Eur Excess Liquidity To Decline - Euro Donwtrend - Parisbas Dec 2010

Market Economics | Interest Rate Strategy | Forex Strategy 16 December 2010
We wish all our readers Happy Holidays

Market Mover and a Happy New Year.
The next edition of Market Mover will be published on 6 January 2011
Market Outlook 2-3

Bond markets are desperately seeking support. Any
Fundamentals 4-30
rebound continues to prove short-lived and the market
Global: Fire and Ice 4-5
action shows little sign of a lasting reversal before the
US FOMC: Pricing Out Japan 6-7
turn of the year.
US: A Curious Case of Consumer 8-10
Deleveraging
The market is oversold. Although better-than-expected
ECB: Room at the Top 11-15
economic data have been fuelling the sharp sell-off, poor
UK: HMS QE2 Sunk Before It Was 16-17
year-end liquidity conditions have been a key factor
Launched
exacerbating the move.
SNB: Governing Two Economies 18
Sweden: Further Tightening 19-20 The lows in yields are behind us. We have updated our
Norway: Hawkish Tone 21-22 forecasts to take into account recent moves and the
Turkey: Reserving Judgement 23-25 reduction in downside risks to growth as well as upward
Japan: Tankan Points to Soft Patch 26-28 surprises in inflation in several developed economies.
Japan: Marking Up 2010 Growth 29-30
Forecast
As real money flows return, we expect yields to
Interest Rate Strategy 31-59 decline at the start of 2011, before resuming their rise
Bonds: Forecast Update 31-32
later in the year.
USD Rates Outlook in Q1 33-36 Curves remain mostly directional as do US/EUR
US: Ideal Timing for LT Bullish 37 spreads which have widened in the recent sell-off.
Hedges
US: OIS Firm, Libor Under Pressure 38-39 JGBs continue to partly resist the sell-off in
MBS: 2011 Outlook – Status Quo 40-42 Treasuries. We expect the belly of the curve to
EUR: Flattening Trend Will Resume 43 underperform in the near term.
EUR: Excess Liquidity to Decline 44
Next Week
Sterling remains extremely vulnerable. We expect
EUR: Euribor Red/Greens 45
GBPUSD to target the 1.5300/1.5200 area.
Opportunities
EUR: 2011 EGB Issuance Preview 46-47
USDJPY has not (yet) reacted to the sharp move of the
US curve. A rally is likely if US data remain on the strong
Gilts: Strategic Trades for 2011 48
side.
JGBs: Watch the Corporate Sector 49
Global Inflation Watch 50-53 We expect EURUSD to resume its downtrend going
Inflation: Post Mortem 2010 54-56 into 2011.
Technical Analysis 57-58
IR Strategy: Track Record for 2010 59
FX Strategy 60-65 Market Views
Looking for Value in the North 60-62
Current 1 Week 1 Month
Technical Strategy: USD Rebound 63-64
Tests Resistance UST 10y T-note Yield (%) 3.52 ↔ ↓
Trading Positions 65 2y/10y Spread (bp) 285 ↔ ↓
Forecasts & Calendars 66-80
2 Week Economic Calendar 66-67
EGB 10y Bund Yield (%) 3.06 ↔ ↓
Key Data Preview 68-74
2y/10y Spread (bp) 199 ↔ ↓
4 Week Calendar 75 JGB 10y JGB Yield (%) 1.28 ↔ ↔
76-77
Treasury & SAS Issuance 2y/10y Spread (bp) 105 ↔ ↔
Central Bank Watch 78
Economic & Interest Rate Forecasts 79
Forex EUR/USD 1.3218 ↓ ↓
FX Forecasts 80
USD/JPY 84.30 ↑ ↑
Contacts 81 IMPORTANT NOTICE. Please refer to important disclosures found at the end of
this report. Some sections of this report have been written by our strategy teams
(shown in blue). Such reports do not purport to be an exhaustive analysis and may
be subject to conflicts of interest resulting from their interaction with sales and
www.GlobalMarkets.bnpparibas.com trading which could affect the objectivity of this report.
Market Outlook
Further capitulation by Analysing the bond market sell-off has not been an easy exercise and, going
bond markets into the year-end, it remains unclear whether we have seen a fundamental
shift or an overdone correction – the reality probably lying in between. As
discussed in last week’s Market Mover, the recent sharp sell-off reflects a
mix of bad positioning, central bank and political news (US fiscal deal),
better economic data (except US payrolls) and year-end market conditions.
The difficulty lies in attaching weights to these different factors but, so far,
the QE2 sell-off looks similar to the QE1 sell-off seen in the spring of 2009.
The recent market action and the risk that upcoming data will continue to
surprise to the upside indicate that the lows in yields are behind us (see our
updated forecasts in the “Forecasts & Calendars” section). However,
although it may remain tough to fight the reflation trade going into 2011, the
big picture still favours a low-yield environment. The economic picture does
not look as bad as it did six months ago but the US output gap continues to
be unusually wide, final demand growth has been lacklustre and the
economic recovery faces substantial headwinds. In addition, underlying
inflation is very weak and will remain so for some time – the trough on core
inflation is still to come. Against this backdrop, policy rates will remain
exceptionally low in 2011 with QE2 targeting a rise in inflation expectations.
Both Real and Nominal Yields Should Drop in Q1

RY co re
3 .0 5 .5
3 .0 C ore , 6m th a hea d
C o re C P I, L H S
2 .5 5 .0
2 .5
4 .5
2 .0
U S 1 0y N o m in a l
2 .0
4 .0
1 .5
3 .5
1 .5
1 .0
3 .0
1 .0
0 .5 1 0y R e al Y ie ld
2 .5
0 .5 0 .0 2 .0
-0 .5 1 .5
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Ja n-0 3 J a n-0 5 J an-0 7 J an-0 9 Ja n-11
Source: BNP Paribas
The different measures of inflation expectations indicate that there has not
(yet) been a fundamental shift in expectations. The US 5y5y forward
breakeven has been rising over the past couple of months while the EUR
one has fallen but both remain in the ‘neutral’ zone. The flat(er) 10/30y
spreads in both the US and Europe also support this view.
Risk appetite remains solid Risk appetite remains solid and is still supported by ample global liquidity
conditions. Some recent data suggest that investment funds have been
switching their allocation from bonds to stocks. But, despite the collapse of
the bond market, there has been no acceleration of the bullish momentum in
equities. This highlights that, beyond some asset switches, the bond market
sell-off has, so far, more to do with wrong positioning − the latest surveys
suggest that the market may have to sell off more before reaching a turning
point. This probably also indicates concerns about possible political
decisions, rising inflation pressures in the emerging world as well as a
decoupling between the main western equity indices and the domestic
economy (household confidence) which is unlikely to last.
Looking for signs of a Overall, judging from the very poor liquidity in the bond market, year-end
stabilisation on Treasuries pressures to cut balance sheets appear to be a significant factor
exacerbating the recent move on Treasuries. The move so far has been
primarily cash driven but, over the past couple of sessions, the attendant
Cyril Beuzit 16 December 2010

Market Mover 2 www.GlobalMarkets.bnpparibas.com
swap spread widening indicates that convexity hedging flows have also
Early 2011 buying played a role. Peak mortgage negative convexity is in the 3.25 to 3.50%
opportunities range, which suggests that we may have seen most of the adjustment. From
this point onward, convexity flows should become a more modest force. With
mortgages finding support, the Treasury market should also become less
volatile, which should mark the beginning of the end to this sell-off.
Both the 2y and the 5y parts of the curve have cheapened on a forward
basis to levels close to the top end of their ranges of the past two years. For
instance, the 5y5y rate is around 5.28% within 20bp of the top since end-
2008. Therefore, the belly of the curve will offer a buying opportunity… but
probably not before the year-end.
In Europe the focus will remain on peripheral markets in coming weeks with
Renewed stress on EMU a big question mark about demand for early 2011 auctions (see “EUR: 2011
peripherals EGB Issuance Preview”). Spreads remain off their November highs but
renewed tensions look likely with Moody’s putting Spain’s rating on review
for a possible downgrade. It is unclear exactly how much progress will be
made towards deciding on a permanent rescue framework at the EU Heads
of State Summit given the extent of the divergence in views among the
individual EU members.
We remain neutral on EGBs going into 2011. Regarding the curve,
directionality is less significant on rebounds, as the short end has some
potential to rally at current levels of yields and the long end is still under
pressure in line with the Treasury market. This leads us to see the near-term
bias for the curve as neutral to slightly steeper − receiving the 2-10y will be
one of our key strategic trades for 2011.
JGBs are still The JGB market continues to follow the global bear trend in bond prices,
outperforming in the with the 10y yield now just below the psychologically important 1.3% level.
Correction pressures appear to have abated slightly, however, with many
sell-off investors prepared to buy into weakness at current levels. The super-long
sector has moved back into its historical range and the 10y sector has also
experienced a significant sell-off. Much is now likely to depend on the extent
to which yields rise for the short- to medium-term JGBs that constitute the
core of banks' bond portfolios.
The BoJ Monetary Policy Board will meet on Monday and Tuesday (20-21
December), but is not expected to announce any new measures. Monetary
policy still looks likely to remain highly accommodative for quite some time to
come and JGB market participants will therefore be focusing most of their
attention on rising stock prices (fuelled by an improvement in economic
sentiment) and the move in overseas rate markets.
Sterling is now in an extremely vulnerable position as the negative mix of
GBP is at risk higher inflation and slower growth dynamics in the UK economy leave the
BoE in a difficult position. Indeed, the sharp spike higher in the BoE’s
Inflation Expectations Survey is a particular concern suggesting that sterling
is now set to come under increasing pressure. We see GBPUSD as at
significant risk as the US continues to produce positive data surprises which,
together with the rise in yields, is providing the USD significant support. We
expect GBPUSD to target the 1.5300/1.5200 area.
However, it is interesting to note that USDJPY, which is traditionally the
USDJPY to push higher currency pair most closely correlated with the US yield curve, has remained
in a range over the past couple of weeks despite the sharp rise in yields.
This seems to be the result of Japanese investors’ continued hedging of
their bond portfolios. However, if US data remain strong, this could be
enough to encourage investors to unwind their hedges, triggering a sharp
move higher in USDJPY.
EURUSD to resume its The EUR is also expected to remain weak as the latest data provide further
downward trend evidence of increasing economic divergence within the eurozone. We expect
EURUSD to extend the major down trend into the end of the year and
through the first half of 2011 with the USD set to embark on a broad-based
rebound.
Cyril Beuzit 16 December 2010
Global: Fire and Ice
requirements and credit restrictions), perhaps fearing
Some say the world will end in fire, some the currency implications of rate increases. Specific
say in ice. experiences vary from country to country, but the
The pendulum is swinging between these broader theme seems the same across emerging
two extremes. markets, from Turkey to China, including Brazil.
Market attention may shift from fears that How will it play out? Our take: global liquidity remains
things are getting too cold in developed abundant, with policies accommodative in the
economies… developed world. Capital flows to emerging markets
remain strong. Pressures for FX appreciation in EM
…to worries that things are getting too hot
persist. But EM policymakers are resisting these FX
in emerging markets.
pressures, and many EM central banks are falling
The problem is that policy stimulus in behind the curve. Policies remain too loose for too
developed economies is fuelling overheating in long. Inflation pressures are building across EM. The
emerging markets, which are resisting FX question is how policymakers will ultimately respond.
appreciation.
In all, market attention may well swing from fears that
things could get too cold in developed economies to
To quote from a poem by Robert Frost, “Some say worries that things are getting too hot in emerging
the world will end in fire, Some say in ice.” Earlier in markets. No one wants a repeat of the great
the year, observers feared that things might get too depression of the 1930s. But the inflationary 1970s
cold in developed economies. But as double-dip were not that great either.
fears fade, attention may shift to concerns that
emerging markets are getting too hot. Ultra-loose Hell is other people
policies in developed economies are fuelling capital At the heart of this ice-and-fire global policy dilemma
flows into emerging markets. But as EM are the tensions between what is seen as best for
policymakers are resisting FX appreciation, inflation developed economies at the current stage of the
pressures will intensify if central banks fall behind the global business cycle and what is seen as best for
curve and let their economies overheat. In all, are we emerging markets – especially when countries fail to
moving from concerns of recession ice in developed fully consider the global implications of their
economies to worries of inflation fire in emerging individual choices. In that context, each country
markets? thinks it is pursuing its own best interests, oblivious
to international spillovers. Hell is others.
Hot and cold
The cold front from the North seems mostly behind The US judges it is doing what is best for the US
us now. Earlier in the year, many feared a double dip economy (QE). If others (such as China) don't let
in growth performance, particularly in the US. their currencies appreciate against the USD, that is
However, in part on the heels of further policy their problem. For the US, the problem is lack of FX
accommodation in developed economies, global flexibility in EM. My currency, your problem. Hell is
growth seems to be finding a better footing. Double- emerging markets.
dip fears have faded, notwithstanding concerns
about sovereign risk in some eurozone economies. By contrast, EM policymakers judge they should not
just allow ultra-loose monetary conditions in
But the Fed's monetary easing is affecting markets developed economies to fuel bubbles in their
well beyond the US. Along with a weaker USD and markets. Emerging market countries do not want FX
rising commodity prices, capital flows to emerging to appreciate beyond what they judge is consistent
markets (EM) have intensified. The resulting with fundamentals. They cannot – and will not – allow
currency appreciation across emerging markets has their policies to be dictated by Washington DC. Hell
prompted policymakers to introduce measures to is the US.
cool these inflows, and to tighten monetary policy by
less than domestic demand considerations in EM As often in economic debates, there is some truth on
alone would dictate. In many cases, EM both sides. The US is right: it is harder and more
policymakers are increasingly resorting to measures painful to engineer global rebalancing if EM
other than outright rate hikes (such as higher reserve policymakers resist FX adjustment. But EMs are also
Marcelo Carvalho 16 December 2010

right: it is hard to rely on the USD as a reliable Conclusion
reserve currency for the international monetary Market attention may well start to swing from one
system when the cornerstone country is pursuing extreme to the other – from concerns of recession ice
domestic policies which are not optimal for others. in developed economies to worries of inflation fire in
emerging markets. At the heart of the matter: policy
Real FX adjustments tend to prevail in the long run – stimulus in the developed world is fuelling
if not via nominal appreciation, then via higher overheating in emerging markets while EM
inflation. The problem with the inflation route is that it policymakers are resisting currency appreciation. All
is much more painful – and probably more claim that hell is other people.
destabilising.
In a nutshell, can EM policymakers deliver stability

without a credible and steady US policy anchor as
the centre of the international monetary system?
What happens if things fall apart and the centre
cannot hold?
Marcelo Carvalho 16 December 2010

US FOMC: Pricing Out Japan
Chart 1: Rates Rising Rapidly
Bold moves by US policymakers have led
investors to price out the Japan scenario,
suggesting that higher rates are here to stay.
The FOMC confirmed its resolve by
interpreting incoming data conservatively and
signalling its commitment to QE2 in the
December FOMC statement.
That said, we think the FOMC is correct in
being cautious about incoming data. With the
strong patch in spending yet to show reliable
follow-through to job creation, forecasts of
significantly above-trend growth and fears of
Source: Reuters EcoWin Pro
inflation being built into longer-term rates are
probably overdone. Chart 2: Retail Sales Firm, Need Follow-
Through to Jobs
Interest rates continued their steady march higher

after the December FOMC meeting as markets
continued to price out any possibility the US could
get stuck in a Japanese-style scenario. US
policymakers have shown a remarkable commitment
to stimulate the US economy; incoming data
suggests some they are getting some traction. The
FOMC made only minor changes to its policy
statement and stayed the course on QE2. The 10-
year Treasury is up more than 100 basis points since
the announcement of QE2 (see Chart 1). However, Source: Reuters EcoWin Pro
that only puts it back at the levels seen in April, when
the recovery looked to be on a moderate but
reasonably steady track. Meanwhile, equities are up the message from US policymakers has been clear.
more than 3% since the November FOMC meeting They will prevent a Japanese scenario at all costs
and nearly 11% for the year. The rise is helping to and the market is reacting accordingly. This
offset house price declines and keep the recovery in enthusiasm from investors is not without its risks.
household net worth on track. November retail sales Higher rates threaten the recovery in an already-
represented yet another data point suggesting we will fragile housing market and higher headline inflation
get a solid gain in GDP in Q4. We have revised up will erode some of the stimulus. Nonetheless, we
our forecast to 2.6% q/q saar. seem to have left the Japanese scenario behind for
now.
The data flow on balance has been encouraging. But
we have yet to see good follow-through to job There were very few changes to the December
growth, something the FOMC emphasised in its FOMC statement. The Fed chose a conservative
statement. Consumers have maintained a saving interpretation of recent data following the recent
rate just under 6% throughout the recovery. Thus the back-up in the unemployment rate. In November, the
recent data will prove to be a fleeting firm patch FOMC said that information received since the last
unless we see hiring pick up. We think consumer meeting confirmed that the "pace of the recovery in
spending and jobs are likely to meet in the middle, output and employment continues to be slow". In the
with consumer spending growth continuing to post latest statement, it indicated that information received
moderate gains (rather than accelerating) and the since the last meeting confirms that the "recovery is
jobs picture improving gradually. While some of the continuing, though at a rate that has been insufficient
volatility in rates markets owes to technical factors, to bring down unemployment”.
Julia Coronado 16 December 2010

Other changes were also modest. While the Fed economy lacks the cyclical turbo boosters of
previously noted that housing starts continue to be manufacturing, construction and finance that fuelled
depressed, this time it said the housing sector job growth early in prior recoveries; another engine of
continues to be depressed. This broader reference job creation has yet to come forward.
includes the decline in prices we have seen of late.
Having previously said that measures of underlying One encouraging sign on the jobs front came from
inflation have trended lower in recent quarters, this the NFIB survey of small businesses for November.
time it said that these measures “have continued to This reported that a net 4% of small companies are
trend downward”. This perhaps suggests a slightly planning to hire. This may sound small, and it is.
more entrenched dynamic. There were few to no However, it is up from the record low of -10%
changes in the policy paragraphs and the parameters reached in March 2009 and has been rising steadily
of the QE2 programme are virtually unchanged. As in recent months. Small businesses have been
expected, the Fed remains cautious and sought to another sector weighing on the recovery. Thus a
send a signal of steady policy. move into positive territory confirms that the
economy is making headway in its healing process
Retail sales posted a solid gain in November, rising and downside risks are diminishing.
0.8% after an upward-revised 1.7% increase in
October. As shown in Chart 2, gains in consumer
spending have not come at the expense of a lower The pricing out of Japan likely means that higher
saving rate. Therefore any acceleration in consumer rates are here to stay. However, we think the
spending growth will likely be dependent on forecasts of significantly above-trend growth and
continued improvement in the labour market. We fears of inflation being built into longer-term Treasury
expect that to be forthcoming but gradual. The US rates are probably overdone.
Julia Coronado 16 December 2010

US: A Curious Case of Consumer Deleveraging
Chart 1: Net Worth Rose in Q3

The Q3 Flow of Funds Accounts indicate a
pick-up in household net worth. This was driven
by capital gains on equity, partially offset by
losses in real estate wealth on the back of
house price declines. Also boosting net worth
were continued declines in both consumer
credit and net mortgage borrowing.
The recent pick-up in retail spending has
been supported by gradual improvement in the
labour market. However, consumer deleveraging
still represents a speed limit.
Three main factors appear to have
contributed to ongoing declines in revolving
credit: households continue to default on their Chart 2: Real Estate Values Declined in Q3
obligations; they are paying off a larger share of
their balances each month; and they are
financing less of their new spending with credit.
Household net worth rose in Q3 as capital gains

on equity holdings were partially offset by
declines in real estate values
The Flow of Funds Accounts for Q3 released last
week indicated that household net worth rose by
USD 1.19trn to USD 54.9trn last quarter, driven
mainly by capital gains on equity holdings. Broad
equity indices rebounded by 11.1% in Q3 after falling Chart 3: Debt Ratios Continued to Fall
11.4% in Q2 and have advanced roughly 8.5% since
then. This suggests net worth will likely continue
increasing in Q4.
As shown in Chart 1, net worth as a percentage of

disposable income in Q3 – while up from the trough
reached in Q1 2009 – was still below its level at the
end of 2009. Real estate values declined
substantially as the expiration of the tax credit
incentive pushed house prices down in Q3. Much of
the gain in equity prices has thus been offset by
falling home prices in a process that will likely persist
in Q4 (Chart 2).
Measures of consumer financial stress have tenant-occupied property, homeowners' insurance

painted different pictures and property tax payments, has dropped to levels
The US has not experienced a deleveraging cycle last seen in 2000. Meanwhile, the ratio of total
since the Great Depression. However, it is household debt to annual disposable personal
sometimes difficult to calibrate when households will income remained at 1.22 in Q3, not far below its
reach a new equilibrium and be ready to borrow peak of 1.35 at the beginning of the latest recession.
again in the aggregate. The Federal Reserve’s Both measures suggest consumers have improved
financial obligation ratio (FOR), which includes their balance sheets, albeit to dramatically different
automobile lease payments, rental payments on degrees (Chart 3). The FOR probably overstates the
Yelena Shulyatyeva 16 December 2010

progress consumers have made as it assumes Chart 4: Revolving Credit Continues to Decline
consumers can refinance all their debt at current low
rates. We know this is not the case, owing to tight
credit and underwater mortgages. But as some
people have been able to take advantage of low
rates to reduce their debt burdens, the true picture
probably lies somewhere between the two measures.
Consumer credit continues to decline…

Incoming data on consumer borrowing suggest
consumers are not yet content, however, as
borrowing continues to contract. Private sector
deleveraging continued at a rapid pace in Q3. In
particular, household borrowing contracted 1.7% in
Q3 following a 2.2% decline in Q2. Mortgage
borrowing fell by 2.5% after a drop of 2.3%. Chart 5: Charge-Off Rates Remain Elevated
Consumer credit contracted 1.5% in Q3 after falling
3.3% in Q2.
In October, consumers continued to deleverage.

Non-revolving credit growth has picked up lately,
supported by increases in student loans. People
continue to enter university to ride out the difficult
labour market recovery. Spending on autos has also
risen of late, probably accounting for some of the
pick-up. However, revolving credit, which tracks
credit card debt, continued to decline in October; it
dropped by USD 5.6bn (Chart 4).
...even as retail sales improve Source: Reuters EcoWin Pro
Retail sales posted a solid gain in November, rising Chart 6: Pay Down Rates Pick Up
0.8% after an upward-revised 1.7% increase in
October. In addition, consumer confidence, while still
at recessionary levels, has improved of late. The
University of Michigan index of buying conditions for
durables surged to the highest level since January
2008. Ongoing deleveraging suggests that high
saving rates still represent a speed limit, with further
acceleration dependent on improving labour market
conditions.
Three main factors appear to have contributed to

ongoing declines in revolving credit
Consumers continued to reduce their debt, largely by
defaulting on their credit cards. While quarterly Source: Haver Analytics
government data on commercial banks suggest that
charge-off rates on credit cards eased from their all- the beginning in 2007 as economic conditions
time highs reached in Q2, they remain at an elevated worsened, “households began to pay off their card
8.4% of the average loan balance (Chart 5). In fact, debt at a significantly slower pace – a trend that
since the economy plunged into recession in 2008, extended into 2008 and 2009…the drop in the payoff
around 70% of the decline in consumer credit has rate has been more pronounced than in the
been caused by consumer defaults. recessions of 1990-91 and 2000-01” (Chart 6). More
recently, however, this trend has reversed. As of
At the recent Philadelphia Payment Cards Center September 2010, the repayment rate had risen to a
Conference, Fed Governor Elizabeth Duke more typical level. According to Governor Duke, “it
suggested that “accelerated payment rates on could also be attributed to a shift in the composition
existing balances do not seem to have contributed of cardholders in bank portfolios toward more
importantly to the drop in credit card debt outstanding creditworthy borrowers as charged-off accounts were
over the past couple of years”. She argued that, at replaced with new accounts underwritten using

stricter criteria”. Regardless of the cause, consumer Chart 7: Cash-In Refinances Surged This Year
credit is currently being paid down at an aggressive
rate, particularly when one considers that the uptrend
in pay downs between 2003 and 2007 owed in large
part to the substitution of home equity debt for credit
card borrowing. Both home equity and credit card
balances are declining.
Indeed, there has been a recent surge in “cash-in”

refinancing whereby homeowners have been
reducing their principal balances through a
refinancing transaction. This could be the result of
tighter lending standards and declining home values,
with lenders requiring homeowners to reduce their
loan balances to access lower mortgage rates.
However, it stands in stark contrast to the peak of the Chart 8: Demand for Credit Remains Sluggish
housing bubble in 2006 when “cash-outs” (refinances
resulting in loan amounts that were at least 5%
greater than the amortised unpaid principal balance
of the original loan) accounted for almost 90% of all
refinancing transactions. As the housing bubble burst
and home values dropped, the cash-out ratio
dropped to 18.5% as of Q3 2010 – the lowest level
since Freddie Mac records began in 1985. In
contrast, the proportion of cash-ins surged to 33% in
Q3 (Chart 7).
Some of the deleveraging can be attributed to a

reduction in new borrowing. According to the Federal
Source: Haver Analytics
Reserve Board’s quarterly Senior Loan Officer
Opinion Survey, despite a modest easing in lending Chart 9: Supply Factors Also Limit Credit
standards, demand for consumer loans remains Increases
weak (Chart 8). According to the quarterly report on
household debt and credit from the New York Fed,
the number of inquiries for new consumer credit is
significantly down from its pre-recession levels (Chart
9 – I).
Supply factors have also likely contributed to the

decline in overall credit card outstanding balances.
Households may be charging less because they had
less credit available. Indeed, the same survey shows
a significant decline in credit card limits since the
peak in mid-2008 (Chart 9 – II).
The relationship between consumers and credit is Source: Reuters EcoWin Pro
undergoing a fundamental change. While a solid
holiday shopping season should help keep the
recovery on track, there are no indications that credit
will soon become the accelerator it once was.

ECB: Room at the Top
Table 1: Executive Board Members
The ECB will have a new president from the
beginning of November 2011.
Name Nationality Term Ends
As the process of choosing a new president J-C Trichet France President 31/10/2011
is lengthy, speculation over who it will be could V Constancio Portugal V/President 31/05/2018
continue for some time yet. G Tumpel-Gugerell Austria Member 31/05/2011
J-M Gonzales-Paramo Spain Member 31/05/2012
A German president remains the most likely
L Bini-Smaghi Italy Member 31/05/2013
outcome, with Axel Weber the front runner. But
J Stark Germany Member 31/05/2014
alternative candidates are also in the frame. Source: ECB
Uncertainty over the change of leadership,
plus increased divergence within the eurozone, Table 2: Timetable for Naming the New ECB
implies a more uncertain policy outlook. President
Steps Likely timing
Heads of State discussions May-June 2011
The structure European Council official approval of
Candidate June-July 2011
The Governing Council of the ECB is made up of six
Executive Board members and the heads of each of ECB expresses opinion July 2011
the national central banks (NCBs) in the eurozone. Monetary & Economic Affairs Commission
The number of NCBs currently stands at 16 but will of EU Parliament hears the candidate September 2011
expand to 17 from the start of 2011 when Estonia EU Parliament expresses opinion September 2011
joins the eurozone. European Council formal nomination September 2011
New ECB President takes up duties 1 November 2011
The six members of the Executive Board of the ECB
serve a non-renewable eight-year term. They can be Source: BNP Paribas
removed only in the case of incapacity or serious

misconduct. The names of the current members are Table 3: Governing Council Membership
in Table 1, along with the expiry dates for their terms.
Jean-Claude Trichet’s eight-year term as president of Total Number of % of % of

the ECB will expire on 31 October 2011. Choosing Country NCB Head GC Members Members Capital Key
his replacement may be a lengthy process (Table 2). Germany A Weber 2 9.1 27.1
Who will get the job, when we will find out and what France C Noyer 2 9.1 20.4
this means for future policy are obviously a source of Italy M Draghi 2 9.1 17.9
Spain MF Ordoñez 2 9.1 11.9
considerable interest for markets.
Netherlands N Wellink 1 4.5 5.7
Belgium G Quaden 1 4.5 3.5
The nomination process Greece G Provopoulos 1 4.5 2.8
According to the ECB statutes, the members of the Austria E Nowotny 2 9.1 2.8
Executive Board should be persons of "recognised Portugal C Costa 2 9.1 2.5
standing and professional experience in monetary Finland E Liikanen 1 4.5 1.8
Ireland P Honohan 1 4.5 1.6
and banking matters" (Article 283 of the EU Treaty,
Slovakia J Makuch 1 4.5 1.0
effective since the ratification of the Lisbon Treaty). Slovenia M Kranjek 1 4.5 0.5
The Executive Board members are chosen by the Luxembourg Y Mersch 1 4.5 0.3
European Council, voting on a qualified majority Cyprus A Orphanides 1 4.5 0.2
basis, on the recommendation of the Council and Malta M Bonello 1 4.5 0.1
after the European Parliament and the Governing Source: ECB, BNP Paribas
Council of the ECB have expressed their opinions.
The timetable for choosing Mr Trichet to be president of July, the ECB had adopted a positive opinion on
of the ECB back in 2003 offers a template for how his nomination. The European Parliament approved
the procedure will evolve this time. Mr Trichet’s term the choice on 23 September, less than two weeks
began in November 2003. The European Council after the EU Commission for Economic and Monetary
officially chose him in mid-July that year. By the end Affairs had heard the candidate.
Dominique Barbet/Ken Wattret 16 December 2010

On the basis of the 2003 timetable, it is most likely Box 1: ECB Governing Council - Voting Rights
that the new president of the ECB will be chosen at
the Heads of State and Government meeting in May The principle for voting at the Governing Council is one
member, one vote. However, with the increasing number
or June next year. It is likely that the nomination will of new eurozone members, the ECB has secured specific
seep through to the public domain before this as the voting rules insuring that no more than 21 people take
European Council will want to ensure the candidate part in the voting (the voting system is described in the
has sufficient support beforehand. Negative opinions Article 10 of Protocol 4 annexed to the EU Treaty).
from the ECB or the European Parliament would not
Since January 2009, the number of eurozone member
necessarily block the appointment but would be very
states has exceeded 15 and the new set of rules can
damaging to the authority of the proposed president apply. However, the Governing Council can decide to
and to the credibility of the ECB. stick to the simple one member one vote system as long
as the number of member countries remains below 18.
An earlier indication of who will be the new president
is also possible. This is because the term of current The system works as follows:
Executive Board member Mrs Tumpel-Gugerell will Every Executive Board member always has a voting right.
come to an end in May next year, so a successor will
The Governors of the NCBs in the main five countries
have to be nominated soon. This could be discussed
have at least four permanent voting rights. The main five
as soon as the EU Summit on 16-17 December. countries are defined according to two criteria: the size of
GDP (with a weighting of 5/6); and the size of the national
The nationality of the proposed successor to Mrs financial system (for the remaining 1/6 weighting). The so-
Tumpel-Gugerell may be an indication of the likely called first group is currently composed of Governors from
nationality of the new president. Media reports have Germany, France, Italy, Spain and the Netherlands.
suggested that Germany and France will discuss the
The second group is composed of the Governors from the
choice of the new Executive Board member and the other central banks and they share the remaining 10 or 11
new president in tandem. The suggestion is that a vote rights on a rotating basis. The frequency of rotation
deal could be struck in favour of the ECB president of the first group cannot be lower than that of the second
being German as long as a France national fills the group. As a result the first group currently has 5 voting
vacancy on the Executive Board, replacing Mrs rights and the second group only 10. From January next
Tumpel-Gugerell but with a high-profile portfolio year, 10 of the 12 members of the second group will have
th
(such as the responsibility for economic analysis). a voting right. Only when an 18 country joins EMU will
the first group lose the fifth voting right it currently holds.
The role of ECB president Different rules, with three groups of Governors, will apply
The ECB president has just one vote like the other from the day the monetary union reaches 22 member
members but has considerably more influence given countries. These rules are also defined in Article 10. They
his or her position in setting the agenda and chairing are intended to prevent the voting rights of the largest
countries being overly diluted as the monetary union
the Governing Council meetings. The ECB president
expands its membership.
is obliged to present and explain the policy decisions
of the Governing Council in the press conference that
follows the policy-setting meetings (which usually Source: EU Treaty, effective since the ratification of the Lisbon Treaty
occur on the first Thursday of each month). This is a
key part of the job and an important issue for who is
chosen – discussed below. What we know is that both previous presidents were
experienced heads of national central banks at the
The president also has to deliver a testimony, and time of their nomination. Having run a central bank is
answer questions, in the European Parliament twice an obvious advantage. But it is not a necessity.
a year. He or she will usually attend the meetings of
finance ministers of the eurozone, an opportunity to Nationality is probably the more important issue. The
make recommendations to finance ministers about presidency of the ECB has not been held by the
other aspects of economic policy. One of the features largest economy, Germany, which is one reason why
of Mr Trichet’s ECB presidency has been less public the initial focus of speculation over who will be the
disagreement between the two camps. new president centred on the Bundesbank’s current
president, Axel Weber.
Who is in the frame?
In theory, any person from the eurozone who meets At the time of writing, we see four main scenarios for
the relevant criteria can be president. But in practice, the choice of the new president of the ECB which we
choosing a President is a complicated process given discuss in turn below. The probabilities which we
the horse-trading between member states over the have attached to each outcome are very fluid given
key roles and responsibilities within the eurozone. the political nature of the decision.

Scenario 1: Axel Weber (40%) Board until his or her current term had expired. A
former Executive Board member could, however, be
The initial front runner for the position and a very nominated to be president.
credible candidate in many respects, Mr Weber has
the requisite experience of having running a central Other high-profile German nationals have also been
bank, is a highly respected economist and is, of floated as possible candidates, including the current
course, German. The suggestion is that, should Mr CEO of the EFSF, Klaus Regling. He has extensive
Weber secure the presidency, the current Executive experience in the financial sector, including at the
Board member Jürgen Stark would then return to the German Finance Ministry and the IMF. But he has
Bundesbank to become its new president. not run a central bank, or even had a senior position
at a central bank, which is an issue. Another is the
There have never been two people from the same practical constraint of his current role at the EFSF.
country on the ECB Executive Board simultaneously,
though there is no formal obstacle to this happening. The implication of the probabilities attached to the
Indeed, as Table 3 highlights, the larger countries are first two scenarios is that we believe it is more likely
under-represented in relation to their contributions to than not that a German will be the next president of
the ECB’s capital. the ECB. But it is not a done deal. Another member
state of the eurozone may yet take the top job. This
At one stage, a Weber presidency was perceived by leads us to the third scenario…
some to be a ‘done deal’, with Chancellor Merkel a
strong supporter of his candidacy. It has looked less Scenario 3: A Compromise Candidate (20%)
of a certainty recently, however, related in part to Mr
Weber’s tendency to express a different view to that Contrary to perceptions before the formation of the
of the Governing Council as a whole. His dissent has ECB that its first president would be a German, the
been most vocal in relation to the Securities Markets job went to the Netherlands. The head of the Dutch
Programme (or SMP). central bank, Wim Duisenberg, got the job, though
only for half a term (i.e. four years). Germany took
His reputation as a ‘hawk’ is also a concern for the the role of Chief Economist for the highly influential
countries in most economic and financial distress Otmar Issing.
given the potential implications for future monetary
policy. The reservations over Mr Weber have led to Mr Duisenberg was a compromise option. He was a
speculation of an alternative outcome… highly experienced central banker, from a core
member state and sufficiently hawkish to placate
Scenario 2: Another German (20%) Germany.
Germany feels that, as the largest economy in the Such a compromise option is also possible this time.
eurozone, it is its turn to hold the ECB presidency. If Indeed, there is a long tradition in Europe of a ‘small
Mr Weber is too controversial a candidate, then an country’ compromise candidate emerging late in the
option would be for another German to take the role. day when there has been insufficient support for the
A potential alternative is the current ECB Executive ‘big country’ front runner. It happened only recently
Board member Jürgen Stark. Though he has never with the choice of Herman Van Rompuy as president
been the head of a central bank, he has extensive of the EU Council.
experience in senior roles at the Bundesbank and the
ECB.
As the outgoing president is French, another French
His candidacy, however, is complicated by a couple national is highly unlikely to secure the role. To some
of issues. First, his reputation as a policy hawk. If this extent this also applies to the Netherlands, given the
is an obstacle to Mr Weber securing the position, nationality of the first ECB president. Would it really
then the same reservations may apply to Mr Stark. be fair that a country representing just 6% of total
However, as he has not showed the same degree of eurozone output accounted for two of the first three
public dissent as Mr Weber, he is probably viewed as ECB presidents? This would seem to rule out the
more of a team player. A second problem is his role current head of the Netherlands central bank, Nout
on the Executive Board. His eight-year term does not Wellink, who would otherwise be seen as a credible
expire until mid-2014. While responsibilities within candidate for the compromise option.
the Executive Board can be switched around, starting
a new term as the president is a different issue. That the newly appointed vice president of the ECB,
the former head of the Central Bank of Portugal, Mr
Our understanding, having spoken to the ECB, is that Constancio, is from southern Europe is an additional
it would not be possible to nominate an existing complication. This makes it more likely that the new
Executive Board member for another position on the president will be from a northern European country, a

key reason why Germany apparently pushed hard for Tough call
Mr Constancio to get the job of vice president. Given the issues highlighted above, predicting who
will get the job is not straightforward. Weighing up all
With so many member states seemingly out of the the information available, our bottom line assumption
running, this has led to speculation that the current is that the most probable outcome is that the next
head of Finland’s central bank, Mr Liikanen, could president of the ECB will come from Germany. We
become the next president of the ECB. He has the are aware that Mr Weber’s candidacy has been
requisite experience of running a central bank and is damaged by his outspokenness. But given the lack of
from a ‘neutral’ part of the eurozone. He also worked practical alternatives, we still believe that a Weber
for the European Commission from 1995 to 2004, so presidency is the single most likely outcome.
has plenty of EU experience.
It is unlikely in our view that the next president of the
But is he the right fit given the specific requirements ECB will come from southern Europe. This is not a
of the role? Mr Duisenberg often struggled in dealing refection of Mr Draghi’s candidacy. As stated above,
with the media. The position of ECB president needs his credentials are impressive. Rather, it reflects the
someone who can deal effectively and comfortably politics of the eurozone.
with a bombardment of questions on a variety of
issues very shortly after the conclusion of what are Policy implications
likely to be, given increasing divergence within the
An obvious worry is that if a German with a hawkish
eurozone, difficult discussions on the Governing
reputation takes the presidency, this will lead to a
Council. Does he have the experience required to
tighter than otherwise monetary policy stance – much
steer the Governing Council in these difficult times?
too tight potentially for the periphery. This is more of
The same question marks also apply to other ‘small a concern now than in the past. In the early days of
country’ names which have periodically cropped up EMU, the German economy struggled. Now, it looks
in speculation, largely centred on Benelux countries. structurally strong. The unemployment rate is at its
One could argue, however, that these countries are lowest in almost two decades and skill shortages in
already over-represented in senior EU positions. fast growing sectors risk generating upward pressure
on labour costs and inflation.
The best compromise option would be for Mr Trichet
to stay in the role. The advantages of continuity in While the ECB sets monetary policy for the eurozone
these highly uncertain times are obvious. How about as a whole it is reasonable to assume that members
extending his term for another four years, say, given of the Governing Council will be influenced by what is
the exceptional circumstances? There are, however, happening in their own countries or those near by.
procedural obstacles. The terms of Executive Board There is some historical experience of this in respect
members are non-renewable which would appear to of German influence on ECB policy.
rule this option out.
That the German economy was going strong in early
The nationality of the current ECB vice president is 2008 – GDP surged by over 5% annualised in Q1 –
one of the obstacles in the way of the last of our four and wage pressures were building, were contributory
scenarios… factors behind the ECB’s decision to raise rates in
July 2008 in the eye of the financial storm. Germany
Scenario 4: Mario Draghi (20%) had pushed hard – rightly, in our opinion at the time –
for a faster pace of tightening in 2006 and 2007 and
In a number of respects, Mr Draghi is a very credible this frustration was instrumental in the decision to
candidate for the ECB presidency. He ticks many of hike in summer 2008.
the most important boxes. He has been a highly
effective head of the Banca D’Italia, is the president Germany was also highly influential on policy in the
of the Financial Stability Board, earned a doctorate in early 2000s but in the other direction. Taylor Rule
economics from MIT, worked at the World Bank for analysis suggests that rates were low in relation to
many years and unlike most of the candidates, has eurozone needs in the early years of EMU (Chart 1),
extensive private sector experience also. when the German economy was performing poorly.
This contributed to the formation of asset price
In contrast to some on the ECB Governing Council, bubbles in other countries which have now burst with
he has kept a remarkably low profile in his near five- such devastating consequences.
year spell running the Banca D’Italia. A key issue in
the way of his candidacy is the national politics More divided
associated with choosing the leadership of the ECB. ECB policy is not determined by the president alone.
Having two Southern Europeans at the helm is not But inasmuch as the president shapes the agenda
acceptable for some. for Governing Council meetings and is influential in

determining how the decisions will be made – on the Chart 1: ECB Policy & Taylor Rule
basis of consensus-building like Mr Trichet, on the 7.0
basis of simple voting or guided more strongly by the
6.0
Executive Board – the choice of the new president is
5.0 Eurozone
highly significant. The president’s style is also going
to be important when it comes to how the ECB will 4.0
interact with other policymakers, like governments, 3.0
during a crisis. 2.0

ECB Refi
1.0
A less consensus-driven approach could result in a 0.0
more responsive ECB, with faster decision-making.
-1.0
But it could also lead to more dissent if members of
-2.0
the Governing Council feel frustrated that they are 98 99 00 01 02 03 04 05 06 07 08 09 10
not being heard. Looking ahead, with the eurozone
looking increasingly divergent growth-wise, greater Sources: Reuters EcoWin Pro & BNP Paribas
dissent and a higher degree of difficulty in forging a
consensus are to be expected. This implies a need Chart 2: ECB Policy & Lending Growth
for strong leadership - but preferably a leadership 5 .5 13
12
style which can persuade the Governing Council to 5 .0 Ban k Len ding (% y/y, 18M th Lag R H S )
11
stick together rather than creating dissent. 4 .5
10
4 .0 9
Shifting to second 3 .5 8
7
3 .0
A likely consequence of a German presidency would 2 .5
6
5
be an increased emphasis on the second pillar of the 2 .0 4
ECB’s monetary policy strategy – monetary analysis. 1 .5 3
If ECB policy were to become less sensitive to short 1 .0 E C B R efi R ate (% )

2
1
run determinants of inflation (e.g. the balance of 0 .5
0
supply and demand) and more sensitive to medium- 0 .0 -1
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
term trends as signalled by the money and credit
analysis, this would also lean towards higher ECB Sources: Reuters EcoWin Pro
policy rates earlier.
Broad money and credit growth rates are not normal those most keen on ‘normalisation’, including from Mr
at present but they are in the process of normalising. Weber and Mr Stark, were leaning.
If this continues, growth rates will look increasingly
out of kilter with the emergency level of policy rates Forecast implications
currently in place (Chart 2). Our forecast remains for the refinancing rate to stay
at 1% until spring 2012, consistent with low domestic
There is also likely to be a greater tendency at a price pressures and subdued growth in the eurozone
German-run ECB to 'lean against the wind' when it as a whole. Market developments will also be key to
comes to potential asset price bubbles. This was a maintaining policy accommodation, as was evident in
prominent theme of Mr Stark’s contributions to the the recent decision to maintain full allotment for all
ECB’s conference last month on the causes and refinancing operations through Q1 2011.
consequences of the global financial crisis. In this
context, the speeches of Mr Weber suggesting that Looking to the longer-term, under Scenarios 1 and 2
the costs of too late an exit from monetary policy the bias would be towards tighter policy and a flatter
accommodation would be greater than the costs of yield curve. Under Scenario 4, this is also possible.
too early an exit are also significant. With the ECB led by southern Europeans there could
be a desire to reinforce the anti-inflation credibility of
Another salient issue given recent developments is the ECB by raising interest rates earlier and more
how sensitive, or otherwise, a German-led ECB quickly than otherwise.
would be to problems in the peripheral economies.
From a purely arithmetical perspective, the solidity of The bottom line is that we are entering an uncertain
the core member states is far more important than era for ECB policy. The vice president is new to the
the problems in the periphery. The combined output job and all members of the Executive Board will see
share of Greece, Ireland and Portugal is around 6%, their terms expire within two and a half years of the
less than a quarter of that for Germany alone. An next president taking up the role. Add the increased
increased emphasis on the solidity of the core was, internal divergence to the mix and forecasting ECB
until recently, the direction in which the speeches of policy is unlikely to be straightforward.

UK: HMS QE2 Sunk Before It Was Launched
Chart 1: BoE CPI Inflation Forecasting Error 2-
We have changed our Bank of England Years Ahead
monetary policy forecast.
Given higher than expected inflation and the
threat this poses to inflation expectations, we
no longer expect the Bank to engage in a
second round of quantitative easing.
Given our view that GDP will grow much
more slowly during 2011 than the BoE’s central
projection, we still believe that the first interest
rate hike is a long way off (2012).
Nonetheless, if inflation expectations rise
abruptly and upside risks to wage inflation
Source: Reuters EcoWin Pro, BoE
emerge, there is a risk that the BoE will hike
Bank Rate during 2011.
End-of-year appraisal
Given the time of year, it is worthwhile assessing
Enough is enough what the BoE has done well and what it has done
We have revised our BoE monetary policy forecast. badly. To its credit, QE1 worked. The economy has
We had expected downward surprises on GDP recovered more swiftly than expected and
growth during 2011 to provoke a downward revision unemployment is lower than feared. Contrary to
to the Bank’s medium-term inflation outlook, opening concerns that the economy might flirt with the risk of
the door to a second phase of quantitative easing. deflation, the UK seems about the furthest from
However, Tuesday’s upward surprise on inflation was deflation of the industrialised economies.
the final nail in the coffin.
However, what the BoE hasn’t done particularly well
CPI inflation accelerated by 0.1pp to 3.3% y/y, is forecast inflation. Chart 1 shows where inflation
contrary to earlier indications that we might have has actually been compared with the BoE’s
seen a slight deceleration. It was a bad number projection 2 years earlier. The shaded bars show that
which is only likely to get worse in the coming it is incredibly rare for inflation to be lower than the
months. Rising utility bills and petrol prices will add to Bank projects. In fact, on average inflation has been
inflation in December, before the VAT hike to 20% around 0.75pp points higher than the Bank’s
pushes inflation even higher in January. We had projection. Given this, there should be a tendency for
expected CPI inflation to peak at 3.6% y/y in the Bank to aim a little higher at the medium-term
February. However, following this week’s surprise, horizon.
the peak is likely to be 3.8% y/y with a significant risk
of 4% y/y. US lessons
The key reason the BoE hasn't begun QE2 already is
There have been persistent upward surprises on worries about inflation expectations. If inflation stays
current inflation over the last two years. While it is above 2% for a long time, people will doubt it is truly
typically the medium-term outlook for inflation that aiming at 2%. If we go to 4%, they definitely won't
matters most for BoE policy, near-term inflation is believe it.
posing an ever-bigger threat to inflation expectations
and wages – with implications for inflation further Also, the Bank will have learned from the Fed's
ahead. The fact remains that around 1pp of current experience that QE can have a perverse effect on
inflation is related to increases in indirect taxes bond yields through inflation expectations, with
including VAT. The latter will eventually drop out of breakevens having risen considerably since
the y/y calculation. Nonetheless, when this happens Bernanke made his Jackson Hole speech (by around
(in 2012), the likely undershoot relative to target is 50bp). Rising inflation expectations are the last thing
looking more and more marginal as time passes. the BoE needs.
Alan Clarke and Paul Mortimer-Lee 16 December 2010

Nominal GDP has been increasing at close to a 6% Conclusion
y/y pace over the last year, and it is questionable Despite our view that GDP growth will disappoint
whether the Bank would want to boost this further. expectations during 2011, the obstruction to further
The labour market in recent months has seen very QE now looks too big. Hence we no longer expect
good job growth, and there is anecdotal evidence of QE2 to be launched. We continue to believe that
pay freezes being less widespread than before. disappointing growth will prevent the first interest rate
Wage growth will probably pick up. hike from being delivered any time soon (not until
2012). In particular, the Bank has aimed high with
Faster-than-expected inflation seems to reflect to an regard to near-term inflation. Nonetheless, if inflation
important degree a bigger pass-through of the expectations do rise appreciably and there are signs
exchange rate shock from sterling's depreciation. that this is pushing wage inflation higher, there is
Why has this happened? It could be that inflationary clearly a risk that the MPC begins to tighten policy
expectations have held up better than normal, during 2011.
possibly as a result of BoE policy. It may be that the
output gap is a lot smaller than the fall in output
might suggest. Neither argues for more QE.
Alan Clarke and Paul Mortimer-Lee 16 December 2010

SNB: Governing Two Economies
As widely expected, the SNB left the policy Chart 1: SNB Policy Rates
target unchanged in December.
The central bank remains extremely
sensitive to the strength of the franc and the
stress in the euro area periphery.
The SNB continues to expect a marked
slowdown in the coming quarters and has
revised its inflation forecast down further.
We think growth will surprise to the upside
but a hike as soon as March looks very
challenging.
The timing of the first hike remains Source: Reuters EcoWin Pro
dependent on the exchange rate.
Chart 2: SNB Inflation Forecasts
As widely expected, the SNB left the policy target
and band unchanged in December. The strength of
the franc continues to delay policy normalisation.
The dilemma for the SNB is setting a single policy
variable for two sectors of the economy that are
experiencing very different monetary conditions. For
the domestic economy, policy looks too loose. But
monetary conditions are tight for exporters. The two
sectors’ performance will diverge accordingly –
domestic demand will contribute more to growth than
in the past, net trade less.
If any of the franc’s current strength reflects rate hike Source: Reuters EcoWin Pro
expectations, the SNB clearly doesn’t want to
validate them. Despite the strength of the economic preferred gauge of core inflation – dynamic factor
data since the last meeting, the SNB continues to inflation – which rose from 0.1% y/y in October 2009
expect a marked slowdown in growth in 2011. to 1.0% last month. Shorter-term measures of
momentum in the GDP deflator are also picking up.
The monetary authority expects growth to slow to
1.5% in 2011 from 2.5% this year. We see risk to the With the franc delivering monetary tightening
upside of that 2011 forecast (we have 2%). Sectors independent of SNB policy, the outlook for policy is
focused on the domestic market are in a strong dependent on the outlook for the exchange rate.
position to respond to the SNB’s zero interest rate Were the franc to depreciate significantly, then given
policy – employment growth is rising and neither the the strength of domestic fundamentals, we would
private nor public sector is characterised by the expect the SNB to hike. But if the franc stays strong,
imbalances evident in many parts of Europe. In the first increase will come later as the SNB awaits
addition, while net trade should contribute less to further evidence on the robustness of the economy.
growth on the combination of a strong franc and Since July, we have had the first hike in March 2011.
robust domestic demand growth, Swiss exports will That now looks very challenging, particularly given
benefit vibrant emerging-market demand. the subdued level of the SNB’s medium-term inflation
The SNB also revised down the medium-term forecast. It is also tricky to think of reasons to expect
outlook for inflation further. 2012 inflation is now the franc to soften between now and then; there are
expected at 1% rather than 1.2%. We are less widespread expectations of an escalation in market
sanguine about medium-term inflation. With a smaller tensions early in 2011 when a large amount of euro
output gap than elsewhere in Europe (we put it at area sovereign debt supply comes onto the market.
c.0.5%), closing more quickly, the drag from spare We will revisit our call first thing in the New Year –
capacity is fading quite rapidly. The prospect of but the risk is clearly that the first hike comes later in
stronger inflation in the future is evident in the SNB’s 2011.
Eoin O’Callaghan 16 December 2010

Sweden: Further Tightening
Table 1: Riksbank’s Latest Forecasts (% y/y)
The Riksbank delivered a 25bp rate hike at
its December meeting, taking the policy rate to 2010 2011 2012 2013
1.25%. 1.3 2.2 2.0 2.6
CPI
There were upward revisions to the GDP and (1.2) (1.7) (2.2) (2.6)
inflation forecasts for 2010 and 2011. 2.1 1.7 1.4 1.9
CPIF
(2.0) (1.3) (1.5) (1.9)
But there were no changes to policy rate
projections as the Bank noted that economic 5.5 4.4 2.3 2.4
GDP
prospects remain “largely the same as in (4.8) (3.8) (2.5) (2.4)
October”. 8.4 7.5 7.0 6.6
Unemp. Rate (%)
(8.4) (7.6) (7.2) (6.8)
We believe the policy rate is still low given
economic fundamentals. Repo Rate (%, 0.5 1.7 2.6 3.3
ann. avg.) (0.5) (1.7) (2.6) (3.3)
Therefore, we continue to expect another
Source: The Riksbank. October 2010 forecasts in brackets
25bp rate hike in February.
Chart 1: Policy Rate (%)
The Riksbank delivered its fourth rate hike in this

cycle at its December meeting, in line with market
expectations, taking the policy rate from 1.00% to
1.25%. The Bank’s rate projections were left
unchanged.
Robust domestic economic growth

Once again, robust growth in the Swedish economy
was acknowledged in the policy statement. On this
the language was quite strong – the Riksbank
described the economy as growing “at a record rate”.
In particular, the upturn was noted as being “broad
based”. On consumption, the Riksbank expects high Chart 2: Consumer Confidence and Private
consumer confidence and “good finances” to Consumption (% y/y)
contribute to further rises in private consumption.
On the inflation front, although underlying inflationary

pressures were perceived to be low, the Riksbank
noted that they “are expected to increase as
economic activity strengthens”.
Uncertainty elsewhere
Despite strong domestic growth, uncertainty over
economic developments elsewhere was also
mentioned. The particular emphasis was on public
finances in Europe as well as the weak housing and
labour markets in the US.
In terms of its latest projections, the Bank revised up Revisions to the Riksbank’s forecasts
its growth forecasts for the eurozone and the US. It As we had expected, there were upward revisions to
now expects eurozone GDP to grow by 1.5% in the Riksbank’s growth forecasts. In particular, given
2011, compared with its previous projection of 1.3%, stronger than expected Q3 GDP, the 2010 GDP
and US GDP by 3.0% (2.4%). projection was pushed up from 4.8% to 5.5%. For
Gizem Kara 16 December 2010

2011, the Riksbank now expects GDP to grow by Chart 3: CPI & CPIF (% y/y)
4.4%, up from 3.8% previously. These upward
revisions again led to lower unemployment rate
forecasts. The 2011 and 2013 forecasts were revised
down by 0.1-0.2pp.
On the inflation front, the Bank’s assessment was

that:
”While higher electricity prices and commodity

prices temporarily push up inflation, underlying
inflationary pressures in the Swedish economy
will be low as a result of low labour costs”.
In line with this assessment, unit labour cost

forecasts for 2010 and 2011 were revised down, from
-1.2% to -2.2% and 0.6% to 0.4%, respectively. Chart 4: Swedish Real GDP (Index, Q1 2005=100)
However, given strong domestic demand, inflation
pressures are expected to build over the forecast
horizon. In terms of revisions to inflation forecasts,
the major change was in the 2011 projections. Both
CPI and CPIF forecasts were revised up – CPI from
1.7% to 2.2%, and CPIF from 1.3% to 1.7%.
What next?
Given the upward revision to growth and inflation
forecasts for next year, one could have expected an
upward revision to rate projections. But the
divergence between the Deputy Governors over the
policy decision meant a revision at this stage was
unlikely. Once again, Deputy Governors Karolina Source: Reuters EcoWin Pro
Ekholm and Lars Svensson entered a reservation

against the decision to raise the repo rate and the
repo rate path in the Monetary Policy Update. somewhat next year, it will remain robust and
significantly exceed that in the eurozone. Therefore,
In all, December’s policy decision and statement we continue to argue that domestic interest rates are
were broadly in line with our expectations. Looking low in Sweden and see some upside risks to the
ahead, we believe the strength of the domestic Riksbank’s rate projections. In particular, we share
economy should lead the Riksbank to deliver further the view of some Deputy Governors that there is a
rate hikes. Although the Riksbank rightly mentions risk of imbalances mounting. As the Riksbank said in
the uncertainty regarding external developments its statement, “a gradual rise in the repo rate can also
abroad, we believe this should not prevent it from contribute to slower growth in household borrowing
implementing more increases. and reduce the risk of imbalances building up in the
Swedish economy”. Against this backdrop, we expect
As Sweden does not suffer from fiscal and other another 25bp rate hike to be delivered at the
structural imbalances or a struggling banking sector, Riksbank’s next meeting in February, if we do not
it continues to outperform other advanced see a significant appreciation in the krona in the
economies. Although we expect growth to moderate meantime.

Norway: Hawkish Tone
Chart 1: Policy Rates (%)
The Norges Bank left its policy rate at 2.00%
at its December meeting, in line with market
expectations.
The statement accompanying the policy
decision was hawkish compared to October’s.
We expect the Norges Bank to deliver a rate
hike in Q2 2011, but a hawkish statement overall
has increased the chances of a hike in Q1.
If the krone does not appreciate significantly
and economic data turn out to be stronger than
the Bank’s expectations, a rate hike is likely in
Q1. Source: Reuters EcoWin Pro
Chart 2: Real GDP (% y/y)

Rates on hold
The Norges Bank kept its policy rate at 2.00% at its
December meeting, in line with market expectations.
In the opening paragraph of the statement, the Bank

mentioned that “underlying inflation has been
approximately as expected” and “growth has picked
up”. But the level of activity was perceived to be
“probably still somewhat lower than normal”. In terms
of external developments, the Bank said that “growth
has been unexpectedly high among several of
Norway’s most important trading partners”. We
believe this mainly reflects stronger-than-expected
growth in Sweden in Q3. Another positive factor Chart 3: Private Consumption & Retail Sales
noted was the increase in oil prices, which provides a
boost to the economy overall.
Less positively, there was acknowledgement of the

uncertainty regarding developments in Europe due to
fiscal concerns. The Norges Bank noted the high
level of borrowing rates in peripheral eurozone
countries. That said, the emphasis was still that
“contagion to other markets has so far been limited”.
Overall, while the Norges Bank kept its policy rate

unchanged, it noted that “the consideration of
guarding against the risk of future financial
imbalances that may disturb activity and inflation
somewhat further ahead suggests that the key policy Source: Reuters EcoWin Pro
rate should not be kept low for too long”. This was
broadly the same as in the Norges Bank’s in-depth “Both the consideration of bringing consumer price
assessment back in October. In all, compared to its inflation up to target and the consideration of
predecessor, the statement had a hawkish tone. stabilising developments in output and employment
imply a low key policy rate”.
Risks around the policy outlook Although it again mentioned that “the low interest
In terms of policy, in its in-depth assessment, the rate level has not triggered an increase in household
Norges Bank noted that: debt growth so far”, there was particular emphasis on

the rise in house prices and consumer spending. Chart 4: Credit To Households and Non-
Against this backdrop, the Norges Bank remains Financial Corporations (% y/y)
aware of the risk of financial imbalances building up
in the economy. Therefore, rates are not expected to
remain low “for too long”.
Policy ahead
Overall, the policy statement signalled that we might
see an upward revision to the Norges Bank’s rate
projections at its March meeting, when the new
Monetary Policy Report will be published. As we
noted before, recent domestic developments suggest
growth will pick up in the quarters ahead. Given the
key policy rate is still low compared to what the
neutral rate should be in Norway, we expect rate Source: Reuters EcoWin Pro
hikes. We expect the next hike to come in Q2, but
the hawkish statement has increased the risk of a Chart 5: Import-Weighted NOK
rate hike in Q1.
At the press conference after the policy decision,

Deputy Governor Qvigstad mentioned that he sees
no reason to change the Bank’s policy rate
projections (the quarterly rate projections in the
October Monetary Policy Report suggested the Bank
intends to deliver a rate hike, at the earliest, in
summer 2011). However, developments in the period
ahead will be key for the timing of the hike.
In particular, if we do not see a signicant appreciation

in the currency, economic data surprises to the
upside and house prices increase markedly, the
Norges Bank is likely to deliver a rate hike in Q1. But Source: Reuters EcoWin Pro
if tensions in financial markets intensify going into
next year due to concerns over the eurozone, the
Bank will wait until Q2.

Turkey: Reserving Judgement
Chart 1: Credit Growth1 and Reserve
The Turkish central bank’s deputy governor, Requirement Ratios in Selected EMs
Erdem Başçı, this week suggested that the CBT
could cut interest rates and increase reserve 40
Credit Growth, y/y,
requirements. 35
%
This would be designed to maintain 30
monetary discipline in the economy while 25

avoiding undue appreciation of the exchange 20
rate.
15 RRR, %
We have serious doubts about the 10

effectiveness of such a policy without support
5
from fiscal policy.
0
We believe the current suggested policy mix
a
R.
sia
ru
a
a
na
nd
il
a
az
di
tin
si
re
Pe
rk
hi
la
ch
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In
us
is likely to result in real exchange rate
Br
Ko
n
Tu
C
Po
ge
ze
do
S.
Ar
C
In
appreciation through higher inflation and would
do little to bolster financial stability in the event Source: ReutersEcowinPro, local authorities. (1) Latest available data.
of a reversal of inflows.
Chart 2: Required Reserves and Their
Remuneration
The Turkish central bank’s deputy governor, Erdem 25 7
Başçı, this week stated that to achieve the dual RRR (RHS)
objectives of “price stability” and “financial stability”, 20
Market overnight rate
6
the optimal policy choice was to reduce the policy 15 5

rate to curb FX inflows and to tighten domestic
conditions through use of tools other than the interest 10 Remuneration Rate of
RR
4
rate (read: reserve requirements).

5 3
Turkey is not alone in its endeavour. An increasing 0 2
number of emerging market countries are looking for

ways to manage monetary policy by avoiding outright -5 Cost of RR( Policy 1
rate-RR)
rate hikes because they fear FX appreciation. They -10 0
have adopted measures to discourage speculative
Jan-08
Mar-08
May-08
Jul-08
Nov-08
Jan-09
Mar-09
May-09
Jul-09
Nov-09
Jan-10
Mar-10
May-10
Jul-10
Nov-10
Sep-08
Sep-09
Sep-10
inflows and address potential financial instability.

These measures are sometimes called macro- Source: CBT, ISE
prudential regulation, which sounds a lot less coarse Although Turkey’s reserve requirement ratios are relatively low
than capital controls. compared to its peers, the CBT stopped paying remuneration on
these reserves as of October 2010.
Emerging markets’ worries are understandable
We have sympathy with the authorities in emerging
markets where achieving domestic balance requires
higher interest rates but where achieving external and is affected by US policy. Second, the inflation
balance argues against that. One of the main effects target is inconsistent with the US' obligations as
of ultra-easy US monetary policy is on inflation issuer of THE reserve currency.
abroad. These effects are often manifested in oil and
other commodity prices (e.g. food). Is the US shock temporary or more lasting?
Clearly, in many countries, the level of interest rates
However, the Fed's inflation objective excludes food is far below nominal growth when the economy is at
and energy. There are two things wrong with this. potential, which appears too loose. If one believes
First, it treats a big chunk of US inflation as that the US output gap is transitory and US inflation
exogenous whereas we all know it is endogenous is low on a temporary basis, then keeping rates down
IMPORTANT DISCLOSURE:
This analysis has been produced jointly by employees of BNP Paribas S.A. ("BNPP") and Turk Ekonomi Bank A.S. (“TEB”). It has been separately
reviewed and approved by BNPP and TEB. BNPP is an indirect shareholder of TEB with 42.125% stake. This analysis does not contain investment
research recommendations.
Paul Mortimer-Lee / Selim Cakir 16 December 2010
to avoid a temporary spike in the exchange rate Chart 3: 2010 Current Account Balances in
against the USD is fine – that would just misallocate Selected EMs
resources and disrupt the pattern of production,
6
growth and inflation.
4
If however, a large US output gap persists for many 2

years – which seems likely – and if US inflation stays
low – also likely – then a permanent change in the 0
exchange rate is justified and rates should not stay -2
long below their domestic equilibrium. Our concern in

-4
several economies is that controls designed to lower
the exchange rate are being inappropriately applied. -6
They might be fine if the shock affecting the US were -8

temporary, but they are inappropriate if the US shock
a
a
na
nd
ey
a
ru
il
R.
sia
si
di
in
az
re
Pe
rk
la
hi
ne
nt
In
ch
us
is more durable, which is our view.
Ko
Br
Po
C
Tu
ge
do
R
ze
S.
Ar
In
C
If such policies are applied inappropriately, nominal Source: BNP Paribas.
GDP is likely to surprise on the upside and so will
inflation. There will be a rise in the real exchange Unlike several other emerging market countries that also need to
deal with capital inflows, Turkey has a large current account
rate brought about through inflation. deficit. As a result, Turkey is more vulnerable to a sharp reversal
of capital inflows.
How does lowering rates and increasing reserve
requirements work?
Lowering rates while increasing reserve post-inflow financial stability. Accordingly, we would
requirements could work by lowering deposit rates argue that a much tighter cyclically adjusted fiscal
available to foreigners and hence reducing FX policy, supported by strict regulations by the Banking
inflows while not reducing loan rates domestically. Regulation and Supervision Authority (BRSA), and
This increased wedge between loan and deposit possibly a tighter monetary policy would represent a
rates is a reason why reserve requirements are a better policy choice for Turkey. If these options are
favoured instrument now. We also fear that, in some not possible prior to elections, the CBT could have
countries, they are a disguised way of running too- also considered intensifying FX purchases and/or
slack policy without owning up to it. administrative measures to curb short-term inflows.
We are sceptical about such policies in general, and Most importantly, for the reserve requirement ratio
this applies to the Turkish initiative. We fear that it is strategy to work, the CBT should be ready to reduce
in fact an easing in policy. This is of concern when TRY liquidity in the system. In such a case, money
Turkish credit growth is extremely rapid (Chart 1). market rates would go above the CBT’s policy rate of
The rapid growth is associated with a considerable 7%. We think the CBT would not allow that and the
current account deficit (Chart 3). liquidity it provides will find its way to credit. The
economy will thus continue to overheat and
We are not the only ones to see the policy shift as ultimately inflation will be the price.
expansionary. The Turkish equity markets rebounded
strongly on the news, with an increase in demand for Effects of higher reserve requirements
risk assets. Higher reserve requirements will:
1) Increase the cost of bank intermediation;
All this suggests that the policy is indeed
expansionary, which we find concerning when growth 2) Lower the rate on deposits and raise the rate on
is already good, credit creation strong and the lending. In Turkey, the cost of raising RR by 1pp
current account deficit wide. The economy looks as increases the cost to banks by 15bp. In the
though it needs a touch on the brake, not the recent past, banks were able to reflect around
accelerator. 60% to 70% of cost increase in the remuneration
paid to deposits.
We have serious doubts about the effectiveness of 3) Tax bank intermediation and encourage non-
such a policy without strong support from fiscal bank intermediation and intermediation outside
policy. A tighter fiscal policy would be much more the country's borders. In the 1970s and 1980s,
effective in containing aggregate demand, limiting US thrifts developed accounts that were
exchange rate appreciation and achieving better designed to attract household deposits in the US
to avoid the reserve requirements applying to 1) It feeds expectations that the central bank is
banks. The IMF mentions South Korea, where reluctant to raise rates when they in fact need to
Korean deposits went from 70% being in deposit rise and so stimulates demand (we see the stock
centre banks in the 1970s to half that in 1992 as market reaction as strong evidence of this);
a result of extensive use of RR and the
consequent disintermediation of the banking 2) It feeds expectations that the central bank does
system; not want to see a rise in the exchange rate (while
4) Reduce stock returns to holders of bank equity. admitting it is undervalued in the sense of being
BCB found evidence of this in Brazil, which weaker than the market would price it left to its
would reduce the rate effect; own devices). This must encourage greater
employment, investment and cost tolerance by
5) People use non-taxed cash more; and
exporters and those competing with imports; and
6) The policy operates on domestic deposits, not
credit. For a country that has more or less closed 3) Circumvention of the controls is profitable and
its output gap and which at the margin is broad liquidity will continue to rise quickly. The
financing credit through external wholesale flows higher the reserve requirement, the greater will
and is running a big current account deficit, the be the incentive to circumvent the regulations.
money effects will be negligible (wholesale
capital comes in, the current account deficit The famous “impossible trinity” of open economy
widens and deposits are unchanged). With an macroeconomics, i.e. the inability to simultaneously
open capital account, there will be leakage in the target the exchange rate, to run an independent
system that would reduce the effectiveness of monetary policy and to allow full capital mobility
RR increases. At the same time, we note that suggests that if capital flows are sustained (i.e in the
circumventing the reserve requirement ratio is absence of effective capital controls), Turkey needs
rather difficult in Turkey since the regulator to choose between nominal appreciation and
(BRSA) applies the RR to every obligation of inflation.
banks, be it bonds or loans from other banks.
We believe that the current suggested policy mix is
likely to result in real exchange rate appreciation.
This will come about through inflation. Moreover, the
The risk is inflation policy mix would do little to reduce the possible
We have concerns that such a policy could end up damage to financial stability in the event of a future
being inflationary. Why? reversal of inflows.
Japan: Tankan Points to Soft Patch
Chart 1: Business Conditions DI
The December Tankan showed that
– All Enterprises
business sentiment among large firms
deteriorated for the first time in seven quarters, 10
but the setback was not as bad as expected.
0
While the outlook DI is weaker than
-10
expected, we judge that sentiment DIs could rise
modestly in the March Tankan. -20
Capital spending plans for large -30

manufacturers were marked up to 2.9% y/y from
-40
2.4% in September. Businesses are focusing
more on expansion overseas, but domestic -50 *Q1 2011 is forecast from December Tankan.
investment should continue picking up as long
as the recovery in exports and production -60
continues. 00 01 02 03 04 05 06 07 08 09 10 11
Source: BoJ, BNP Paribas

The BoJ’s next move depends on the Fed.
So long as the Fed does not expand QE2, Chart 2: Business Conditions DI
pressures are unlikely to intensify on the BoJ – Large Enterprises
for further easing to counter appreciating
pressures on the yen. 30
20
If the Fed takes additional action, causing
10
the yen to strengthen against the dollar, the BoJ
will be pressed to do more to neutralise such 0
pressures by expanding the scale of its Asset -10

Purchase Programme. -20
-30 Manufacturing
-40 Nonmanufacturing
Modest decline in DIs confirms a soft patch
-50
*Q1 2011 is forecast from December Tankan.
In the December Tankan survey, business sentiment -60
modestly retreated for the first time in seven quarters. 00 01 02 03 04 05 06 07 08 09 10 11
This indicates that the economy has entered a lull, as
corporate earnings have stalled due to slowing
exports and the end of domestic stimulus machinery and shipbuilding/heavy machinery.
programmes. Even so, the setback in business Interestingly, the business conditions DI for small
confidence was not as bad as expected, and the manufacturers, while remaining in negative territory,
survey results confirm that fallout from the end of improved two points from September, suggesting
green car subsidies and yen appreciation had only that the negative factors weighing on the mood of
limited adverse effects on overall business activity. their larger manufacturing cousins have not filtered
down (though the outlook does not look good, with
Setback in confidence not as bad as expected
the forecast DI for small makers showing an 11-point
In terms of the Tankan’s headline index, the current drop).
conditions diffusion index (DI) for large
manufacturers fell three points from the September Moving on to non-manufacturers, the current
survey to +5. Weakness was pronounced in sectors conditions DI for large enterprises fell just one point
affected by the end of stimulus programmes such as from September to +1. The setback in sentiment was
motor vehicles or by ongoing inventory adjustments modest both in areas directly connected to factory
in the global IT/digital sector like electrical machinery. activity such as the wholesale trade and in areas
Collateral damage was sustained by material- connected to consumer spending like the retail trade
supplying sectors such as non-ferrous metals and and services for individuals. As for the retail trade,
chemicals. However, business confidence continued despite the stabilisation of department store sales
to improve on the back of solid Asian demand for and the surge in last-minute demand for eco-friendly
capital goods in industries such as general-purpose appliances ahead of the downsizing of the eco-point
Ryutaro Kono/ Hiroshi Shiraishi 16 December 2010

system in December, the plunge in car sales Chart 3: Business Conditions DI
following the end of fiscal incentives inevitably took a – Medium-Sized Enterprises
greater toll on confidence. On the upside, the DI for
the communications industry was relatively strong, 20
and the DI for business-oriented services posted a 10
sharp increase. The DI for small-sized non- 0
manufacturers fell just one point to -22. -10
-20
Outlook DI also shows weakness but…
-30
While the decline in the current condition DIs were
-40 Manufacturing
smaller than expected, the forecast DIs showed that
firms are quite cautious about the outlook. We had -50 Nonmanufacturing
caution about the outlook as it is difficult to gauge the -60

level of domestic demand following the end of -70
stimulus programmes. But the December Tankan 00 01 02 03 04 05 06 07 08 09 10 11
shows large manufacturers are more wary about the
future than we expected, with their outlook DI falling Source: BoJ, BNP Paribas
seven points. It seems that producers are quite Chart 4: Business Conditions DI
concerned about the uncertainties surrounding – Small Enterprises
demand for cars and home appliances, as well as the
squeeze on profit margins from resurgent commodity 20
prices. In contrast, the outlook DI for large non- 10
manufacturers is down just two points. 0
-10
The resurgent commodities market reflects the
-20
revival in global manufacturing, spearheaded by
booming domestic demand in China and other -30
emerging economies. At least for the time being, -40

Manufacturing
brisk exports to these economies will likely offset the -50
Nonmanufacturing
damage from higher commodity prices. Meanwhile, -60
with US Christmas sales proving solid (so far), it is -70
likely that inventory adjustments in the IT/digital 00 01 02 03 04 05 06 07 08 09 10 11
sectors will make faster headway. Consequently, Source: BoJ, BNP Paribas
despite the downbeat tone of the latest forecast DIs,
when the next Tankan is released on 1 April we feel despite fallout from the probable rise in commodity
business sentiment may not be all that weak. It could prices.
even modestly rise, as we expect the export-led
recovery to resume at the start of 2011, with Capex plans largely unchanged from September
momentum steadily growing from the spring as the With regard to the FY 2010 capital spending plans,
negative payback from eco-point sales fades. large manufacturers project a 2.9% y/y increase
(Domestic demand, however, will be too weak to (2.4% in September), for a revision rate of -1.0%.
drive the economy due to the effects of an ageing Large non-manufacturers forecast gains of 3.0%
population.) (1.6%), for a revision rate of 1.3%. The upward
revision for non-manufacturers is largely due to a
Meanwhile, the latest sales and profit projections mark-up for land purchases, which suggests
show a slight upward revision for FY 2010 as a whole, improving conditions in the real estate market. But
but forecasts for the latter half of the year have been GDP-based capital investment is closer to the
marked down for both sales and profits. In fact, Tankan’s “software and fixed investment excluding
second-half profits for large enterprises (all land purchases”. Spending plans here show large
industries) are now projected to drop a modest 1.0%. manufacturers project a rise of 4.1% y/y and large
On the surface, it seems that these companies are non-manufacturers a rise of 4.5%, with the revisions
pessimistic about the future, following a first half year rates for both being negative at -0.9% and -0.3%,
when profits surpassed expectations. However, it is respectively. Whether spending plans include real
more likely that second-half forecasts are being estate or not, domestic appetite for capex is not
adjusted now to avoid large-scale revisions of the robustly picking up. Indeed, while many firms during
annual projection. Once it becomes clear that exports Q3 settlements marked up their spending plans,
are back on a recovery track, sales and profit alongside increased profit projections, the upward
projections for FY 2010 could well be revised upward, revisions for investment were concentrated in

spending on overseas plants. Owing to the Chart 5: Fixed Investment Including Land
appreciation of the weak yen and the robustness of Purchasing Expenses, Excluding Software
domestic demand in emerging markets, Investment (%)
manufacturers and non-manufacturers are both
focusing more on expansion overseas, rather than 30
investment at home. Hence the recovery in domestic 20
investment continues to lag that of profits.
10
Even so, with the export-led recovery set to get back
0
on track in 2011, we believe domestic investment will
continue to gradually pick up. On this score, -10
spending plans show downward revision in the first
-20
half of FY 2010, when concerns were mounting
about a double dip in the US/Europe and yen -30 Large Enterprises/Manufacturing
appreciation. But the plans for the second half are Large Enterprises/Nonmanufacturing
-40
uniformly marked up as these uncertainties have
02 03 04 05 06 07 08 09 10
been dispelled.
BoJ policy: No policy change, unless the Fed
acts Chart 6: Fixed Investment Including Land
Purchasing Expenses, Excluding Software
With the concern over a double-dip recession having
Investment (%)
faded, global share prices and bond yields have
crept higher and the greenback has appreciated of 30
late. This reflects that fact that global manufacturing 20
started to turn up again in October, led by emerging
10
economies. The manufacturing cycle in the
developed world is also reviving on the back of 0
exports to booming EMs. On this score, that the -10
recoveries in emerging economies are accelerating -20
reflects not just their autonomous growth dynamics
-30
but also the effects of the Fed’s QE2 (via defence of
Small Enterprises/Manufacturing
fixed exchange rates). In this sense, QE2 is starting -40
Small Enterprises/Nonmanufacturing
to benefit the US economy (via exports). Given this -50
backdrop, the Fed seems likely to take a wait-and- 02 03 04 05 06 07 08 09 10
see stance for a while. Source: BoJ, BNP Paribas
As pointed out in earlier reports, Japanese monetary

policy is influenced most by the exchange rate, and
the factor currently impacting the exchange rate most
is US monetary policy. So long as the Fed does not could move to ease further. While America’s natural
move to expand QE2, pressures are unlikely to rate of interest is unlikely to be revived by such
intensify on the BoJ for further easing to counter macro-stabilisation measures, the Fed – fully aware
appreciating pressures on the yen. Hence, Japanese of this – will probably still undertake aggressive
monetary policy should be unchanged for the time action.
being.
In such an event, the yen is likely to strengthen
That said, it will still take a considerable amount of further against the dollar, and the BoJ will inevitably
time for the US’s balance sheet troubles to be be pressed to do more to neutralise such pressures.
undone. US domestic demand is thus likely to Given that Japan depends on exports for growth, as
continue lacklustre, even if revived exports trigger a domestic demand is chronically sluggish due to the
cyclical recovery. More fiscal stimulus might give US effects of an ageing population (and the economic
growth a firmer tone, but it will likely be only short- structure is not yet geared to benefit from yen
lived. As a result, the US jobless rate will probably appreciation), Japan cannot allow currency
show only limited improvement and the core inflation appreciation to damage the export sectors.
rate will probably continue trending lower (the Consequently, if the action by the Fed causes
headline inflation rate, however, could rise on the another wave of yen appreciation, we expect the BoJ
resurgent commodities market and higher crude oil to respond by expanding the scale of its Asset
prices). If such weak conditions continue, the Fed Purchase Programme (currently JPY 35 trillion).

Japan: Marking Up 2010 Growth Forecast
Chart 1: Contributions to Real GDP (% q/q, pp)
Growth in Q3 was marked up slightly more
than projected, to 4.5% annualised from 3.9%, 3
due to upward revisions in private capital 2
investment and inventory. 1
But the robust tone of Q3 is essentially a 0
product of policies that triggered a surge in -1
demand for green car and cigarettes; the -2

Domestic Demand
underlying pace of growth slowed alongside -3 (excluding Stocks)
softening exports. Payback for the Q3 policy -4 Stocks
factors is likely to see contraction in Q4. -5 External Demand
Even so, with the global economy back on a -6

06/1Q 07/1Q 08/1Q 09/1Q 10/1Q
recovery track, Japanese growth should resume
in early 2011 and accelerate from the spring.
Source: Cabinet Office, BNP Paribas
Meanwhile, the final figures for last year
show the economy contracted 6.3% in 2009 Chart 2: Real GDP (% q/q)
(rather than 5.2%). The economy’s collapse in
the two quarters following the Lehman shock 4
was sharper than previously estimated while the 3

2
subsequent recovery was slightly faster.
1
Following the revision of past GDP data, our 0
new forecasts call for 4.4% growth in 2010 (up -1
from 3.6%) and 1.6% in 2011 (1.4%). -2
-3
-4 The 1st preliminary
-5 The 2nd preliminary
Annualised growth rises to 4.5% on stronger
-6
capital spending 06 07 08 09 10
In the second preliminary real GDP reading for Q3,
growth was marked up slightly more than we had Source: Cabinet Office, BNP Paribas
projected, coming in at 1.1% q/q (4.5% annualised).
This compares to the preliminary (first estimate)
reading of 0.9% q/q (3.9% annualised). On the
upside, as expected, private capital investment was
marked up (to 1.3% q/q from 0.8%), reflecting the
latest MOF survey of corporate financial statements. -2.4% y/y (from -2.0%), the latest report also
There were also upward revisions to inventory indicates that deflationary pressures have not let up.
(contribution of 0.2pp from 0.1pp); personal
consumption (1.2% q/q from 1.1%); and government Growth in FY 2009 sharply marked down
consumption (0.2% q/q from 0.1%). On the downside, Meanwhile, the final figures for growth in FY 2009
public investment was revised down to -1.0% q/q were also released. Real GDP’s rate of contraction
from -0.6%. was marked sharply down, to -2.4% from -1.8% (on a
CY-basis, to -6.3% from -5.2%). On a quarterly basis,
The robust growth registered in Q3 was essentially a there were steeper annualised drops in both Q4 2008
product of special factors that bolstered household (-11.9% rather than -10.4%) and Q1 2009 (-19.9%
spending (last-minute demand for eco-friendly cars rather than -15.8%), reflecting sharper declines in
and hoarding of cigarettes ahead of a tax hike). personal consumption and inventory. All quarterly
Indeed, the underlying pace of growth appears to readings thereafter have been revised up modestly.
have slowed as export growth eased. With nominal The new figures show that the swing in the inventory
GDP growth being marked down to 0.6% q/q or 2.6% cycle was greater; hence the economy’s collapse in
annualised (from 0.7% q/q, 2.9% annualised), and the wake of the Lehman shock was sharper and its
the GDP deflator’s negative margin expanding to subsequent pace of recovery slightly faster.

After a modest contraction in Q4, the recovery Chart 3: Real GDP (JPY trn, sa)
should resume
570
Looking ahead, we expect growth to be significantly
affected by policy factors in the coming months. 560
These ‘policy-created fluctuations’ will become 550
apparent in Q4, when negative payback will emerge
540
for the Q3 rush to buy green cars and cigarettes.
According to our estimates, these two factors alone 530
7.5 ％
minus 10.1 ％
could depress Q4 GDP quarterly growth by roughly Annualized
520
0.7pp (2.8pp in annualised terms). But the economy 4.9 ％
is unlikely to contract that much, thanks to the 510
downsizing of another stimulus programme – the 500
eco-point system. This programme for buying 02 03 04 05 06 07 08 09 10 11
energy-efficient appliances generated a surge in last-
minute demand products such as LCD TVs in
Source: Cabinet Office, BNP Paribas
October and November. That said, the eco-point
system, just like the green car subsidies, has only Chart 4: Domestic Final Consumption
robbed demand from the future. Thus, while the Expenditure of Households (s.a., Q1 2008=100)
economy might enjoy some support in Q4, there will
be comparable negative payback in Q1 2011. 140
135 Durable goods
Semi-durable goods
These policy-induced fluctuations make it hard to 130
Non-durable goods
125 Services
gauge the economy’s true state. However, the 120
outlook does not look too bad as there are growing 115
signs that global manufacturing, led by China, is 110
recovering again. Thus, we see Japan emerging from 105
its soft patch. Although exports have been stagnant, 100
95
partly owing to ongoing adjustments in the global 90
IT/digital industries, they should start accelerating in 85
the not-too-distant future on the back of surging Q1'07 Q1'08 Q1'09 Q1'10
Asian demand. On this score, exports to China,
Japan’s largest trading partner, rebounded in Source: Cabinet Office, BNP Paribas
October. Early indications for November suggest
exports overall should pick up the pace. In a similar
vein, data for machinery orders show overseas
bookings grew at a double-digit rate in October.
New forecasts
With the global economy back on a recovery path, Based on the latest official GDP data, our new
we suspect that Japan’s stalled factory sector would annual growth forecasts are as follows: 3.4% in FY
have touched bottom in October before starting to 2010 (up from 2.7%) and 1.6% in FY 2011
bounce back – were it not for misguided interventions (unchanged); on a CY basis, 4.4% in 2010 (3.6%)
by the authorities. In short, domestic demand still and 1.6% in 2011 (1.4%). Our quarterly forecasts
lacks the vigour to drive the economy, owing to the (annualised) are now -0.8% in Q4, 1.2% in Q1 2011,
effects of an ageing population. But we expect a 2.0% in Q2, 2.0% in Q3, 2.0% in Q4 and 1.6% in Q1
cyclical recovery, triggered by exports, to resume in 2012. The large upward revision to our 2011 forecast
early 2011. The pace of growth should accelerate is largely due to the official revisions to the growth
from the spring, by which time fallout from the end of path in the past several quarters noted above. (The
the eco-point system will have faded. It is these base effect for FY 2011 rose to 1.9pp from 1.6pp,
fundamentals (the state of the economy, looking while Q2 and Q3 2010 were also revised up). Were it
through the effects of policy meddling) that are not for the revisions to past data, our forecasts would
probably driving the current stock market rally. not be significantly different.

Bonds: Forecast Update
Table 1: Key Bond Yield Forecasts
We have revised our government bond
forecasts in light of the surprisingly large jump Spot Q1'11 Q2'11 Q3'11 Q4'11 Q1'12
in yields in recent weeks. US
Fed Funds 0.25 0.25 0.25 0.25 0.25 0.25
In the near term, we believe the sell-off is 2-year 0.66 0.50 0.75 0.85 1.00 1.10
overdone and will partly reverse during Q1. 10-year 3.50 3.00 3.25 3.50 3.75 4.00
Eurozone
Longer term, we believe that QE2 is a
Refi 1.00 1.00 1.00 1.00 1.00 1.00
commitment to create inflation and, among
2-year 1.08 1.00 1.20 1.30 1.50 1.70
other things, should exert upward pressure on
10-year 3.07 2.75 2.90 3.15 3.35 3.50
10-year yields. We expect 10-year Treasury Japan
yields to reach 3.75% by the end of 2011 and ODR 0.30 0.30 0.30 0.30 0.30 0.30
4.6% a year later. Call Rate 0.10 0.10 0.10 0.10 0.10 0.10
2-year 0.20 0.25 0.25 0.25 0.25 0.25
10-year 1.28 1.20 1.30 1.40 1.40 1.40
Source: BNP Paribas. End Period, Spot Rates as at 16 December
In light of the surprisingly large jump in bond yields in
recent weeks, we have revised up our yield forecasts Source: Reuters EcoWin Pro
for the next two years (Table 1). We believe that the Chart 2: 2s10s vs Fed Funds
sell-off reflects a combination of bad positioning,
central bank and political news (US fiscal
agreement), better economic data (except US
payrolls) and year-end market conditions. The
difficulty is attaching weights to these different
factors.
We believe that the key influences on the outlook for

yields are:
There is an unusually large output gap. At some

stage, this means the economy will grow
significantly above trend for an unusually long
period;
In the near term, the recovery faces substantial
headwinds and final demand growth has Also at some stage, mortgage demand will return
remained lacklustre; (it may be the middle of the decade but that
Underlying inflation is very weak and will remain should affect bonds);
so for some time; We believe that the first Fed rate hike is a long
Policy rates are exceptionally low. The Fed is way off; and
making exceptional helicopter drops of money to The USD's reserve currency status is fraying
build up expectations that it will be able to avoid around the edges.
deflation;
The Fed has made it clear that it wants to raise Putting this into the context of our bond yield
inflation. Our view is that the stock of QE is a forecasts, the 2-year yield will continue to be very
promise to create excess inflation down the road much dependent on the outlook for the Fed funds
(i.e. around 2014) that will raise inflation rate. We believe that the Fed is unlikely to hike rates
expectations today and so raise prices and any time soon (not until late 2012). Given this, the
activity today by lowering real policy rates; 2-year yield should maintain a narrow spread to Fed
funds through to mid-2012 (Chart 1). Thereafter, we
The budget deficit is unusually high. Debt is rising
quickly in relation to GDP. There are no credible expect a sharp widening in that spread in anticipation
of the first hike, which should flatten the 2s10s
fiscal consolidation plans;
portion of the curve at that time (Chart 2).
At some stage, the Fed will sell Treasuries back
to the market − an exceptional occurrence;
Paul Mortimer-Lee / Cyril Beuzit 16 December 2010

Further out along the curve, we believe that the lows More generally, the curve is likely to fluctuate a lot
in yields are behind us. However, while the trend in because long-term expectations about growth,
yields is likely to be upwards through most of 2011, inflation and the deficit are going to be the main
we expect a rally early in the new year. In particular, drivers – not Fed funds expectations. Growth this
the recent sell-off looks overdone. The start of the year has been very close to consensus expectations
recent sell-off was primarily due to extreme market at the end of 2009 – yet the market has done a lot
positioning (QE2’s ‘buy the rumour, sell the fact’, like without that much solid macro ‘news’. Expectations
QE1 in 2009) and the move has been exacerbated about the future are very unstable, so the long-term
by year-end market conditions. We expect 10-year bond will be unstable and hence the curve’s shape
yields to move back down during Q1. will fluctuate.
Risk appetite remains solid and supported by ample In one year’s time we would expect:
liquidity conditions. Recent data suggest that The recovery to be better established;
investment funds have been switching their allocation
QE to have ended;
from bonds to stocks. Nonetheless, it is noteworthy
that risky assets have not extended their gains in the Inflation on the core measure to have troughed
wake of the recent sharp setback on bonds. but at a level below today's;
Emerging market inflation to be higher;
This highlights that, beyond some asset switches, the
Debt to be higher, but the deficit not much better;
bond market sell-off has so far more to do with wrong
and
positioning − the latest surveys of speculative
positioning suggest that the market may have to sell The market to be looking for Fed rate hikes and
off more before reaching a turning point. maybe Treasury sales by the Fed (the soft
exchange rate policy favours the latter first).
Overall, judging from the very poor liquidity in bond These factors argue for higher bond yields over the
markets, year-end pressures to cut balance sheets coming year. By contrast, policy is currently 75bp
appears to be a significant factor exacerbating the lower than ahead of the 2003/04 Fed-hiking cycle.
recent moves on Treasuries. The move so far has Based on a 3:1 relationship between policy and
been primarily cash driven but, over the past couple 10-year yields, this suggests that the 10-year yield
of sessions, the attendant swap spread widening should be around 25bp lower now compared with
indicates that convexity hedging flows have also 2003/04. This and lower spot inflation argue for lower
played a role. yields.
We expect the rally in the 10-year during Q1 to give Ahead of the 2003/04 hiking cycle yields were 3½%.
way to a sell-off over the remainder of the year – in We believe that, taking on board all of the above,
turn, temporarily steepening the curve. Thereafter, yields should be higher by the end of 2011 than at
we would expect 2s10s to flatten during 2012 as the the end of 2003, hence we target 3.75%.
first Fed rate hike approaches.
The pace of the sell-off will depend on: During 2012, the first Fed rate hike will be
approaching and possibly even the start of a reversal
How much the fiscal and debt premium adds to
of QE. The political and fiscal prospects are highly
yields;
uncertain, but it seems likely that there will be a
How much competition from the return of private reasonable risk premium in Treasuries. With inflation
funding needs adds to yields (since mortgage rising, we would expect at least a 100bp sell-off. We
rates are rising it argues for less demand via expect 10-year yields to rise to around 4.6% by end-
refinancing, though the flip side is more demand 2012.
as new purchases recover);
Less central bank appetite; and In Europe, we have also revised up our forecast for
Bund yields, though by slightly less than in the US.
The extent that the market prices in an inflation
The focus will remain on peripheral markets over the
overshoot over the coming decade.
weeks ahead with a big question mark about the
The last will be the most important, particularly for demand for early 2011 auctions. Spreads remain off
the belly of the curve. We suspect that the their November highs but renewed stress looks likely
commitment to excess inflation will be a temporary with Moody’s putting Spain’s rating on review for a
one. We would be surprised if this does not add up to possible downgrade. Although we expect the ECB to
50bp or more of excess steepness compared with begin hiking rates earlier than the Fed, we continue
past cycles. to expect Bunds to outperform Treasuries linked to
the greater willingness of the Fed to deliver
unconventional policy stimulus to raise inflation and
inflation expectations.
Paul Mortimer-Lee / Cyril Beuzit 16 December 2010

USD Rates Outlook in Q1
Macro environment supportive of low rates
through Q1 Table 1: FY 2011 Treasury Coupon Issuance
Forecast (USD bn)
The confluence of lacklustre growth, core inflation at its
lowest in decades, persistently high unemployment and Net Issuance in Bills 120
Treasury purchases by the Fed are likely to prevent a Redemptions (ex-Bills) -755
runaway selloff in the early part of 2011. The driving
force in the USD rate market will continue to be yield 2y 420
grab, which will manifest itself in duration extension, 3y 384
preference for (high-quality) spread products and 5y 420
selling convexity (think callables and mortgages). 7y 348
10y 264
Having said that, the back-up in rates seen since 30y 168
November threw cold water on expectations that QE 5y TIPS 32
would put a soft cap on rates. What became apparent 10y TIPS 64
is that the Fed is doggedly going after inflation 30y TIPS 15
expectations, trying to boost them in the long run. And Coupon Issuance: 2,115
if they succeed, and there is reason to believe they will
given the amount of excess liquidity they are pumping Total Net Issuance 1.5 Trillion
into the system, then intermediate and long term rates Source: BNP Paribas
have no reason to be anywhere near the lows of 2009
and 2010. In other words, even in the absence of a Table 2: 7y-17y Debt Outstanding is Shrinking
material improvement in the economy in short order, (USD bn)
Fed’s actions may actually have conspired to put a soft Expected Fed
Gross Supply in Issuance Net of
floor on the 10y and 30y rates, more so than the 2y. Maturity Purchases in
Next 8 Months Fed Buying
Next 8 Months
Any improvement in the employment picture, no matter
1.5 - 2.5y 45 280 235
how temporary or tentative it may prove to be, would 2.5 - 4y 180 256 76
almost surely add fuel to the fire and bring expectations 4 - 5.5y 180 280 100
for a faster recovery. As a result, we are revising up our 5.5 - 7y 207 232 25
7 - 10y 207 176 -31
earlier forecasts, putting the 10y at around 3% by the 10 - 17y 18 0 -18
end of Q1. There are clearly risks to either side of this 17 - 30y 36 112 76
level. Still we believe that after the turn of the year, no
Source: BNP Paribas
longer held back by balance sheet constraints as they
are now, investors will test long positions. Why? Table 3: Fed Will Shift Purchases Away From
Because rates along the curve do offer value in the 2y and 5-7y in Favour of 7-10y Sector
near term thanks to all the factors cited above. So at
Allocation in Allocation in Change vs Change vs
the very least what we can say is, look for a reversal in Maturity
MBS Program 2009 Program
New Allocation
MBS Pattern 2009 Pattern
rates – back to 3%, below, or somewhat above? That is 1.5 - 2.5y 14% 18% 5% -9% -13%
2.5 - 4y 11% 20% 20% 9% 0%
not quite the point, as much as the direction. 4 - 5.5y 21% 18% 20% -1% 2%
5.5 - 7y 38% 21% 23% -15% 2%
7 - 10y 4% 10% 23% 19% 13%
QE2 purchases will cancel out net Tsy 10 - 17y 6% 7% 2% -4% -5%
17 - 30y 5% 6% 4% -1% -2%
supply
Source: BNP Paribas
The peak in Treasury issuance was seen during 2008-
09, at over USD 150bn of net supply per month. Since
then the Treasury has cut issuance sizes and net as rates turn around? We are confident that we will not
supply is now running at USD 100-110bn per month see the extent of richness we did at the time, with
which we expect to remain relatively stable through Treasury 2s5s10s reaching -75bp. However, the 5y
FY11 (see Table 1 for breakdown of issuance should still lead the way down. The 10y should also
forecast). follow suit, giving rise to a compression of the
This monthly figure closely matches the USD 110bn 2s10s30s spread. Therefore, it is best to overweight
per month that the Fed intends to purchase as part of the belly of the curve.
QE2. Interestingly, when looking at specific maturity Turning to the back end, the 30y yield is unlikely to
sectors it appears the Fed’s purchases will not perfectly drop precipitously because concerns about long-term
match the supply in that sector (see Table 2) The 5y inflation in the face of QE are likely to persist. Unless
was the main beneficiary of the rally before the market the collective mindset of investors shifts toward
reversed course in November. Is this likely to happen disinflation, we would be hard pressed to see 10s30s
IR Strategy NY 16 December 2010

Market Mover, Non-Objective Section 33 www.GlobalMarkets.bnpparibas.com
move decisively below current levels of around 100bp – Chart 1: Projected 3-Month Treasury Returns
even though that is still on the high side as far as the under an Unchanged Yield Curve (%)
history of this spread.
1.6
On the flipside, a significant steepening in the back end Mid 2016 - Newly Issued 10s
is also rather unlikely, because of the implication for 1.4 Early 2017
forward rates. To provide some perspective, the 10y
3m Nominal Returns
1.2
forward 10y swap rate is in the 5.25% area as of this
writing. Anything above 5% begins to look attractive for 1 2029 / 2030 / 2031
2014
long duration players such as pension funds and 0.8
insurance companies. In our view, the very presence of 0.6
this backstop bid will likely keep the back end from
selling off, or lagging massively in the event of a rally. 0.4
Late 2012 / Early 2013
For example the Fed will not purchases securities 0.2
under 1.5yrs in maturity, and purchase only about half 0
of the supply out till the 5yr sector. In the 7-10y sector 0 5 10 15 20
the Fed will be purchasing more than the monthly Effective Duration
supply, and in the very long end the Fed will purchase
Source: BNP Paribas, Yield Book
about half of supply. Thus, the support for the belly of
the curve is greater. Chart 2: Favour Bullets over Barbells in the 4-7y
Another important point is that the market will have to Sector
adjust to the Fed’s shift in purchase allocation.
1.4
Purchases will now focus on the 7-10y sector much
more than the market was previously accustomed to, Buy 3.25% 05/16
and the 2y and 5y sectors will get fewer purchases 1.2

3m Nominal Returns
(see Table 3). This was the rationale behind one of our
top relative value trades since the November FOMC 1
meeting – the 5s10s Tsy flattener. Having now backed
away from record steep levels, we expect this to 0.8
continue as the overall disinflation theme also helps
flatten the yield curve. 0.6
Sell 1.875% 02/14 or 1.75% 01/14
and 1.875% 08/17 or 1.875% 09/17
RV along the Treasury Curve

0.4
A quick look at Chart 1 shows us the various peaks and 2 3 4 5 6 7
troughs along the 3-month return profile of Treasuries Effective Duration
under an unchanged yield curve environment. The
local kinks on the return profile mark the sectors to buy
(peaks) and the sectors to sell (troughs). The most Chart 3: Declining Treasury Supply to Put
prominent peak is in the mid 2016 to early 2017 sector Widening Pressure on Swap Spreads
and newly issued 10y notes.
140 -0.15
In addition to the profile in an unchanged yield curve, Issuance Forecast
analyzing the Treasury universe under various 120 YoY Change in 1+ Yrs -0.10
bullish/bearish scenarios we find that issues maturing Debt Outstanding net
100 of Fed Purchases
mid/late 2016 still look attractive from a return -0.05
(R.H.S, Log Scale Inv.)
perspective, while issues maturing in early 2014 (Jan 80
0.00
2014 and Jan 2014) and late 2017 (Aug 2017 and Sept 60
2017) fall in the troughs of the return profile, helping us 0.05
favour bullets over barbells (see Chart 2). Interestingly, 40
the above mentioned portfolio would perform the best 20 10y Swap Spread 0.10
in the event one were neutral on rates or overweight
0 0.15
bullish scenarios while limiting losses on bearish
scenarios. -20 0.20
96 98 00 02 04 06 08 10
Cautiously optimistic on swap spreads Source: BNP Paribas, Treasury Direct
With rates likely to be range-bound/moderately lower in
the coming months, this should also keep 5y and 10y
swap spreads from rising substantially due to the
general directionality. Nevertheless, there are other pace of Treasury supply has historically had strong
technical factors at play that lead us to foresee a explanatory power, and it seems this is set to decline in
moderate upward bias in the coming months. The y/y the months ahead (see Chart 3). In fact, Tsy issuance

net of Fed buying is going to have an even steeper Chart 4: Expect High Corp Issuance in January
decline relative to what was seen in recent years. (USD bn)
There are other factors at play that will periodically tilt
90 Average Issuance since 2000
the balance one way or the other. Corporate issuance
tends to weigh on swap spreads due to issuers 75
hedging their fixed liabilities by receiving in swaps. 60
Issuance tends to be below average near the end of
the year so this should help spreads widen, although 45
January tends to be one of the biggest issuance 30
months in the year so this will pose challenges (see
Chart 4). 15
In general, issuers appear to be comfortable swapping 0

from fixed to floating out to 5yrs, due to the widely held
Oct
Jan
Feb
Mar
Apr
June
Aug
Sep
May
July
Nov
Dec
view that the economic backdrop will not be conducive
Source: BNP Paribas
to a big spike in rates in the next few years. This makes
earning the carry an attractive proposition over that Chart 5: Carry and Rolldown in Agency Bullets
time span. Go out to the 10yr sector though and the
story changes somewhat. Many issuers are content to 55 Rolldown
49 Carry
lock in rates 10 years at the current levels (despite the
43
recent backup) as they still fall in the lower end of 37 26
historical ranges. In other words, issuers are reluctant 28 15
31 12
to take a risk by getting into the carry game for fear that 25
10 4
rates may indeed back up briskly past the first few 19
27
years. Therefore, the widening impact could be 13
17 21
25 25
20
7
magnified in the 10y sector in particular due to a
1
combination of net removal of Treasury supply in that -5 2y 3y 5y 7y 10y 30y
sector as noted above, and a dearth of swapped
issuance. We would expect the 10y swap spread to Source: BNP Paribas
reach 20-25bp as a result.
Chart 6: 5y Agency Callable vs Bullet
Agencies to do well, especially callables 220
200
GSE reform will start coming back into focus as we
Total Rate of Return Difference (bp)
180
160
approach the congressional deadline of January 2011 140
for an overhaul plan. However, the deadline is unlikely 120
100
to be met given lack of progress on this issue. We 80
60
would expect a proposal to be presented by the 40
20
deadline, followed by the first draft in Q2 2011, with a 0
final resolution possible in H2 2011. Although we don’t -20
-40 5nc3m berm vs. bullet
think private recapitalization is on the cards, we would -60 5nc6m berm vs. bullet
-80 5nc1y berm vs. bullet
expect that the government will guarantee both MBS -100
and debentures whatever the arrangement is. -30 -20 -10 0 10 20 30 40 50 60 70 80 90 100
Parallel Shift (bps)
In the interim, Fannie and Freddie continue be
supported by unlimited backstop from the US Treasury Source: BNP Paribas
and investors don’t seem to be worried. We like
agencies due to carry/rolldown advantage over Table 4: Combined GSE Issuance Projections
Treasuries. The 5y sector was recently under pressure Proj Proj Proj
in billions 2010 2011 2012
mostly due to temporary re-allocation related flows, and Discount Fannie Mae 512 563 620
now offers biggest carry/rolldown package. We prefer Notes Freddie Mac 486 535 481
the 3y-5 sector, which not only provide best FHLBanks 1167 1284 1477
Sub-Total 2,165 2,382 2,578
carry/rolldown along the agency curve at 49-51bp over
Callables Fannie Mae 319 287 258
6m (see Chart 5) in absolute terms, but also on vol Freddie Mac 216 206 185
adjusted basis. We expect investors to continue FHLBanks 314 340 391
Sub-Total 849 833 834
moving out the curve to pick up yield and extend
Bullets Fannie Mae 86 77 69
duration, especially if yields start to come down again. Freddie Mac 128 122 110
We also like callables for additional pick-up in yield and FHLBanks 148 170 196
Sub-Total 362 369 375
a wide band of outperformance relative to duration
Total Issuance 3,376 3,584 3,787
matched bullets, especially in the sell-off. Since we
Source: BNP Paribas, FNMA, FHLMC, FHLB
expect lower rates in Q1, before gradually rising

through the rest of the year, we recommend callables Chart 7: Agy Issuance Supplying Vega to Vol
with 6m to 1y lockouts. In general, an investor will give Market – Helping Keep Vol Relatively Low
up some outperformance potential but widen the
200 6m5y Implied Volatility 0
outperformance range for any given horizon by moving
from a 5nc3m berm to a 5nc6m berm (Chart 6). A 180 Vega Vol Supply from Agy -20
5nc6m has a lower projected maximum Issuance ($mm, Inverted R.H.S)
160
outperformance of ~150p over a duration-matched -40
bullet, but will withstand a larger range of yield curve 140
shifts (from -20bp to +100bp) before underperforming -60
120
over the 6m horizon. -80
Total debt issuance for the three housing GSEs – 100
Fannie Mae, Freddie Mac and the Federal Home Loan -100
80
Banks – is on pace to total ~USD 3.4 trillion for 2010. -120
60
Just under two-thirds of this issuance has been in
discount notes, with the other third in long-term 40 -140
callables and bullets. Projections for 2011 and 2012 Mar-09 Jun-09 Sep-09 Dec-09 Apr-10 Jul-10 Oct-10
are for total agency debt issuance to rise by ~6% per Source: BNP Paribas
year, to USD 3.6trn and USD 3.8trn respectively,
primarily driven by re-growth of the advance business Chart 8: Upper-Left Vol Leads the Move
at the FHLBanks. Fannie and Freddie are likely to
1.7 1y2y/1y10y Vol Ratio 4
shrink their long-term debt issuance while filling in
1y2y/5y2y Vol Ratio
financing gaps with increased discount note issuance 3.5
1.5 2y Swap Rate (R.H.S)
(see Table 4).
3
1.3
Volatility surface may gradually rotate toward 2.5
that of Japan's
1.1 2
As rates have risen since the FOMC delivered QE2, so
has swaption implied vol. More specifically, shorter 1.5
0.9
expiry/front end volatilities jumped significantly. This 1
was not only because of realized volatility but also 0.7
0.5
because the sell-off moved the front end of the curve
out of the "anchoring" region of ultra-low rates. 0.5 0
Taking into account our bullish view for the coming Mar-08 Sep-08 Apr-09 Oct-09 May-10 Nov-10
months, volatilities will likely go back down especially Source: BNP Paribas
for shorter expiry/front end. Additionally, issuance in
structured notes such as Agency callables picked up Chart 9: Actual Directionality in Implied Vol is
during the period when rates remained low and Vastly Greater than That Implied by Skew
investors searched for yield pick-up. This has supplied 1y10y ATM Vol Change on Week
vol into the marketplace and if rates go back down a (ATM Vol) minus (Previous Week's Vol at that Strike)
similar pattern is likely to play out (Chart 7). 12
As the Fed-on-hold and low-rate environment becomes 8

more and more prolonged, then it could be useful to
look at the vol surface's evolution in Japan for some 4
guidance. Not only are levels of vol much lower, but the
0
ratio of 2y tails over 10y tails are lower since short
rates are not expected to be raised any time soon. -4
Also, the ratio of short expiries over longer expiries is
much lower since rates become increasingly range- -8
bound and this drives gamma vol lower vs vega vol. All
of these are symptoms of a low-rate environment, and -12
in the US the pattern has been quite strong (Chart 8). Jan-10 Apr-10 Jul-10 Oct-10
We certainly acknowledge the risk scenario of higher Source: BNP Paribas

rates, and vol will likely rise in that scenario. In fact,
even when considering that vol is higher at strike levels
above the forward rates (i.e. payer skew is positive), investors will show interest in buying protection against
when the market sells off and reaches those higher higher rates while rates are still low. But even then one
strikes then the vol at that particular strike still tends to can expect vol to rise for fixed strike levels (e.g. at 5%
increase (Chart 9). Payer skew is already at historical strikes as opposed to ATM+50bp) if economic
highs, and this should continue to be supported since sentiment picks up.

US: Ideal Timing for LT Bullish Hedges
Chart 1: Hedging Against a Wide Range of
Much has been said recently about the Lower Rates (Profit Region at Expiry)
failure of QE2 to drive rates lower. However,
our forecast for a prolonged period of relatively 7 10y Swap Rate
low rates is based on the economic backdrop
6
of low/stable inflation and a high
unemployment rate. The consensus across 5
Profit Region
Wall Street economists is that this fundamental
landscape is unlikely to improve much in the 4
coming quarters.
3
The recent rise in rates and vol has led to a
much improved entry level on strategies such 2
as those which are long delta and short vol.
1
STRATEGY: Consider receiver spreads in
0
vega space such as the structure below.
Jan-01 Jun-03 Dec-05 Jun-08 Dec-10
Source: BNP Paribas

We explore strategies with a limited upfront cost but
large potential for gains if spot rates continue to stay Chart 2: PnL Profile at Expiry
near current levels. The trade we show is to buy an 15
at-the-money 4y10y receiver (roughly 5.00% strike at
the time of writing) and sell twice the notional in a 10
200bp out-of-the-money receiver. This reduces the
upfront cost and the only scenario where the trade
PnL ($MM)
5
loses money at expiry beyond the premium is if the
10y spot rate is at ultra-low levels (below 1.00%). 0
Chart 1 shows the profit region for the trade at expiry,
and Chart 2 shows a PnL profile. (5)
These types of structures have often been unwound

(10)
well before maturity. In the meantime, they carry well 0% 1% 2% 3% 4% 5% 6%
and gain value in a rally; thus they are often thought 10y Spot Rate at Expiry
of as interim hedge assets. The carry is positive due
to theta and rolldown in the 4y10y rate. After one Source: BNP Paribas
year, the estimated PnL is +25% of the entry cost in
an unchanged scenario, +50% in a -50bp move, and
flat in a +50bp move.
Table 1 shows the trade details and various greeks. norm vol) at just over 100%. This has improved
Note that the investor would be selling the receiver significantly from the 92-94% range it had been in
skew (ratio of 3%-strike norm vol over 5%-strike during the three months prior to the recent selloff.
Table 1: Trade Details for Receiver Spread with Current Cost of 303c
Structure Strike Norm Vol (bp) Notional ($) PV01 ($) Vega ($) Gamma ($) Theta ($)
Buy 4y10y Rec 5.00% 115.8 100,000,000 34,591 644,080 1,391 (3,063)
Sell 4y10y Rec 3.00% 116.2 (200,000,000) (20,370) (658,871) (653) 3,987
Net 14,222 (14,791) 739 924
Source: BNP Paribas
Suvrat Prakash 16 December 2010

Market Mover, Non-Objective Research Section 37 www.GlobalMarkets.bnpparibas.com
US: OIS Firm, Libor Under Pressure
Chart 1: OIS/Bor Spread Curve
OIS remains fixed in the front end, as the
Fed renewed its commitment to maintain an 45
easing stance at Tuesday’s FOMC meeting. 40
During yesterday’s sell-off, convexity hedgers 35
OIS/Bor Spread (bps)

finally materialized in the market, driving 30
eurodollar futures lower and mechanically 25
pressuring OIS/Bor and swap spreads wider. 20
15
Nerves are a bit frayed, balance sheets still
10
need to shrink and funding pressures are likely
5
to intensify going into year-end. European
0
sovereign debt came under renewed pressure
ED1
ED2
ED3
ED4
ED5
ED6
ED7
ED8
Spot
as Moody’s placed Spain (Aa1) on review for
possible downgrade, but front Libor settings
Source: BNP Paribas
barely nudged.
STRATEGY: We favour being in steepeners Chart 2: OIS/Bor Spread History
in OIS/Bor spreads as the back-end of the curve 100
is simply much too flat (Chart 1) and we think 90
swap spreads will stay under pressure for the 80
OIS/Bor ED2
OIS/Bor ED6
next few sessions. We recommend adding a 70
Basis Spread (bp)
long 2y swap spread position as protection in 60
case the European crisis intensifies and Libor 50
blows out. 40
30
20
10
OIS/Bor Steepeners 0
Nov-10
Jan-09
Jun-09
Mar-09
Sep-09
Dec-09
Feb-10
May-10
Aug-10
Sep-10
Dec-10
The OIS/Bor spread curve has been flattening
mechanically during the sell-off as the reds and
greens have pushed wider but OIS has remained Source: BNP Paribas
fixed and 3m Libor settings have only nudged higher. Chart 3: OIS/Bor Slope History
The result has been that the OIS/Bor spread curve
looks too flat (shown in Chart 1). A 2-year history of 40
OIS/Bor spreads for ED2 and ED6 is shown in Chart 30
ED2/ED6 slope
2, and Chart 3 tracks the slope between these two 20

spreads. The current 4bp slope is below the average
Basis Spread (bp)
10
slope of the past two years of ~8bp. Given underlying 0
pressures in the market from convexity hedgers, -10
shrinking of balance sheet and seasonal withdrawal -20
of liquidity we think reds and greens could continue -30
to sell-off. In particular, the slope between M11 at -40
+35bp (ED2) to M12 at +39bp (ED6) is likely to -50

Nov-10
Jan-09
Jun-09
Mar-09
Sep-09
Dec-09
Feb-10
May-10
Aug-10
Sep-10
Dec-10
steepen going into year-end.
The front of the curve should stay anchored as we Source: BNP Paribas
think overnight to 3m Libor settings will stay tame.
Having experienced two prior waves of sharp
increases in dollar funding pressures due to the
European crisis – in early 2009 and spring of 2010 –
we think most high credit quality European banks
have already secured funding over the turn.
Moreover, Libor quotes are just that – quotes – and
they enjoy (or suffer from) a potential disconnet
Mary-Beth Fisher 16 December 2010

Market Mover, Non-Objective Research Section www.GlobalMarkets.bnpparibas.com
38
between a bank’s perception vs. reality of where they and long the M12 spread. The primary risk to this
can fund. position is that an intensifying crisis in the Eurozone
translates into sharply higher 3m Libor and this
Longer-dated eurodollar futures, however, appear to section of the spread curve inverts – similar to what
be coming under renewed pressure from convexity occurred in the spring of 2010 and February of 2009.
hedgers who are squaring-up positions before year- The Feb09 inversion was sharp but only lasted a few
end, generating considerable paying in swaps and days, while the inversion last spring endured for
pushing spreads wider. several weeks. To hedge that risk we recommend
overlaying a long 2-year swap spread, which should
We recommend entering an OIS/Bor spread curve outperform if such a crisis occurs.
steepener by being short the OIS/Bor M11 spread
Mary-Beth Fisher 16 December 2010

39
MBS: 2011 Outlook – Status Quo
We favour an overweight MBS position as Chart 1: FNM 30Y October 2010 S-Curve
convexity flows are likely behind us with the 10Y
selling off beyond 3.50%. Incremental extension 35 33.2
30.1 30.5
in a sell-off is not likely to be material. 30 27.7
28.6
26.5 26.7
Nov 15, 2010 (10Y~ 3%) 24.3
25
Prepays should remain contained on an 21.2
1m CPRs
20 10Y~ 3.25%
overall scale in a rally due to capacity
15
constraints.
10 8.6
The status quo is likely to prevail on GSE 5 3.5 3.8
10Y ~ 3.50%
1.4
reform, as close exploration of every possibility 0
leads to a dead end. -50 -25 0 25 50 75 100 125 150 175 200 225 250
Moneyness
Issuance should be about USD 100bn/month
at current level of rates with net issuance about Source: BNP Paribas
flat. More importantly, net supply is choked off
as Fed prepays may have slowed from USD Chart 2: 15Y vs 30Y Performance by Coupon
32bn to USD 12bn due to the sell-off and should (12/15 close)
be readily absorbed by other investors. 30Y 1M Performance 15Y 1M Performance
30Y 4, 15Y 3.5 -1-05 1 -0-16 2
We continue to favour up in coupon on 30Y 4.5, 15Y 4 -0-30 5 -0-16 7
attractive carry and the low probability of a 30Y 5, 15Y 4.5 -0-13 0 -0-05 5
government-induced refi wave in 2011. 30Y 5.5, 15Y 5 0-03 0 0-05 1
30Y 6, 15Y 5.5 0-19 6 0-10 7
15s/30s should underperform on the
strength of the basis. GN/FNs should maintain Source: BNP Paribas, Yield Book
the status quo, but if it rallies, up in coupon in
GNs could outperform on supply. reasonable mapping from primary mortgage rates
We like buying lower coupon specified given current spread levels. In terms of the current
pools as a cheap option against a rally but coupon the 4.30% threshold was key in our mind
higher coupon specifieds may not hold as much (roughly 75 bp in the money). After convexity selling
value. as Treasuries crossed the 3.50% mark on
Wednesday, with the current coupon overshooting to
Short resets and higher coupon seasoned 4.43%, we think that mortgage duration may have a
ARMs offer attractive spreads and IO ARMs smooth ride in either rate direction going forward.
should continue to prepay slower with limited
The prepayment S-curve of the universe in
prepay opportunities.
aggregate is more relevant since servicers are the
We like CMOs that benefit from the dominant convexity hedger in today’s market.
slowdown in speeds due to the sell-off that Servicer convexity flows do not depend on who holds
locked out PACs. TBA-ish IIOs look attractive vs the MBS. With major convexity selling behind us, we
storied IIOs for the same reason. like being overweight mortgages into the New Year.
STRATEGY: Overweight into 2011 with up in
Prepays: Remain muted, with capacity limits at
coupon bias.
low rates, though specific coupon-vintages
under threat
We think that capacity constraints may have come
Overweight mortgages with the major convexity into play in prepays over the past couple of months,
flush behind us and should we rally back to rate lows or beyond,
The mortgages basis has suffered as the sell-off capacity constraints are likely to keep prepayments
caused convexity selling, leading to an overhang of relatively dampened. Of course, prepays in lower
dealer inventory in lower coupons. As shown in Chart coupons are likely to be significant. But once we hit
1, the convexity profile of the mortgage universe capacity limits, lack of a further increase in
indicates that the main choke off in prepays happens prepayments should keep overall convexity of the
around the 3.50% 10Y treasury. While these universe at bay. In fact, if we rally beyond a certain
numbers are expressed in 10Y terms, this is a point, prepays for example in 4.5s and 5s may
Anish Lohokare / Timi Ajibola 16 December 2010

40
reduce while those in 4s pick up, as the overall Specified Pool Valuation (payup levels
prepay speed remains the same while the indicative only)
contribution of 4s increases pushing that of 4.5s and
MBS %Even OAS %Even OAS
5s down. Identifier
Payup
Payup
Payup
Payup
Thus we expect the status quo of muted prepays FNMA4.5-2008 2008 0 0% 2 -250%
(<30 CPR aggregate) to be maintained on an overall FNMA4.5-2007 2007 4 26% 12 71%
FNMA4.5-2006 2006 8 34% 18 69%
scale, with specific coupon vintage prepay stories FNMA4.5-2005 2005 12 33% 23 70%
continuing to be in play. FNMA4.5-2004 2004 18 37% 29 73%
FNMA4.5-2003 2003 22 36% 38 77%
FNMA4.5-2002 2002 26 39% 38 72%
Regulatory outlook: GSE reform too big to solve LLB 34 64% 46 43%
MLB 22 51% 40 47%
Status quo is likely to be maintained despite any HLB 16 60% 25 48%
discussions of reform, as a close exploration of every
possibility leads to a dead end. Taking GSEs on the FNMA5.0-2008 2008 0 0% 0 0%
FNMA5.0-2007 2007 0 0% 0 0%
government balance sheet is unlikely to be a FNMA5.0-2006 2006 6 28% 6 27%
palatable option due to the bloody battle over debt FNMA5.0-2005 2005 10 35% 20 80%
ceiling expected even without the GSEs. To find a FNMA5.0-2004 2004 16 48% 26 115%
FNMA5.0-2003 2003 20 51% 31 110%
buyer with enough capital in this market to take on FNMA5.0-2002 2002 22 44% 36 84%
almost USD 5trn mortgage credit portfolio is also LLB 60 101% 72 87%
unlikely. Equally unlikely is spinning off the MLB 38 83% 60 98%
HLB 28 108% 36 116%
companies as private firms due to considerable
losses, large delinquent loan portfolios and already FNMA5.5-2008 2008 0 0% 1 -25%
FNMA5.5-2007 2007 2 30% 8 173%
low equity prices. FNMA5.5-2006 2006 8 72% 18 221%
GSEs’ retained portfolio is already shrinking, and a FNMA5.5-2005 2005 12 45% 28 105%
FNMA5.5-2004 2004 20 76% 35 213%
faster shrinkage is possible (though esp FRE is FNMA5.5-2003 2003 26 80% 40 175%
significantly lower on portfolio size than mandated). FNMA5.5-2002 2002 21 47% 45 124%
A merger of the GSEs is possible but should not LLB 74 112% 82 91%
MLB 60 120% 70 106%
impact the overall marketability of securities. HLB 30 106% 32 93%
Differences in operations would need to be ironed
out. If any or both GSEs are merged with GNMA, in FNMA6.0-2008 2008 2 -23% 2 -13%
FNMA6.0-2007 2007 4 205% 8 141%
addition to operational constraints, fee schedules FNMA6.0-2006 2006 16 407% 20 795%
and underwriting standards would also have to be FNMA6.0-2005 2005 32 111% 36 120%
merged, but once again this would mean the FNMA6.0-2004 2004 48 183% 56 225%
FNMA6.0-2003 2003 60 215% 60 282%
government taking on GSE debt which seems FNMA6.0-2002 2002 68 130% 70 177%
unlikely. LLB 80 139% 85 117%
MLB 56 140% 64 127%
HLB 26 148% 32 143%
Supply and demand
Even if the refi index were to increase beyond the
highs reached recently, capacity constraints are UIC should outperform
likely to keep supply stuck at current levels. For The new-year brings in a gridlocked Congress that’s
2011, we expect issuance to be around the current likely to be focussed on high level issues facing the
USD 100bn/month levels at current rate levels. Net country. The possibility of a government induced
issuance is likely to straddle the flat level. refinancing wave is unlikely in our opinion. A sell-off
Net supply however is a different story due to the is likely to cause up in coupon flows, helping the
reinvestment of Fed MBS paydowns into Treasuries. trade. A rally may hurt low coupons
But due to the sell-off these may have reduced disproportionately due to convexity and supply, and
sharply from a USD 32bn level to roughly USD 12bn. help up in coupon as well.
Given cheap valuations, both on a spread and rate
basis, we see banks, overseas investors and money 15/30s: Negative as 30Ys rebound
managers easily taking up this slack, but we may Lower coupon 15Ys performed very well in the sell-
have to wait until the new year to see these flows off as lower coupon 30Ys underperformed, but as the
coming fully to fruition. Of course, these lower mortgage basis rebounds, either after an incremental
prepays on the Fed portfolio may take a couple of sell-off or in a further rally, 15s/30s should
months to realize due to processing times. underperform. As we expect up in coupon in 30Ys to
do well, as a result, down in coupon in 15Ys/30Ys
may outperform.

41
Chart 4: IO ARMs Continue to be Call
GN/FN: status quo Protected; Seasoning Provides Call Protection
We expect a status quo on the structure of the in ARMs
GSEs, and thus the premium attributed to the explicit 45 Libor IO Libor Amort
guarantee for GNs is unlikely to change materially. 40
With the sell-off, Fed paydowns reinvested into 35
treasuries, a negative factor for conventionals, has 30
subsided considerably. Should we rally however, up
25
in coupon in GN/FNs should outperform as lower
CPR
20
coupons may suffer due to increased supply.
15
One wild card could be the additional data provided 10
by GNMA. Starting in February 2011, GNMA will 5
require servicers to collect loan purposes data with
0
possible values of purchase, refi, loan mod-hamp 2010 2009 2008 2007 2006 2005 2004
and loan mod-non hamp. If the data is not available Vintage
then the pool would be a fail. GNMA did release
Source: eMBS
some of this data for pools originated since May
2010 but the data provision was voluntary on part of Chart 5: WAL and I-Spread Profiles for a
servicers. While there was talk of loss mitigation Locked-Out PAC Off Seasoned 5s
loans having high CPR, this was not the case in the
160 10
limited data that was disclosed. Depending on the 9
statistics that ultimately come out, the adverse 140
8
selection of pools could affect the TBA deliverability. 120
7
100
6
Spec pools: Comeback in a rally? 80 5
Pay-ups initially came under pressure at higher rates 60

4
as concerns moved away from call risk, but have 40

3
2
since stabilized. We continue to favour selling 20
Spd/I WAL
1
seasoned higher coupon pools, as muted 0 0
prepayments reduce the need for call protection. The 6 12 18 24 30 36 42
moneyness of the coupons implies that extension

risk is not likely to come into the picture unless we Source: BNP Paribas, Bloomberg
sell off materially from already high rate levels. We

like loan balance collateral off lower coupons, as storied collateral in favour of TBAish collateral makes
valuation is attractive after recent cheapening, and it sense.
provides excellent insurance in a rally. Consider a locked out PAC off around 66 WALA FG
5s. At an indicative price of 107-04 as of Wednesday
ARMs: Favour short resets and high coupon 3pm, this bond is only 63 bp to the I-curve at 40
seasoned ARMs CPR, about the speed at which it paid in Nov.
As seen in recent prepayment reports, newer However at a speed of 20 CPR, which is quite
collateral in ARMs picked up, responding to lower reasonable given the considerable slowdown in the
rates while seasoned collateral remained call refi index, the spread is much higher at 150 bp. If we
protected. In fixed rates on the other hand, in 5s and rally back to only about 2.9% 10Y (our expectation
to some extent in 5.5s, seasoned collateral speeds for Q1-11), the profile is still likely to be attractive, as
have been quite significant. In terms of relative value, the spread is about 152 bp/I at 25 CPR, as the
we continue to like short resets into Q1-2011. Higher locked out feature helps protect the bond. The
coupon seasoned ARMs offer attractive spreads as average life profile is also quite protected at relevant
well. IO ARMs continue to offer call protection vs prepay speeds, given the PAC structure.
amortizing ARMs as their refinancing options remain Consider two Inverse IOs off 6s, one loan balance
constrained. another TBAish. The TBA-ish bond at a USD 11
handle as a 4.25% yield to forward (YTF) at 33 CPR,
CMOs: Pricing in the speed slowdown its November speed. If the speed slows down to
As the market has sold off, the CMO market appears about 16 CPR, the YTF improves to 16.25%. For the
to have been lagging the pricing in of slower speeds. loan balance IIO which prepaid at about 18 CPR last
We like the theme of picking bonds benefiting from month and priced roughly around 15-24, the YTF is
this slowdown going into the New Year. Locked out 4.65%, but at 12 CPR it improves to 11.7%. The
PACs off seasoned 5s for example benefit from this TBA-ish collateral thus offers a much better YTF if
theme. In the inverse IO space, selling bonds off the speed slowdown is maintained.

42
EUR: Flattening Trend Will Resume
Chart 1: Expectations Track Actual Inflation
Although the curve is still flatter than at the
start of the year, the flattening bias has been
interrupted by strong steepening pressures.
However, the recent correction should prove
temporary. Flattening remains the structural
theme for the curve next year.
STRATEGY: Receiving the 2-10y remains
our key strategic trade for 2011.
The belly of the curve severely hit by QE

Same player shoots again… When, in 2009, the Fed
started QE1, the US curve suffered bear-steepening
pressures that persisted for roughly two months. This
also affected the EUR curve. Indeed, bearish Source: BNP Paribas
pressures on the belly of the curve accompanied the
ECB’s rate cuts, favouring lower rates at the short Chart 2: Higher Real Rates Will Help Flattening
end.
The latest developments are similar in several

respects. QE2 is raising inflation expectations,
fuelling bear-steepening pressures across the US
curve and, given contagion effects, across the EUR
curve as well. In 2009, the EUR 2-10y sector
steepened by more than 40bp in the sell-off. So far,
the recent bear-steepening bias has resulted in a
steepening of the EUR 2-10y of more than 50bp.
This is a significant move especially as, unlike in
2009, the steepening correction was not aided by a
decline in short-term rates. The resteepening that
took place therefore seems too large to be consistent
with structural factors. Hence there is now room for a
return to the structural flattening trend.
Source: BNP Paribas
Inflation expectations will moderate

easing from the peaks reached earlier this year. The
A decline of inflation expectations is a precondition outlook for next year is less favourable. The gradual
for a better tone on the belly of the curve. We expect normalisation of liquidity conditions will cause the
the current rise in inflation expectations to prove ECB to remove, at least partly, current non-standard
temporary. In the main, inflation expectations are measures. This will put rates at the front end under
tracking actual inflation rates. As core inflation modest upward pressures. At the moment, the
continues to moderate in the US and will remain market is discounting that normalisation will be
subdued in Europe, expectations should also decline. achieved at the start of Q4 2011. So far, this has not
This will help to lower the inflation expectation spread significantly through the short end of the bond
component on medium and long-term yields. Such a market curve. But, as the normalisation takes place,
development will help the belly of the curve to rally yields at the short end will push higher. The flattening
slightly in the early months of 2011. bias will therefore be reinforced during the year,
although the bull flattening we expect in Q1 will
The short end will be more exposed next year
gradually give way to bear flattening.
The ECB recently decided to extend its
accommodative conditions for liquidity, but this has Strategy: Receiving the 2-10y remains our key
not prevented the level of excess liquidity from strategic trade for 2011.
Patrick Jacq 16 December 2010

EUR: Excess Liquidity to Decline Next Week
Chart 1: Short-Term Liquidity is Increasing
In addition to its regular weekly MRO, the
ECB will have to provide liquidity as EUR
200.9bn are expiring from 3mth and 1y tenders.
We expect liquidity to drop on the back of
next week’s operations. The magnitude of the
decrease in liquidity will set the tone in the
eonia space.
STRATEGY: Benefit from the recent
compression to play tactical OIS/BOR (IMM1)
spread extension.
Demand at next week’s tenders

The expiry of the 3mth (EUR 104bn) and the 1y
(EUR 96.9bn) tenders next week will be offset by a
new 3mth LTRO and a 13day quick tender that will
Source: BNP Paribas
provide liquidity beyond the turn of the year. From
the 1y tender which is maturing, one can expect that Chart 2: Limited Impact Near Term
at least a quarter will not be rolled, as this
corresponds to carry trades benefiting from the last
1y tender the ECB conducted in December 2009.
When it comes to the 3mth LTRO expiring, it
corresponds to the roll of different LTROs (3tmh,
6mth, 1y) that matured in September. It is difficult to
see precisely where demand came from, in particular
because liquidity fell significantly at the end of
September despite the solid demand for the 3mth.
However, liquidity provided at recent 3mth LTRO
suggests that demand for this maturity is solid. As a
result, the total demand for both 3mth and 13day
tenders next week could be in the EUR 150-170bn
area, or a EUR 30-50bn drop in liquidity. This range
is wide as uncertainty remains high, and the drop in
liquidity is significant.
When it comes to the split between 3mth and 13day Source: BNP Paribas
tenders, it makes sense to see 3mth liquidity still elevated enough at this juncture. Don’t expect
elevated. At the moment, liquidity provided by the significant upward pressures on eonias near term. If
MRO is less than EUR 190bn and the liquidity liquidity falls more significantly, the impact will be
provided by LTROs is slightly below EUR 350bn. more pronounced. There was evidence in the past
After next week’s tenders, we expect a higher that the impact on eonia is more significant when
proportion to come from short-term liquidity. A split of excess liquidity falls below EUR 40bn. As a result,
EUR 130bn/EUR 30bn between the 3mth and the we expect limited impact given our expectations for
13day tenders would lead, other things being equal, demand next week. Neither do we expect strong
to an extension of short-term liquidity in the total tensions at the end of the year, as a significant
liquidity provided in the eurosystem. proportion of liquidity in the system will run beyond
the turn. Further, there will be a MRO on 29
Limited impact on rates near term December, which will provide short-term liquidity.
The eurosystem is running long of liquidity in the The ECB will do what is necessary to avoid year-end
amount of around EUR 90bn. A EUR 40bn fall in tensions.
liquidity will have therefore have limited impact on Strategy: Benefit from the recent compression to
rates near term, as excess liquidity will remain play tactical OIS/BOR (IMM1) spread extension.
Patrick Jacq 16 December 2010

EUR: Euribor Red/Greens Opportunities
Chart 1: Eur, GBP, USD 3/7/11 Gen Flies:
Reds Euribor are back in cheap territory
Cheapening More Pronounced On Euribor
versus fronts and greens and also relative to
Euro$. 50
Red Euribor
decoupling from Eurodollar
Further downward pressure – which is likely 35
in illiquid year-end market conditions – should 20
be used to enter bullish trades. 5
STRATEGY: Sell the U1U2U3 fly in the -10
+12/15 area or the U1H2-U2H3 box at +3/5 -25
targeting -10 on both. -40
-55
-70
Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10
Reds Euribor below mid-November’s lows 3/7/11 Euribor fly 3/7/11 Sterling fly 3/7/11 Eurodollar fly
In this article, we focus on trading opportunities on Source: BNP Paribas

Euribor flies and calendar spreads. The rally seen at
the short end in the wake of disappointing non-farm Chart 2: Distribution of 3/7/11 Gen Euribor Fly
payrolls was short-lived and some stronger US data vs. Euro$ One: Euribor Fly Getting Too High
over the past week have pushed reds Euribor below 0.05
EUR 3/7/11 with USD 3/7/11
mid-November’s lows. The bearish dynamics should 0.045 Peak at -10.1
persist in the very near term fuelled by weak sterling 0.04

(November RPI data were again disappointing) and 0.035
Eurodollar contracts (the latest retail sales data 0.03
surprised to the upside). However, it is worth 0.025
Selling area
remembering that a similar sell-off in December 2009 0.02
was followed by a sharp rebound in January. 0.015
rd th 0.01
In addition, 1y calendar spreads, such as the 3 /7 ,
0.005
currently Sep 11/Sep 12, have bear steepened
0
almost 50bp from late-August’s low and are getting -80 -70 -60 -50 -40 -30 -20 -10 0 10 20 30
close to the 50% retracement of the November 2009- Current level: 5.0
August 2010 flattening trend. Even though August’s Source: BNP Paribas
level on spreads should remain the cyclical low, the
Chart 3: 3/5-7/9 Euribor Box: Sell U1H2 vs.
pricing in of a 65bp tightening on the eonia curve by
U2H3 in the 4-6bp Area
September 2012 seems excessive given current
uncertainty regarding the eurozone. 80
rd th th
Chart 1 shows the 3 /7 /11 generic flies on the 65
USD, Euro and GBP curves. The difference between

50
the Euribor and the Eurodollar flies is really
overstretched pointing to the relative cheapness of 35
red Euribor. Another way to underscore that 20

selling area
cheapness is the position of the Euribor fly within its
5
distribution relative to the Eurodollar fly. An additional
panic sell-off, pushing the Euribor fly to the high 10s, -10
would provide an attractive risk/reward for longs Sep -25
11 versus Sep 12 and Sep 13 targeting a return to Jan-09 Apr-09 Jul-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
3/5 vs 7/9 Euribor box 3/5 generic Eur spd
the -5/-10bp area. 3/5 vs 9/11 Euribor box 7/9 generic Eur spd
Another interesting RV trade on a final downward Source: BNP Paribas
move would be to sell the front/red-red/green box. As

Chart 3 shows, the Sep 11/Mar 12-Sep 12/Mar 13 Strategy:
box disinverted 12bp over the past week’s sell-off. 1) Sell the U1U2U3 Euribor fly in the +12/15 area
The +5/7bp area has tended to be a strong targeting -10 by late January.
resistance on the generic over the past year and the
dollar one is trading 15bp below the Euribor one! 2) Sell the U1H2 – U2H3 box at +3/+5.
Eric Oynoyan 16 December 2010

45
EUR: 2011 EGB Issuance Preview
Table 1: 2011 EGB Issuance Projections
We expect gross EGB issuance of
EUR 827bn in 2011 from EUR 943bn in 2010. In EUR Sovereign Financing: Projections for 2011 (EUR bn)
Issuer
2010 Bond 2010 Net
Redemptions Deficit Borrowing Needs Bond Issuance Issuance Net Issuance Issuance
net supply terms, we expect EUR 311bn in 2011 Austria 8.3 10.2 18 19 21 11 12
from EUR 430bn in 2010. Bond redemptions will Belgium 24.0 16.0 40 34 41 10 16
Finland 5.7 6.3 12 15 16 9 7
be EUR 35bn higher in 2011 at EUR 548bn. France 91.8 90.0 182 180 188 88 105
January is expected to be the heaviest month in Germany 147.3 33.0 180 195 207 48 74
terms of issuance with an estimated EUR 84bn Greece

Ireland
27.7
4.4
18.7
16.4
46
24
-
-
18
22
-
-
2
22
of EGB supply. Italy 155.2 73.0 228 225 260 70 88
Netherlands 27.9 23.9 52 50 52 22 29
We present the full 2011 bond and bill Portugal 9.6 9.3 19 18 22 8 16
redemption profile as this often signals Slovenia

Spain
1.0
45.1
2.1
43.7
3
89
3
88
3
94
2
43
2
59
pressure points, especially for weaker Total 548 343 894 827 943 311 430
sovereigns where concentration is higher. Only
AAA bond redemptions are scheduled for Source: BNP Paribas
January. Heavy AAA issuance in early January Chart 1: Gross Supply in 2009-2011
is historically linked to ASW compression.
280 Gross Supply
A more detailed research piece will follow 240
once the official funding plans of all eurozone 2009 2010 2011 est.
200
issuers have been released.
160
120
80
Forecasting 2011 European government bond (EGB) 40
issuance has become more difficult lately given the 0
need to forecast not only how much a country will
ia
ly
ria
nd
e
m
y
l
ce
ga
nd
an
ec
an
ai
issue in the coming year but also whether a country

Ita
en
iu
la
st
an
rt u
Sp
re
rla
m
lg
nl
ov
Ire
Au
Fr
Be
Fi
er
G
Po
he
Sl
G
will need to issue in the first place or not. We expect

et
N
Greece and Ireland to stay away from the primary Source: BNP Paribas
markets in 2011 as they are both under EU/IMF aid
Chart 2: Net Supply in 2009-2011
mechanisms that cover state financing except for
T-bills which will keep being rolled-on in the market. 120
Net Supply
In our central case scenario, we believe that, sooner 100
or later, Portugal will need to follow the same route 2009 2010 2011 est.
80
towards the EFSF but we do not believe this will be
the case for Spain, which we do not think faces the 60
same fate at the three smaller peripherals. As a 40
result, a direct comparison between 2010 and
estimated 2011 issuance is distorted by the fact that 20
not all countries that issued paper in 2010 will issue 0

in 2011.
ly
ia
d
ria
e
m
y
s
n
l
ce
ga
lan
an
nd
ai
ec
an
Ita
en
iu
st
an
rt u
Sp
re
lg
m
nl
la
ov
Ire
Au
Fr
er
Be
Fi
er
G
Po
Sl
th
G
Nevertheless, we expect both gross and net 2011

Ne
issuance to decline since most European Source: BNP Paribas

governments have adopted fiscal consolidation
measures aimed at decreasing their budget deficits.
Bond redemptions will be higher in 2011 (by forecasts are subject to revision on the release of
EUR 35bn), offsetting part of the impact of the fiscal eurozone countries’ funding plans for 2011.
consolidation efforts on gross supply, but net supply
will decrease significantly in the year ahead (see Charts 1 and 2 show the gross and net supply figures
Table 1 for more details). In total, we expect 2011 in the 2009-2011 period for eurozone countries. In
EGB issuance of around EUR 827bn, down from percentage terms, we expect Belgium (-17%),
943bn in 2010 (-12%). In net supply terms in 2011, a Portugal (-17%) and Italy (-13%) to see the biggest
steeper reduction is expected to around EUR 311bn decrease in gross supply in the year ahead. In net
from EUR 430bn in 2010 (-28%). Note these supply terms, Portugal, Belgium and Germany will
Ioannis Sokos 16 December 2010

46
see the biggest falls although net supply will be much Table 2: Monthly Bond & Bill Redemptions
lower in almost all eurozone countries in 2011.
Bonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011
As we’ve seen over the course of 2010, the ITA 0.0 21.7 30.5 0.0 14.6 12.2 2.7 20.2 46.0 0.0 15.5 0.0 163.3
FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0
redemption profile can signal pressure points for GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3
weaker sovereigns. In Table 2 we present the SPA 0.0 0.0 0.0 15.5 0.0 0.0 17.0 0.0 0.0 14.1 0.0 0.0 46.6
monthly bond and bill redemption profile for 2011. In GRE 0.0 0.0 9.1 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.8
BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.6 28.0
January, for example, only AAA bond redemptions NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9
are scheduled. For Spain, the pressure points will be AUS 8.3 0.1 0.1 0.0 0.9 0.0 0.6 0.0 0.0 0.0 0.0 0.1 10.0
in April, July and October in 2011, while for Portugal POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5
IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5
they lie in April and June. Countries with a higher FIN 0.0 5.7 0.0 0.0 1.5 0.0 0.0 0.1 0.1 0.0 0.0 0.0 7.3
concentration in terms of accumulated redemptions Total 63.2 27.4 66.1 58.5 24.0 35.5 87.6 27.1 88.6 46.7 20.0 24.5 569.2
as a percentage of the total, such as Portugal and
Spain, usually face higher pressure around their T-Bills Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011
redemption dates. The redemptions of core countries ITA 17.4 17.3 17.3 17.3 14.6 6.6 7.5 7.2 7.7 7.2 6.1 4.2 130.1
FRA 33.3 35.9 29.7 15.1 15.8 14.2 8.5 7.4 5.6 7.1 5.8 2.0 180.3
are better dispersed throughout the year. In the table GER 11.0 11.0 11.0 11.0 11.0 11.0 4.0 4.0 4.0 3.0 3.0 2.0 86.0
we include redemptions of bonds issued in all SPA 8.7 7.8 6.5 6.2 6.5 4.2 4.2 7.1 5.3 8.2 3.7 4.6 73.0
GRE 4.2 0.4 1.4 2.4 0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 8.8
currencies and this is why the total figure of BEL 5.5 6.2 6.4 4.1 3.7 2.0 1.9 2.1 2.0 2.0 1.8 1.6 39.5
EUR 569bn is higher than the figure shown in NET 9.7 8.3 11.6 3.5 4.0 8.0 0.0 0.0 2.7 0.0 0.0 0.0 47.9
Table 1. AUS 0.1 0.0 0.7 1.1 0.0 0.0 0.2 0.9 0.2 0.2 0.3 0.0 3.5
POR 3.4 3.5 3.8 0.0 0.0 0.0 1.8 1.4 1.4 1.4 1.4 0.0 18.1
IRE 2.1 1.2 1.6 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.0
In Table 3 we estimate the monthly issuance in each FIN 3.6 2.2 2.5 1.1 1.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 10.8
country taking into account the historical patterns of Total 99.0 93.7 92.4 63.0 57.4 46.0 28.0 30.1 28.9 29.0 22.1 14.4 604.0
issuance and the existing redemption profile. As is
usually the case, January is expected to be the Source: BNP Paribas
heaviest month in terms of EGB issuance with a Table 3: Monthly/Country Breakdown of 2011
EUR 84bn forecast. Bear in mind that EFSF and EGB Issuance
EFSM issuance needs to be added on top of that
figure. AAA issuance in January is estimated at 2011 GER FRA ITA SPA NET BEL AUS POR FIN Total
Jan 19.0 19.7 20.6 9.1 5.5 4.2 4.0 0.8 1.0 83.9
around EUR 50bn. This could lead to a compression Feb 18.0 16.2 19.6 8.5 6.5 3.7 1.5 3.3 0.0 77.3
in ASW in January, repeating a seasonal pattern that Mar 16.0 19.9 18.0 10.5 3.0 3.3 1.5 0.8 4.0 77.1
Apr 19.0 16.7 23.2 5.2 6.5 3.3 2.0 1.7 1.5 79.0
has been seen in previous years. EFSF’s Regling May 19.0 17.6 15.2 6.2 7.8 0.0 1.8 1.8 0.0 69.4
has already said that the EFSF may issue between Jun 18.0 17.4 23.2 7.7 3.5 3.3 1.9 2.2 1.5 78.7
Jul 11.0 17.0 16.8 12.4 6.0 6.6 1.2 2.5 0.0 73.5
EUR 5bn and 8bn of bonds in January. At these Aug 13.0 0.0 18.5 3.3 0.0 2.8 0.9 1.1 0.0 39.5
levels we do not think that the extra EFSF issuance Sep 20.0 16.5 23.7 6.9 2.5 2.9 1.9 1.7 4.0 80.0
Oct 12.0 16.9 21.2 6.6 5.7 2.3 1.4 1.0 1.7 68.9
will have an impact on AAA eurozone issuance. Nov 20.0 16.7 18.1 8.5 3.0 1.7 1.0 1.0 1.5 71.4
Dec 10.0 5.3 6.8 3.2 0.0 0.0 0.0 0.0 0.0 25.3
In 2010, the 10y sector’s share of total issuance rose Total 195 180 225 88 50 34 19 18 15 824
to 31% from 27% in 2009. The 30y sector’s share of
total issuance was unchanged at 7%. In 2011 we Source: BNP Paribas
expect core countries to increase the duration of their

debt, taking into account the search for duration by
real money accounts. T-Bill issuance could decrease
further, continuing the trend seen in 2010. In the
case of Germany which is one of the few countries
that has released its funding plans, the breakdown
across different maturity buckets will not change
much compared to 2010. 2y and 5y issuance
increases by 1.1% as a percentage of total supply 2011 issuance starts in December with the end-of-
while 10y issuance’s share falls by 1.4% and 30y month Italian auctions which settle in the first days of
issuance’s by 0.8%. 2011. Then, during the first week of January,
Germany will tap the 10y DBR Jan-21 for EUR 5bn.
Finally, for Spain, we calculate that redemptions that We also expect France to issue OATs that week.
stem from regional bonds in 2011 amount to around Austria and Netherlands are expected to issue bonds
EUR 6.5bn versus a 50bn outstanding. Out of these in the second week of the year, together with Italy
EUR 6.5bn, 3.7bn will expire in November. These and potentially Spain. In the absence of Greece and
figures are not high enough to be a threat right now Ireland, we expect Portuguese and Spanish auctions
since SPGB redemptions will be EUR 46bn in 2011 to be a barometer for investors’ appetite for
and Spanish Letras another EUR 73bn. peripherals.
Ioannis Sokos 16 December 2010

47
Gilts: Strategic Trades for 2011
Chart 1: Gilt/Bund Rolling Correlation
Realised Gilt interest rate volatility has
markedly increased since mid-October. It has 1.0 1.0
hence become a complex task to establish 0.9
strategic positions given the elevated macro 0.8 0.9
uncertainty. In this context, we recommend two 0.7
trades for investors with a medium-term 0.6 0.8
horizon. 0.5
STRATEGY: a) Buy Gilt 4.25% 2039 asset 0.4 0.7
swap around 6M Libor +29bp; b) sell the 0.3

3M Corr (Gilt 10y, Bund 10y)
Gilt/Bund 2s10s box, i.e. sell Gilt 5.25% 2012 vs 0.2 0.6
Gilt 4.75% 2020 duration weighted and buy 0.1 3M F.D. Corr(Gilt 10y, Bund 10y) -
(RHS)
Schatz 1.00% 2012 vs Bund 3.25% 2020 duration 0.0 0.5
Jan-09 Jul-09 Jan-10 Jul-10 Dec-10
weighted.
Source: BNP Paribas
Gilts have recently been driven more by events in the Chart 2: Evolution of Gilt Issuance
eurozone than domestic developments. Level
correlation with Germany has increased above 0.9 250
GBP bn
since November (Chart 1). Indeed, interest rate
volatility has markedly increased. In contrast to 200
Gilt Issuance
gyrations in yields, swap spreads have been
BNP Paribas Forecast
relatively stable over the past month. The average 150
spreads on Short and Medium Gilts are unchanged

whereas the average spread has widened by 3bp on 100
Long Gilts. At the same time, gross financing

50
requirement is expected to remain stable around
GBP 170bn in 2011 and to drop from GBP 143bn in
0
2012 to GBP 87bn in 2014 (Chart 2). Meanwhile, 1998 2000 2002 2004 2006 2008 2010 2012 2014
Moody’s UK banking system outlook released on
Monday remains negative. Of particular concern, in Source: BNP Paribas
our view, is the still-high utilisation of wholesale
Chart 3: Gilt/Bund 2s10s Box
funding which exposes banks to refinancing risk as
the SLS will not be renewed. GBP 110bn is to be 2.0
repaid by February 2010. Moreover, GBP 125bn of 1.5

government-guaranteed debt will mature through
1.0
April 2014. Clearly, the cost of liquidity (hence libor
rates) will increase. We thus recommend playing the 0.5
normalisation of Long-Gilts swap spreads, which are 0.0
still hovering in negative territory. -0.5
Strategy: Buy Gilt 4.25% 2039 asset swap around -1.0

6M Libor +29bp.
-1.5
The Gilt/Bund 2s10s box is hovering around 40bp. In -2.0
our view, steepening pressures on core yield curves 2003 2004 2005 2006 2007 2008 2009 2010
in the eurozone next year will be more pronounced

Source: BNP Paribas
than on the Gilt curve. Firstly, markets are likely to
price in increased exposure of core paper in the tighten earlier than the ECB, we think. Accordingly
eurozone to the euro periphery via the EFSF while we recommend short positions in the box at current
Gilts could retain their status as safe haven assets. levels. It visited levels below -140bp in mid-2004
Note that the price return for the 7y-10y sectors in when the policy rate differential reached 2.75%
Germany and in the UK in November (peak of Irish (Chart 3).
crisis) were -1.36% and -1.26% respectively. Strategy: Sell Gilt 5.25% 2012 vs buy Gilt 4.75%
Secondly, inflation and inflation expectations are
2020 duration weighted. Buy Schatz 1.00% 2012 vs
markedly different. The BoE will be expected to
Sell Bund 3.25% 2020 duration weighted.
Matteo Regesta 16 December 2010

48
JGBs: Watch the Corporate Sector
Chart 1: Machinery Orders and 5-year JGB Yield
Although the level of private sector orders
in October was 5.5% below the average for Q3, 16000 Overseas orders (JPY bn) 2
it was 3.6% above the average for Q2 and
14000
shows that a slow recovery continues.
1.5
12000
Corporate willingness to invest in plant and Private demand (JPY bn)
equipment is recovering, even though the 10000
expiry of support for environmentally friendly 1
8000
autos is acting to reduce output and earnings.
6000
If corporate behaviour becomes more 0.5
aggressive, ample funds on hand will boost 4000 5-year JGB (%, RHS)
capital expenditure and potentially improve the 2000 0
employment environment. 2007 2008 2009 2010 2011
We maintain a cautious stance on the belly

Source: BNP Paribas
of the curve. While the short end and the
super-long end are likely to outperform over
the near term, the latter still faces fiscal risk
over the longer term.
spring, has started to reaccelerate. October

machinery order data also revealed that orders from
Machinery orders are trending higher overseas surged 16.0% m/m, after rising 6.9% in
How long will the improvement in expected growth September.
persist? At the very least, it will last until the results of
the US Christmas sales are known. The focus of In addition, machine tool orders – a precursor of
markets will shift after the start of the year to demand machinery orders – soared 20.5% m/m in November.
for the Chinese New Year. Next for Japan will be the Not only were overseas orders strong (+19.5%) but
equity prices at March book closings. As a result of so were private sector orders (+22.8%). After falling
curtailing capital expenditure and employment, the at the beginning of autumn, machine tool orders are
Japanese corporate sector is awash with cash; again picking up. Corporate willingness to invest in
investors will examine whether these events lead to plant and equipment is recovering, even though the
vigorous, positive corporate behaviour. expiry of support for environmentally friendly autos is
acting to reduce output and earnings.
The 9 December release of October machinery
orders (excluding ships and electric power) showed Corporate action could have a major impact on
that private sector orders fell 1.4% m/m, their second domestic money flows
consecutive drop. However, declines in the last two The halt of yen appreciation and the retreat of
months are a reaction to the summer surge (July: downside risk to global growth lie behind these signs
+8.8% m/m; August: +10.1%; September: -10.3%). of a pick-up in capex-related indicators. If corporate
Although the level of private sector orders in October behaviour becomes more aggressive, ample funds
was 5.5% below the average for Q3, it was 3.6% on hand will boost capital expenditure and potentially
above the average for Q2 – indicating that a slow improve the employment environment. Corporate
recovery continues. action could also have a major impact on domestic
money flows.
Corporate willingness to invest is recovering
The Japanese economy, the manufacturing sector in Pressures for bear flattening, a reaction to the
particular, is experiencing a soft patch because of protracted bull steepening of the yield curve caused
slowing exports and the termination of subsidies for by double-dip concerns, will persist for some time. In
environmentally friendly autos. On this score, the current environment, we maintain a cautious
improvements have paused in business conditions stance on the belly of the curve. The short end and
DIs of the December BoJ Tankan, released on the super long end are likely to outperform over the
Wednesday. On the other hand, the global near term. However, we note that the super-long end
manufacturing cycle, which had slowed from the still faces fiscal risk over the longer term.
Koji Shimamoto 16 December 2010

49
Global Inflation Watch
Inflation data over the holiday period Chart 1: Japanese CPI (% y/y)
3
There are some important inflation releases over the Core CPI
holiday period and at the very beginning of January. 2
While most of the November inflation data is now out,

1
Japan will publish its CPI release for the month on 28
December. That will be followed the next day by the 0
first December data release in the euro area from
-1
Germany. That will be followed by the eurozone flash
HICP on the second working day of the year, 4 -2
CPI excluding energy and food, but not alcohol
January.
-3
In Japan, inflation jumped by 0.5pp in October, in 02 03 04 05 06 07 08 09 10
most part thanks to a tobacco tax hike. The trimmed

mean core measure of inflation also rose, gaining Source: Reuters EcoWin Pro, BNP Paribas
0.1pp to reach -0.3% y/y. That compares with its
-1.3% low at the end of 2009. In November, we
expect both the headline core CPI and trimmed mean
Chart 2: EZ HICP Energy & Brent (EUR)
measures of inflation to move sideways, though the
moderation in deflation should continue in the coming
quarters.
December inflation should be marked by robust
energy prices given the strong rise in oil prices
between the end of November and mid-December.
This is particularly true in the euro area, where this
move has been exacerbated by the falling value of
the euro in the second half of November.
In Germany, we are expecting headline CPI inflation
to reach 1.7% y/y in December, the second
consecutive 0.2pp increase. Energy inflation is
forecast to reach 8% y/y – its highest level since
Source: Reuters EcoWin Pro, BNP Paribas
October 2008. Food inflation should also gain –
November’s 1% gain in food prices was the first
concrete evidence of pass-through from the soft
commodity shock to consumer prices, and this Chart 3: German Clothing HICP (% m/m, sliced)
process has much further to go.
This strength in commodity prices should dominate a
decline in core inflation. In November, core inflation
rose by 0.2pp in Germany to 0.78% y/y, largely on a
jump in clothing inflation. This jump, however, was
driven by changing seasonality in the discounting of
clothes in the run-up to the holiday period. A large
amount of this strength should therefore unwind in
December, when discounts come a month later than
in 2009.
This strong German release should contribute to a
rise in inflation across the euro area – headline
inflation is expected to hit 2.1% y/y on similar Source: Reuters EcoWin Pro, BNP Paribas
dynamics. It should remain around 2% until early

spring 2011, when energy base effects should drag it
lower.
Luigi Speranza/Eoin O’Callaghan 16 December 2010

Table 1: BNP Paribas' Inflation Forecasts
Eurozone France US
Headline HICP Ex-tobacco HICP Headline CPI Ex-tobacco CPI CPI Urban SA CPI Urban NSA
Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y index % m/m % y/y Index % m/m % y/y Index % m/m % y/y
2009 108.1 - 0.3 107.9 - 0.2 119.3 - 0.1 118.0 - 0.1 214.5 - -0.3 214.5 - -0.4
(1)
2010 109.8 - 1.6 109.5 - 1.5 121.1 - 1.5 119.8 - 1.5 218.1 - 1.6 218.0 - 1.6
(1)
2011 111.6 - 1.6 111.2 - 1.6 123.2 - 1.7 121.7 - 1.6 221.0 - 1.3 221.0 - 1.4
Q3 2009 108.0 - -0.4 107.8 - -0.5 119.4 - -0.4 118.1 - -0.4 215.4 - -1.6 215.7 - -1.6
Q4 2009 108.6 - 0.4 108.4 - 0.3 119.7 - 0.4 118.4 - 0.3 216.8 - 1.5 216.2 - 1.4
Q1 2010 108.6 - 1.1 108.3 - 1.0 120.3 - 1.3 119.0 - 1.2 217.6 - 2.4 217.0 - 2.4
Q2 2010 110.0 - 1.5 109.7 - 1.4 121.3 - 1.6 120.0 - 1.5 217.2 - 1.8 218.1 - 1.8
Q3 2010 109.9 - 1.7 109.5 - 1.6 121.2 - 1.5 119.8 - 1.5 218.0 - 1.2 218.3 - 1.2
(1)
Q4 2010 110.8 - 2.0 110.4 - 1.9 121.7 - 1.6 120.2 - 1.6 219.4 - 1.2 218.8 - 1.2
(1)
Q1 2011 110.7 - 1.9 110.3 - 1.9 122.2 - 1.6 120.8 - 1.5 220.6 - 1.4 220.0 - 1.4
(1)
Q2 2011 111.6 - 1.5 111.2 - 1.4 123.1 - 1.5 121.6 - 1.4 220.8 - 1.6 221.6 - 1.6
Jan 10 108.1 -0.8 1.0 107.75 -0.8 0.9 119.7 -0.2 1.1 118.32 -0.2 1.0 217.6 0.2 2.7 216.69 0.3 2.6
Feb 10 108.4 0.3 0.9 108.10 0.3 0.8 120.4 0.6 1.3 118.99 0.6 1.2 217.6 0.0 2.2 216.74 0.0 2.1
Mar 10 109.4 0.9 1.4 109.09 0.9 1.3 120.9 0.5 1.6 119.58 0.5 1.5 217.7 0.1 2.4 217.63 0.4 2.3
Apr 10 109.9 0.5 1.5 109.58 0.4 1.4 121.3 0.3 1.7 119.90 0.3 1.6 217.6 -0.1 2.2 218.01 0.2 2.2
May 10 110.0 0.1 1.6 109.71 0.1 1.5 121.4 0.1 1.6 120.04 0.1 1.6 217.2 -0.2 2.0 218.18 0.1 2.0
Jun 10 110.0 0.0 1.4 109.70 0.0 1.3 121.4 0.0 1.5 120.02 0.0 1.4 216.9 -0.1 1.1 217.97 -0.1 1.1
Jul 10 109.7 -0.3 1.7 109.31 -0.4 1.7 121.0 -0.3 1.7 119.68 -0.3 1.6 217.6 0.3 1.3 218.01 0.0 1.2
Aug 10 109.9 0.2 1.6 109.54 0.2 1.5 121.3 0.2 1.4 119.97 0.2 1.3 218.2 0.3 1.2 218.31 0.1 1.1
Sep 10 110.1 0.2 1.8 109.76 0.2 1.7 121.2 -0.1 1.6 119.88 -0.1 1.5 218.4 0.1 1.1 218.44 0.1 1.1
Oct 10 110.5 0.4 1.9 110.16 0.4 1.8 121.4 0.1 1.6 120.03 0.1 1.5 218.9 0.2 1.2 218.71 0.1 1.2
Nov 10 110.6 0.1 1.9 110.27 0.1 1.8 121.5 0.1 1.6 120.09 0.0 1.5 219.1 0.1 1.1 218.80 0.0 1.1
(1)
Dec 10 111.2 0.5 2.1 110.87 0.5 2.1 122.1 0.4 1.8 120.59 0.4 1.7 220.2 0.5 1.4 218.85 0.0 1.3
(1)
Jan 11 110.3 -0.9 2.0 109.87 -0.9 2.0 121.7 -0.3 1.7 120.24 -0.3 1.6 220.4 0.1 1.3 219.52 0.3 1.3
(1)
Feb 11 110.6 0.3 2.1 110.25 0.3 2.0 122.3 0.5 1.6 120.83 0.5 1.5 220.7 0.2 1.4 219.95 0.2 1.5
(1)
Mar 11 111.3 0.6 1.7 110.89 0.6 1.6 122.7 0.3 1.4 121.19 0.3 1.3 220.6 -0.1 1.3 220.58 0.3 1.4
(1)
Apr 11 111.5 0.2 1.5 111.11 0.2 1.4 123.0 0.2 1.4 121.47 0.2 1.3 220.7 0.1 1.4 221.16 0.3 1.4
(1)
May 11 111.6 0.1 1.5 111.24 0.1 1.4 123.2 0.2 1.5 121.69 0.2 1.4 220.8 0.0 1.7 221.72 0.3 1.6
(1)
Jun 11 111.7 0.0 1.5 111.27 0.0 1.4 123.3 0.1 1.6 121.77 0.1 1.5 220.9 0.0 1.8 222.04 0.1 1.9
Updated Dec 16 Dec 16 Dec 16
Next
Dec Flash HICP (Jan 4) Dec CPI (Jan 13) Dec CPI (Jan 14)
Release
Source: BNP Paribas, (1) Forecasts
Chart 4: Eurozone Core HICP (% y/y) Chart 5: US Core CPI (% y/y)
Source: Reuters EcoWin Pro Source: Reuters EcoWin Pro
Since printing an all-time low in April, core inflation has been a The downward trend in shelter inflation was recently interrupted
touch stronger in recent months, reflecting gains in both core and leading indicators suggest its strength will continue until year-
goods and core services inflation. While we expect core services end. The renewed collapse in the housing market should see a
inflation to head lower, the rebound in core goods has further to reversion to a downward trend from early next year.
run. We expect a brief interruption to the downward trend in core.

Japan UK Sweden
Core CPI SA Core CPI NSA Headline CPI RPI CPI CPIF
Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y Index % m/m % y/y
2009 100.3 - -1.3 100.3 - -1.3 110.8 - 2.1 213.7 - -0.5 299.7 - -0.3 191.2 - 1.9
(1)
2010 99.2 - -1.1 99.2 - -1.1 114.5 - 3.3 223.6 - 4.6 303.3 - 1.2 195.1 - 2.0
(1)
2011 98.6 - -0.6 98.6 - -0.6 118.3 - 3.3 232.7 - 4.1 309.2 - 2.0 197.6 - 1.3
Q3 2009 99.9 - -2.3 100.1 - -2.3 111.3 - 1.5 214.4 - -1.4 299.5 - -1.2 191.6 - 1.6
Q4 2009 99.7 - -1.8 99.9 - -1.8 112.1 - 2.1 216.9 - 0.6 301.3 - -0.4 193.2 - 2.3
Q1 2010 99.7 - -1.3 99.3 - -1.2 112.9 - 3.2 219.3 - 4.0 301.2 - 1.0 194.0 - 2.6
Q2 2010 99.3 - -1.2 99.3 - -1.2 114.4 - 3.4 223.5 - 5.1 302.8 - 1.1 194.9 - 2.1
Q3 2010 98.8 - -1.1 99.1 - -1.0 114.7 - 3.1 224.5 - 4.7 302.9 - 1.1 194.8 - 1.7
(1)
Q4 2010 99.1 - -0.6 99.3 - -0.6 115.8 - 3.3 227.0 - 4.7 306.2 - 1.6 196.5 - 1.7
(1)
Q1 2011 98.9 - -0.9 98.4 - -0.9 117.0 - 3.6 229.4 - 4.6 305.9 - 1.5 195.5 - 0.8
(1)
Q2 2011 98.7 - -0.6 98.7 - -0.6 118.2 - 3.3 232.6 - 4.1 309.0 - 2.1 197.2 - 1.2
Jan 10 99.6 -0.1 -1.3 99.2 -0.6 -1.3 112.4 -0.2 3.4 217.9 0.0 3.7 299.8 -0.6 0.6 193.0 -0.2 2.6
Feb 10 99.8 0.2 -1.2 99.2 0.0 -1.2 112.9 0.4 3.0 219.2 0.6 3.7 301.6 0.6 1.2 194.2 0.6 2.7
Mar 10 99.8 0.0 -1.2 99.5 0.3 -1.2 113.5 0.5 3.4 220.7 0.7 4.4 302.3 0.2 1.2 194.7 0.3 2.5
Apr 10 99.3 -0.5 -1.5 99.2 -0.3 -1.5 114.2 0.6 3.7 222.8 1.0 5.3 302.4 0.0 1.0 194.8 0.0 2.2
May 10 99.3 0.0 -1.2 99.3 0.1 -1.2 114.4 0.2 3.3 223.6 0.4 5.1 302.9 0.2 1.2 195.0 0.1 2.1
Jun 10 99.2 -0.1 -1.0 99.3 0.0 -1.0 114.6 0.2 3.2 224.1 0.2 5.0 303.0 0.0 0.9 195.0 0.0 1.9
Jul 10 98.9 -0.3 -1.1 99.0 -0.3 -1.1 114.3 -0.3 3.1 223.6 -0.2 4.8 302.0 -0.3 1.1 194.3 -0.3 1.7
Aug 10 98.8 -0.1 -1.0 99.1 0.1 -1.0 114.9 0.5 3.1 224.5 0.4 4.7 302.1 0.0 0.9 194.3 0.0 1.4
Sep 10 98.7 -0.1 -1.1 99.1 0.0 -1.1 114.9 0.0 3.0 225.3 0.4 4.6 304.6 0.8 1.4 195.8 0.8 1.8
Oct 10 99.1 0.4 -0.6 99.5 0.4 -0.6 115.2 0.2 3.1 225.8 0.2 4.5 305.6 0.3 1.5 196.3 0.3 1.8
(1)
Nov 10 99.2 0.1 -0.6 99.3 -0.2 -0.6 115.6 0.4 3.2 226.8 0.4 4.7 306.6 0.3 1.8 196.8 0.2 1.9
(1)
Dec 10 99.1 -0.1 -0.6 99.2 -0.1 -0.6 116.6 0.9 3.6 228.4 0.7 4.8 306.5 0.0 1.6 196.4 -0.2 1.5
(1)
Jan 11 99.0 -0.1 -0.6 98.6 -0.6 -0.6 116.6 -0.1 3.7 228.4 0.0 4.8 304.4 -0.7 1.5 194.7 -0.9 0.8
(1)
Feb 11 98.9 -0.1 -0.9 98.3 -0.3 -0.9 117.1 0.5 3.8 229.5 0.5 4.7 306.1 0.6 1.5 195.5 0.4 0.6
(1)
Mar 11 98.7 -0.2 -1.1 98.4 0.1 -1.1 117.4 0.3 3.5 230.3 0.3 4.3 307.1 0.3 1.6 196.3 0.5 0.8
(1)
Apr 11 98.7 0.0 -0.6 98.6 0.2 -0.6 117.9 0.4 3.3 232.0 0.8 4.1 308.6 0.5 2.1 196.9 0.3 1.1
(1)
May 11 98.7 0.0 -0.6 98.7 0.1 -0.6 118.2 0.3 3.3 232.7 0.3 4.1 309.1 0.2 2.1 197.2 0.2 1.1
(1)
Jun 11 98.6 -0.1 -0.6 98.7 0.0 -0.6 118.4 0.1 3.3 233.0 0.2 4.0 309.2 0.0 2.1 197.4 0.1 1.2
Updated Nov 26 Dec 14 Dec 09
Next
Nov CPI (Dec 28) Dec CPI (Jan 18) Dec CPI (Jan 13)
Release
Chart 6: Japanese CPI (% y/y) Chart 7: UK CPI (% y/y)
Source: Reuters EcoWin Pro Source: Reuters EcoWin Pro, BNP Paribas
Prices are expected to continue falling but the pace of decline is We expect inflation to remain above target for the remainder of the
easing as the economy recovers. year, although trending down.

Canada Norway Australia
CPI Core CPI Headline CPI Core CPI Core
Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y Index % q/q % y/y
2009 114.4 0.3 113.6 1.8 125.7 2.2 118.4 2.6 167.8 - 1.8 - - 3.7
(1)
2010 116.5 1.8 115.5 1.6 128.7 2.3 120.0 1.4 172.9 - 3.1 - - 2.8
(1)
2011 118.6 1.8 117.1 1.4 130.3 1.3 121.6 1.3 178.3 - 3.3 - - 2.9
Q3 2009 114.7 0.5 -0.9 113.9 1.2 1.6 125.8 0.0 1.8 118.5 0.0 2.4 168.6 1.0 1.3 - - 3.5
Q4 2009 114.9 0.6 0.8 114.4 1.9 1.6 126.6 0.6 1.4 119.3 0.7 2.3 169.5 0.5 2.1 - - 3.4
Q1 2010 115.4 2.0 1.6 114.9 1.6 1.9 128.4 1.4 2.9 119.4 0.1 2.0 171.0 0.9 2.9 - - 3.1
Q2 2010 116.2 2.6 1.4 115.5 2.3 1.8 129.1 0.6 2.6 120.3 0.8 1.5 172.1 0.6 3.1 - - 2.7
Q3 2010 116.8 2.2 1.8 115.6 0.3 1.6 128.2 -0.7 1.9 119.9 -0.3 1.2 173.3 0.7 2.8 - - 2.4
(1)
Q4 2010 117.4 1.5 2.2 116.0 1.2 1.4 129.0 0.7 1.9 120.5 0.5 1.0 175.2 1.1 3.1 - - 2.5
(1)
Q1 2011 117.9 1.6 2.1 116.4 1.6 1.4 129.4 0.2 0.8 120.6 0.1 1.0 176.1 0.6 3.2 - - 2.4
(1)
Q2 2011 118.3 1.7 1.9 116.9 1.7 1.2 130.3 0.8 1.0 121.7 0.9 1.1 177.3 0.7 3.3 - - 2.6
Updated Nov 23 Dec 10 Oct 29
Next
Nov CPI (Dec 21) Dec CPI (Jan 10) Q4 CPI (Jan 25)
Release
Chart 8: Canadian Total Versus Core CPI Chart 9: Australian CPI (% y/y)
Source: Reuters EcoWin Pro, BNP Paribas Source: Reuters EcoWin Pro, BNP Paribas
Wage pressures appear subdued, suggesting that underlying Near-term inflation pressures should be muted but, with the limited
inflation should remain within the target range. spare capacity in the labour market being eroded, underlying
inflation is likely to settle near the top of the RBA's target range.
CPI Data Calendar for the Coming Week

Day GMT Economy Indicator Previous BNPP F’cast Consensus
Mon 20/12 07:00 08:00 PPI y/y : Nov 4.3% 4.6% 4.6%
Tue 21/12 12:00 07:00 CPI m/m : Nov 0.4% 0.3% n/a
12:00 07:00 Bank of Canada Core CPI m/m : Nov 0.4% 0.2% n/a
Thu 23/12 07:45 08:45 PPI y/y: Nov 4.3% 4.0% n/a
10:15 11:15 CPI y/y : Dec 2.9% 3.1% n/a
Tue 28/12 23:30 08:30 CPI National y/y : Nov 0.2% 0.0% n/a
23:30 08:30 Core CPI National y/y : Nov -0.6% -0.6% n/a
23:30 08:30 CPI Tokyo y/y : Dec 0.2% 0.1% n/a
23:30 08:30 Core CPI Tokyo y/y : Dec -0.5% -0.5% n/a
Wed 29/12 09:00 10:00 States Cost of Living y/y : Dec 1.5% 1.7% 1.5%
09:00 10:00 HICP (Prel) y/y : Dec 1.6% 1.8% n/a
Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision Source: BNP Paribas

Inflation: Post Mortem 2010
Chart 1: Inflation Supply
Increasing supply and liquidity in 2010.
EUR bn US EMU UK JPY
Real Yields: At or below Jan levels.
80
Breakevens: At or below Jan levels.
60
ASW: Strong despite stress on EGBs & vol.
Volatility: Normalisation continues. 40
Tomorrow, we will publish our main views for 2011 in 20

the Inflation Monitor but today we focus one last time
on 2010. Deepening credit and balance-sheet 0
concerns, greater uncertainty and risk aversion, an 2003 2004 2005 2006 2007 2008 2009 2010 2011
YTD For
increased regulatory burden and anxiety about
inflation and deflation: 2010 has not been a year for Chart 2: Monthly Turnovers in Linkers
the faint-hearted.
EUR bn, 1M Lehman
Conso in 2009 Up in 2010
Supply & Demand: Thanks to the normalisation in 150
market conditions in 2009, sovereigns came back to

inflation markets more aggressively in 2010. The US USD
100
issued USD 87bn of TIPS in 2010 against only USD
59bn in 2009. The UK issued GBP 31bn of UKTI EUR
against GBP 28bn in 2009. In the eurozone, France
50
doubled linkers supply to EUR 24bn thanks to the
launch of new 10y benchmarks in FRF and EUR
inflation. With EUR 11bn in 2010 compared to EUR 0
GBP
5bn in 2009, Germany stuck to its commitment to Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
issue EUR 2-3bn of linkers every quarter although it
did not issue a new benchmark. Finally, with only Chart 3: TIPS TR vs Gold & ED15
EUR 14.5bn vs EUR 17bn in 2009, Italy is the only
issuer to have reduced inflation supply, probably
because of the launch of the CCT-eu programme.
Liquidity wise, we note a marked improvement in
2010 (Chart 2). Using official data, turnover
increased in the US, UK and France by 21%, 37%
and 55% respectively. Based on BNPP data (note
BNPP is number one in TIPS and top three in EZ
secondary markets), activity has jumped even more
for German linkers while barely improving on BTPeis.
Demand wise, HFs are coming back gradually but Chart 4: US 10y BE vs NY, WTI and SPX
ALM demand has stayed strong and ASW activity is
still supporting activity in linkers and swap. The focus
has also switched to structured solutions that reduce
counterparty and funding risk. In this context, use of
TRS solutions should expand further. In 2010,
pension funds have continued to be active in linkers
despite deterioration in funding ratios while inflows in
ETFs have declined compared to 2009. In France,
the increase of the Livret A rate and of real yields is
triggering some activity in swap in Q4, distorting
slightly further valuations vs. EUR breakevens.
Source: BNP Paribas, Bloomberg, AFT, Fed, UK DMO
Real Yields and Breakevens: Real yields mainly
followed gold prices and weakening growth
Herve Cros / Shahid Ladha / Sergey Bondarchuk 16 December 2010

expectations until November’s FOMC then rose in
line with short-term contracts (Chart 3). Deflation C. 5: Quarterly Returns in Linkers 1y+ Indices
fears surged during the summer but breakevens 6% EUR GBP USD
have been more sensitive to oil and stocks than 5%

Linkers
nominals since the Jackson-Hole speech (Chart 4). 4%
Looking at the 10y maturity, the sell-off was huge in 3%
November but real yields are finishing 2010 at (EUR)

2%
1%
or a bit below (US & UK) levels prevailing in early 0%
January. Meanwhile, breakevens are finishing the -1%
year close to (US) or below (UK, EUR) Jan levels. -2%
-3%
Total returns: Late sell-off and EGB crisis. 2009 -4%

Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10
was a year of normalisation for distressed assets.
Therefore it is unsurprising that linkers have not Chart 6: Quarterly Returns in BE trades
managed to repeat the same performance in 2010 as
8% EUR GBP USD
in 2009. Beyond the recent unwinding of the QE
trade, the market seems to be acknowledging the 6%
Breakevens
positive effects of loose monetary policy more on 4%
growth (via higher real yields) than on inflation

(inflation breakevens mainly stable since November).
2%
This also explains stocks’ strong performance. 0%
Overall, in local-currency terms, TIPS have returned -2%
5% in 2010 vs. 10% in 2009, slightly underperforming -4%
vs. nominals against 16% outperformance in 2009. Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10
UK linkers have done better with 5% return in 2010 Chart 7: Linkers ASW: Return to 0
vs. 6% in 2009. Still, relative to nominals, UKTI has
80
barely outperformed against 8% differential in 2009. OATEI20 Real ASW
UKTI20 Real ASW

Finally, in the eurozone, performance has been TIPS Jan-19 Real ASW
mixed between issuers. BTPei underperformed both 60
in real and breakeven terms (around -4% return)

while French and German linkers underperformed 40
only vs. nominals. Overall, EUR linkers have

returned 1% in 2010 (vs. 8% in 2009), i.e. 3% less 20
than nominals (vs. +3.5% outperformance in 2009).

Clearly, the stress on EGBs and the need for fiscal 0
tightening are putting pressure on breakevens, Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
especially on BTPei. Chart 8: Linkers R/N ASW Discounts: Tight

60 OATEI20 R/N ASW Discount 40
Asset Swap: Strong performance. After being UKTI20 R/N ASW Discount TIPS
stable most of H1, linkers ASW have followed 50
TIPS Jan-19 R/N ASW Discount 35
nominals in H2 and are returning close to 0bp margin 40

VIX, RHS
30
vs. Libor (Chart 7), benefiting from an expected 30
UKTI
improvement in governments’ deficits next year. 20
25
Given the context of volatility and stress in EGBs, we 20

10
highlight the stability in Linkers/Nominals ASW
discounts, especially in the EZ and the US (Chart 8). 0 OATei 15
Globally, ASW discounts are finishing the year tighter -10 10
than in Jan. The carry trade has worked again in Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
2010. We also expect the trend of switching out of Chart 9: Implied Vol
P/P to proceeds ASW to continue in EZ in 2011. 2.50% EUR Implied Inflation Vol
USD EUR Implied Interest Rate Vol
2.30% USD Implied Inflation Vol
Volatility: Down but still 50% higher than 2.10%

USD Implied Interest Rate Vol
nominal. Despite a resurgence of deflation fears 1.90%
1.70%
during the summer, inflation volatility has declined in 1.50%
EUR
2010 (Chart 9) although it still trades 50% richer than 1.30%
nominal vol. We also note an expansion of the real 1.10%
rate swaptions market and arbitrage between local 0.90%
0.70%
inflations. 0.50%
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
Source: BNP Paribas, Bloomberg

Table 1: BNP Paribas Carry Analysis
Benchmark Carry
Pricing Date 15-Dec-10 Term 1 Term 2 2m 3m 6m 12m
Repo Rate 0.42% 0.42% 0.34% 0.34% 0.34% 0.56%
Sett. Date 16-Dec-10 01-Feb-11 01-Mar-11 16-Feb-11 16-Mar-11 16-Jun-11 16-Dec-11
Yield BE Real BE Real BE Real BE Real BE Real BE Real BE
Short-end
OATei Jul-12 -1.00% 1.91% 3.9 0.8 34.2 29.7 24.8 21.3 -16.3 -20.8 2.1 -2.7 -77.6 -40.5
OATI Jul-13 -0.37% 1.71% -0.9 -5.0 12.8 6.3 8.9 3.4 2.0 -5.7 27.1 12.8 30.2 7.1
TIPS Jul-12 -0.78% 1.34% -4.3 -7.2 -13.4 -18.2 -9.0 -13.0 -5.5 -11.5 51.7 36.7 22.5 -18.5
UKTi Aug-13 -1.62% 2.83% 21.5 17.2 15.8 8.6 23.1 17.4 17.0 8.7 66.6 49.5 72.6 38.5
5y
OATei Jul-15 0.51% 1.65% 5.5 0.7 18.2 10.5 14.4 7.7 3.9 -5.7 19.9 1.1 30.5 -5.9
OATi Jul-17 0.72% 2.02% 1.7 -2.9 8.3 0.8 6.5 -0.1 5.2 -4.2 18.8 0.3 29.1 -6.9
TIPS Apr-15 0.09% 1.69% 1.2 -3.8 -0.1 -8.2 0.5 -6.2 3.6 -6.4 26.1 4.8 30.2 -16.3
UKTi Jul-16 0.05% 2.62% 14.5 9.0 14.2 5.3 16.6 9.3 16.2 5.6 47.0 25.4 66.2 22.3
JGBI-4 June-15 1.05% -0.55% 5.3 4.1 4.9 2.9 6.0 4.5 0.9 -1.5 -6.2 -11.0 17.9 7.2
10y
OATei Jul-20 1.34% 1.98% 3.9 -0.2 11.1 4.3 8.9 3.0 4.4 -4.1 14.7 -1.9 24.5 -7.9
OATI Jul-19 1.06% 2.08% 1.8 -2.5 7.3 0.2 5.8 -0.4 5.1 -3.8 16.7 -0.8 26.6 -7.4
TIPS Jul-20 1.14% 2.26% 2.1 -3.1 2.4 -6.0 2.2 -4.7 4.6 -5.6 17.7 -3.4 25.4 -18.2
UKTi Nov-22 0.83% 3.07% 5.6 0.7 12.3 4.4 9.2 2.7 12.5 3.1 24.8 5.9 40.1 2.4
JGBI-16 June-18 1.37% -0.44% 3.9 2.3 4.0 1.4 4.5 2.5 1.7 -1.4 -1.4 -7.6 15.1 2.0
30y
OATei Jul-40 1.71% 2.18% 1.7 -0.6 4.4 0.7 3.6 0.3 2.0 -2.7 6.2 -2.9 10.2 -7.1
OATI Jul-29 1.59% 2.22% 1.5 -1.7 4.8 -0.3 3.9 -0.7 3.8 -2.7 11.0 -1.6 18.0 -6.2
TIPS Feb-40 1.98% 2.61% 1.3 -2.2 1.8 -3.9 1.6 -3.1 2.8 -4.0 9.0 -4.9 13.8 -14.4
UKTI Mar-40 0.78% 3.67% 2.2 -0.9 4.9 -0.2 3.6 -0.5 4.9 -1.0 9.6 -2.2 15.1 -8.2
Short-end Term 1 -> Term 2 Term 1 -> Term 2 Term 2 -> 3m 3m -> 6m 6m -> 12m
OATei Jul-12 30.3 28.9 20.5 18.9 -41.1 -42.1 18.4 18.1 -79.7 -37.7
OATI Jul-13 13.7 11.3 9.1 6.4 -6.9 -9.1 25.1 18.5 3.1 -5.7
TIPS Jul-12 -9.1 -11.0 -7.3 -9.3 3.5 1.4 57.2 48.3 -29.3 -55.2
UKTi Aug-13 -5.7 -8.7 20.5 17.6 -6.1 -8.7 49.6 40.8 6.0 -11.1
5y
OATei Jul-15 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
OATi Jul-17 12.7 9.7 9.9 6.6 -10.5 -13.4 16.0 6.8 10.6 -7.0
TIPS Apr-15 6.6 3.7 5.1 1.8 -1.2 -4.1 13.5 4.5 10.3 -7.2
UKTi Jul-16 -1.2 -4.4 -0.7 -3.9 3.0 -0.2 22.5 11.1 4.2 -21.0
JGBI-4 June-15 -0.4 -1.2 -2.7 -3.4 -5.2 -6.0 -7.1 -9.5 24.1 18.2
10y
OATei Jul-20 7.1 4.5 5.9 2.9 -4.5 -7.1 10.3 2.2 9.8 -5.9
OATI Jul-19 5.5 2.7 4.4 1.2 -0.6 -3.4 11.5 3.0 9.9 -6.6
TIPS Jul-20 0.3 -2.9 0.6 -2.7 2.3 -0.9 13.2 2.2 7.6 -14.9
UKTi Nov-22 6.8 3.7 5.7 2.6 3.4 0.4 12.3 2.8 15.4 -3.5
JGBI-16 June-18 0.1 -0.9 0.1 -0.9 -2.8 -3.9 -3.1 -6.2 16.5 9.6
30y
OATei Jul-40 2.8 1.3 2.3 0.7 -1.6 -3.0 4.1 -0.3 4.1 -4.1
OATI Jul-29 3.3 1.3 2.7 0.5 -0.1 -2.1 7.3 1.1 6.9 -4.6
TIPS Feb-40 0.4 -1.7 0.5 -1.7 1.2 -0.9 6.2 -1.0 4.7 -9.5
UKTI Mar-40 2.7 0.8 2.3 0.3 1.3 -0.5 4.7 -1.2 5.5 -5.9
Source: BNP Paribas

Technical Analysis – Interest Rates & Commodities
Bond & Short-Term Contracts
Europe 10y: Still weak MT within a ST rising channel & now close to key 3.08/3.11 (LT 38.2%+MT 61.8%)
US 10y: Break above 3.37 (MT 61.8%) increased MT weak bias for LT falling resistance (3.68)
Short-term contracts m1: ST toppish bias on ED (risk of top H&S) & Euribor (falling ABC to develop?)
Equities & Commodities

WTI (Cl1): Sill up MT within MT rising channel but stalling below 90.19 top with risk of further ST consolidation
Equity markets: MT positive bias persists with new tops in US while European markets remain rather toppish
US 10y: Break above 3.37 (MT 61.8%) calls for key 3.68 MT Trend: Up Range: 3.25/3.58
MT SCENARIO remains up 2.80 <= 2.94 <= 3.09 <= 3.37 –!– 3.58 => 3.68 => 4.00/4.07
Market broke decisively above 2.96 (wave “3”
top) early December to then extend rising
wave “5”. This strengthened MT bearish
scenario with a move above critical 3.37 (MT
61.8%), which is now targeting 3.68 (LT
falling resistance line) & then on a breakout
4.00/4.07 (April top & LT 61.8%). Trend
indicators (DMI+MACD) are up oriented again
ALTERNATIVE SCENARIO...ST correction

It will fail to extend rise beyond 3.68 (LT
falling resistance line) & will start a ST
consolidation towards 3.05/3.08 (ST 38.2%+
61.8%) initially with 3.25 & 3.15 (38.2, 50%)
before. First step would be a break below ST
daily rising channel support (now at 3.41)
STRATEGY
Waiting for a signal now
US/EUR 10y bond: Is it developing the rising “C of ABC” of a major wave “B”?MT Trend: Neutral Range: 25/55
MT SCENARIO is up -20.9/-21.4 <= 4.0/8.0 <= 23.5 <= 33.8 -!!- 47.0 => 56.2 => 85.8/86.5 => 119.7
After 5 waves down move (major wave “A”?)
which reached key 0.2/0.6 support area, it
has started a correction (major wave “B”?)
above the MT falling wedge resistance. It is
perhaps still developing the rising wave “C” of
ABC” towards 47.0 & 56.2 (ST 50, 61.8%),
sustained by trend indicators which have
turned up oriented again
ALTERNATIVE SCENARIO...Wave C to start
Correction (major wave “B”?) could end now
around ST 50% (47.0) and will resume fall to
perhaps develop the major wave “C” for a
move below critical 0.0/4.0/8.0 (LT 50% &
end-2009 low & last low) towards -21.4 (LT
61.8%) with intermediates on 33.8 & 23.5 (ST
38.2, 61.8%)
STRATEGY
Long on 10/15 sold 30/40. Wait for a 56 test
to sell
Christian Séné 16 December 2010

57
Germany 10y: Stalling below MT 61.8%. Beware of a ST rising channel break MT Trend: Up Range: 2.80/3.10
MT SCENARIO is still up 2.64 <= 2.70 <= 2.95 –!– 3.08/3.11 => 3.39 => 3.70
Negative break above MT falling channel and
2.50 (wave “1” top) allowed the rising wave
“3” to develop beyond key 2.64 (LT falling
wedge res) to extend MT rise towards key
3.08/3.11 (LT 38.2%+MT 61.8%) area initially
within a ST rising channel. A break would see
an extension towards 3.39 (LT 50%) then
ALTERNATIVE SCENARIO...ST correction
Current ST correction in wave “3” will stall &
end below key 3.11 (MT 61.8%) and it will
then resume fall for a classic pullback towards
2.62/64/69 (61.8%+LT falling wedge res + ST
38.2%) with 2.79 & 2.70 (38.2, 50%) before.
Slight bearish divergences on daily RSI could
help such a scenario to develop.
STRATEGY
Sell stop 2.95 S/L 3.01 for 2.70/2.80
UK 10y: Negative within ST rising wedge towards MT 61.8% (3.73) MT Trend: Up Range: 3.40/3.75
MT SCENARIO remains up 3.14 <= 3.23 <= 3.33 <= 3.49 –!– 3.73 => 3.80/3.83 => 4.00 => 4.30
Break above bottom 2-dip neckline turned MT
bias negative. It took sharply the way up with
3.53/3.55 (MT 50%+end-July top+2-dip
target) now overcome for a move towards
critical 3.73 (MT 61.8%) & 3.83 (LT falling
wedge resistance). Trend indicators (DMI &
MACD) remain up but RSI looking expensive
ALTERNATIVE SCENARIO… ST correction
It will now stall below MT 61.8% at 3.73 &
take the way down again with a break then
below MT rising wedge support (3.49) to
extend correction towards 3.33 (ST 50%) &
3.23 (ST 50%) initially. A break below 61.8%
(3.14) is needed to rekindle the previous MT
falling bias towards 2.79 (last low)
STRATEGY
Buy break below 3.49, for 3.33 S/L 3.54.
S&P: Above key 1228 but is the corrective wave “IV” now over or not? MT Trend: Up Range: 1180/1260
MT SCENARIO is still up 1129 <= 1156 <= 1173 <= 1215/28 –!– 1287 => 1299 => 1393
Last sharp rise allowed now to slightly over-
come 1220/28 (April top & LT 61.8%). This
break is strengthening last bullish bias &
possible rising wave “5” scenario with 1246
(bottom H&S target) now reached, next
targets being 1272 (ST rising wedge res),
1299 (MT 138.2% extension) & then 1393 (LT
rising channel res).
ALTERNATIVE SCENARIO…wave 4 not over
The corrective wave “4” is not yet over.
Indeed, we still have the risk of being within a
wave “4” in irregular and not yet in a wave “5”.
In this event, we could see soon a continu-
ation of the corrective wave “4” by developing
a falling “C of ABC” towards 1156 (ST 38.2%).
This would be confirmed with a move below
ST rising wedge support (1215)
STRATEGY: Sell only below 1215 for 1150/70
S/L 1228. Stay long above 1215 if you are
Christian Séné 16 December 2010

58
IR Strategy: Track Record for 2010
During 2010, we proposed 60 strategies (25 of them medium-term) with an average hit ratio of 62% across all portfolios. Total
P/L for the year stands at EUR 1550k with a significant contribution coming from linkers, yield-curve and money-market
strategies. In terms of currency distribution, both EUR and GBP strategies contributed significantly (EUR+1600k). Risk analysis
suggests a stabilisation of average risk per trade relative to 2009. The 2010 investment environment has been characterised by
abundant central bank liquidity, high volatility in sovereign risk premia and a strong performance by risky assets.
Track Record Summary 2010

Total number of trades 60 Tactical positions (near-term trade ideas) 35
Total P/L (bp) during the period 165 Hit ratio 61%
Total P/L (EUR k) during the period 1550 Risk/Reward 2.2
Hit ratio 62% Strategic positions (medium-term trends) 25
Average dv01 (EUR k) 9.0 Hit Ratio 63%
Average P/L (EUR k) 27.5 Risk/Reward 4.5
Risk/Reward 3.1
2010 Valuation (EUR) 2010 Valuation (Basis Points)

Short-term Linkers Cash/Swaps Box/Cross Options Short-term Linkers Cash/Swaps Box/Cross Options
Total P/L (EUR k) 293 840 525 -13 -93 Total P/L (bp) 39 69 77 -10 -9
Share 23% 11% 44% 2% 20% Share 23% 11% 44% 2% 20%
P/L contribution 19% 54% 34% -1% -6% P/L contribution 23% 42% 46% -6% -5%
Avg. Profit 58 120 61 #DIV/0! 51 Avg. Profit 7 10 8 #DIV/0! 11
Avg. Loss -71 #DIV/0! -64 -13 -19 Avg. Loss -9 #DIV/0! -8 -10 -3
Avg. P/L ratio 0.8 #DIV/0! 1.0 #DIV/0! 2.6 Avg. P/L ratio 1 #DIV/0! 0.9 #DIV/0! 4
% profitable 71% 100% 67% 0% 17% % profitable 71% 100% 70% 0% 17%
Max profit 117 265 240 -13 66 Max profit 12 27 24 -10 11
Max loss -103 8 -122 -13 -80 Max loss -12 1 -16 -10 -9
P/L Contribution by Strategy (EUR P/L) P/L Contribution by Currency (EUR P/L)
1000 1200
EUR P/L by strategy 1000

800 EUR P/L by ccy
800
600
600
400
400
200
200
0
0
-200 -200
Money Market Linkers Curve Cross Ccy Options EUR USD GPB Other
P/L Evolution in 2010 P/L Evolution over Three Years

1800 3000
EUR (k) EUR (k)
1600 Single Trade P/L Single Trade P/L
2500
Cumulatd EUR P/L 2010 Cumulated EUR P/L
1400
2000
1200
1000 1500
800 1000
600
500
400
0
200
0 -500
-200 -1000
Source for all Charts & Tables: BNP Paribas
Interest Rate Strategy 16 December 2010

59
Looking for Value in the North
Heading into 2011, the outlook for the Chart 1: Sweden GDP Outperformance
eurozone is clouded by persistent problems in
peripheral Europe.
The key risk for the EUR is data from Spain
as the risk of a double-dip recession leaves the
currency vulnerable to a larger-scale debt crisis.
Look north for the value in Europe. Norway
and Sweden are good ways to position for the
underlying strength in core Europe.
Both countries have solid macro
fundamentals with a tightening bias for
monetary policy.
We recommend buying both the NOK and
SEK against the EUR going into 2011.
Source: BNPP Bloomberg: The Swedish economy is expected to
outperform the eurozone and US in the upcoming year. This should
provide further support for the SEK as growth remains subdued elsewhere
Summary in the G10.
Heading into the New Year, concerns over the Chart 2: Norway’s Government Surplus vs.
eurozone periphery continue to dominate as EURNOK
investors question whether Portugal and Spain will
be next. Within Europe, there are two shining stars in
the north, Norway and Sweden. While the EUR
outlook may be clouded by an assortment of risks,
the SEK and NOK serve as good proxies for the EUR
without the burden of the problems in the periphery.
Macroeconomic fundamentals give the Scandinavian
countries the edge, with both Sweden and Norway
recovering well. Also, valuations against the euro
suggest that there is further room for gains. Sweden
in particular is a good proxy for the EUR given that it
is part of the EU, maintains strong balance sheets
and has similar export characteristics to Germany. It
is the closest thing to betting on Germany’s
Source: Bloomberg, BNP Paribas. Note: Healthy government balances
economic performance without worrying about should keep NOK well supported especially as the scrutiny sovereign debt
vulnerabilities within EMU. The main risk for the SEK takes hold into 2011.
is the tightening in global liquidity as Asian central
banks try to fend off inflationary pressures. In a risk- vulnerable position as we head into 2011. Growth in
off environment, the NOK would be the favoured the periphery will be constrained by fiscal austerity
currency. In either scenario, we remain bullish on measures. Large spending cuts including in public
both the NOK and SEK against the EUR. wages and higher taxes will reduce personal
consumption. Investment is also likely to decline.
European constraints External trade will need to be the saving grace if the
Now that Ireland and Greece have both been bailed peripheral nations are to be dragged out of
out, markets have shifted their focus to who will be recession. Greece, Portugal and Ireland will all have
next: Portugal, Spain or both. It was reported that an impact on the eurozone. However, the key risk for
Portugal was pressured by other states to take on a the EUR heading into 2011 is economic data from
bailout package to prevent the fall of Spain. Spain, the fourth-largest economy in the eurozone.
However, this has not come to pass. The lack of a Our base-case scenario is that Spain will head into a
unified message from EU officials has kept the double-dip recession. This would reduce tax
markets jittery, with macroeconomic fundamentals in revenues, increase fiscal spending, cut asset values
peripheral Europe set to keep the eurozone in a even more and worsen the banks’ balance sheets.
Mary Nicola 16 December 2010

60
Spain’s ambitious budget targets coincide with
optimistic assumptions on nominal growth. As such, Chart 3: EURNOK Spot vs. EURNOK PPP
we expect them to be missed – only deepening the
gloom over Spain.
The other problem the eurozone will face next year is

the disparity in growth rates between core and
peripheral Europe. Growth in Germany is expected to
moderate in 2011 but should remain strong. External
demand will drive growth, especially as emerging
markets’ expansion continues. About 16% of total
German exports end up in Asia. This divergence in
growth within EMU will leave the ECB with a policy
dilemma as one part of the eurozone will need loose
monetary policy and the other part will need tighter
monetary policy. Loose monetary policy may have to
remain in place to allow the peripheral just to muddle
Source: Bloomberg, BNPParibas. EURNOOK spot is trading around PPP
through. This growing divergence between the core levels after being significantly “undervalued” for some time. In light of
of Europe and the periphery will add to pressure on potential tight liquidity in 2011, the NOK is a safe trade given its defensive
the euro. qualities.
Chart 4: EURSEK Spot vs. EURSEK PPP

Norway and Sweden: the favoured ones
While the EUR will remain vulnerable to events in
peripheral Europe, the NOK and SEK will be proxies
for performance of the eurozone core. Economic
fundamentals in both countries support a bullish view
on the Scandies, which will likely lead to further rate
hikes by both central banks in 2011. While the
Norges Bank sat on its hands this week, it did adopt
a more hawkish tone. The Riksbank, however,
increased the repo rate by 25bp to 1.25%, making
clear in the accompanying statement that further
hikes are in the pipeline.
Unlike the eurozone, Norway’s consumer and

government sectors are both relatively strong. While Source: Bloomberg, BNP Paribas. Note: Current EURSEK spot levels is
much of the eurozone must restore its balance above EURSEK PPP. Based on this, the SEK is of particularly good value
against the EUR as there is strong justification for further appreciation.
sheets, leading indicators and PMI data underline the SEK appreciation against the EUR will only bring it to its “fair value” level.
expansionary trend in Norway. Rising oil prices will
boost economic performance. Debt levels in Norway
remain low and the current account surplus is robust. speculation that the pace of tightening will be
These dynamics alone warrant NOK appreciation. maintained into 2011. The central bank increased its
While the economy is in good shape, the Norges growth forecast for 2011 to 4.4% vs. 3.8% and the
Bank has been reluctant to hike interest rates due to inflation forecast was raised to 2.2% from 1.7% in
softer inflation. CPI figures have consistently 2011. CPI is nearing the Riksbank’s 2% target, with
undershot central-bank and market expectations. the headline rate coming in at 1.8% y/y in November.
With the more hawkish tone set by the Norges Bank, Swedish house prices have risen for eighteen
we now expect speculation to build for a hike in consecutive months, increasing an annual 5% in the
March rather than the middle of the year, three months through October. The Riksbank
compounding the NOK’s strength. Governor said that he personally tracks household
credit when deciding rate policy. Interest rate
Sweden: Europe’s outperformer differentials will spark further strength of the SEK,
Among European countries, Sweden has been one which may lead to a decline in competitiveness
of the fastest-growing economies in 2010. Low against Sweden’s trading partners.
government debt and strong current account
surpluses will appeal to investors, especially since Nevertheless, the strength of the domestic economy
Sweden is part of the European Union – just not the underscores the need to hike interest rates. The real
EMU. With the strong growth seen over the last year, economy, particularly the labour market, is
this week’s hike from the Riksbank will lead to recovering well.

61
The currency side of the story Chart 5: USDSEK Spot vs. USDSEK PPP
Growth and interest rate differentials suggest that
both the NOK and SEK will outperform the EUR and
even the USD in 2011. But what is the story on the
currency front? The market was significantly short
USD on the back of the prospects of QE2. This
provided some support for both the EUR and SEK, in
particular the SEK as it benefited from the pick-up in
risk appetite and the liquidity trade. The NOK, on the
other hand, did not reap the same benefits as its
defensive qualities kept it relatively stable.
As 2011 approaches and global liquidity drops off on

the back of Asia policy tightening, the NOK may
outperform the SEK but they will both outperform the
EUR. From a valuation perspective, EURNOK is Source: Bloomberg, BNP Paribas. Note: USDSEK is currently trading
trading around the PPP level while EURSEK is below the USDSEK PPP, suggesting that SEK is “overvalued” against the
trading above the PPP level. This implies that further USD. However, it is important to note that it is not at extreme levels as
appreciation against the EUR is warranted, seen in 2008. The USD was weakened as it was being used as a funding
currency as prospects of QE2 came to light.
especially for the SEK.
Chart 6: USDNOK Spot vs. USDNOK PPP
Against the USD, both the NOK and SEK spot values
are above the PPP values. This may suggest that
they are not good buys against the USD. However, it
is worth noting two things. First, as shown in Charts 5
and 6, they are no longer at extreme levels. Second,
the USD was arguably used as a funding currency
for much of 2008 and again in recent months on the
anticipation of QE2. Short USD positioning was at an
extreme over the past few months.
The risks to NOK and SEK in 2011

Source: Bloomberg, BNP Paribas: USDNOK spot is also trading below
While both currencies look attractive, there are a few USDNOK PPP implying that NOK is “overvalued” against the USD. Like
risks worth noting. Global risk appetite is of particular the SEK it is not trading at extreme levels as seen back in 2008 before the
importance to these two countries. The SEK benefits peak of the financial crisis and the start of the USD unwind.
in a risk-on environment while the NOK gains in risk-

off. Also, the pace of rate hikes in Norway versus
Sweden will to some degree depend on how the
For example, when China allowed faster appreciation currencies perform. We expect the Riksbank to be
of its currency in September, the SEK’s beta to CNY more hawkish than the Norges Bank, finding support
appreciation was similar to that of the AUD. This was for the SEK. The Riksbank may nevertheless be
mostly on the back of the improvement in risk cautious on hiking too fast as the SEK’s appreciation
appetite rather than Sweden’s links to China (these against the EUR, its key trading partner, could
are fairly limited). In 2011, Asia will have to start present roadblocks for the recovery.
tightening more aggressively than they have been,
thereby limiting the ample global liquidity that had Weakness in the eurozone periphery will position the
been provided by central banks around the world. two Scandie currencies as the more favoured
currencies by investors. Sweden serves as a good
On the back of that, the NOK should outperform the proxy for Germany’s likely strong growth in 2011
SEK. In addition, OPEC is calling for USD 100/bbl as given their similar export characteristics. We expect
a fair price for oil. If there is a significant rise in oil the SEK to outperform the NOK in early 2011, but
prices, again the NOK should outperform the SEK. gains will slow if risk appetite is challenged and NOK
However, if Asia allows for faster FX appreciation as will outperform the SEK. But given the differing
a way to offset inflationary pressures, then the risk- characteristics of the SEK and NOK, we recommend
on environment will take hold and the SEK will likely buying both these currencies against the EUR.
outperform the NOK. Moves against the USD will be
a function of risk appetite as well.

62
USD Rebound Tests Resistance
The USD recovery continued this week versus EUR, GBP and JPY but now faces strong resistance
This is reflected by strong EURUSD and GBPUSD support at 1.3165 and 1.5485, and strong
USDJPY and US Dollar Index resistance at 84.60 and 80.40
AUDUSD, a key leader of the risk-on rally during the past six months, is potentially forming a head
and shoulders top, with a break of key 0.9750 support risking a medium-term sell-off
The decline in IMM futures trading volume suggests the seasonal slowdown in FX trading activity
has begun, creating volatile swings in the process
Based on data from the Chicago Mercantile has entered the oversold zone (28% on the 8-week
Exchange, it seems the seasonal slowdown in FX stochastic) and is currently more oversold than at
trading activity has begun, with Monday’s trading the 1.2590 August low. These monthly and weekly
volume in EURUSD futures falling 18% below the momentum factors, combined with counter-trend
30-day moving average for volume. Reduced chart pattern features, suggest a fair probability key
liquidity during the latter part of December has a 1.2965 support will hold, with EURUSD holding
tendency to exaggerate currency swings, and between 1.2965-1.35 for the rest of December.
volatile swings could continue into year-end. Confirming recent USD strength will not only require
Recent wide swings in EURUSD have muddled the knocking EURUSD below 1.2965 support, but also
chart pattern. As a result of overlapping moves, validation via driving GBPUSD and AUDUSD below
both the powerful November decline (1.4280- key support at 1.5485 and 0.9825, respectively, and
1.2965) and the December rebound (1.2970- the US Dollar Index (DXY) above 80.40 key
1.3498) have counter-trend features. On balance, resistance. Watch AUDUSD. On the bearish side,
this suggests watching key support at Tuesday’s 1.0024 high smacks of the “right
1.3165/1.3080, and key resistance at shoulder” in a potential head and shoulders bearish
1.3500/1.3625. Currently EURUSD is under the reversal pattern (“left shoulder” at the 1.0003
bearish influence of declining weekly and daily October 15 high; “head” at the 1.0183 Nov 5 peak).
momentum indicators. This risks breaking 1.3165 Although not a textbook example, the important
and 1.3080 support, sparking a re-test of the 1.2965 point is that Aussie could be forming an important
November 30 low. One caveat: despite the 10-cent secondary top near 1.0030/50 resistance: a
November collapse which created a bearish key subsequent break of 0.9750 support would be the
reversal month amid one of the sharpest monthly initial signal for a deeper decline with scope to test
declines on record, EURUSD monthly momentum and even crack the 0.9535 Dec 1 low.
remains neutral. Also, bearish weekly momentum
Chart 1: EURUSD – Nears test of key 1.2965 support

At nearly 10 cents, the 1.44 1.4280
severe November 1.4160
decline off 1.4280 has
the potential to kick-off 1.40 1.3690
a longer-term decline
towards pivotal 1.36 1.3335
support from the
Aug/Sep base at 1.32
1.2590-1.2642.
However, recent 1.28 1.2965
erratic trading and
pattern analysis 1.2642
1.24
suggest scope for
holding above 1.2965
support as 1.30-1.35 1.20
trading occurs into 1.1875
year-end. 1.16
23-Apr-10 22-Jun-10 19-Aug-10 18-Oct-10 15-Dec-10
Source: BNP Paribas
Andrew Chaveriat 16 December 2010

63
Chart 2: AUDUSD – Head and shoulders top may be forming
Although not a classic
1.0180
example by any means, 1.02
the past 2 months of A$
trading resemble a head
& shoulders bearish 0.98
reversal pattern.
0.9380
Critically, this week’s 0.94 0.9535
high is stalling close to 0.9220
resistance from the mid-
0.90 0.8860
Oct high (“left shoulder”)
below the 1.0183 Nov 0.8770
peak (“head”). Mixed 0.86
momentum indicates a
break below 0.9750 0.82 0.8315
support is an open
question: but if seen, a 0.8085
medium-term decline 0.78
would be favoured 23-Apr-10 22-Jun-10 19-Aug-10 18-Oct-10 15-Dec-10
Source: BNP Paribas
Chart 3: EURGBP – Retracing the autumn decline
The breakout above the 0.8940
Oct down channel plus 0.89
bullish daily momentum 0.8810
and multiple bullish daily 0.88
divergence suggest the
0.87
Oct-Dec decline is being
retraced. We expect 0.86 0.8530 0.8510
bullish weekly
momentum to arrive 0.85
soon, for the first time 0.84 0.8425
since mid-Oct. Anchored
by the recent 0.8332/48 0.83 0.8345
double-bottom, we favour
a choppy rebound initially 0.82
targeting 0.8565-0.8600, 0.81 0.8140
and then 0.8635/50 over 0.8065
the next 2-4 weeks 0.80
23-Apr-10 22-Jun-10 19-Aug-10 18-Oct-10 15-Dec-10
Source: BNP Paribas

Chart 4: USDKRW – Higher toward 1190 and potentially 1210
The April/Nov twin-
bottom just above 1100 1330
psychological support is
an ideal way to complete 1277
the May decline off 1277 1280
and begin a multi-month
rebound. The dollar
rebound is driven by 1230
bullish weekly
momentum, currently as 1199
1185
strong as during the
explosive Apr-May jump. 1180
The support base at 1130 1167
is seen holding as a
medium-term rebound 1130
extends toward 1190,
and if exceeded, 1210 1115
1107
(61.8% retracement of 1103
1080
the May-Nov decline).
07-Jan-10 08-Mar-10 05-May-10 02-Jul-10 31-Aug-10 28-Oct-10
Source: BNP Paribas

64
Currency Spot Trade Recommendations Date
EURAUD 1.3400 Short 1.3930, lower stop to 1.3600, target 1.2930 19 Nov 2010
EURCHF 1.2810 Short from 1.3475 achieved the 1.2775 target 17 Nov 2010
USDKZT 147.56 Short at 147.00, stop at 149.50, target 135.00 28 May 2010
Source: BNP Paribas

65
Economic Calendar: 17 - 31 December
GMT Local Previous Forecast Consensus
Fri 17/12 07:45 08:45 France Industry Survey : Dec 100 102 102
08:00 09:00 Norway Unemployment Rate : Dec 2.7% 2.7% 2.8%
08:45 09:45 Eurozone ECB’s Weber Speaks in Munich
10:00 11:00 Foreign Trade Balance (sa) : Oct EUR2.4bn EUR2.0bn n/a
12:45 13:45 ECB’s Honohan Speaks in Dublin
09:00 10:00 EU EU Leaders Conclude Summit in Brussels
09:00 10:00 Italy Industrial Orders y/y : Oct 17.9% 20.0% 16.0%
09:00 10:00 Germany Ifo Business Climate : Dec 109.3 109.8 109.0
09:00 10:00 Ifo Expectations : Dec 106.3 106.8 106.0
09:00 10:00 Ifo Current Conditions : Dec 112.3 112.8 112.5
14:00 15:00 Belgium Consumer Confidence : Nov 0 0 n/a
15:00 10:00 US Leading Indicators m/m : Nov 0.5% 1.0% 1.1%
Mon 20/12 07:00 08:00 Germany PPI m/m : Nov 0.4% 0.4% 0.4%
07:00 08:00 PPI y/y : Nov 4.3% 4.6% 4.6%
08:30 09:30 Neths Consumer Confidence : Dec -7 -5 n/a
09:00 10:00 Eurozone Current Account (sa) : Oct EUR-13.1bn EUR-2.0bn n/a
Tue 21/12 Japan BoJ Rate Announcement

00:01 00:01 UK GfK Consumer Confidence : Dec -21 -22 -21
09:30 09:30 PSNCR : Nov GBP2.4bn GBP14.7bn n/a
09:30 09:30 PSNB : Nov GBP9.7bn GBP17.0bn GBP16.8bn
00:30 11:30 Australia RBA MPC Minutes
07:00 08:00 Germany GfK Consumer Confidence : Jan 5.5 5.7 5.7
08:00 09:00 Sweden Consumer Confidence : Dec 22.6 22.0 n/a
10:00 11:00 Italy Unemployment Rate : Q3 8.5%
12:00 07:00 Canada CPI m/m : Nov 0.4% 0.3% n/a
12:00 07:00 CPI y/y : Nov 2.4% 2.2% n/a
12:00 07:00 Bank of Canada Core CPI m/m : Nov 0.4% 0.2% n/a
12:00 07:00 Bank of Canada Core CPI y/y : Nov 1.8% 1.7% n/a
Wed 22/12 23:50 08:50 Japan Trade Balance (nsa) : Nov JPY821.3bn JPY510.1bn JPY480.1bn
(21/12)
08:30 09:30 Sweden PPI m/m : Nov -0.7% 0.3% n/a
08:30 09:30 PPI y/y : Nov 2.3% 1.7% n/a
08:30 09:30 Italy ISAE Consumer Confidence : Dec 108.5
09:00 10:00 Retail Sales y/y : Oct 0.3%
10:00 11:00 Wages y/y : Nov 1.5%
09:00 10:00 Norway Unemployment Rate (sa) : Oct 3.5% 3.5% n/a
09:30 09:30 UK BoE MPC Minutes
09:30 09:30 GDP (Final) q/q : Q3 0.8% (p) 0.8% 0.8%
09:30 09:30 GDP (Final) y/y : Q3 2.8% (p) 2.8% 2.8%
09:30 09:30 Current Account : Q3
13:30 08:30 US GDP (Final, saar) q/q : Q3 2.5% (p) 2.5% 2.8%
13:30 08:30 GDP Deflator (Final, saar) q/q : Q3 2.3% (p) 2.3% 2.3%
13:30 08:30 Corporate Profits (Rev, saar) q/q : Q3 2.8% (p) 2.7% n/a
15:00 10:00 Existing Home Sales : Nov 4.43mn 4.74mn 4.71mn
15:00 10:00 FHFA House Prices m/m : Oct
15:30 10:30 EIA Oil Inventories
14:00 15:00 Belgium Business Confidence : Dec 0.8 1.0 n/a
Thu 23/12 Japan Public Holiday

07:45 08:45 France Household Consumption m/m : Nov -0.7% 1.1% n/a
07:45 08:45 Household Consumption y/y : Nov -0.3% -0.3% n/a
07:45 08:45 PPI m/m : Nov 0.8% -0.1% n/a
07:45 08:45 PPI y/y: Nov 4.3% 4.0% n/a
08:30 09:30 Neths GDP (Final) q/q : Q3 -0.1% (p) -0.1% n/a
08:30 09:30 GDP (Final) y/y : Q3 1.8% (p) 1.8% n/a
10:15 11:15 Belgium CPI m/m : Dec 0.1% 0.4% n/a
10:15 11:15 CPI y/y : Dec 2.9% 3.1% n/a
Market Economics 16 December 2010

GMT Local Previous Forecast Consensus
Thu 23/12 13:30 08:30 US Durable Goods Orders m/m : Nov -3.4% -0.5% -0.6%
(Cont.) 13:30 08:30 Personal Income m/m : Nov 0.5% 0.2% 0.3%
13:30 08:30 Personal Spending m/m : Nov 0.4% 0.5% 0.5%
13:30 08:30 Initial Claims 420k 425k 420k
14:55 09:55 Michigan Sentiment (Final) : Dec 71.6 74.3 74.5
15:00 10:00 New Home Sales : Nov 283k 300k 300k
13:30 08:30 Canada GDP m/m : Oct
Fri 24/12 US Public Holiday

10:00 11:00 Switzerland SNB Quarterly Bulletin
14:00 15:00 France Job Seekers (sa) : Nov -20k -10k n/a
Mon 27/12 Holiday UK, Canada

Japan BoJ Minutes
05:00 14:00 Housing Starts y/y : Nov 6.4% -0.6% n/a
08:30 09:30 Neths Producer Confidence : Dec 0.3 0.5 n/a
Tue 28/12 Holiday UK, Canada

23:30 08:30 Japan CPI National y/y : Nov 0.2% 0.0% n/a
23:30 08:30 Core CPI National y/y : Nov -0.6% -0.6% n/a
23:30 08:30 CPI Tokyo y/y : Dec 0.2% 0.1% n/a
23:30 08:30 Core CPI Tokyo y/y : Dec -0.5% -0.5% n/a
23:30 08:30 Household Consumption y/y : Nov -0.4% 0.4% n/a
23:30 08:30 Unemployment Rate (sa) : Nov 5.1% 5.0% n/a
23:50 08:50 Industrial Production (sa) m/m : Nov -2.0% 1.0% n/a
23:50 08:50 Retail Sales y/y : Nov -0.2% 1.4% n/a
(27/12)
06:30 07:30 France GDP (Final) q/q : Q3 0.4% (p) 0.4% n/a
06:30 07:30 GDP (Final) y/y : Q3 1.8% (p) 1.8% n/a
07:45 08:45 Housing Starts (nsa, 3-mths) y/y : Nov 2.3% 3.0% n/a
08:30 09:30 Sweden Retail Sales (sa) m/m : Nov 0.8% 0.4% n/a
08:30 09:30 Retail Sales (nsa) y/y : Nov 5.1% 5.5% n/a
14:00 09:00 US S&P/Case-Shiller Home Price Index : Oct
15:00 10:00 Consumer Confidence : Dec 54.1 57.0 54.5
Wed 29/12 08:00 09:00 Spain Retail Sales y/y : Nov -2.8%
09:00 10:00 Eurozone M3 y/y : Nov 1.0% 1.5% 1.6%
09:00 10:00 M3 y/y (3-Mth) : Nov 1.1% 1.2% 1.2%
Germany States Cost of Living m/m : Dec 0.1% 1.0% 0.9%
States Cost of Living y/y : Dec 1.5% 1.7% 1.5%
HICP (Prel) m/m : Dec 0.1% 1.1% n/a
HICP (Prel) y/y : Dec 1.6% 1.8% n/a
09:30 09:30 UK BoE Housing Equity Withdrawal : Q3
10:30 11:30 Switzerland KoF Leading Indicator : Dec 2.12 2.08 n/a
15:30 10:30 US EIA Oil Inventories
Thu 30/12 08:30 09:30 Italy ISAE Business Confidence : Dec 101.6
08:10 09:10 Eurozone Retail PMI : Dec 51.3 52.0 n/a
08:30 09:30 Eurocoin : Dec 0.45 0.50 n/a
13:30 08:30 US Initial Claims
14:45 09:45 Chicago PMI : Dec 62.5 61.0 61.0
Fri 31/12 Holiday US, Germany, Italy, Spain, Sweden
During 29-31 UK Nationwide House Prices Index m/m : Dec -0.3% -0.3% n/a
Week Nationwide House Prices Index y/y : Dec 0.4% -0.3% n/a
Release dates and forecasts as at c.o.b. prior to the date of publication: See Daily Economic Spotlight for any revision Source: BNP Paribas

Key Data Preview
Chart 1: German Ifo Business Climate BNP Paribas Forecast: Still Going Strong
120
Current Conditions
Germany: Ifo Business Climate (December)
115 Release Date: Friday 17 December
110 Ifo’s business climate index improved for the sixth straight
105
Expectations (4-Mth Lag) month in November, rising above its high point during the
previous expansion from 2005 to 2008.
100
The sub-indices measuring current business conditions
95 and future expectations both improved last month, with the
90 former at a very elevated level (see chart).
85
The assessment of current business conditions in Germany
is still a little short of its cycle high in 2006 (115.5) and we
80
expect a further improvement in December.
75
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 The improvement in Ifo’s sentiment surveys was initially
due to the exceptional strength in the manufacturing and
export sectors but domestic sectors, including retail, have
Dec (f) Nov Oct Sep also shown a pronounced improvement more recently. The
business climate index for the retail sector has risen to its
Headline 109.8 109.3 107.7 106.8 strongest level since the early 1990s. Survey participants
Expectations 106.8 106.3 105.2 103.9 have signalled a moderation in the rate of externally-driven
Current Conditions 112.8 112.3 110.2 109.8 growth relative to the spring peaks but domestic demand is
picking up the baton.
Key Point: The latest ‘hard’ activity data have been strong in
Sentiment will remain elevated, with the economic Germany, with industrial output rising at its fastest m/m rate
expansion broadening out. for six months in October. This points to a further pick-up in
expectations, though this could be tempered by the recent
sharp rise in bond yields.
Chart 2: French Business Surveys (Normalised) BNP Paribas Forecast: Modest Gain
125 France: Monthly Industrial Survey (December)
Manufacturing
120 Release Date: Friday 17 December
115
The correction of manufacturing confidence in November
110
can be partly explained by social unrest and its impact on
105
the chemical industry. This should be temporary, and we
100
forecast a production catch-up starting in November.
95
90
Apart from the automobile industry, orders have been
85
relatively robust recently, which should support confidence
Services
80
and output in the coming months.
75 It is important to highlight that, contrary to what has
70 happened in Germany, the recession is being followed by
65 normalisation but no real catch-up. Headline indices for
00 01 02 03 04 05 06 07 08 09 10
services as well as for manufactured goods have both
Source: Reuters EcoWin Pro been in a narrow range, from 99 to 102, during the last
three months. There is still plenty of scope for production to
SA Dec (f) Nov Oct Dec 09 increase, as the low capacity utilisation ratio shows, should
Services Index 102 102 101 90 demand be strong enough.
Manufacturing Index 102 100 102 88 The French economy is trapped between dynamic northern
Overall Manuf. Outlook 10 8 8 -5 Europe and poor-performing southern Europe. This may
Own Manuf. Outlook 14 11 16 4 have to do with geography, but it is also due to
competitiveness. We are thus moderately confident about
the growth outlook for France.
Key Point:
We expect a technical recovery in manufacturing,
but there is no post-recession catch-up in sight.

Key Data Preview
Chart 3: Canadian Inflation BNP Paribas Forecast: Moderate Pressure
Canada: CPI (November)
Release Date: Tuesday 21 December
We expect Canadian headline CPI to increase by 0.3% in
November, as higher energy prices continue to pressure
headline inflation. Consequently, headline inflation should
moderate to 2.2% y/y in November from a rate of 2.4% y/y
in October.
The Bank of Canada core CPI is expected to increase by
0.2% m/m in November. Shelter costs are likely to be a
significant factor in November’s reading. We are expecting
moderation close to 0.1% m/m—coming off the significant
0.6% increase in October. Note that food, shelter, and
transportation prices make up 63.5% of the headline
Source: Reuters EcoWin Pro inflation index.
m/m % Nov (f) Oct Sep Aug Going forward, the main upside risks to the inflation outlook
are higher commodity prices. On the other hand, a
CPI 0.3 0.4 0.2 -0.1 deceleration in the growth of unit labour costs, the relatively
Bank of Canada Core 0.2 0.4 0.2 0.1 strong CAD weighing on import costs, and a more
pronounced correction in the housing market should limit
Key Point: core inflation growth.
Food and energy prices are likely to push prices
higher in November. A moderation in shelter prices
is likely to be followed by a decline in the coming
months.
Chart 4: Japan: Trade Balance (JPY bn, s.a.) BNP Paribas Forecast: Larger Surplus
1400 Japan: Trade data (November)

1200 Release Date: Wednesday 22 December
1000 Based on trade data through mid-November, we expect
800 nominal exports and nominal imports will both increase for
600 the month as a whole, with the result that the seasonally
400 adjusted trade surplus expands. Owing to the yen’s
200 appreciation (which causes yen-based prices to decline for
0 imports and exports), nominal exports and imports have
-200 been trending lower. Real exports (adjusted for exchange
-400 rate and price fluctuations) have also lost momentum since
-600 May, reflecting the fading impact of overseas inventory
-800 restocking and fiscal stimulus. Even so, the slowdown by
00 01 02 03 04 05 06 07 08 09 10 exports to China, Japan’s top trading partner, show signs
of reaccelerating, including a double-digit surge in October.
Such strength dovetails with recent Chinese indicators
JPYbn Nov (f) Oct Sep Aug showing domestic demand is expanding and the Chinese
manufacturing cycle has recovered (manufacturing PMI
Trade balance (nsa) 510.1 821.3 788.5 84.0
has been soaring since bottoming out in July). What is
Trade balance (sa) 691.0 578.5 611.3 580.2 more, there are signs that the manufacturing cycles in the
US and EU are also starting to turn up. Thus, we expect
Key Point: the pace of export growth will strengthen moving forward.
Shipments to China revived sharply in October and In November, we expect real exports and real imports will
we expect overall real exports to pick up the pace in both expand.
November.

Key Data Preview
Chart 5: US: Existing & Pending Home Sales BNP Paribas Forecast: Up
US: Existing & New Home Sales (November)
Release Date: Wednesday & Thursday 22 & 23 Dec
Existing home sales are expected to jump 7% m/m to
4.74mn annualised units in November, more than offsetting
the last month’s 2.2% decline. Pending sales that are
based on contract signings and lead existing sales by one
to two months jumped 10.4% m/m in November. In
addition, mortgage applications to purchase surged 17.9%
m/m in November, further supporting our forecast for an
increase in existing home sales.
New home sales plunged 8.1% in October to 283k
annualised units. We expect a rebound of 6% m/m to 300k
in November, in line with strong mortgage applications.
Source: Reuters EcoWin Pro Both new and existing home sales remain low by historical
standards and relatively small monthly changes in the
Nov (f) Oct Sep Aug number of homes sold translate into relatively large swings
New Home Sales in growth rates.
(000s saar) 300 283 308 275
Existing Home Sales
(millions saar) 4.74 4.43 4.53 4.12
Key Point:
Existing home sales are expected to jump 7% m/m
to 4.74mn annualised units while new home sales
should rebound 6% to 300k in November, in line with
strong mortgage applications.
Chart 6: French Sales of Manuf. Goods BNP Paribas Forecast: Rebounding

8 5 France: Hh Consumption of Manuf. Goods (November)
Manuf. Goods Sales (% y/y, volume)
7 0 Release Date: Thursday 23 December
6
5 -5 Household confidence has been rising since July despite
4 -10 social unrest. The INSEE index is still very weak in
3 absolute terms, but the EU Commission puts confidence in
-15
2 line with long-term average. As a result, durable goods
1 -20 sales ex-autos have been quite dynamic recently; this
0 Household Confid. (RHS) -25 momentum should continue.
-1 Commission Survey
-30 Sales of clothes have been relatively robust in the last few
-2
-35 months, printing strong gains vs. weak 2009 levels. This
-3
trend should continue, with the help of cold weather.
-4 -40
05 06 07 08 09 10 Some 90% of the retail sales decline in October was due to
cars; we expect this to be corrected. Car sales, which are
Source: Reuters EcoWin Pro included in the French overall retail sales data, were
boosted last year by car sales incentives. As the incentive
Volume index Nov (f) Oct Sep Nov 09
has been halved since last year (to EUR 500), the effect is
SA-WDA
weaker this year but has not totally disappeared.
% m/m 1.1 -0.7 1.6 1.2 November new car registrations, up 19% m/m but down
% y/y -0.3 -0.3 1.2 3.8 10.4% y/y, show this. Car sales will again drive the
headline retail sales data in the last few months of this
Key Point: year.
Correction of car sales should boost the November According to retailers, Christmas sales are proving
figure. The underlying trend should remain strong. relatively dynamic; this could boost their turnover during
the last weekend of November. The bulk of the benefit
should be visible in the December data (due on 25 January
2011).

Key Data Preview
Chart 7: US Confidence vs Consumption BNP Paribas Forecast: Solid Spending,
Subdued Income
US: Personal Income & Spending (November)
Release Date: Thursday 23 December
Personal consumption is forecast to rise 0.5% in November
after a similar gain in October. The gain will be driven by a
surge in retail holiday spending while auto purchases were
flat on the month and we look for a modest increase in
service expenditures. The increase would be consistent
with a healthy gain of between 2.5% and 3.0% in overall
consumer spending in Q4 as consumers gain a little more
confidence in the recovery.
Meanwhile personal income is forecast to rise by a
subdued 0.2% in November reflecting weakness in
aggregate hours worked captured in the employment
Source: Reuters EcoWin Pro report. This comes on the heels of a 0.5% surge that was
driven by a more robust increase in wages and salaries.
% m/m Nov (f) Oct Sep Aug Smoothing through the monthly volatility, wage and salary
Personal Income 0.2 0.5 0.0 0.5 income is growing at a moderate pace serving as a
Consumption 0.5 0.4 0.2 0.3 foundation for continued gains in spending. The more
Core PCE Prices 0.0 0.0 0.0 0.1
subdued increase in income should lead the personal
saving rate to move lower.
Key Point: The core PCE price index is expected to be flat in
A surge in holiday shopping should lead to a solid November, which would hold the y/y steady at a record low
gain in spending while income gains will be 0.9% where we expect it to be for the next four months.
subdued. Headline inflation is expected to rise 0.2% suggesting a
0.3% increase in real consumer spending.
Chart 8: US: ISM Points to Moderation BNP Paribas Forecast: Small Decline
US: Durable Goods (November)
Release Date: Thursday 23 December
Durable goods orders are expected to fall 0.5% in
November, reflecting a plunge in orders for Boeing aircraft.
Meanwhile, we look for orders ex transportation to rise a
solid 1.5% after plunging 2.7% a month prior. The October
reading was disappointing and contradicts some of the
resilience we have seen in other manufacturing indicators.
Therefore we look for a rebound which would leave
equipment and software investment on a more moderate
but still robust growth trajectory in Q4.
% m/m Nov (f) Oct Sep Aug

Durable Goods -0.5 -3.4 5.0 -0.8
Ex-Transport 1.5 -2.7 1.3 2.1
Key Point:
A decline in the headline will mask a solid rebound in
orders ex-transportation.

Key Data Preview
Chart 9: Japanese Unemployment Rate (% sa) BNP Paribas Forecast: Slight Improvement
6.0 Japan: Unemployment rate (November)

5.5 We expect the unemployment rate in November to drop
0.1pp to 5.0%, reversing the 0.1pp increase in October.
5.0 Basically, though, the jobless rate is still seesawing in the
low 5% range, a pattern that has continued since the rapid
improvement from 5.6% in July 2009 ended in January-
4.5
February at 4.9%. Despite the economy’s relatively robust
expansion, job growth continues to lag because
4.0 corporations are reluctant to aggressively hire owing to
lingering perceptions of over-staffing.
3.5 Although perceptions of excessive employment are steadily
00 01 02 03 04 05 06 07 08 09 10 waning, it will be some time before job growth clearly picks
Source: Reuters EcoWin Pro up, especially since the economy looks headed for a
momentary contraction in Q4 due to the winding down of
% s.a. Nov (f) Oct Sep Aug stimulus programmes and negative payback for front-
Unemployment rate 5.0 5.1 5.0 5.1 loaded demand.
Key Point:
The jobless rate continues to seesaw in the low 5%
range. With the economy likely to contract in Q4, it
will be some time before job growth clearly picks up.
Chart 10: Japanese CPI (% y/y) BNP Paribas Forecast: Modest Improvement
3 Japan: CPI (National, November)

Core CPI Release Date: Tuesday 28 December
2
In October, the rate of decline in the national core CPI
improved a sharp 0.5pp from September to -0.6% y/y, due
1
in large part to the effects of a tobacco tax hike. But even
excluding such one-off policy factors, the “10% trimmed
0
mean CPI” – which excludes volatile special factors such as
-1
the tobacco tax (contribution:+0.28pp) and the earlier tuition
fee exemptions for public high schools (+0.52pp) – showed
-2
CPI excluding energy and food, but not alcohol an improvement of 0.1pp to -0.3% in November. This index
has been steadily on the mend since hitting a low of -1.3%
-3 in November 2009. Based on the Tokyo CPI numbers for
02 03 04 05 06 07 08 09 10 November (after making allowances for differences with the
national index), we estimate that the national core index in
November will decline at the same 0.6% rate as in October
% y/y Nov (f) Oct Sep Aug and that the national 10% trimmed mean CPI will also move
sideways.
Core CPI -0.6 -0.6 -1.1 -1.0
CPI 0.0 0.2 -0.6 -0.9
Key Point:
Although one-off factors have made prices volatile
of late, trend indicators (10% trimmed mean CPI)
confirm deflation continues to moderate.

Key Data Preview
Chart 11: Japanese Production and Exports BNP Paribas Forecast: First Increase in Six
Months
120 150 Japan: Industrial Production (November)

(2005=100, s easonally adjusted)
115 140 Release Date: Tuesday 28 December
110 130 We expect production in November to expand 1.0% m/m,
105 Production 120 the first rise in six months. With exports slowing to a virtual
100
110 standstill, factories have hit a soft patch since the summer,
95 made worse by huge production cuts in October that were
100
90 triggered by the end of green car subsidies. But the
90
85 forecast index projects output will rebound in both
80 80 November and December. While such forecasts warrant
Exports (RHS)
75 70 caution owing to the upward bias in the METI’s seasonally-
70 60 adjusted data in Q4, it seems safe to say that producers
65 50 are not especially downbeat about future demand. Indeed,
00 01 02 03 04 05 06 07 08 09 10 the cyclical outlook for the manufacturing cycle does not
look too bad as global manufacturing is recovering again.
One note of caution is that production in Q4 is being
Nov (f) Oct Sep Aug propped up by rush demand ahead of the downsizing of
another stimulus programme (eco-point system), which has
% m/m 1.0 -2.0 -1.6 -0.5
triggered stronger-than-expected sales of LCD TVs and air
conditioners. The demand thus robbed from the future will
have negative consequences on production in Q1 2011.
Key Point: However, we expect manufacturing to be supported by the
Production in November should recover for the first resumption of brisk exports to emerging Asia from the start
time in six months, thanks to last-minute demand for of next year. The recovery in the manufacturing sector
home appliances ahead of the downsizing of a should resume, with the pace becoming pronounced from
stimulus program. the spring when fallout from the end of the eco-point
system fades.
Chart 12: US Consumer Confidence BNP Paribas Forecast: Up

US: Consumer Confidence (December)
The Conference Board Index of Consumer Confidence is
expected to increase to 57.0 in December from 54.1 in
November. Consumers continued to gain confidence in
early December, as the University of Michigan consumer
sentiment index indicated.
Consumers enjoyed putting the election behind them, saw
the stock market bounce, and retailers are luring them with
discounts this holiday season. Indeed, early data suggest
that more shoppers visited stores and websites over Black
Friday weekend and on Cyber Monday and spent more
than a year ago. Retailers are anticipating a happier festive
Source: Reuters EcoWin Pro season this year as the recovery gradually gains
momentum. Moreover, the proposed extension of tax cuts
Dec (f) Dec 2H Dec p Nov and unemployment benefits should help boost confidence
Conference Board 57.0 54.1 in the second half of the month.
Michigan Sentiment 74.3 74.4 74.2 71.6
Key Point:
The proposed extension of tax cuts and
unemployment benefits should help boost
confidence in the second half of the month.

Key Data Preview
Chart 13: Eurozone M3 & Bank Lending (% y/y) BNP Paribas Forecast: Trending Higher
12.5
Private Sector
Eurozone: Monetary Developments (November)
Bank Lending Release Date: Wednesday 29 December
10.0
The y/y growth rate in M3 decelerated in the two months to
7.5
October. Still, at 1.0%, it was almost 1½ percentage points
above its cycle low in February 2010.
5.0 Given the unusually large m/m drop in M3 in November
2009 (of 0.5%), the y/y rate of increase in M3 is likely to
M3
2.5 rise in November this year. The three-month average y/y
rate of growth is forecast at 1.2%, a 13-month high.
0.0 The differential between narrow and broad money growth
rates in the eurozone has narrowed The y/y growth rate of
-2.5
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
M1, having been in double digits for almost a year from
mid-2009, fell to 4.9% y/y in October, a 20-month low.
As with M3, the y/y growth rate in bank lending remains low
% y/y Nov (f) Oct Sep Aug but has been trending upwards. October’s 1.4% growth
rate compares to a trough of -0.8% in October 2009.
M3 1.5 1.0 1.1 1.2
Loans to households have been the main driver of the pick-
M3 (3-mth Avg.) 1.2 1.1 0.8 0.5
up, rising by 2.9% y/y in October. Lending for mortgages is
Private Sector Loans 1.4 1.4 1.2 1.2
stronger, up by 3.6% y/y in October, than consumer credit,
which continues to contract on a y/y basis.
Key Point: Lending to the non-financial corporate sector is lagging that
The y/y rates of growth in M3 and bank lending are for households, as is typically the case. The rate of decline
low by past standards but are trending higher. has moderated, however, to -0.6% y/y in October versus a
trough of -2.7% in January 2010.
Chart 14: German CoL BNP Paribas Forecast: On The Rise

Germany: CoL (October, preliminary)
Release Date: Wednesday 29 December
In November, inflation in Germany was pushed higher by a
combination of stronger core inflation and a sharp increase
in food prices. Core inflation rose by 0.2pp to 0.8% y/y, as
the sharp discounting in clothing prices last November
dropped out of the y/y comparison and retailers increased
their prices in November this year. Food inflation rose,
meanwhile, as the impact of the soft commodity price
shock finally began to show in the data.
In December, we expect a further rise in German inflation
as a sharp rise in energy prices over the month and a
further gain in food inflation dominate a decline in core
Source: Reuters EcoWin Pro inflation.
Energy prices are expected to have risen by nearly 2%
% Dec (f) Nov Oct Sep m/m in December on a combination of a fall in the euro’s
CoL m/m 1.0 0.1 0.1 -0.1 value in November and a sharp rise in oil prices at the start
CoL y/y 1.7 1.5 1.3 1.3 of December. That should push y/y energy inflation to
HICP m/m 1.1 0.1 0.1 -0.2 around 8% - its highest level since October 2008.
HICP y/y 1.8 1.6 1.3 1.3 Core inflation, meanwhile, is expected to give up much of
its November gain as the clothing discounts come one
month later than 2009 and a household goods price base
Key Point: effect washes out.
Headline inflation should rise further as an increase
in commodity inflation dominates a decline in core.

Economic Calendar: 3 – 28 January
3 January 4 January 5 January 6 January 7 January
Eurozone: Manufacturing Eurozone: HICP (Flash) Eurozone: PPI Nov, Eurozone: Retail Sales Eurozone: Labour Nov,
PMI (Final) Dec Dec Industrial Orders Oct, PMI Nov, Business and GDP (Final) Q3
Spain: HICP (Flash) Dec UK: CIPS Manufacturing Services (Final) Dec Consumer Confidence Germany: Industrial
UK: Holiday Dec, Net Consumer Spain: IP Nov Dec Production Nov, Trade
Switz: PMI Dec Credit Nov, Mortgage US: ADP Employment UK: CIPS Services Dec Balance Nov
US: ISM Manufacturing Approvals Nov Change Dec, ISM Germany: Factory Orders France: Trade Balance
Dec Germany: Labour Nov Services Dec Nov Nov
France: Consumer Neths: CPI Dec Norway: Industrial
Confidence Dec Switz: CPI Dec Production Oct, Retail
US: Factory Orders Nov, Sales Nov
FOMC Minutes US: Labour Dec,
Consumer Credit Nov
Canada: Labour Dec
During Week: Germany Retail Sales Nov, Italy CPI Dec, UK Halifax House Prices Dec
Australia: Retail Sales Australia: Trade Balance Japan: M2 Dec, Current Australia: Labour Dec Japan: CGPI Dec
Nov Nov Account Nov Japan: Machinery Orders Eurozone: Trade
France: Industrial Japan: Leading Indicator Eurozone: Industrial Nov Balance Nov, HICP Dec
Production Nov Nov Production Nov Eurozone: ECB Rate Germany: HICP Dec
Sweden: Industrial France: BoF Survey Dec France: Current Account Announcement & Press Spain: HICP Dec
Production Nov UK: BRC Retail Sales Nov Conference UK: PPI Dec
Norway: CPI Dec, PPI Monitor Dec UK: Trade Balance Nov France: CPI Dec US: CPI Dec, Retail
Dec US: NFIB Small Business US: Import Prices Dec Neths: Retail Sales Nov, Sales Dec, Industrial
Optimism Dec, Wholesale Industrial Production Nov Production Dec, UoM
Inventories Nov UK: Industrial Production Sentiment (Prel) Jan,
Nov, BoE Rate Business inventories
Announcement Nov
Sweden: CPI Dec
US: PPI Dec, Trade
Balance Nov
During Week: Germany Retail Sales Nov, WPI Dec
UK: Rightmove House Canada: BoC Rate Japan: Tertiary Index Nov Germany: PPI Dec Eurozone: PMIs
Prices Jan Announcement Eurozone: Current Neths: Labour Dec, (Flash) Jan
UK: DCLG House Prices Account Nov Consumer confidence Jan Germany: Ifo Survey
Nov, CPI Dec Belgium: Consumer US: Existing Home Sales Jan
Germany: ZEW Survey Confidence Dec Dec Belgium: Business
Jan UK: Labour Dec Confidence Dec
US: Empire Canada: BoC Monetary UK: PSNCR Dec,
Manufacturing Jan, TICS Policy Report PSNB Dec, Retail Sales
Data Nov, NAHB Housing US: Housing Starts Dec Dec
Index Jan
During Week: Germany WPI Dec
Australia: PPI Dec Australia: CPI Dec France: Job Seekers Dec
Japan: Trade Balance Japan: BoJ Monetary
Eurozone: Industrial Japan: BoJ Rate UK: BoE Minutes Dec Policy Meeting Minutes,
Orders Nov Announcement Norway: Norges Bank
Eurozone: Business and CPI Tokyo Jan, CPI
France: Industry Survey France: Housing Starts Rate Announcement
Consumer Confidence National Dec, Labour
Jan Dec, Retail Sales Dec, US: New Home Sales
Jan Dec, Household
Neths: Producer Quarterly Industrial Dec, FOMC Rate Germany: HICP (Prel) Consumption Dec,
Confidence Jan Survey Q1 Announcement Jan Retail Sales Dec
UK: GDP (Adv) Q4 France: Consumer Eurozone: Eurocoin
US: S&P/CaseShiller Confidence Jan Jan, Monetary
House Prices Nov, Spain: Retail Sales Dec Developments Dec
Consumer Confidence Sweden: Labour Dec, US: ECI Q4, GDP (Adv)
Jan, FHFA House Prices PPI Dec, Consumer Q4, UoM Sentiment
Nov Confidence Jan (Final) Jan
Canada: CPI Dec US: Durable Goods
Orders Dec, Pending
Home Sales Nov
During Week: Germany GfK Consumer Confidence Jan, UK Nationwide House Prices Jan
Source: BNP Paribas Release dates as at c.o.b. prior to the date of this publication. See our Daily Spotlight for any revisions

Treasury and SAS Issuance Calendar
Daily update onto https://globalmarkets.bnpparibas.com, Research & Apps, Tools & Applications, Mkt Calendar, Government Flows
In the pipeline - Treasuries:

France: Cancelled its BTF auction initially planned for 27 Dec. First BTF auction of 2011 will take place on 3 Jan, settlement on 6 Jan
Austria: Expects to make one or two syndicated issues in 2011
Germany: Intends to issue inflation-linked federal securities (EUR2-3bn quarterly) and reserves the right to issue foreign currency bonds in '11
Poland: May issue euro-denominated bonds as early as January 2011
UK: Index-Linked Gilt 30y-50y area (syndicated) in the second half of January 2011 and two mini tenders, one in Feb & the other in Mar
Belgium: Likely to issue 3 new OLO benchmarks (launched through syndications) in 2011 - plans also to buy back bonds maturing in 2012 for
EUR 2.19bn in 2011
Neths: DSL 10-year (new, DDA) in Feb/Mar 2011 - exact timing yet to be announced, may lead to changes in the regular issuance calendar
Czech Rep.: Plans at least one eurobond benchmark in 2011 - currency denomination is to be defined
Denmark: In 2011, to issue a 5-year EUR loan (EUR 1-2bn) and EUR or USD loans may be issued in the 2-5y maturity segment
Slovak Rep.: Will open two new bond issues in 2011, a 3y zero-coupon bond (up to EUR 1.5bn) and a 7y or 10y bond (EUR 3bn)
Slovenia: Plans to issue Eurobond in H1 2011
During the week:
US: Announcement of 2-, 5- & 7y Notes (new) details on Thu 23 Dec
FNMA: December syndicated auction, details announced on Mon 20 Dec
Date Day Closing Country Issues Details BNPP forecasts
Local GMT
17/12 Fri 11:00 16:00 US Outright Treasury Coupon Purchase (2028-2040) USD 1.5-2.5bn
20/12 Mon 11:00 16:00 US Outright Treasury Coupon Purchase (2018-2020) USD 7-9bn
Outright Treasury Coupon Purchase (2014-2016) USD 6-8bn
21/12 Tue 12:00 17:00 Canada Repurchase of 10 Cash Mgt Bonds (Jun11 - Jun12) CAD 1bn
11:00 16:00 US Outright Treasury Coupon Purchase (2016-2017) USD 7-9bn
Outright TIPS Purchase (2012-2040) USD 1-2bn
22/12 Wed 12:00 03:00 Japan JGB 15 Jan 2013 JPY 2.6tn
11:00 16:00 US Outright Treasury Coupon Purchase (2021-2027) USD 1.5-2.5bn
27/12 Mon 13:00 18:00 US Notes 2-year (new) 23 Dec USD 35bn
28/12 Tue 11:00 16:00 US Outright Treasury Coupon Purchase (2013-2014) USD 6-8bn
13:00 18:00 US Notes 5-year (new) 23 Dec USD 35bn
29/12 Wed 10:55 09:55 Italy CTZ 23 Dec EUR 2-3bn
13:00 18:00 US Notes 7-year (new) 23 Dec USD 29bn
30/12 Thu 10:55 09:55 Italy 3 & 10y BTPs and CCT 23 Dec EUR 5-8bn
03/01 Mon 11:00 16:00 US Outright Treasury Coupon Purchase (2018-2020) USD 7-9bn
04/01 Tue 11:00 16:00 US Outright TIPS Purchase (2012-2040) USD 1-2bn
05/01 Wed 11:00 10:00 Germany Bund 2.5% 4 Jan 2021 EUR 5bn
11:00 16:00 US Outright Treasury Coupon Purchase (2028-2040) USD 1.5-2.5bn
06/01 Thu 12:00 03:00 Japan JGB 10-year 30 Dec JPY 2.2tn
10:50 09:50 France OATs 31 Dec EUR 7-9bn
10:30 10:30 UK Gilt 3.75% 7 Sep 2020 29 Dec
07/01 Fri 11:00 16:00 US Outright Treasury Coupon Purchase (2013-2014) USD 6-8bn
10/01 Mon Slovak Rep. SLOVGB 4% 27 Apr 2020 (#214) 6 Jan
11/01 Tue 12:00 03:00 Japan Auction for Enhanced-liquidity 4 Jan JPY 0.3tn
11:00 10:00 Austria RAGBs 4 Jan EUR 1-2bn
10:30 10:30 UK Index-Linked Gilt 1.25% 22 Nov 2032 4 Jan
Neths DSL 15 Jan 2014 (new) EUR 2.5-3.5bn
Denmark DGBs 6 Jan
13:00 18:00 US Notes 3-year (new) 6 Jan USD 32bn
12/01 Wed 11:00 10:00 Germany OBL 26 Feb 2016 (Series 159) (new) EUR 6bn
11:00 10:00 Sweden T-bonds 5 Jan
10:30 10:30 Portugal OTs (To be confirmed) 6 Jan EUR 1-2bn
13:00 18:00 US Notes 10-year 6 Jan USD 21bn
13/01 Thu 12:00 03:00 Japan JGB 30-year 6 Jan JPY 0.6tn
10:30 09:30 Spain Bonos (TBC) 27 Dec EUR 3-5bn
10:55 09:55 Italy 5-year BTP and possibly 15- or 30-year BTP 5 Jan EUR 7-9bn
13:00 18:00 US Bond 30-year 6 Jan USD 13bn
Sources: Treasuries, BNP Paribas

Next week's T-Bills Supply Next week's Eurozone Redemptions
Date Country Issues Details Date Country Details Amount
17/12 UK T-Bills Jan 2011 GBP 0.5bn 23/12 France BTF EUR 8.0bn
T-Bills Mar 2011 GBP 1bn 24/12 Greece GTB (13W) EUR 0.4bn
T-Bills Jun 2011 GBP 1.5bn Total Eurozone Short-term Redemption EUR 8.4bn
20/12 Japan T-Bills Apr 2011 JPY 4.8tn Next week's Eurozone Coupons
France BTF Mar 2011 EUR 3.5bn
Country Amount
BTF Dec 2011 EUR 1.5bn
US T-Bills Mar 2011 USD 29bn Italy EUR 0.1bn
T-Bills Jun 2011 (new) USD 28bn Belgium EUR 0.7bn
FHLMC Bills 3-month & 6-month 17 Dec Total Long-term Coupon Payments EUR 0.8bn
21/12 Spain Letras Mar 2011 20 Dec
Letras Jun 2011 20 Dec
Canada T-Bill Mar 2011 CAD 7.4bn Chart 1: 2011 EGBs Issuance Projections
T-Bill Jun 2011 CAD 2.8bn EUR Sovereign Financing: Projections for 2011 (EUR bn) 2010 Bond 2010 Net
T-Bill Dec 2011 CAD 2.8bn Issuer Redemptions Deficit Borrowing Needs Bond Issuance Issuance Net Issuance Issuance
US T-Bills 4-week 20 Dec Austria 8.3 10.2 18 19 21 11 12
FHLB Discount Notes Belgium 24.0 16.0 40 34 41 10 16
Finland 5.7 6.3 12 15 16 9 7
22/12 FNMA Bills 3-month & 6-month 20 Dec
France 91.8 90.0 182 180 188 88 105
23/12 FHLB Discount Notes Germany 147.3 33.0 180 195 207 48 74
Sources: Treasuries, BNP Paribas Greece 27.7 18.7 46 - 18 - 2
Ireland 4.4 16.4 24 - 22 - 22
Italy 155.2 73.0 228 225 260 70 88
Netherlands 27.9 23.9 52 50 52 22 29
Portugal 9.6 9.3 19 18 22 8 16
Slovenia 1.0 2.1 3 3 3 2 2
Spain 45.1 43.7 89 88 94 43 59
Comments and charts Total 548 343 894 827 943 311 430
Chart 2: EGBs Redemptions in 2011

EGB supply is over for 2010 and our focus turns Bonds Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011
now to 2011 issuance. We expect total EGB gross ITA 0.0 21.7 30.5 0.0 14.6 12.2 2.7 20.2 46.0 0.0 15.5 0.0 163.3
issuance of EUR 827bn, down from EUR 943bn in 2010. FRA 17.8 0.0 0.0 18.4 0.0 0.0 29.3 0.0 13.8 15.7 0.0 0.0 95.0
In net supply terms, we expect a fall to EUR 311bn in GER 23.3 0.0 15.0 19.0 0.0 15.0 24.0 0.0 16.0 17.0 0.0 18.0 147.3
SPA 0.0 0.0 0.0 15.5 0.0 0.0 17.0 0.0 0.0 14.1 0.0 0.0 46.6
2011 from EUR 430bn in 2010. Our article “EUR: 2011 GRE 0.0 0.0 9.1 1.0 7.0 0.0 0.0 6.8 0.0 0.0 0.0 5.8 29.8
EGB Issuance Preview” in this week’s Market Mover has BEL 0.0 0.0 11.3 0.0 0.0 3.4 0.0 0.0 12.7 0.0 0.0 0.6 28.0
more details. For that reason, we do not show the NET 13.9 0.0 0.0 0.0 0.0 0.0 14.1 0.0 0.0 0.0 0.0 0.0 27.9
standard charts on the RHS but some general charts on AUS 8.3 0.1 0.1 0.0 0.9 0.0 0.6 0.0 0.0 0.0 0.0 0.1 10.0
POR 0.0 0.0 0.0 4.5 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 9.5
2011 EGB issuance preview. IRE 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.5 0.0 4.5
Only the end-of-month Italian auctions remain in FIN 0.0 5.7 0.0 0.0 1.5 0.0 0.0 0.1 0.1 0.0 0.0 0.0 7.3
2010, which settle and account for 2011 issuance. Total 63.2 27.4 66.1 58.5 24.0 35.5 87.6 27.1 88.6 46.7 20.0 24.5 569.2
Outside the eurozone, there will be no issuance in

the US in the week ahead. Only Japan will issue paper
Chart 3: Expected 2011 EGBs Issuance
in the week ahead. Breakdown
2011 GER FRA ITA SPA NET BEL AUS POR FIN Total
Jan 19.0 19.7 20.6 9.1 5.5 4.2 4.0 0.8 1.0 83.9
Feb 18.0 16.2 19.6 8.5 6.5 3.7 1.5 3.3 0.0 77.3
Mar 16.0 19.9 18.0 10.5 3.0 3.3 1.5 0.8 4.0 77.1
Apr 19.0 16.7 23.2 5.2 6.5 3.3 2.0 1.7 1.5 79.0
May 19.0 17.6 15.2 6.2 7.8 0.0 1.8 1.8 0.0 69.4
Jun 18.0 17.4 23.2 7.7 3.5 3.3 1.9 2.2 1.5 78.7
Jul 11.0 17.0 16.8 12.4 6.0 6.6 1.2 2.5 0.0 73.5
Aug 13.0 0.0 18.5 3.3 0.0 2.8 0.9 1.1 0.0 39.5
Sep 20.0 16.5 23.7 6.9 2.5 2.9 1.9 1.7 4.0 80.0
Oct 12.0 16.9 21.2 6.6 5.7 2.3 1.4 1.0 1.7 68.9
Nov 20.0 16.7 18.1 8.5 3.0 1.7 1.0 1.0 1.5 71.4
Dec 10.0 5.3 6.8 3.2 0.0 0.0 0.0 0.0 0.0 25.3
Total 195 180 225 88 50 34 19 18 15 824
All Charts Source: BNP Paribas

Central Bank Watch
Date of
Current Next Change in
Interest Rate Last Comments
Rate (%) Coming 6 Months
Change
EUROZONE
Doubts about the sustainability of the recovery and low inflation
-25bp No Change
Minimum Bid Rate 1.00 pressures imply no rise in the refinancing rate for a considerable
(7/5/09)
period of time: we expect the first increase only in H2 2012.
US
-75bp
Fed Funds Rate 0 to 0.25 No Change The FOMC is expected to maintain the funds rate at 0 to 0.25%
(16/12/08)
for an extended period. It will execute its QE2 programme through
+25bp
Discount Rate 0.75 No Change H1 2011, with a high probability of an extension through H2 2011.
(18/2/10)
JAPAN
-10bp
Call Rate 0 to 0.10 No Change We expect the BoJ to maintain its overnight call rate at 0 to
(5/10/10)
0.1% for an extended period. It could well expand its asset
-20bp purchase programme, depending mainly on moves in the yen.
Basic Loan Rate 0.30 No Change
(19/12/08)
UK
Persistent upward surprises on inflation and rising inflation
-50bp
Bank Rate 0.5 No Change expectations mean that the next BoE move will be a tightening.
(5/3/09)
We expect disappointing growth to delay the first hike until 2012.
DENMARK
Higher money market rates in the eurozone are likely to
-10bp
Lending Rate 1.05 No Change continue to put pressure on the krone. Thus, further increases in
(14/1/10)
the interest rate on certificates of deposit are on the agenda.
SWEDEN
+25bp Strong domestic economic growth should lead to further rate
+25bp
Repo Rate 1.25 (15/2/11) hikes. We expect the Riksbank to deliver the next rate hike at
(15/12/10)
February’s meeting.
NORWAY
We expect the Norges Bank to raise rates in Q2 2011. Given the
+25bp +25bp Bank’s hawkish statement in December, the risk is that the rate
Sight Deposit Rate 2.00
(5/5/10) (12/5/11) hike comes in Q1 if economic data surprise to the upside and
the krone does not appreciate significantly.
SWITZERLAND
-25bp +25bp Rates look inappropriate given the strength of the domestic
3 Mth LIBOR Target
0.0-0.75 (12/3/09) (17/3/11) economy. But the first hike is being delayed by financial stress in
Range
the markets and the exceptional strength of the CHF.
CANADA
+25bp +25bp In light of developments in global financial markets and the US
Overnight Rate 1.00 economic outlook in particular, the BoC is pausing to allow
(8/9/10) (1/6/11)
further progress in the recovery. Rate hikes should resume in
+25bp +25bp June 2011, with 75bp of increases delivered by the end of next
Bank Rate 1.25
(8/9/10) (1/6/11) year.
AUSTRALIA
The RBA’s December statement said policy is “appropriate for
the economic outlook”, suggesting it is now more data
+25bp +25bp
Cash Rate 4.75 dependent. We expect above-trend growth in late 2010 and
(2/11/10) (1/3/11)
early 2011 on the back of strength in Asia. This should be
enough to prompt a further rate rise in March.
CHINA
With growth momentum robust, spurred on by the launch of
QE2, the PBOC will further tighten policy through RRR and
1Y Bank Lending +25bp +25bp
5.56% liquidity controls. Furthermore, we expect three more 25bp rate
Rate (19/10/10) (Dec 10)
hikes in coming months: one before end-2010, one in Q1 and
one in Q2. RMB appreciation will also quicken.
BRAZIL
The BCB has been on hold since the last hike in July. However,
+50bp +50bp as the inflation picture is worsening, the monetary authority is
Selic Overnight Rate 10.75
(21/7/10) (19/1/11) likely to resume hiking rates by January 2011, to tame inflation
expectations and pull inflation back towards the target.
Source: BNP Paribas Change since our last weekly in bold and italics
For the full EMK Central Bank Watch please see our Local Markets Mover

Economic Forecasts
GDP Year 2010 2011
(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US -2.6 2.8 2.4 2.4 3.0 3.2 2.6 2.2 2.4 2.5 2.5
Eurozone -4.0 1.7 1.3 0.8 1.9 1.9 2.0 1.9 1.2 1.1 1.2
Japan -5.2 3.6 1.4 5.0 2.7 4.4 2.6 1.4 1.4 1.0 1.9
World (2) -0.6 4.7 4.1 4.8 5.0 4.8 4.4 4.1 3.9 4.0 4.2
Industrial Production Year 2010 2011

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US -9.3 5.5 3.0 2.7 7.4 6.6 5.3 4.2 3.0 2.4 2.5
Eurozone -14.6 6.4 1.6 4.6 9.0 6.9 5.2 3.1 1.1 0.8 1.6
Japan -21.9 15.0 1.2 27.4 21.0 13.4 2.6 -1.3 -1.6 1.2 6.2
Unemployment Rate Year 2010 2011

(%) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US 9.3 9.7 9.5 9.7 9.7 9.6 9.7 9.7 9.7 9.5 9.3
Eurozone 9.4 10.0 10.2 9.9 10.0 10.0 10.1 10.1 10.2 10.2 10.2
Japan 5.1 5.1 4.6 4.9 5.2 5.1 5.0 4.8 4.7 4.5 4.5
CPI Year 2010 2011

(% y/y) ’09 ’10 (1) ’11 (1) Q1 Q2 Q3 Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US -0.3 1.6 1.2 2.4 1.8 1.2 1.2 1.2 1.5 1.3 0.9
Eurozone 0.3 1.6 1.6 1.1 1.5 1.7 2.0 1.9 1.5 1.5 1.6
Japan -1.4 -0.7 -1.0 -1.2 -0.9 -0.8 0.1 -1.0 -1.1 -0.8 -1.3
Current Account Year General Government Year

(1) (1) (1) (1)
(% GDP) ’09 ’10 ’11 (% GDP) ’09 ’10 ’11
US -2.7 -3.4 -3.3 US (4) -10.0 -8.9 -9.9
Eurozone -0.6 -0.5 -0.2 Eurozone -6.3 -6.2 -4.7
Japan 2.8 3.5 3.5 Japan -10.2 -8.2 -6.8
Interest Rate Forecasts

Interest Rate (3) Year 2011 2012
(%) ’09 ’10 (1) ’11 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)
US
Fed Funds Rate 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50
3-month Rate 0.25 0.30 0.30 0.30 0.30 0.30 0.30 0.30 0.45 0.75 0.90
2-year yield 1.14 0.60 1.00 0.50 0.75 0.85 1.00 1.10 1.50 2.15 2.40
10-year yield 3.84 3.35 3.75 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.60
2y/10y Spread (bp) 269 275 275 250 250 265 275 290 275 235 220
Eurozone
Refinancing Rate 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75
3-month Rate 0.70 1.05 1.35 1.20 1.25 1.30 1.35 1.50 1.75 1.75 2.00
2-year yield 1.37 1.00 1.50 1.00 1.20 1.30 1.50 1.70 2.05 2.30 2.45
10-year yield 3.40 2.95 3.35 2.75 2.90 3.15 3.35 3.50 3.75 3.90 4.10
2y/10y Spread (bp) 203 195 185 175 170 185 185 180 170 160 165
Japan
O/N Call Rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10
3-month Rate 0.46 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35
2-year yield 0.15 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.30 0.30 0.30
10-year yield 1.30 1.30 1.40 1.20 1.30 1.40 1.40 1.40 1.40 1.50 1.50
2y/10y Spread (bp) 115 105 115 95 105 115 115 115 110 120 120
Footnotes: (1) Forecast (2) Country weights used to construct world growth are those in the IMF World Economic Outlook Update
April 2010 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated
Source: BNP Paribas
Market Economics / Interest Rate Strategy 16 December 2010

Market Mover www.GlobalMarkets.bnpparibas.com
79
FX Forecasts*
USD Bloc Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13
EUR/USD 1.34 1.27 1.25 1.20 1.23 1.25 1.30 1.32 1.32 1.33 1.34
USD/JPY 82 85 84 88 92 95 100 110 120 119 118
USD/CHF 0.97 1.01 1.05 1.11 1.09 1.08 1.05 1.05 1.06 1.06 1.07
GBP/USD 1.61 1.55 1.51 1.46 1.45 1.52 1.55 1.57 1.61 1.66 1.70
USD/CAD 0.98 0.95 0.96 0.93 0.95 0.95 1.00 1.02 1.09 1.11 1.14
AUD/USD 1.02 1.02 0.99 0.92 0.93 0.92 0.93 0.92 0.90 0.87 0.85
NZD/USD 0.78 0.79 0.78 0.74 0.73 0.72 0.69 0.67 0.66 0.64 0.62
USD/SEK 6.90 7.09 7.04 7.58 7.56 7.36 7.08 6.89 6.89 6.99 6.94
USD/NOK 6.04 6.22 6.16 6.33 6.10 5.92 5.77 5.76 5.68 5.49 5.30
EUR Bloc Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13
EUR/JPY 110 108 105 106 113 119 130 145 158 158 158
EUR/GBP 0.83 0.82 0.83 0.82 0.85 0.82 0.84 0.84 0.82 0.80 0.79
EUR/CHF 1.30 1.28 1.31 1.33 1.34 1.35 1.36 1.38 1.40 1.41 1.44
EUR/SEK 9.25 9.00 8.80 9.10 9.30 9.20 9.20 9.10 9.10 9.30 9.30
EUR/NOK 8.10 7.90 7.70 7.60 7.50 7.40 7.50 7.60 7.50 7.30 7.10
EUR/DKK 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46 7.46
Central Europe Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13
USD/PLN 2.87 3.07 3.16 3.25 3.09 3.12 2.96 2.88 2.84 2.78 2.69
EUR/CZK 24.4 24.7 24.5 24.3 24.5 24.3 24.0 23.9 23.8 24.0 23.8
EUR/HUF 280 290 285 280 275 270 270 270 265 260 255
USD/ZAR 6.90 7.30 7.50 7.40 7.30 7.40 7.30 7.30 7.50 7.20 7.10
USD/TRY 1.43 1.50 1.52 1.48 1.47 1.49 1.46 1.47 1.46 1.45 1.43
EUR/RON 4.30 4.35 4.50 4.50 4.40 4.20 4.30 4.20 4.20 4.20 4.20
USD/RUB 32.00 32.10 31.46 31.65 30.81 30.11 29.07 28.85 28.41 27.86 27.32
EUR/PLN 3.85 3.90 3.95 3.90 3.80 3.90 3.85 3.80 3.75 3.70 3.60
USD/UAH 8.0 7.9 7.9 7.8 7.8 7.5 7.5 7.5 7.5 7.5 7.5
EUR/RSD 110 105 115 105 100 98 97 96 95 93 92
Asia Bloc Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13
USD/SGD 1.30 1.29 1.28 1.27 1.26 1.25 1.24 1.23 1.22 1.21 1.20
USD/MYR 3.10 3.05 3.00 2.95 2.90 2.87 2.85 2.83 2.80 2.77 2.75
USD/IDR 8800 8600 8400 8300 8200 8100 8000 7900 7800 7800 7800
USD/THB 30.00 29.50 29.00 28.70 28.50 28.30 28.00 27.70 27.50 27.50 27.50
USD/PHP 43.00 42.50 42.00 41.50 41.00 40.50 40.00 39.50 39.00 39.00 39.00
USD/HKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80 7.80
USD/RMB 6.65 6.58 6.52 6.49 6.45 6.40 6.35 6.30 6.26 6.23 6.20
USD/TWD 30.00 29.70 29.40 29.00 28.70 28.50 28.30 28.00 28.00 28.00 28.00
USD/KRW 1100 1080 1060 1050 1040 1030 1020 1010 1000 1000 1000
USD/INR 44.00 43.50 43.00 42.50 42.00 41.50 41.00 40.50 40.00 40.00 40.00
USD/VND 20500 20500 20500 20500 20500 20500 20500 20500 20500 20500 20500
LATAM Bloc Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13
USD/ARS 3.98 4.05 4.13 4.20 4.28 4.36 4.44 4.52 4.60 4.68 4.75
USD/BRL 1.70 1.68 1.66 1.65 1.63 1.63 1.65 1.67 1.70 1.71 1.73
USD/CLP 480 473 467 463 458 460 462 465 471 473 475
USD/MXN 12.30 12.00 11.70 11.45 11.30 11.30 11.50 11.80 12.00 12.08 12.15
USD/COP 1830 1800 1750 1720 1700 1705 1730 1745 1760 1770 1780
USD/VEF (Priority) (1) 2.59 2.59 2.59 2.59 2.59 2.59 2.59 2.59 2.59 5.30 5.30
USD/VEF (Oil) (1) 4.29 4.29 4.29 4.29 4.29 4.29 4.29 4.29 4.29 8.80 8.80
Others Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12 Q3 '12 Q4 '12 Q1 '13 Q2 '13
USD Index 78.79 82.04 83.11 86.11 85.63 84.56 83.26 83.51 84.81 84.22 83.77
*End Quarter
(1) Following the devaluation of the VEF, there is now an official ‘priority’ exchange rate and a so-called ‘oil’ exchange rate used for certain transactions
Source: BNP Paribas
Foreign Exchange Strategy 16 December 2010

Market Coverage
Market Economics
Paul Mortimer-Lee Global Head of Market Economics London 44 20 7595 8551 paul.mortimer-lee@uk.bnpparibas.com
Ken Wattret Chief Eurozone Market Economist London 44 20 7595 8657 kenneth.wattret@uk.bnpparibas.com
Luigi Speranza Head of Inflation Economics, Eurozone, Italy London 44 20 7595 8322 luigi.speranza@uk.bnpparibas.com
Alan Clarke UK London 44 20 7595 8476 alan.clarke@uk.bnpparibas.com
Eoin O’Callaghan Inflation, Eurozone, Switzerland, Ireland London 44 20 7595 8226 eoin.ocallaghan@uk.bnpparibas.com
Gizem Kara Scandinavia London 44 20 7595 8783 gizem.kara@uk.bnpparibas.com
Dominique Barbet Eurozone, France Paris 33 1 4298 1567 dominique.barbet@bnpparibas.com
Julia Coronado Chief US Economist New York 1 212 841 2281 julia.l.coronado@americas.bnpparibas.com
Yelena Shulyatyeva US, Canada New York 1 212 841 2258 yelena.shulyatyeva@americas.bnpparibas.com
Bricklin Dwyer US, Canada New York 1 212 471-7996 bricklin.dwyer@americas.bnpparibas.com
Ryutaro Kono Chief Economist Japan Tokyo 81 3 6377 1601 ryutaro.kono@japan.bnpparibas.com
Hiroshi Shiraishi Japan Tokyo 81 3 6377 1602 hiroshi.shiraishi@japan.bnpparibas.com
Azusa Kato Japan Tokyo 81 3 6377 1603 azusa.kato@japan.bnpparibas.com
Makiko Fukuda Japan Tokyo 81 3 6377 1605 makiko.fukuda@japan.bnpparibas.com
Richard Iley Head of Asia Economics Hong Kong 852 2108 5104 richard.iley@asia.bnpparibas.com
Dominic Bryant Asia, Australia Hong Kong 852 2108 5105 dominic.bryant@asia.bnpparibas.com
Mole Hau Asia Hong Kong 852 2108 5620 mole.hau@asia.bnpparibas.com
Xingdong Chen Chief China Economist Beijing 86 10 6561 1118 xd.chen@asia.bnpparibas.com
Isaac Y Meng China Beijing 86 10 6561 1118 isaac.y.meng@asia.bnpparibas.com
Chan Kok Peng Chief Economist South East Asia Singapore 65 6210 1946 kokpeng.chan@asia.bnpparibas.com
Marcelo Carvalho Head of Latin American Economics São Paulo 55 11 3841 3418 marcelo.carvalho@br.bnpparibas.com
Italo Lombardi Latin America New York 1 212 841 6599 italo.lombardi@americas.bnpparibas.com
Florencia Vazquez Latin American Economist Buenos Aires 54 11 4875 4363 florencia.vazquez@ar.bnpparibas.com
Michal Dybula Central & Eastern Europe Warsaw 48 22 697 2354 michal.dybula@pl.bnpparibas.com
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Eric Oynoyan Europe Alpha Strategist London 44 20 7595 8613 eric.oynoyan@uk.bnpparibas.com
Matteo Regesta Europe Alpha Strategist London 44 20 7595 8607 matteo.regesta@uk.bnpparibas.com
Ioannis Sokos Europe Alpha Strategist London 44 20 7595 8671 ioannis.sokos@uk.bnpparibas.com
Camille de Courcel Europe Alpha Strategist London 44 20 7595 8295 camille.decourcel@uk.bnpparibas.com
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Koji Shimamoto Head of Interest Rate Strategy Japan Tokyo 81 3 6377 1700 koji.shimamoto@japan.bnpparibas.com
Tomohisa Fujiki Japan Strategist Tokyo 81 3 6377 1703 Tomohisa.fujiki@japan.bnpparibas.com
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FX Strategy
Hans Redeker Global Head of FX Strategy London 44 20 7595 8086 hans-guenter.redeker@uk.bnpparibas.com
Ian Stannard FX Strategist London 44 20 7595 8086 ian.stannard@uk.bnpparibas.com
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Andy Chaveriat Technical Analyst New York 1 212 841 2408 andrew.chaveriat@americas.bnpparibas.com
Emerging Markets FX & Interest Rate Strategy
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Chin Loo Thio FX & IR Asia Strategist Singapore 65 6210 3263 chin.thio@asia.bnpparibas.com
Robert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 robert.ryan@asia.bnpparibas.com
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Gao Qi FX & IR Asia Strategist Shanghai 86 21 2896 2876 gao.qi@asia.bnpparibas.com
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Elisabeth Gruié FX & IR CEEMEA Strategist London 44 20 7595 8492 elisabeth.gruie@uk.bnpparibas.com
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81
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Market Economics | Interest Rate Strategy | Forex Strategy 16 December 2010

We wish all our readers Happy Holidays

Market Outlook 2-3

Both Real and Nominal Yields Should Drop in Q1

Source: BNP Paribas

Cyril Beuzit 16 December 2010

Marcelo Carvalho 16 December 2010

In a nutshell, can EM policymakers deliver stability

Marcelo Carvalho 16 December 2010

Interest rates continued their steady march higher

Julia Coronado 16 December 2010

Julia Coronado 16 December 2010

Chart 1: Net Worth Rose in Q3

Household net worth rose in Q3 as capital gains

As shown in Chart 1, net worth as a percentage of

Measures of consumer financial stress have tenant-occupied property, homeowners' insurance

Yelena Shulyatyeva 16 December 2010

Consumer credit continues to decline…

In October, consumers continued to deleverage.

...even as retail sales improve Source: Reuters EcoWin Pro

Three main factors appear to have contributed to

Yelena Shulyatyeva 16 December 2010

Indeed, there has been a recent surge in “cash-in”

Some of the deleveraging can be attributed to a

Supply factors have also likely contributed to the

Yelena Shulyatyeva 16 December 2010

removed only in the case of incapacity or serious

Jean-Claude Trichet’s eight-year term as president of Total Number of % of % of

Dominique Barbet/Ken Wattret 16 December 2010

Dominique Barbet/Ken Wattret 16 December 2010

Dominique Barbet/Ken Wattret 16 December 2010

Dominique Barbet/Ken Wattret 16 December 2010

interact with other policymakers, like governments, 3.0

during a crisis. 2.0

If ECB policy were to become less sensitive to short 1 .0 E C B R efi R ate (% )

Dominique Barbet/Ken Wattret 16 December 2010

Alan Clarke and Paul Mortimer-Lee 16 December 2010

Alan Clarke and Paul Mortimer-Lee 16 December 2010

Eoin O’Callaghan 16 December 2010

The Riksbank delivered its fourth rate hike in this

Robust domestic economic growth

On the inflation front, although underlying inflationary

Gizem Kara 16 December 2010

On the inflation front, the Bank’s assessment was

 ”While higher electricity prices and commodity

In line with this assessment, unit labour cost

Ekholm and Lars Svensson entered a reservation

Gizem Kara 16 December 2010

Chart 2: Real GDP (% y/y)

In the opening paragraph of the statement, the Bank

Less positively, there was acknowledgement of the

Overall, while the Norges Bank kept its policy rate

Gizem Kara 16 December 2010

At the press conference after the policy decision,

In particular, if we do not see a signicant appreciation

Gizem Kara 16 December 2010

 This would be designed to maintain 30

monetary discipline in the economy while 25

 We have serious doubts about the 10

the optimal policy choice was to reduce the policy 15 5

rate (read: reserve requirements).

Turkey is not alone in its endeavour. An increasing 0 2

”While higher electricity prices and commodity

This would be designed to maintain 30

We have serious doubts about the 10

Capital spending plans for large -30

But the robust tone of Q3 is essentially a 0

Even so, with the global economy back on a -6

There is an unusually large output gap. At some

RV along the Treasury Curve

STRATEGY: Sell the U1U2U3 fly in the -10