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AUG 11 DBS Daily Breakfast Spread

AUG 11 DBS Daily Breakfast Spread

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Published by: Miir Viir on Aug 11, 2010
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Daily Breakfast Spread, 11 Aug 2010
Daily Breakfast Spread
DBS Group Research11 Aug 2010
Greater China, Korea
The Bank of Korea will meet tomorrow morning to review monetary policy. It iswidely known that the BOK will continue normalizing policy after raising thebenchmark repo rate by 25bps in July (the first hike since the global crisis), but thepace of interest rate normalization remains a question. In our view, the BOK is likelyto keep rates unchanged at 2.25% on tomorrow’s meeting before moving again inSeptember. The BOK meeting is scheduled on a frequent (monthly) basis. Back-to-back rate hikes will quickly push up the repo rate to 4% in the beginning of nextyear and 5% (the precrisis neutral level) in mid-2011. With uncertainties stilllingering in the global economy (such as US growth sustainability and Chinaslowdown), the BOK would be inclined to normalize policy in a gradual manner toavoid the risks of derailing economic recovery.On the data front, the Korean economy continued to grow but the growth ratemoderated slightly in 3Q. Exports decelerated to 29.6% YoY in July from 30.1% inJune (a modest 0.3% MoM sa). Business sentiment in the manufacturing industryimproved marginally to 109 (sa) in August from 108 in July. Consumer confidencestayed unchanged at 112 in July, the same level as in the previous month.Meanwhile, inflation remained stable, both for the headline CPI (2.6% YoY in July)and core CPI (1.7%). Residential property prices have retreated, falling on MoM basisfor the first time over 16 months (-0.2% in July). By any measure, policymakers arenot under great pressure to hike rates at the current juncture. Our year-end targetfor the repo rate is maintained at 3.0%, and the 12-month target is 4.0%.
: The Fed shifted policy back to a strictly neutral stance yesterday, announcingthat it would reinvest proceeds from maturing MBS (housing) securities into longer-term government bonds. The shift was a symbolic one: maturing proceeds of some$130bn over the coming year would, if not reinvested, have shrunk the Fed’sbalance sheet by about 5%. That’s too small an amount to have a “fundamental”impact on rates or economic activity. Short-term rates, currently at or near zero,would have been unaffected by the move, absent a separate and explicit policymove to change them. Longer-term rates such as 10Y Treasury yields (chart below),have run the gamut between 4.00% and 2.15% anyway, with little or no change inFed balance sheet size.
US Fed expectations
Source: Bloomberg fed fundfuturesNotes: Given a FF target rate of0.25%, an implied FF rate of0.30 is interpreted roughly asthe market pricing in a 20%chance of a Fed hike to 0.50%from 0.25% (30 is 1/5th of thedistance to 50 from 25). DBSexpectations are presented indiscrete blocks of 25bps, i.e., theFed moves or it does not. Seealso “Policy rate forecasts”below.
Implied fed funds rateSep-10Dec-10Mar-11
Current0.170.170.191wk ago0.180.180.22
   8   A  u  g   0   7   2   5   J  u  n   0   8   3   1   D  e  c   0   8   2   8   J  a  n   0   9   2   5   F  e   b   0   9   2   5   M  a  r   0   9   2   0   M  a  y   0   9   1   5   J  u   l   0   9   9   S  e  p   0   9   1   4   O  c   t   0   9    1   1   N  o  v   0   9    9   D  e  c   0   9    6   J  a  n   1   0    3   F  e   b   1   0    3   M  a  r   1   0    3   1   M  a  r   1   0    2   8   A  p  r   1   0    2   6   M  a  y   1   0    2   3   J  u  n   1   0    2   1   J  u   l   1   0
US Fed balance sheet and 10Y UST yields
USD bn, nsaFed balance sheet size%10Y UST yields
Daily Breakfast Spread, 11 Aug 2010
With the reinvestment policy, the Fed took the middle ground between doingnothing (leaving a very slight / natural tightening in place) and outright easing viaincreased purchases of longer-term bonds (so-called quantitative easing). The Fednoted that output (supply) and employment gains had slowed in recent months –this and the move back to strict neutrality reassures investors worried about thethreat of a double-dip that the Fed does not have its head in the sand. Meanwhile,the FOMC noted that it continues to anticipate a gradual recovery and does not seethe need for outright easing at this point in time.Where to from here? As it should, that all depends on the data. We are in the campthat believes the recovery is indeed proceeding and expect GDP growth to runbetween 2.5% - 2.75% over the next few quarters (and indeed the next few years).That’s below average, but not by a lot. Meanwhile, although the unemploymentrate is still a sky-high 9.5%, the improvement in private sector nonfarm payrolls isaveraging about 50k per month. That’s as fast as any post-war recovery pace, andthree times faster than in the last two recessions. In short, we continue to think thatthe next move for Fed policy rates is up, not down. And we continue to envision afirst Fed move in that direction in June/July of 2011, a month or two earlier thanwhat markets currently have priced in.
The Fed made good its pledge to sustain the US recovery. Owing to themoderation in the pace of the recovery, the FOMC meeting yesterday made thedecision to maintain the holdings of securities at the Fed. This is achieved byreinvesting the principal payments from agency debt and agency mortgage-backed securities in longer term Treasuries, as well as rolling over the holdings ofTreasuries as they mature. To markets, this was touted as Quantitative Easing II andthus, considered as negative for the US dollar.The market still needs to sort itself out before it can resume selling dollars again.First, QE II is considered a measure against deflationary fears but gold was boughtup in anticipation of future inflation. Second, there were mixed reactions to thesurge in China’s trade surplus. While markets worry that China’s import slowdownmay be pointing to a slowdown in growth ahead, it was difficult to ignore thenegative reaction of US lawmakers seeking to tie China’s trade surplus to the lack ofCNY appreciation. A widening in US’s trade deficit data tonight will surely revivethe politicization of the CNY issue ahead of the US mid-term elections scheduledfor November 2. Then again, markets are only comfortable selling US dollars if theyare assured that equities can continue to head north as bond yields head south.Until there is more clarity, currencies will probably take their cue from equities inthe near-term. Judging from this morning’s reaction, investors seem to be leaningmore towards caution than assuming more risk.
Daily Breakfast Spread, 11 Aug 2010
Economic calendarCentral bank policy calendar
EventConsensusActualPreviousAug 9 (Mon)
TW: trade balance (Jul)USD 1.35bnUSD 2.16bnUSD 1.41bn-- exports31.0% y/y38.5% y/y34.1% y/y-- imports39.7% y/y42.7% y/y40.4% y/y
Aug 10 (Tues)
SG: GDP (2Q, F)25.2% q/q saar24.0% q/q saar45.9% q/q saar--19.3% y/y18.8% y/y16.9% y/yPH: exports (Jun)25.0% y/y33.4% y/y37.3% y/yCN: trade balance (Jul)USD 19.6bnUSD 28.73bnUSD 20.02bn-- exports 35.0% y/y38.1% y/y43.9% y/y-- imports30.0% y/y22.7% y/y34.1% y/yMY: industrial production (Jun)11.8% y/y9.4% y/y12.3% y/y
Aug 11 (Wed)
SK: unemployment rate (Jul)3.7% sa3.5% saJP: machine orders (Jun)5.4% m/m sa-9.1% m/m saCN: CPI (Jul)3.3% y/y2.9% y/yCN: retail sales (Jul)18.5% y/y18.3% y/yCN: industrial production (Jul)13.4% y/y13.7% y/yUS: trade balance (Jun)-USD 42.1bn-USD 42.3bn
Aug 12 (Thur)
JP: industrial production (Jun, F)-1.5% m/m saIN: industrial production (Jun)8.3% y/y11.5% y/yEZ: industrial production (Jun)0.6% m/m sa1.0% m/m saUS: initial jobless claims (Aug)479K
Aug 13 (Fri)
SG: retail sales (Jun)-3.4% y/y-3.4% y/yHK: GDP (2Q)6.3% y/y8.2% y/y--2.0% q/q sa2.4% q/q saEZ: GDP (2Q, A)0.7% q/q sa0.2% q/q sa--1.4% y/y0.6% y/yUS: CPI (Jul)0.2% m/m sa-0.1% m/m saUS advance retail sales (Jul)0.5% m/m sa-0.5% m/m sa
PolicyDateCountryRateCurrentConsensusDBSActualThis week
BoJ target rate0.10%0.10%0.10%0.10%11-Aug
7-day repo rate2.25%2.50%2.25%12-Aug
ECB bulletin (Aug)
Next week
No policy meeting this week
Last week
o/n reference rate6.50%6.50%6.50%6.50%05-AugEZrefi rate1.00%1.00%1.00%1.00%

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