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trateg

con

Economics& Strategy

http://research.cibcwm.com/res/Eco/EcoResearch.html

Jerey Rubin

(416) 594-7357

jeff.rubin@cibc.ca

Avery Sheneld

(416) 594-7356

avery.shenfeld@cibc.ca

Benjamin Tal

(416) 956-3698

benjamin.tal@cibc.ca

Peter Buchanan

(416) 594-7354

peter.buchanan@cibc.ca

Meny Grauman

(416) 956-6527meny.grauman@cibc.ca

Krishen Rangasamy

(416) 956-3219

krishen.rangasamy@cibc.ca

“

Headline US CPI infation will graba negative handlein the next ew months, but it will be runningnorth o 4% inless than a year.

”

Refation

by Je Rubin

January 23, 2009

Past and Coming Episodes o US Refation

-505101520253035 45 55 65 75 85 95 05WW IIKoreaVietnam SubprimeUS CPI, y/y % chg10Fcst

Quantitative easing may have some newwrinkles in it (see pages 7-9) but it’s basicallymonetizing the decit by any other name.And this time the Fed won’t be just buyingTreasuries but also some o Wall Street’s mosttroubled assets. But as Congress and the newObama Administration get ready to dole outthe second tranche o the TARP program,the bond market may soon start wonderingwhere the money to pay or all these assets,and the $825 billion economic stimuluspackage, will be coming rom?The same place it came rom in Argentinain the late 1980s or in Zimbabwe today. Justcreate more money. I the central bank printsit, someone will spend it. Already US moneysupply (M2) is growing at a nearly 20% ratein the last three months and the printingpresses are just warming up. And there’s noshortage o more troubled assets to monetizealong with $1.5 trillion-plus in ederal decitsto keep money supply growth chuggingalong in the uture.As it buys up spread product, the Fedwill leave Treasuries to be mopped up byoreigners. Since outsiders, like the People’sBank o China, now own over 50% oAmerica’s debt, there has never been a bettertime to refate. Why deault on your taxpayerswhen you can deault on someone else’s? A10-year Treasury bond will, o course, matureat par, but who’s to say the greenback won’tsink 40% against the yuan over its term likeit did against the yen between 1971 and1981?The prospect o relation may seemincredulous on the cusp o negative CPInumbers in the US, but past decits thatwere a mere raction o today’s in relationto the size o the American economy,were readily monetized. And without ail,monetization led to an explosive bout osubsequent infation (Chart). The huge WorldWar II decits saw infation peak at almost20% in 1947. When the printing presseswere turned up to pay or the Korean War,infation moved rom negative territory toover 9% within the space o nine monthsin the early 1950s. And when Arthur Burnsgreased the Fed’s presses ater the VietnamWar, infation soon made a triumphant returnto double-digit territory.Not that it will particularly be needed, butrefation will get more than a helping handnext year rom today’s collapsed oil market.Global oil demand will all this year, but it willbe global supply that will be alling by 2010(see pages 4-6). And it will keep alling untilprices recover to at least the marginal cost oan incremental barrel, which in today’s worldis a barrel rom oil sands.Headline US CPI infation will grab a negativehandle in the next ew months, but it will berunning north o 4% in less than a year.

CIBC W

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arkets

StrategEcon

- January 23, 2009

MARKET CALLINTEREST & FOREIGN EXCHANGE RATES

US and Canadian policy eorts will now take greater aim at spreads rather than government yields. The Fed,o course, is done in terms o the unds rate, and is buying mortgage and agency bonds rather than Treasuries.Treasury yields will drit higher as investors move out the credit curve to escape ballooning sovereign supplyand renewed infation risks in 2010, with the Fed’s printing press running at ull speed.The Bank o Canada’s nal hal-point cut is ully priced in, leaving no room or an impact on government bondyields. Minister Flaherty hinted that the budget could include measures to address credit market spreads andthe banking system, so there may be better scope or returns on a well-chosen portolio o spread product,particularly once there are at least some signs o a return to growth in the latter hal o the year.Pessimism on the global outlook and the health o the nancial system has re-ignited debt-repayment fowsthat avour the yen and the US dollar. As a result, we’ve altered our near-term currency orecasts to allow orthat run to continue through Q1. While our year-end euro target is unchanged, we’ve weakened expectationsor C$ and A$ gains with more o the commodities recovery now slated or 2010.•••

2009END OF PERIOD:22-Jan Mar Jun Sep DecCDA

Overnight target rate1.000.500.500.500.7598-Day Treasury Bills0.830.350.350.400.70Chartered Bank Prime3.002.502.502.502.752-Year Gov't Bond (2.75% 12/10)1.131.001.251.752.0010-Year Gov't Bond (4.25% 06/18)2.742.903.003.253.4030-Year Gov't Bond (5% 06/37)3.623.653.703.803.95

U.S.

Federal Funds Rate0.230.100.100.100.5091-Day Treasury Bills0.100.200.200.300.352-Year Gov't Note (0.88% 12/10)0.740.800.951.051.4510-Year Gov't Note (3.75% 11/18)2.582.702.752.803.0030-Year Gov't Bond (4.5% 05/38)3.253.303.353.403.45Canada - US T-Bill Spread0.730.150.150.100.35Canada - US 10-Year Bond Spread0.160.200.250.450.40Canada Yield Curve (30-Year — 2-Year)2.492.652.452.051.95US Yield Curve (30-Year — 2-Year)2.502.502.402.352.00

EXCHANGE RATES

— (US¢/C$)79.976.980.082.084.7 — (C$/US$)1.2521.3001.2501.2201.180 — (Yen/US$)8990959392 — (US$/euro)

1.30

1.251.281.321.35 — (US$/pound)1.391.361.421.511.56 — (US¢/A$)65.764.067.070.072.0

CIBC W

orld

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StrategEcon

- January 23, 2009

STRATEGY AND EARNINGS OUTLOOK

•••While the US economy is now mired deeply in recession, the stock market has already discounted adepression. The ourth and rst quarters could well be the US economy’s worst six months in decades.Continuing nancial troubles also cloud the near-term prospects or equities. But with the bar now set solow insoar as the economy’s health is concerned, even the aintest signs o lie beyond mid-year should litthe TSX back to the 11,000 level by the end o 2009.We added a point o weighting to the tech sector, reducing our previous underweight. Valuations therehave improved as a result o late 2008’s sell-o. Osetting that, we lopped a urther point rom our alreadyunderweight position in industrials. Rails, which make up hal o the sector’s weight, ace urther reductionsin reight volumes as the recession bites, although transit equipment and engineering rms could benetrom ramped-up inrastructure outlays.Oil prices are receiving scant support on the demand side as the global economic slump intensies. But supplytrends are a dierent story. OPEC cuts may help somewhat, but most o the supply response will come romthe invisible hand o the market, which is laying the seeds or a solid rebound in crude prices during the nextrecovery (see pages 4-6). Recession prices have already delayed or cancelled one million barrels per day oplanned oil sands production in Canada, just a raction o cuts that are occurring globally.

Source: Thomson First Call, CIBC WM

762851935796010020030040050060070080090010002006200720082009CIBCWM Fcst

TSX Index-Adj. Oper. Earnings-15%13%10%12%

8,98811,00012,90813,83304,0008,00012,00016,0002006200720082009

TSX Composite Index (close)

Projected

2006 2007 2008 2009 LatestEnergy 11.1 14.7 42.6 -24.6 9.5Industrials 21.9 38.2 -3.1 -18.0 10.3Materials 80.2 30.2 39.1 -9.4 11.6Financials 19.2 13.5 -12.7 -11.1 10.8Utilities 0.4 49.6 -61.2 122.6 28.3Consumer Staples -3.0 0.0 5.2 -7.9 13.8Consumer Discretionary 6.1 8.5 19.6 -12.0 11.2Info Tech 121.1 133.5 37.6 12.1 13.0Health Care 29.8 -38.8 -20.5 6.0 14.2Telecom Services 26.3 33.0 -4.3 -13.7 12.1