Market Outlook - BNP PARIBAS - Investment Services India

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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 Market Mover 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. Patrick Jacq 29 January 2010 Market Mover 3 www.GlobalMarkets.bnpparibas.com
Page 1: Market Economics | Interest Rate St
Page 5 and 6: The subtle changes in the wording o
Page 7 and 8: US: Get It While You Can • As the
Page 9 and 10: 500,000, the months-supply level of
Page 11 and 12: France: Roaring Consumption • Ret
Page 13 and 14: should be particularly true for the
Page 15 and 16: UK Inflation: Bridging the Gap •
Page 17 and 18: eceive roughly 60/40 weight within
Page 19 and 20: 1.2% m/m in November, partly offset
Page 21 and 22: or absence of competitors in a spec
Page 23 and 24: Japan: Polarisation in Machine Tool
Page 25 and 26: Australia: The Next Step • Data r
Page 27 and 28: US: Post-FOMC Treasury Market Overv
Page 29 and 30: US: Rolling Down the Agency Spread
Page 31 and 32: US: Poor Housing Underscores MBS Su
Page 33 and 34: Fannie Mae has not discussed the in
Page 35 and 36: EUR: Timing the 20Y Point • The l
Page 37 and 38: EUR 3-5bn (new 10y) in February? Co
Page 39 and 40: JGBs: Supply Continues to Weigh •
Page 41 and 42: Table 1: BNP Paribas' Inflation For
Page 43 and 44: Table 3: BNP Paribas' Inflation For
Page 45 and 46: Pricing Date Repo Rate EUR DRI FRF
Page 47 and 48: CNY: Revaluation and FX Reserves
Page 49 and 50: domestic-demand led one is underway
Page 51 and 52: USD Bullish Signals • USD Trade W
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Currency Spot Trade Recommendations
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Economic Calendar: 29 Jan - 5 Feb (
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Key Data Preview Chart 3: Japanese
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Key Data Preview Chart 7: Change in
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Key Data Preview Chart 11: US PMI M
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Key Data Preview Chart 15: US Non-F
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Economic Calendar: 8 February - 5 M
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Next week's T-Bills Supply Date Cou
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Economic Forecasts GDP Year 2009 20
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Market Coverage Market Economics Pa
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Market Outlook - BNP PARIBAS - Investment Services India

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