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JGBs: Fiscal Austerity – Not an Easy Task • Since Kan’s “third way to growth” that puts emphasis on the social welfare is nothing more than “big government”, markets will worry about the growing fiscal burden of an ageing population. • Now that the Upper House elections are over, financial markets will again take note of the various difficulties in restructuring government finances. The JGB market’s attempts to test the upside have ended and steepening pressures are growing. LDP 84 New Komeito 19 Chart 1: Parties’ Diet Standings The Upper House 242 seats Source: BNP Paribas Your Party 11 DPJ 106 LDP 116 The Lower House 480 seats New Komeito 21 DPJ 306 Fiscal restructuring remains difficult The DPJ suffered a crushing defeat in the 11 July Upper House elections, losing the majority it held with its coalition ally NPP. As a result, the DPJ will need to collaborate with the New Komeito Party and Your Party, on each economic policy measure. Thus it has become difficult for the DPJ to pursue fiscal austerity independently. A consumption tax hike has become a politically delicate subject, particularly now, since the election defeat is deemed due to PM Kan’s comments on a hike in the rate. Under the current circumstances, fiscal restructuring remains difficult, even with the ten seats won by Your Party, which is the only party that respects the market mechanism. Instead, the left wing of the DPJ that stresses correcting economic disparities — the Kan-Edano policy line — has become even more prominent and their policy affinity with the New Komeito is growing. Since Kan’s “third way to growth” that puts emphasis on the social welfare is nothing more than “big government,” markets will worry about the growing fiscal burden of an ageing population. Not easy to implement the Scandinavian model The Scandinavian model that combines significant welfare benefits with a sizeable tax burden is being re-evaluated, in part because of the stable economic performance of northern European nations. However, other factors have also played a role in their success: small populations of several million individuals help explain the high average levels of education, high labour mobility and great trust in governments. It would not prove easy to implement successfully this model in Japan, a nation with a rapid rise in the average age of the population of 130 million. Incidentally, consumption tax (VAT) rates are around 25% in northern European countries. If Japan were to raise its consumption tax rate incrementally from the current 5% to 25%, this would take twenty years if the rate was hiked by 1% per annum or ten years if increased 2% annually. Since memories of the sizeable impact that past consumption tax hikes have had on the Japanese economy are still fresh, it is unrealistic to hike this tax continuously without regard to the state of the economy. This implies that once the government has started to go down the road of raising the consumption tax, it will find the going long and hard. Steepening pressures are growing Now that the Upper House elections are over, financial markets will again take note of the various difficulties in restructuring government finances: 1) talk of hiking the consumption tax has again proven to be a headwind for the ruling bloc and the consumption tax ‘trauma’ will linger among lawmakers; 2) despite PM Kan’s stress on fiscal discipline, a coalition government makes it hard to implement all policy measures; and 3) apart from future consumption tax changes, the government has to start the compilation of the FY2011 budget. The JGB market’s attempts to test the upside have ended and steepening pressures are growing. Not only will uncertainty over the eurozone financial system abate but implementing fiscal austerity will not be an easy task. After the Upper House election and bank stress tests, we should focus on the real economy. With the economy resilient, the earnings environment for financial institutions is not unfavourable. Hence we recommend that investors carefully evaluate the fundamentals rather than rushing into the market. Koji Shimamoto 16 July 2010 Market Mover, Non-Objective Research Section 32 www.GlobalMarkets.bnpparibas.com
Global Inflation Watch June CPI in Focus The final release of the eurozone HICP for July showed a marginal rise in core inflation (from 0.85% y/y to 0.92%) offset by a slowdown in energy inflation, as a modest fall in energy prices over the month (-0.4%) was exacerbated by base effects. The modest acceleration in prices of clothing and recreational items probably reflects the impact of the weaker euro. Spanish data also revealed some passthrough from the VAT hike. We expect more in July but, with the main retailers announcing that they have not transferred it to their customers, the overall impact of the tax hike should remain limited (we assume a 40% pass-through, implying a boost to Spanish core inflation of around 0.6pp). All in all, neither the euro weakening nor the VAT increases implemented in some countries appears to be sufficient to halt the underlying downward trend in core inflation that we expect to resume from July, with aggressive discounts putting downward pressure on the prices of goods such as clothing and furniture. The picture was slightly different in the UK, where the CPI/RPI releases surprised once again to the upside. Upward pressures were seen in a number of servicerelated components, with core CPI inflation matching its all-time high of 3.1% y/y. We remain of the view that inflation will slow over the next few months, as the impact of the GBP weakness fades, while growth in disposable income slows from the robust pace seen recently. Recent data and some creep in inflation expectations (Chart 2) highlight the risk that the downward trend turns out to be slower than we currently anticipate. The next focus is Friday’s release of the US CPI. The headline CPI is expected to fall by 0.1% m/m. Pump prices fell throughout June – the lagged response to weaker crude oil prices in May. As a result, after seasonal adjustment, the energy CPI should fall by 1.4% m/m in June. The core CPI, meanwhile, should be unchanged m/m, pulling the y/y rate down to 0.85% from 1.0% y/y previously – closer to its 1961 all-time low of 0.7% y/y. If there is a risk, it is that state and local governments raise taxes on tobacco and other goods to help redress budget deficits – as they did in May. However, the clear trend in US core inflation is downwards. Indeed, one of the key trends in the US since the start of the year has been the broadening of disinflationary trends within core inflation. Chart 1: Eurozone HICP (% y/y) Source: Reuters EcoWin Pro, BNP Paribas Chart 2: UK Inflation Expectations vs. CPI Source: Reuters EcoWin Pro Chart 3: US Core CPI (% y/y) Source: Reuters EcoWin Pro, BNP Paribas Luigi Speranza/Eoin O’Callaghan 16 July 2010 Market Mover 33 www.GlobalMarkets.bnpparibas.com
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Page 3 and 4: 2-10s receivers attractive in the 1
Page 5 and 6: arrest the slow growth dynamic we s
Page 7 and 8: US Housing: A Cold Summer • After
Page 9 and 10: we expect residential investment to
Page 11 and 12: ebounded from -13% y/y to +8%. That
Page 13 and 14: At first glance, this latest develo
Page 15 and 16: But property prices have barely cor
Page 17 and 18: political leaders persuaded the pub
Page 19 and 20: …average fiscal multiplier is 1,
Page 21 and 22: US: 10y Range Trade with a Receiver
Page 23 and 24: give-up because we’re switching f
Page 25 and 26: term structure models mentioned bel
Page 27 and 28: swaps. The overall volume of USD 9.
Page 29 and 30: EUR: Deflation Macro Hedge Via Opti
Page 31: EUR: SAS Diversification to Enhance
Page 35 and 36: Table 2: BNP Paribas' Inflation For
Page 37 and 38: Inflation: Sell 30y in the UK & US
Page 39 and 40: GBP: Market Downplays Shift to CPI
Page 41 and 42: averaging introduces sizable upside
Page 43 and 44: Europe ITraxx Credit Indices • Ou
Page 45 and 46: SEN vs. SUB There has been no stron
Page 47 and 48: Technical Analysis - Interest Rates
Page 49 and 50: Trade Reviews Options, Money Market
Page 51 and 52: should not come as a complete surpr
Page 53 and 54: EUR/USD Rally Sets Sights on 1.3000
Page 55 and 56: Currency Spot Trade Recommendations
Page 57 and 58: Economic Calendar: 16 - 23 July (co
Page 59 and 60: Key Data Preview Chart 3: US Housin
Page 61 and 62: Key Data Preview Chart 8: French Hh
Page 63 and 64: Key Data Preview Chart 11: UK GDP v
Page 65 and 66: Treasury and SAS Issuance Calendar
Page 67 and 68: Central Bank Watch Interest Rate EU
Page 69 and 70: FX Forecasts* USD Bloc Q3 '10 Q4 '1
Page 71: RESEARCH DISCLAIMERS: IMPORTANT DIS

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