Monday, April 27, 2009

EMU Economic Indicators Preview (Week of 27 April to 3 May 2009)

German CPI inflation (April): increasing temporarily
M3 growth (March): declining
EMU industrial confidence and economic sentiment (April): slightly better
German adjusted unemployment (April): sharper rise
EMU inflation flash estimate (April): up slightly

The German GfK consumer confidence for May and French consumer confidence for April might have remained unchanged at best, but Italian business and consumer confidence could have recovered, after having plummeted in March. Therefore, EMU economic sentiment and EMU industrial confidence will probably have improved in April.

The preliminary results for national German CPI for April are due to be released on Tuesday at the latest. We expect German consumer prices to have gone up by 0.2 % month-on-month; the annual rate would increase temporarily to 0.8%. Due to the Easter holidays, prices for accommodation services and package tours are likely to have increased.

Gasoline and heating oil prices have gone up too. As in preceding months, gas prices are expected to have gone down, whereas electricity prices will probably have risen again. The Eurostat flash estimate is likely to show that euro area inflation increased to 0.7% yoy in April. This would correspond with a monthly increase in HICP of 0.5 % in unadjusted terms.

We expect M3 growth to have remained subdued in March. However, individual components seem to be developing quite differently, mainly reflecting low short term interest rates and thus low opportunity costs of holding cash. Reservations regarding the banking system might also be playing a role. On the one hand, growth of overnight deposits has increased and money market funds have been attracting investors. Currency in circulation is actually rising at a rate of over 13% yoy, possibly supported by demand from eastern Europe. On the other hand, short term time deposits and bank debt securities have been declining rapidly. Overall, we expect M3 to have risen only moderately at 5.7% yoy. Credit growth is falling fast: growth of loans to the private non-bank sector could have declined to 3.2% yoy in March, down from 4.2%.

German unadjusted unemployment generally tends to decline noticeably after the winter months. The weather conditions have been favourable this April, but due to the sharp recession, unadjusted unemployment could nevertheless have gone up slightly, albeit somewhat less than in March. Thus adjusted unemployment could have risen by about 90,000 in April. The adjusted unemployment rate would reach 8.3%, 0.7 percentage points up on the cyclical low of 7.6% last November. The figures would be even worse by now if the government had not eased the terms for short-time work allowances: at the end of 2008, about 270,000 people worked short-time, compared to only 78,000 in December 2007.

The harmonized EMU unemployment rate could have gone up to 8.8% at least in March. In many European countries, particularly in Spain, unemployment has been rising since spring 2008, and it is now increasing rapidly in Germany too.

BHF-BANK http://www.bhf-bank.com

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results.

This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.

US Economic Indicators Preview (Week of 27 April to 3 May 2009)

Consumer confidence (Mar): rising noticeably, albeit still at depressed level
GDP (Q1): contracting less sharply due to net exports and private consumption
FOMC: emphasis on ongoing need for credit easing measures
PCE core deflator (Mar): annual rate remaining unchanged
ISM manufacturing index (Apr): contracting more slowly again

At 26.0, the Conference Board's consumer confidence stabilised at a level close to its record low in March. Expectations improved slightly, whereas the current assessment declined further due to the rapidly rising level of unemployment. However, despite the unfavourable labour market situation, we forecast that consumer confidence will have risen to about 33.0 in April, because the University of Michigan's (UMI) preliminary April consumer sentiment rose by about 5 points. As the graph shows, the Conference Board's consumer confidence index, which is more volatile, is currently much lower than the UMI indicator. We expect the final April UMI consumer sentiment to have remained more or less unchanged, despite the fact that the latest weekly ABC consumer comfort poll has risen by 4 points to -47.

The advance GDP figures for Q1 are likely to show another sharp annualised decline of about -4.0% qoq. However, the rate will be much less negative than in Q4: private consumption, which had fallen by 4.3% in the last three months of 2008, could have remained stable or even risen slightly. And as the real trade deficit narrowed significantly in February, net exports will have contributed positively to growth, by about one percentage point. However, the depletion of inventories will probably have cancelled that out. Investment, particularly in residential and commercial construction, deteriorated substantially, and total investment could have contributed -5 percentage points to growth. But government spending could have increased markedly, particularly due to defense outlays.

The PCE core deflator was only 0.9% in Q4, but could have risen to an annualised 1.6% qoq in the 1st quarter, still well within the Fed's comfort zone of 1-2%.

The FOMC will maintain the target range for the federal funds rate at 0 to ¼ percent, and indicate that it is likely to remain at this level for an extended period. Furthermore, the committee will emphasise again that the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. This time, the assessment of economic prospects could be somewhat brighter, in line with the Beige Book's notion that the pace of decline has slowed. But the Beige Book also reported that there was further downward pressure on prices due to economic slack, and thus the committee could again see some risk of inflation persisting for a time below rates that best foster economic growth and price stability in the longer term. This would emphasise the ongoing need for credit easing measures, and the Fed's balance sheet volume, currently at $2.24bn, is likely to rise to above $3bn this year.

Personal income could have decreased again by 0.2% mom in March, as aggregate working hours fell sharply and average hourly earnings rose by a mere 0.2% mom. Given that retail sales declined by 1.1% mom and gasoline prices were lower, we expect nominal personal spending to have dropped by 0.5% mom. Real personal spending might not have gone down as much.

Just like core CPI, the core PCE deflator could have risen by around 0.2% mom in February, leaving the annual rate unchanged at 1.8%. However, the FOMC expects it to approach 1% in the coming months, and to remain at the lower end of its comfort zone in 2010 and 2011.

The employment cost index (ECI) went up by a mere 0.5% qoq in Q4, illustrating that the unfavourable labour market situation has slowed the updrift in wages noticeably. We expect the ECI to have increased by 0.5% qoq again in Q1, lowering the annual growth rate of employment costs further from 2.6% to 2.5%.

As expected, initial jobless claims went up again to 640k in the week ending 18 April. We predict that jobless claims will have continued rising to about 650k in the week ending 25 April, slightly higher than the last 4-week moving average.

Since January, the ISM manufacturing index has improved for three consecutive months, albeit remaining well within the contraction zone. Given that the Philadelphia Fed index and the New York Empire manufacturing index in particular have both risen to much less negative levels, we forecast that the ISM manufacturing index will have increased again to 38.0 in April - still far below the expansion threshold of 50. The Chicago PMI, which had fallen to a long-time low of 31.4 in March, could have recovered noticeably to about 36.0 in April.

Factory orders went up by 1.8% mom in February, mainly due to a rebound in defense orders. But this increase might be revised downward by about 0.5 percentage points, due to the fact that February durable goods orders only rose by 2.1% instead of 3.5%. We already know that durable goods orders fell by 0.8% mom in March. As the ISM new orders component recovered by 8 points to 41.2, we expect non-durable goods orders to have fallen at a slower pace than before. Thus in March, total factory orders could have declined by 0.8% mom too.

Between August 2007 and February 2009, domestic vehicle sales virtually halved from their peak of 12.7m annualised to a mere 6.4m. After rebounding to 7.1m in March, they are expected to have stabilised around this still very low level in April.

BHF-BANK http://www.bhf-bank.com

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

Sunday, April 26, 2009

Australian & New Zealand Weekly : CPI Reveals Dramatic Squeeze on Bank Margins - Questions Capacity to Pass on RBA Rate Cuts

Week beginning 27 April 2009

Australia: CPI reveals dramatic squeeze on bank margins - questions capacity to pass on RBA rate cuts.
Australian data: a quiet week with RBA private credit data due.
New Zealand: RBNZ to cut OCR 50bp to 2.50%, but statement important for longer-term rate expectations.
New Zealand data: business confidence, merchandise trade and building consents.
US data focus: consumer confidence, advance Q1 GDP, ISM manufacturing and factory orders.
US FOMC: statement to most likely maintain the status quo, but could speak of some stabilisation.
Key economic & financial forecasts.

Last week's data releases were dominated by the CPI for the March quarter. The headline number (0.1%qtr) was well below our forecast of 0.8% but this discrepancy was entirely due to the item "deposit and loan facilities". That component fell by 14.1% - a staggering move in the quarter for any component of the CPI and contributing 0.66ppts of the 0.7ppts by which we missed with our forecast.

Naturally that component did not figure in the Trimmed Mean CPI (one of the RBA's two preferred measures of underlying inflation) which gives the measure after eliminating those items that explained the top and bottom 15% of moves after adjusting for weights. The Trimmed Mean actually registered higher than our forecast (1.0%qtr vs 0.8%) and the fair conclusion from the release is that underlying price pressures were a little stronger than we had anticipated despite the plunge in the headline measure. The combination of the lagged effects of the 30% fall in the AUD/USD through the second half of 2008 and reduced discounting, possibly in anticipation of the spending of fiscal stimulus packages, seems to explain most of the slippage.

However, we have maintained our view on monetary policy for the remainder of the year.

True, with a 1.1%qtr read for the March quarter (average of the trimmed mean and weighted median CPI) it will now be difficult for the RBA to achieve its 3% annual underlying inflation forecast for 2009. That will require an average of around 0.6% per quarter (down from 1.1%) for the remainder of the year. Certainly the lagged effect of the currency depreciation will fade and the slowdown in wage and demand pressures will see the underlying inflation rate moving in the right direction. Certainly housing costs (the largest component of the CPI) and holidays (down 4.5% in Q1) are pointing to powerful downward pressures associated with demand that can be expected to remain a big drag on inflation through 2009.

Probably the most important aspect of the CPI result from a policy perspective was the plunge in the "deposit and loan facilities" component. That component was incorporated in the CPI in 2005 to try to capture the interest rate effect on inflation without the interest rate feeding directly into the Index.

This is an unusual measure which the Bureau of Statistics has developed to measure the 'price' of retail financial services. Essentially the methodology is to sample banks deposit and loan rates and take a mid point. The price of deposit services is assessed as the difference between the mid point and deposit rates. The price of loan services is measured as the difference between the mid point and loan rates.

If the spread between loan and deposit rates narrows it means that either the price of deposit services has fallen or the price of loan services has risen or, as was the case in the March quarter, a substantial change in the relativities (spread contraction).

The staggering 14.1% fall in this item in the March quarter indicates that the extent of the fall in inflation (annual inflation fell from 3.7% to 2.5%) was largely due to the narrowing of the loan/deposit spread. The key dynamic would have been the full pass through of the 100bp RBA rate cut in February to mortgages and other personal loan products which was not matched by a comparable cut in retail deposit rates.

This is not the first time this series has behaved strangely (up by 9.5% in 2008Q2) although the average move prior to Q1 had been 1.2% and the biggest fall since it was included in the CPI was -2.1%. The large move, however, does emphasise the challenge banks are dealing with by having to compete for retail deposits while keeping the official family happy on the mortgage rate side in a period of falling RBA rates.

This damaging collapse in the retail spreads for banks provides a persuasive explanation as to why the pass through of the latest 25bp rate cut by the RBA was so muted - banks' retail spreads are under pressure.

Readers will recall that a key rationale for our choice of 2% as the low point for the cash rate in this cycle was the level of rates below which the banks would not pass on any further reductions to mortgage rates. It was predicated on the view that banks would want to be competitive in the retail savings market and would be reluctant to push deposit rates below a certain level - the level of deposit rates consistent with a 2% cash rate seemed a reasonable floor.

However the evidence from the CPI indicates that banks may already have reached the point where margins need to be protected and retail deposit rates must be held up.

The bank pass through should NOT be the determinant of how far the RBA can cut. Around 50% of banks' assets are direct housing loans while around 30% of loans would be linked to the bank bill rate. Even with no adjustment to mortgage rates, 'bank bill' borrowers will derive a benefit from lowering the cash rate. Banks themselves fund around 45% of liabilities out of the bank bill/ floating rate swap market and any fall in bank bill rates will benefit funding costs.

With bank funding costs currently rising sharply as 'cheap' pre-crisis term funding has to be replaced with 'expensive' post-crisis term funding, relief in the bank bill/floating rate swap market might avert actual increases in other loan rates, including mortgage rates.

In short, that rate level below which banks are unable to pass rate cuts through to mortgage rates may not define the low point in the cycle.

That leaves open an even lower rate level to define the lowpoint in the cycle. We are happy to retain our target rate of 2% with downside risks, with the flexibility to fall further not being restricted by the pass through capacity of the banks.

Our target of 2% by 2009Q4 is consistent with our growth profile of a contraction of 1% in GDP in 2009. Thursday, the IMF produced its latest forecast that GDP would contract by 1.4% in 2009 - more pessimistic than our view and weaker than the lowpoint in the previous recession in Australia when the economy contracted by 1.3% in 1991. A likely quarterly profile that would be consistent with the IMF's forecast would see the Australian economy contracting in the second half of 2009. In contrast our forecast envisages a return to anaemic but nevertheless positive growth in the second half of 2009. With business investment, employment, inventories and exports still contracting, despite some early stability in new housing construction and consumer spending, there would be ample justification for the RBA to cut rates through the end of 2009.

A profile envisaged by the IMF with the overall economy continuing to contract in the second half of 2009 would probably see the RBA cutting below our 2% target.

Australia: Data Wrap

Q1 PPI

Q1 Final Stage PPI inflation was well below consensus at -0.4%qtr (consensus +0.6%, Westpac +0.3%), cutting the annual rate to 4.0%yr from 6.4%, the lowest since 2007Q4.
Non-core elements subtracted slightly less from the PPI than expected, with weaker than expected food prices (fell 0.9%, subtracting 0.15ppts) but a smaller than expected fall in petroleum refining prices (fell 9.0%, subtracting 0.22ppts), giving a net 0.38ppt subtraction from the quarterly PPI.
The 0.9% fall in food prices followed a 3.1% rise previously. While CPI food prices are more margin dependent and not well correlated with PPI equivalents, the easing of PPI food price pressures suggests some downside risk to food within the Q1 CPI (our f/c is 1.8%qtr vs 2.0% prev).
Ex-food and petroleum, the core PPI was very subdued, despite some latent import price pressures from the currency's sharp fall in Q4. The core PPI was flat%qtr (weakest since 2003Q4) slowing the annual rate to 5.2%yr from 6.8%yr previously.
Although the AUD import weighted TWI fell 0.6%qtr in Q1 and the core MPI rose 1.8%qtr, core imports in the PPI were stronger, rising 4.8%qtr.
Abstracting from import pressures, domestic core pressures eased markedly, even outside of particular weakness in building construction output prices. The domestic core PPI ex-construction and utilities was -0.3%qtr and 3.0%yr (vs 0.9%qtr, 4.5%yr prev), the weakest quarter since we began this subset in 2002.
Building construction prices were -1.6%qtr. With house construction output prices -0.5%qtr, our CPI house purchase forecast has been revised to -0.5%qtr (from 0.6%).

Q1 CPI

The headline CPI was weak in Q1 at 0.1%qtr (vs -0.3% prev). The result was below consensus (0.5%) and the bottom of the forecast range (0.2%). This took the annual headline inflation rate to 2.5% from 3.7% previously, the lowest since 2007Q3.
However, the headline result was well below our forecast courtesy of greater than expected price falls in just two areas - deposit and loan facilities, and holidays. These alone detracted 0.86ppts from the quarterly headline CPI pace. Deposit and loan facilities plunged 14.1%qtr (vs -1.9% prev) despite a similar proportional fall in mortgage rates to Q4, implying markedly greater pressure on bank margins from deposit rate competition.
The dominance of the heavy downward bias to the headline CPI from just two areas was also reflected in much higher than expected underlying CPI results. Large price falls in deposit and loan facilities, petrol and holidays dropped out of the trimmed distribution, while stronger than usual pressures in many items of discretionary retailing and increases in seasonally adjusted education were in the trimmed mean. We calculate the average of the RBA trimmed mean and weighted median measures was 1.07%qtr (consensus 0.8%), up from 0.74%qtr previously, providing only a slight fall in the average annual rate to 4.21%yr from 4.35% previously.
The main positive headline contributions were from pharmaceuticals, rents, secondary education fees, vegetables and electricity. These were largely offset by falls in deposit and loan facilities, petrol, domestic holidays and overseas holidays.

Round-up of local data released last week

Date	Release	Previous	Latest	Mkt f/c
Mon 20	Q1 PPI %qtr	1.3%	-0.4%	0.6%
Tue 21	Mar merchandise imports, AUDbn	16.6	17.3	-
	Apr RBA Board meeting minutes	-	-	-
	RBA Governor Stevens' speech	-	-	-
Wed 22	Q1 headline CPI %qtr	-0.3%	0.1%	0.5%
	Q1 avg RBA underlying CPI %qtr	0.7%	1.1%	0.8%
Thu 23	Mar motor vehicle sales	-4.0%	-3.2%	-

New Zealand: Week ahead & Data Wrap

The long game

Markets will be intensely focused on what the RBNZ has to say at next Thursday's OCR review, following a rate cut in March that actually kicked off a substantial tightening in financial conditions.

The outlook for the global economy has continued to deteriorate since the March Monetary Policy Statement. The latest growth forecasts by the IMF suggest that New Zealand's major trading partners will contract by 2.8% this year and grow by just 0.8% in 2010 - this compares to the RBNZ's March forecasts of -1.8% and +1.6% respectively. Forecasts for the Asia-Pacific region, which was previous expected to be relatively resilient, are now being revised down heavily.

This bodes poorly for any near-term recovery in the New Zealand economy, which is already starting from a weaker point than the RBNZ assumed. GDP fell by 0.9% in the December 2008 quarter, against the RBNZ's forecast of a 0.8% decline, and we think they will revise down their forecast of a 0.8% drop in Q1 as well. The latest Quarterly Survey of Business Opinion will have reinforced the sense that Q1 was at least as difficult as Q4 - indeed, without the contributions of agriculture and government (which are not covered by the QSBO), GDP in the last two quarters could have been on a par with some of the horrific outturns seen overseas.

On top of this, financial market developments have been less than helpful. In March the RBNZ was fairly cautious about the scope for further interest rate cuts, but their forecasts did rest on an easier mix of monetary conditions - largely through a weaker exchange rate. Instead, the New Zealand dollar has risen in recent weeks, and is currently tracking around 10% above the RBNZ's projections.

Of more concern is the sharp rise in long-term interest rates. The smaller than expected 50bp rate cut and weak easing bias in March initially pushed interest rates higher, which borrowers read as a signal that rates have passed the bottom of the cycle. This created a wave of demand to lock in fixed-term rates at what were historically low levels, which saw long-term swap rates rise by more than 100bp at one stage. This was of such concern to the RBNZ that on 1 April they issued a statement that “the rise in longer-term interest rates is unwarranted and inconsistent with the monetary policy outlook” - the first time in over ten years that they have given explicit guidance to the market in between OCR reviews, and a clear indication that things aren't going to plan.

On a more positive note, net inward migration has picked up markedly in recent months, with fewer New Zealanders heading overseas as job prospects in Australia and the UK deteriorate. The RBNZ's last projection was for a net inflow of 5,700 this year, but with the annual pace already running at 7,500, they may revise their forecasts to as much as 15,000. Activity in the housing market has also picked up in recent months, though it has taken record-low mortgage rates just to achieve this modest rebound. And world prices for milk powder exports have bounced from their lows, though nowhere near enough to justify the recent gains in the NZ dollar.

On balance, the economic picture is even weaker than expected in the March MPS, implying a strong economic case for a 50bp rate cut next week. However, we admit that tactical considerations make this a much closer call between 25bp and 50bp. The RBNZ believe that there are consequences in taking the OCR to very low levels. The March press release noted that “New Zealand needs to retain competitiveness in the international capital markets”, implying that rates among New Zealand's peers (specifically Australia) may be a constraint on policy settings here. If that is the case, it means that the RBNZ has very little firepower left - they may prefer to hold some back, giving them room to respond to weaker economic data as it arrives later in the year.

The more important part of next week's statement may be how the RBNZ deals with keeping longer-term interest rate expectations in check. It's widely recognised that central banks have little direct control over long-term interest rates, but they can have a strong indirect influence, by clearly signalling their future policy intentions to the market. But what the market took from the March MPS was that the cash rate was unlikely to go much lower in the near term, and was expected to start rising again by mid-2010. No rate hikes for a year is certainly “an extended period” in real time, but when it comes to determining, say, a five year borrowing rate, it's not a long time at all.

The RBNZ faces a difficult balancing act in conveying to the market that interest rates will remain low for as long as necessary, without committing to a specific timetable (as a couple of central banks have done recently). But at the least, we think they will need to make it clear that interest rates are likely to be lower, and for longer, than anticipated in the March MPS.

The other data of note next week are business confidence, merchandise trade and building consents. We have revised down our near-term GDP forecasts and now expect another very weak outturn of -1% in the June quarter; this would be consistent with business confidence remaining at the historic lows seen in recent months. The trade balance is expected to improve further due to falling import demand, and building consents are expected to remain close to record low levels.

Round-up of local data released last week

Date	Release	Previous	Latest
Tue 21 Apr	Mar external migration ann.	6,160	7,482
Thu 23 Apr	Mar credit card transactions	0.3%	-3.1%

Data Previews

Aus Mar private credit

Apr 30, Last: 0.0%, WBC f/c: 0.2%

Mkt f/c: 0.3%, Range: -0.1% to 0.5%

Private credit growth is slowing as the economy contracts. We're forecasting a rise of just 0.2% in March.
With credit unchanged in February, three month annualised growth has eased to 1.4%. With business expected to lower investment expenditure the outlook is for soft credit growth.
On the plus side, housing credit growth is improving as new lending (housing finance) recovers in response to very low interest rates now in place, boosted by the First Home Owners' Grant.
Business credit declined by 0.6% in February and further declines are in prospect given the current economic backdrop. That said, monthly movements for this segment are volatile. It would not surprise to see a temporary lift in March, following the particularly soft February reading.

NZ Mar merchandise trade NZDm

Apr 29, Last: 489, WBC f/c: 450:

We expect a seasonal pickup in exports to $3.83bn, masking a gradual decline in the underlying trend as trading partner demand cools.
Imports are expected to rise to $3.38bn, which would still leave them down 3% on a year ago. Car imports rose in March after two exceptionally weak months, though the increase was skewed towards lower-value used cars.
We expect the annual trade balance to improve further this year, as imports are dragged down by weak consumer spending and falling business investment.

NZ Apr NBNZ business confidence

Apr 29, Last: -39.3%

Own-activity expectations remained at record lows in the March quarter, broadly consistent with a 1% quarterly contraction in GDP. We expect this survey to signal a similar contraction in Q2 as well.
Monetary conditions have tightened considerably since the mid-March Monetary Policy Statement, consumer spending remains soft, and anecdotally, firms are shedding staff at a growing pace.
However, a stabilisation in commodity prices and rising house sales offer glimmers of hope for some sectors.

NZ RBNZ OCR review

Apr 30, Last: 3.00%, WBC f/c: 2.50%, mkt f/c: 2.50%

The economic outlook has worsened since the March Monetary Policy Statement. Global growth forecasts continue to fall, and financial conditions in New Zealand have tightened when the RBNZ expected them to ease.
There is a strong economic case for a 50bp cut next week, but other considerations make it a close call between 25bp and 50bp.
We think the RBNZ will need to strengthen their commitment to keeping interest rates low for an extended period, if they want to keep a lid on longer-term rates.

NZ Mar building consents s.a.

Apr 30, Last: 11.6%, WBC f/c: 0.6%

Dwelling consents bounced off their lows in February, largely as a result of a surge in apartment consents - an area that has been seriously lacking over the past year. Even so, dwelling consents remain close to multi-decade lows.
House sales are a good leading indicator of residential consents, and have clearly lifted off the bottom since the beginning of the year. That points to a pick up in consents over the next few months. We expect a 0.6% rise in total consents in March, on the assumption that ex-apartment consents build on the gains in February.
The trend in non-residential consents has been tracking lower since November last year, although the pace of decline has accelerated in the past couple of months. Business surveys point to a continuation of this trend in March.

US Q1 GDP advance

Apr 29, Last: -6.3% annualised, WBC f/c: -5.0% annualised

Although the US economy was in mild recession for most of last year, the pace of output decline steepened sharply in Q4, when the economy contracted 6.3% annualised, its weakest quarterly performance since 1982. Falling consumer spending explained about half of the decline, with business investment and housing retrenchment most of the rest.
Partial data point to another contraction in growth in Q1, but less steep than in Q4, mainly because consumer spending on durables looks to have stabilised, and other discretionary spending has benefitted from lower gasoline prices. Housing will again fall steeply but its impact on the GDP bottom line is less as it is such a small part of the economy now. Business investment spending is expected to have fallen even faster in Q1 (based on slumping orders and shipments). Inventory rundown is also likely to be a big drag on growth.

US FOMC rate decision

Apr 29

Following the March 18 FOMC meeting the Committee once again stated "that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period".
That will certainly remain the position following the April 29 meeting, though the statement may note some tentative evidence that activity may be stabilising at very weak levels in some sectors.
Also in March, the Fed finally stated that it was prepared to buy longer term Treasuries if considered appropriate, ending months of will they/won't they speculation.
The April 29 statement will most likely maintain the status quo - steady rates at close to zero; preparedness to "employ all available tools", but nothing new is expect to be announced.

US Apr ISM factory report

May 1, Last: 36.3, WBC f/c: 38.5

The factory ISM hit its low of 32.9 in Dec 2008, then recovered modestly to the 35-36 region through Q1 this year, still consistent with a rapid pace of industrial sector decline (official IP data averaged falls of 1.7% over the last five months).
The Fed surveys from the NY and Philly districts appear to have bottomed out early this year and both were significantly higher in April. This suggests that the national ISM should post a further gain in April, though continued weakness in the jobs component is to be expected.
Prior to the national ISM, watch for the Dallas and Richmond regional Fed indices on Monday 27/Tuesday 28 and the Chicago PMI on Thursday 30, all of which we expect to improve somewhat - but don't confuse improvement with strength: these surveys are all still pointing to declining output.

Westpac Institutional Bank http://www.westpac.com.au

Disclaimer

All customers please note that this information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs. Australian customers can obtain Westpac's financial services guide by calling +612 9284 8372, visiting www.westpac.com.au or visiting any Westpac Branch. The information may contain material provided directly by third parties, and while such material is published with permission, Westpac accepts no responsibility for the accuracy or completeness of any such material. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice and Westpac is under no obligation to update the information or correct any inaccuracy which may become apparent at a later date. Westpac Banking Corporation is regulated for the conduct of investment business in the United Kingdom by the Financial Services Authority. © 2004 Westpac Banking Corporation. Past performance is not a reliable indicator of future performance. The forecasts given in this document are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts.

This Week's Market Outlook

Highlights

Risk appetites falter initially, but stage a comeback
USD on its heels and gold may be set to advance
Stress test preview proves anticlimactic and ambiguous
What to expect from the Fed, RBNZ, and BoJ next week
Key data and events to watch next week

Risk appetites falter initially, but stage a comeback

Markets overall continue to waver on signs that the global downturn is stabilizing, and after an initial bout of weakness, riskier assets have staged a mild comeback. The G7 draft communique explicitly noted that the global economy was showing signs of stabilization. On the week, stocks and JPY-crosses have declined slightly, but are well above the lows seen at the beginning of this past week. The USD, as measured by the US dollar index, is down more substantially on the week, which would seem inconsistent with only minor losses in risky assets, but makes sense given the heavy weighting of Europe in the index. European data this week carried the torch of improving sentiment, with Eurozone confidence gauges (ZEW, IFO and PMI's) all improving more than expected and bolstering the view that the worst is over.

On balance, though, in spite of some better data points and ostensibly improving outlooks, risky assets have failed to show significant upside progress, which is reminiscent of the prior week as well. As such, I can't shake the impression that the balance of risks remains biased toward a relapse in the current sentiment rebound. In the S&P 500, it also looks like a rounding top is forming and momentum (stochastics & MACD) continues to fade, while ADX readings remain well below trending levels.

USD on its heels and gold may be set to advance

In FX, EUR/USD staged a solid rebound from earlier losses that saw the pair drop below a key support zone at 1.3050/1.3100, only to regain that level and advance on the week. The ECB is likely to cut rates down to 1.00% when they next meet on May 7, and every indication is that they will also announce some form of quantitative easing, whether it's buying corporate debt or government debt. Those developments may restrain EUR strength, but further gains cannot be ruled out. EUR/USD has broken above the Ichimoku cloud and looks to have further upside potential while it holds above the cloud in the 1.3100-50 area. The Kijun line is at 1.3311 and a key trend line from the 1.3740 recent highs will be at 1.3350/60 and falling next week; strength above those levels could see EUR gains back toward 1.36/1.37.

USD/JPY also appears to have more potential toward USD weakness, as price fell below the 200-day moving average this past Monday, and subsequent weakness sent it below the Kijun line at 97.80, which opens up scope down to the cloud top at 95.80-96.20 initially. Weakness below there may see potential to the cloud bottom at 93.40. The combination of USD weakness and JPY strength may lead to another fitful week of trading in the JPY-crosses.

Gold prices seem to be having the best of both worlds, benefiting from USD weakness as well as a rebound in risk appetites. News that China has been accumulating gold in its reserves over the last 7 years helped fuel further gains on Friday, however, I would actually look at that as more of a sell-signal than a buy signal, since China would be unlikely to reveal its actions while it's still accumulating gold. Still, spot gold has closed inside its Ichimoku cloud, with the cloud base at 904.45 needing to hold on a daily closing basis. The Kijun line is at 916.07 and a trend line from the Feb highs will be at about 918 and falling next week, presenting a formidable resistance zone. Strength above those levels may see gains to the cloud top at 935 initially. Alternatively, weakness below the Tenkan line at 890.60 and rising may suggest a false break higher and a return to recent lows near 864/865.

Stress test preview proves anticlimactic and ambiguous

The Fed's Stress Test White Paper and accompanying headlines proved ambiguous at best. While it noted that "most" banks have more capital than needed, it also said banks will be told to hold a "buffer" for losses into 2011. Just what "most" means is anyone's guess and ditto for what size "buffer" is needed. The assumptions themselves left much to be desired. The most striking was the 2009 unemployment rate, which is assumed at no worse than 8.9% for the year. Given the recent rate of job losses and the fact that we are already sitting at 8.5%, we could take out this so-called worst case scenario by next month. The doomsday scenario for 2010 unemployment in the Fed's mind is 10.3%, a far cry from a truly adverse situation of somewhere upwards of 11%.

The other fly in the ointment was the line that the banks' estimates are "not necessarily consistent" with that of regulators. This begs the question, whose estimates are worse? Ultimately, the release adds more confusion with regards to the state of affairs in the financial industry and we will have to wait until May 4 when the official stress test report cards come out. The equity market didn't know what to do with the whole thing, with stocks dipping initially on the news and rebounding sharply thereafter. If the market decides to err on the side of caution, given the puzzling nature of the report, we would expect stocks to head lower in the near-term.

What to expect from the Fed, RBNZ, and BoJ next week

The Fed will release its statement on Wednesday at 1815GMT/1415ET. The target rate will remain the 0.00-0.25% range and the Fed will likely note that they will continue to engage in quantitative easing via the purchases of Treasury securities. Two important things to look for in the statement will be 1) whether the Fed decides that more aggressive Treasury purchases are necessary as yields have ground significantly higher since the first QE announcement (witness the 10-year now flirting with the 3.0% level once again) and 2) whether the word "stabilization" will be used when describing the economy. Indeed, the theme from the recent Beige Book - a resource which the Fed uses extensively in its meeting - was that while economic growth remains extremely subdued there were some signs of "stabilization" emerging. We would think that a more upbeat assessment on the US economy, coupled with a more aggressive plan for Treasury purchases would see "risk trades" become better bid and hurt the US dollar. This in turn would be constructive for EUR, the yen crosses, and the commodity currencies.

The Reserve Bank of New Zealand announcement is scheduled for Wednesday at 2100GMT/1700ET. The consensus is that the bank will slash rates by -50 basis points to 2.50%. There are, however, a few economists/strategists looking for a more modest -25 bps reduction. While a cut looks warranted given still weak economic data and slowing inflation, we think the likelihood of the smaller -25 bps reduction is very high. Economic data remain weak but continue to show signs of life. Retail sales improved 0.2% in February after a sharp -1.2% contraction the prior month. Meanwhile, the more forward-looking business PMI jumped to 40.7 in March from 38.9 and the trade deficit is expected to narrow for the third consecutive month to NZ$4.89 billion from NZ$5.16 billion. Inflation remains on the decline and the latest consumer price report showed the annual rate slipping to 3.0% in 1Q from 3.4% prior.

One of the better arguments as to why the bank will not cut by the more aggressive -50 bps, however, is that they said as much themselves. In their last communique the RBNZ noted that "any future cuts will be much smaller than observed recently." We think that given the market's overwhelming expectation for a -50 bps cut, the reaction in NZD from a less aggressive reduction will be positive. In deciding to cut by less, the bank will likely justify this with an overall rosier picture for the economy. This will also mean that New Zealand will enjoy a much bigger interest rate differential, thus allowing it to attract more investment from abroad. Kiwi weakness would likely emerge from a -50 bps cut coupled with dovish musings on the economy.

The Bank of Japan communique is expected sometime Thursday evening and they will also remain on hold at the inconsequential 0.10% rate. BoJ Governor Shirakawa said just this month that "the current benchmark rate of 0.1 percent is the most appropriate policy now", so we expect no change on this front. The economic outlook is likely to resemble that of Japan's Cabinet Office which said in their April assessment that the "economy is worsening rapidly while in a severe situation" - no change from the prior two months. On the "non-standard measures" front, we expect the BoJ to reaffirm its commitment to purchase more commercial paper, corporate bonds, and government bonds. In sum, we expect little in the way of earth-shattering news from the BoJ. The yen crosses should continue to trade commensurately with risk assets.

Key data and events to watch next week

The US economic calendar is on the busy side next week and the action kicks off with the S&P/CaseShiller home price index and consumer confidence on Tuesday. Wednesday is the highlight with the first take on 1Q GDP, the Fed rate decision/statement (more on this above) and the weekly crude oil inventory report. Thursday has personal income/spending, initial jobless claims and the Chicago PMI on deck. Friday closes out the week with University of Michigan sentiment index, ISM manufacturing, factory orders and vehicle sales.

The eurozone calendar is lighter and starts off on Monday with the German GfK consumer confidence survey. Tuesday will see German consumer prices while Wednesday has eurozone business climate indicator and consumer confidence lined up. Thursday closes out the week with the eurozone consumer price estimate, unemployment and French producer prices. There are a couple of ECB speakers as well, with Mersch presenting the Financial Stability Report on Wednesday.

It isn't very busy in the UK either. The Hometrack housing survey is due to be released over the weekend and the CBI distributive trades report is the highlight on Tuesday. Wednesday has GfK consumer confidence due up while Friday ends the week with mortgage approvals and the PMI manufacturing report.

There is slightly more action in Japan and it starts with retail trade numbers on Monday. Tuesday sees small business confidence while Wednesday has PMI manufacturing and industrial production on deck. The BoJ will meet on interest rates Thursday (more above) and we also get housing starts, employment and consumer price data.

It is ultra-light in Canada and all of the noteworthy data is due up on Thursday. That day has industrial product prices and monthly GDP due up. BoC Deputy Chief Wilkins is also expected to speak and is likely to highlight the more upbeat assessment for the Canadian economy.

Last but not least, it is a characteristically light week down under. NZ trade kicks it off on Tuesday while NZ business confidence, building permits and the RBNZ rate decision are Wednesday (analysis above). AU business confidence and performance of manufacturing index close out the action on Thursday.

Brian Dolan, Chief Currency Strategist Jacob Oubina, Currency Strategist Forex.com http://www.forex.com

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Weekly Economic and Financial Commentary

U.S. Review

Green Shoots or Just Weeds?

The recent rebound in the stock market, less overtly bad economic news, and the onset of spring have lots of people reporting sightings of green shoots. Spring always brings a sense of renewal as people gradually end their winter hibernation and come out and take advantage of the better weather. How much more or less activity is seen as “picking up” is the key to seeing whether this is the start of a self-reinforcing recovery. We remain skeptical but are clearly pleased to see a slightly better tone to the economic and financial data. First quarter real GDP remains on a pace to decline at around a four percent pace.

Actual economic data for the week present a mixed picture of the state of the U.S. economy. Sales of existing homes fell slightly more than expected and about one-half of all sales were either short sales or foreclosure sales. Actual buyers remain in short supply and mortgage applications for the purchase of a home are still depressed. Applications for refinancings have perked up, however, which is creating some economic activity of its own.

Unemployment Is Still Rising

We have long stressed that the most important real-time economic indicator during these troubling times is first-time claims for unemployment insurance. In addition to the weekly first-time claims numbers, the report includes data on continuing claims and the insured unemployment rate. The insured unemployment rate has been rising a tenth of a percentage point a week, which has virtually matched the increase in the unemployment rate. The latest data show the insured unemployment rate up to 4.6 percent, which is the highest it has been since the series began back in 1983. The most recent increases suggest the civilian unemployment rate will rise from 8.5 percent to 8.9 percent in April. Every monthly jump in the unemployment rate causes more and more people to realize that double-digit unemployment remains a high probability. The unemployment rate is known to be a lagging indicator and tends to peak about six months after the recession ends. The past two recessions saw the unemployment rate peak a year or more after the recession officially ended.

Weekly first-time unemployment claims are a leading indicator and there is some sign that the pace of layoffs is leveling off. This past week, which is the survey week for the April employment report, saw claims bounce back by 37,000 to 640,000. The increase follows two weekly declines, the last of which was a large drop during the Passover/Good Friday week. Claims remain slightly below their cycle highs but remain extremely high nonetheless. The most recent reading is consistent with another 650,000 drop in nonfarm payrolls.

The loss of jobs is only part of the story. A larger proportion of job losses today are occurring among full-time workers and reflect permanent cutbacks as opposed to temporary layoffs. In addition, many workers who have avoided layoffs have seen their income cut substantially as hours worked, bonus payments, commissions and other types of incentive compensation have been cut back substantially.

Durable goods orders came in slightly better than expected, but considered in the context of a downward revision to February data, the report was roughly in-line with expectations. Non-defense capital goods orders ex-aircraft came in positive for the second month in a row, suggesting signs of life in business spending.

Adding to the better news in business spending, it appears new home sales are at least stabilizing in the mid 300,000 range. We would not completely rule out further declines from here, but are hopeful that a bottom is forming.

U.S. Outlook

Consumer Confidence • Tuesday

Despite the slight up-tick in March from an all-time low, it is clear that consumers are still quite troubled by both the current state of the U.S. economy as well as its near-term prospects. Consumer confidence has historically shown a correlation with conditions in the labor market, and with total job losses since employment peaked in December 2007 now over 5 million, consumer confidence will likely remain near historic lows. Given that the labor market will remain severely challenged through 2010. We expect despite the anticipated move higher in April, consumer confidence will remain below trend for the foreseeable future, keeping downward pressure on economic growth prospects.

Previous: 26.0 Wachovia: 32.0 Consensus: 29.0

GDP • Wednesday

After falling at a revised annualized rate of 6.3 percent in the fourth quarter, we now expect economic growth probably contracted for the third consecutive quarter, albeit at a slower pace, around four percent. This means the fourth quarter of 2008 will likely mark the darkest hour of this recession. The improvement may be due to a significant lessening of the drag on growth from consumer spending, residential investment and exports. However, business investment in structures likely declined sharply in the first quarter and should continue to contract well into 2010.

We continue to expect the recession will end late in the year or in first quarter of 2010. The end of the recession, however, will not mark the end of the economy's struggles. The unemployment rate is expected to rise throughout 2010, peaking at 10 percent or more.

Previous: -6.3% Wachovia: -4.0% Consensus: -4.9%

ISM Manufacturing Index • Friday

The Institute of Supply Management's (ISM) index of activity in the manufacturing sector likely rose for the fourth consecutive month in March, but remains squarely in recession territory. Weak ISM readings are consistent with declines in industrial production and manufacturing jobs. Durable goods orders were down and suggest new orders and order backlogs should also decline, indicating more weakness in the pipeline. The regional purchasing manager reports remain weak, but have shown tentative signs of improvement. Still, the outlook for the manufacturing sector is that it will remain under considerable pressure.

Previous: 36.3 Wachovia: 36.8 Consensus: 38.0

Global Review

U.K. Economy in Dire Straits

Data released this morning showed that real GDP in the United Kingdom plunged at an annualized rate of 7.4 percent in the first quarter of this year relative to the fourth quarter of 2008 (chart at left). Whether measured sequentially or on a year-over-year basis, which was down 4.1 percent, the downturn in real GDP is the worst for the British economy since the dark days of 1979-80.

A detailed breakdown of real GDP in the first quarter into its underlying demand components is not yet available, so it is difficult to say with precision where the sources of weakness are concentrated. However, a preliminary breakdown via industries offers some clues. For starters, industrial production is estimated to have plunged more than 20 percent (annualized rate) in the first quarter, and construction spending was off roughly 10 percent. Output in the services industries appears to have contracted about five percent. The only sectors to have recorded positive growth were agriculture and the government.

Given the nosedive in industrial production, it is likely that exports fell at a double-digit pace yet again. (Exports declined 15 percent in the fourth quarter.) In addition, capex was probably very weak in the first quarter. However, retail spending appears to have held up reasonably well (see top chart). Monthly data show that the volume of retail spending rose 1.0 percent in the first quarter relative to the previous quarter.

So how do we square the sharp decline in production that occurred in the first quarter with the relative resiliency in retail spending? The answer is that a sizeable drop in inventories must have occurred, and this inventory liquidation should eventually lead to stabilization in the British economy later this year. Indeed, some “green shoots” may be appearing. As seen in the middle chart, the purchasing managers' indices for manufacturing and service sectors both posted decent increases in March. Both indices remain below the demarcation line that separates expansion from contraction, but it appears that the rate of decline may be starting to level out. In addition, some indices of house prices have edged higher recently.

As in the United States, the sharp contraction in the British economy has caused the government's finances to hemorrhage. Chancellor Darling released his budget numbers this week, and the outlook read like a horror novel. The public-sector borrowing requirement is expected to exceed 12 percent of GDP in 2009-10, a peace-time record. The deficit news contributed to the sell-off this week in the market for British government bonds.

As shown in the bottom chart, the British pound has traded in a fairly narrow range versus the U.S. dollar since the beginning of the year. We project that the British economy will continue to contract over the next two quarters, albeit at slower rates than during the last two quarters. And as we discuss in a recent special report (see “The Global Economy: Who Gets Out of the Gate First?”) we believe the U.S. economy will show signs of stabilizing before most other major economies. Therefore, we look for the dollar to appreciate modestly versus sterling through the end of the year.

Global Outlook

Japanese Industrial Production • Thursday

Japanese industrial production, which was down 37 percent in February relative to the same month last year, has essentially collapsed since last autumn. When surveyed last month, however, companies expected that industrial production would rebound somewhat in March and April. Although we are somewhat skeptical of this projection, the large decline in inventories in February means that an uptick in production in March is not completely out of the realm of possibility.

Other data on the docket for March will help analysts sharpen their GDP estimate for the first quarter. Data on retail sales will be released on Tuesday, and the labor market report and housing starts print on Friday. Regardless of the outturns, the first quarter was probably another disastrous quarter for Japanese real GDP.

Previous: -9.4% (month-on-month change) Consensus: 0.8%

German Unemployment Rate • Thursday

The unemployment rate in Germany fell to a 16-year low last September, but more than 200,000 workers have subsequently become unemployed as the German economy has fallen into a deep downturn. The consensus forecast anticipates that the unemployment rate, which will be announced on Thursday, edged higher in April.

The rise in joblessness is not good news for consumer spending. In that regard, data on German retail spending in March are also slated for release on Friday. Data on CPI inflation in Germany and the broader Euro-zone are on the docket earlier in the week. However, with European economies in deep recession at present, the current inflation rate has taken a back seat in the minds of most investors. Indeed, inflation should trend lower this summer and consumer prices may actually decline on a year-over-year basis.

Previous: 8.1% Consensus: 8.2%

U.K. Manufacturing PMI • Friday

As discussed in the main body of this report, the U.K. economy contracted at a sharp rate in the first quarter. However, recent data suggest that the rate of decline may be starting to level out. In that regard, the manufacturing PMI for April, which will be released on Friday, will give market participants some insights into the state of the British economy at the beginning of the second quarter. Another increase in the PMI would be consistent with the view that the rate of decline in the U.K. economy is starting to slow.

A number of house price indices ticked up in March. Therefore, April data on house prices, which will be released next week, will make for interesting reading. Data on consumer lending, which print on Friday, will provide some insights into the current state of consumer financing.

Previous: 39.1 Consensus: 40.0

Point of View

Interest Rate Watch

FOMC Meets: Policy Unchanged

Low inflation and continued recession suggest that the Federal Open Market Committee (FOMC) will vote to maintain the generous liquidity provision to get the economy started. If the federal funds rate remains in the zero to 25 basis point range a positive yield curve will be maintained, which will encourage banks to lend and promote economic growth.

We expect that modest economic growth late this year will allow the FOMC to maintain its very low funds rate policy through the year. Current credit policy at the Fed also suggests that market rates on Treasuries, mortgage-backed securities and asset-backed securities are being driven by the Federal Reserve to lower-than-sustainable levels in a non-inflationary, trend growth environment. While in the short-run this may be sustainable, we view this as counter-productive in the longer-run for two reasons. First, the real market price for these assets is not being revealed and therefore there is no true price discovery. Second, the growth of the Fed's balance sheet is a concern for inflation. In the short-run, the Federal Reserve can do all this given the large output gap and the shortage of secondary credit. However, the fallout of this easy monetary policy would suggest a greater risk of a combination of a weaker dollar and/or higher inflation. In six months we expect the economy will be in recovery, suggesting that market-determined interest rates will rise along with the demand for credit. As this happens the Federal Reserve is likely to begin withdrawing liquidity from its credit facilities and the short-run textbook liquidity effect will give way to the income and inflation expectations effects (as well as the currency effect). Private market interest rates will rise.

Topic of the Week

U.S. Healthcare Spending

Healthcare is an economic concern because it represents a sizable sector of the economy by any measure. Medical care and goods account for more than 20 percent of total spending, and more than 16 percent of GDP. This level of spending will likely continue to rise, but not indefinitely. While it may be easy to recognize a flawed system, it is much more difficult to find the perfect solution. Trade-offs must be made, and one must make such decisions fully aware of the costs, benefits, and potentially unexpected ramifications of them. While there is much to dislike about the current system, an international perspective shows that many citizens across the globe are dissatisfied as well, though often for different reasons. Concerns in the U.S., such as the uninsured population and high out-of-pocket expenditures are replaced with complaints of long waits and low levels of confidence in receiving quality care. Around the world, the reality is that healthcare systems are neither entirely public nor entirely private—there is always a combination of the two, the difference often being the relative contribution. In addressing weaknesses of the current system, decision-makers would do well not to lose sight of its strengths. Still, the U.S., with the highest per capita healthcare spending in the world, has neither the best quality nor the widest access. It is clear that change must, and therefore will, come. However, it is not guaranteed that all stakeholders will be better off, and less likely that all will be satisfied with the result. Careful consideration and gradual policy changes are apt to be the most effective ways to achieve long-term solutions to this very large and growing problem. Please see our website for more complete commentary.

Wachovia Corporation http://www.wachovia.com

Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.

The Weekly Bottom Line

HIGHLIGHTS

Bank of Canada cuts overnight rate to 0.25% (effective lower bound) and commits to leave rate on hold until mid-2010 .
Monetary Policy Report underwhelms markets as BoC fails to commit to quantitative or credit easing.
But U.S. housing market vulnerabilities could yet force monetary policy into this unchartered territory.

Canada's monetary policy was the main event this week, with advance speculation of a dive into the unchartered territory of Quantitative Easing/Credit Easing (QE/CE). But prudence is the banker's mantra and the Bank of Canada held to that credo - particularly on the QE/CE front. Anticipating fireworks, one might overlook the subtle boldness of this week's actions: in just a week the Bank broke new ground with its conditional commitment to maintain the current overnight rate for over a year, substantial tweaking of the payments system, extension of repo duration, and principles for undertaking QE/ CE. Even though we didn't get a dollar allocation or a pledge to buying specific products, we better understand how the bank views QE/CE and under what circumstances it would deploy this yet-untested tool.

In recent weeks, there was growing speculation that the Bank would proceed immediately with non-traditional monetary policy. Despite all of the Bank's measures, markets were disappointed in the lack of QE/CE specifics, and the bond curve steepened. Nonethless, conditions for Canadian financial markets still remain much improved, with corporate spreads easing on the week.

QE/CE: The Final Frontier?

On Tuesday, the Bank cut its overnight target by 25 basis points, bringing it to the 0.25% effective lower bound. While a 0% rate is so technically problematic that it is infeasible, there are perils to even a 0.25% rate. With the overnight target as a reference rate, the latest 25 bps cut has adverse effects on bank margins and money markets. Nonetheless, by bringing rates to their lower bound, attention is now on non-traditional measures. With unprecedented openness, the Bank made a conditional commitment to hold these rates steady until Q2/2010. Since the Bank cannot ease the yield curve by further cuts to shortterm rates, it has used a promise to hold them low longer to cement rate expectations and influence yields at longer durations. They also waded further out along the yield curve by extending the duration of Purchase and Resale Agreements to six- and twelve-month terms at rates corresponding to the overnight target. In order to counteract low rate perils, the Bank narrowed the operating band so that banks received 0.25% on their settlement reserves rather than 0%. As well, the Bank expanded the amount available for settlement balances in its Large Value Transfer System (LVTS) from a typical $25 million to $3 billion, increasing banks' short-term liquidity backstop. While the Bank didn't say so, this still looks to us a possible means to expand the money supply: if banks bite, has the potential to expand the monetary base by nearly 4%.

Tuesday's announcement whet appetite for the Bank's Monetary Policy Report (MPR). The Bank issues an MPR four times annually in order to communicate its outlook and explain its policy. In this MPR, the Bank observed the deepening and synchronized recession, worsening its forecast for 2009 contraction and cutting its forecast for a 2010 rebound. It also halved its forecast for potential growth from 2.4% to 1.2%, observing that the external shock and consequent restructuring will cleave much of Canada's productive capacity. Lower potential growth points to a less severe output gap and less risk of acute disinflationary pressures.

Given the move to the lower bound, this MPR had to be a tandem act: In its March rate announcement, the Bank had committed to "outline" a framework "to provide additional monetary stimulus, if required, through credit and quantitative easing". The Bank had to acknowledge the elephant in the room that few tools remained once overnight rate cuts were exhausted. However, markets expected specifics (and even perhaps an immediate move to QE). Instead, the Bank laid out in general terms the three ways in which it would provide additional stimulus: 1) Additional statements about future interest rates; 2) QE through purchases of assets; and 3) CE in certain impaired credit markets to reduce risk premiums and improve liquidity. Clearly viewing QE as an untested tool, the use of which is fraught with unintended consequences, the Bank's core message was "QE if necessary; but not necessarily QE". Governor Carney also emphasized that any QE would be in response to a substantial deterioration against the Bank's baseline scenario and would be undertaken with a wellformulated "exit strategy". As well, QE and CE are regarded as potentially complementary but fundamentally separate. On the CE side, the measure is clearly regarded as a less preferable option and the Bank set a very high bar for both the scenarios and approach under which CE would be undertaken. The Bank hinted at its preference for "sterilizing" any such interventions (injecting funds in particular markets while withdrawing money elsewhere).

The Bank faces a slight conundrum that economic conditions call for continued stimulus, but the worsened and synchronized global recession is outside Canada's making - let alone our control. Price stability remains the Bank's primary mandate and it is rightly reticent to abuse its wellearned credibility. That inflation expectations remained anchored commends its prudence. The crystal ball remains very cloudy, but the Bank has clearly articulated its baseline scenario and committed to appropriate actions should conditions deteriorate further.

But U.S. Housing still on "Red Alert"

The potential source of downside risks is obvious: the U.S. financial system remains volatile and the root problems in the housing market have yet to resolve. Markets anxiously await the Treasury's "stress test" announcement on May 4th, and Geithner's statement that the "vast majority" of banks have passed still leaves much unknown. While the "toxic assets" are the centerpiece, "good" mortgage assets will be increasingly strained. While the initial round of mortgage distress owed to bad practices, the mounting foreclosures are now linked to rising unemployment, fuelling a vicious downward spiral in housing prices. U.S. house sales data for March out this week, showing a 3% M/M tumble, confirms the ongoing bleakness. We estimate that the under-water" mortgages could double if prices fall another 10% and argue that breaking this interaction between unemployment, underwater mortgages and foreclosures remains the lynchpin of housing market stability (see "U.S. Housing Market - Searching for the Bottom," April 23). While buoyed by signs of a turning "second derivative," the seas remain choppy.

UPCOMING KEY ECONOMIC RELEASES

U.S. Real GDP - Q1/09

Release Date: April 29/09 Q4 Result: -6.3% Q/Q ann. TD Forecast: -5.3% Q/Q Consensus: -5.0% Q/Q

After a stunning pace of decline in the final quarter of 2008, the U.S. economy continued to sink like a stone at the outset of 2009. A dramatic drop-off in world trade likely resulted in both exports and imports falling by close to 35% (annualized) - their biggest declines in forty years. Given the larger size of imports, net-trade will likely be a small positive contributor to growth but more than anything reflects the impact of several quarters of weakened U.S. domestic demand. Excess capacity in the business sector likely led to a dramatic pullback in business investment as firms cut back on all types of expenditures from equipment and software to construction to inventories. Moreover, a rising inventory-to-sales ratio saw firms scaling back production in order to draw down excess inventories. Smaller defense outlays suggest that the government sector will also subtract from growth in the first quarter. Perhaps the one glimmer of hope amidst all the grey is that after two quarters of dramatically reigning in spending, U.S. consumers look to have rebounded slightly in the first quarter. Nonetheless, the fall in retail sales in March and continued labour market deterioration suggests this could be a short lived phenomenon.

U.S. FOMC Interest Rate Decision

Release Date: April 29/09 Current Rate: 0.00% to 0.25% TD Forecast: 0.00% to 0.25% Consensus: 0.00% to 0.25%

The next instalment of the Federal Open Market Committee (FOMC) interest rate decision will be delivered on April 29. However, as has been the case in the past few months, with the Fed explicitly committing itself to keeping interest rates "exceptionally low" for an extended period of time, the actual interest rate announcement is unlikely to attract much attention. Instead, the focus will undoubtedly be on the tone and content of the statement. Of particular interest will be whether the Fed increases the size of its balance sheet to bolster its current quantitative easing programs. On this front, given that the Fed took the plunge into quantitative easing at its last interest rates meeting with the decision to expand its balance sheet by up to $1.15T, we believe that the risks of a further expansion of the balance sheet at this meeting are low. However, the Fed may use the opportunity to offer some insights on their relative effectiveness. In terms of the economic and inflation outlook, with the U.S. economy continuing to weaken, we expect the economic assessment to remain quite bleak, and the tone very dovish, though possibly reflecting the modest improvements in condition recently. We also believe the Fed will repeat its concerns about price inflation persisting below levels consistent with price stability, and reaffirm its commitment to employing "all available tools to promote economic recovery and to preserve price stability." The bottom line is that little is expected to change relative to the last statement.

U.S. Personal Income & Spending - March

Release Date: April 30/09 February Result: income -0.2% M/M, spending 0.2% M/M; core PCE deflator 0.2% M/M, 1.8% Y/Y TD Forecast: income -0.2% M/M; spending -0.1% M/M; core PCE deflator 0.1% M/M, 1.8% Y/Y Consensus: income -0.2% M/M; spending -0.1% M/M; core PCE deflator 0.1% M/M, 1.8% Y/Y

The squeeze on U.S. households' balance sheets appears to have gathered steam in recent months as the dramatic turn in U.S. labour market conditions and accelerating home price depreciation have meant that the problems facing U.S. consumers have intensified. And even though equity markets have recovered since mid-March, consumer confidence has continued to languish in depressed territory on account of the elevated level of economic anxiety. Despite the weight of this combustible mix, personal spending advanced in the first two months of this year, ending six consecutive monthly declines, though personal income has risen in only one of the last five months. The outlook for both indicators, however, is not so favourable. Our call is for personal income to fall by a further 0.2% M/M in March, with spending expected to fall by a more modest 0.1% M/M. Indeed, with the backdrop for U.S. consumers continuing to remain grim, we expect both personal income and spending to remain weak in the near term, with the impact of the fiscal stimulus likely to bolster both indicators later this year. In terms of prices, despite the underlying economic weakness, the core PCE deflator is expected to rise for the third straight month, gaining a further 0.1% M/M in March. The annual pace of core PCE inflation, however, is expected remain flat at 1.8% Y/Y. In the months ahead, we expect the core PCE deflator to start easing as the growing economic slack dampens core price pressures.

Canadian Real GDP - February

Release Date: April 30/09 January Result: -0.7% M/M TD Forecast: 0.1% M/M Consensus: -0.2% M/M

The new calendar year has not been particularly kind to the Canadian economy, as the domestic economic recession appears to have intensified dramatically in the first quarter. Much of the intensification in the economic crisis is due in large part to the firming up of the global economic recession, which has sent Canadian export demand into a freefall. Indeed, despite the massive monetary and fiscal stimuli that have been administered to the ailing Canadian economy, things appear to have gone from bad to worse. And with the impact of the ongoing global financial crisis continuing to seep into the real economy there is little hope that the weakness in economic activity will go away any time soon. Despite this dire prognosis, economic activity appears to have ticked-up slightly in February on the back of strong export demand, and the resurgence in the Canadian manufacturing sector and housing activity during the month. The gains in these sectors, however, are likely to be offset by weak retail sales activity. As such, our call is for the Canadian economy to post a meagre 0.1% M/M gain in February, following the brutal 0.7% M/M drop the month before. Notwithstanding this respite in February, Canadian economic fundamentals remain very weak, and we expect the downward trajectory in Canadian GDP to return in very short order and continue for at least several months to come.

U.S. ISM Manufacturing Report - April

Release Date: May 1/09 March Result: 36.3 TD Forecast: 39.0 Consensus: 38.0

Despite the weakening domestic economy, there have been a number of recent encouraging signs indicating that the pace of decline in U.S. manufacturing sector activity may be abating. This much has become clear in the actual ISM headline index, which has risen in the last three months, after reaching a cyclical low of 32.9 in December. Moreover, with the regional manufacturing sector indicators also pointing to further improvement (even though all of the indices remain in contractionary territory), we expect the ISM index to post its fourth consecutive monthly gain in April, climbing to 39.0. Adding to the sense of an upward momentum in the index are the recent strong gains in new orders, which reached a historic low in January. However, this improvement in the index should not be construed a an improvement in U.S. manufacturing activity, as the state of the U.S. manufacturing sector remains extremely weak and output has continued to decline. Moreover, with the economic backdrop for U.S. goods producers remaining very dire, we expect manufacturing activity to remain weak for some time, even though the pace of decline should continue to ease.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.

Weekly Focus: Stressed by the Stress Tests

Global update

No quantitative easing from Sweden's Riksbank this time around, but drawing closer
Euro-zone industrial indicators surprised on the upside and continued to move upward in April. Both the German Ifo and euro-zone PMI are pointing towards improvement
Data out of Asia in the past week added to the recovery story as South Korean exports continued to grow
US housing prices are showing signs of improvement, and housing sales are beginning to stabilise
Q1 financial earnings reports surprise on the upside

Market movers ahead

Results of financial system stress tests
US FOMC meeting, ISM and Q1 GDP data
Euro-zone CPI and UK manufacturing PMI
Monetary policy meeting at the Bank of Japan
More Q1 earnings reports

Market Movers Ahead

Global

In the US the key focus will be on the FOMC meeting and Q1 GDP data on Wednesday, and ISM on Friday. Furthermore, banks will receive their stress test results this weekend. Although the results will not be made public before May 4, rumours are likely to emerge as early as next week. In terms of the FOMC meeting, we do not expect a scale up on quantitative easing or announcement of new measures. The statement is nevertheless likely to say that such steps could be taken if deemed necessary. Q1 GDP is set to post another sharp decline but could surprise positively compared to consensus expectations. Another positive surprise is likely to come from the ISM index Friday. We expect an above consensus rise to 40. The week will also see the release of the S&P/Case-Shiller house price index. So far three of the four home price indexes that we track have shown an improvement and the one missing is the Case-Shiller. Moreover, the flow of Q1 earnings reports will continue next week.
In Euroland there are no major movers, but M3 data, German länder CPI and Euro Flash CPI will be of interest. UK releases PMI manufacturing where we see scope for a further increase and an upward surprise.
In Asia the most interesting event will be the monetary policy meeting in Japan. BoJ will likely revise growth markedly lower but we don't expect new quantitative measures as the new stimulus package from the government has eased the pressure on BoJ.

Scandi

In Sweden the upcoming week will only have 3½ working days on the financial markets as banks will close early the day before May 1. As far as macro data is concerned, there are no big movers and shakers, but we will keep an eye on confidence data. Retail sales will also be worth watching.
In Norway we are keeping a close eye on retail sales, as private consumption is important with regards to our divergent view on the Norwegian economy relative to Norges Bank. Norges Bank is not expected to purchase any foreign currency in May, which should lend support to the NOK.
We expect unemployment in Denmark to rise from 2.5% in February to 2.7% in March. Unemployment is still very low, but should rise quite sharply over the next six months on the back of the strong decline in production.

Global Update

More signs of recovery as restocking is under way …

The past week offered further evidence of a turnaround in the global economy. Euroland PMI data offered yet another positive surprise as the manufacturing new orders index rose from 30.9 to 37.4. Furthermore, since the inventory index continued lower the balance between orders and inventories rose to the highest level since 2006. The order-inventory balance is a good leading indicator of overall PMI as illustrated in the first chart. It is striking that Euroland is already showing signs of improvement as it is generally expected to be lagging in the cycle, but it probably mirrors that the global economy has been hit by a simultaneous huge shock from the financial crisis leading to extremely sharp cut backs in production. It now seems that inventory reduction globally has come very far and that the headwinds from this side will fade in the coming quarters. Euroland will also gain from this, but the recovery is likely to be slower than in the US and Asia.

The drawdown in inventories is also evident when comparing US industrial production with actual demand. Until November 2008 the two were moving lower in tandem, but since then demand has stabilised while production has continued to decline markedly. Inventories are therefore at extremely low levels at a time when monetary and fiscal stimuli are likely to kick in and lift demand. This might lead to a continued rise in ISM, which tends to be quite important for financial markets as a gauge of the business cycle. Data out of Asia this week also added to the recovery story. South Korea released exports for the first 20 days of April which showed another month of gains giving more credence to the case that the improvement seen in previous months is not just noise but actually taking place.

… while IMF is cutting growth forecasts further

These data make it all the more puzzling why IMF chose to revise down its growth forecast sharply during the past week (see table). Since its previous forecast in January, financial markets as well as economic indicators have improved. Our own projections are now more upbeat and we see little reason to revise them down. If anything, we start to see upside risk to H2 09 based on the data mentioned above. This is likely to put further upward pressure on bond yields during the coming quarters.

Banks and the US auto sector continue to be in focus

Earnings for Q1 have taken centre stage in the past week as well and especially banks are in focus. The picture has been a bit mixed but overall Q1 has been the first quarter in a long time where banks have been able to deliver positive surprises. Losses are still big, but revenues from trading activity are increasingly working as a buffer to absorb the losses. There is still great uncertainty over the need for further capital, which could dilute existing shareholders. Banks will receive the results of their stress tests today and the results will be made public on May 4. However, at least some information on the outcome of the tests is likely to be leaked to the press already this weekend and would be an important driver for markets in the short term.

The US auto sector has also come back into focus as the deadlines for restructuring plans are drawing closer. Chrysler faces a deadline of 1 May to conclude a partnership with Fiat and cut its debt and labour costs, or face bankruptcy. At the same time General Motors has said it is working on a debt-for-equity exchange ahead of its 1 June deadline. The latest story has been that Fiat is pursuing a stake in the European arm of General Motors. A lot of uncertainty surrounds the auto sector, which is likely to continue in coming weeks. This is keeping markets a bit sidelined - despite the more encouraging economic signs.

Financial views

Equities

We reiterate our positive market view and anticipate a further 10-15% upside in US and global stocks at year-end.
Still, a test of sustainability should be expected during the coming weeks as market focus will move from economic healing signals to Q1 reporting season and the stress tests of 19 banks in the US. We anticipate that the stock market will pass this test, although a 5-10% correction might be on the cards due to the likely very weak Q1 EPS results.

Fixed Income

Global: Bond yields are expected to range trade short term, but to rise on a 3-6m horizon based on improving macro conditions. US expected to underperform Euroland in sell-off.
Intra-Euro: We are overweight peripherals (Italy, Greece, Spain) versus Germany in 2-5y maturity. On longer maturities we prefer France and Finland versus Germany.
Scandi: We are underweight long Danish government bonds versus Finland in the 10Y area, but overweight in the 2Y area and overweight Swedish government bonds versus Germany in the 5Y area. We recommend overweight of Norwegian govies versus Germany in 10y segment. We are underweight Danish mortgages versus government bonds in all segments (callable, Capped Floaters and non-callable) except for 1-2 year noncallable mortgage bonds.

Credit

We remain overweight credit as an asset class as we believe that the market in general is pricing a too severe default scenario. That said, the fundamental outlook is grim with defaults going to rise sharply and the ride is likely to be rough as uncertainty over the timing of an economic recovery persists. In our view, the most prudent way to build up an overweight position is via the primary market.

FX Outlook

EUR/USD is expected to drift lower on the back of relative interest developments and the relationship between US and Euroland in the business cycle. EUR/GBP remains overvalued, but is set to continue lower. Carry can keep on performing while defensive currencies will face additional headwind. High correlation to equities is expected to fade.
SEK and NOK have good potential against EUR, but the risk of quantitative easing and general risk aversion represent obstacles. Medium-term horizon appears bright. DKK is attractive (e.g. against CHF) due to sound carry.

Commodities

Commodities have performed relatively strongly the last month fuelled by heavy Chinese buying of metals, high OPEC compliance and optimism in the market that we have passed the cyclical through.
Even though sentiment is very strong, we are a bit cautious calling for higher prices after this rally. Underlying demand outside China is still relatively weak and the risk of stocks continuing to rise is still evident. However, looking 3-6 months ahead we expect a new leg up in commodity prices.

Full Report in PDF

Danske Bank http://www.danskebank.com/danskeresearch

Disclaimer

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector.