commerzbank forecast

Economic Research

For important disclosure information please see end of this document

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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

0

50

100

150

200

250

300

350

400

450

1-Jun 4-Jul 6-Aug 8-Sep

Italy Spain

ECB purchases

Source: Bloomberg, Commerzbank Research

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 week’s 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. 1

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

research.commerzbank.com

Week in Focus

What could add further fuel to the debt crisis?

09 September 2011

Chief Economist

Dr Jörg Krämer +49 69 136 23650 [email protected]

Managing Editor Peter Dixon +44 20 7475 4806 [email protected]

http://crswp01.zit.commerzbank.com:8080/workflow/overview�

mailto:[email protected]�

mailto:[email protected]�

2 research.commerzbank.com 09 September 2011

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 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 year-end. (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 bond-buying 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 Event Date Event Sep. 13 Italy: Issuance of EUR 6-7.5 bn Oct 20. Spain: Issuance of EUR 4.5 bn Sep. 15 Spain: Issuance of EUR 4-5 bn Oct. 28 Italy: Issuance of EUR 6 bn Sep. 29 Italy: Issuance of EUR 7.5-8.5 bn Nov. 7 Eurogroup meeting Late Sep. Troika Report on Greece Mid-Nov. 2nd IMF Review on Portugal Late Sep. Greek debt exchange offer Nov. 20 Parliamentary elections in Spain Oct. 3 Eurogroup meeting Nov. 29 Eurogroup meeting Oct. 6 Spain: Issuance of EUR 3.5 bn Dec. 9 EU summit Oct. 13 Italy: Issuance of EUR 5 bn Dec. 14 4th IMF Review on Ireland Oct. 17/18 EU summit Source: Bloomberg, EU, Commerzbank Research

Christoph Weil Tel. +49 69 136 24041

09 September 2011 research.commerzbank.com 3

(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 inparentheses: Number of reporting months

CHART 2: Deficit targets for 2011 and 2012 Envisaged budget balances in % of GDP

-2

-1

0

1

2

3

4

GR (7) PT (7) IR (8) SP (7) IT (6)target for (x) months target for the whole year achieved

0

2

4

6

8

10

12

Es It Pt Ir Gr

2011 2012

Source: National financial statistics, Commerzbank Research Source: Stability programmes, Commerzbank Research


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 third-smallest 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 ECB’s 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 Date Comment AAA-countries Germany Sep. 29 “Chancellor’s majority” not yet reached France Sep. 9 Netherlands Sep. 13 Minority government needs support from the opposition. Freedom Party against expanding the EFSF Austria late Sep. Finland Sep. 15 EFSF expansion controversial Luxembourg Sep. 15 Other countries Italy No parliamentary approval required Spain Government may approve in advance Belgium Sep. 13 Slovakia by Dec. Coalition partner against expanding EFSF Slovenia Q4 Government without majority in parliament. Chance of early elections


The added value of investor sentiment surveys 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 bull-minus-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 strategy’s 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.

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

Anna SchröderTel. +49 69 136 87791


Product idea: Three-year Bear Floater Capitalise on modestly rising 3m Euribor rates and high volatility

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 ECB’s 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: A3 / A- / stable Type: Bearer/Schuldschein Size: € 10m Maturity: 3 years Reference index (RI): 3M Euribor Coupon: 3.5% * n/N with n:= number of days, with RI within range, and

N:= calendar days pa Range: Upper boundary: 2.5%, lower boundary: 1% Fixing: Daily Basis: Annually, act/act, following, unadj.

Markus Koch+49 69 136 87685


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 Aug mom,

yoy 0.2 1.9

– -0.41.9

CPI excl. tobacco Aug 122.2 – 121.9 9:30 GBR CPI Aug yoy 4.6 4.5 4.4 RPI Aug yoy 5.2 5.2 5.0 RPI, index Aug 236.1 – 234.7 Trade Balance Jul GBP bn -4.4 -4.3 -4.5 Wednesday, 14 September 2011 9:30 GBR Jobless claims change Aug sa, k 35 35 37.1 Unemployment rate Jul %, sa 7.9 7.9 7.9 Average earnings (three-month average) Jul yoy 2.7 2.7 2.6

10:00 EUR Industrial production Jul mom, sa yoy

0.7 3.7

1.54.8

-0.82.7

13:30 USA PPI Aug mom, sa -0.4 -0.1 0.2 PPI excl. food & energy Aug mom, sa 0.2 0.2 0.4

• Retail sales Aug mom, sa 0.2 0.2 0.5

Retail sales ex autos Aug mom, sa 0.3 0.2 0.5 15:00 Business inventories Jul mom, sa 0.5 0.5 0.3 22:00 NZL RBNZ interest rate decision Aug % 2.50 2.50 2.50 Thursday, 15 September 2011 8:30 SUI Swiss National Bank interest rate decision Aug % 0.00 0.00 0.00 9:30 GBR Retail sales, volume Aug mom, sa -0.3 -0.3 0.2 10:00 EUR HICP, final Aug yoy 2.5 2.5 2.5 (p) HICP excl. energy, food, tobacco, alcohol Aug yoy 1.2 1.1 1.2

• 13:30 USA Empire State Index Sep sa -2.00 -2.95 -7.72

CPI Aug mom, sa 0.3 0.2 0.5 CPI excl. food & energy Aug mom, sa 0.2 0.2 0.2 Initial claims 9 Sep k 410 – 414 14:15 Industrial production Aug mom, sa 0.1 0.1 0.9 Capacity utilisation Aug %, sa 77.4 77.5 77.5

• 15:00 Philadelphia Fed Index Sep sa -10.0 -16.4 -30.7

EUR: ECB’s 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.


Economic data preview:

USA: To what extent has the debt debate unsettled the economy? The potential for sovereign default in August should have left its negative imprint on economic activity in the USA. Nonetheless, next week’s 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 July’s 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 Car sales, monthly data, seasonally-adjusted annualised rate

CHART 4: USA – Hours worked declined in August Manufacturing, hours worked and production, month-on-month change in %

10.0

10.5

11.0

11.5

12.0

12.5

13.0

13.5

14.0

Jan-10 Jul-10 Jan-11 Jul-11

-4

-3

-2

-1

0

1

2

Jan-07 Jul-08 Jan-10 Jul-11

hours worked production

Source: Global Insight, Commerzbank Research Source: Global Insight, Commerzbank Research

Dr Christoph BalzTel. +49 69 136 24889


Central Bank Watch (1) Fed

CHART 5: Expected Federal Funds Rate (USD)

0,0

0,2

0,4

0,6

0,8

1,0

current Dez 11 Mrz 12 Jun 12 Sep 12 Dez 12

08.09.11 01.09.11 Commerzbank Overnight Index Swaps

TABLE 2: Consensus forecast Fed funds rate

Q4 11 Q2 12 Q4 12

Consensus 0.25 0.25 0.25

High 0.25 1.00 1.50

Low 0.25 0.25 0.25

Commerzbank 0.25 0.25 0.25

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 Fed’s security portfolio.

Dr Christoph Balz +49 69 136 24889


ECB CHART 6: Expected ECB minimum bid rate (EUR)

0,5

1,0

1,5

2,0

2,5

3,0


08.09.11 01.09.11 Commerzbank

Overnight Index Swaps

The ECB staff experts revised down their growth projectionfor this year from 1.9% to 1.6%, and from 1.7% to 1.3% for2012. Inflation projections for 2011 and 2012 have been leftunchanged. 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 bank’s definition of pricestability. 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 emphasisedthat “the risks to the economic outlook for the euro area areon the downside” (so far: “balanced”). In addition, “theGoverning Council views the risks to the medium-term outlookfor price developments as being broadly balanced” (so far:“upside”) ECB president Trichet stressed the “particularly highuncertainty” and said that “a very thorough analysis of allincoming data and developments over the period ahead iswarranted”. That said, the ECB continues to highlight that“short-term interest rates are low” and that the ECB’s”monetary policy stance remains accommodative”, which inour view means that the ECB will need to see a furthersignificant deterioration of the situation before it starts to consider rate cuts.

Dr Michael Schubert+49 69 136 23700

TABLE 3: Consensus Forecasts ECB minimum bid rate

Q4 11 Q2 12 Q4 12

Consensus 1.50 1.50 1.75

High 1.75 2.00 2.50

Low 1.50 1.00 1.00

Commerzbank 1.50 1.50 1.50

Source: Reuters, Commerzbank Research


Central Bank Watch (2) BoE

CHART 7: Expected interest rate for 3-month funds (GBP)

0,5

1,0

1,5

2,0


08.09.11 01.09.11 CommerzbankFutures

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


BoJ CHART 8: Expected interest rate for 3-month funds (JPY)

0,0

0,2

0,4

0,6

0,8

1,0



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 SNB’s 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 government’s third supplementary budget in October.

Wolfgang Leim+49 69 136 24525


SNB (Switzerland) CHART 9: Expected interest rate for 3-month funds (CHF)

-0,5

0,0

0,5

1,0



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 week’s 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



Bond market preview: Supply, economy, politics, rating

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 US Treasuries

Yield (10 years) Sideways Sideways

Curve (10 – 2 years) Neutral Neutral

Source: Commerzbank Research

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 week’s political events might prove to be additional stumbling blocks for the bond market. Signals are expected from today’s and tomorrow’s 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, Moody’s 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 Weekly supply of euro sovereign bonds in the year-to-date, calendar weeks, in EUR bn

CHART 11: Bunds to remain near their historical lows Yield of ten-year sovereign bonds, in % p.a

0

5

10

15

20

25

30

35

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Angebot Durchschnitt im bisherigen Jahresverlauf

2

3

4

5

6

7

2008 2009 2010 2011

DE ES IT

Source: Bloomberg, Commerzbank Research Source: Bloomberg, Commerzbank Research

Momentum outlook for Bund future 12 – 16 September

Economy → Inflation → Monetary policy ↑ Trend → Supply ↑ Risk aversion ↑

Rainer GuntermannTel. +49 69 136 87506


FX market preview: SNB pulls the ripcord

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 Bias Range Bias

EUR-USD 1.3500-1.4250 EUR-GBP 0.8550-0.8850 EUR-JPY 105.00-110.50 GBP-USD 1.5650-1.6300 USD-JPY 75.00-79.00 EUR-CHF 1.2050-1.2250

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 6th September, 10 minute data

CHART 13: Risk still assumed to be high EUR-USD, 1 month risk reversals, 25 delta, percentage points, annualised volatility

1.10

1.12

1.14

1.16

1.18

1.20

1.22

0:00 10:00 12:00 14:00 16:00 18:00 20:00 22:00

-4.0

-3.0

-2.0

-1.0

0.0

Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11

Source: Bloomberg Source: Bloomberg

Alexandra Bechtel

Lutz Karpowitz

Alexandra Bechtel

Lutz Karpowitz

Alexandra Bechtel

You Na Park

Alexandra Bechtel

Lutz Karpowitz

Alexandra Bechtel

You Na Park

Tel. +49 (0) 69 136 41250

Lutz KarpowitzTel. +49 69 136 42152


Equity market preview: 8 reasons against a DAX recession scenario

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 former-growth 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 31/12DAX 30 5,406 -6.6 -26.7 -21.8 662 635 2.0 11.4 8.2 10.9MDAX 8,715 -5.0 -20.3 -14.0 741 729 17.7 25.7 11.8 13.9Euro Stoxx 50 2,151 -6.6 -24.5 -23.0 278 294 5.5 12.3 7.7 9.5S&P 500 1,199 -1.7 -9.2 -4.7 98 95 16.8 13.3 12.3 13.3Source: 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 highiTraxx Financial Senior in bps

CHART 15: Kospi P/BV has already corrected to 1.0x Kospi forward P/BV ratio

Source: Factset Source: Factset

0

50

100

150

200

250

300

Jan-07 Jan-08 Jan-09 Jan-10 Jan-110.8

1.0

1.2

1.4

1.6

1.8

2.0

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Andreas HürkampTel. +49 69 136 45925


Commerzbank Forecasts TABLE 7: Growth and inflation Real GDP (%) Inflation rate (%) 2010 2011 2012 2010 2011 2012USA 3.0 1.7 2.3 1.6 3.2 1.7Canada 3.2 2.3 2.3 1.8 2.8 1.8Japan 4.0 -0.5 2.5 -0.7 0.0 0.5Australia 2.7 2.0 3.8 2.8 3.3 3.0Euro area 1.7 1.7 0.8 1.6 2.6 1.8 -Germany 3.7 3.0 1.5 1.1 2.4 2.1 -France 1.4 1.6 1.0 1.5 2.3 2.0 -Italy 1.1 0.7 0.4 1.5 2.4 1.7 -Spain -0.1 0.7 0.5 1.8 3.0 1.5United Kingdom 1.4 1.2 1.5 3.3 4.5 2.8Sweden 5.4 4.5 2.0 1.2 3.0 2.3Switzerland 2.6 2.0 1.2 0.7 0.6 1.0Norway 0.3 1.5 2.0 2.4 1.6 1.8

• 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.

TABLE 8: Interest rates (end-of-quarter) 08.09.11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12USA Federal funds rate 0.25 0.25 0.25 0.25 0.25 0.253-months Libor 0.34 0.35 0.30 0.35 0.45 0.502 years* 0.19 0.40 0.30 0.40 0.45 0.505 years* 0.90 1.55 1.40 1.50 1.60 1.7010 years* 2.03 2.90 2.85 2.95 3.15 3.25Spread 10-2 years 184 250 255 255 270 275Swap-Spread 10 years 19 20 25 25 25 30Euro area Minimum bid rate 1.50 1.50 1.50 1.50 1.50 1.503-months Euribor 1.53 1.65 1.65 1.80 1.75 1.852 years* 0.47 1.20 1.20 1.25 1.35 1.505 years* 1.00 1.75 1.70 1.80 1.90 2.1010 years* 1.90 2.80 2.60 2.80 2.90 3.10Spread 10-2 years 143 160 140 155 155 160Swap-Spread 10 years 75 40 45 45 40 35United Kingdom Bank Rate 0.50 0.50 0.50 0.50 0.50 0.503-months Libor 0.90 0.75 0.75 0.75 0.80 0.952 years* 0.60 0.75 0.65 0.80 1.05 1.3010 years* 2.40 3.10 2.80 3.00 3.10 3.15Japan Over night rate 0.10 0.10 0.10 0.10 0.10 0.103-months Libor 0.19 0.20 0.20 0.20 0.20 0.202 years* 0.14 0.20 0.20 0.20 0.20 0.2010 years* 1.02 1.25 1.10 1.20 1.25 1.25

• 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 low-yield 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.

TABLE 9: Exchange rates (end-of-quarter) 08.09.11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12EUR/USD 1.40 1.43 1.40 1.37 1.35 1.35USD/JPY 77 82 82 83 83 88GBP/USD 1.61 1.66 1.65 1.63 1.63 1.65EUR/JPY 108 117 115 114 112 119EUR/CHF 1.21 1.21 1.21 1.21 1.23 1.25EUR/GBP 0.87 0.86 0.85 0.84 0.83 0.82EUR/SEK 8.93 8.93 8.85 8.80 8.80 8.90EUR/NOK 7.53 7.70 7.65 7.60 7.70 7.75AUD/USD 1.06 1.06 1.05 1.02 1.00 0.98NZD/USD 0.84 0.84 0.83 0.81 0.80 0.79USD/CAD 0.98 0.96 0.95 0.97 0.99 1.00

• Ongoing speculation about QE3 is a drag on the dollar in the short term.

• The interruption in ECB interest hikes and/or massive bond purchases by the ECB will weigh on the euro in the medium-term.

• The sovereign debt crisis should put further pressure on the euro in the long term.

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


Research contacts (E-Mail: [email protected])

Chief Economist Dr Jörg Krämer

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This document has been created and published by the Corporates & Markets division of Commerzbank AG, Frankfurt/Main or Commerzbank’s branch offices mentioned in the document. Commerzbank Corporates & Markets is the investment banking division of Commerzbank, integrating research, debt, equities, interest rates and foreign exchange.

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Disclaimer This document is for information purposes only and does not take account of the specific circumstances of any recipient. The information contained herein does not constitute the provision of investment advice. It is not intended to be and should not be construed as a recommendation, offer or solicitation to acquire, or dispose of, any of the financial instruments mentioned in this document and will not form the basis or a part of any contract or commitment whatsoever.

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