Thursday, 26 August 2010
Summary
For a speed-read version
of the report please read
the extracts in the left-
hand margin.
The economy appears to
be swiftly declining after a
modest recovery.
Point of recognition approaching
In recent decades, we have become increasingly accustomed to central banks
coming to the rescue when stock prices and the economy slide too far. Despite the
fact that economies everywhere have been stimulated fiscally and monetarily on a
large scale since the outbreak of the credit crisis, the recovery has only been
modest. Worse still, the recovery in the US has already clearly declined again and it
looks as if this will shortly happen in Europe, too.
On the basis of experience over the past few decades, the assumption is that central
banks will come to the aid once more. Especially as it is evident that we cannot
expect much further help from the fiscal quarter. In theory, central banks are
certainly capable of helping. In practice, however, in our view they no longer have
much room to maneuver. After all, the concern is that if monetary policy is loosened
much further confidence in the central banks will be lost. That swiftly leads to a
currency crisis and soaring long-term interest rates. In other words, a disaster for
the economy.
It will probably become clear this weekend how far central banks are willing to go
when Bernanke delivers his speech on the situation the American economy is in and
how monetary policy should respond.
Implications for the financial markets
Assuming that there, indeed, turns out to be little room left for the monetary
authorities, then we foresee the S&P 500 index rapidly falling below the crucial 1,010
level. In our view, this will be accompanied by EUR/USD falling over the coming
months to quarters towards approximately parity. We then also envisage yields on
10-year US and German Treasuries falling further by around 0.75% before soaring
due to fears of further deteriorating public finances.
POINT OF RECOGNITION APPROACHING
Stocks have been under clear downward pressure again recently and investors are
fleeing to Treasuries from the economically strong countries and to the dollar and
Swiss franc. The underlying reason is evident. After the credit crisis broke out, large-
scale fiscal and monetary policy was implemented everywhere. This would normally
have generated an economic boom, but this time the recovery was very modest. We
should not actually be too surprised by this; if you look at what happened after
previous credit crises then what is happening now is not abnormal. The only thing is
that the modest recovery we have seen so far is already clearly tailing off in the US
and looks set to do so in Europe shortly. This is contrary to the historical pattern. In
the past, the economy might have been more difficult to get off the ground after a
credit crisis, but growth grew rather than declined. Naturally, if the current decline in
growth only lasts a couple of quarters and growth then picks up again, then there is
not much wrong, on balance. Things will only get difficult if growth carries on
declining.

This decline is creating
expectations of further
monetary stimulus, as this
is what happened in the
past.
This time, however,
stimulation will not be
able to both promote
growth and compensate
for the tailing off of fiscal
stimulation.
So can central banks
actually do anything to
create a positive spiral?
Investors do not believe in recovery: real return on
Treasuries near zero
5
4
3
% 2
1
-0
-1
-2
-3
Q1 Q3 Q1 Q3 Q1 Q3 Q1
07 08 09 10
US, GDP (quarterly change)
5-yr real yield US government bond
Source: Reuters EcoW in/ECR
This is exactly what investors and the financial markets are trying to work out. In
this respect, however, it is evident that we cannot expect much help from the fiscal
side. Virtually everywhere, governments are terrified of ending up in Greece’s
situation, so are attempting to prevent public debt from rising much further
expressed as a percentage of the total economy. This also means that now growth is
declining the only help that can be expected is monetary. This is exactly what
investors and financial markets have been counting on for years. This has become
known as the Greenspan put. In other words, under Greenspan we got used to the
fact that as soon as the economy and stock prices slid too far – especially if this
generated a deflation threat – central banks would loosen monetary policy until the
economy started recovering. Over the past thirty years, this has even led to a firm
conviction that central banks are always ready to make sure the situation does not
get out of hand. This has been proved right this time, in as much as central banks
immediately started loosening monetary policy drastically as soon as the credit crisis
broke out. In the Far East – with the exception of Japan – this has, indeed, led to
high economic growth. As we said, this is not the case in the West. The combination
of large-scale fiscal and monetary loosening has only led to a highly modest recovery
there, which now already appears to be reversing. The question is whether the
monetary authorities still have sufficient weapons and ammunition in their arsenal to
not only compensate for the gradual waning of fiscal stimulation but also get the
economy growing more rapidly. There would be no doubt about this if the Western
and Japanese economies had meanwhile ended up in a self-perpetuating spiral of
more consumption, increasing investments, rising employment and falling
unemployment, higher wage rises, even more consumption and so forth.
Unfortunately, this is not the case and growth continually has to be managed from
outside. This is not only amazing, but also concerning, as the monetary authorities
have already lowered interest rates to 0%, created a great deal of extra money and
stuffed the banks full of extra reserves (quantitative easing). Especially as, so far, all
this has also been accompanied by highly substantial fiscal stimulation. This justifies
the question of whether central banks still have sufficient weapons and ammunition
to get a positive spiral off the ground. We will go into this in further detail below.
 PRACTICE VERSUS THEORY
In theory, central banks In theory, central banks can create extra money indefinitely. The first step has
have plenty of stimulation always been to lower interest rates. This encourages numerous parties to save less
options. and borrow more. In principle, this pushes up the money supply. In the 1960s and
1970s this was often overdone, so excessive money creation led to rising inflation.
Now, however, there is a risk of deflation. The ECB, the Fed and the Bank of Japan
have therefore already gone one step further: they have started quantitative easing,
but only in a moderate form so far. In other words: apart from lowering interest
rates to around 0% central banks have also stuffed the banks in their own country
with extra large reserves. This cuts both ways, though; to achieve this goal they
often bought mortgage bonds and Treasuries from the banks. This not only gave the
banks more reserves so that it became increasingly appealing for them to extend
new loans; it also suppressed long-term interest rates. That way, the Fed, for
example, substantially brought down mortgage interest rates.

Stimulating by means of This last course of action is exceptional, however. It has never been done since
buying bonds from banks World War II, except in Japan. Lowering short-term interest rates has always proved
is risky in practice, sufficient. We also have to remember that these operations are highly risky. After all,
though, as it encourages
under normal circumstances, such a tremendously high growth of the money supply
inflation as soon as
lending picks up. and bank reserves would be extremely inflationary. This is not the case now
because, on one hand, banks remain reluctant to lend and, on the other, most
parties are attempting to repay old loans as far as possible rather than borrowing
extra money. The idea of this monetary policy is to get the economy and lending
going again. As soon as this is the case, it will be quite a different story. There is
then too much money in circulation and bank reserves are too high. A highly
inflationary situation then arises. It is therefore absolutely necessary to immediately
withdraw the extra money and reserves from the system as soon as the economy
and lending recover. This is more easily said than done, however. Monetary policy
then has to be drastically tightened in view of the recent tremendous loosening. This
not only entails great risks for economic growth; it will also encounter great political
resistance. So the more monetary stimulation now, the greater the chance of
inflation ultimately rising rapidly.

Lower Fed policy rate no longer encourages consumer

spending
6 2.600
2.575
5
2.550
USD (thousand billions)

Consumer credit
4 2.525
2.500
3
%

2.475
2 2.450
2.425
1 Fed funds rate
2.400
0 2.375
07 08 09 10

US, Fed funds rate US, consumer credit

Source: Reuters EcoW in/ECR
Rising inflation is actually
an advantage for repaying
debts.
The result, however, is
rapidly-rising long-term
interest rates, which
would be disastrous for
public finances.
This makes further
monetary stimulation
risky.
This restricts central
banks’ room to maneuver.
No one knows just how
much they can still do.
It is often said that this would not be such a bad thing, as then debts start weighing
less heavily (old loans can be repaid more easily with dollars or euros that have
depreciated in value, due to inflation). This is only one side of the coin, though.
Inflation also means higher interest rates. In the current situation that would be
disastrous, especially for public finances. After all, the current high public debt, which
will continue rising for the time being anyway, can only be maintained because there
is so little interest to pay on them. If interest rates rise, public finances will soon get
out of hand in most Western countries.
That is why it is so difficult to implement an even more aggressive form of
quantitative easing. After all, if all the forms of monetary loosening are still
insufficient to help economic growth and lending, central banks can always buy
Treasuries directly from the government. The indirect result is that extra money
created by the central bank is distributed to the population. That swiftly leads to
increased consumption and higher asset prices, against which more can be
borrowed. A policy of increasing bank reserves also, however, leads far more quickly
to rising inflation.
This is the great dilemma facing central banks at the moment: many investors and
financial markets are blindly assuming that the central bank will always save the day
if the economy and lending slide too far. After all, it is charged with the task of
ensuring stable price levels and that does not include deflation. In other words: as
soon as deflation threatens the central bank has to loosen monetary policy further.
In theory, it has the means to do so indefinitely. If needs be, the central bank can
buy stocks, bonds, property and so forth directly from the private sector. In practice,
however, that is not the case. The key word here is confidence: confidence amongst
investors and financial markets that the central bank will withdraw all the extra
money and reserves in time before the deflation threat turns into an inflation threat.
As soon as this confidence disappears, long-term interest rates will discount the fact
and rise. The effect of monetary policy is then exactly the opposite of what it was
intended to achieve. Instead of helping the economy, it drives it into the ground. The
practical problem this primarily presents is that nobody knows where that limit lies;
at what level of quantitative easing will confidence wane and will interest rates rise
rather than fall. The only thing we do know is that you only find out once the limit
has been exceeded – and it is too late – and that the more aggressive the
quantitative easing, the greater the risk of the limit being exceeded and inflation
soaring.
Cash on banks' balance sheets have to be withdrawn as
soon as they start lending again, to prevent inflation
1.2 1.70
USD (thousand billions)
USD (thousand billions)
1.0 1.60
0.8 1.50
0.6 1.40
0.4 1.30
0.2 1.20
0.0 1.10
07 08 09 10
US, banks' reserves (lhs)
US, commercial and industrial loans (rhs)
Source: Reuters EcoW in/ECR

According to a popular
technical method, stock
prices are about to fall.
This becomes more certain
when the S&P 500 index
slides below 1,010.
The fall will then
accelerate as soon as the
remaining hope turns into
pessimism: The point of
recognition.
We will reach this point as
soon as it becomes clear
that the central banks are
unable to do much, either,
as has proved the case in
Japan.
MONETARY AUTHORITIES’ ROOM TO MANOEUVRE
RESTRICTED
There are many ways of analyzing and predicting markets, both fundamentally and
technically. One of the chart-technical methods we often follow ourselves is the
Elliott Wave method. This method assumes that every market rises or falls in a five-
wave pattern, as long as this is the main direction, and every interim correction
follows some kind of three-wave pattern. If you look at the way stock prices have
been falling in the West over the past year, then you can clearly see the downturns
following a five-wave pattern and the corrections a three-wave pattern. This leads us
to believe that the main direction for stocks is downwards. This does not, however,
say much as whether stock prices will now immediately start falling or whether there
will first be numerous rises - perhaps even to new highs - is impossible to predict
with the Elliott Wave method. Certainly not when it comes to the timing of these
movements.
This uncertainty would soon disappear as soon as the S&P 500 index fell below
1,010. A point we are no longer far from. After all, as soon as this happens there is a
good chance that the S&P 500 index is in the middle of the second major downward
wave (the fall from the high at 1,570 to 600 was the first major downward wave. The
subsequent recovery to around 1,220 was the first major correction and the fall since
is part of the second downward wave and no longer of the correction, as soon as the
S&P 500 index falls below 1,010). From past experience – and that is what concerns
us now – we now that two things almost always happen:
The fall accelerates.
This happens when the point of recognition is reached. Until that time,
many market parties continue hoping that the fall so far is only a
correction within an uptrend. Many are now hoping that the S&P 500
index is bottoming out just above 1,000, after which it will rise. As soon
as the point of recognition has been passed that hope will swiftly
evaporate. Generally, as it then quickly becomes clear why this hope was
unjustified, the downtrend accelerates. We repeat: this is a phenomenon
that almost always happens in the middle of the second major
downtrend. The third and last major downtrend is always based on
pessimism. In other words, hope has then turned into fear of further
deterioration.
We are going into so much detail here because we will not have to wait long to see
where that point of recognition will be. We already mentioned above that from a
fiscal point of view we can’t expect much new help from the Western and Japanese
economies. That will have to come from the monetary quarter, as has been the case
for the past thirty years. It is also quite possible, though, that too many hopes are
being pinned to that now. We already saw that this week in Japan. In Japan,
economic growth is declining rapidly, there is no more room for real fiscal
stimulation, the central bank has been applying quantitative easing for years already
and they are still suffering from deflation. Actually, export is the only bright point for
Japan, but this is now seriously threatened by the ever-increasing yen rate and the
weakening of growth in the rest of the Far East. This is also aggravating deflation,
through increasing import competition. The obvious solution would therefore be
intervention to suppress the yen rate. There will be little point in attempting to do so,
though, if the US and the EU do not follow suit. They have no intention of doing so;
for them export is one of the few sectors generating growth. If Japan wants to turn
 the tide, then its already extremely loose monetary policy will have to be loosened
even further. The Japanese government has been exerting great pressure on the
Japanese central bank in this sense for some time. With little success, so far. In the
past few weeks, however, the government announced ceremoniously that
For years already, Japan negotiations would take place between the government and the central bank last
has failed to avert Monday. Many assumed that such an event would only be announced on a grand
deflation with a loose scale if a considerable level of agreement had already been reached between the
monetary policy. Any parties on the subject. The meeting that was to be held last Monday was looked
further loosening will forward to with excitement. The disappointment was great, however, when the
destroy confidence in the negotiations proved to have been restricted to a fifteen-minute phone call between
yen. the minister of finance and the head of the central bank. It was soon clear that the
two parties had not discussed anything substantial. Naturally, this has nothing to do
with unwillingness on the part of the central bank. It is obvious that the central bank
is terrified that as soon as it loosens policy further – even without political pressure –
it will lose the confidence of the markets and interest rates will rise. The point of
recognition would be when the realization dawns that this also applies to the Fed and
the ECB. In other words: naturally, these central banks still have some room for
further loosening, but it is insufficient to crank growth up to any real extent. From
this point of view, things are actually getting increasingly difficult for the Fed and the
ECB. More about that below.

This could also happen to Even w ith zero interest rates Japan cannot get its
the dollar and euro. economy back on track
6 Growth averages 7.5
around zero
5 5.0

2.5
4
0.0
3
%

%
-2.5
2
-5.0
1 -7.5

0 -10.0
90 92 94 96 98 00 02 04 06 08 10

Japan, policy rate (lhs)

Japan, GDP growth (rhs)
Source: Reuters EcoW in/ECR

A BOND BUBBLE
Earlier in this report we already mentioned that no self-perpetuating spiral has been
created in either the US or Europe. That is a real problem now growth is already
clearly declining in the US and looks as if it will shortly do so in Europe. After all,
growth is now falling back to levels at which employment is increasing less quickly
Without monetary than the working population. This means rising unemployment again and therefore
stimulation, growth will downward pressure on wage rises, especially now unemployment is already around
decline in the West. 10%. Consumers therefore have no extra money to spend, unless:
 There is help from the fiscal quarter. As we said, this is not on the cards.

Consumers borrow more. They are unwilling to do so, though, as they

are seeing a substantial proportion of their provision for retirement being
lost due to the fall in housing and stock prices. This is being partly
compensated for by rising bond prices, but on the other hand new
investments in bonds yield hardly any return any longer. Additionally,
apart from the fact that consumers prefer to repay old debts than enter
into new ones, banks are still reluctant to extend new loans. This picture
would, of course, change drastically if property and/or stock prices were
to rise substantially. Lending will have to recover first, though.

The danger of low growth in the current circumstances is that it quickly leads to
mounting unemployment and insufficient consumer spending. The next step is that
investments decline, causing overcapacity and deflation. The economy then slides
further. This will not happen if a self-perpetuating spiral is created, but then growth
first has to be above 3% for some time. Otherwise, the economy will have the
constant tendency to slide, especially as we can expect property and stock prices to
fall further.

Not much needed to create full-blown deflation

105.0

102.5

100.0
Index (2007 = 100)

97.5

95.0

92.5

90.0

87.5
08 09 10
US, House prices index
US, Consumer Prices less food and energy
Source: Reuters EcoW in/ECR

Monetary stimulation is This brings us back to monetary policy. Now that the US economy is declining again,
therefore the only this week all eyes are on Fed chairman Bernanke, who will be delivering a speech in
remaining hope for Jackson Hole on Friday on ‘the state of the American economy and how the central
investors and central
bank should respond’. Of course there are hopes that it will include an
banks cannot afford to
disappoint them with their announcement of further quantitative easing. This will probably happen, too, but
plan of approach. what matters is the degree. Bernanke will undoubtedly realize that he would be
playing with fire to disappoint the financial markets in this respect. Stock prices
would then immediately drop, which could easily plunge the economy into a
recession due to the negative wealth effect this entails. The point of recognition has
then clearly been reached. He will attempt to avoid this. But what more can the Fed
do? The easiest thing is for the Fed to continue buying Treasuries from the banks.
This increases bank reserves even further, further suppressing long-term interest
rates. Will this have much effect, though? After all, banks already have large

They will also realize that
pumping even more
money into the economy
can lead to:
loss of confidence,
deflation and
a flight by foreign holders
of US Treasuries from the
dollar, creating a dollar
crisis.
They will then adopt a
highly reserved attitude to
monetary stimulation, so
we feel the point of
recognition is fast
approaching.
reserves and long-term interest rates are already extremely low. It is unclear why
increasing reserves further should suddenly be of much aid to the economy or asset
prices. If this fails to provide the necessary help, then there is just one remaining
option: distributing money via the government or, if needs be, directly. We already
talked about the great risks entailed. As soon as this leads to a loss of confidence in
the central bank all hell will break loose. Furthermore, at the moment there are two
extra complications in this respect:
Investors have recently been avoiding stocks en masse and deviating
into bonds. On one hand because this is probably the best protection
against deflation; on the other hand because the central bank is
expected to buy more bonds. This has now created a bond bubble. In
any event, yields on 10-year US Treasuries have responded by sliding to
around 2.5%. Yields can only remain so low as long as the nominal
growth of the US economy remains at roughly the same level or falls
further. This is where the snag is, however. At the moment, core
inflation in the US is at around 1%. This means that to achieve 2.5%
nominal growth, the economy has to grow in real terms by around 1.5%.
That growth level is way below potential growth, though, which means
persistent downward pressure on inflation. Especially as unemployment
will then rise. In other words, it will then only be a question of time
before the US experiences deflation. This can mean only two things.
Either the deflation is accepted – but then dwindling tax revenue will
result in public finances getting out of hand – or the Fed will fight
deflation by distributing money. Both will probably send long-term
interest rates soaring sooner or later.
Due to years of large deficits on the American current account, the US
has become a major debtor to the rest of the world. In other words,
innumerable foreign investors currently own US bonds. The central banks
in China, Japan and the Middle East alone are sitting on thousands of
millions of dollars’ worth of US bonds. Naturally, they will take action as
soon as they see US public finances getting out of hand and/or the Fed
handing out dollars. In time, this will lead to an increased supply of
dollars on the currency market. Not only will bond prices fall; the dollar
will also plummet. A sharp fall in the dollar will aggravate the rise in
interest rates, however, so even more bonds are sold, creating an even
greater supply of dollars and so forth. In other words: there will soon be
a dollar crisis.
This is why we feel we are not far from the point of recognition. In our view, it will
quite soon become clear that, like the Bank of Japan, the Fed cannot do an awful lot
more than it has already done. From this point of view, the Fed needs to take a good
look in the mirror. Bernanke has always said that as soon as deflation threatens the
central bank should go all out with monetary loosening. The longer it hesitates, the
more limited the options become. In retrospect, the Fed probably responded too
slowly. We should stress that, as long as the S&P 500 index remains above 1,010,
things are not hopeless. Evidently, the market feels the Fed still has sufficient room
to save the situation. Let us hope that is indeed the case.
 Distrust in Fed policy could induce large scale dumping
by big investors
1.0
0.9 Beginning of a
trend reversal?
0.8

USD (thousand billions)

0.7
0.6
0.5
0.4 Japan
0.3
0.2
0.1
0.0
98 00 01 02 03 04 05 06 07 08 09

US, TIC, Chinese holdings of Treasury Securities

US, TIC, Japanese holdings of Treasury Securities
Source: Reuters EcoW in/ECR

Back to summary ^

IMPLICATIONS FOR THE FINANCIAL MARKETS

We foresee growth Europe experienced a strong second quarter. Germany, in particular. This surprisingly
weakening in Europe. good growth was, however, based on three developments that are now coming to an
end.

Fiscal stimulation. This will gradually turn into fiscal tightening over the
coming quarters.

Stock build-up. This is now largely over.

Export. To the Far East, in particular. It looks as if growth will decline in

the Far East now, however, especially if growth fails to pick up in the near
future in the US.

There is an additional factor for Germany. Due to tensions within the EMU, a lot of
money has flowed from Southern to Northern Europe. This has considerably increased
the availability of money in Germany, causing construction to pick up. This does not
alter the fact that we soon expect the situation to deteriorate throughout Europe,
including Germany.

The problems in Nevertheless, this shows the dilemma the ECB is facing. If the European economy
Southern Europe then weakens, this means the attempts being made in Southern Europe to reduce budget
become more difficult to deficits will largely fail. After all, lower growth means lower tax revenue and higher
solve and the differences
government expenditure. Hence the recent widening of the spread between interest
between North and
South will increase. rates in Southern and Northern European countries. Investors are increasingly
assuming that if growth declines budget deficits in the Southern European countries
will remain far too high. For Northern European countries, incidentally, this also applies
to low growth but to a far lesser degree. The public finance problem is simply less
serious there. This does cause major complications, though.
Ultimately, the ECB will If the Southern European countries (and Ireland) are not to end up in a similar
have to come to the situation to Greece if growth remains low, then they will have to make drastic cuts and
rescue. Probably raise taxes. This will further brake their economies, making it more difficult to reduce
resulting in an overly
budget deficits. Investors are aware of this, too, so they are withdrawing their money
tight policy for the South
and too loose a policy for from Southern Europe. Interest rates in those countries will therefore not fall alongside
the North. those in Germany. For the Southern European countries, this means rising interest
rates, which will suppress asset prices and make it increasingly difficult for banks to
raise money, inhibiting economic growth even further. The only one that can halt that
spiral is the ECB. It can buy up bonds from the Southern European countries and
further loosen monetary policy. With the growth figures we have been seeing recently
from Northern European countries – Germany in particular – it will be entirely
unnecessary to further loosen monetary policy, though. There is therefore a good
chance that the ECB will adopt a stance somewhere in the middle with its monetary
policy. In other words, they will implement too tight a monetary policy for the
Southern European countries and too loose a policy for the Northern European
countries.

Impossible for ECB to apply one-size-fits-all policy

4
3 Germany
2
1
0
Greece
-1
%

-2
-3
-4
-5
-6
-7
Q1 Q2 Q3 Q4 Q1 Q2
09 10
Germany, GDP % Chg. YoY Greece, GDP % YoY
Spain, GDP % Chg. YoY
Source: Reuters EcoW in/ECR

A negative outlook for If we transfer this picture to currency rates, there will evidently be a great deal of
the world economy is downward pressure exerted on EUR/USD if the world economy is viewed more
exerting downward negatively and vice versa.
pressure on EUR/USD.
The worse the situation the world economy finds itself in, the more difficult
it becomes for Southern European countries to reduce their budget deficits.
Unfortunately, the ECB is unable to compensate for this adequately
through monetary policy. If the world economy becomes less buoyant then
tensions within the European Monetary Union will increase, weakening the
euro.

When an economy weakens, a lot of old carry trades are reversed,

increasing the demand for dollars (and yen).
The weakening of the A common counter-argument is that if the world economy weakens the Fed will loosen
euro and the influence of monetary policy further than the ECB. After all, as its economy and labor market are
reversing carry trades more flexible, there will be more of a deflation risk in the US than in Europe. This has
will be decisive for the
always been the case so far, which is why the dollar rate always falls. We already
currency market.
mentioned that the room for further loosening monetary policy has decreased
substantially. This time, we therefore see it playing a far smaller role. In any event, in
our view it will be overshadowed by the weakening euro and the reversal of carry
trades.

Incidentally, the lengths the Fed dares to go to in further loosing monetary policy will
probably become clear this weekend. After all, recent economic figures have been far
weaker than expected. We can therefore deduce that growth in the US economy has
declined to 1.5% or lower. As we already mentioned, this means that if new life is
breathed into the economy, there is a strong chance of a further slide and deflation.
We certainly cannot expect anything from the fiscal authorities before the elections in
November, so the Fed will have to take action. This weekend’s conference in Jackson
Hole is the ideal opportunity for announcing this.

We feel the Fed will be Clearly, we expect there to be disappointments. We therefore fear it will not be long
unable to prevent before the S&P 500 index slides below the major support level of 1,010. The point of
sentiment turning and recognition will then quickly be reached and hopes of higher growth will turn into fears
the S&P 500 index
of further weakening. The S&P 500 index could then fall further to around 800, at
falling to 800.
least. Probably not in a straight line, though. After all, central banks all over the world
are probably going to announce a looser monetary policy as soon as they see stock
prices plunging. Hopes will then be temporarily raised until it (quite quickly) turns out
that the monetary authorities are unable to do enough.

We foresee EUR/USD Continuing along these lines, we expect EUR/USD to fall towards parity over the
falling towards parity. coming months to quarters. Only if the Fed manages to pull a rabbit out of the hat can
we expect another recovery first. Most likely to no further than 1.31 – 1.33, but we
don’t think this will happen. We also envisage EUR/USD falling further with the
following support levels around 1.24 and 1.18. A fall in the S&P 500 index below
1,010, in particular, would confirm that both stock prices and EUR/USD will probably
continue their downtrends (a rise in the S&P 500 index would indicate a delay,
though).

As long as there is The situation is not much different for yields on 10-year US, German and Japanese
insufficient confidence in Treasuries. As long as there is still the feeling that central banks are unable to do
the central banks’ ability enough to prevent the economy weakening further, deflation fears will grow and there
to save the situation,
will be a continued flight to the safe haven of Treasuries. Especially as if there is any
Treasuries will remain
popular as safe havens. further monetary loosening, it will probably be in the form of central banks buying
more Treasuries. We therefore envisage yields on 10-year German and US Treasuries
(now around 2.2% and 2.5% respectively) to fall further in the coming months to
quarters to around 1.5% (Japanese yields to around 0.5%). Here, too, the S&P 500
index falling below 1,010 would confirm this, while a rise above 1,080 would indicate a
slight further rise. In this respect, a lot depends on what Bernanke comes up with this
weekend. Incidentally, if he proposes a plan for a considerable further loosening of
We envisage yields on
monetary policy, then long-term interest rates will rise sharply. We don’t expect this,
10-year US and German
Treasuries falling to though. What we do have to allow for, however, is that as soon as the S&P 500 index
1.5%. slides below 1,010, credit spreads will widen everywhere. The same applies to the
difference between interest rates in Northern and Southern Europe.
 EUR / USD EUR / JPY
1.400 130.0

1.375 127.5

1.350 125.0
122.5
1.325
120.0

EUR/USD

EUR/JPY
1.300
117.5
1.275
115.0
1.250
112.5
1.225 110.0
1.200 107.5
1.175 105.0
Feb Apr Jun Aug Feb Apr Jun Aug
10 10
Source: Reuters EcoWin/ECR Source: Reuters EcoWin/ECR

USD / JPY
95
94
93
92
91
USD/JPY

90
89
88
87
86
85
84
Feb Apr Jun Aug
10
Source: Reuters EcoWin/ECR

Back to summary ^