Economic Research

Week in Focus
What could add further fuel to the debt crisis?
The Troika Report, EFSF ratification, a Greek debt exchange and a plethora of ECB government bond purchases are all risk events which might add further fuel to the sovereign debt crisis. Page 2 Euro-area bond markets are still strained
10-y government bonds, yield spreads versus Bunds of corresponding maturity
450 400 350 300 250 200 150 100 50 0 1-Jun Italy
Source: Bloomberg, Commerzbank Research

09 September 2011

ECB purchases

4-Jul

6-Aug Spain

8-Sep

The added value of investor sentiment surveys: Our analysis suggests that surveys of investors expectations of future asset performance contain predictive power. This can be used to define trading strategies across a range of asset classes. Page 5 Product Idea Three-year Bear Floater: This product enables investors to profit from moderate rises in Euribor rates and high volatility. Page 6

Outlook for week of 12 to 16 September

Economic data: Despite concerns over sovereign default in August, next weeks data on retail sales and industrial production are expected to ease recessionary concerns. Page 7 Bond market: In view of ongoing economic worries and debate over the sovereign debt crisis, ten-year Bund yields could reach new record lows next week. Page 11 FX market: EUR-USD continues to trade sideways despite the fact that the event risks in Europe will remain high over the coming weeks. CHF-EUR is likely to remain above the SNB's target of 1.20. Page 12 Equity market: We have defined eight factors which lead us to believe that the DAX will not repeat its poor 2008 performance. Page 13
Chief Economist Dr Jrg Krmer
+49 69 136 23650 joerg.kraemer@commerzbank.com

Managing Editor Peter Dixon

+44 20 7475 4806 peter.dixon@commerzbank.com

research.commerzbank.com

For important disclosure information please see end of this document

What could add further fuel to the debt crisis?

Christoph Weil Tel. +49 69 136 24041

The Troika Report, EFSF ratification, a Greek debt exchange and a plethora of ECB government bond purchases are all factors which might add further fuel to the sovereign debt crisis. In this note, we take a closer look at the events and risks which are likely to arise in the weeks and months ahead. Although we are convinced that politicians will do everything in their power to keep a lid on the crisis, investors will still worry about the possibility of political accidents. The following events will keep investors on edge in the further course of the year:

(1) Fifth IMF Review on Greece

Signs are increasing that the next tranche of aid loans to Greece will not be released in a timely fashion. Representatives of the International Monetary Fund (IMF), the EU Commission and the ECB, the so-called troika, are currently preparing the fifth Progress Report on Greece. Depending on the results, the IMF and euro zone finance ministers will decide on whether the next EUR 8 bn loan tranche will be disbursed in September, as envisaged. As with the last report in spring, a cliff-hanger seems to be the most likely outcome. Recently, even the Greek finance minister admitted that the country will once more miss its deficit target this year. The troika are pressing for faster reforms and also asked to see the 2012 draft budget. Against this backdrop, the completion of the Progress Report should not be expected before end-September. While we believe that the euro countries and the IMF will be late in delivering the next tranche, the disbursement should still be in due time to prevent Greece from defaulting on its debt. If not, the inherent risks are unlikely to be manageable, not least due to the rising nervousness in the financial markets.

(2) Long-winded EFSF 2.0 ratification

On July 21, the euro zone heads of state and government decided to increase the effective lending capacity of the European Financial Stability Facility (EFSF) to EUR 440 bn and to extend the range of instruments available to the rescue fund. For the EFSF reform to be implemented, approval from national governments is still required in several countries (box, p. 4). However, there is some opposition to enlarging the EFSF, particularly in Slovakia and Finland. Nonetheless, while ratification is unlikely to go off smoothly, it should still be finalised by yearend.

(3) ECB bond purchases to continue in the months ahead

In the past four weeks, the ECB has been buying sovereign bonds of Italy and Spain to prevent yields from rising further. Many ECB council members only reluctantly approved the measure, others are reported to have voted against. With hopes now dashed that the EFSF will be in a position to help the ECB by end-September, the central bank will have to maintain its bondbuying programme. But the longer the purchase programme lasts and the bigger its volume, the more opposition will come from council members. Statements to that effect could spark market fears that the ECB might cease its purchases. We consider this unlikely, but are forced to admit that the ECB may possibly decide to reduce the volume of its purchases, in order to step up pressure on individual countries to consolidate their budgets. TABLE 1: Key events
Date Sep. 13 Sep. 15 Sep. 29 Late Sep. Late Sep. Oct. 3 Oct. 6 Oct. 13 Oct. 17/18 Event Italy: Issuance of EUR 6-7.5 bn Spain: Issuance of EUR 4-5 bn Italy: Issuance of EUR 7.5-8.5 bn Troika Report on Greece Greek debt exchange offer Eurogroup meeting Spain: Issuance of EUR 3.5 bn Italy: Issuance of EUR 5 bn EU summit Date Oct 20. Oct. 28 Nov. 7 Mid-Nov. Nov. 20 Nov. 29 Dec. 9 Dec. 14 Event Spain: Issuance of EUR 4.5 bn Italy: Issuance of EUR 6 bn Eurogroup meeting 2nd IMF Review on Portugal Parliamentary elections in Spain Eurogroup meeting EU summit 4th IMF Review on Ireland

Source: Bloomberg, EU, Commerzbank Research

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09 September 2011

(4) Greek debt exchange

The voluntary debt exchange, whereby private creditors accept a haircut on their holdings of Greek debt, could still go wrong. This Friday, national central banks will forward the exchange offers of regulated financial institutions to Athens, leaving it to the Greek government to decide on whether the exchange volume is sufficient. Government officials have made it clear that Greece will not proceed with the transaction unless participation reaches 90%. Most importantly, this threshold does not only apply to all sovereign bonds maturing by July 2020, but also to all securities that become due for repayment by August 2014. Against this backdrop, we have some doubts whether such a high participation rate can be achieved. Holders of shorter-term debt, in particular, might be reluctant to swap their bonds for new longer-dated securities. Although, in our view, participation is unlikely to exceed 70 - 80%, we assume that the Greek government will nonetheless move ahead with the exchange. After all, the country still needs to refinance debt to the tune of EUR 8 bn this year, for which it does not have the necessary funds, especially if the disbursement of the next loan tranche has to be postponed to a later-than-envisaged date. At the beginning of October, we expect to see an official exchange offer from the Greek government. During the subsequent two-week period, private investors can submit their binding offers. Thus, the debt exchange would likely be finalised by mid-October.

(5) The spectres of EFSF 3.0 and euro-bonds

Discussions over extending the EFSF or issuing joint government bonds will continue, as it is clear that not even the higher lending capacity of the rescue fund will suffice to support Spain and Italy if they are cut off from the capital markets. The upcoming meetings of EU heads of government and finance ministers will indicate whether or not political resolutions can be found to these issues (table 1, page 1). However, as experience shows, such decisions will only be made under extreme pressure.

(6) Consolidation off track

Greece is not the only country which is likely to miss its 2012 deficit target. According to our Debt Monitor, risks have been mounting over recent months that public deficits in Portugal and Spain may also turn out higher-than-envisaged (chart 1). Meanwhile, the governments of both countries have adopted additional austerity packages. But unless these have a visible effect in the coming months, budget consolidation will not make the envisaged headway. Failure to achieve the targets could cast further doubt on the respective governments' willingness and ability to persevere with fiscal consolidation.

(7) Growth assumptions for 2012 too positive?

In the months ahead, these countries will pass their 2012 budgets. Although the consolidation targets for 2012 have already been earmarked in the medium-term stability programmes (chart 2), the underlying growth assumptions could soon prove overly optimistic, which CHART 1: Not all countries will meet their targets
Public deficit reduction in % of GDP, change in the year-to-date estimated on the basis of the financial statistics, figures in parentheses: Number of reporting months

CHART 2: Deficit targets for 2011 and 2012

Envisaged budget balances in % of GDP

4 3 2 1 0 -1 -2 GR (7) PT (7) IR (8) SP (7) target for (x) months target for the whole year IT (6) achieved

12 10 8 6 4 2 0 Es 2011 It Pt Ir 2012 Gr

Source: National financial statistics, Commerzbank Research

Source: Stability programmes, Commerzbank Research

09 September 2011

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would leave new holes in public finances. After all, sentiment indicators are signalling that growth in the euro zone will slow to a modest pace in the second half of 2011.

(8) Additional countries to slip under the rescue umbrella?

There is a high risk that more countries will be cut off from the capital markets. Already, markets are demanding higher interest rates from Spain and Italy than Greece & Co. have to pay for their emergency loans. Cyprus, in particular, is under severe financial stress. For ten-year sovereign bonds, the Cypriot finance ministry presently has to offer investors yields of over 8%, far more than Greece, Ireland and Portugal had to pay when they turned to the EU for help. The thirdsmallest euro country needs to refinance 50% of its government debt by 2013. Another matter of great concern is the disproportionately large financial sector and its heavy exposure to Greek debt, which suggests that the financial system may need government support in future. While the volume of a potential three-year rescue programme would be comparatively small (an estimated EUR 10 bn), the bailout would nonetheless have to pass the usual political hurdles.

(9) Italy and Spain still in need of huge funds

Italy and Spain plan to issue new bonds to the tune of around EUR 40 bn by the end of October. With investors remaining distrustful of both countries, this will be no small task. Meanwhile, risk premiums are on the rise again, despite the ECBs on-going purchases of Spanish and Italian sovereign bonds. While we expect that both countries will manage to place their issues, high prices and relatively low subscriptions would fuel fears that these countries might also be cut off from capital markets.

Risks of a political accident

Taken in isolation, each of the above-mentioned risks appears to be manageable. In sum, however, there is a likelihood that an accident may occur. Thus, high levels of market unrest are likely in the weeks and months ahead. Risks remain that the crisis will escalate further before it abates. As risk premiums for bonds in the euro zone periphery are likely to stay at elevated levels, we continue to recommend underweighting peripheral bonds.

Box: Road map of EFSF ratification Country AAA-countries Germany France Netherlands Austria Finland Luxembourg Other countries Italy Spain Belgium Slovakia Slovenia Date Sep. 29 Sep. 9 Sep. 13 late Sep. Sep. 15 Sep. 15 Comment Chancellors majority not yet reached Minority government needs support from the opposition. Freedom Party against expanding the EFSF EFSF expansion controversial

No parliamentary approval required Government may approve in advance Sep. 13 by Dec. Q4 Coalition partner against expanding EFSF Government without majority in parliament. Chance of early elections

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09 September 2011

The added value of investor sentiment surveys

Anna Schrder Tel. +49 69 136 87791

Surveys of investors expectation of future asset performance contain predictive power, but not necessarily in the way one might suppose. As shown in depth in our Cross Asset Feature, short-term expectations tend to add value to an investment strategy when used as contrarian indicators in the equity space. On the contrary, sentiment surveys asking investors about their medium-term expectation provide valuable trading signals in a momentum strategy for a wide range of assets.1

Sentiment surveys reflect psychological patterns in investor behaviour

Survey-based investor sentiment is usually summarized by three figures, corresponding to the percentage of survey respondents who are bullish or bearish on an underlying asset or expect it to trade sideways. In the data covered by our analysis it is striking that on average, there are more bulls than bears in the equity market and in the commodity market. The opposite holds for sentiment regarding fixed income. Most commonly, the survey results are summarized in a bullminus-bear index (a net bullish index). The pattern in which these bull-bear indices move together generally reflects the perception of riskiness of an asset: Sentiment indices for risk assets, e.g. the Dax and oil, tend to move in tandem. The opposite holds between risk assets and safe haven assets. For example, the correlation between the proportion of net bulls in the Dax on one hand and Bund futures on the other, is negative at -66% for short-term sentiment.

allowing us to derive simple trading strategies

When calculating future asset performance conditional on sentiment indices, we identify a substantial difference between survey data based on what investors expect on a one-month horizon and what they expect on a six-month horizon. Short-term expectations appear negatively related to the asset performance in the following one, three or six month(s), while medium-term expectations seem to be positively related to subsequent asset performance. This indicates that short-term expectations often tend to be wrong but on a six month view investors tend to get it right more often than not. Independently, we detect a negative relation between the level of the neutrality index, which captures the proportion of investors who expect the market to trade sideways, and future asset performance in other words, if investors are unclear about the future performance of an asset, this is more likely to be followed by negative than by positive asset performance.

which generate outperformance across the board

These observations allow us to derive a number of successful trading strategies for a one-week investment horizon. Intuitively, the use of short- and medium-term sentiment information in one strategy is most promising. One possible strategy is to define the short-term indicators as a contrarian indicator and the medium-term bull-bear index as a momentum indicator: If the average investor is very bearish regarding the one-month performance of an asset and very bullish regarding its six-month outlook, the strategy places a maximum weight in the asset and a minimum weight in cash, and vice versa. By definition of the trading signal, the strategy has on average the same amount invested in the asset and in cash. The survey data extends back roughly ten years for most equity indices, bonds and currencies, and five years for gold and oil. Correspondingly, we test the strategy over the longest possible time horizon and compare it to a benchmark of 50% asset and 50% cash. The strategys returns are above the benchmark returns for all eleven assets for which data is available. The information ratio, which reflects a risk-adjusted excess return of the strategy over the benchmark, varies between 15% and 95% and is statistically significant at a 95% confidence level when using data on the Dax, the Eurostoxx 50, Bund futures, EUR/USD and USD/JPY. Results of a strategy which combines sentiment indices of two asset classes to form a decision of how to weight each one vs. a fifty-fifty benchmark indicate that sentiment data also contains value for investment decisions across asset classes.

For further details see the Cross Asset Feature Survey-based sentiment indices, 5 September 2011

09 September 2011

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Product idea: Three-year Bear Floater

Capitalise on modestly rising 3m Euribor rates and high volatility

Markus Koch +49 69 136 87685

The economic outlook for the euro area has deteriorated considerably and the ECB will not resume hiking rates before 2013. Three-month Euribor thus looks set to rise only modestly in the long-term. Structured products benefiting from sideways to modestly higher reference rates receive additional tailwind from high volatility as investors can sell embedded optionality at historically high levels through bear floaters, for instance. At its most recent meeting, the ECB signalled a pause in its tightening cycle. Given the deteriorating economic outlook and the risks emanating from the sovereign debt crisis we do not expect the ECB to implement further rate hikes before 2013. Money market rates should therefore move sideways to moderately higher over a multi-year horizon as both we and the forward market expects amid limited risks of trading outside a tight range. It is notable that historical and, in particular, implied volatilities for options on the Euribor future are still trading close to multi-year highs. The picture is similar when approximating volatilities based on short-tenured swaptions. These excessive, and in our view unsustainable, levels together with our rate expectations offer an attractive opportunity to set up a three-year Bear Floater referencing 3-month Euribor. The underlying sale of currently expensive optionality allows for relatively wide ranges to be set, reducing the risk (by historical standards) of fixings being reported outside the range (daily fixings). This is also supported by the fact that the ECB will not exclusively focus its future monetary course on the inflation (expectations) compass needle. Rather, the stabilisation in the periphery is another variable entering the ECBs monetary reaction function. In case of doubt, this would argue for a rate stabilisation of the money market curve, fundamentally improving the performance chances of range accrual structures. If the reference rate always trades within the ranges of 1% and 2.5% (see box), a coupon of 3.5% p.a. would be generated. This would correspond to a coupon significantly above the entire IRS curve (best case), foregoing the interest rate risk of an investment at the long end of the curve. Nevertheless, there is a risk of no coupons should the reference rate always trade outside the corridor (worst case). However, this is not what we expect. Rather, market expectations implied by the slope of the forward curve are distributed relatively tightly around current Euribor levels.

3y Bear Floater (indicative) Issuer: Type: Size: Maturity: Reference index (RI): Coupon: Range: Fixing: Basis: A3 / A- / stable Bearer/Schuldschein 10m 3 years 3M Euribor 3.5% * n/N with n:= number of days, with RI within range, and N:= calendar days pa Upper boundary: 2.5%, lower boundary: 1% Daily Annually, act/act, following, unadj.

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09 September 2011

Preview The week of September 12th to September 16th

Time Region Indicator Period Forecast Survey Last

Monday, 12 September 2011 There are no market-moving indicators scheduled for release. Tuesday, 13 September 2011 6:30 FRA CPI CPI excl. tobacco CPI RPI RPI, index Trade Balance Aug Aug Aug Aug Aug Jul mom, yoy yoy yoy GBP bn 0.2 1.9 122.2 4.6 5.2 236.1 -4.4 4.5 5.2 -4.3 -0.4 1.9 121.9 4.4 5.0 234.7 -4.5

9:30

GBR

Wednesday, 14 September 2011 9:30 GBR Jobless claims change Unemployment rate Average earnings (three-month average) Industrial production PPI PPI excl. food & energy Retail sales Retail sales ex autos Business inventories RBNZ interest rate decision Aug Jul Jul Jul Aug Aug Aug Aug Jul Aug sa, k %, sa yoy mom, sa yoy mom, sa mom, sa mom, sa mom, sa mom, sa % 35 7.9 2.7 0.7 3.7 -0.4 0.2 0.2 0.3 0.5 2.50 35 7.9 2.7 1.5 4.8 -0.1 0.2 0.2 0.2 0.5 2.50 37.1 7.9 2.6 -0.8 2.7 0.2 0.4 0.5 0.5 0.3 2.50

10:00 13:30

EUR USA

15:00 22:00 NZL

Thursday, 15 September 2011 8:30 9:30 10:00 SUI GBR EUR USA Swiss National Bank interest rate decision Retail sales, volume HICP, final HICP excl. energy, food, tobacco, alcohol Empire State Index CPI CPI excl. food & energy Initial claims Industrial production Capacity utilisation Philadelphia Fed Index Aug Aug Aug Aug Sep Aug Aug 9 Sep Aug Aug Sep % mom, sa yoy yoy sa mom, sa mom, sa k mom, sa %, sa sa 0.00 -0.3 2.5 1.2 -2.00 0.3 0.2 410 0.1 77.4 -10.0 0.00 -0.3 2.5 1.1 -2.95 0.2 0.2 0.1 77.5 -16.4 0.00 0.2 2.5 (p) 1.2 -7.72 0.5 0.2 414 0.9 77.5 -30.7

13:30

14:15

15:00

EUR: ECBs monthly bulletin (9:00). Friday, 16 September 2011 14:55 USA Consumer sentiment (University of Michigan), preliminary Sep sa 58.0 56.9 55.7

Source: Bloomberg, Commerzbank Economic Research *Time BST (subtract 5 hours for EDST, add 1 hour for CET), # = Possible release; mom/qoq/yoy: change to previous period in percent, AR = annual rate, sa = seasonal adjusted, wda = working days adjusted;

= data of highest importance for markets.

9 September 2011

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Economic data preview:

USA: To what extent has the debt debate unsettled the economy?

Dr Christoph Balz Tel. +49 69 136 24889

The potential for sovereign default in August should have left its negative imprint on economic activity in the USA. Nonetheless, next weeks data on retail sales and industrial production are unlikely to show a sharp fall. In August, the USA was teetering on the brink of default as political parties haggled over an increase in the debt ceiling. Amid uncertainty about how a debt default would affect the economy, corporates and consumers were probably reluctant to spend. While the economy still expanded at a fairly solid pace in July, hard data available to date suggests that economic growth in August virtually ground to a standstill. However, there is no solid evidence yet that economic activity is paralysed, as it was after the Lehman bankruptcy in September 2008. Thus, for example, US car sales in August were practically unchanged from July (chart 3). We expect more or less the same outturn for overall retail sales. Following an increase of up to 0.5% in July, retail sales look set to have inched up by 0.2% in August (consensus: 0.2%). This, however, is exclusively owed to higher gasoline prices. Moreover, stagnation seems to be on the cards for industrial production in August, as the number of hours worked in manufacturing the core sector declined compared with the previous month (chart 4). And, unlike in July, weather conditions should have dampened energy production somewhat. Against this backdrop, we expect that, following Julys 0.9% increase, industrial output rose by just 0.1% in August (consensus: 0.1%). In addition, the first results from September business surveys are due to be released in the week ahead. In August, the Empire State index and, above all, the Philly Fed index took a sharp plunge, sparking fears that the US economy might slip into recession. However, with hard data remaining relatively solid and successive sentiment surveys recording considerably more moderate declines, there is good reason to expect that both indicators may have recovered slightly in September. With this in mind, we argue that the Philly Fed index rose to -10.0 from -30.7 in August (consensus: -16.4), while the Empire State index looks set to have edged up to -2.0 from -7.7 (consensus: -2.95). Still, despite their recovery, both indicators would still remain at fairly subdued levels.

United Kingdom: Weak growth, high inflation

As in other industrialised economies, UK demand indicators continue to point to a loss of momentum. Claimant count unemployment has risen sharply since March, and we expect the August figures to show a rise of 35k (consensus: 35) with the unemployment rate hovering just below 8%. Retail sales volumes also remain sluggish, and on the basis of survey evidence we look for sales to have declined by 0.3% last month. In addition, the UK has an inflation problem, due in large part to the January hike in VAT. CPI inflation in August is likely to have inched up to 4.6%, and higher domestic energy bills could well push this above 5% within the next couple of months. CHART 3: USA Neither up nor sharply down in August CHART 4: USA Hours worked declined in August
Car sales, monthly data, seasonally-adjusted annualised rate Manufacturing, hours worked and production, month-on-month change in %

14.0 13.5 13.0 12.5 12.0 11.5 11.0 10.5 10.0 Jan-10 Jul-10 Jan-11 Jul-11

2 1 0 -1 -2 -3 -4 Jan-07 Jul-08 hours worked

Source: Global Insight, Commerzbank Research

Jan-10

Jul-11 production

Source: Global Insight, Commerzbank Research

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09 September 2011

Central Bank Watch (1)

Fed
The members of the Federal Open Market Committee are currently positioning for the next meeting on 20/21 September, which will probably focus on a detailed debate about additional stimulus measures. The members are deeply divided about whether or not these would make sense. One of the most vocal advocates of more accommodation is Charles Evans (Chicago Fed). He urged very significant amounts of added accommodation as the economic outlook had weakened substantially. He suggested the Fed should commit itself to low interest rates until the unemployment rate had come down to 7% - 7.5%, provided that medium-term inflation simultaneously remained below 3%. Jeffrey Lacker (Richmond Fed), in contrast, is sceptical about whether further easing would be successful. He believes it would merely boost inflation whilst doing little to help growth. Narayana Kocherlakota (Minneapolis Fed) showed himself similarly hawkish. He said the US economy needed no further stimulus in August and probably would not need it in September either. However, we assume the majority of the FOMC will follow Bernanke and decide to ease monetary policy, for example by extending the average maturity of the Feds security portfolio. Dr Christoph Balz +49 69 136 24889 CHART 5: Expected Federal Funds Rate (USD)
1,0 0,8 0,6 0,4 0,2 0,0 current Dez 11 Overnight Index Swaps 08.09.11 Mrz 12 Jun 12 Sep 12 Dez 12

01.09.11

Commerzbank

TABLE 2: Consensus forecast Fed funds rate

Q4 11 Consensus High Low Commerzbank 0.25 0.25 0.25 0.25 Q2 12 0.25 1.00 0.25 0.25 Q4 12 0.25 1.50 0.25 0.25

Source: Bloomberg, Commerzbank Research

ECB
The ECB staff experts revised down their growth projection for this year from 1.9% to 1.6%, and from 1.7% to 1.3% for 2012. Inflation projections for 2011 and 2012 have been left unchanged. This means that at least in its baseline scenario, the ECB expects modest, but still positive quarter-on quarter growth rates, and inflation to fall back from the current high level to a rate which is in line with the banks definition of price stability. Hence, the ECB Council decided to leave key rates as they are, without signalling a rate change in the short term. In line with the downward revised forecasts, the ECB adjusted its wording at the press conference: The ECB emphasised that the risks to the economic outlook for the euro area are on the downside (so far: balanced). In addition, the Governing Council views the risks to the medium-term outlook for price developments as being broadly balanced (so far: upside) ECB president Trichet stressed the particularly high uncertainty and said that a very thorough analysis of all incoming data and developments over the period ahead is warranted. That said, the ECB continues to highlight that short-term interest rates are low and that the ECBs monetary policy stance remains accommodative, which in our view means that the ECB will need to see a further significant deterioration of the situation before it starts to consider rate cuts. Dr Michael Schubert +49 69 136 23700 CHART 6: Expected ECB minimum bid rate (EUR)
3,0 2,5 2,0 1,5 1,0 0,5 current Dez 11 Overnight Index Swaps 08.09.11 Mrz 12 Jun 12 Sep 12 Dez 12

01.09.11

Commerzbank

TABLE 3: Consensus Forecasts ECB minimum bid rate

Q4 11 Consensus High Low Commerzbank 1.50 1.75 1.50 1.50 Q2 12 1.50 2.00 1.00 1.50 Q4 12 1.75 2.50 1.00 1.50

Source: Reuters, Commerzbank Research

09 September 2011

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Central Bank Watch (2)

BoE
The BoE is following the strategy of primum non nocere (first do no harm) by waiting on the sidelines before assessing whether the economy really does need additional monetary easing. The option of expanding the QE programme remains on the table but in the absence of evidence pointing to a dramatic downturn, now is not the time to implement it. We have long argued that asset purchases are not the right strategy for the current set of problems, which are probably more amenable to fiscal solutions. However, there are indications that many MPC members are ready to implement additional QE should the need arise, including some who were voting for rate hikes as recently as two months ago. Therefore, the minutes of yesterday's MPC meeting, due for release on 21 September, will be crucial to assess the tone of the debate on whether to restart the asset purchase programme. Peter Dixon +44 20 7475 1808 CHART 7: Expected interest rate for 3-month funds (GBP)
2,0

1,5

1,0

0,5 current Dez 11 Mrz 12 Jun 12 Sep 12 Dez 12 Futures 08.09.11 01.09.11 Commerzbank

Source: Bloomberg, Commerzbank Research

BoJ
At its September meeting, the Bank of Japan left monetary policy unchanged after again spending large amounts in August. Back then, the central bank had used a massive JPY 4.5 trn for forex market intervention and another JPY 10 trn to expand its securities purchasing programme to JPY 50 trn. Following the SNBs foreign exchange measures, markets focused on a potential reaction from the BoJ as the yen is also under strong upside pressure given its status as a preferred currency for risk-averse investors. While pegging the yen is unlikely, further liquidity measures from the BoJ should still be expected potentially together with the governments third supplementary budget in October. Wolfgang Leim +49 69 136 24525 CHART 8: Expected interest rate for 3-month funds (JPY)
1,0 0,8 0,6 0,4 0,2 0,0 current Dez 11 Mrz 12 Jun 12 Futures 08.09.11 01.09.11 Sep 12 Dez 12

Commerzbank

Source: Bloomberg, Commerzbank Research

SNB (Switzerland)
The Swiss National Bank (SNB) has taken action to fight the strong franc. Last Tuesday, it announced that it would not tolerate an exchange rate below 1.20 against the euro, making it clear that it will embark on unlimited FX intervention, if necessary. In August it already drastically boosted liquidity in the money market, in an attempt to lower interest rates and to weaken the franc. Compared with July, the monetary base should have increased by around 200% and is now set to rise further. The 3M-Libor has dropped to its zero target rate, while some money market rates and futures have slipped into negative territory. At next weeks monetary policy meeting, the SNB will explain its measures and probably also how it plans to keep a lid on the long-term risks accompanying such an accommodative policy. Dr Ulrike Rondorf +49 69 136 45814 CHART 9: Expected interest rate for 3-month funds (CHF)
1,0 0,5 0,0 -0,5 current Dez 11 Mrz 12 Jun 12 Futures 08.09.11 01.09.11 Sep 12 Dez 12

Commerzbank

Source: Bloomberg, Commerzbank Research

10

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09 September 2011

Bond market preview:

Supply, economy, politics, rating

Rainer Guntermann Tel. +49 69 136 87506

Concerns over weak economic growth and the ongoing debate about the sovereign debt crisis should keep bond markets on their toes in the days ahead. The spotlight will be on the meetings of the G7/EU finance ministers. On top of that, an above-average issuance of euro government bonds is on the cards in the week ahead. Ten-year Bund yields might hit new record lows. A trading range on low yield levels seems assured. TABLE 4: Weekly outlook for yields and curves Bunds Yield (10 years) Curve (10 2 years)
Source: Commerzbank Research

US Treasuries Sideways Neutral

Sideways Neutral

Momentum outlook for Bund future 12 16 September Economy Inflation Monetary policy Trend Supply Risk aversion

Bund yields look set to remain near their new historical lows, as neither economic concerns nor uncertainty over the progress in the euro area sovereign debt crisis will evaporate any time soon. Moreover, the intervention of the Swiss National Bank is depressing Bund yields. In the week ahead, these issues will continue to be an issue for the bond markets. On top of that, the upcoming wave of government bond issues in Italy and Spain is adding extra flavour to the crisis cocktail. As far as the economy is concerned, we believe that, while hard data looks set to weaken, it is unlikely to take a sharp plunge. This should already be largely priced in current yield levels. Moreover, next weeks political events might prove to be additional stumbling blocks for the bond market. Signals are expected from todays and tomorrows meeting of the G7 finance ministers on how they plan to counter global economic and financial market risks. At the same time, speculation is mounting that the central banks might take action against the economic and market risks. If, however, the statements remain vague, crisis premiums on US Treasuries and Bunds will remain at elevated levels and historically low yields could decline further. Another focal point will be the meeting of the EU finance ministers and central bank presidents in the latter half of next week. The greater the differences of opinion, the lower the Bund yields. In this fragile environment, a new flurry of government bonds to the tune of some EUR 28 bn is looming next week (chart 10). Peripheral markets have stabilised thanks to the ECB's bond purchases (chart 11). Yet, above all the auctions in Italy and Spain (totalling up to EUR 13 bn) are adding to nervousness, because in the week ahead the Italian parliament is also voting on the new austerity package. Moreover, Moodys looks set to announce an updated credit rating for Italy, since the usual three-month period following the June 17 announcement that the country is on review for a possible downgrade, comes to an end in the week ahead.

CHART 10: Italy

and Spain are becoming active again

CHART 11:

Bunds to remain near their historical lows

Weekly supply of euro sovereign bonds in the year-to-date, calendar weeks, in EUR bn

Yield of ten-year sovereign bonds, in % p.a

35 30 25 20 15 10 5 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 Angebot Durchschnitt im bisherigen Jahresverlauf

7 6 5 4 3 2 2008 DE

2009

2010 ES

2011 IT

Source: Bloomberg, Commerzbank Research

Source: Bloomberg, Commerzbank Research

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FX market preview:
SNB pulls the ripcord

Lutz Karpowitz

Tel. Tel. +49 69 136 42152 +49 (0) 136 41250 Alexandra Na Park Lutz Karpowitz You Bechtel

EUR-USD continues to trade sideways despite the fact that the event risks in Europe will remain high over the coming weeks. The Swiss central bank has pulled the ripcord and will now only accept a minimum exchange rate in EUR-CHF of 1.20. From our point of view this announcement is credible. Even in periods of increased risk aversion EUR-CHF will initially not ease below the 1.20 mark. TABLE 5: Expected weekly trading ranges Range EUR-USD EUR-JPY USD-JPY 1.3500-1.4250 105.00-110.50 75.00-79.00 Bias EUR-GBP GBP-USD EUR-CHF Range 0.8550-0.8850 1.5650-1.6300 1.2050-1.2250 Bias

Source: Commerzbank Research

The ruling of the German Constitutional Court was only one of the stumbling blocks the euro had to overcome. Before the EFSF can be extended, many obstacles in the shape of the euro zone parliaments still have to be passed. The risk remains that the EFSF will only be able to assume its intended tasks with some delay. This is problematic for the euro as the ECB will have to step into the breach until then. A central bank willing to accept the risk of inflation for the sake of buying bonds would put pressure on any currency. The Swiss National Bank has pulled the ripcord and announced that it will no longer accept EUR-CHF exchange rates below 1.20 (chart 12). By its own accord it is prepared to intervene on the FX markets to an unlimited extent to defend this level. Markets had wondered for some time when the SNB would take further steps and it was the approach adopted, rather than the announcement of measures, which came as a surprise. By publicly setting a lower threshold of 1.20 it seems to be putting all its eggs into one basket. Regardless of how strong the pressure on the currency pair becomes, it will have to support the level. Otherwise it would lose all credibility, with the appreciation pressure on the franc being even stronger than before. We assume that EUR-CHF will not ease below 1.20 again and advise against EUR-CHF shorts. That applies even in case of a notable rise in risk aversion (chart 13). Even though the franc would once again be in demand as a safe haven, the SNB has unlimited ammunition for intervention in the form of its printing its own currency.

CHART 12: EUR-CHF jumps above 1.20

EUR-CHF, exchange rate development on 6 September, 10 minute data
th

CHART 13: Risk still assumed to be high

EUR-USD, 1 month risk reversals, 25 delta, percentage points, annualised volatility

1.22 1.20

0.0

-1.0 1.18 1.16 1.14 -3.0 1.12 1.10 0:00 10:00 12:00 14:00 16:00 18:00 20:00 22:00 -4.0 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11
Source: Bloomberg

-2.0

Source: Bloomberg

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Equity market preview:

8 reasons against a DAX recession scenario

Andreas Hrkamp Tel. +49 69 136 45925

Record highs in Italian CDS spreads and in the iTraxx Financial Senior; persistently weak M1 money growth in the euro zone; weakening OECD leading indicators for formergrowth regions such as Brazil, India and Turkey, and the latest weak US labour market report signal that the probability of a DAX recession scenario has increased further. However, we have eight reasons why we believe that a rerun of the DAX 2008 recession scenario is too pessimistic. TABLE 6: DAX minus 27% in Q3 - is DAX correct in anticipating a recession scenario? Earnings 11e Performance (%) since Index points Growth (%) P/E 11e Index 31/08 30/06 31/12 current 31/12 current 31/12 current 31/12 DAX 30 MDAX Euro Stoxx 50 S&P 500 5,406 8,715 2,151 1,199 -6.6 -5.0 -6.6 -1.7 -26.7 -20.3 -24.5 -9.2 -21.8 -14.0 -23.0 -4.7 662 741 278 98 635 729 294 95 2.0 17.7 5.5 16.8 11.4 25.7 12.3 13.3 8.2 11.8 7.7 12.3 10.9 13.9 9.5 13.3

Source: Commerzbank Corporates & Markets, I/B/E/S

In our view the correction of the DAX price-to-book ratio towards 1.0x indicates that the DAX has already priced in a 2-quarter-recession scenario. Indeed, the record high of the Italian CDS index at 470bps, the record high of the iTraxx Financials index at 270bps (chart 14), the persistently weak annual M1 money growth of 0.9% in the euro zone and the disappointing US labour market report all indicate that the recession probability has increased further over recent weeks. However, we stick to our view that a DAX 2008 recession scenario is unlikely as (1) US monetary policy is more expansionary than three years ago with steeper yield curves and stronger money growth; (2) In contrast to 2008, weekly US railroad data still indicate a robust trend in transportation of chemicals and metals in recent weeks; (3) Unlike 2008 the oil price has not spiked in 2011; (4) Therefore inflation in developing economies is much lower than in 2008, and their central bank policies are more accommodative; (5) In contrast to 2008, commodities such as copper, aluminium and nickel have so far not followed the plunge of equity markets; (6) Lower net debt to EBITDA ratios and lower wage growth indicate that companies should be better prepared for a slowdown in orders and sales; (7) The price-to-book ratios of developing economies such as South Korea (Kospi P/BV at 1.0x) and Brazil (Bovespa P/BV at 1.2x) are already near 2009 lows (chart 15); And (8) the forward P/E of the Nasdaq 100 has already approached the 2009 trough of 11x. In our view there is still a chance the DAX might avoid a 2008/09 recession scenario. But first and foremost, a sustainable decline in euro debt crisis indicators such as Italian CDS and the iTraxx Financials Senior index remain a precondition for the DAX to have any chance of stabilising and recovering in the coming months.
CHART 14: iTraxx

Financial Senior index at an all-time high

CHART 15: Kospi

P/BV has already corrected to 1.0x

iTraxx Financial Senior in bps 300 250 200 150 100 50 0 Jan-07
Source: Factset

Kospi forward P/BV ratio 2.0 1.8 1.6 1.4 1.2 1.0 0.8

Jan-08

Jan-09

Jan-10

Jan-11

Jan-07
Source: Factset

Jan-08

Jan-09

Jan-10

Jan-11

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Commerzbank Forecasts
TABLE 7: Growth and inflation Real GDP (%) 2010 2011 USA 3.0 1.7 Canada 3.2 2.3 Japan 4.0 -0.5 Australia 2.7 2.0 Euro area 1.7 1.7 -Germany 3.7 3.0 -France 1.4 1.6 -Italy 1.1 0.7 -Spain -0.1 0.7 United Kingdom 1.4 1.2 Sweden 5.4 4.5 Switzerland 2.6 2.0 Norway 0.3 1.5 TABLE 8: Interest rates (end-of-quarter) 08.09.11 Q4 11 USA Federal funds rate 0.25 0.25 3-months Libor 0.34 0.35 2 years* 0.19 0.40 5 years* 0.90 1.55 10 years* 2.03 2.90 Spread 10-2 years 184 250 Swap-Spread 10 years 19 20 Euro area Minimum bid rate 1.50 1.50 3-months Euribor 1.53 1.65 2 years* 0.47 1.20 5 years* 1.00 1.75 10 years* 1.90 2.80 Spread 10-2 years 143 160 Swap-Spread 10 years 75 40 United Kingdom Bank Rate 0.50 0.50 3-months Libor 0.90 0.75 2 years* 0.60 0.75 10 years* 2.40 3.10 Japan Over night rate 0.10 0.10 3-months Libor 0.19 0.20 2 years* 0.14 0.20 10 years* 1.02 1.25 TABLE 9: Exchange rates (end-of-quarter) 08.09.11 Q4 11 EUR/USD USD/JPY GBP/USD EUR/JPY EUR/CHF EUR/GBP EUR/SEK EUR/NOK AUD/USD NZD/USD USD/CAD 1.40 77 1.61 108 1.21 0.87 8.93 7.53 1.06 0.84 0.98 1.43 82 1.66 117 1.21 0.86 8.93 7.70 1.06 0.84 0.96 2012 2.3 2.3 2.5 3.8 0.8 1.5 1.0 0.4 0.5 1.5 2.0 1.2 2.0 Q1 12 0.25 0.30 0.30 1.40 2.85 255 25 1.50 1.65 1.20 1.70 2.60 140 45 0.50 0.75 0.65 2.80 0.10 0.20 0.20 1.10 Q1 12 1.40 82 1.65 115 1.21 0.85 8.85 7.65 1.05 0.83 0.95 Inflation rate (%) 2010 2011 1.6 3.2 1.8 2.8 -0.7 0.0 2.8 3.3 1.6 2.6 1.1 2.4 1.5 2.3 1.5 2.4 1.8 3.0 3.3 4.5 1.2 3.0 0.7 0.6 2.4 1.6 Q2 12 0.25 0.35 0.40 1.50 2.95 255 25 1.50 1.80 1.25 1.80 2.80 155 45 0.50 0.75 0.80 3.00 0.10 0.20 0.20 1.20 Q2 12 1.37 83 1.63 114 1.21 0.84 8.80 7.60 1.02 0.81 0.97 Q3 12 0.25 0.45 0.45 1.60 3.15 270 25 1.50 1.75 1.35 1.90 2.90 155 40 0.50 0.80 1.05 3.10 0.10 0.20 0.20 1.25 Q3 12 1.35 83 1.63 112 1.23 0.83 8.80 7.70 1.00 0.80 0.99 2012 1.7 1.8 0.5 3.0 1.8 2.1 2.0 1.7 1.5 2.8 2.3 1.0 1.8 Q4 12 0.25 0.50 0.50 1.70 3.25 275 30 1.50 1.85 1.50 2.10 3.10 160 35 0.50 0.95 1.30 3.15 0.10 0.20 0.20 1.25 Q4 12 1.35 Ongoing speculation about QE3 is a drag on the dollar in 88 the short term. 1.65 119 The interruption in ECB interest hikes and/or massive 1.25 bond purchases by the ECB 0.82 will weigh on the euro in the 8.90 medium-term. 7.75 The sovereign debt crisis 0.98 should put further pressure on 0.79 the euro in the long term. 1.00 10-year US Treasury, and Bund, yields should remain below 3% for an extended period, with a chance to increase only marginally once the sovereign debt crisis and the economic woes subside somewhat. The structural lowyield environment remains in place. Slowing growth and the unresolved debt crisis prevent ECB rate hikes until early 2013. The Fed remains on hold until well into 2013. Moves at the long-end determine the shape of the yield curves. The euro zone government debt crisis is not over yet. Yield spreads will decline only slowly and unevenly in the medium-term. 10Y Bund swap spreads will decline to 40 to 45 bps from their extreme crisis levels.

The biggest economic risk is an escalation of the sovereign debt crisis in the euro zone. The euro area economy is hardly growing. The unemployment rate will rise again. The US economy is likely to avoid a recession. Weaker growth will act to dampen inflation.

Source: Bloomberg. Commerzbank Economic Research; bold change on last week; * Treasuries, Bunds, Gilts, JGBs

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