Fishing Forex PIPS

BOC Withholds From Signaling Tightening

2011-10-04T21:32:00.000-07:00

Recent headwind in global economic outlook should deter BOC's tightening schedule. We believe the central bank will leave the policy rate unchanged at 1% in September. Indeed, Fed's decision to keep interest rates at exceptionally low levels at least until mid-2013 and the increasing downside risks to inflation signaled the BOC will leave the overnight rate unchanged at least until mid -2012. That said, it's also unlikely for the central bank to trim interest rates as headline inflation remains high and the job market is robust.

GDP contracted -0.4% q/q in 2Q11, following a downwardly revised +3.6% expansion in the prior quarter as deterioration in US economy dampened exports. Domestically, growth remained strong with business investment and household spending showing decent growths during the quarter. Headline inflation eased to +2.7% in July, from 3.1% in June and +3.1% in May, due to lower energy costs and changes in tax policy. Yet, inflation stayed at the upper limit for BOC's target. Core CPI rose to +1.6% in July from +1.3% in June. Employment increased only +7K in July after growing more than +20K in each of the past 3 months but the positive sign came from full-time payrolls which continued to rise. The jobless rate slid to 7.2% from 7.4% in June and May.

At the opening statement before the House of Commons Standing Committee on Finance, BOC Governor Mark Carney said that several downside risks, such as the intensified Eurozone sovereign crisis, the downgrade of US credit rating and weakness in macroeconomic data, to the central bank's July MPR projection have been realized. While the spillovers to the Canadian financial markets have been less 'pronounced', the impacts are still 'notable'. Carney stated that 'the considerable external headwinds' are now 'blowing harder' and Canada will have to adapt to a world that is 'awash with debt' and it will 'take years' for the balance sheets to be repaired. As a result, risks to inflation have also skewed to the downgrade as a result of 'somewhat weaker economic momentum globally'. Yet, it reminded us that growth will continue with acceleration being seen in the second half of the year, led by business investment and household expenditures.

We expect the BOC will deliver a less hawkish statement in September. In the July meeting, the central bank stated that 'some of the considerable monetary policy stimulus currently in place will be withdrawn'. That appeared to be more hawkish than the May statement which stated ''some of the considerable monetary policy stimulus currently in place will be eventually withdrawn'. The BOC this month may withhold the tightening rhetoric as policymakers may prefer to gather more information regarding global economic developments.

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2011-10-04T19:12:00.000-07:00

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A Few Doves Favored More Easing Than Just A Guideline On Fed Funds Rate

2011-10-04T10:55:00.000-07:00

The minutes of the August FOMC meeting unveiled that a few members believed the Fed should have done more at the meeting, given the economic developments. The range of tools that policymakers discussed to stimulate the economy included reinforcing forward guidance about the likely path of monetary policy, additional asset purchases, increasing the average maturity of securities holdings, reducing the interest rate paid on excess reserve balances. However, the preference of the above tools was not shown. Information received during the intermeeting period had led the staff to revise down the projection for real GDP growth in the second half of 2011 and in 2012 'notably'. Concerning inflation, policymakers believed headline inflation has 'moderated' as 'prices of energy and some commodities have declined from their earlier peaks'.

As the minutes stated, 'a few members' preferred 'a more substantial move at this meeting'. Some members favored additional easing as they expected 'the unemployment rate to remain well above, and inflation to be at or below, levels consistent with the Committee's mandate. However, they were willing to accept 'the stronger forward guidance as a step in the direction of additional accommodation' as this was 'a measured response to the deterioration in the outlook over the intermeeting period'. In choosing the time horizon of 'at least through mid-2013', members also considered 'conditioning the outlook' for the Fed funds rate on 'explicit numerical values for the unemployment rate or the inflation rate'. While some members said that stating an explicit time horizon would 'establish greater clarity regarding the Fed's intentions and its likely reaction to future economic developments', others questioned about 'how an appropriate numerical value might be chosen'.

Policymakers did not show preference on the stimulating tools but they 'agreed that the September meeting should be extended to two days' as more time is needed for discussion. Among the tools, we believe lengthening the duration of securities holdings would be preferable currently as it would lower longer term interest rates without needing to boost the size of the Fed's balance sheet.

As far as the economic outlook is concerned, most members downgraded their forecasts after taking information during the intermeeting period into account. In particular, the lower estimates of real GDP in recent years that were contained in the annual revisions to the NIPA led the staff to lower its estimate of potential GDP growth, both during recent years and over the forecast period, and to mark down further the staff forecast. Moreover, a 'couple of participants' worried that the 'exceptionally high level of long-term unemployment' could lead to 'permanent negative effects on the skills and employment prospects of those affected'. Concerning inflation, the members 'continued to expect prices to rise at a subdued pace in 2012'.

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2011-10-04T06:01:00.000-07:00

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Central Bank Forecasts: ECB Remains on Hold Through 2012

2011-10-03T15:19:00.000-07:00

After rate hikes in April and July (each by +25 bps), ECB's main refinancing rate is now at 1.5%. We expect the central bank will remain on hold through 2012 given weakened growth and inflation outlook. Recent macroeconomic data have been disappointing. Eurozone's GDP growth eased to +0.2% q/q in 2Q11 from +0.8% in the prior quarter. Germany's economy expanded only +0.1% q/q while growth in France stalled. Manufacturing activities have shown signs of fatigue with manufacturing PMI slipping to 49.7 in August from 50.4 a month ago. while consumer confidence soured as there's no way out for the sovereign debt crisis. ZEW's survey showed that Eurozone's economic sentiment tumbled to -40 in August from -7 a month ago. The market had expected a pickup to -6.2. The index for Germany alone plunged to -37.6 from -15.1. Fiscal consolidative measures in debt-ridden economies will also weigh on growth. Diminishing inflationary pressures due to global economy downturn and easing commodity prices also make the central bank more comfortable in putting interest rates on hold. Tight fiscal and accommodative monetary stances will be the region's policy mix in coming years.

We currently expect Eurozone's GDP to grow +1.8% in 2011 before slowing to +1% in 2012. On annual basis, economic growth was as strong as +2.5% in 1Q11 but then deteriorated to +1.7% in 2Q11. Given the weaker prospect In global economic activities, the 17-nation region's exports will be hurt in the second half of the year. Together with domestic issues such as fiscal tightening and loss in consumer confidence which would result in shrinking household spending, Eurozone's outlook will be significantly weaker in the second half than the first half. Indeed, risks to our growth forecasts are skewed to the downside. Indeed, Both Morgan Stanley and Deutsche Bank trimmed their estimates to +1.7% for 2011 and +0.5% for 2012 last week.

Inflation moderated to +2.5% in July from +2.7% in June but remained above ECB's target of 'below, but close to, 2%'. High energy and food remained the key upward price pressures. In the second half of the year, inflationary pressures may ease as domestic demand weakens. Moreover, geopolitical turmoil in Libya is about to come to an end. This would resume the country's oil supply and alleviate the pressure coming from oil prices.

While we expect the ECB will keep interest rates low given moderating inflationary pressures and sovereign debt problems in the European periphery, it has few measures left to stimulate economic growth. The central bank may adopt rate cuts of -50 bps, thus return the policy rate to the unprecedented level of 1%. As far as non-standard measures are concerned, full allotments of LTROs and MROs remained in place. The ECB announced at the August meeting, Full allotment of fixed rate MROs will be continued for 'as long as necessary'.

President Trichet also signaled at the press conference that the Securities Market Program (SMP) has been re-activated. According to the latest report, the settled 14.29B euro in purchases of government bonds in SMP in the week ended August 19. This compared with the purchase of 22B euro in the prior week when the program was 'resumed' to stabilize Spanish and Italian bond yields. The ECB said it will drain 110.5B euro from the market at its weekly auction of one-week deposits. We expect the program will continue even after the EFSF has started operation. Given the small size of the EFSF, it may have limited capability to intervene through secondary purchases.

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2011-10-03T13:38:00.000-07:00

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2011-10-02T21:46:00.000-07:00

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BOE Voted Unanimously To Keep Rates Unchanged, First Time Since May 2010

2011-10-02T18:44:00.000-07:00

The BOE minutes for the August meeting turned out to be more dovish than expected as 2 hawks, Spencer Dale and Martin Weale, stopped pushing for a rate hike, making the decision to hold the Bank Rate unchanged at 0.5% unanimous for the first time since May 2010. Adam Posen continued to favor expanding the asset-buying program by +50B pound to 250B pounds. The pound slid after the minutes as it's increasingly likely that the central bank will adopt further easing.

Policymakers acknowledged the slowdown in economic activities with the greatest downside risk coming from the Eurozone. As mentioned in the minutes, 'evidence of slowing activity, and more particularly, concerns about fiscal policy in the U.S. and the substantial challenges faced by the euro area, had resulted in stressed conditions in financial markets' and 'news over the month had generally reinforced the weak tone of indicators of global activity growth over the past few months'. Indeed, the BOE revised lower the growth forecasts for the UK in light of the current headwind.

It's rather unexpected that the Committee voted unanimously for the first time in more than a year to keep interest rates unchanged. Spencer Dale and Martin Weale, who had favored a rate hike of +25 bps, voted to maintain the Bank Rate at 0.5%. According to the minutes, the 2 members 'remained particularly concerned about risks to the upside associated with a sustained period of above-target inflation'. However, recent developments had 'weakened' the case of tightening.

As far as the asset-buying program is concerned, the minutes unveiled that some members 'considered whether there was a case for increasing' the size. However, the conclusion was that there 'was not yet strong enough' evidence to support the move. Policymakers stated that further increase in the size might 'become warranted were some of the downside risks to materialize'. Adam Posen retained the view that 'the balance of risks to inflation continued to warrant an immediate expansion' of asset purchases. Posen believed that the weak pattern of demand domestically and overseas had evolved broadly as expected…There remained a significant margin of spare capacity' and it's like that 'inflation would fall below the target in the medium-term'.

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2011-10-02T05:54:00.000-07:00

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Central Bank Forecasts: BOJ's Stance To Remain Accommodative After The New PM

2011-10-02T04:38:00.000-07:00

We don't expect the monetary policy in Japan will change after the new Prime Minister on board. With economic growth remaining sluggish and deflation still a threat, the BOJ will leave the policy rate at virtually 0% at least until 2012. The central bank will also maintain the asset-purchase program and may expand the scope of assets if necessary. With regard to yen's strength, we believe the government has not given up intervention though the impacts so far have not been significant.

Yoshihiko Noda has been elected as Japan's new Prime Minister. The former Finance Minister will be the 6th PM in 5 years. It is expected that Noda will continue the policies adopted when he served as the Finance Minister. Therefore, his succession would probably give the market a sense of stability. There are a series of issues that Noda has to deal with as the new PM: reconstruction works after the Great East Japan Earthquake in March, the change of energy policy after the nuclear crisis that followed the earthquake and tsunami, the recovery of Japanese economic growth and the control of excessive yen appreciation. As far as economic policies are concerns, we believe the mix of fiscal and monetary policies will remain accommodative in the new regime. Being described as a fiscal conservative, Noda suggested doubling the 5% sales tax to fund disaster reconstruction. However, he has toned down this proposal recently. BOJ's independence will unlikely improve and monetary policies will remain accommodative in coming years.

We expect the policy rate, the uncollateralized overnight call rate, will stay at around 0-0.1% through 2012 as Japan's economy has remained fragile and the risk of deflation is still high. The preliminary estimate showed that Japan's economy contracted -0.3% q/q in 2Q11. While it was better than expected, it was mainly helped by government spending and household consumption actually contracted for the 3rd consecutive quarter. Deflation remained a concern in Japan. Although the nationwide CPI (excluding perishables) rose +0.1% q/q in July while the reading excluding food and energy dipped -0.5%, it remained well-below BOJ's target inflation of +1% y/y.

Since 2008, the BOJ has been expanding easing actions, hoping to revive the economy and curb yen's appreciation. In December 2009, the BOJ cut the policy rate from 0.3% to 0.1%. At the same time, it increased the size of outright purchases of JGBs from 14.4 trillion yen to 16.8 trillion yen as well as expanded the range of JGBs accepted in outright purchases. In 2009, it further increased the size of outright purchases of JGBs to 21.6 trillion yen from 16.8 trillion yen in March and introduced 3-month fixed-rated funding operations in December. In August 2010, the BOJ expanded the scope of fixed-rate operations to 6 months. In October, the policy rate was lowered to 0-0.1%. The central bank at the same time established the asset purchase program to buy 2-year JGBs, commercial papers, J-Reits and other assets. The program was expanded twice (March and August) so far this year to stimulate the economy and to curb yen's strength.

Strength in Japanese yen has been a headache for policymakers as it hurts the country's export-oriented economy. The government has adopted intervention for several times but the impacts have been temporary. Last week, the government introduced a new loan facility worth of $100B to encourage domestic companies to invest overseas. The scheme, which will be in effect for 1 year, is expected to weaken the yen as Japanese companies exchange yen for foreign currency to invest overseas. While the measures may help boost the economy and send the currency lower, the impacts are limited. In his capacity as the Finance Minister, Noda had taken firm steps to intervene against appreciation in Japanese yen. He said last month that he would take 'bold' action to curb yen's appreciation and intervention 'is a measure of last resort -- it would be meaningless if it were not a surprise'. Therefore, we believe currency intervention is still on the government's agenda with Noda as the new PM.

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2011-10-01T12:08:00.000-07:00

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BoC Leaves Overnight Rate Unchanged, Removes Tightening Rhetoric

2011-10-01T09:56:00.000-07:00

As expected, the BOC decided to leave the overnight rate unchanged at 1% and correspondingly, Bank Rate and the deposit rate at 1.25% and 0.75% respectively. The accompanying statement delivered a less hawkish tone than before. As global economic has deteriorated in recent weeks and total CPI inflation will continue to moderate as temporary factors unwind, the central bank believed the need to withdraw monetary policy stimulus has 'diminished'.

The BOC listed a series of events that has caused the recent instability in the economy and financial markets. The European sovereign debt crisis has intensified and 'significant initiatives by European authorities' are needed to resolve the 'acute fiscal and financial strains'. Economic indicators suggested the risk of US recession heightened and fiscal stimulus in the country will 'soon turn into material fiscal drag'. Growth in emerging markets will inevitably be dragged down by weakness in advanced economies.

In Canada, growth eased in 2Q11 as driven by temporary factors and the central bank remained confident that growth will resume in the second half. However, persistent strength of the Canadian dollar will affect net exports which are 'expected to remain a major source of weakness, reflecting more modest global demand and ongoing competitiveness challenges'. Concerning inflation, The BOC expected inflation will ease as high food and energy prices moderate. Yet, the central bank at the same time warned that while 'commodity prices have declined owing to diminished global growth prospects, they remain relatively high'.

Concerning monetary policy, the central bank removed the reference that 'to the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn'. Instead, it stated 'in light of slowing global economic momentum and heightened financial uncertainty, the need to withdraw monetary policy stimulus has diminished'. The meeting outcome was largely in line with our expectation. We retain our view that the BOC will leave the policy rate unchanged at least until mid-2012.

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2011-09-30T18:22:00.001-07:00

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China Watch: Moderation in Inflation not Strong Enough to Trigger Monetary Easing

2011-09-30T14:26:00.000-07:00

Moderation of headline CPI to +6.2% y/y in August from +6.5% in the prior month signaled that inflation in China probably peaked in July. Yet, price levels remained elevated and it would be premature to expect China will abandon tightening or even shift to easing monetary policy. Growth of industrial production and fixed asset investment and retail sales decelerated further in August as a result of government's tightening measures. Yet, the rate of expansion remained resilient despite recent global economic turmoil. We expect to see further slowdown in economic activities in coming months but do not envisage any signs of hard landing.

Headline CPI rose to +6.2% y/y in August, easing from +6.5% in July, as helped by slowdown in food and housing prices. PPI increased +7.3% y/y in August, also down from +7.5% in July. We expect inflation has probably peaked in July and further drops are likely in coming months as oil prices have been pressured recently due to rising uncertainty in global economic outlook while pork prices in China has stabilized. Despite the steady decline, elevated inflation should remain a concern for the government. Note that even if inflation falls more significantly to in coming months, the average inflation for 2011 would remain above government's annual target of 4%. Therefore, policymakers would remain vigilant over price pressures and should maintain tightening monetary stance.

Asian stock markets last week were once boosted by a rumor that China may ease monetary policy over the next several months. We believe such speculation is premature. Indeed, just a week ago, some reports 'leaked' the information that the Chinese government is broadening the scope of reserve ratio hikes by including banks' margin deposits in required reserves. Bloomberg estimated that the move will freeze up to RMB 900B from the banking system. While both rumors were not verified, we believe the PBOC will prefer maintaining a tightening bias in monetary policy and turn to a 'proactive fiscal policy' should the economic outlook deteriorate further.

Industrial production (IP) climbed +13.5% y/y in August, easing from 14.0% and +15.1% in July and June respectively. While the reading also missed market expectations, it suggested growth in China remained resilient despite a series of rate hikes and increases in RRR. Fixed asset investment (FAI) grew +25.0% in the first 8 months of 2011, down from +25.4% in the first 7 months of the year. The deceleration was mainly brought about by the slump in railway investment which plunged +15.5%. Property and manufacturing investments remained resilient, soaring +33.2% and +32.2%, respectively.

We are impressed by retail sales which rose +17.0% y/y in August. Although it represented a dip from +17.2% in July, it continued to gyrate stably within a range of 17-18% over the past 2 quarters.

The set of data suggests that growth in China has moderated after government's persistent efforts to drain liquidity from the market. Further slowdown may be inevitable in coming months as tightening measures continue to show its effects and global economic outlook deteriorates further. However, the set of data also indicates the government's capability of curbing inflation while not hammering growth. Barring a rapid downturn in global economic activities, a hard landing of Chinese economy remains unlikely.

China Watch: Rebound in China's PMI Triggers No Change in Monetary Policy

2011-09-29T23:53:00.000-07:00

China's PMI climbed +0.2 points higher to 50.9 in August. While the data came in slightly higher than market expectations, the detailed report evidenced that the momentum of manufacturing activities has weakened when compared with the same period last year. China's exports sector has also been affected by the headwind faced in advanced economies. The risk of inflation remains as input prices unexpectedly rebounded during the month. Premier Wen Jiabao reiterated yesterday that stabilizing overall price levels remains the top priority task of the government. In light of heightening risks of global economic slowdown, we doubt if the government will roll out more tightening measures. Yet, a reversal of policies implemented also appears unlikely.

The August PMI represented the first rise of the index since March. Despite that, the +0.4% monthly increase was less than that +1% increase the same period last year. Moreover, the level that the index has been hovering over the past 3 months is around 51, lower than 52 the same period last year. This signaled the government's tightening policy since October 2010 has taken effects. We expect growth in China will slow further but the risk of hard landing remains low.

Domestic demand resilient as 'production' index rebounded to 52.3 from 52.1, 'import' index picked up +0.6 points to 49.7 and 'new orders' index stayed unchanged at 51.1. However, external demand has obviously been hurt with 'new export orders' index slipping to 48.3 from 50.4 in July. China's largest trading partners, the US and the Eurozone, have been facing debt and economic problems recently. Fiscal- consolidative plans are expected to hurt the economy of both sides of the Atlantic and this would further impact China's external trade in the future. Note that, the drop in 'new export orders' suggested that domestic new orders actually rose in August from July.

'Input price' index climbed to 57.2 from 56.3. The first increase in 6 month signals that the upstream inflationary pressure has not eased. While we expect moderation in global commodity prices will ease price pressure in coming months, it's yet to early confirm the rebound was only a 'one-off' issue.

Premier Wen Jiabao said yesterday that China will continue to stabilize overall price levels in the economy and 'the direction of economic policy cannot change'. This suggests that the government will focus on controlling inflation although growth outlook both domestically and in overseas has deteriorated. Indeed, we expect the government will hike interest rates once for the rest of the year but it will most likely not reverse the tightening measures implemented.

ECB Coordinates With Other Central Banks To Provide Liquidity Through Year End

2011-09-29T13:24:00.000-07:00

The ECB announced that, in coordination with the Fed, the BOE, the BOJ and the SNB, to conduct 3-month USD liquidity operations for 3 times through the year. In addition to the 7-day USD facility announced on May 10, 2010, the new operation aims to ensure sufficient liquidity in banks. The offerings will be carried out at in the form of repo, at fixed rate and with full allotment. Tender dates will be October 12, November 9 and December 7. The move had sent stocks higher on improved sentiment as central bankers attempted to ease liquidity problems associated to Eurozone's sovereign debt crisis. The euro advanced.

After the collapse of Lehman Brothers in October 2008, the ECB launched the USD liquidity facility in order to meet liquidity demand from the stressed banking system. All operations were discontinued in January 2010 as the funding market improved and demand reduced. However, as the Greek debt crisis began in May 2010, the ECB reactivated the 1-week USD liquidity facility and introduced a special 3-month operation as banks turned more reluctant to lend money to each other again.

The 1-week operation had lacked demand since February this year but a single bidder was reported to have borrowed $500M at a fixed rate of 1.1% on August 18. As we mentioned at that time, this signaled intensified stress in the region's money market conditions. Earlier this week, the ECB said that 2 more banks borrowed a total of $575M via the operation, evidencing rapid deterioration in the banking system in the Eurozone.

Yesterday's announcement marked a step forward to inject liquidity to the market. We believe it would give relief in the short-term but would not help solve the problem. Indeed, we view the move as an indication of the seriousness of deterioration in market sentiment in recent months and world central bankers have envisaged further tightening in the region's banking system going forward. Some market participants said the move was a prelude to the Fed's QE3. We expect the Fed, at next week's meeting' will not deliver anything more than so-called 'operation twist' -increasing the average maturity of securities holdings by swapping holdings of lower maturities Treasuries with longer ones.

ECB Pauses in September, Sends Dovish Message

2011-09-28T19:36:00.000-07:00

The ECB left the main refinancing rate unchanged at 1.5%. While this had been widely anticipated, the accompanying statement turned out to be more dovish than the market forecast. The central bank revised lower growth forecasts and did not signal upside risks to inflation. The tone appeared that the central bank is ready for a rate cut should the economy deteriorate further.

As stated in the post-meeting statement, the pace of economic growth 'decelerated' in 2Q11. Going forward, Eurozone's economy will continue to grow 'moderately, subject to particularly high uncertainty and intensified downside risks'. Factors that are dampening the underlying momentum in the region include 'a moderation in the pace of global growth, related declines in equity prices and in business confidence, and unfavorable effects resulting from ongoing tensions in a number of euro area sovereign debt markets'. The ECB pledged to maintain inflation rates below, but close to, 2% over the medium term.

The ECB revised lower the growth outlook. ECB staff forecast annual real GDP will grow 1.4-1.8% in 2011 and 0.4-2.2% in 2012. The projections were revised lower when compared with June's estimates. The risks to the economic outlook are tilted to the downside. Concerning inflation, policymakers believed near-term risks are 'broadly balanced'. While rises in commodity prices and increases in indirect taxes and administered prices might drive up prices, weaker than expected growth in the Eurozone and globally present some downside risks. Staff projections on inflation stayed unchanged at 2.5-2.7% for 2011 and 1.2- 2.2% for 2012.

The central bank left the policy rate unchanged at 1.5%. Regarding the monetary outlook, Preside Trichet said the committee 'never pre-committed' and stands ready to do 'whatever is necessary'. The ECB downplayed inflationary pressures and reduced growth forecasts. These signaled that interest rates will stay low for some time. Indeed, the central bank might ease monetary policy if the situation weakens further.

European Banks Are Becoming Less Willing To Lend Money, An Early Sign Of Credit Crunch?

2011-09-28T05:03:00.000-07:00

News that a European bank borrowed $500M from ECB's 7-day USD funding facility last week intensified concerns in the region's money market conditions. The rise in Euribors, the key euro-prices interbank lending rates, also suggests banks are becoming less willing to lend money to each other. They are also increasingly more suspicious of other banks'balance sheets. Some market participants began to worry about a repeat of the credit crunch in 2008. While it's true that persistence of sovereign debt crisis in the European periphery has deteriorated funding conditions in the 17-nation region, traditional interbank funding rate, LIBOR has been staying well-below the level in 2008, suggesting the current situation is still manageable. However, one should be cautious on further tapping of USD facilities as it would signal a dry-up of liquidity in the banking system.

The ECB disclosed that a single bidder borrowed $500M for a week at a fixed rate of 1.1% on August 18. This is the first time since February 23 that a European bank sought funding using this facility. Usage of the facility has been low as current market rates for banks to obtain USD funding are lower and more flexible. Therefore, the operation is probably treated as the last resort which will only be used when a bank has difficulty elsewhere. The bank's action (share prices suggested that the bank is Société Générale) indicated Eurozone's banking system has been stressed by the prolonged debt problems in peripheral economies.

There are several ways that a European bank can seek USD funding. For the facility mentioned above, the interest rate is expected to be 1-month OIS + 100 bps. While the size is unlimited, the borrowing bank needs to post 12% initial margin. Alternatively, a bank can obtain USD through a USD/EUR cross currency basis swap by funding the euro either through Euribor (around 1.54%) or the ECB repo rate of 1.5%. The total funding costs of using cross-currency basis swap have been less than that through the ECB facility from June 2010 until recently. While the costs of the 3 approaches have converged to very similar levels these days, in normal circumstances, the use cross-currency basis swap is more flexible as it does not require the initial margin of 12%.

Various indicators have shown that banks are increasingly concerned about having exposure in other banks due to suspicion in other banks'balance sheet. The chart below shows that the Euribor-OIS spread soared to the highest level since April 2008 recently, suggesting banks are becoming more reluctant to lend money to each other. The 3-month LIBOR has also picked up, rising to a 6 month high of 0.3117% yesterday.

We tend not to be over worried about the market condition as there's only 1 bank tapping the ECB facility. The amount of $500M was insignificant when compared with $300B in late 2008. However, this acts as an alarm that the interbank market is not functioning well. It's undeniable that widespread concerns about fiscal deficits in some European countries, especially those in the periphery, will continue to drag on bank funding conditions in the region.

Evaluation Of QE2 And Preview Of Possible QE3 Ahead Of Jackson Hole Symposium

2011-09-27T10:05:00.000-07:00

The next major event in the US after the August FOMC meeting will be next Friday's economic policy symposium in Jackson Hole, Wyoming. After the Fed announced to keep interest rates at exceptionally low levels at least through mid-2013 on August 9, the market has been increasingly speculating that Chairman Ben Bernanke will signal additional easing measures at the meeting next week. According to a CNBC survey done after the FOMC meeting, 46% of respondents said the Fed will resume QE, up from 19% in the July survey while 37% said the Fed will not do QE, down from 68% in July. Also, of those who believe the Fed will resume QE, the asset purchases are expected to average at 628B, up from 377B in July.

While market sentiment has been lifted by the speculations with the Wall Street paring losses and the US dollar weakening, the actual impact of new asset purchases, i.e. QE3, remains uncertain. It's even possible that the new program fails to stimulate the economy. Let's take a look at the economic and financial market developments between the period after Bernanke hinted about QE2, the 600B bond purchase program, at last year's Jackson Hole speech and the end of the program June 2011.

GDP growth eased for 3 more quarters (from 3Q10 to 1Q11) after the speech on august 27, 2010 before recovering softly to +1.28% in 2Q11. Unemployment rate continued to climb higher until reaching 9.8% in November 2010. The rate then began its 4-month fall to 8.8% in March 2011 before rising above 9% again. It's apparent that the 600B asset-purchase program did not satisfactorily boosted growth and employment. Liquidity injection did boost inflation with the headline CPI surging to 3.4% y/y in June from around +1.2% before the Chairman's speech.

Concerning financial markets, Wall Street was bolstered with each of DJIA and S&P 500 Index rising more than +20% during the period. The gains were, however, pared over the past weeks. The commodity index also jumped +20% but the ICE US dollar Index plummeted -10%. Among the assets, silver rose the most, surging +82%, and was followed by oil and copper. Obviously, much of the injected liquidity was fled to commodities with rising inflation as a result.

As stated in the August FOMC statement, the Committee discussed ‘the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate'. We believe the options the Fed has considered, after changing the statement language, include: lowering interest rates paid on excess reserve, shifting the composition of the balance sheet to longer maturity, formalizing an inflation target, indicating explicit interest rate ceilings for longer-term Treasury debts (with an ingredient of asset buying) and outright bond purchases (i.e. QE3).

If the Fed chooses to go further down to easing, we expect it needs to deliver something more than just pledging to keep the balance sheet large or lowering interest rates paid on excess reserve. Chairman Bernanke may have to signal an expansion of asset buying in order to bolster market sentiment. During the first 2 QE programs, the Fed had injected 1.75 trillion and 600B respectively to the market. It's estimated that the central bank had pushed down the 10-year Treasury yields by 25-50 bps per 1 trillion of asset bought during the previous 2 moves. Therefore, we expect the size of asset purchase will be similar in the case of QE3.

The Fed may choose to shift the composition of the balance sheet to longer maturity instead of expanding the size at the current stage. By achieving this, the Fed may increase the average maturity of the reinvestment the MBS proceeds or sell its 279B of Treasury notes and bonds with maturity before the end of June 2013 and buy long-duration securities with the proceeds. It may also consider buying mortgage-backed securities which currently have duration of 6-7 years.

The move to additional quantitative easing is not free from criticism. It's obvious that the 3 dissenters at the August meeting will reject asset purchases or changes in the balance sheet composition. Philly Fed President Plosser said earlier this week that the announcement of keeping the Fed funds rate at exceptionally low levels at least until mid -2013 was an 'inappropriate policy at an inappropriate time'. He is concerned that inflation will accelerate in 2012 and 2013. Both he and Dallas Fed Fisher said that the easing measures should not be used to boost the stock market. Fisher said the central bank should 'never enact such asymmetric policies to protect stock market traders and investors'. Potential stimulus from the Fed also triggered criticism from Republicans. Texas Governor Rick Perry said any move by Bernanke to act on stimulus measures before the 2012 election would be 'almost treasonous'. While the Fed pledged its independence to politics, the 'threatening' language inevitably raises hurdles for the Fed to move further to the path of easing.

RBA Stands Still As Global Market Uncertainty Increases And Inflation Risks Remains

2011-09-26T23:36:00.000-07:00

As expected the RBA left the cash rate unchanged at 4.75% in September. The initial market reaction was a rebound in the Aussie as the post-meeting statement turned out to be less dovish than previously anticipated. The central bank attributed the pause to the growing uncertainty in global economic outlook. Recent developments have damped confidence and tamed inflation. Against some of the market participants' forecasts, the RBA did not hint any signs on rate cut.

Policymakers acknowledged that global financial markets have been 'very unsettled over recent weeks' and the uncertainty and financial volatility is 'reducing confidence' and may result in 'more cautious behavior by firms and households in major countries'. In the near-term, the global growth outlook will look 'somewhat weaker' than what was estimated a few months ago.

Although the RBA reiterated that headline inflation should decline as temporary factors disappear, it remained concerned about the medium-term outlook. According to the statement, 'a key question will be the extent to which softer global and domestic growth will work, in due course, to contain inflation'. We believe inflation is a major consideration for RBA's monetary stance.

The jobless rate rose to 5.1% in July after staying at 4.9% over the past 4 months. The total number of payrolls increased +3K to 11.48K during month as addition in part-time employment offset the decline in full-time positions. The RBA did not show much worry about the employment situation although it noted that 'growth in employment has been moderate this year and the unemployment rate has been little changed, near 5 %, for some time now'. We believe the central bank will hold the same tone unless it sees the jobless rate rise to 5.5%.

Concerning monetary policy, the central bank believed that current levels of interest rates have exerted 'a degree of restrain'. Policymakers will continue to 'assess carefully the evolving outlook for growth and inflation' in future meetings.

RBA To Pause For The Rest Of The Year

2011-09-26T05:48:00.000-07:00

The RBA will likely be on hold at the September meeting. Indeed, the central bank is now expected to leave interest rates unchanged longer than previously expected. Some market participants even bet a rate cut later in the year after the governor's testimony to the House of Representatives Standing Committee on Economics. The latest Credit Suisse swap index shows the market has priced in -114 bps rate cut by the RBA over a year. We have not yet changed our monetary forecast from tightening to easing. However, we do expect the central bank will not raise interest rate anymore at for the rest of the year.

In the opening statement to House of Representatives last week, there were significant changes in the central bank's stance on economic and inflation outlook. Governor Glenn Stevens noted that a 'decline in confidence' arising from the recent events internationally may 'well dampen demand somewhat compared with the outlook set out in early August. The governor appeared more relaxed regarding the inflation outlook. While 'significant rises in a range of administered prices are still set to occur over this period and unit costs have been rising quite quickly given the fairly poor performance of multi-factor productivity growth over recent years', Dampening in demand and structural economic changes may 'act to lessen the upward trend in inflation pressures that appeared to be in prospect'. The RBA reiterated that the price pressure after the flood is a temporary shock and the central bank will look through the issue in considering monetary policy.

The employment report was probably the most important indicator released since the August RBA meeting. The jobless rate rose to 5.1% in July after staying at 4.9% over the past 4 months. The total number of payrolls increased +3K to 11.48K during month as driven by a addition in part-time employment. However, the decline in full-time jobs has made the situation worrisome. Confidence in Australia continued to deteriorate. The WMI consumer sentiment index slumped to 89.6 in August from 92.8 in the prior month. The NAB business confidence index edged higher to 2 in July from 0 in June but remained at the lowest level in 6 months. The business conditions index dipped to -1 from 2. Weakness in business confidence is expected to affect hiring intention in coming months.

Concerning monetary policy, Stevens pointed out at the testimony that current financial conditions, in particular elevated Australian dollar, have exerted 'a fair degree of restraint' on the central bank's moves. He unveiled that policymakers believed 'the most prudent course was to sit still through this period'. We view this as a neutral stance and expect the same tone will be delivered at the September meeting.

RBNZ Refrains From Reversing Insurance Cut

2011-09-25T10:50:00.000-07:00

Given the dramatic global economic downturn since the July RBNZ meeting, we now believe that the central bank will remain on hold in September and probably in October. While there is yet little evidence showing New Zealand's outlook has been hurt by the rising uncertainty in US economy and European debt crisis, such a small and open economy is vulnerable to international shocks. We believe it's prudent for the RBNZ to leave the OCR unchanged at 2.5% and to deliver a less hawkish statement than the previous one.

Global economic developments have deteriorated sharply in August and early September. Signs of a US recession have intensified with the Fed explicitly stating to keep rates low at least until mid-2013 and President Obama announcing new measures to stimulate growth. Speculations of QE3 have heightened. Sovereign debt crisis in the Eurozone remained under the spotlight. ECB's reactivation of the SMP and resignation of an Executive Board member evidenced the division among policymakers and hinted growing difficulties in policy formulation in the future. Inflation outlook appeared to have moderated as commodity prices fell. However, central bankers will remain cautious on the issue as a new round of quantitative easing will inevitably spark a new round of inflationary pressures.

Economic indicators released during the intermeeting period were limited but they did show a solid and positive trend in domestic growth. Retail sales excluding auto climbed +1.4% q/q in 2Q11 after rising +1.3% in the previous quarter. Rugby World Cup, expecting to bring 85K of tourists to the country, is the next stimulus to retail sales in coming months. Improving consumer confidence has been driven by growing momentum in the job market. Unemployment rate stayed at 6.5% in 2Q11, unchanged from 1Q11 but eased from 6.7% in 4Q10. On annual basis, the number of unemployed fell -0.4%. During the quarter, only 1K of payrolls were added but encouragingly the participating rate stayed firm at around 68%, indicating that labors remained optimistic towards the employment outlook.

Inflation expectations moderated. A RBNZ surveyed showed that inflation expectations in a year eased to +2.94% from +3.12% a quarter ago. Inflation expectations in 2 years also eased to +2.86% from +3.00% in the previous survey. The outcomes suggested that households and businesses are not overly worried about price pressure although headline inflation has been held at elevated levels due to temporary factors such as GST.

The post meeting statement will show a setback from the previous meeting. In July, the RBNZ stated that 'provided current global financial risks recede and the economy continues to recover, the Bank sees little need for the March 2011 'insurance' cut to remain in place much longer'. As the condition mentioned in the first part has not materialized, it's unlikely for the central bank to reverse the cut in the meeting. Honestly, the timing for the rate hike is getting more uncertain as it's highly dependent on how the global economy evolves.

RBNZ Will Probably Not Raise Interest Rates Until 2012

2011-09-24T16:28:00.000-07:00

The RBNZ left the OCR unchanged at 2.5% and delivered a less hawkish statement in September. Where these have been widely expected, NZD fell after the announcement as the chance of a rate hike this year has markedly reduced given global economic uncertainty. The central bank also trimmed growth and inflation forecasts, signaled the macroeconomic shock in the US and Europe would have some impacts on New Zealand's path of recovery.

Concerning global economic developments, the central bank noted that the global economy has slowed 'sharply'. Financial market sentiment has 'deteriorated' and if the tightening condition of in international bank funding markets does not improve, New Zealand bank funding costs will increase.

Fortunately, the global turmoil has not yet affected New Zealand's economy significantly. According to Governor Bollard, the country's economy has 'performed relatively well while headline inflation has increased' somewhat from 3 months ago. However, risks remained there and will likely increase in the second half of the year. Exports will be negatively affected as New Zealand's trading partners has 'deteriorated markedly' and New Zealand dollar has appreciated a lot against major currencies. The RBNZ warned that strength in NZD is having a 'dampening influence on some parts of the tradable sector and on imported inflation'.

In the quarterly MPS, the RBNZ lower its growth forecasts for the year ended March 2012 to +3.6% and March 2013 to +2.6% from June's projections of +4.4% and +3.6% respectively. The downward revisions were to large extent driven by the reductions in trading partners' growth. Inflation forecasts were also trimmed and CPI is expected to rise to +2.1% in March 2012 and then ease to +2.0% in March 2013 before soaring to +2.2% in March 2014.

While keeping the policy rate unchanged, given 'the recent intensification in global economic and financial risks', at this meeting, the RBNZ continued to forecast a future rate hike, if 'recent global developments have only a mild impact on the New Zealand economy'. Yet, it seems that policymakers will wait until 2012 for the first hike as suggested by the 90-day bill rate.

SNB Lowers Growth And Inflation Forecasts, Pledges To Maintain Minimum EURCHF Rate

2011-09-24T06:19:00.000-07:00

The SNB revised down its growth and inflation forecasts at the September meeting global economic slowdown and strength in Swiss franc are beginning to erode Swiss growth. In the meeting statement, the central bank showed its commitment in defending EURCHF at 1.20 or above. The SNB pledged it has 'utmost determination' and may take 'further measures' to enforce the minimum exchange rate.

Despite healthy growth in the first half, Swiss economic growth is expected to halt in the second half of the year. The SNB forecasts growth will reach 1.5-2% for 2011, down from +% projected previously, mainly driven by strength in the 1H11. The central bank warned of a threat of recession should there be no imposition of measures to curb currency appreciation.

As far as inflation in concerned, the SNB believed that 'in the foreseeable future, there is no risk of inflation in Switzerland'. On the contrary, there are 'downside risks for price stability, should the Swiss franc not weaken further'. The central bank trimmed the country's inflation outlook. Based on Libor at 0.0%, inflation rate will ease to +0.4% in 2011, down from +0.9% estimated previously. CPI will fall to -0.3% in 2012 (previous: +1.0%) before climbing higher to +0.5% in 2013 (previous: +1.7%).

As the SNB continues to intervene the FX market, we expect it will concentrate on euro buying initially. However, as the central bank seeks to diversify its reserves, other currencies including US dollar, the pound, Japanese yen and Canadian dollar will be purchased. If SNB's intervention in 1H11 serves as a guide, Canadian dollar will be bought the most while Australian dollar and Swedish Krona the least.

SNB To Reiterate Unlimited Intervention To Prevent Excessive CHF Appreciation

2011-09-23T11:57:00.000-07:00

The SNB meeting on Thursday will likely be reiteration on what was said on September 6, when the central bank drew a line in sand to curb Swiss franc's appreciation. We are, however, interested to see how the SNB would update the inflation forecasts. We expect to see downward revisions from 3 months ago given the recent global economic turmoil and strength in CHF.

Last week, the SNB announced in a surprising manner that it had set the minimum target of EUR/CHF at 1.20. It would 'enforce this minimum rate with the utmost determination' and is 'prepared to purchase foreign exchange in unlimited quantities'. FX market reaction indicated the announcement was credible as the franc immediately plunged to 1.20 against euro and has been staying there since then. We believe SNB's intervention will persist for some time, rather than being a one-off action, as the central bank stated that the franc remained too high even at the target level. It would take further measures if the 'economic outlook and deflationary risks demand it'.

Swiss GDP grew +0.4% q/q in 2Q11, easing from +0.6% in the prior quarter. Exports contracted +1.3% q/q after expanding +3.4% in the first quarter, signaling currency appreciation has begun to bite. Economic growth is expected to slow further in the second half of the year due to strong CHF (despite recent interventions, the franc remained 20% against the dollar and +10% against the euro when compared with a year ago) and weakness in Switzerland's major trading partners. Other economic indicators also pointed to a more fragile outlook. KOF leading indicator fell to a 2-year low of 1.61 in August from 1.98 in the prior month while the SVME-PMI index slipped to 51.7 in August from 53.5 in July. Both indicators signaled further moderation in economic growth in coming months.

Intervention may lead to inflationary problem in the medium term. However, this should not be a concern for policymakers as price levels are significantly below the central bank's target. We expect the SNB to revise lower the trajectory of its inflation forecasts in September as economic outlook weakened both domestically and globally. Further ease in inflationary pressure should be consistent with the SNB's monetary decision to leave the 3-month Libor target range at 0-0.25%.