Jul-25 4.93% 2.06% 5.5 0.2 2.8 -8.4 10.5 -6.8 27.2 -7.6 50.5 -19.8 

GGBEI Jul-30 4.90% 2.28% 4.3 -0.7 2.2 -8.5 8.2 -8.4 21.2 -12.5 39.0 -29.4 

OATEI Jul-32 1.81% 2.29% 2.4 0.4 -1.0 -5.3 2.6 -4.1 9.2 -4.2 14.9 -10.5 

BTPEI Sep-35 2.35% 2.51% 2.3 0.0 -0.4 -5.5 3.0 -4.9 9.4 -6.5 16.0 -14.4 

OATEI Jul-40 1.80% 2.36% 1.7 0.1 -0.7 -4.3 1.9 -3.7 6.5 -4.3 10.5 -9.9 

BTPEI Sep-41 2.61% 2.32% 2.2 0.0 -0.1 -4.8 3.0 -4.2 9.0 -5.4 15.4 -12.4 

FRF 

OATI Jul-11 -0.57% 1.37% 11.6 8.8 0.0 -6.1 27.7 17.6 44.0 23.8 10.2 17.3 

OATI Jul-13 0.07% 1.69% 6.4 2.9 3.2 -4.3 16.0 4.1 26.1 2.0 29.0 -16.0 

OATI Jul-17 1.05% 1.92% 4.0 0.9 3.7 -3.0 10.7 0.2 18.5 -2.3 27.0 -12.8 

OATI Jul-19 1.36% 1.98% 3.5 0.6 3.5 -2.8 9.5 -0.4 16.6 -2.9 25.1 -12.2 

OATI Jul-23 1.70% 2.15% 2.8 0.4 3.1 -2.2 7.9 -0.4 13.9 -2.7 21.5 -10.2 

OATI Jul-29 1.77% 2.30% 2.3 0.0 2.5 -2.3 6.3 -1.2 11.1 -3.5 17.1 -10.7 

USD 

Pricing Date 

Repo Rate 

USD DRI 

Sett. Date 

28-Jan-10 

108.29179 

118.32036 

02-Feb-10 

28-Jan-10 

216.31519 

29-Jan-10 

EUR 

Term 1 

Term 2 

3m 

6m 

0.39% 

0.40% 

0.41% 0.50% 

108.61000 

107.88256 108.39167 

109.20726 

118.60000 118.51495 

119.00967 

119.46301 

01-Mar-10 

01-Apr-10 

03-May-10 

02-Aug-10 

Term 1 

0.13% 

215.94900 

01-Mar-10 

Term 2 

0.13% 

216.97541 

01-Apr-10 

12m 

0.80% 

109.78565 

120.02061 

02-Feb-11 

3m 

6m 

12m 

0.14% 0.20% 

0.41% 

217.71853 

220.52829 

220.34043 

29-Apr-10 29-Jul-10 31-Jan-11 

Yield BE Real BE Real BE Real BE Real BE Real BE 

TIPS Apr-10 -1.10% 1.15% -221.8 -216.3 244.8 281.4 - - - - - - 

TIPS Jan-11 -0.93% 1.24% -29.9 -31.7 15.5 11.7 53.8 47.8 301.1 288.9 - - 

TIPS Apr-11 -0.71% 1.17% -21.7 -24.2 15.7 10.3 45.8 37.6 209.7 192.0 358.5 339.3 

TIPS Jan-12 -0.47% 1.36% -12.0 -15.5 11.6 4.3 29.7 18.8 112.8 89.1 105.4 56.4 

TIPS Apr-12 -0.35% 1.37% -10.1 -13.8 11.2 3.5 27.3 15.9 98.7 74.4 92.0 40.9 

TIPS Jul-12 -0.38% 1.50% -9.3 -12.8 9.7 2.3 24.0 13.0 86.5 62.9 75.2 26.9 

TIPS Apr-13 -0.15% 1.68% -6.3 -10.2 8.5 0.3 19.6 7.4 65.3 40.1 58.5 6.0 

TIPS Jul-13 0.04% 1.63% -5.4 -9.5 9.0 0.7 19.9 7.6 64.5 38.6 62.0 8.6 

TIPS Jan-14 0.30% 1.62% -4.1 -8.3 9.1 0.6 19.2 6.7 59.6 33.3 61.4 7.3 

TIPS Apr-14 0.26% 1.81% -3.9 -8.1 8.3 -0.2 17.6 5.0 54.3 28.4 54.5 0.7 

TIPS Jul-14 0.42% 1.71% -3.4 -7.6 8.6 0.1 17.7 5.2 53.9 27.7 56.3 2.7 

TIPS Jan-15 0.59% 1.78% -2.8 -7.0 8.3 -0.3 16.8 4.0 49.8 23.3 53.7 -0.4 

TIPS Jul-15 0.67% 1.92% -2.4 -6.7 7.9 -0.8 15.7 2.9 46.1 19.5 50.1 -4.1 

TIPS Jan-16 0.82% 1.95% -2.0 -6.3 7.7 -1.0 15.1 2.4 43.6 17.2 48.6 -5.2 

TIPS Jul-16 0.88% 2.06% -1.8 -6.1 7.4 -1.3 14.4 1.7 41.3 14.9 46.2 -7.2 

TIPS Jan-17 0.99% 2.11% -1.5 -5.7 7.2 -1.4 13.8 1.3 39.1 13.2 44.4 -7.9 

TIPS Jul-17 1.05% 2.19% -1.4 -5.5 6.9 -1.5 13.3 0.9 37.2 11.7 42.5 -9.0 

TIPS Jan-18 1.13% 2.25% -1.1 -5.1 6.5 -1.6 12.4 0.5 34.4 10.1 39.6 -9.4 

TIPS Jul-18 1.18% 2.30% -1.0 -5.0 6.2 -1.9 11.7 -0.1 32.4 8.2 37.4 -11.2 

TIPS Jan-19 1.23% 2.35% -0.9 -4.7 6.2 -1.4 11.6 0.5 31.8 9.2 37.1 -8.4 

TIPS Jul-19 1.29% 2.36% -0.8 -4.6 5.9 -1.7 11.0 -0.1 30.2 7.5 35.4 -10.1 

TIPS Jan-20 1.33% 2.33% -0.7 -4.4 5.6 -1.9 10.4 -0.5 28.4 6.4 33.4 -10.8 

TIPS Jan-25 1.83% 2.39% -0.2 -3.7 4.8 -2.4 8.6 -1.8 22.6 1.4 28.0 -14.1 

TIPS Jan-26 1.88% 2.43% -0.1 -3.5 4.5 -2.2 8.1 -1.7 21.1 1.3 26.2 -12.9 

TIPS Jan-27 1.92% 2.42% -0.1 -3.4 4.4 -2.2 7.9 -1.7 20.6 1.1 25.7 -12.9 

TIPS Jan-28 1.95% 2.43% -0.1 -3.3 4.1 -2.4 7.3 -2.1 18.9 0.2 23.6 -13.6 

TIPS Apr-28 1.99% 2.44% -0.1 -3.1 4.5 -1.6 8.1 -0.8 21.0 2.8 26.4 -9.4 

TIPS Jan-29 1.97% 2.48% -0.1 -3.1 4.1 -1.9 7.3 -1.4 19.1 1.4 23.9 -11.2 

TIPS Apr-29 1.99% 2.45% -0.1 -3.1 4.4 -1.6 7.9 -0.9 20.3 2.6 25.6 -9.4 

TIPS Apr-32 1.97% 2.50% -0.1 -2.9 3.8 -1.9 6.8 -1.5 17.6 0.8 22.1 -11.2 

GBP 

Pricing Date 

Repo Rate 

Sett. Date 

28-Jan-10 Term 1 

0.49% 

29-Jan-10 

01-Mar-10 

Term 2 

0.50% 

01-Apr-10 

Yield BE Real BE Real BE Real BE Real BE Real BE 

UKTi Aug-11 -1.04% 1.70% -28.1 -29.6 -3.6 -6.7 34.0 29.0 94.8 84.2 541.4 656.4 

UKTi Aug-13 -0.26% 2.44% -10.4 -15.1 2.5 -7.0 20.0 6.1 47.5 18.2 87.3 26.2 

UKTi Jul-16 0.54% 2.77% -4.7 -9.0 3.7 -4.8 14.5 2.0 32.3 6.7 57.8 5.6 

UKTi Nov-17 0.65% 3.01% 9.4 5.2 5.6 -2.6 12.2 0.2 31.9 7.3 51.6 1.9 

UKTi Apr-20 0.96% 3.01% -2.7 -6.5 3.2 -4.3 10.5 -0.4 23.0 0.8 41.0 -3.6 

UKTi Nov-22 1.02% 3.33% 6.4 3.2 4.2 -2.0 8.7 -0.3 21.9 3.6 35.3 -1.0 

UKTi Jul-24 1.11% 3.24% -1.9 -5.0 2.6 -3.6 8.1 -1.0 17.5 -0.8 30.6 -5.7 

UKTi Nov-27 0.99% 3.37% 4.5 1.9 2.9 -2.4 6.1 -1.7 15.4 -0.4 24.5 -6.6 

UKTi Jul-30 0.98% 3.38% -1.6 -3.9 1.9 -2.7 6.2 -0.5 13.5 -0.2 23.3 -3.4 

UKTi Nov-32 0.85% 3.51% 3.6 1.3 2.2 -2.4 4.7 -2.1 11.9 -1.8 18.6 -8.1 

UKTi Jan-35 0.81% 3.57% -1.3 -3.5 1.3 -3.0 4.5 -1.7 9.7 -2.8 16.5 -8.1 

UKTi Nov-37 0.71% 3.64% 2.9 0.9 1.7 -2.4 3.8 -2.3 9.5 -2.6 14.7 -8.9 

UKTi Nov-42 0.61% 3.72% 2.3 0.4 1.4 -2.4 3.0 -2.6 7.5 -3.6 11.5 -10.1 

UKTi Nov-47 0.50% 3.78% 2.1 0.3 1.2 -2.4 2.6 -2.6 6.6 -3.7 9.9 -10.0 

UKTi Mar-50 0.49% 3.78% 1.9 0.2 1.0 -2.3 2.3 -2.6 6.0 -4.0 9.0 -10.2 

UKTi Nov-55 0.46% 3.75% 1.9 0.3 1.0 -2.1 2.3 -2.3 5.9 -3.3 8.8 -9.0 

JPY 

Pricing Date 

Repo Rate 

JPY DRI 

Sett. Date 

28-Jan-10 

99.952 

02-Feb-10 

Term 1 

0.12% 

99.700 

10-Mar-10 

Term 2 

0.12% 

99.300 

10-Apr-10 

3m 

0.13% 

98.953 

06-May-10 

6m 

0.13% 

98.674 

02-Aug-10 

12m 

0.14% 

99.100 

02-Feb-11 

Yield BE Yield BE Yield BE Real BE Real BE Real BE 

JGBI-1 Mar-14 1.31% -0.92% -4.7 -5.4 -12.8 -14.1 -18.9 -20.7 -20.8 -24.5 8.3 0.0 

JGBI-2 Jun-14 1.27% -0.84% -4.4 -5.2 -12.1 -13.5 -17.8 -19.8 -19.8 -23.8 6.5 -2.3 

JGBI-3 Dec-14 1.34% -0.85% -3.8 -4.6 -10.4 -11.9 -15.4 -17.5 -16.6 -20.8 7.6 -1.7 

JGBI-4 Jun-15 1.41% -0.84% -3.3 -4.2 -9.1 -10.7 -13.4 -15.7 -14.1 -18.6 8.3 -1.7 

JGBI-5 Sep-15 1.30% -0.70% -3.4 -4.3 -9.2 -10.9 -13.5 -15.9 -14.7 -19.4 5.5 -4.9 

JGBI-6 Dec-15 1.36% -0.72% -3.1 -4.1 -8.6 -10.4 -12.7 -15.1 -13.5 -18.4 6.4 -4.3 

JGBI-7 Mar-16 1.40% -0.71% -3.0 -4.0 -8.2 -10.0 -12.0 -14.6 -12.6 -17.7 6.9 -4.3 

JGBI-8 Jun-16 1.53% -0.80% -2.6 -3.7 -7.5 -9.4 -11.0 -13.7 -10.9 -16.2 9.1 -2.4 

JGBI-9 Sep-16 1.46% -0.69% -2.7 -3.8 -7.5 -9.4 -11.0 -13.7 -11.3 -16.7 7.3 -4.3 

JGBI-10 Dec-16 1.48% -0.67% -2.6 -3.6 -7.2 -9.2 -10.5 -13.3 -10.7 -16.3 7.3 -4.7 

JGBI-11 Mar-17 1.54% -0.69% -2.4 -3.5 -6.8 -8.8 -9.9 -12.8 -9.8 -15.5 8.2 -4.0 

JGBI-12 Jun-17 1.61% -0.72% -2.2 -3.3 -6.3 -8.4 -9.3 -12.2 -8.8 -14.7 9.0 -3.4 

JGBI-13 Sep-17 1.60% -0.66% -2.2 -3.3 -6.2 -8.3 -9.1 -12.1 -8.8 -14.7 8.4 -4.2 

JGBI-14 Dec-17 1.62% -0.64% -2.0 -3.2 -5.9 -8.1 -8.7 -11.8 -8.3 -14.3 8.6 -4.3 

JGBI-15 Mar-18 1.66% -0.64% -2.0 -3.2 -5.8 -8.0 -8.5 -11.5 -8.0 -14.1 8.7 -4.2 

JGBI-16 June-18 1.73% -0.67% -1.8 -3.1 -5.4 -7.7 -8.0 -11.2 -7.2 -13.5 9.5 -3.9 

Shahid Ladha / Herve Cros 29 January 2010 


45 


3m 

0.49% 

29-Apr-10 

6m 

0.53% 

29-Jul-10 

12m 

0.77% 

31-Jan-11

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. 

Current* Targets Stop Entry 

Closed Strategies 

TY/RX Spread Sell RXH0 Buy TYH0 

Trade closed (28/1). PnL: EUR -12.5k. 

New Strategies 

USD Butterfly Pay USD 2M-fwd 2y3y5y 

Near low end of historical range. We are positioned for a Fed on hold and this is an 

ideal hedge. Negative carry/roll is less in forward than spot. 

OATI/BTPEI BE Steepener Buy OATi BE 1.30% 2019 Sell BTPei BE 1.85% 2012 

Real curve too steep, BTPei-12 too rich, OAi-19 too cheap, EUR/FRF at risks into 

Jan CPI.New stop win at 24bp (27 Jan). 

Eurodollar Spread Buy EDZ0Z1 

Hawkish FOMC statement should lead to higher rate hike expectations, and the 

recent flattening in whites/reds on flight-to-quality concerns provides a decent entry 

point. Spread rolls up from Dec/Dec to Sep/Sep. 

Options 

Euribor Fly Buy ERU0 9862/75/87 P 

Cheap downside strategy, playing the normalisation of Eonia. The position 

complements with the upside fly (no-normalisation strategy). 

Euribor Fly Buy ERU0 9912/25/37 C 

Upside protection in case of liquidity spillover post June. Rolldown trade. 

Eurodollar Call Buy EDU0 99.25 C 

The expectation of a Fed on hold makes rolldown strategies attractive. In this case, 

the theta loss over 3m or 6m is more than compensated by the rolldown in an 

unchanged scenario. 

Bund Spread Buy RXH0 Feb 124/12450 CS 

Bunds have priced in supply factors for the start of the year. Tech picture is 

interesting, while 124 is a tech target within the rising channel. 

Sterling Fly Buy L Z0 9900/25/50 C 

Rolldown strategy for unchanged MPC through 2010. 

-29.0 

(S) 

25.0 

(T) 

148.0 

(T) 

1.5 

(S) 

1.5 

(S) 

28.0 

(T) 

3.0 

(T) 

4.0 

(S) 

25.0 45.0 39.0 

(26-Jan) 

-5.0 -38.0 -27.75 

(15-Jan) 

35.0 24.0 15.0 

(22-Jan) 

180.0 130.0 146.0 

(27-Jan) 

12.5 0.0 1.5 

(13-Jan) 

12.5 0.0 1.5 

(12-Jan) 

50.0 0.0 23.5 

(08-Jan) 

15.0 0.0 3.0 

(06-Jan) 

25.0 0.0 3.5 

(05-Jan) 

*Tactical (T) and strategic (S) trades. **Risk: vega, gamma for options, or ΔDV01 for futures, bonds and swaps. 

Carry 

/ mth 

Risk** 

P/L 

(ccy/Bp) 

2.5k/01 EUR - 

12.5k 

-5bp 

15k/01 USD -19k 

-1bp 

-5/+20 10k/bp EUR 

+100k 

+10bp 

10k/01 USD +20k 

+2bp 

10k/01 EUR 0k 

0bp 

10k/01 EUR 0k 

0bp 

5k/01 USD +28k 

+4.5c 

2.5k/01 

EUR 0k 

0c 

5k/01 GBP 

+2.5k 

+0.5c 

Interest Rate Strategy 29 January 2010 


46 


CNY: Revaluation and FX Reserves 

• Chinese inflation and initial tightening 

measures are raising market expectations for a 

resumption of CNY appreciation. 

• Beijing’s decision on the timing and extent 

of appreciation will probably hinge not only on 

domestic inflationary pressures but also on the 

extent to which global growth rebounds; 

whether or not a quid pro quo can be negotiated 

with the West will also play a part. 

• The introduction of a crawling peg in 2005 

triggered hot money inflows as China was 

continuing to invest in export capacity, 

promising further surpluses. Today, China has 

moved its focus to domestic demand 

development, suggesting internal and external 

surpluses will decline. 

• We lay out the road map towards Sterling 

devaluation. 

Chinese revaluation is inevitable… 

Recent moves by the PBOC – tightening reserve 

requirement ratios and hiking bill yields – have 

highlighted the inflation and bubble risks associated 

with the Chinese growth story. The perception that 

these measures may not be sufficient to tame 

excesses has many viewing a further appreciation of 

the Chinese Yuan as inevitable. 

The repercussions of such a revaluation are seen as 

widespread. Some see a resulting restoration of 

balance in global trade systems while others see the 

end of Chinese FX intervention as the death-knell for 

US Treasuries, the EUR and the AUD. But we beg to 

differ here: we see no major change from the status 

quo as China moves towards a stronger currency. 

…but financial system still awash with liquidity 

How far the Chinese tightening proceeds against a 

still-uncertain global growth environment is anyone’s 

guess. But it appears that the rate of liquidity 

absorption in the system could be lagging, 

underpinning the recent moves by Beijing to adjust 

3M and 1Y PBOC bills higher in yield and increase 

bank reserve requirements for larger deposit-taking 

institutions by 50bp to 16%. 

Indeed, beyond the relatively self-evident facts 

embedded in Chart 1, showing the continuing spike 

in money supply, FX reserves and outstanding 

PBOC bills, is the less manifest reality that 

sterilisation bill issuance in China in net terms has 

USD bn 

2500 

2000 

1500 

1000 

500 

0 

Mar-04 

Chart 1: PBoC’s FX Sterilization (I) 

Sep-04 

Mar-05 

Sep-05 

Source: CEIC, BNP Paribas 

USD bn 

300 

250 

200 

150 

100 

50 

0 

-50 

-100 

FX Reserves 

Outstanding PBoC Bills 

M0 Money Supply %YoY (RHS) 

Mar-06 

Sep-06 

run behind the overall build in FX reserves, at least 

by our (admittedly lagging) calculations (Chart 2). 

Market crying wolf over liquidity withdrawal 

Despite fears of withdrawal of liquidity, the reality is 

that loan growth has continued to soar, with local 

Mar-07 

Sep-07 

Mar-08 

Sep-08 

Chart 2: PBoC’s FX Sterilization (II) 

1Q.04 

Bill Issuance (USD bn) 

Net Issuance (USD bn) 

Change in Foreign Reserves (USD bn) 

M0 Money Supply %YoY (RHS) 

3Q 

1Q.05 

3Q 

1Q.06 

Source: CEIC, PBoC, BNP Paribas 

thousand billions 

3Q 

1Q.07 

3Q 

1Q.08 

3Q 

1Q.09 

Chart 3: 2007-09 Deposits vs Loans 


Mar-09 

3Q 

%YoY 

18 

Sep-09 

20 

18 

16 

14 

12 

10 

8 

6 

4 

2 

0 

16 

14 

12 

10 

8 

6 

4 

2 

0 

%YoY 

Rob Ryan 29 January 2010 


47 


media reporting that new loans totalled CNY 1.45trn 

in the first 19 days of January, equivalent to almost 

20% of the authorities’ CNY 7.5trn target for the 

whole of the 2010. While loans have historically been 

strongest in the first three months of the year, this 

risks outpacing the figure for January last year, as 

banks attempt to lend before restrictions and/or 

quotas are imposed. Further, the overhang of loans 

made last year but yet to be deployed (Chart 3) 

suggests that even a cap on new loans will still leave 

an enormous amount of dry powder. 

Not coincidentally, inflation is picking up. Part of the 

jump from 0.6% y/y in November to 1.9% in 

December can be attributed to base effects as prices 

fell in late 2008; part is due to food price inflation as a 

result of poor weather. However, leading indicators of 

inflation suggest that the risk is on the upside (Chart 

4), and BNP Paribas’ China economists expect an 

acceleration towards 5% in the middle of the year. 

Revaluation - When and how? 

Does all this pressure point to an inevitable CNY 

appreciation? Yes. But, as with all bets on the CNY, 

the issue is one of degree and timing. We have yet to 

meet anyone who has made good money shorting 

USD/CNY, the arcane politics of Chinese currency 

appreciation notwithstanding. But the hard metrics of 

the China story continue to entice no matter, and 

understandably so: this is a “cake and icing trade”. In 

other words, why not have currency exposure as real 

and non-tradable assets in China move sharply 

higher because of the endemic lack of capacity incountry 

to meaningfully absorb or intermediate 

liquidity? 

The money thus continues to pour in. Chart 5 shows 

our so-called hot money proxy for China, which 

benchmarks incoming cash flows by taking the sum 

of the 1Y CNY deposit rate and 1Y NDF CNY implied 

appreciation less the 1Y onshore USD deposit rate. 

The change in FX reserves less China’s trade 

balance and foreign direct investment shows a 

similar cash influx (Chart 6). So surely it makes 

sense to allow a stronger currency to dissuade some 

of these flows, and introduce the potential for twoway 

risk into the market? 

M1 %YoY - M2 %YoY 

6 

4 

2 

0 

-2 

-4 

-6 

-8 

-10 

-12 

-14 

Chart 4: Chinese Inflation vs M2-M1 

Jan-05 

M1 %YoY - M2 %YoY (LHS) 

CPI %YoY (RHS) 

Jul-05 

Jan-06 

Jul-06 

Source: Bloomberg, BNP Paribas 

USD bn 

50 

40 

30 

20 

10 

0 

-10 

-20 

-30 

-40 

-50 

Jan-06 

Jan-07 

Jul-07 

Jan-08 

Jul-08 

Jan-09 

Jul-09 

Chart 5: China Hot Money Proxy (I) 

Apr-06 

Hot Money Proxy MoM (3MMA, LHS) 

Hot Money Proxy YoY (3MMA, RHS) 

Jul-06 

Oct-06 

Jan-07 

Apr-07 

Jul-07 

Oct-07 

Hot Money Proxy = Change in FX Reserves - Trade Balance - FDIs 


14 

12 

10 

8 

6 

4 

2 

0 

-2 

-4 

-6 

Jan-04 

Jan-08 

Apr-08 

Jul-08 

Oct-08 

Jan-09 

Apr-09 

Jul-09 

Chart 6: China Hot Money Proxy (II) 

Jul-04 

Change in FX Reserves (m/m USD bn, RHS) 

Hot Money Proxy (%, LHS) 

Jan-05 

Jul-05 

Jan-06 


Jul-06 

Jan-07 

Jul-07 

Jan-08 

Jul-08 

Jan-09 

Oct-09 

Jul-09 

10 

8 

6 

4 

2 

0 

-2 

-4 

200 

150 

100 

50 

0 

-50 

-100 

-150 

-200 

CPI %YoY 

USD bn 

100 

80 

60 

40 

20 

0 

-20 

-40 

Indeed it does, from an economics point of view, and 

where it applies to a normal market economy. But we 

hasten to add here: currency policy is foreign policy 

in China and, though it is probably safe to contend 

that Beijing didn’t foresee the global credit crisis, the 

end-game that could conceivably bring meaningful 

Anglo-Saxon currency debasement has been 

regarded in some China policymaking circles as 

beneficial to Chinese interests. 

After all, Beijing could have long ago unilaterally 

moved to revalue its currency because of Western 

diktat – and, not uncoincidentally, when economic 

conditions were good in the West. Or, it can revalue 

its currency as a consequence of devaluation in the 

likes of the USD – and as per capita incomes in the 

West fall towards Chinese and Asian levels. 

A further point to make is that putting off appreciation 

buys time and space for the country to adapt. The 

necessary shift from an export-led economy to a 



48 


domestic-demand led one is underway, but will take 

many years. Similarly, central to the retooling of the 

Chinese economy is the development of a deep and 

liquid domestic bond market able to intermediate 

capital and price risk. This is also many years away. 

Diplomacy is letting someone have it your way 

It is clear to us that Beijing’s decision on the peg will 

be taken in the national interest, and not in response 

to outside pressure. But, where these coincide, it will 

be in Beijing’s interest to try to extract whatever it can 

from the situation rather than revaluing unilaterally. In 

that respect, the G20 forum is likely to become a 

focus for negotiation, with China holding out the 

prospect of a stronger CNY, perhaps in return for a 

much greater say in the IMF. While there is scope for 

movement around the Toronto meeting in June, more 

likely perhaps is the November meeting, to be held in 

Seoul, firmly within Beijing’s sphere of influence. 

Assuming that the decision is taken to revalue – 

whether for economic or political reasons – what 

form is the revaluation likely to take? A stronger than 

expected global recovery would suggest a more 

robust export sector more able to take the pain of 

faster appreciation. This scenario might see a one-off 

minor revaluation of 2-3% followed by a relatively 

steep 5% annual pace of appreciation. A slower 

recovery might see a slower pace of appreciation, 

without an initial jump. If the global recovery were to 

stall completely, the postponement of any move 

should be viewed as more than a possibility. 

On the issue of trade balances: expectations are that 

a shift in the currency will restore some balance to 

global trade. However, the original de-peg in July 

2005 led to a 17.5% appreciation of CNY over a 3- 

year period; over the same period, China’s trade 

balance soared (Chart 7). Thus even a relatively 

significant appreciation might be expected to leave 

trade balances largely unaffected. 

However Beijing’s inherently cautious approach 

implies that a large one-off revaluation of 10% or 

more is unlikely: our favoured scenario is a return to 

a crawling basket peg in the second half of this year. 

Initially the ‘basket’ is likely to be composed almost 

entirely of the USD, with a shift to a more tradeweighted 

basket to be slowly implemented over a 

period of years. 

Is China changing its reserve status? 

When China re-valued its exchange rate in July 

2005, currency reserve growth only paused for a 

short period. In fact, in 2006 reserve growth 

accelerated once again despite the currency moving 

closer to is equilibrium. Indeed, the crawling peg 

invited investors to move hot money into China in 

expectation of further currency gains. In addition, the 

USD mn 

Chart 7: Trade Balance vs USDCNY in 2005 

50,000 

40,000 

30,000 

20,000 

10,000 

0 

-10,000 

-20,000 

Jan-04 

Jul-04 

Jan-05 


15% 

10% 

5% 

0% 

-5% 

-10% 

-15% 

-20% 

Trade Balance 

Jul-05 

Jan-06 

Jul-06 

2005 appreciation was not accompanied by a change 

in the growth composition in China. China continued 

pushing export capacity growth, running an 

increasingly productive supply-oriented economy. 

This constellation triggered capital inflows while 

bringing about continued export surpluses and 

domestic savings. Unsurprisingly, the trade surplus 

widened and so did currency reserves. 

The difference between 2005 and 2010 

Now the situation is different. Export capacity is no 

longer being pushed; rather, all the emphasis is on 

promoting domestic demand. The composition of 

China’s economic growth is in transition and this 

transition will reduce foreign surpluses and domestic 

savings. A side effect of this development will be that 

China no longer acts as the anchor for global 

inflation. Instead, China will inflate prices for tradable 

goods as it will reduce their supply by using an 

increasing share of its production domestically. 

Hence, there is a fundamental difference between 

the China of 2005 and the China of today. This 

difference has been generated by the global crisis or, 

more specifically, by the implosion of China’s export 

markets. In 2005, China was able to rely on 

continued demand for its products in global markets 

due to booming Western demand. However, the 

Jan-07 

USDCNY (RHS) 

Jul-07 

Jan-08 

Jul-08 

Jan-09 

Jul-09 

Chart 8: EURUSD vs Asian FX Reserves* 

Jan-08 

Apr-08 

Jul-08 

3-Month change in 

EURUSD (LHS) 

Oct-08 

Jan-09 

Apr-09 

Jul-09 

Oct-09 

3-Month change in 

FX Reserves* (RHS) 

8.5 

8.0 

7.5 

7.0 

6.5 

6.0 

7% 

6% 

5% 

4% 

3% 

2% 

1% 

0% 

-1% 

Source: BNP Paribas *Asian Reserves are FX-Adjusted Reserves of 

China, India, Japan, Korea, Thailand & Singapore 



49 


West has consumed future income and is now deleveraging. 

This de facto means the West will have to 

convert to net exports while China will have to move 

in the opposite direction. In the end, re-balancing will 

take place and the result of rebalancing will be 

deceleration in currency reserve growth. 

The implication for currency markets is 

straightforward. There will be less USD supply 

coming via reserve reallocation. 

Road map to sterling weakness 

According to our PPP models, sterling is fairly 

valued, but this should not lead to the misinterpretation 

that the GBP will rally in the medium 

term. If at all, sterling has only short-term upside, 

with the long-term outlook remaining heavily biased 

to the downside. 

The BoE will stop QE-related monetary expansion as 

its inflation rates have surprised to the upside. This 

means that there needs to be an alternative buyer for 

the Gilt market. Bear in mind, the GBP 178bln budget 

deficit forecast by the government for 2009 has been 

entirely funded by the BoE, which has absorbed GBP 

198bln in debt securities (mainly Gilts) from the open 

market (see Chart 9). This operation allowed yields 

to remain comparatively low despite the government 

borrowing record amounts. In the absence of the 

BoE extending its QE operations, the Gilt market 

must attract private funds. We doubt that these 

private savings can be secured from domestic 

sources. Ahead of the general election, the 

government will try to create a feel-good factor. Most 

of its support measures are aimed at supporting the 

demand side of the economy, including housing. 

Hence domestic savings are back in decline and, in 

the absence of domestic funds being invested in the 

Gilt market, the UK will have to import capital. This 

will work in favour of sterling for the next couple of 

weeks but will came at a high cost as Gilt yield 

differentials rise, moving domestic borrowing costs 

up. 

After the election there will be the reality check and 

that will be brutal. It will be Hobson’s choice: either 

cut deficits (which will weaken demand) or face rating 

downgrades (which will drive borrowing costs 

higher). But higher borrowing costs are obviously the 

worst option for an overleveraged economy. After all 

those years of exuberant consumer spending on 

future income expectations, it is clear that domestic 

demand can no longer be the main source of 

economic activity. The UK will need to become 

supply driven, but the chief thrust of the Brown 

government’s economic policy has been to create the 

aforementioned feel-good factor. Instead of 

promoting the supply side of the British economy, 

everything has been done to support private 

Chart 9: BoE Asset Purchases by Type 

Period/ WE Commercial Gilts Corporate Total 

paper 

bonds 

2009 Q3 922 151,775 1,073 153,771 

01-Oct-09 225 4,200 72 4,497 

08-Oct-09 80 4,200 139 4,419 

15-Oct-09 25 4,200 33 4,258 

22-Oct-09 145 4,201 13 4,359 

29-Oct-09 0 4,200 62 4,262 

05-Nov-09 0 0 63 63 

12-Nov-09 0 3,400 60 3,460 

19-Nov-09 70 1,700 13 1,783 

26-Nov-09 224 3,400 5 3,629 

03-Dec-09 0 1,701 4 1,705 

10-Dec-09 125 3,400 2 3,527 

17-Dec-09 190 1,700 0 1,890 

24-Dec-09 0 0 0 0 

31-Dec-09 25 0 0 25 

Amount outstanding financed by the Treasury bills as at 31 Dec 

- - - - 

Amount outstanding financed by central bank reserves as at 31 Dec 

429 188,076 1,549 190,053 

Total amount outstanding as at 31 Dec 

429 188,076 1,549 190,053 

Source: BoE 

Chart 10: Foreign Holdings in the Gilt market 

250,000 

200,000 

150,000 

100,000 

50,000 

0 

Holdings 

(GBP m) 

% of Total 

(rhs) 

40.0% 

35.0% 

30.0% 

25.0% 

20.0% 

15.0% 

10.0% 

Q1 2006Q1 2007Q1 2008Q1 2009 

Source: BoE, BNPP. Foreign holdings in the Gilt market have declined 

below 30% of the total outstanding. However, the absolute holding has 

exceeded GBP 200bln, representing a new high. With the BoE expected to 

confirm the suspension of its QE operations next Thursday, upcoming Gilt 

supply needs to be absorbed by domestic private or foreign funds. The 

BoE withdrawing from QE may lead to sterling inflows as foreign accounts 

move into Gilts. Nonetheless, foreign buying interest in the Gilt market will 

only be generated if Gilt interest rate differentials rise; we doubt the 

economy can take that. 

consumption including housing. This approach is 

unsustainable and will have to be corrected after the 

election. In the unlikely event the current government 

wins another term, Labour might try muddling 

through by keeping government expenditure high 

while trying to reduce the budget gap through a 

higher tax take. This policy approach is unlikely to be 

tolerated by the rating agencies and will ultimately 

lead to a downgrade. A Tory government will face 

equally strong hurdles. The IMF has just warned that 

the British economy would not be able to withstand 

an abrupt tightening of fiscal conditions in the early 

stages of its current economic recovery. A fine line 

between fiscal consolidation and keeping the 

economy going needs to be found and currency 

strength would be counterproductive to that stance. 

What the UK needs is a combination of tight fiscal 

and loose monetary policies which will create text 

book style currency weakness. 



50 


USD Bullish Signals 

• USD Trade Weighted Index has confirmed the break above the 200-day moving average, 

suggesting that the longer-term trend has turned bullish 

• EURUSD set to accelerate the down trend once again with a sharp decline towards longer-term 

pivotal support in the 1.3735 area 

• USDCHF has also broken higher from the major down trend that had developed over the last year 

confirming the bullish outlook 

• GBPUSD testing important near-term up trendline support and currently sitting right on the 200- 

day moving average. But, a bearish break-out from the major trading range still needed 

The overall technical outlook for the USD has 

continued to improve and this can been seen on 

the BNP Paribas USD Trade Weighted Index, 

which after testing the 200-day moving average 

over the past week has finally confirmed a bullish 

breakout (with a daily closing price above the 

200-day ma). We would now expect further broad 

based USD gains, allowing the USD Index to 

head towards the top end of the ascending 

channel that has developed over the course of 

the past two months. At least a 50% retracement 

of the entire USD decline seen throughout 2009 

is now expected, implying USD gains of at least 

5% in the medium term. We also note that 

technical indicators are giving strong positive 

momentum signals. 

We expect these USD gains to become 

increasingly emphasised against the euro with 

EURUSD now putting increasing pressure on the 

downside, breaching important near-term support 

at the 1.40, which had been effective over the 

past six months. Given that EURUSD has already 

triggered many medium-term bearish signals over the 

course of the past few weeks (broken below the 200- 

day moving average and major up trendline support), 

a sustained break below the 1.40 level will accelerate 

the down trend towards the long-term pivotal support 

at the 1.3735 level. A decline below here would 

confirm that the long-term EURUSD outlook has 

turned bearish, with sustained losses towards the 

1.33/1.31 area expected. 

However, one place where USD strength has yet to 

be fully reflected is against sterling. GBPUSD has 

been trapped within a broad range over the past nine 

months. However, signs of GBPUSD weakness are 

starting to develop. Initial trendline support is 

currently being tested and the 200-day moving 

average has been breached. A decline to the bottom 

end of the trading range at 1.5720 is now expected, 

but a break below here would still be required to 

trigger a longer-term bearish signal, implying 

GBPUSD weakness towards the 1.5065 area initially. 

EURUSD is keeping 

the pressure on the 

downside. 

Major medium-term 

bearish signals have 

already been triggered 

– break of trendline 

support and the 200- 

day moving average. 

Chart 1: EUR/USD – Set to Accelerate the Down Trend 

1.5060 1.5144 

1.49 

1.4842 

1.4446 

1.4630 

1.44 1.4340 

1.4480 

1.4219 

1.39 

1.4015 

1.4582 

The break below 1.40 

will test the long term 

1.34 

pivotal support at 

1.3750, a break of 

which opens the way 

to 1.33/1.31. 1.29 

1.3750 

09-Jun-09 

06-Aug-09 

05-Oct-09 

02-Dec-09 

27-Jan-10 


Ian Stannard 29 January 2010 


51 


Chart 2: USD/CHF – Breaking Higher through Major Support 

USDCHF has broken 

sharply higher through 

down trendline 

resistance that had 

been in place over the 

1.17 

1.15 

1.13 

course of the past 1.11 

1.1020 

year. 

1.0935 

1.09 

Pivotal resistance in 

the 1.0505/65 area is 

1.07 

being approached. A 1.05 1.0595 

break above here will 

1.0565 

1.0450 

1.0505 

open upside potential 1.03 

towards the 1.1020 

1.01 

area. 

0.9920 

0.99 

09-Jun-09 06-Aug-09 05-Oct-09 02-Dec-09 


GBPUSD is keeping 

the pressure on the 

near-term up trendline 

support. 

A break below here 

will trigger a decline 

towards the bottom 

end of the long-term 

trading range, where 

major support is 

placed at 1.5720/10 

level. 

A break below 1.5710 

confirms that the longterm 

outlook is bearish 


USDJPY pullback 

remains corrective and 

is now nearing an end. 

Chart 3: GBP/USD – Bottom End of the Range to be Tested 

1.71 

1.69 

1.67 

1.65 

1.63 

1.61 

1.59 

1.57 

1.55 

1.53 

1.51 

1.49 

1.47 

1.45 

1.6745 

10-Jun-09 

1.7042 

07-Aug-09 

1.6742 

06-Oct-09 

Chart 4: USD/JPY – Pullback is Just a Correction 

99 

99.70 

97.78 

1.6880 

1.5710 1.5830 

03-Dec-09 

1.6457 

1.0135 

27-Jan-10 

28-Jan-10 

A rebound from initial 

support at the 88.95 

level provides an initial 

positive signal, but a 

break back above the 

91.85 level is needed 

to confirm a corrective 

bottom, triggered a 

renewed bullish signal. 

We anticipate a 

resumption of the 

recovery. 

97 

95 

93 

91 

89 

87 

85 

93.85 

10-Jun-09 

91.75 

07-Aug-09 

92.32 

87.98 

84.81 

06-Oct-09 03-Dec-09 

88.95 

93.76 

28-Jan-10 




52 


Currency Spot Trade Recommendations Date 

EUR/USD 1.3975 Sell 1.4095, stop at 1.4210, target 1.33 28 Jan 2010 

GBP/USD 1.6145 Sell 1.6190, stop at 1.6390, target 1.51 28 Jan 2010 

USD/CHF 1.0525 Buy 1.0460, stop 1.0360, target 1.10 28 Jan 2010 

EUR/GBP 0.8660 Buy 0.8540, stop 0.8460, target 0.92 28 Jan 2010 

EUR/AUD 1.5595 Short at 1.5680, lower stop to 1.5760, target 1.50 22 Jan 2010 

AUD/JPY 80.50 Longs from 84.00 stopped at 83.00 28 Jan 2010 

EUR/SEK 10.267 Shorts from 10.220 stopped at 10.270 22 Jan 2010 




53 


Economic Calendar: 29 January - 5 February 

GMT Local Previous Forecast Consensus 

Fri 29/01 23:30 08:30 Japan CPI National y/y : Dec -1.9% -1.8% -1.7% 

23:30 08:30 Core CPI National y/y : Dec -1.7% -1.4% -1.3% 

23:30 08:30 CPI Tokyo y/y : Jan -2.3% -2.0% -2.1% 

23:30 08:30 Core CPI Tokyo y/y : Jan -1.9% -1.8% -1.8% 

23:30 08:30 Household Consumption y/y : Dec 0.7% 1.7% 1.6% 

23:30 08:30 Unemployment Rate (sa) : Dec 5.2% 5.2% 5.3% 

23:50 08:50 Industrial Production (Prel, sa) m/m : Dec 2.2% 3.0% 2.5% 

(28/01) 

05:00 14:00 Housing Starts y/y : Dec -19.1% -18.5% -18.8% 

00:01 00:01 UK Gfk Consumer Confidence : Jan -19 -18 -18 

08:00 09:00 Spain Unemployment Rate : Q4 17.9% 17.9% 18.5% 

08:00 09:00 HICP Flash y/y : Jan 0.9% 1.3% 1.2% 

08:30 09:30 Eurozone Eurocoin : Jan 0.68 0.75 n/a 

09:00 10:00 Bank Lending Survey : Q4 

09:00 10:00 M3 y/y : Dec -0.2% -0.4% -0.5% 

09:00 10:00 M3 y/y (3-Mth) : Dec 0.6% -0.1% -0.1% 

10:00 11:00 Unemployment Rate : Dec 10.0% 10.0% 10.1% 

10:00 11:00 HICP (Flash) y/y : Jan 0.9% 1.1% 1.2% 

11:15 12:15 ECB’s Bini Smaghi Speaks in Milan 

16:45 17:45 ECB’s Constancio Speaks on Law and the Financial System 

09:00 10:00 Italy PPI m/m : Dec 0.3% 0.0% 0.1% 

09:00 10:00 PPI y/y : Dec -3.1% -1.5% -1.5% 

09:00 10:00 Norway Retail Sales (sa) m/m : Dec -1.2% 0.7% 0.8% 

09:00 10:00 Retail Sales (nsa) y/y : Dec 2.1% 2.9% 3.2% 

10:30 11:30 Switzerland KoF Leading Indicator : Jan 1.68 1.62 1.71 

13:15 08:15 US Fed’s Kohn Speaks at FDIC Conference on Interest Rate Risk 

13:30 08:30 GDP (Adv, saar) q/q : Q4 2.2% 4.6% 4.6% 

13:30 08:30 GDP Deflator (Adv, saar) q/q : Q4 0.4% 1.2% 1.3% 

13:30 08:30 Employment Cost Index q/q : Q4 0.4% 0.4% 0.4% 

13:30 08:30 Employment Cost Index y/y : Q4 1.5% 1.4% n/a 

14:45 09:45 Chicago PMI : Jan 58.7 57.5 57.2 

14:55 09:55 Michigan Sentiment (Final) : Jan 72.5 73.9 73.0 

13:30 08:30 Canada GDP m/m : Nov 0.2% 0.3% 0.3% 

Mon 01/02 07:45 08:45 France PPI m/m : Dec 0.2% -0.4% n/a 

07:45 08:45 PPI y/y : Dec -4.5% -3.4% n/a 

08:30 09:30 Switzerland PMI Manufacturing : Jan 54.6 55.5 n/a 

09:00 10:00 Eurozone PMI Manufacturing (Final) : Jan 52.0 (p) 52.0 (p) 52.0 (p) 

10:00 11:00 Annual GDP : 2009 

09:30 09:30 UK CIPS Manufacturing : Jan 54.1 52.5 54.0 

09:30 09:30 Mortgage Approvals : Dec 60.5k 60.0k 61.0k 

09:30 09:30 Net Consumer Credit : Dec GBP-0.4bn GBP-0.5bn GBP-0.4bn 

13:30 08:30 US Personal Income m/m : Dec 0.4% 0.2% 0.3% 

13:30 08:30 Personal Spending m/m : Dec 0.5% 0.2% 0.3% 

15:00 10:00 Construction Spending m/m : Dec -0.6% -0.5% -0.3% 

15:00 10:00 ISM Manufacturing : Jan 55.9 55.5 55.6 

Tue 02/02 00:30 11:30 Australia NAB Business Confidence : Dec 19 18 n/a 

03:30 14:30 RBA Rate Announcement 

09:00 10:00 Eurozone ECB’s Constancio Speaks 

10:00 11:00 PPI m/m : Dec 0.1% -0.1% 0.0% 

10:00 11:00 PPI y/y : Dec -4.4% -3.1% -3.1% 

Market Economics 29 January 2010 

Market Mover 54 2 www.GlobalMarkets.bnpparibas.com

Economic Calendar: 29 Jan - 5 Feb (cont) 

GMT Local Previous Forecast Consensus 

Wed 03/02 00:30 11:30 Australia Trade Balance : Dec AUD-1700mn AUD-2500mn n/a 

09:00 10:00 Eurozone PMI Services (Final) : Jan 52.3 (p) 52.3 52.3 

10:00 11:00 Retail Sales (sa) m/m : Dec -1.2% 0.4% 0.4% 

10:00 11:00 Retail Sales (ca) y/y : Dec -4.0% -2.4% -2.4% 

09:00 10:00 Norway Unemployment Rate (sa) : Nov 3.2% 3.3% n/a 

13:00 14:00 Norges Bank Rate Announcement 

09:30 09:30 UK CIPS Services : Jan 56.8 55.5 56.5 

13:15 08:15 US ADP Labour Change : Jan -84k -30k -30k 

15:00 10:00 ISM Non-Manufacturing : Jan 50.1 51.5 51.0 

15:30 10:30 EIA Oil Inventories 

17:00 12:00 Fed’s Warsh Speaks at NY Association for Business Economics 

Thu 04/02 00:30 11:30 Australia Retail Sales m/m : Dec 1.4% 0.5% n/a 

00:30 11:30 Retail Sales y/y : Dec 7.3% 3.6% n/a 

11:00 12:00 Germany Factory Orders m/m : Dec 2.8% 1.0% 0.0% 

11:00 12:00 Factory Orders y/y : Dec 1.3% 10.4% 9.5% 

12:00 12:00 UK BoE Rate Announcement 

12:00 12:00 BoE Asset Purchase Target GBP200bn GBP200bn GBP200bn 

12:45 13:45 Eurozone ECB Rate Announcement 

13:30 14:30 ECB Press Conference 

13:30 08:30 US Non-Farm Productivity (Prel, saar) q/q : Q4 8.1% 5.2% 5.6% 

13:30 08:30 Unit Labour Costs (Prel, saar) q/q : Q4 -2.5% -2.5% -2.1% 

13:30 08:30 Initial Claims 470k 470k n/a 

15:00 10:00 Factory Orders m/m : Dec 1.1% 3.0% 1.2% 

Fri 05/02 00:30 11:30 Australia RBA Policy Statement 

07:45 08:45 France Trade Balance : Dec EUR-5.3bn EUR-5.5bn n/a 

07:45 08:45 Budget Balance (Cumulative) : Dec EUR-56.5bn EUR-138.0bn n/a 

08:00 09:00 Spain Industrial Production (wda) y/y : Dec -5.7% -2.3% n/a 

09:00 10:00 Norway Manufacturing Production m/m : Dec 0.9% 0.5% n/a 

09:00 10:00 Manufacturing Production y/y : Dec -3.3% -1.4% n/a 

09:30 09:30 UK Input PPI (nsa) m/m : Jan 0.1% 0.8% n/a 

09:30 09:30 Output PPI (nsa) y/y : Jan 3.5% 3.9% 3.7% 

09:30 09:30 Output PPI (Ex-FDT, nsa) y/y : Jan 2.6% 2.6% n/a 

10:00 11:00 Italy CPI (NIC, Prel) m/m : Jan 0.2% 0.0% n/a 

10:00 11:00 CPI (NIC, Prel) y/y : Jan 1.0% 1.2% n/a 

10:00 11:00 HICP (Prel) m/m : Jan 0.2% -1.4% n/a 

10:00 11:00 HICP (Prel) y/y : Jan 1.1% 1.4% n/a 

10:30 11:30 Eurozone ECB’s Liikanen Speaks in Finland 

11:00 12:00 Germany Industrial Production m/m : Dec 0.7% 1.5% 0.4% 

11:00 12:00 Industrial Production y/y : Dec -8.0% -2.7% -3.8% 

12:00 07:00 Canada Unemployment Rate : Jan 8.5% 8.5% n/a 

12:00 07:00 Payroll Jobs y/y : Jan -2.6k 15.0k n/a 

13:30 08:30 US Non-Farm Payrolls (Chg) : Jan -85k 0k 27k 

13:30 08:30 Unemployment Rate : Jan 10.0% 10.1% 10.0% 

13:30 08:30 Average Hourly Earnings m/m : Jan 0.2% 0.2% 0.2% 

20:00 15:00 Consumer Credit : Dec USD-17.5bn USD-9.0bn USD-9.2bn 

22:15 17:00 Fed’s Bullard Speaks at Washington University 

During 27-31/1 World World Economic Forum, Davos 

Week 1-8/2 Germany Retail Sales (BBK, Real, sa) m/m : Dec -1.1% 1.0% 1.0% 

Retail Sales (BBK, Real, sa) y/y : Dec -2.8% -2.4% -2.4% 

2-6/2 UK Halifax House Prices m/m : Jan 0.9% 0.6% n/a 

Halifax House Prices (3mth) y/y : Jan 1.1% 3.6% n/a 

Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision 




Key Data Preview 

3 

2 

1 

0 

-1 

-2 

-3 


Core CPI 

CPI excluding energy and food, but not alcohol 

02 03 04 05 06 07 08 09 


% y/y Dec (f) Nov Oct Sep 

Core CPI -1.4 -1.7 -2.2 -2.3 

CPI -1.8 -1.9 -2.5 -2.2 

Key Point: 

The core CPI’s rate of decline should ease again in 

December as the base effect from changes in 

petroleum product prices wanes. However, 

deflationary pressures won’t be easily overcome as 

the economy is likely to lose steam from the spring. 

BNP Paribas Forecast: Smaller Decline 

Japan: CPI (National, December) 

Release Date: Friday 29 January 

After hitting a record -2.4% y/y in August, the rate of 

decline in the national core CPI has steadily eased for 

three straight months, coming in at -1.7% in November. 

Based on Tokyo metropolitan area data for December, we 

predict that the national core CPI will fall by just 1.4% y/y in 

December. But the moderation in the decline in the CPI 

does not reflect the easing of deflationary pressures, rather 

it is just a technical reaction to the sharp change in 

petroleum product prices a year earlier. This technical 

factor should continue to temper the CPI’s rate of decline 

though January, after which the fall in the CPI will reaccelerate 

as this base effect disappears. 

With the economy expected to lose some momentum from 

the spring, when the effects of the fiscal stimulus fade, 

deflationary pressures are certain to persist for the time 

being. Meanwhile, planned fiscal policy measures are likely 

to weigh on the core CPI, such as the abolition of public 

high school tuition fees, which could shave 0.4 of a 

percentage point off the index from April. 

Chart 2: Japanese Unemployment Rate (% sa) 

6.0 

5.5 

5.0 

4.5 

4.0 

3.5 

00 01 02 03 04 05 06 07 08 09 


% sa Dec (f) Nov Oct Sep 

Unemployment Rate 5.2 5.2 5.1 5.3 

Key Point: 

Although the jobless rate has stopped rising thanks 

to the revival in industrial activity and flexible wage 

adjustments that have lessened the need for sharper 

labour cutbacks, it will still be some time before 

employment starts recovering. 

BNP Paribas Forecast: Flat 

Japan: Unemployment Rate (December) 


The unemployment rate inched up 0.1 of a percentage 

point in November to 5.2% but the trend is downwards after 

the peak in July at a record 5.7%. Since the total number of 

people employed is not growing at all, the downturn in the 

jobless rate is largely a product of a continued rise in the 

number of discouraged workers (people who have given up 

on finding jobs and have left the workforce). Another factor 

keeping the jobless rate in check is the flexibility of wages, 

particularly bonuses, which has helped to lessen the need 

for painful cutbacks in employment. While the worst is over 

on the jobs front thanks to the pick-up in the economy on 

the back of fiscal stimulus and robust exports to Asia, 

conditions are far from ripe for a recovery in employment. 

From the spring, it is very likely that the economy will enter 

a “soft patch” as the effects of the fiscal stimulus fade. And 

even though the jobless rate is expected to continue 

trending lower, reflecting the steady shrinkage of the 

workforce due to the rise in the average age of the 

population, a "jobless recovery" should continue for quite 

some time to come. 



56 



Chart 3: Japanese Production and Exports 

120 

115 

110 

105 

100 

95 

90 

85 

80 

75 

70 

65 

(2005=100, seasonally adjusted) 

00 01 02 03 04 05 06 07 08 09 

Source: METI, BNP Paribas 

Production 

Exports (RHS) 

150 

140 

130 

120 

110 

100 

90 

80 

70 

60 

50 

Dec (f) Nov Oct Sep 

IP % m/m 3.0 2.2 0.5 2.1 

IP % y/y 6.5 -4.2 -15.1 -18.4 

Key Point: 

Solid exports to the rest of Asia will keep production 

on a recovery track for the time being, moderating 

the “soft patch” expected in the first half of 2010, 

when the economy is likely to lose some momentum. 

BNP Paribas Forecast: Recovery Continues 

Japan: Industrial Production (December) 


We expect industrial production to expand by 3.0% m/m in 

December, the tenth straight month of increase. With the 

forecast index projecting gains of 3.4% in December and 

1.3% in January, the recovery in the industrial sector looks 

likely to continue for the time being, reflecting the effects of 

the domestic fiscal stimulus (subsidies for buying ecofriendly 

cars and household appliances), coupled with 

robust exports to the rest of Asia. Thanks to expansionary 

policies by many Asian nations, coupled with dollar-buying 

FX intervention to stem local currency appreciation from 

capital inflows linked to an increase in dollar-carry trades, 

monetary conditions elsewhere in Asia have become 

extremely accommodative. This is leading to a robust 

recovery in domestic demand. While the soundness of 

such growth is questionable, the Asian economies will 

probably continue to perform strongly for some time, 

maintaining the strength of Japanese exports and 

production. Thus, even though the domestic economy is 

expected to lose some momentum in the first half of 2010 

as the effects of the inventory cycle and domestic fiscal 

stimulus start to fade, the solid tone of exports to Asia 

should allow the coming economic “soft patch” to be mild. 

Chart 4: Eurozone M3 & Bank Lending (% y/y) 

12.5 

10.0 

7.5 

5.0 

2.5 

0.0 

Private Sector Bank Lending 

-2.5 

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 


% y/y Dec (f) Nov Oct Sep 

M3 -0.4 -0.2 0.3 1.8 

M3 (3-mth Avg.) -0.1 0.6 1.6 2.5 

Private Sector Loans -0.1 -0.7 -0.8 -0.3 

Key Point: 

The y/y rates of change in M3 and bank lending are 

forecast to remain negative in December, although 

they should be bottoming out. 

M3 

BNP Paribas Forecast: Double Negative 

Eurozone: Monetary Developments (December) 


The y/y rate of change in M3 fell below zero in November 

for the first time in the series’ history. In each of the three 

months to November, M3 declined on a m/m basis so the 

weakness is not a ‘base effect’ distortion. We forecast a 

deepening of the y/y contraction in December, pushing the 

three-month moving average y/y rate of change below zero 

for the first time ever. 

The divergence between narrow and broad money growth 

remains acute, with the y/y rate of increase in M1 in double 

digits in November for the fifth straight month. The y/y rate 

of change in M3 less M2 is in double digits in a negative 

direction, with the steepness of the yield curve encouraging 

purchases of longer-term assets outside of M3. 

The y/y rate of change in bank lending to the private sector 

has been negative since September. We forecast that it will 

remain negative in December but, due to base effects, the 

rate of contraction will diminish markedly and a shift into 

positive territory is likely by end-Q1 at the latest. 

Loan growth to households has continued to pick up, which 

may in part relate to car purchase incentives. The lending 

data for non-financial corporates are still exceptionally 

weak, however, with outstanding loans contracting by 

almost 5% on a six-month annualised basis in November. 



57 



Chart 5: Eurozone HICP (% y/y) BNP Paribas Forecast: Back Above 1% 

Source: Reuters EcoWin Pro, BNP Paibas 

% Jan (f) Dec Nov Oct 

Headline m/m -0.6 0.3 0.1 0.2 

Headline y/y 1.1 0.9 0.5 -0.1 

Core m/m -1.5 0.5 -0.1 0.3 

Core y/y 0.9 1.1 1.0 1.2 

Key Point: 

Headline inflation should continue to rise in January 

on strong food and energy price increases. Core 

inflation should tick lower. 

Eurozone: Flash HICP (January) 


Headline inflation has rebounded quickly from its lows in 

the eurozone. From a low of -0.7% y/y in July, headline 

inflation reached 0.9% y/y in December, its highest rate 

since February. The disproportionate driver of this rebound 

has been commodity price base effects: the large declines 

in energy and food prices at the end of 2008 have dropped 

out of the y/y comparison, mechanically sending headline 

inflation higher. 

In January, headline inflation should continue its ascent. 

Food and energy inflation will once again be the culprits, 

but not base effects, the influence of which will wane this 

year. Instead, the large increase in oil prices at the turn of 

the year and a pick-up in fresh food prices associated with 

the cold weather will explain the rise. 

Core inflation, meanwhile, should continue its trend down. 

After the weak German data, we expect it to tick down by 

0.2pp to 0.9% y/y to equal to its all-time low. January is 

traditionally a month of discounting, a process that has 

become increasingly aggressive over time. 

We expect core inflation to become more of a talking point 

this year for policymakers. 

Chart 6: Canadian GDP vs. Manufacturing 

Shipments 


Nov (f) Oct Sep Aug 

GDP % m/m 0.3 0.2 0.4 -0.1 

Key Point: 

Canadian GDP should increase by 0.3% m/m in 

November. 

BNP Paribas Forecast: Upward Trend 

Canada: GDP (November) 


After a tepid start in Q3, when GDP expanded by a meagre 

0.4% q/q annualised, the Canadian recovery is expected to 

gain momentum in Q4, when we forecast GDP rose by a 

healthy 3.1%. On a monthly basis, GDP by industry 

increased 0.2% m/m in October and is forecast to rise by 

0.3% m/m in November. 

The ongoing rebound should be supported by stronger 

manufacturing activity in the US which, in turn, is benefiting 

from inventory rebuilding and exports to Asia. In October, 

US industrial production rose by only 0.2% m/m, with 

Canadian IP up by a meagre 0.1% m/m. However, US IP 

improved in November and December, gaining 0.6% m/m 

in both months, boding well for activity north of the 49 th 

parallel. 

In addition, ongoing credit growth and the recent strength 

of home sales point to healthy activity in the service sector, 

especially in the real estate sector. 




Chart 7: Change in US Private Inventories 


Q4 (f) Q3 Q2 Q1 

GDP % q/q AR 4.6 2.2 -0.7 -6.4 

GDP Deflator % q/q 

AR 1.2 0.4 0.0 1.9 

Key Point: 

Real GDP growth jumped in Q4 to an estimated 4.6% 

q/q annualised mostly because of inventories. The 

deflator remained subdued rising by 1.2%. 

BNP Paribas Forecast: A Big Increase 

US: GDP (Q4 2009) 


Q4 GDP growth is expected to have accelerated sharply to 

4.6% q/q annualised from the downward revised increase 

of 2.2% in Q3. While our forecast is a sharp pick-up from a 

disappointingly slow initial quarter of recovery, the 

acceleration is more than entirely attributable to the 

reduction in inventory de-stocking. The change in 

inventories is forecast to contribute 3.6 percentage points 

to GDP growth after a 0.7pp contribution in Q3. Meanwhile, 

final sales are expected to grow just 1.2%, down from the 

1.5% pace a quarter earlier and well below what we 

consider to be the economy’s potential. Consumer 

spending is expected to grow 1.8%, below the 2.8% pace 

in Q3 when spending was boosted by the cash for clunkers 

programme. Growth in residential investment is also 

projected to slow, to 5.8% from 18.9% as housing starts 

have lost momentum. Investment in equipment and 

software should pick up modestly to 2.5% from 1.5%, while 

spending on structures is forecast to decline 22% after an 

18.4% drop. Government spending is expected to grow 

2.1% after a 2.6% rise. The trade deficit is expected to 

widen modestly, subtracting 0.2pp from growth after a 

0.9pp subtraction in Q3. The GDP deflator is forecast to 

rise by an estimated 1.2% in Q4, up from 0.4% in Q3. 

Ultimately, growth will need to be generated from final 

demand as the inventory cycle fades, so we would not put 

too much weight on the burst in the headline rate. 

Chart 8: US Total Compensation is Decelerating 


Q4 (f) Q3 Q2 Q1 

Total Compensation 0.4 0.4 0.4 0.3 

Wages and Salaries 0.4 0.4 0.4 0.3 

Benefits 0.4 0.4 0.3 0.5 

BNP Paribas Forecast: Slower Wage Growth 

US: Employment Cost Index (Q4 2009) 


We expect the Employment Cost Index to rise 0.4% in Q4 

2009 after similar gains in Q2 and Q3. Our forecast would 

be consistent with further deceleration in growth of total 

compensation to 1.4% y/y from 1.6%, a new record low 

since this data series began in 1982. Both wages and 

salaries and benefit cost growth are on downward trends in 

the private sector and among state and local government 

workers. The ECI is one of the broadest measures of 

employee compensation, and it slowed sharply through the 

recession as benefit costs moderated sharply along with 

wages. The record low reading would be consistent with 

the weakest labour market since WWII, something that 

feeds into compensation with a significant lag - suggesting 

more weakness over the next year. This will keep growth in 

disposable income subdued even as the labour market 

recovers, leaving businesses with little pricing power. 

Key Point: 

We expect the ECI to have risen 0.4% in Q4 2009, 

leaving total compensation growth at a new record 

low of 1.4% y/y. 



59 



Chart 9: UK Composite CIPS vs GDP 


Jan (f) Dec Nov Oct 

52.5 54.1 51.8 53.4 

Key Point: 

We expect a weather-induced setback in the CIPS 

surveys during January. 

BNP Paribas Forecast: Down 

UK: CIPS Manufacturing (January) 

Release Date: Monday 1 February 

We expect the UK CIPS manufacturing survey to suffer a 

setback during January, falling by more than a point to 

52.5. The reason is disruptions to orders and output 

caused by inclement weather. The worst snow for several 

decades prevented employees from getting to work, 

deliveries from arriving at their intended destinations and 

backlogs at ports and airports. 

The flash estimate for the eurozone PMI was weaker than 

expected, and this was attributed to the weather. We 

estimate that UK GDP during Q1 could be reduced by 

around 0.1 percentage points based on an assumption of a 

small proportion of the working population being absent 

from work during the height of the disruptions. To be 

consistent with this, the CIPS survey should experience a 

temporary loss of thrust. 

Fundamentally, the outlook for the CIPS remains broadly 

upbeat. Financial and monetary conditions remain 

considerably looser than the long-run average, consistent 

with further headway for the survey indicators. Output has 

yet to feel the full benefit of the rebound in overseas 

demand from the artificially depressed levels at the height 

of the credit crunch. Hence we expect the likely setback in 

January to be temporary. 

Chart 10: US Confidence vs Consumption 


% m/m Dec (f) Nov(f) Oct Sep 

Personal Income 0.2 0.4 0.3 0.3 

Consumption 0.2 0.5 0.6 -0.6 

Core PCE 0.1 0.0 0..2 0.1 

Key Point: 

Income and consumption are both forecast to rise in 

December by 0.2%. The deflator will increase by 

0.1%, cutting their growth in half in real terms. 

BNP Paribas Forecast: Modest Rises 

US: Personal Income & Spending (December) 


Personal consumption is forecast to increase by 0.2% in 

December as consumers participated in relatively subdued 

holiday spending following two months of substantially 

larger gains. Most of the spending has been on goods, 

mainly vehicles in October, general merchandise in 

November and gasoline and drugs in December. While up 

from 12 months earlier, holiday spending relative to 

November was limp. Consumers have supported their 

burst of spending on goods by curtailing their expenditure 

on services. Income growth in December is also forecast to 

grow by 0.2%. Another month of declining employment 

(-0.01%) combined with a relatively modest increase in 

hourly earnings of 0.16% pushes wages and salaries up by 

0.1% and larger increases in non-wages boost incomes. 

Therefore income growth for 2009 is nudged forward by 

0.2% from last December. In contrast, consumption is 

forecast to rise by 3.7% over 2009. Fortunately, the 2009 

fiscal stimulus act lowered tax rates and therefore caused 

disposable income to rise 3.5% y/y, faster than income. 

Faster growing DPI during 2009 helped preserve the 

savings rate around the same level: 4.7%, the same as in 

December 2008. The personal consumption deflator is 

forecast to rise by 0.1% in December and thus increase by 

2.1% y/y, up from 0.6% in 2008. The core deflator is 

forecast to rise by 0.1% and 1.4% y/y, down from 1.8% in 

2008. 


Market Mover 22 60 



Chart 11: US PMI Manufacturing Surveys 



Headline index 55.5 55.9 53.6 55.7 

Prices Paid 60.0 61.5 55.0 65.0 

BNP Paribas Forecast: About Steady 

US: ISM (January) 


We look for the ISM manufacturing index to edge down to 

55.5 in January after rising to 55.9 in December. Regional 

manufacturing indexes sent mixed signals in January, and 

on average have remained weaker than the ISM (see 

chart). Thus we expect the index to give back a bit of its 

December surge. 

Our forecast would still be consistent with robust expansion 

in the manufacturing sector as rising global trade and the 

upswing of the inventory cycle stimulate activity. Inventory 

data in particular have turned decisively positive in recent 

months, indicating a fairly significant contribution to GDP 

from manufacturing production. Meanwhile, we look for the 

prices paid index to fall back to a still-elevated 60.0 from 

61.5 a month prior, in line with the drop in commodity 

prices at the start of the year. 

Key Point: 

The ISM manufacturing index should edge down to 

55.5 in January after surging in December. Prices 

paid should edge down to a still-elevated 60.0. 

Chart 12: UK CIPS Services vs FTSE All-Share 



55.5 56.8 56.6 56.9 

Key Point: 

We expect a temporary setback for the CIPS 

services, largely due to the adverse winter weather. 

BNP Paribas Forecast: Down 

UK: CIPS Services (January) 

Release Date: Wednesday 3 February 

We expect a snow-induced setback for the services sector 

CIPS during January. The prolonged spell of snowfall in the 

early portion of the month caused many parts of the 

country to come to a standstill. We estimate that employee 

absence, shorter working days, transport disruptions etc 

will subtract around 0.1 percentage point from Q1 GDP. To 

be consistent, this would require the CIPS surveys to 

temporarily lose upward thrust. 

We are confident that this will be a temporary setback. The 

fundamentals that have underpinned the impressive 

rebound in the CIPS surveys remain in place, i.e. equities 

have bounced back, monetary policy remains very loose 

and the GBP exchange rate has weakened over the last 

year or so. At some point, these supports to activity will 

fade, but for now we expect them to continue pushing the 

CIPS surveys higher. 

To be consistent with the latest BoE GDP projection, the 

composite of the two CIPS surveys will need to reach 

around 58 from 55.7 currently. We suspect that it can do 

so, but such a level will be short-lived. Thereafter, once 

stimulus measures fade, a lower survey reading and slower 

pace of GDP expansion are more likely. 





Chart 13: US NM ISM Components 



NM Composite 51.5 50.1 48.7 50.6 

Prices Paid 57.5 58.7 57.8 53.0 

Key Point: 

The ISM services index is expected to improve to 

51.5 in January 

BNP Paribas Forecast: Up 

US: ISM Non Manufacturing (January) 

Release Date: Wednesday 3 February 

The ISM non-manufacturing index improved to 50.1 in 

December from a reading of 48.7 previously, but the index 

remained below the recent high of 50.9 recorded in 

September. We believe the index will reach 51.5 in 

January. Several factors suggest economic prospects in 

the non-manufacturing sector are improving, although the 

pace of improvement remains moderate. Initial claims 

declined in January, but continuing claims including 

emergency and extended programmes still remain at 

record highs. ISM Production has been quite strong lately 

as improving global trade and the upswing of the inventory 

cycle stimulate activity, but NM ISM new orders seem to 

lag positive improvements in the manufacturing sector. 

Nevertheless, seven non-manufacturing industries 

indicated growth in December, including Retail Trade: "The 

environment seems to be improving, but we will continue to 

be cautious as we look forward". Nine industries still 

reported contraction. Overall, we expect the upward trend 

in NM ISM to continue into January and the number of 

industries reporting growth to increase. 

Chart 14: Level of German Output & Orders 

120 

115 

110 

105 

100 

95 

90 

85 

80 

75 

Index Levels, 2005=100 

Output 

70 

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 


Orders (RHS) 

Dec (f) Nov Oct Sep 

Output % m/m 1.5 0.7 -1.7 3.0 

Output % y/y -2.7 -8.0 -12.4 -12.6 

Orders % m/m 1.0 2.8 -1.9 1.3 

Orders % y/y 10.4 1.3 -8.3 -12.6 

Key Point: 

Leading indicators suggest further ‘catch-up’ for 

orders and output. 

130 

120 

110 

100 

90 

80 

70 

60 

BNP Paribas Forecast: Still Strengthening 

Germany: Industrial Production & Orders (December) 

Release Date: Thursday 4 & Friday 5 February 

Leading indicators of industrial production and orders point 

to further increases in the period ahead. The PMI for the 

manufacturing sector rose for the twelfth month in a row in 

January, reaching its highest level since mid-2008. The 

sub-index for output rose sharply, to 58.4, five percentage 

points above its long-run average. 

On the basis of the signals from the surveys, we look for a 

strong 1.5% m/m increase in production in December. This 

would imply a 1.8% q/q rise in industrial output for Q4 as a 

whole, the second successive strong gain and consistent 

with a further expansion in GDP in Q4. 

Given the exceptionally large gain in manufacturing orders 

in November, 2.8% m/m, we look for a moderation in the 

rate of increase in December. Still, given our forecast of a 

1% m/m rise, orders in Q4 as a whole will have increased 

by almost 2% q/q, the third strong q/q gain in succession. 

Given favourable base effects relating to the collapse in 

activity in late 2008 and early 2009, y/y rates of change will 

continue to rise sharply in coming months. The y/y rate of 

change in orders has already turned positive and output 

should follow suit from January onwards. 

Despite the near-10% rebound since April 2009, the level 

of industrial production remains around 15 percentage 

points below its peak in spring 2008. 

. 





Chart 15: US Non-Farm Productivity 


% q/q, AR Q4 (f) Q3 Q2 Q1 

NF Productivity 5.2 8.1 6.9 0.3 

ULC -2.5 -2.5 0.0 -5.0 

BNP Paribas Forecast: Productivity Surge 

US: Non-Farm Productivity & ULC (Q4, preliminary) 

Release Date: Thursday 4 February 

Non-farm productivity is forecast to continue its upward 

push, rising 5.2% q/q AR in Q4 following a 8.1% q/q AR 

surge in Q3. Non-farm business output is expected to grow 

strongly, and while hours worked are beginning to pick up, 

they fell modestly overall in Q4. Productivity is surging 

early in the economic recovery and our forecast would 

imply growth of 5.1% y/y. 

Meanwhile, unit labour costs are forecast to decline 2.5% 

q/q AR after a similar decline in the previous quarter. 

Compensation per hour is estimated to have risen much 

more slowly than productivity as the weakest labour market 

in the post-war period is allowing employers to wring out 

productivity gains while reducing labour costs. Our forecast 

would imply a 2.5% y/y decline in unit labour costs, the 

lowest reading in fifty years, highlighting our concerns that 

deflationary pressures will come to the fore in 2010. 

Key Point: 

Productivity growth is forecast to surge again in Q4 

as output grew strongly while hours continued to 

contract. Unit labour costs should continue to 

plunge. 

Chart 16: Canadian Employment 



Unemployment rate % 8.5 8.5 8.5 8.6 

Payroll jobs (k) 15.0 -2.6 79.1 -43.2 

Key Point: 

Canadian employment is forecast to increase by 15k 

in January after a surprise stall in December. 

BNP Paribas Forecast: Upward Momentum 

Canada: Labour Report (January) 

Release Date: Friday 5 February 

Canadian employment remains very volatile. Indeed, after 

shrinking by 43k in October, employment surged by 79k in 

November then effectively stalled in December, easing by 

2.6k. In spite of this volatility, the underlying momentum 

remains positive and conditions have improved significantly 

since the beginning of 2009. In addition, the disappointing 

news stemming from the negative payrolls reading in 

December was partially offset by a 1.5% m/m increase in 

hours worked, suggesting the economic recovery remains 

on track. Nevertheless, the growth momentum of hours 

worked has eased compared to Q3, implying downside 

risks remain. 

In January, we expect employers to create 15k jobs. Hiring 

in the service industry should increase at a healthy pace, 

supported by activity in the real estate sector. In contrast, 

conditions are likely to remain subdued in the 

manufacturing sector. 

The unemployment rate is expected to remain at 8.5% in 

January. 





Chart 17: US Payrolls BNP Paribas Forecast: Payrolls Flat to Start 2010 



Payroll Jobs k 0 -85 4 -127 

Unemployment Rate % 10.1 10.0 10.0 10.1 

Key Point: 

Payrolls are expected to be flat in January and the 

unemployment rate should inch higher to 10.1%. 

US: Labour Report (January) 

Release Date: Friday 5 February 

We look for a flat reading on non-farm payrolls in January 

after an unexpected decline of 85k in December. The 

private service sector should create 45k jobs, driven largely 

by temporary hiring and the government will likely hire 10k 

workers. While job losses should continue to slow in the 

goods-producing sector, neither the manufacturing nor the 

construction sectors are anywhere near job creation and 

we expect these sectors will offset service sector gains. 

The unemployment rate is expected to rise to 10.1% on 

steady labour force participation and a household survey 

job loss; job losses in the household survey have averaged 

more than 200k more than non-farm payrolls in recent 

months, likely owing to the fact that it captures small 

businesses hurt most by ongoing credit constraints. A 

couple of factors to be aware of in the January report: 

January has by far the largest seasonal factor, averaging 

just under 3 million in recent years; this raises the potential 

for statistical noise. In addition, seasonal factors will be 

revised back to 2005 and monthly detail will be included 

from the annual benchmarking of payrolls through March 

2009 that was initially estimated at a total downward 

revision of 824k over 12 months. Finally, the Household 

Survey will include a population benchmark that will affect 

estimates of the labour force. 




Economic Calendar: 8 February – 5 March 

8 February 9 February 10 February 11 February 12 February 

Japan: M2 Jan, Current 

Account Dec 

France: BoF Survey (Prel) 

Jan 

Neths: Industrial 

Production Dec 



Australia: NAB Business 

Confidence Jan, Westpac 

Consumer Confidence 

Feb 

Germany: Trade Balance 

Dec, CPI Jan, HICP Jan 

UK: Trade Balance Dec, 

RICS House Price 

Balance Jan, BRC Retail 

Sales Monitor Jan 

US: Wholesale Trade 

Dec 

Japan: CGPI Jan, 

Machinery Orders Dec 

UK: BoE Inflation Report, 

IP Dec 

France: IP Dec, Current 

Account Dec 

Italy: IP Dec 

Sweden: IP Dec, AMV 

Labour Jan 

Norway: PPI Jan, CPI Jan 

US: Trade Balance Dec, 

Treasury Statement Jan 

Australia: Labour Jan 

Eurozone: ECB Monthly 

Bulletin 

France: Investment 

Survey Jan 

Spain: GDP (Flash) Q4 

Sweden: Riksbank Rate 

Announcement & 

Monetary Policy Report 

Neths: CPI Jan 

Switz: CPI Jan 

US: Retail Sales Jan, 

Business Inventories Dec 

During Week: Germany WPI Jan 


UK: Rightmove House 

Prices Feb 

Italy: Trade Balance Dec 

US: Public Holiday 

Australia: RBA MPC 

Minutes 

Eurozone: EU25 New 

Car Registrations Jan 

UK: CPI Jan 

Germany: ZEW Survey 

Feb 

US: Empire State Survey 

Feb, TICS Data Dec, 

NAHB Housing Index Feb 

Japan: Tertiary Index Dec 

Eurozone: Trade Balance 

Dec 

UK: Labour Feb, BoE 

MPC Minutes, DCLG 

House Prices Dec 

Spain: GDP Q4 

Belgium: GDP (Flash) Q4 

US: Import Price Index 

Jan, Housing Starts Jan, 

Industrial Production Jan, 

FOMC Minutes 

Japan: BoJ Rate Ann 

UK: PSNCR Jan, PSNB 

Jan, CBI Industrial Trends 

Feb 

Sweden: CPI Jan, 

Labour Jan 

Norway: GDP Q4 

Eurozone: Governing 

Council Meeting (No Rate 

Announcement) 

Neths: Labour Jan 

US: PPI Jan, Leading Ind 

Jan, Philly Fed Feb 

Canada: CPI Jan 


Italy: Non-EU Trade 

Balance Jan 

Neths: Consumer 

Confidence Feb 

Japan: BoJ Monetary 

Policy Meeting Minutes 

UK: CBI Distributive 

Trades Jan 

Germany: Ifo Survey Feb 

France: Retail Sales Jan, 

CPI Jan, Housing Starts 

Jan 

Italy: CPI Jan, ISAE 


Feb 

Neths: Producer 


Belgium: Business 


US: Consumer 


Japan: Trade Balance 

Jan 

Eurozone: Industrial 

Orders Dec 

Germany: GDP (Final) 

Q4 

France: Job Seekers Jan 

Italy: Retail Sales Dec 

Norway: Labour (sa) Dec 

US: New Home Sales Jan 

Eurozone: Monetary 

Developments Jan, 

Business & Consumer 

Survey Feb, Retail PMI 

Feb 

Germany: Labour Jan 

France: PPI Feb, 


Feb 

Italy: ISAE Business 


Spain: PPI Jan 

Sweden: PPI Jan, 


Feb 

Norway: Labour (nsa) 

Dec 

Belgium: CPI Feb 

US: Durable Goods 

Orders Jan 

During Week: Germany Import Prices Jan, UK Nationwide House Prices Feb 

1 March 2 March 3 March 4 March 5 March 

Eurozone: Labour Jan, 

PMI Manufacturing (Final) 

Feb 

UK: CIPS Manufacturing 

Feb, Net Consumer Credit 

Jan, Mortgage Approvals 

Jan 

Sweden: GDP Q4 

Norway: Retail Sales Jan 

Switz: PMI Feb 

US: Personal Income & 

Spending Jan, ISM 

Manufacturing Feb, 

Construction Spending Jan 

Canada: GDP Dec & Q4 

Japan: Labour Jan, 

Household Consumption 

Jan 

Australia: Retail Sales 

Jan, RBA Rate 

Announcement 

Eurozone: HICP (Flash) 

Feb, PPI Jan 

Italy: CPI Feb 

Switz: GDP Q4 

Canada: BoC Rate 

Announcement 

Australia: GDP Q4 

Eurozone: Retail Sales 

Jan, PMI Services (Final) 

Feb 

UK: CIPS Services Feb 

US: ISM Services Feb, 

ADP Employment Change 

Feb 

Eurozone: GDP (2 nd Est) 

Q4, ECB Rate 

Announcement & Press 

Conference 

UK: BoE Rate 

Announcement, BoE 

Asset Purchase Target 

Mar 

Neths: CPI Feb 

US: Non-Farm 

Productivity (Final) Q4, 

ULC (Final) Q4, Factory 

Orders Jan 

During Week: Germany Retail Sales Jan, Import Prices Jan 


Release dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions 

65 

Eurozone: Industrial 

Production Dec, GDP 

(Flash) Q4 

Germany: GDP (Flash) Q4 

France: GDP (Prel) Q4, 

Non-Farm Payrolls (Prel) 

Q4, Wages (Prel) Q4 

Italy: GDP (Prel) Q4 

Spain: HICP Jan 

Neths: GDP (Prel) Q4, 

Retail Sales Dec 

US: UoM Sentiment (Prel) 

Feb 

Eurozone: Current 

Account Dec, PMIs (Flash) 

Feb 

UK: Retail Sales Jan 

Germany: PPI Jan 

France: Business Survey 

Feb 

Italy: Industrial Orders 

Dec 

US: CPI Jan 

Japan: CPI Tokyo Feb, 

CPI National Jan, IP Jan, 

Housing Starts Jan, Retail 

Sales Jan 

Eurozone: HICP Jan, 

Eurocoin Feb 

UK: GfK Consumer 

Confidence Feb, GDP (2 nd 

Est) Q4 

Germany: States’ Cost of 

Living Feb, HICP (Flash) 

Feb 

Italy: PPI Jan 

Spain: HICP Feb 

Sweden: Retail Sales Jan 

Switz: KOF Leading 

Indicator Feb 

US: GDP (2 nd Release) 

Q4, Chicago PMI Feb, 

Existing Home Sales Jan, 

UoM Sentiment (Final) Feb 

UK: PPI Feb 

Germany: Factory Orders 

Jan 

Spain: Industrial 

Production Jan 

Norway: Industrial 

Production Jan 

US: Labour Feb, 

Consumer Credit Jan 


Treasury and SAS Issuance Calendar 

Daily update onto https://globalmarkets.bnpparibas.com, Tools & Apps, Analytical Tools, Market Calendar, Government Flows 

In the pipeline - Treasuries: 

Spain: To issue a new syndicated 15y Obligacion in February (exact date to be set) 

France: To consider a dollar-denominated bond issue in 2010 

Germany: Reserves the right to issue foreign currency bonds, as market conditions allow 

Greece: Plans to issue a 10y bond via a syndicated deal (EUR 3-5bn) in February 

Poland: Plans to sell at least USD 1bn of dollar-denominated bonds (maturity shorter than 10y) in Q1 

Portugal: New OT to be launched via syndication, maturity & timing subject to market conditions 

UK: To announce a further syndicated offer in Q1 in due course 

Finland: To issue new 5y & 10y RFGBs and to tap 4 to 5 auctions with possibly 2-3 in H1 (details announced a week prior to auctions) 

Neths: To issue a new 30y DSL (DDA, before the summer). No plans for inflation-linked bonds. May issue a dollar-denominated bond (in '10) 

Czech Rep.: Issue in euros possible and a dollar-denominated bond is under consideration 

Denmark: To issue a EUR 5y loan (EUR 1-2bn) in H1 '10. To open new 5y & 10y DGBs H2 '10. To launch a T-bill programme on 25 February 

Slovak Rep.: Plans up to EUR 1.5bn syndicated 10y before the end of Q1 

During the week: 

UK: (Feb 15 mini tender) choice of gilt on 5 February 

UK: No gilt purchase operations (current target achieved). MPC to review its asset purchase programme at its February meeting (3-4 Feb) 

FNMA: First syndicated auction in February, details announced on 2 February 

Date Day Closing Country Issues Details BNPP forecasts 

Local GMT 

02/02 Tue 12:00 03:00 Japan JGB Dec 2019 JPY 2.2tn 

10:30 10:30 UK Gilt 5.25% Jun 2012 GBP 3.75bn 

Neths DSL Jul 2020 (DDA) (new) 29 Jan min. EUR 5bn 

12:00 17:00 Canada Repurchase of 8 Cash Mgt Bonds (Jun-10 - Jun-11) CAD 1bn 

03/02 Wed 11:00 10:00 Germany OBL 2.5% Feb 2015 (Series 156) EUR 6bn 

10:30 10:30 UK Gilt 5% Mar 2018 GBP 3bn 

12:00 17:00 Canada CAN 10-year 28 Jan 

04/02 Thu 12:00 03:00 Japan JGBs 20y Auction for Enhanced-liquidity issue 81-112 

JGBs 30y Auction for Enhanced-liquidity issue 3-30 

JPY 0.3tn 

10:30 09:30 Spain Bono 2.3% Apr 2013 1 Feb EUR 3bn 

10:50 09:50 France OATs 10- &/or 15- &/or 30-year 29 Jan EUR 7.5-9bn 

11:00 10:00 Sweden ILBs 3.5% Dec 2015 (# 3105) SEK 0.5bn 

08/02 Mon Slovak Rep. SLOVGB 4.5% May 2026 (#206) 

09/02 Tue 12:00 03:00 Japan JGB 30-year 2 Feb JPY 0.6tn 

11:00 10:00 Austria RAGBs 2 Feb 

10:30 10:30 UK Gilt 4.5% Sep 2034 2 Feb 

Neths DSL 2.75% Jan 2015 EUR 2-3bn 

13:00 18:00 US Notes 3-year (new) 3 Feb USD 40bn 

10/02 Wed 11:00 10:00 Germany Bund 3.25% Jan 2020 EUR 5bn 

11:00 10:00 Sweden T-bonds 3 Feb SEK 3bn 

10:30 10:30 Portugal OTs (To be confirmed) 4 Feb 

12:00 17:00 Canada CAN 3-year 4 Feb 


11/02 Thu 10:30 10:30 UK Index-Linked Gilt 1.875% Nov 2022 2 Feb 

13:00 18:00 US Bond 30-year (new) 3 Feb USD 16bn 

12/02 Fri 10:55 09:55 Italy 5-year BTP and possibly 15- or 30-year BTP 5 Feb 


10:00 10:00 Ireland Gilt 9 Feb EUR 1-1.5bn 

17/02 Wed 11:00 10:00 Germany Schatz Mar 2012 (new) EUR 7bn 

12:00 17:00 Canada CAN 30-year 11 Feb 

18/02 Thu 10:30 09:30 Spain Obligacion 4.2% Jan 2037 15 Feb 

10:50 09:50 France BTANs 2- &/or 5-year 12 Feb 

11:50 10:50 France OATis , OATeis, BTANeis 12 Feb 

11:00 10:00 Sweden ILBs 11 Feb SEK 1bn 

19/02 Fri 12:00 03:00 Japan Auction for Enhanced-liquidity 12 Feb JPY 0.6tn 

22/02 Mon 12:00 11:00 Belgium OLO 15 Feb 

Slovak Rep. SLOVGB (to be confirmed) 

13:00 18:00 US TIPS 30-year (new) 18 Feb USD 12bn 


10:55 09:55 Italy CTZ 18 Feb 

Neths DSLs (Off-the-run facility) 17 Feb 


24/02 Wed 10:55 09:55 Italy BTPeis 18 Feb 

11:00 10:00 Sweden T-bonds 17 Feb 

10:30 10:30 Portugal OTs (To be confirmed) 18 Feb 

10:30 10:30 UK Gilt 3.75% Sep 2019 16 Feb 

Denmark DGB 4% Nov 2010 (buy back) 

12:00 17:00 Canada CANi 30-year 18 Feb 


Sources: Treasuries, BNP Paribas 



66 


Next week's T-Bills Supply 

Date Country Issues Details 

29/01 UK T-Bills Mar 2010 GBP 1bn 

T-Bills May 2010 GBP 2bn 

T-Bills Aug 2010 GBP 1.5bn 

01/02 France BTF Apr 2010 EUR 4bn 

BTF Jul 2010 

EUR 2.5bn 

BTF Dec 2010 

EUR 2.5bn 

Neths DTC Mar 2010 EUR 0.25-0.75bn 

DTC Apr 2010 

EUR 1-2.5bn 

DTC May 2010 

EUR 1-2.5bn 

DTC Jul 2010 

EUR 1-2.5bn 

US T-Bills May 2010 USD 23bn 

T-Bills Aug 2010 (new) USD 26bn 

FHLMC Bills 3-month & 6-month 29 Jan 

02/02 Belgium TC May 2010 29 Jan 

TC Jul 2010 

29 Jan 

US T-Bills 4-week 1 Feb 

FHLB Discount Notes 

03/02 Japan T-Bills May 2010 JPY 5.7tn 

Sweden T-Bills May 2010 SEK 10bn 

T-Bills Jun 2010 SEK 5bn 

Portugal BT Jan 2011 EUR 0.5bn 

FNMA Bills 3-month & 6-month 1 Feb 

04/02 FHLB Discount Notes 

05/02 Japan T-Bills 6-month 29 Jan 

UK T-Bills 29 Jan 

Sources: Treasuries, BNP Paribas 

Comments and charts 

• EGB gross supply will remain at the same level as 

the last couple of weeks at around EUR 22.5bn, while in 

10y duration-adjusted terms, it will amount to 

EUR 17.2bn. Net supply will be positive as EUR 29bn of 

redemptions are coming from Spain and Italy. 

• Germany will tap its OBL Feb-15 for EUR 6bn on 

Wednesday. On Tuesday, the Netherlands will launch a 

new DSL Jul-20 (DDA) for a minimum size of EUR 5bn. 

On Thursday, Spain will tap its Apr-13 bond for an 

expected size around EUR 2-3bn while France will 

conduct its end-of-month reopenings of the 10y &/or 15y 

&/or 30y sectors. 

• Outside of the eurozone, there will be two auctions 

in the UK, a tap of Gilt Jun-12 for GBP 3.75bn and 

Mar-18 for GBP 3bn. Japan, Canada and Sweden will 

also issue paper next week. 

Next week's Eurozone Redemptions 

Date Country Details Amount 

31/01 Spain Obligacion 4% EUR 17.2bn 

01/02 Italy CCT EUR 11.3bn 

04/02 Finland RFGB 3.25% EUR 0.5bn 

Total Eurozone Long-term Redemption 

EUR 29bn 

04/02 France BTF EUR 10.1bn 

Total Eurozone Short-term Redemption EUR 10.1bn 

30 

25 

20 

20 

15 

10 

5 

0 

-5 

-10 

-15 

-20 

-25 

-30 

30 

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 Feb 1st Week of Feb 8th Week of Feb 15th Week of Feb 22nd 

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) 

2-3-YR 5-7-YR 10-YR >10-YR 

EGBs Gross Supply (EUR bn, 10y equivalent) 

15 

10 

5 

0 


All Charts Source: BNP Paribas 



67 


Central Bank Watch 

Interest Rate 

EUROZONE 

Current 

Rate 

Minimum Bid Rate 1.00 

US 

Fed Funds Rate 0 to 0.25 

Discount Rate 0.50 

JAPAN 

Call Rate 0.10 

Basic Loan Rate 0.30 

UK 

Bank Rate 0.5 

DENMARK 

Lending Rate 1.05 

SWEDEN 

Repo Rate 0.25 

NORWAY 

Sight Deposit Rate 1.75 

SWITZERLAND 

3 Mth LIBOR Target 

Range 

CANADA 

0.0-0.75 

Overnight Rate 0.25 

Bank Rate 0.50 

AUSTRALIA 

Cash Rate 3.75 

CHINA 

1Y Bank Lending 

Rate 

BRAZIL 

5.31% 

Selic Overnight Rate 8.75% 


Date of Last 

Change 

-25bp 

(7/5/09) 

-75bp 

(16/12/08) 

-75bp 

(16/12/08) 

-20bp 

(19/12/08) 

-20bp 

(19/12/08) 

-50bp 

(5/3/09) 

-10bp 

(14/1/10) 

-25bp 

(2/7/09) 

+25bp 

(16/12/09) 

-25bp 

(12/3/09) 

-25bp 

(21/4/09) 

-25bp 

(21/4/09) 

+25bp 

(1/12/09) 

-27bp 

(22/12/08) 

-50bp 

(22/7/09) 

Next Change in 

Coming 6 Months 

No Change 

No Change 

+25bp 

(Mar/May) 

No Change 

No Change 

No Change 

-5bp 

(Feb/Mar) 

No Change 

+25bp 

(24/3/10) 

No Change 

No Change 

No Change 

+25bp 

(2/2/10) 

+27bp 

(Q3) 

No Change 

Comments 

Given excess capacity, underlying inflation should continue to 

decelerate, implying that higher policy rates should remain off 

the agenda for some time to come. 

The FOMC reaffirmed its commitment to purchase USD 1.25trn 

of mortgage-backed securities and USD 175bn of agency debt, 

and to end its purchases by 31 March. It will also maintain the 

funds rate at 0 to 0.25% for an extended period. Extreme 

liquidity initiatives will end in the next few weeks foreshadowing 

a probable rise in the discount rate. 

With the BoJ forecasting negative CPI inflation through H1 of FY 

2011, we expect its ultra-low interest rate policy to remain in 

place for some time to come. 

We expect the MPC to pause the Asset Purchase Facility 

purchases at the February meeting. 

We expect the lending rate to fall further. The timing will depend 

on foreign exchange reserve developments. 

The Riksbank is maintaining its cautious stance and intends to 

keep the repo rate at 0.25% until autumn 2010. We agree with 

this central assessment and expect the first rate hike to be 

delivered in Q3 2010. 

Given an increase in bank lending rates and an appreciation of 

the krone since the last rate hike in December, we believe the 

Norges Bank will increase its policy rate further in March. 

By relaxing its commitment to prevent currency appreciation the 

SNB is de facto tightening policy and has kept the ball rolling 

towards an eventual increase in rates. The strong franc remains 

the biggest hurdle to the first hike. 

The BoC committed to keep rates unchanged until mid-2010, 

conditional on the outlook for inflation. While domestic conditions 

are stronger than in the US, the BoC is unlikely to begin raising 

interest rates well ahead of the Fed. 

Strong labour data, the erosion of already limited spare capacity 

and underlying inflation above the target range should 

encourage the RBA to raise the cash rate at its next meeting. 

The latest 50bp RRR hike is likely to mark the beginning of a 

series of measures to tighten policy. The first hike in key policy 

rates is expected in Q3 when the CPI rate is forecast to exceed 

3%. However, given the authorities' rising caution about excess 

credit, an earlier move cannot be ruled out. 

The BCB frontloaded monetary easing by cutting rates by 

500bp. Given signs of a stabilisation of the Brazilian economy 

and an improvement in global conditions, we expect the BCB to 

remain on hold for a long period. 

Change since our last weekly in bold and italics 

For the full EMK Central Bank Watch please see our Local Markets Mover 



Economic Forecasts 

GDP 

Year 2009 

2010 

(% y/y) ’08 ’09 (1) ’10 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US 0.4 -2.5 2.5 -3.3 -3.8 -2.6 -0.2 2.2 2.9 2.7 2.2 

Eurozone 0.5 -3.9 1.3 -5.0 -4.8 -4.0 -1.6 1.2 1.6 1.3 0.9 

Japan -1.2 -5.3 1.2 -8.9 -5.8 -5.1 -1.7 1.7 1.2 0.9 0.8 

World (2) 3.1 -0.9 3.7 -2.3 -2.0 -0.9 1.4 3.8 4.0 3.7 3.4 

Industrial Production 

Year 

2009 

2010 

(% y/y) ’08 ’09 (1) ’10 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US -2.2 -9.7 4.1 2.0 5.6 4.6 4.2 4.1 4.4 4.6 4.4 

Eurozone -1.7 -14.4 2.7 -17.7 -18.2 -15.0 -6.5 3.5 4.8 1.8 0.6 

Japan -3.4 -22.3 15.6 -34.6 -27.8 -20.1 -4.7 28.1 19.2 11.5 6.9 

Unemployment Rate 

Year 

2009 2010 

(%) ’08 ’09 (1) ’10 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US 5.8 9.3 10.1 6.9 8.1 9.3 10.1 10.2 10.0 10.2 10.0 

Eurozone 7.6 9.4 10.4 8.8 9.3 9.6 9.9 10.2 10.4 10.6 10.6 

Japan 4.0 5.1 5.3 4.4 5.2 5.5 5.3 5.3 5.3 5.3 5.2 

CPI 

Year 

2009 

2010 

(% y/y) ’08 ’09 (1) ’10 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) 

US 3.8 -0.3 2.5 -0.2 -0.9 -1.6 1.5 2.8 2.8 2.4 1.9 

Eurozone 3.3 0.3 1.3 1.0 0.2 -0.4 0.4 1.2 1.1 1.3 1.5 

Japan 1.1 -1.8 -1.4 -0.1 -1.0 -2.2 -2.1 -1.7 -2.1 -1.9 -0.9 

Current Account 

(% GDP) ’08 

Year 

’09 (1) ’10 (1) General Government 

(% GDP) 

’08 

Year 

’09 (1) ’10 (1) 

US -4.9 -3.5 -4.4 US (4) -3.1 -11.0 -10.2 

Eurozone -1.6 -0.8 -0.8 Eurozone -1.9 -6.5 -6.9 

Japan 3.2 2.7 3.0 Japan -6.7 -10.6 -9.1 

Interest Rate Forecasts 

Interest Rate (3) 

Year 

2009 

2010 

(%) ’08 ’09 (1) ’10 (1) Q1 Q2 Q3 Q4 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 0.25 

3-month Rate 1.43 0.25 0.45 1.19 0.60 0.29 0.25 0.30 0.30 0.40 0.45 

2-year yield 0.77 1.14 1.30 0.80 1.12 0.95 1.14 1.00 0.90 1.15 1.30 

10-year yield 2.22 3.84 3.75 2.67 3.54 3.31 3.84 3.25 3.00 3.30 3.75 

2y/10y Spread (bp) 145 270 245 187 242 236 270 225 210 215 245 

Eurozone 

Refinancing Rate 2.50 1.00 1.00 1.50 1.00 1.00 1.00 1.00 1.00 1.00 1.00 

3-month Rate 2.89 0.70 1.10 1.51 1.10 0.75 0.70 0.60 0.60 0.65 1.10 

2-year yield 1.74 1.37 1.50 1.23 1.38 1.28 1.37 1.25 1.25 1.50 1.50 

10-year yield 2.95 3.40 3.50 3.00 3.38 3.23 3.40 3.10 2.90 3.20 3.50 

2y/10y Spread (bp) 121 203 200 177 200 195 203 185 165 170 200 

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 

3-month Rate 0.74 0.46 0.35 0.65 0.56 0.54 0.46 0.45 0.45 0.40 0.35 

2-year yield 0.40 0.15 0.45 0.41 0.32 0.25 0.15 0.20 0.25 0.35 0.45 

10-year yield 1.18 1.30 1.70 1.35 1.36 1.31 1.30 1.40 1.50 1.60 1.70 

2y/10y Spread (bp) 78 115 125 94 104 106 115 120 125 125 125 

Footnotes: (1) Forecast (2) Country weights used to construct world growth are those in the IMF World Economic Outlook Update 

April 2009 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated 


Market Economics / Interest Rate Strategy 29 January 2010 


69 


FX Forecasts* 

USD Bloc Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 

EUR/USD 1.40 1.36 1.32 1.31 1.34 1.35 1.38 1.42 1.44 1.46 1.43 

USD/JPY 93 97 100 108 110 115 120 118 116 114 112 

USD/CHF 1.04 1.05 1.10 1.12 1.11 1.13 1.12 1.11 1.11 1.10 1.13 

GBP/USD 1.59 1.49 1.39 1.31 1.43 1.45 1.50 1.56 1.58 1.62 1.61 

USD/CAD 1.07 1.09 1.13 1.15 1.11 1.09 1.06 1.04 1.02 1.05 1.08 

AUD/USD 0.92 0.86 0.84 0.82 0.85 0.87 0.89 0.92 0.96 0.93 0.92 

NZD/USD 0.72 0.70 0.68 0.65 0.64 0.66 0.68 0.69 0.72 0.69 0.67 

USD/SEK 7.07 7.35 7.73 7.71 7.46 7.26 6.96 6.55 6.39 6.44 6.71 

USD/NOK 5.79 6.10 6.29 6.26 6.04 5.78 5.51 5.28 5.14 5.14 5.31 

EUR Bloc Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 

EUR/JPY 130 132 132 141 147 155 166 168 167 166 160 

EUR/GBP 0.88 0.91 0.95 1.00 0.94 0.93 0.92 0.91 0.91 0.90 0.89 

EUR/CHF 1.45 1.43 1.45 1.47 1.49 1.52 1.55 1.57 1.60 1.61 1.62 

EUR/SEK 9.90 10.00 10.20 10.10 10.00 9.80 9.60 9.30 9.20 9.40 9.60 

EUR/NOK 8.10 8.30 8.30 8.20 8.10 7.80 7.60 7.50 7.40 7.50 7.60 

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 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 

USD/PLN 2.80 3.09 3.30 3.09 3.06 2.96 2.75 2.82 2.64 2.53 2.52 

EUR/CZK 26.0 26.2 26.2 25.8 25.2 25.5 25.0 24.7 24.3 24.0 23.9 

EUR/HUF 255 280 278 265 260 255 250 260 255 255 255 

USD/ZAR 8.00 8.20 8.30 8.50 8.40 8.50 8.40 8.20 7.80 7.80 7.50 

USD/TRY 1.48 1.53 1.58 1.55 1.60 1.58 1.55 1.50 1.43 1.45 1.45 

EUR/RON 4.30 4.30 4.40 4.35 4.40 4.30 4.20 4.00 3.90 3.80 3.75 

USD/RUB 30.51 31.84 30.59 28.96 27.75 26.78 25.62 25.23 24.53 24.91 26.13 

EUR/PLN 3.92 4.20 4.35 4.05 4.10 4.00 3.80 4.00 3.80 3.70 3.60 

USD/UAH 8.9 8.4 8.6 8.7 8.5 8.3 7.9 7.5 5.5 5.3 5.4 

EUR/RSD 92 105 95 93 90 87 85 87 90 86 87 

Asia Bloc Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 

USD/SGD 1.37 1.36 1.36 1.34 1.33 1.32 1.31 1.30 1.30 1.30 1.30 

USD/MYR 3.31 3.28 3.26 3.20 3.18 3.15 3.13 3.10 3.10 3.10 3.10 

USD/IDR 9000 8800 8700 8600 8500 8400 8300 8200 8100 8000 8000 

USD/THB 32.70 32.50 32.30 32.00 31.70 31.50 31.30 31.00 31.00 31.00 31.00 

USD/PHP 45.50 45.00 44.50 44.00 43.50 43.00 42.70 42.50 42.00 42.00 42.00 

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 6.83 6.83 6.72 6.62 6.57 6.52 6.47 6.42 6.37 6.32 6.27 

USD/TWD 30.70 30.50 30.30 30.00 29.70 29.50 29.30 29.00 29.00 29.00 29.00 

USD/KRW 1120 1090 1070 1050 1030 1020 1010 1000 1000 1000 1000 

USD/INR 45.00 44.00 43.00 42.00 41.00 40.00 39.00 38.00 38.00 38.00 38.00 

USD/VND 17300 17000 16700 16500 16400 16300 16200 16000 16000 16000 16000 

LATAM Bloc Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 

USD/ARS 3.89 4.20 4.10 4.20 4.25 4.35 4.45 4.50 4.60 4.70 4.80 

USD/BRL 1.75 1.90 1.80 1.75 1.75 1.80 1.80 1.85 1.85 1.85 1.85 

USD/CHL 505 530 525 530 530 535 535 535 540 540 540 

USD/MXN 13.00 13.75 13.10 12.50 12.50 12.50 12.50 12.50 12.25 12.25 12.00 

USD/COP 1900 2100 2050 2000 2000 2050 2100 2100 2150 2150 2200 

USD/VEF priority (1) 2.59 2.59 2.59 2.59 2.59 2.59 2.59 2.59 5.30 5.30 5.30 

USD/VEF oil (1) 4.60 4.60 4.60 4.60 4.60 4.60 4.60 4.60 8.80 8.80 8.80 

*End Quarter 

(1) Following the devaluation of the VEF, there is now an official ‘priority’ exchange rate and a so-called ‘oil’ exchange rate used for certain transactions 


Foreign Exchange Strategy 29 January 2010 



70

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 

Brian Fabbri Chief Economist North America New York 1 212 841 3633 brian.fabbri@americas.bnpparibas.com 

Julia Coronado Senior US Economist New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.com 

Anna Piretti US, Canada New York 1 212 841 3663 anna.piretti@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 

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 

Chan Kok Peng Chief Economist Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.com 

Michal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.com 

Rafael de la Fuente Chief Economist Latin America ex Brazil New York 1 212 841 3637 rafael.delafuente@americas.bnpparibas.com 

Italo Lombardi Latin America New York 1 212 841 6599 italo.lombari@americas.bnpparibas.com 

Alexandre Lintz Latin America São Paulo 55 11 3841 3418 alexandre.lintz@br.bnpparibas.com 

Diego Donadio Latin America São Paulo 55 11 3841 3421 diego.donadio@@br.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 

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 

Bülent Baygün Head of Interest Rate Strategy US New York 1 212 471 8043 bulent.baygun@americas.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 

Anish Lohokare MBS Strategist New York 1 212 841 2867 anish.lohokare@americas.bnpparibas.com 

Koji Shimamoto Head of Interest Rate Strategy Japan Tokyo 81 3 6377 1700 koji.shimamoto@japan.bnpparibas.com 

Takafumi Yamawaki Japan Strategist Tokyo 81 3 6377 1705 takafumi.yamawak@bnpparibas.com 

Tomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1702 Tomohisa.fujiki@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 

Sebastien Galy FX Strategist New York 1 212 841 2492 sebastien.galy@bnpparibas.com 

Andy Chaveriat Technical Analyst New York 1 212 841 2408 andrew.chaveriat@americas.bnpparibas.com 

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 

Gao Qi FX & IR Asia Strategist Singapore 65 6210 3264 gao.qi@asia.bnpparibas.com 

Shahin Vallée Head of FX & IR Strategy CEEMEA London 44 20 7595 8306 shahin.vallee@uk.bnpparibas.com 

Elisabeth Gruié FX & IR CEEMEA Strategist London 44 20 7595 8492 elisabeth.gruie@uk.bnpparibas.com 

Bartosz Pawlowski FX & IR CEEMEA Strategist London 44 20 7595 8195 Bartosz.pawlowski@uk.bnpparibas.com 

For Production and Distribution, please contact: 

Ann Aston, Market Economics, London. Tel: 44 20 7595 8503 Email: ann.aston@uk.bnpparibas.com 

Danielle Catananzi, Interest Rate Strategy, London. Tel: 44 20 7595 4418 Email: danielle.catananzi@uk.bnpparibas.com 

Derek Allassani, FX Strategy, London. Tel: 44 20 7595 8486 Email: derek.allassani@uk.bnpparibas.com 

Martine Borde, Market Economics/Interest Rate Strategy, Paris. Tel: 33 1 4298 4144 Email martine.borde@bnpparibas.com 

Editors 

Amanda Grantham-Hill, Interest Rate Strategy/Market Economics, London. Tel: 44 20 7595 4107 Email: amanda.grantham-hill@bnpparibas.com 

Nick Ashwell, FX/Market Economics, London. Tel: 44 20 7595 4120 Email: nick.ashwell@uk.bnpparibas.com 

BNP Paribas Global Fixed Income Website 

www.globalmarkets.bnpparibas.com 

Bloomberg 

Fixed Income Research BPCM Market Economics BPEC 

Interest Rate Strategy BPBS Forex Strategy BPFR 

71

RESEARCH DISCLAIMERS: 

IMPORTANT DISCLOSURES: Please see important disclosures in the text of this report. 

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