Global Economics & Financial Markets Weekly Labour Market ... · year note outperformed this week...

Economics

January 9, 2009

Global Economics & Financial Markets Weekly Labour Market Blues

Mickey Levy Chief Economist (1) 646 855 1045 [email protected]

Holger Schmieding (44) 20 7174 4924 [email protected]

As the global recession deepens, the labour market is turning down sharply in key Western economies. For the second month in a row, US non-farm payrolls plummeted by more than half a million in December. In the Eurozone, which had entered recession a little later than the US, the dole queues lengthened by just above 200k in November. First German data for December suggest that the increase of unemployment will soon quicken in the Eurozone. Partly in response to the labour market blues, governments are discussing ever bigger fiscal packages. US president-elect Obama has forcefully made the case for a further huge stimulus program exceeding $700 bn, and the US Congress likely will top that in the eventual legislation. Even Germany, which had long been reluctant to abandon its balanced budget priority, looks set to agree details on a €50bn package this Monday. However, the sheer size of the packages is not the major issue, in our view. We can only hope that the packages will be designed to work, strengthening incentives to invest, to work and to hire beyond lavishing money on politically favoured projects. If applied well, the combined aggressive monetary and fiscal stimulus could help to stabilise the global economy in late 2009 and end the labour market blues in early 2010.

Other Contributors:

Alberto Boquin

Edgar Camargo

Mai Doan

Tomoko Fujii

Lawrence Goodman

David Hauner

Peter Kretzmer

Gilles Moëc

Matthew Moore

John Rothfield

Matthew Sharratt

Robert Sinche

Forecast Changes

UK GDP: We lower our 2009 call from –2.5% to –2.9%

BoE: We now expect only a 50bp cut in February from –75bp before

Key Events/Indicators

US Retail Sales (Wed 14): Likely to slump 1.1% mom in December

ECB (Thu 15): We look for a 50bp cut to 2.0%

Eurozone Core Inflation (Thu 15): Expect a fall to 1.8% in December

US CPI Inflation (Fri 16): Look for a 1.4% mom decline in December

Contents Strategy Highlights ................................................................................................................. 2 United States: Economic Slide Continues as Obama Plan Begins To Take Shape ........... 4 Japan: BoJ Not Done Yet, Stimulative Fiscal Policy in the Pipeline.................................... 6 Eurozone: ECB to Ease as Economy Seems to Fall Off a Cliff............................................. 8 UK: BoE Scales Back Pace of Easing on Sterling Fears....................................................... 11 Canada: To The Rescue.......................................................................................................... 14 Australia/New Zealand: Who’s Hiring Over Summer? ........................................................ 15 Emerging EMEA: Falling Like Rocks ..................................................................................... 16 Latin America: Central Bank Easing Cycles to Begin Soon ................................................. 18

This report is distributed in the U.S. by Banc of America Securities LLC (BAS), member FINRA and SIPC. This report is issued and approved in the U.K. by Banc of America Securities Limited (BASL), a wholly-owned subsidiary of Bank of America N.A., and is authorized and regulated in the U.K. by the Financial Services Authority. BAS and BASL are subsidiaries of Bank of America Corporation.

For more information concerning the role of economists and trading desk strategists who have authored this report, please see the important conflicts disclosures at the end of this report.

Recipients who are not institutional investors or market professionals should seek the advice of their independent financial advisor before considering information in this report in connection with any investment decision or for a necessary explanation of its contents.

Economics

Global Economics & Financial Market Weekly 2 09 January 2009

Strategy Highlights

Currency Strategy

Robert Sinche1 (1) 646 855 5984 [email protected]

Underlying economic momentum suggest little potential for sustained USD gains

Despite significant day-to-day volatility, the USD is about unchanged over the first full week of the year. Covering of short USD positions from December has provided some USD support, but the underlying economic momentum suggests little potential for sustained USD gains. Employment data for December was particularly weak (record low workweek), and while USD-supportive fiscal stimulus is likely, the political process will likely push final passage into February, leading to renewed USD weakness during the weeks ahead.

Given the collapse of EUR/GBP over the last two weeks (down over 8%) and recent setback in EUR/JPY, it is impressive that EUR/USD has not fallen further this week. EUR/USD continues to hover around its 100-day moving average (currently 1.3569), but a test above 1.40 remains likely if the ECB rate cut at its 15 January meeting is 50bp or less. The extent of weakness in cyclical data in recent weeks suggests a 50bp rate cut, so commentary about future policy will take on significant importance for the EUR.

The EUR/GBP test of 1.00, unjustified in our view, has failed and given way to sharp position liquidation. Combined with the smaller-than-expected BoE rate cut and the MPC's focus on the weakness of the (trade-weighted) GBP, the GBP has rebounded toward more reasonable levels versus both the EUR and USD. A EUR/USD test above 1.40 during the early months of the year should help GBP/USD climb toward 1.60.

Weak employment data, soft oil prices and significant exposure to the US economic downturn suggest the CAD is unlikely to perform well versus most other G10 currencies.

While risk aversion has maintained a bid for the JPY, cyclical data appear increasingly weak, with the composite leading indicator collapsing -10.7% in the last four months. Given the weakness in exports and growth, verbal intervention is likely to develop if USD/JPY falls below 90, although actual intervention remains unlikely unless USD/JPY falls below its December 17 low (87.14).

Fixed Income Strategy

Matthew Moore2 (1) 646 855 8797 [email protected]

Issuance amid weak data

Treasuries were little changed last weak as further signs of economic weakness from a 7.2% unemployment rate and weak same-store sales were offset by issuance and the prospect of more issuance. The CBO estimated a FY2009 deficit of $1.2tn and a FY2010 deficit of $0.7tn. However, those estimates exclude much of the TARP, a second stimulus package, financing for the wars in Afghanistan and Iraq and other items. Therefore, we estimate a $2.1tn financing need in FY2009 and a $1.0tn financing need in FY2010.

We expect increases in auction sizes and a new 7-year issue to help finance the growing deficit. Ordinarily, such issuance would be hard for the market to digest, but these are not ordinary times and the Fed could help out by buying Treasuries. Still, we note that the 5-year note outperformed this week amid 3-year and 10-year supply, so supply remains important.

1 Robert Sinche is a Bank of America GFX strategist. The opinions expressed by Mr. Sinche should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request. 2 Matthew Moore is a Treasury and Agency trading desk strategist. The opinions expressed by Mr. Moore should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

mailto:[email protected]

Economics


Emerging Market Strategy

Lawrence Goodman3 (1) 646 855 2883 [email protected]

Invigoration of “Bear Market” rally

The nascent "bear market" rally driven by valuations, technical factors and public policy measures will likely be invigorated by a further ease in EM inflation, increased policy flexibility and, at some stage, stabilization in the slide in economic activity.

First, the potential for a rapid reduction in inflation will likely provide EM central banks with additional flexibility to further reduce local rates. “Base effects” will likely help promote a consistent reduction in reported inflation through early 2009, although important country and regional differences will likely exist.

Second, a few macro indicators are beginning to suggest that the pace of deterioration in the manufacturing sector in Asia is starting to stabilize. The macro environment will likely remain weak and fragile, yet early signals of stabilization surfacing warrant further attention.

In this environment, a variety of interesting trades present. Opportunities include short USD/KRW, short USD/BRL, and long TRY/ZAR.

3Lawrence Goodman is a Bank of America GFX strategist. The opinions expressed by Mr. Goodman should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

Economics


United States: Economic Slide Continues as Obama Plan Begins To Take Shape

Peter E. Kretzmer (1) 646 855 1046 [email protected]

Mickey Levy (1) 646 855 1045 [email protected]

While the economy has begun the year in steep decline, last week’s releases contained some tentative but hopeful signs. The broad ISM non-manufacturing survey showed a slower pace of decline in December, and vehicle sales posted a slight rise. The economy will continue to shrink early in 2009, but household spending will not fall as rapidly as in 2H 2008. However, the December payroll report was grim, with 524,000 nonfarm jobs lost and a 7.2% unemployment rate. The Federal Reserve and incoming Administration both painted a dire economic picture, as extreme policy measures were introduced.

Following the rebound in inflation-adjusted consumer spending in November, vehicle sales improved slightly in December, even as they completed a year of dreadful decline with another 35% year-over-year drop. After three consecutive monthly declines and the lowest sales rate in more than 25 years in November, sales posted a 1.4% gain to 10.3 million units in December. Led by domestic models, total car sales increased for first time in 7 months, while light truck sales fell off after a November rise. Despite the December bounce, vehicle sales fell a stunning 58.8% annualized in 4Q 2008 and 18.4% for the year. With sales at historically low levels, further large declines are unlikely, adding a source of stability to consumer spending. We project that consumption fell 1.8% annualized last quarter, after a 3.8% drop in 3Q 2008. We expect still smaller declines in the first half of 2009. However, large production declines, in line with lower desired inventories, large drops in business spending on equipment and software and shrinking export demand, will continue to weigh on overall GDP.

The vehicle industry ended 2008, a year of collapsing sales, with a slight rise in December.

Another hopeful sign was contained in the December Institute of Supply Management (ISM) survey of non-manufacturing activity. In contrast to the manufacturing recession, which continued to worsen last month, non-manufacturing showed slight signs of stabilizing. The survey’s overall index rose to 40.6 (from 37.3 in November). While the pace of decline eased, only one industry, retail trade, reported growth. Seventeen industries reported contraction, including health care and social assistance, which had been experiencing growth in the face of recession. And many more respondents still reported declining than advancing business activity, orders and employment, although the share reporting gains increased. The business activity index jumped to 39.6 in December (from 33.0), while the new orders index rebounded to 39.9 (from 35.4 in November) but remained at its second lowest level in a 12-year history.

In contrast to the manufacturing recession, which continued to worsen last month, non-manufacturing industries showed slight signs of stabilizing.

The December employment report indicated continued sharp nonfarm payroll declines, in line with the steep economic contraction underway. For the second consecutive month, there were over half a million payroll jobs lost. Nonfarm payrolls fell 524,000 last month, and there were 154,000 in net additional job losses for October and November. For the year, 2.59 million jobs were lost. Job losses became more concentrated in goods-producing industries last month, with an easing, though still large, decline in service-providing jobs. Moreover, declines in hours worked accelerated in December, as the average workweek declined an all-time low of 33.3 hours, pointing to further payroll losses ahead. Aggregate hours worked plummeted 1.2%. The unemployment rate, which as recently as September was 6.2%, continued its steep rise, ending the year at 7.2%. We continue to project an above-8% unemployment rate in 2H 2009.

However, for a second consecutive month, there were over half a million payroll jobs lost in December.

The FOMC minutes for the December 15-16 meeting indicate that the FOMC appreciated the gravity of economic and financial conditions, noting the intensification of the economic downturn and continued strained financial conditions. The discussion of inflation now largely centered on the risk of excessive decline. Members noted the intensification of the adverse feedback loop from financial conditions to economic performance, and the added risk to the U.S. economy of recent foreign deterioration. Members agreed that the Committee would need to focus on tools outside of the Federal funds rate to impart additional monetary stimulus, including both the quantity and composition of the Fed balance sheet. The FOMC directive to the New York Fed Operating Desk both stated the new 0 – ¼ % target range for fed funds and explicitly instructed the Desk on the purchase of $100 billion of GSE debt and $500 billion of agency-guaranteed mortgage-backed securities by the end of 2Q 2009.

The Fed shifted the focus of monetary policy to its balance sheet at the December meeting, appreciating the gravity of the intensifying downturn.

Economics


Later last week, President-elect Barack Obama began the strong push for a huge fiscal package to be quickly drafted and signed into law. Obama argued that its unprecedented scale was justified by the dire economic situation, stating that at this time, only government possessed the means to reverse the economy’s downward trajectory. Despite its large implied budget deficits, Obama reassured financial markets of his commitment to longer term fiscal prudence. The Congressional Budget Office also released new budget projections last week, with a FY2009 deficit estimate of $1.2 trillion or 8.3% of GDP, prior to an Obama fiscal stimulus package. Obama proposed productivity-enhancing infrastructure spending, including alternative energy production and conservation, computerizing all healthcare records, modernizing classrooms and libraries, updating the nation’s power grid while expanding its broadband lines and increasing investment in science and technology. He also promised stepped up aid to states for “vital programs” and reiterated his support for middle-class tax relief. In the financial sphere, the President-elect proposed a sweeping effort against foreclosures, the prevention of catastrophic failures of financial institutions, and regulatory reform.

Figure 1. US Economic Indicators Day GMT Indicator For BAC Mkt Last

Tue 13 13:30 International Trade ($) Nov -48.5bn -51.0bn -57.2bn

19:00 Treasury Budget ($) Dec -85.0bn -50.0bn -164.4bn

Wed 14 13:30 Import Prices Dec n.a. -5.2% -6.7%

13:30 Retail Sales Dec -1.1% -1.2% -1.8%

Ex auto -1.0% -1.3% -1.6%

15:00 Business Inventories Nov -0.5% -0.5% -0.6%

Thu 15 13:30 Jobless Claims Wk 1/10 n.a. n.a. 467k

13:30 Producer Price Index Dec -1.8% -2.0% -2.2%

Ex food & energy 0.1% 0.1% 0.1%

15:00 Philadelphia Fed Survey Jan -35.0% -35.0% -36.1%

Fri 16 13:30 Consumer Price Index Dec -1.4% -0.9% -1.7%

Ex food & energy -0.1% 0.0% 0.0%

14:15 Industrial Production Dec -0.8% -0.9% -0.7%

Capacity Utilization 74.7% 74.6% 75.4%

15:00 Consumer Sentiment Jan n.a. 59.0 60.1 Source: Bank of America, Bloomberg and Haver Analytics.

Obama began his push for a huge fiscal package to be quickly drafted and signed into law, arguing its unprecedented scale was justified by the dire economic situation.

Treasury Budget

International Trade

Retail Sales

The trade deficit is expected to narrow sharply in November. Led by a stunning 30% decline in the acquisition cost of imported crude, imports are expected to plunge. As the global slowdown continues, exports are also expected to fall. The decline in oil prices in December will put further downward pressure on imports.

December is typically a surplus month for the Treasury. However, revenues are expected to be 16% lower this December relative to a year earlier as both individual and corporate tax receipts were off. TARP outlays, along with large increases in defense, education, Medicare and unemployment benefits will push spending sharply higher.

Retail sales are expected to fall for the sixth consecutive month, an unprecedented business cycle development. Tumbling household net worth, rising unemployment and depressed consumer confidence continue to have an adverse impact on spending. Also notable is that with gasoline prices off about 20%, gasoline service station sales will likely post another large drop. We expect real consumption spending declined an annualized 1.8% in the recently completed fourth quarters.

The large slide in crude oil, gasoline, fuel oil and natural gas prices in December implies that the headline price indexes will be off by more than 1.0% for the third consecutive month. The global contraction is keeping the core indexes in check. The risk now is that a worsening in economic conditions brings about deflation.

Producer Price Index Consumer Price Index

Industrial Production & Capacity Utilization

As evidenced by the precipitous drop in the ISM production index, the manufacturing recession continued to worsen in December. Increased output in the utility and mining sectors will, however, provide a partial offset to depressed manufacturing activity.

Economics


Japan: BoJ Not Done Yet, Stimulative Fiscal Policy in the Pipeline

Tomoko Fujii4 (81) 3 3508 5947 [email protected]

Bank of Japan Governor Shirakawa has confirmed that the central bank still has more to do. While there remains a possibility of allowing flexibility for the 0.10% overnight rate target, more liquidity injections in a way to support corporate finance and bank balance sheets should be the main focus. Meanwhile, although political uncertainty is intensifying, the direction toward expansionary fiscal policy should be intact this year.

BoJ Governor Shirakawa stated that the central bank still has more to do in his January 8 Parliamentary testimony. Governor Shirakawa also said on January 4 that he expects the worst point for the Japanese economy will probably be the first half of FY2009 (which will start from April 2009). In its mid-term review of the semi-annual outlook report at the January 21-22 monetary policy meeting, the BoJ is likely to revise down its FY2009 growth and inflation expectations to negative territory. Our own forecasts are a 1.0% contraction of real GDP and a 0.5% drop in core CPI. The likely timing for the next step should be February 19, right after the expected revelation of 4Q GDP plunge (with our estimate at –6.5% saar). Around that time, domestic market tensions could begin to intensify (in the form of particularly lower equities and a stronger yen), ahead of the fiscal year-end.

The BoJ will probably shift the focus from a rate cut to more liquidity injections to support corporate finance

BoJ Governor Shirakawa stated that the central bank still has more to do

Fiscal policy is turning stimulative

While there remains a possibility of allowing flexibility for the 0.10% overnight rate target (for example, to allow a daily weighted average below 0.10%), more liquidity injections in a way to support corporate finance and bank balance sheets should be the main focus. Governor Shirakawa emphasized the importance of lower borrowing costs for companies (rather than overnight rates in the interbank market). He also reiterated that zero interest rates could undermine market functions partly because higher transactions costs than interest incomes would discourage market activities. The debate over central bank asset quality suggests that an expansion of outright purchases of JGBs from the current ¥1.4tn per month should be the easiest choice. Still, Governor Shirakawa’s emphasis on the need to support corporate finance suggests that the Bank will probably announce outright purchases of corporate bonds as well. If equity market tensions intensify concerns about major banks’ balance sheets, the BoJ would also consider equity purchases from banks by March.

Although political uncertainty is intensifying, the direction toward expansionary fiscal policy should be intact this year. The FY2008 second supplementary budget entails new fiscal stimulus measures of about 0.5% of GDP in our view, and positive effects of the stimulus on the economy should begin to be felt by the spring. At the same time, the central government’s general expenditure of the FY2009 initial budget is to rise by 9.4%, the highest growth since FY1979. This increase alone is equivalent of about 0.9% of GDP, although local spending cutbacks will probably mute overall public demand growth. Former Reform Minister Watanabe’s hint of departure so far has not led to a bigger move, but the need to call the next general election by September 2009 despite very low popular support for the Aso Cabinet suggests significant risks of a political leadership change and political party reorganizations over the next several months. There seems to be a reasonably high chance of a general election in the spring, right after the budget passage. Still, the main opposition Democratic Party of Japan (DPJ), which will probably win in case of an early election, has confirmed no consumption tax hike any time soon (until the economy recovers). Both the ruling Liberal Democratic Party and the DPJ should maintain expansionary fiscal policy and postpone painful structural reforms this year.

4 Tomoko Fujii is a Bank of America GFX strategist. The opinions expressed by Ms. Fujii should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

Economics


Figure 2. Japan Economic Indicators Day GMT Indicator For BAC Mkt Last

Mon 12 23:50 M3 yoy Dec 0.6% 0.6% 0.6%

M2 yoy 1.6% 1.7% 1.7%

Bank Lending yoy 3.4% n.a. 3.2%

23:50 Current Account (¥, nsa)1 Nov 456bn 600.0bn 1705.8bn

Adjusted Current Account (¥) 618bn 625.4bn 1113.2bn

23:50 Foreign Bond/Note Investment (¥) Dec n.a. n.a. -606.8bn

Wed 14 23:50 Core Private Machinery Orders mom Nov -5.0% -8.0% -4.4%

23:50 Domestic Corporate Goods Prices mom Dec -1.7% -1.5% -1.9%

Thu 15 23:50 Foreign Bond/Note Investment (¥) Jan 4-10 n.a. n.a. -442.9bn

Fri 16 5:00 Investment Trust Data, Fgn Bond Net Assets (¥) Dec n.a. n.a. 15.5tn 1 The last value refers to the year-ago level. Source: Bloomberg, Reuters and Bank of America estimates.

Average outstanding loan growth for banks and thrifts likely picked up to 3.4% yoy in December from 3.2% yoy in November. However, any pickup should not mean a recovery in economic activities. Large companies likely rushed into borrowings from banks simply because of difficulties in capital market fund-raising.

Bank Lending

The declining trend in Japan’s external surplus likely continued in November. The unadjusted current account surplus likely shrank sharply to ¥456bn from ¥1,706bn a year ago. The goods trade balance probably shifted to a modest deficit from a surplus a year ago while the income balance surplus likely dropped yoy on nonresidents’ increased repatriation from their investments in Japan.

Current Account

The downward momentum for business investment probably intensified in November. Core private machinery orders excluding volatile ships and electric power likely dropped by 5% mom in November (down by 4.4% mom in October), leaving the October-November average 8.5% below the 3Q level.

Machinery Orders

Deflationary forces on domestic goods prices probably continued in December. Domestic corporate goods prices likely dropped by 1.7% mom in December (down 1.9% mom in November), taking the yoy growth rate to 0.6% from 2.8% in November, on lower oil and commodity prices.

Domestic Corporate Goods Prices

Economics


Eurozone: ECB to Ease as Economy Seems to Fall Off a Cliff

Gilles Moëc (44) 20 7174 4101 [email protected]

Holger Schmieding (44) 20 7174 4924 [email protected]

Sometimes, fast-footed market economists are accused by their more staid academic peers that they habitually use big words to describe modest changes. There may be some truth in this. But the current data for the Eurozone are so bad that modest words would not do them justice. Economic activity seems to be contracting at such a pace that the term “falling off a cliff” seems an adequate description. Although the ECB still seems reluctant to ease rates much further, we do expect the bad data to convince the ECB that a 50bp cut is required on January 15.

Many policy makers and economists remember the 1992/1993 recession in Europe as particularly nasty one. Unfortunately, the current recession looks set to be worse, and potentially significantly so. Although our calls for 2009 Eurozone GDP had been well below consensus since October, and although we had slashed it again to -2.5% in December, most incoming data are even worse than our very pessimistic expectations. Just consider some of the key releases last week:

A nasty recession Exports down, output down, orders down, retail sales down modestly, confidence down a lot, unemployment up: Can the ECB ask for more reasons to cut?

• German exports fell by 10.6% in a single month in November, the worst decline since the start of the pan-German series in 1991. Having already stagnated since roughly February 2008, exports now show the full impact of the post-Lehman global recession.

• German industrial output fell by 6.3% in November after two major declines in the two months before, pushing the November reading 8% below the August level. French output did not fare much better, with falls of 3.7% in October and 2.4% in November..

• The 6.0% monthly slump in German factory orders in November points to a further decline in output ahead (see Figure 4). Since August, orders have decline by a near-incredible 19.3%.

• Only retail sales are holding up better, with a 0.6% monthly rebound in November after a 1% drop in October. Still, the average for October and November falls 0.5% short of the 3Q 2008 average. The support from much lower oil prices for real disposable incomes is showing up in the data.

• Still, the additional deep declines in consumer confidence, which now almost mirrors the plunge in industrial confidence, does not bode well for the consumption outlook (Figure 3).

• The 207k rise in Eurozone unemployment in November brought the total increase since February to just above 1 million. German data for December suggest that worse is to come

Recent ECB speeches suggest that the bank is still reluctant to cut substantially further. However, we maintain our view that a close look at recent data will elicit a 50bp cut on January 15, probably followed by a pause in February and a final 50bp cut to a record low of 1.5% in March.

Figure 3. Eurozone Confidence Figure 4. German Orders and Output

-35

-30

-25

-20

-15

-10

-5

0

5

10

Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07

Consumer confidenceIndustrial confidence

-15

-10

-5

0

5

10

Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08-30-25-20-15-10-505101520

Industrial Output Orders, 3mo fwd (rhs)

Source: EU Commission survey Source: text.

Economics


A crucial issue for the Eurozone is debt. When it comes to debt, the Eurozone presents the reverse image of the US. While lending to households remained cautious in the Eurozone in the last 10 years, loans to the corporate sector increased markedly. The financial situation of the corporate sector is now a key vulnerability for the Eurozone.

Eurozone the reverse image of the US Consumer credit and mortgage debt much more manageable in the Eurozone than in the US Businesses are more leveraged in the Eurozone than in the US In the UK, the housing market correction may predominantly affect consumer spending Households are safer in the Eurozone, but no cause for complacency

Outstanding consumer credit equalled 18.5% of GDP in 2007 in the United States versus 3.6 % in the Eurozone. The new flows of consumer credit amounted to roughly 3.5% of US private consumption in the year to 3Q 2008 versus only 1% in the Eurozone. Even if banks dramatically tighten their lending standards, the impact on consumer spending is unlikely to be catastrophic in the Eurozone. Mortgage debt levels are also lower in the Eurozone, with outstanding mortgages equal to 76% of GDP in the US in 2007, against 57% in the Eurozone. Practices similar to “sub-prime” lending never took off on a large scale in Europe. We do not expect any US-style plunge in mortgage origination in the Eurozone, although a significant contraction is likely on the back of declining purchasing power, higher unemployment and funding difficulties in the banking sector. The impact of such a contraction should remain manageable in the Eurozone. Housing starts peaked in the US at 42% above their 15 year average level in January 2006. At peak (December 2005), housing permits in the Eurozone exceeded their 15 year average level only by 23%.

However, the situation is different on the corporate side. US corporations scaled down their investment efforts after the economic slowdown of 2001. Private non-residential investment fell from a peak at 12.6% of GDP in 2000 to a trough at 9.8% in 2003. However, the correction in the Eurozone was minimal, with the same ratio falling from a peak at 13.2% in 2000 to a trough at 11.9% in 2003 (see Figure 5). Whereas corporate debt to value added was at a similar level in the US and the Eurozone in 1999, corporate debt rose by more than 60 percentage points between 1999 and 2Q 2008, to 240%, against 180% in the US, “only” 20 points above 1999 (see Figure 6). The amount of corporate debt to roll over is huge in the Eurozone.

So far, bank credit has continued to flow to the Eurozone corporate sector. However, refinancing costs for businesses are increasing. Corporate profitability started to decline before the recession already. In 2Q 2008, gross savings to value added fell to 16.8%, 0.8 percentage point below 2Q 2007 and significantly below the peak of 19.1% of 3Q 2004. This was before the economic situation deteriorated further in the summer and fall of 2008. Profitability likely fell further in 2H 2008 under the pressure of higher debt payments, falling demand and squeezed margins.

The need to extract additional resources from operations to fund the increased debt service burden, and the willingness to reduce the level of debt, will add to the economic downturn in the Eurozone. Strong pressure to reduce staff levels and rein in compensation, in order to raise gross operating surpluses, will weigh on the disposable income of households and thus on consumer spending. Moreover, deleveraging will directly hit investment.

Figure 5. Private Non-Residential Investment Figure 6. Corporate Debt: An Issue for the Eurozone

9

9.5

10

10.5

11

11.5

12

12.5

13

13.5

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

US Eurozone

140

160

180

200

220

240

260

Mar-99 Mar-01 Mar-03 Mar-05 Mar-07

Eurozone Corporate Debt US Corporate Debt

In % of GDP. Source: National Accounts In % of gross value added. Source: Federal Reserve, Eurostat

Economics


Figure 7. Eurozone Economic Indicators Day GMT Country Indicator For BAC Mkt Last

Mon 12+ 07:30 France Banque de France Business Sentiment Dec 65 66 68

Tue 13 07:45 France Central Government Balance (€) Nov n.a. n.a. -60.7bn

Wed 14 07:45 France Current Account (sa, €) Nov n.a. n.a. -5.0bn

07:50 France CPI mom Dec -0.3% -0.3% -0.5%

yoy 1.1% 1.1% 1.6%

HICP yoy 1.3% 1.3% 1.9%

08:15 Germany GDP (not calendar adjusted) 2009 1.4% 1.4% 2.5%

Fiscal Balance (in % of GDP) -0.2% 0.0% 0.0%

09:00 Italy Industrial Production (sa) mom Nov -1.3% -1.1% -1.2%

(wda) yoy -6.7% -6.5% -6.9%

10:00 Eurozone Industrial Production (sa) mom Nov -2.1% -1.9% -1.2%

(wda) yoy -6.0% -5.8% -5.3%

Thu 15 07:00 Germany CPI (final) mom Dec 0.3% 0.3% -0.5%

yoy 1.1% 1.1% 1.4%

HICP (final) yoy 1.1% 1.1% 1.4%

07:00 EU Car Registrations yoy Dec -28% n.a. -25.8%

08:00 Spain CPI mom Dec -0.5% -0.5% -0.4%

yoy 1.4% 1.4% 2.4%

HICP (final) yoy 1.5% 1.5% 2.4%

09:00 Italy CPI (NIC, final) mom Dec -0.1% -0.1% -0.4%

yoy 2.2% 2.2% 2.7%

HICP (final) yoy 2.3% 2.3% 2.7%

10:00 Eurozone CPI (final) mom Dec -0.1% -0.1% -0.5%

yoy 1.6% 1.6% 2.1%

Core (final) yoy 1.8% 1.8% 1.9%

Fri 16 08:00 Spain Housing Transactions yoy Nov n.a. n.a. -27.7%

10:00 Eurozone Trade Balance (sa, €bn) Nov n.a. n.a. 0.9bn Source: Bloomberg, Reuters and Bank of America estimates.

The huge output declines in Germany (-3.1%mom) and France (-2.4% mom) point to a dismal result for the Eurozone as a whole. Since October, almost all hard data for the Eurozone have turned down sharply.

Eurozone Output Eurozone Inflation According to the flash estimate, inflation fell from 2.1% in November to 1.6% in December.

The detailed release will likely confirm that falling oil prices were the key driver, with a likely small decline in core inflation playing only a minor role. If oil prices do not rebound beyond €50 per barrel, headline inflation will probably dip to around -0.3% yoy in mid-2009 before base effects from the recent slump in oil prices may push the headline rate up again to around 1.5% by the end of this year.

Economics


UK: BoE Scales Back Pace of Easing on Sterling Fears

Matthew Sharratt (44) 20 7174 1633 [email protected]

The BoE has switched from the breakneck speed at which the Bank Rate had been lowered since the November meeting last year to a more normal pace of easing, by only cutting by 50bps at their January meeting. Worries over the already significant depreciation in sterling appeared to play a key role in the greater caution displayed by the MPC. Still, with the economy in dire straits and unemployment surging upward, we expect rates to fall further in coming months, probably close to zero by 2Q 2009. Although no reference was made to quantitative easing, the evolution of policy thinking on this front remains critical, in our view.

Some stabilisation in forward-looking activity indicators at exceptionally weak levels casts little New Year cheer on the UK economic outlook, in our view. With the recession biting harder, and the decline in manufacturing intensifying significantly, the Bank of England still has plenty of work to do to ensure that its aggressive monetary easing finds its way into the real economy in a more meaningful way than we have seen to date.

No New Year cheer GDP decline likely to deepen significantly in current quarter, in our view Housing market implosion shows no signs of letting up

Our calculation for the composite UK PMI, which combines construction, services and manufacturing, remained unchanged at a record low of 36.5 in December. A further sharp fall in the construction PMI in December (from 31.8 to 29.3) was offset by slight rises (to still near-record lows) in both the services PMI (40.2 in December from 40.1 in November) and the manufacturing PMI (from 34.5 to 34.9). In 3Q, our composite PMI averaged 43.6 and slumped to 37.4 in 4Q. This signals that the decline in GDP in 4Q is likely to be much greater than the –0.6% qoq we saw in 3Q.

Households remain under tremendous pressure as unemployment surges and the implosion in the housing market shows scant sign of letting up. The employment component in the services PMI fell to a record low of 40.5 in December from 43.1. Rapidly deteriorating labour market prospects imply a major drag on household spending in coming months, in our view. Separately, a Nationwide survey revealed that house prices slumped by 2.5% mom in December, the biggest decline since May last year. The year-over-year decline worsened to –15.9% in December from –13.9% the month before. From the peak in 3Q 2007, house prices have now fallen 17% according to this index. Not surprising, consumer sentiment continues to wilt. Consumer confidence fell to a fresh 4-year low in December according to a separate Nationwide survey, with the headline index declining 4 points to 47. The present situation index dropped 2 points to 28 while the forward-looking expectations component fell 4 points to 60. Still, a gauge of willingness to spend rose sharply by 16 points to 82—an 18-month high—as massive discounting encouraged shoppers onto the High Street ahead of Christmas. However, with the Festive Season out of the way, households are likely to significantly retrench most forms of discretionary spending over the current quarter, in our view. We expect household consumption to slump 1.6% qoq in 1Q 2009 after a 0.7% qoq fall in 4Q 2008.

Figure 8. Recession Deepens Figure 9. Manufacturing Under Extreme Pressure

36

41

46

51

56

61

1992 1994 1996 1998 2000 2002 2004 2006 2008

Composite UK PMI

34

39

44

49

54

59

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0PMI (lhs) Manufacturing Output yoy (rhs)

Source: CIPS and BofA calculations. Source: CIPS & ONS.

Economics


Industrial production was hard hit in November, registering the ninth consecutive monthly decline, the longest such stretch since 1980. However, it was the scale of the monthly decline which raised eyebrows. Production slumped 2.3% mom in November, leaving the October/November average a whopping 3.2% below the 3Q level, after a decline of 1.4% qoq in 3Q. Manufacturing output suffered even more, tumbling 2.9% mom, with the October/November average 3.6% below the 3Q level. This implies that the GDP decline in 4Q will likely be more than our previous forecast of –0.9%. As a result, we have revised our 4Q estimate to show a –1.1% drop. Our call for the decline in GDP in 2009 as a whole is now –2.9% from –2.5% previously.

Industrial production tumbles in November BoE takes its foot off the petal in December MPC views “substantial” decline in sterling as reason for caution Downbeat economic view Significant risks of inflation undershoot What about the ‘next stage’ of monetary policy? BoE likely to cut rates to 0.5% by end 1Q 2009

Despite data continuing to show the economy in dire straits, the BoE took their foot off the accelerator pedal of monetary easing at their January meeting and only cut by a cautious 50bp to 1.5%—having slashed rates by a total of 250bps over the prior 2 meetings. With rates markets pricing in 65bps of easing ahead of the meeting, sterling appreciated roughly 0.9% against the EUR and by 1.1% against the USD in the aftermath of the decision.

The sharply lower level of sterling in recent months appeared to play a limiting role for the BoE on the size of a possible cut, with the brief statement accompanying the decision referring to the “substantial” fall in sterling on three occasions.

The MPC warned that the global economy was undergoing an “unusually sharp and synchronized” downturn and that, domestically, business and consumer confidence had fallen “markedly”. The statement also noted that consumer spending had weakened and that the outlook for business and residential investment had deteriorated.

In justifying their decision to cut rates to an all-time record low of 1.5%, the MPC judged that there were significant risks of undershooting the 2% inflation target with rates at 2%. The statement also blandly noted that the MPC expected inflation “to fall further”.

As the Bank Rate gets ever closer to zero, the key issue remains the “next stage” of monetary policy in the form of ‘quantitative easing’. The statement noted that further measures to increase the flow of lending to non-financial sector are needed but gave no detail at all on the evolution of the debate on the possible need for non-traditional forms of monetary policy, such as buying government and corporate debt. It is possible that this may be aired in the minutes due to be published on January 21st. However, with Chancellor Darling this morning stating that the current debate over “printing money” was “entirely hypothetical”, it does not appear that an official statement on quantitative easing is just around the corner.

For this reason, it appears that the very near-term strategy for the BoE is to exhaust its traditional ‘ammunition’ and take the Bank Rates even lower in the next few months. With its very downbeat characterisation of the economy, the statement itself suggests that the BoE is not yet done easing rates. We expect the Bank rate to fall to 0.5% by end 1Q, with 50bps cuts likely in both February and March. Over the course of February and March, we may get more specific information from both the BoE and the Treasury as to the kinds of measures they would jointly like to use to directly target lending rates in the economy—once there is no more room for further meaningful cuts in the Bank Rate.

Economics


Figure 10. UK Economic Indicators Day GMT Indicator For BAC Mkt Last

Tue 13 00:01 BRC Retail Sales Monitor (like-for-like sales) yoy Dec -2.9% n.a. -2.6%

00:01 RICS House Price Balance Dec -72.0 -74.0 -76.0

09:30 Visible Trade Balance (£) Nov -7.5bn -7.6bn -7.8bn

Non-EU Trade Balance (£) -4.2bn n.a. -4.4bn

09:30 DCLG UK House Prices yoy Nov -9.2% n.a. -7.4% Source: Bloomberg, Reuters and Bank of America estimates.

Trading reports suggest that the Christmas shopping period was not an unmitigated disaster for all retailers as significant discounting helped cushion sales. Still, relative to a year ago festive season trading was under significant pressure which will likely be confirmed by the BRC sales survey. With the festive season now firmly out of the way, the current quarter is likely to be exceedingly tough on the High Street with a risk that more chains could fall into administration as consumers retrench significantly.

BRC Retail Sales Trade Deficit Although growth in goods exports declined sharply over 2H 2008, import growth decelerated at an

even faster pace. This corresponds to a 35% decline in the sterling trade weighted index since the beginning of 2007. As a result, the trade deficit—which had increased on trend continuously over the past decade—is now showing signs of stabilization. We expect that, as import growth slows even more sharply in coming months, the deficit in goods trade will improve to –5.2% of GDP for 2009 as a whole from a likely –6.3% in 2008.

Figure 11. Other Europe Economic Indicators

Day GMT Country Indicator For BAC Mkt Last

Mon 12 08:30 Sweden Budget Balance (SEK) Dec n.a. n.a. 19.7bn Tue 13 08:30 Sweden CPI mom Dec -0.5% -0.4% -0.8%

yoy 1.9% 2.0% 2.5%

Underlying yoy 1.5% 1.5% 1.6%

Thu 15 09:00 Norway Trade Balance (NOK) Dec n.a. n.a. 31.4bn

Fri 16 08:15 Switzerland Producer & Import Prices mom Dec -0.8% -0.6% -1.4%

yoy 0.4% 0.6% 1.1%

09:00 Sweden AMV Unemployment Rate Dec 3.8% 4.1% 3.5% Source: Bloomberg, Reuters and Bank of America estimates.

Economics


Canada: To The Rescue

John Rothfield5 (1) 415 622-9459 [email protected]

Another BoC rate cut on January 20 and a fiscal stimulus on January 27 will be welcomed, but the size of both is still at issue.

The Bank of Canada’s commodity price index fell by 12.5% in December and by a cumulative 48% since June. The 48% decline in the second half comprised –61% for energy, –33% for food and –25% for ‘industrial materials’. For the entire year (December/December) the BoC commodity price index fell 28%, almost identical to falls in the New Zealand commodity price index produced by ANZ of –27%, and the RBA commodity index ex coal and iron ore which fell about –30% (coal and iron ore are omitted from that analysis because yearly contract prices were reset in 2Q 2008, near the height of the boom). While price changes for aggregate commodity baskets have been fairly similar across these three dollar bloc commodity currencies (in Australia’s case the full impact will be delayed until 2Q 2009 when contract prices for coal and iron ore are reset), the economic impact of the change in commodity prices depends, among other things, on the importance of commodities in GDP. Here, Canada is at a slight advantage. According to data in the Bank of Canada’s Autumn Review (“Adjusting to the Commodity-Price Boom: The Experience of Four Industrialized Economies’ Michael Francis), in 2007 commodities represented 7% of Canadian GDP, similar to New Zealand (7.2%) but a bit less than Australia (9.7%). That said, the delay in the impact on Australia until coal and iron ore prices actually fall, and the fact that 75% of Canadian exports go to the US, still leave Canada with an overall disadvantage as the US recession deepens.

Commodity price impact similar across dollar bloc

The week ahead brings the important quarterly (winter) surveys from the Bank of Canada, of businesses and a new survey of loan officers. In the autumn business survey respondents expected broadly unchanged sales, investment and production ahead although the percentage of firms reporting tighter credit conditions moved up sharply. We expect to see most categories fall away in the winter survey, but just how far will be of interest, since it will be a good guide to the unraveling of decoupling from the US economic situation. The senior loan officer survey results will be important for the Government which is understood to be including measures to ease credit availability in its January 27 budget. The November trade figures will be most notable for showing the trend in real exports, the first feed into factor GDP in the middle month of 4Q. While nominal values are being held up by a falling CAD (with many goods denominated in USD) real or inflation adjusted exports fell 1.6% in October to be 2.9% below their 3Q average, led by further weakness in autos. Real imports also plunged in October to be 4.9% below their 3Q average. The drop in real imports may indicate a slowing of Canadian domestic demand, so confirmation in the November data would be notable.

BoC survey and November foreign trade last big numbers before BoC meeting and MPR on January 20 and 22

Figure 12. Canada Economic Indicators Day GMT Indicator For BAC Mkt Last

Mon 12 13:30 Business Outlook Survey Winter n.a. n.a. +3

Senior Loan Officer Survey n.a. n.a. 49.8

13:30 New Housing Price Index mom Dec -0.3% n.a. -0.4%

Tue 13 13:30 Merchandise Trade (CAD) Nov +2.0bn n.a. +3.8bn

Thu 15 13:30 Vehicle Sales mom Nov -5% n.a. -0.9% Source: Bloomberg, Reuters and Bank of America estimates.

5 John Rothfield is a Bank of America GFX strategist. The opinions expressed by Mr. Rothfield should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

Economics


Australia/New Zealand: Who’s Hiring Over Summer?

John Rothfield6 (1) 415 622-9459 [email protected]

Will the poor run of Australian data continue into the new week? Australia’s jobs report for December has the greatest risk of being worst in the cycle since the seasonals ‘expect’ about 150-160Kof summer break hires that might not have eventuated this year. In New Zealand, the quarterly survey of business opinion is out.

Australia: New economic data was mixed. The most ‘leading’ of all the news, the three AiG sectoral surveys for December, were all very soft, languishing in the low to mid 30s. Housing sector reports for November were very weak with a resumed drop in home sales and another plunge in building approvals. The value of building approvals fell –10% including –17% for new residential (especially apartments), –1.6% for non residential and –0.6% for renovation work. The weakness in building approvals and anecdotal evidence of more weakness in house prices than has shown up in the official data so far is a real setback, since new building is lagging well behind underlying demographically driven demand. The Government will hope that extra assistance for new home buyers, a narrowing of credit spreads and another rate cut will start to stem the tide of weakening building activity from December onwards, but the AiG Performance of Construction index for December gave little sign of immediate relief. Other data was not so bad. While the retail trade data these days is subject to skepticism given the reduced sample size, it did show a 0.4% mom rise in November after + 1.0% in October, suggesting some benefit to retailers from less money spent on gas, imminent tax cuts and lower interest rates. This will provide some offset in 4Q GDP to very weak car sales. The international trade balance was a surplus of $A1448mn in November, lower than the record surpluses of recent months but another strong result nonetheless. Exports, which had surged 7% in October, eased back 4% in November but remained at high levels. Imports rose by a rounded 2% despite a 24% drop in imports of fuels due to lower prices, thus illustrating some resilience in domestic demand as well as the valuation effect of a cheaper currency. The weak ahead brings the December jobs report. This might be a bad number since seasonals for December ‘expect’ about 150-160k summer retailing jobs that this year may not have materialized.

Mixed economic data, but tending to net weakening

New Zealand: Of most interest will be the NZIER quarterly survey of business opinion (QSBO). As the NZ Treasury noted in its November economic assessment the 3Q QSBO showed some recovery in business confidence and expected activity but “the survey was completed before the renewed financial market volatility and thus may overstate the current level of confidence”. NZ economic numbers have recently been coming out flat rather than weak, so the QSBO headline readings may hold up OK for now, despite this global turmoil.

NZIER QSBO might hold up better than business surveys in many economies

Figure 13. Australia and New Zealand Economic Indicators Day GMT Country Indicator For BAC Mkt Last

Mon 12 00:30 Australia ANZ Job Ads mom Dec n.a. n.a. -8.6%

21:00 New Zealand NZIER Business Survey – General Situation 4Q n.a. n.a. -24

– Own Activity n.a. n.a. -8

Tue 13 21:45 New Zealand Building Permits mom Nov n.a. n.a. -21.9%

Wed 14 00:30 Australia Housing Finance mom Nov 1.0% n.a. 1.3%

Investment Lending mom n.a. n.a. 0.7%

Thu 15 00:30 Australia Employment Change Dec -25K n.a. -15.6K

Unemployment Rate 4.7% n.a. 4.4%

11:00 New Zealand QV House Prices yoy Dec n.a. n.a. -6.8% Source: Bloomberg, Reuters and Bank of America estimates.

6 John Rothfield is a Bank of America GFX strategist. The opinions expressed by Mr. Rothfield should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

Economics


Emerging EMEA: Falling Like Rocks

David Hauner7 (44) 20 7174 4852 [email protected]

Mai Doan7

(44) 20 7174 1730 [email protected]

Emerging EMEA’s economies are falling like rocks. Industrial production declined at double-digit rates in Hungary and Turkey in November, and so did Czech exports. Compared to this, a 4.4% yoy drop in South Africa’s manufacturing looks mild. This slower rate of decline reflects a lower base, but also better credit conditions than in the even more highly leveraged Eastern European economies. This data underscores the case for further rapid rates easing. Nevertheless, we believe that some central banks have more room than others, as a function of currency weakness. While we expect faster easing than priced in the Czech Republic and Hungary, we believe that Poland’s, South Africa’s, and Turkey’s central banks will need to be more cautious.

In the race for the most dismal reading of the weak, Turkey’s IP took the lead with a decline by 13.9% yoy in November, much worse than in October (–8.5%). In particular, manufacturing was hit hard (–15.5% yoy) due to a sharp contraction in the export-oriented textiles and auto sectors. This data lends support to our call for low growth in 2008 (1.0%) and a contraction in 2009 (–1.2%). Meanwhile, CPI inflation eased to 10.1% yoy from 10.8%, and PPI inflation dropped to 8.1% yoy from 12.3%. In the light of this worse-than-expected data, we revised our call for the CBRT meeting next week to a 100bp cut.

IP data confirms weak growth prospects in Turkey in 2009

Steeper decline in both home and foreign demand in Hungary

Sharp declines in IP and inflation highlight that the National Bank of Hungary will likely ease rates faster than currently priced in. The November IP came in at a dismal –10.1% yoy from –7.2% previously. This is the worst reading in more than 16 years, driven by the plunge in export demand from Western Europe, particularly in the automotive sector. The PPI inflation slowed to 7.1% yoy in November from 7.8%, with a broad based moderation in the price pressures. Meanwhile, the trade balance unexpectedly recorded a surplus of €100mn in November due to imports that fell even faster than exports (–10.2% mom versus 7.4%). This is in line with our expectation of an improvement in the external imbalance next year, yet confirming that the Hungarian economy is entering a painful recession. We look for total rate cuts of 200bp in 1Q to bring the base rate to 8.0% in March, and further to 5.0% at end-year.

The Czech trade balance in November unexpectedly recorded a deficit of CZK0.5bn versus the consensus for surplus of CZK5bn. Exports posted the biggest annual slump on record, –18.0% yoy, with widespread declines across all sectors. Meanwhile, CPI inflation fell to 3.6% yoy in December from 4.4% previously, driven by transport and food price deflation. The data confirm our view for at least a 0.5% contraction in the Czech economy this year, and the need for the CNB to cut the repo rate to 1% by March from the current level of 2.25%.

Czech exports growth at record low, expect further sharp rates easing

In South Africa, there are tentative signs that demand is bottoming out but the production outlook remains weak. The rate of decline in vehicle sales slowed for the third month in a row in December, to –26.0% yoy. Meanwhile, manufacturing output fell sharply by 4.4% yoy in November after -1.8% in October. However, while the weak economy provides room for substantial rate cuts, we believe that market expectations have become excessive against the background of the weak ZAR, and rates will fall by 100bp less than priced in 2009.

Demand bottoming out but production to weaken in South Africa

In Romania, the NBR kept rate unchanged at 10.25%, but we think that the central bank will soon have to switch to an easing bias. The NBR was cautious about a weaker RON and the continued uncertainty on the budget front. However, the Romanian economy cannot escape the impact of the global downturn and a credit squeeze. Already, IP fell by –3.0% yoy in October and retail sales growth more than halved to 8.6% yoy from the previous month. We expect incoming data to surprise on the downside, arguing for a 50bp rate cut on February 4.

NBR kept rates unchanged but easing bias imminent

7 David Hauner and Mai Doan are Bank of America GFX strategists. The opinions expressed by Mr. Hauner and Ms. Doan should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

Economics


Figure 14. Emerging EMEA Economic Indicators


Mon 12 - Russia Trade Balance ($) Nov 2.0bn 7.0bn 11.9bn

15:00 Turkey Current Account ($) Nov -0.8bn -1.2bn -2.6bn

Tue 13 08:00 Romania CPI yoy Dec 6.5% 6.6% 6.7%

09:30 South Africa SACOB Business Confidence Dec n.a. n.a. 86.7

- Israel Trade Balance ($, sa) Dec n.a. n.a. -1039.4mn

Wed 14 08:00 Czech Rep Industrial Production yoy Nov -9.0% -8.0% -7.6%

08:00 Romania Retail Sales yoy Nov n.a. n.a. 8.6%

13:00 Poland CPI yoy Dec 3.3% 3.3% 3.7%

17:00 Turkey CBT Rate Announcement Jan 15 14.00% 14.25% 15.00%

Wed 14+ - Romania Current Account (€) Nov n.a. n.a. -14.4mn

Thu 15 08:00 Czech Rep PPI yoy Dec -0.2% -0.2% 1.2%

08:00 Hungary CPI yoy Dec 3.5% 3.6% 4.2%

08:00 Hungary Industrial Production yoy Nov -10.1% n.a. -10.1%

08:00 Romania Industrial Production yoy Nov n.a. n.a. -3.0%

09:00 Czech Rep Current Account (CZK) Nov -10.5bn -8.50bn -21.99bn

10:00 South Africa PMI Dec n.a. n.a. 39.5

13:00 Poland Current Account (€) Nov -2500mn -2060mn -2219mn

16:30 Israel CPI yoy Dec 3.5% 3.5% 4.5%

Thu 15+ - Russia Industrial Production yoy Dec -9.2% -9.2% -8.7% Source: Bloomberg, Reuters and Bank of America estimates.

Turkey: CBT Rates, Current Account

The key release this week will be the policy rate in Turkey. In light of the inflation and IP data last week (see above), we revised our call to a 100bp cut, considering also that the CBRT seems to be in a hurry to lower rates before the elections in March and the likely adoption of an IMF program. Separately, we believe that the current account has improved more in November than the consensus expects, which would provide support for our view that the deficit will contract sharply to -3.8% of GDP in 2009 from 6.1% in 2008.

In Poland, inflation is likely to have declined further in December to 3.3%. However, we believe that further rates easing will be smaller than priced in, due to the effectively lower inflation target resulting from ERM-II accession that we expect to occur in 2009. Meanwhile, the current account deficit is likely to have deteriorated significantly further in November.

Poland: CPI, Current Account

We expect the disinflation trend to continue swiftly in Hungary to 3.5% in December, creating more room for the NBH to ease rates. Separately, the final reading of the dismal November IP will likely show weakness particularly in the export-related sectors.

Czech Rep: IP, PPI, Current account

Hungary: CPI, IP

The declines in export demand, output production and producer prices in the Czech Republic will strengthen the case for 125bp cut by the CNB this quarter. November IP will remain deep in contraction zone given the 18% slump exports. Despite this, the current account deficit may narrow due to a seasonal improvement in the income account. Meanwhile, the PPI will likely see the first deflation in three years in December, given the sharp drop in food and oil prices.

Further slowdown in inflation in Israel is likely in view of the decline in food and fuel prices, as well as a resilient ILS. In fact, the prospect of weaker domestic activity even raises a small risk of deflation going forward, suggesting that the BoI will ease rates to a trough of 1.0%.

Israel: CPI

Russia’s trade surplus is likely to have shrunk to only $2bn in November, in our view, highlighting that Russia’s current account is set to record a deficit in 2009; we expect 3.0%.

Russia: Trade balance, IP

In Romania, CPI inflation will likely slow, but only moderately, to 6.5%. The disinflation impact from lower commodity prices and fading domestic demand is being partly offset by a weaker RON. Yet, a severe slowdown in the economy will likely see NBR easing soon.

Romania: CPI

Economics


Latin America: Central Bank Easing Cycles to Begin Soon

Edgar Camargo8 (52 55) 5230-6429 [email protected]

Lawrence Goodman9 (1) 646 855 2883 [email protected]

Alberto Boquin9 (212) 548 2789 [email protected]

In Brazil, lower inflation will likely underscore the potential for a succession of policy rate cuts by the Monetary Policy Committee (Copom) with the first installment coming on January 21. In Mexico, annual inflation may begin its expected downward trend earlier than originally anticipated. We anticipate a rate cut cycle of 150bps in the over-night lending rate throughout 2009 taking it down to 6.75%.

Brazil: The bellwether IPCA inflation closed the year below the upper end of the 2.5%-6.5% target with the components demonstrating a clear potential for a sharp future reduction in the rate of inflation in Brazil. December IPCA registered 5.90% yoy down from 6.39% in the previous month and below the 6.41% peak during the year witness as recently as October. The potential for Brazilian inflation to fall sharply in coming months is high.

In Brazil, inflation closed the year above COPOM’s target range…but likely to fall sharply in future Food one of the main contributors to a lift in inflation Lower inflation will likely lead to monetary easing in our view In Mexico, inflation climbs in December Financial market volatility left Banxico on hold

The components of the latest IPCA release reveal that only three sectors are contributing to a lift in inflation: food and beverages (+11.1%), personal expenses (+7.4%), and clothing (+7.3%). In each sector, the potential for a slide is high especially in food and beverages where the slide in wholesale commodity prices will likely act on IPCA with a short lag. IPCA inflation can readily slide to reported figures of 4.5% yoy by the middle of 2009. We estimate that base effects alone will shave 0.3% from reported inflation in the first half of 2009.

Lower inflation will likely underscore the potential for a succession of policy rate cuts by the Monetary Policy Committee (Copom) with the first installment coming on January 21st. Although the rate cut is expected, the market response will likely prove meaningful as tangible evidence will now exist that the Central Bank (BCB) is now in a rate cutting mode. Nonetheless, gains in rates trades will likely prove more limited than in recent weeks as expectations have shifted and positioning is now long. For example, DI futures contracts on the BM&F went from net short in early October of –109k to peak of 108k in late December. Some of these positions have been slightly pared back to +63k as of January 8. Local rates will likely remain high in Brazil relative to other Emerging Markets and net short BRL positions will contribute to 'bear market' rally. . .expect USD/BRL to test 2.110.

Mexico: Mexican prices climbed 0.69% in December, slightly above market expectations (0.67%). This result took year-over-year inflation to 6.53% in 2008, not only exceeding the Bank’s 3% +/- 1% medium-term inflation target range but also falling above the upper limit of Banxico’s projected range (6%). Core inflation climbed 0.62% in December leading to an annual rate of 5.73% in 2008. Throughout 2008, both core and non-core inflation components maintained an upward trend. The latter one was particularly affected by higher public administered prices—which climbed to 8.0% in December 2008 from 3.4% in December 2007—pressured by the federal government’s decision to increase domestic fuel prices in response to the high international fuel prices that prevailed during most of 2008.

Banxico’s decision to stay on hold at its last meeting of 2008 was in part a result of the huge volatility experienced by financial markets and the expectation for higher inflation readings at the beginning of 2009. Recent inflation reports show that price pressures—derived from several cost increases that have already materialized and are being translated

8Edgar Camargo is a Rates: Economic Strategist at Bank of America. The opinions expressed by Mr.Camargo should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request. 9Lawrence Goodman and Alberto Boquin are Bank of America GFX strategists. The opinions expressed by Mr. Goodman and Mr. Boquin should not be read as impartial because the relevant trading desk may have positions in, or be engaged in trading in, instruments referred to herein. For further information, please read the Bank of America NA (London) general policy statement on the handling of research conflicts, available on request.

Economics


into final prices—have been exacerbated by the significant MXN depreciation that could likely affect the behavior of the merchandise core component at the beginning of 2009.

Easing commodity and energy prices in addition to the expected significant deterioration in Mexico’s economic activity will likely attenuate inflation throughout 2009 giving space for the central bank to begin a rate cut cycle in 1Q 2009. We have emphasized previously that even though faced with still rising inflation at the beginning of 2009—and with annual inflation exceeding the upper limit (6%) of the central bank’s latest projections—Banxico would be “pressured” to act sooner rather than later. President Calderon’s stimulus measures which include a freeze in nationwide gasoline prices, a reduction in natural gas prices, and a reduction in electricity prices have led markets to downplay inflation risks in coming months and frontload the possibility of Banxico rate cuts as early as January.

Rate cut cycle to begin in 1Q 2009, in our view We see inflation falling to 4.1% by year end

While the announced measures will allow annual inflation to begin its expected downward trend earlier than originally anticipated, our inflation forecasts are still above the current central bank projections for most of 2009. Based on this, we would be inclined to think that the central bank will assess its own balance of risks and consider whether or not it needs to revise its own projections by month-end upon the release of the quarterly inflation report and its 2009 monetary program before beginning the easing cycle. In any case, given our expectation of seeing inflation falling to 4.1% by year-end, we anticipate a rate cut cycle of 150bps in the over-night lending rate throughout 2009 taking it down to 6.75%.

Figure 15. Latin America Economic Indicators


Wed 14 20:30 Mexico IGAE yoy Oct -1.9% -1.7% 1.9%

Thu 15 10:00 Brazil IGP-10 Inflation mom Jan n.a. n.a. 0.03%

Fri 16 11:00 Brazil Retail Sales yoy Nov n.a. n.a. 10.1%

15:00 Mexico Banxico Monetary Policy Meeting Jan 8.25% 8.00% 8.25% Source: Bloomberg, Reuters and Bank of America estimates.

Economics


Figure 16. Critical Events Day GMT Venue Event

Sun 11 - Basel Global Economy Meeting of central bank heads from leading industrial and emerging economies at BIS (to Jan 12)

Mon 12 17:40 Atlanta Fed Lockhart speaks on US economic outlook

Tue 13 09:00 Strasbourg ECB President Trichet attends EU parliament ceremony marking 10 year anniversary of the Euro

13:00 London Fed Chairman Bernanke gives Joseph Stamp memorial lecture at London School of Economics

15:30 Helsinki ECB Liikanen chairs panel on “Euro: 10 years”

22:00 Columbia Fed Lacker speaks on “Financial conditions and the economic outlook”

Wed 14 - Paris OECD publish Eurozone Economic Survey

13:30 Newark Fed Plosser speaks on US economic outlook

18:00 Cedar Rapids Fed Stern speaks on prospects for policy

19:00 Washington Fed releases Beige Book

Thu 15 00:30 Sydney RBA publishes Monthly Bulletin

05:00 San Francisco Fed Yellen speaks on US economic outlook

12:45 Frankfurt ECB announces interest rate decision (press conference follows at 13:30GMT)

14:00 Weinfelden SNB Jordan speaks

15:30 Frankfurt ECB Stark speaks at panel discussion

18:40 Madison Fed Evans to speak to Wisconsin Bankers Association

18:40 Hattiesburg Fed Lockhart speaks on US economic outlook

Fri 16 00:30 Tokyo BoJ holds quarterly branch managers’ meeting (followed by Regional Economic Report Release and Press Conferences)

- Brunnen SNB Hilderbrand speaks

09:00 Paris International Energy Agency publishes monthly oil market report

17:15 Richmond Fed Lacker speaks on “Financial conditions and the economic outlook” Source: Bloomberg, Reuters and Bank of America estimates.

Figure 17. Central Bank Meetings

Fed ECB BoJ BoE BoC SNB Riksbank

Jan 28 Jan 15 Jan 22 Feb 05 Jan 20 Mar 11 Feb 10

Mar 17 Feb 05 Feb 19 Mar 05 Mar 03 Jun 18 Apr 20

Apr 29 Mar 05 Mar 17 Apr 09 Apr 21 Sep 17 Jul 01

Jun 24 Apr 02 Apr 07 May 07 Jun 04 Dec 10

Aug 11 May 07 May 22 Jun 04 Jul 21

Norges RBA RBNZ Brazil/COPOM Banco de Mexico Poland NB Hungary NB

Feb 04 Feb 03 Jan 29 Jan 21 Jan 16 Dec 23 Dec 22

Mar 25 Mar 03 Mar 12 Mar 11 Feb 20 Jan 23 Jan 19

May 06 Apr 07 Apr 30 Apr 29 Mar 20 Feb 25 Feb 23

Jun 17 May 05 Jun 11 Jun 10 Apr 17 Mar 25 Mar 23

Aug 12 Jun 02 Jul 30 Jul 22 May 15 Apr 29 Apr 20 Date denotes monetary policy announcement in local time Source: Bloomberg, Reuters and Bank of America estimates.

Economics


Figure 18. Economic Forecasts

PPP USD GDP Unemployment CPI Current Account Budget Balance Weight Weight % change (%) % change as % of GDP as % of GDP

2008 2009 2010 2008 2009 2010 2008 2009 2010 2008 2009 2010 2008 2009 2010

World (USD) 100.00 2.5 0.1 2.9 World (PPP) 100.00 3.4 1.1 3.6 THE AMERICAS 31.17 32.73 1.9 -0.9 2.8 United States 20.86 23.11 1.2 -1.8 2.6 5.7 7.8 8.0 3.3 -0.5 1.3 -4.7 -3.9 -4.3 -3.2 -8.4 -7.5 Canada 1.92 2.52 0.6 -0.2 2.0 6.1 6.5 6.5 2.6 0.6 1.9 1.3 -0.6 -1.1 0.5 -0.5 -0.5 Latin America 8.16 7.01 4.5 1.5 3.5

Brazil 2.80 2.68 5.3 2.7 3.9 8.0 8.5 8.2 5.8 5.0 4.1 -1.8 -2.0 -1.8 -1.6 -2.3 -2.2 Mexico 2.05 1.84 2.0 -1.5 2.8 3.9 4.4 4.0 6.5 4.1 3.7 -1.3 -2.5 -2.1 0.0 -1.8 -2.0 Argentina 0.81 0.55 6.9 2.0 3.0 8.4 9.8 9.2 8.8 9.4 8.1 2.7 0.9 2.0 0.7 0.5 0.0 Chile 0.36 0.29 4.2 3.0 3.8 8.3 9.9 8.7 9.2 6.8 3.8 3.5 0.1 -3.0 6.5 5.0 2.5

EUROPE 29.59 37.67 1.6 -1.7 1.7 Eurozone 15.63 22.59 0.7 -2.5 1.6 7.5 8.8 8.9 3.3 0.7 1.6 -0.4 0.0 0.0 -1.6 -4.9 -3.6

Germany 4.24 6.16 1.1 -2.4 1.5 7.3 7.8 7.8 2.6 0.3 1.2 -0.5 -3.6 -2.0 France 3.09 4.80 0.8 -2.0 1.7 7.4 8.8 9.0 3.3 0.6 1.5 -3.1 -4.5 -3.5 Italy 2.68 3.87 -0.5 -2.4 1.1 6.8 8.1 8.3 3.5 0.9 1.5 -2.7 -4.7 -3.7

Other Western Europe 4.89 7.52 1.1 -2.0 1.2 United Kingdom 3.24 4.49 0.8 -2.9 0.8 5.6 7.9 9.2 3.6 0.6 1.5 -1.8 -2.0 -1.9 -5.3 -9.3 -7.3 Switzerland 0.45 0.79 1.8 -2.0 1.4 2.5 2.8 2.9 2.5 0.0 0.8 13.5 12.6 12.2 1.2 -0.4 0.2 Sweden 0.50 0.83 0.5 -1.5 1.9 6.5 7.9 7.8 3.5 1.2 1.6 8.2 7.0 6.3 2.5 -1.0 -0.8 Norway 0.38 0.78 2.2 -1.2 1.8 2.6 4.0 4.7 3.8 -0.2 0.3 17.6 16.1 15.4 13.0 7.0 5.0

Other Europe 8.75 7.57 4.6 0.7 2.3 Poland 0.97 0.91 5.2 1.0 2.1 9.7 10.0 11.0 4.2 3.7 2.3 -5.3 -5.6 -4.5 -2.2 -2.5 -2.2 Hungary 0.29 0.26 1.5 -1.0 1.3 8.0 9.0 8.5 6.1 3.1 2.4 -5.9 -5.2 -3.8 -3.4 -2.5 -2.0 Czech Republic 0.38 0.35 4.0 -0.5 1.9 5.8 6.2 7.1 6.4 2.1 1.9 -2.4 -3.5 -2.9 -1.2 -2.0 -1.4 Russia 3.24 2.87 5.9 0.0 4.7 7.0 7.5 8.0 14.1 9.4 6.3 3.9 -3.0 -6.0 5.8 -2.0 -3.0 Turkey 1.37 1.29 1.0 -1.2 3.2 10.1 10.5 11.0 10.5 9.4 7.8 -6.1 -3.8 -3.2 -1.6 -2.4 -2.2

ASIA & PACIFIC 32.46 24.02 4.4 3.2 5.0 Japan 6.43 7.81 -0.2 -1.9 1.2 4.0 4.6 4.5 1.5 -0.5 0.0 3.4 2.8 3.0 -4.6 -5.5 -4.1 China 11.41 6.81 9.0 8.0 9.1 4.5 4.6 5.0 6.1 3.0 2.8 8.5 8.0 7.2 0.2 -1.7 -1.5 Other Asia 13.06 7.44 5.5 4.7 5.7 Oceania 1.37 1.96 2.1 1.2 2.6

Australia 1.17 1.72 2.3 0.8 2.6 4.2 5.5 5.9 4.4 2.8 2.9 -4.7 -4.7 -5.0 0.5 -0.5 -0.5 New Zealand 0.17 0.22 -1.0 -0.5 2.2 4.1 5.4 6.0 4.1 2.7 2.6 -9.1 -7.9 -5.8 2.5 -0.7 -0.7

AFRICA / MID EAST 7.22 5.58 4.4 2.6 3.0 South Africa 0.72 0.48 3.3 1.2 2.7 24.2 24.5 25.0 11.4 6.7 6.0 -8.0 -8.2 -7.1 0.2 -1.5 -1.2

ASSUMPTIONS 2008 2009 2010

Oil Prices (WTI) 105 50 55 World Trade 4.0 -2.0 5.0

Note: GDP and CPI data are annual averages. Weights are calculated according to current USD value. (Source: IMF).

Source: National statistical offices and Bank of America estimates.

Economics


Figure 19. Interest Rates and Monetary Policy Forecasts 3-Month 6-Month 12-Month

Key Central Bank Rates Next Move Current Forecast Forecast Forecast

Fed Funds +25 bp in Mar '10 0 - 0.25% 0 - 0.25% 0 - 0.25% 0.25 EMU Refi -50bp in Jan 2009 2.50 1.50 1.50 2.00 JPY ON Call -20bp in Feb'09 0.10 0.10 0.10 0.10 UK Base -50bp in Feb '09 1.50 0.50 0.50 0.75 SNB 3-month Libor Target -25bp in Jan 09 0.0-1.0 0.0-0.5 0.0-0.5 0.5-1.50 BOC Overnight Target -50bp in Jan 2009 1.50 0.75 0.75 1.50 RBA Cash Rate -75bp in Feb'09 4.25 3.00 3.00 3.75 RBNZ OCR -100 bp in Jan'09 5.00 3.75 3.50 4.25 Swedish Repo -50 bps in Feb 2009 2.00 1.50 1.50 1.75 Norway Deposit Rate -100bp in Feb 09 3.00 1.50 1.00 1.25 Brazilian Selic ON -50bp in January 2009 13.75 12.75 12.25 12.25 Mexican Overnight Rate -50bps in Feb 2009 8.25 7.75 7.00 6.75

Source: Bloomberg, Reuters and Bank of America estimates.

3-month 6-month 12-month

Interest Rates Current Forward Forecast Forward Forecast Forward Forecast

USD: 3mo 1.00 0.98 1.30 1.03 1.10 1.35 0.90 10yr 2.45 -0.19 2.40 2.53 2.70 2.54 3.30 EUR: 3mo 2.68 1.92 2.40 1.74 2.10 2.03 2.50 10yr 2.93 2.94 2.80 2.94 3.30 2.93 4.00 JPY: 3mo 0.74 0.58 0.70 0.49 0.45 0.51 0.50 10yr 1.18 1.21 1.15 1.22 1.10 1.16 1.30 GBP: 3mo 2.33 1.49 1.25 1.48 1.10 1.87 1.25 10yr 3.14 3.19 3.22 3.20 3.35 3.26 4.30 CHF: 3mo 0.73 0.44 0.25 0.40 0.25 0.73 1.00 10yr 3.00 2.98 2.30 2.97 2.70 2.96 3.30 CAD: 3mo 1.25 0.79 3.10 0.73 3.20 0.99 3.30 10yr 2.63 2.66 3.70 2.68 3.90 2.72 4.30


3m Interest Rates

Current

3 Month Forecast

6 Month Forecast

12-Month Forecast

SEK 2.28 1.70 1.60 2.10 NOK 3.52 2.40 1.70 2.08 DKK 4.15 2.45 2.15 2.55 CZK 3.60 1.86 1.66 1.76 HUF 8.00 8.80 6.60 5.10 PLN 5.21 5.96 5.21 5.21 RUB 22.50 21.50 18.00 11.00 TRY 16.49 14.74 14.74 14.74 ARS 16.38 n.a. n.a. n.a. BRL 12.85 11.85 11.80 12.55 MXN 8.14 7.70 7.00 6.75 AUD 4.25 3.40 3.50 4.00 NZD 5.25 4.20 4.00 4.75 HKD 3.79 3.60 3.50 3.60 SGD 0.88 n.a. n.a. n.a. ZAR 11.50 10.43 9.43 7.93


Economics


Figure 20. Exchange Rate Forecasts 3-Month 6-Month 12-Month

Exchange Rates Current Forward Forecast Forward Forecast Forward Forecast

USD vs

EUR 1.35 1.34 1.42 1.34 1.36 1.34 1.31 JPY 90.2 90.1 93.0 90.0 98.0 89.8 104.0 GBP 1.52 1.51 1.58 1.51 1.46 1.51 1.35 CHF 1.11 1.11 1.08 1.11 1.10 1.11 1.11 CAD 1.19 1.19 1.20 1.19 1.24 1.19 1.29


Exchange Rates Current 3 Month Forecast

6 Month Forecast

12-Month Forecast

USD vs

ARS 3.45 3.56 3.67 3.89 BRL 2.27 2.00 1.90 2.10 MXN 13.70 12.25 12.28 12.65 CNY 6.84 6.80 6.75 6.55 KRW 1343 1300 1300 1200 INR 48.26 46.00 47.00 45.00 SGD 1.48 1.48 1.49 1.46 ZAR 9.78 9.09 8.64 9.47 PLN 3.00 2.61 2.50 2.60 AUD 0.71 0.75 0.74 0.71 NZD 0.59 0.62 0.60 0.58

EUR vs

JPY 121 132 133 136 GBP 0.89 0.90 0.93 0.97 CHF 1.50 1.53 1.50 1.45 SEK 10.68 10.25 10.00 9.50 NOK 9.44 8.80 8.40 8.20 CZK 26.6 25.0 24.0 24.0 HUF 278 250 240 230 PLN 4.04 3.70 3.40 3.40


Economics


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Economics


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