Rules, Discretion and The Right Assessment: Copy Deadline: 17 December 2010

No.
131 1st quarter 2011 Copy deadline: 17th December 2010
Rules, discretion and the right assessment

In the current uncertain environment, investors are looking for tags with which to mark market trends in the near future. Economic policy initiatives are less and less able to fill this role. At the time of the great moderation, policy rules were valuable signals about how officials actions would react to different circumstances in a predictable way. In this period of new normality, the details of which have not yet been precisely set out, discretion is increasingly replacing rules as the watchword for public actions. In reaction to certain events, policymakers have been forced to embark on further stimulus initiatives. This has been the case recently for central banks on both sides of the Atlantic. This balance in favour of discretion rather than rules is likely contributing to a more elevated level of volatility for markets, simply because expectations are less stable. There is probably no way to escape from this new environment. However, markets should expect governments and policymakers to offer the most accurate diagnosis of the situation as it stands currently. It is unclear whether that is really the case. In the US, there is more reluctance to resolve the debate as to whether the current crisis is structural or cyclical. The temptation is to incline in favour of the latter while historical references argue in favour of the former. Ultimately, there is a risk of disappointment for the market with stimulus policies that could be perceived increasingly as a simple way of buying time rather than providing sustainable economic growth close to potential. This is probably not the best way to reduce the level of volatility. In the EU, officials have implemented strong measures to insure against the liquidity risk for both sovereigns and banks. This is a necessary condition but insufficient to prevent a solvency crisis, especially for sovereigns. Time has been bought and should be well used. Even taking into account that fiscal consolidation is not the enemy of growth or a way to lose the next general election, the Eurozone needs a more dynamic economy, mostly at its periphery. Markets will become more confident only when EU institutions have taken this type of initiative.
Macroeconomic strategy: Too many local issues to tackle global problems ..........................................................................................2 Monetary Policy: The Fed has its reasons, but the ECB orders things differently!..............................................................................6 Interest Rates US: Ending crisis yields.........................................7 Interest Rates Europe: The only way is up for euro yields...........8 Exchange Rates: Traditional drivers to return .................................9 Energy: Oil markets tightening at the end of the year ...................10 Metals: Buy aluminium...................................................................10 US: Gradual return to health aided by policy stimulus ..................11 Japan: Soft landing even without policy stimulus ..........................15 Eurozone: A big if.........................................................................16 France: Good things come to those who wait ...............................18 Germany: Inside strength ..............................................................19 Italy: Moderate but positive growth ahead.....................................20 Greece: Even more effort is needed..............................................21 Spain: Government holds its course in the storm..........................22 Scandies: European safe haven....................................................23 UK: The sober years......................................................................24 Australia: Resilience helped by China ...........................................25
New Zealand: Reconstructing growth........................................... 25 Canada: Is it serious, doctor? ....................................................... 26 Emerging countries: Short-term gain for long-term pain? ............ 27 Central Europe: Turnaround year ................................................. 29 Russia: Back on the growth trend................................................. 29 South Africa: Taking off slowly...................................................... 30 Turkey: The risky bet of monetary policy ...................................... 30 Asia: Powering ahead: will outperformance continue?................. 31 Mexico: The sad bamba................................................................ 32 Brazil: Time to slow down ............................................................. 32 MENA: A two-speed recovery gets into gear................................ 33 Exchange rate forecasts ............................................................... 34 Interest rate forecasts developed countries............................... 35 Interest rate forecasts emerging countries ................................ 36 Economic forecasts....................................................................... 37 Economic forecasts....................................................................... 38 Economic forecasts quarterly breakdown.................................. 39 Commodities forecasts ................................................................. 40
Macroeconomic strategy: Too many local issues to tackle global problems

Four main concerns form the backdrop to the doubts in the market today. The acceptance of the current pace of US growth; the divergent economic performance in Europe; the capacity of emerging countries to ensure the main macroeconomic equilibria; the will to rebalance global growth. It is not certain whether the conditions for achieving these four goals at once will be met.
BRIC growth vs G3*

10% 8% 6% 4% 2% 0% -2% 00 -4% -6% GDP growth G3 GDP growth BRIC 02 04 06 08 10 12 forecasts
The global recovery is continuing, but at considerably different paces in industrialised and emerging countries. The GDP growth differential between the two groups of countries is in the order of one to three, from 2% to 6%. From this simple observation emerge four concerns that form the backdrop to the doubts in the markets today: The acceptance or otherwise of the current pace of US growth; Diverging economic performances in Europe; The ability of emerging countries to reconcile strong growth, macroeconomic stability and a home for Western capital inflows in search of attractive yields; The difficulty, which at first sight seems paradoxical in an environment like this, of rebalancing the global economy, and above all reducing external deficits here and surpluses there at the same time.
* YoY GDP weighted by PPP GDP Source: Bloomberg, Crdit Agricole CIB
Potential versus actual GDP growth

6% Forecast 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% 1990 1994 1998 2002 2006 2010 Real Potential GDP {CBO} (USDbn Chn.2005) % Chg - Period to Period Real GDP (SAAR, USDbn Chn.2005) % Chg - Period to Period
We start with the US, where the prospect of annual growth running at around 2% pa for some foreseeable time is not going down well (the pace of growth should be above potential in 2011 and 2012, with the risk of a downward correction just after). This is predominantly due to what that implies partly in terms of an absence of average return on capital invested in US assets, and partly due to an unemployment rate that is staying too high for too long. This leads to the temptation, which is very evident in the current climate, to consider the current low growth not as a structural phenomenon related to the need to rebalance and consolidate the balance sheets of many economic agents from households to public authorities to financial institutions but as an essentially short-lived cyclical weakness. If that were the case, all that those in charge of economic policy would have to do would be to insist more on the need to prime the economic stimulus pump for growth, to end up by accelerating and veering durably towards a socially acceptable trend of at least 3% pa. This position triggers at least three comments. In the first place, it is no doubt impossible to believe that the diagnosis of a cyclical air pocket is the best-established. It is simply that the US cannot dodge the logically founded and historically observable rule that a period of slow growth is necessary for deleveraging. Perhaps we may admit that this is well underway as regards households. The fact remains that the debate as to exactly how far the savings rate will rise (and it has already risen from 2% to 6%) is not over, and that there are at least as many arguments in favour of it continuing to rise as there are for it stabilising. At all events, banks are unlikely to return to precrisis leverage levels, while the effort of restructuring the public finances has yet to get off the ground. Faced with such headwinds, however strong the growth drivers of exports and business investment, they will be insufficient to guarantee the US economy lasting growth of at least 3% per year. This does not mean that achieving a performance on this scale is not possible occasionally. Structural obstacles are adversely affecting potential growth (ie, growth observable over the medium term) but are not stopping shorter-term cyclical developments related to inventory or investment cycles, for example from making their effects felt. Thus, potential growth of 2% (no doubt the yardstick to adopt for some years to come) is no obstacle to cyclical fluctuations taking the GDP growth trend to around 3.5% at some point in time. Next comes the collective difficulty (from the people and their economic elite right through to their political masters, including policymakers) of admitting that the new growth regime may spawn economic policy mistakes that could have damaging consequences in terms of the outlook for activity. Pushing
st Macro Prospects No. 131 1 quarter 2011
Source: CBO, BEA, Crdit Agricole CIB
Herv Goulletquer
herve.goulletquer@ca-cib.com +33 1 41 89 88 34
Household financial situation improving too hard to get an economy to accelerate when it is not capable of doing so involves a threefold risk. In the first place, and insofar as economic policy is deemed credible, it can make expectations unstable. Private agents are adjusting 70000 14 60000 12 their forecasts upwards, whether in terms of activity, results or yields, before 50000 10 realising that any improvement in growth is not lasting. Secondly, what ends up 40000 8 as being seen as a surfeit of optimism on the part of those in charge of economic 30000 6 policy as regards their scope for action undermines the very effectiveness of that 20000 4 action. The channelling of expectations is altered as a result, and trust in public 10000 2 initiatives diminishes. In the third place, the economic policy levers may be set too 0 0 high, which could be unfavourable, if only because it makes the task of so-called Q180Q185Q190Q195Q100Q105Q110 normalisation that much more delicate. How far will the US Federal Reserve H'holds & Nonprofit Orgs: Net Worth push on into the terra incognita of quantitative easing before it realises just how (NSA, USDbn) Personal Saving Rate (SA, %) (rhs) weak the response of the US economy is, since in a post-balance-sheetrecession period, the preference for saving and deleveraging makes monetary Source: BEA, FRB policy less effective? Even if there is still some wriggle-room in terms of fiscal stimulus initiatives (although this is in hock to the current antagonistic climate reigning in Washington), the nature of the problems created in the wake of excessive activism would be comparable. Is the monetary multiplier broken in the US?
250 230 210 190 170 150 130 110 90 Jan-08 Oct-08 Jul-09 Apr-10 monetary base money supply (M2) loans & leases in bank credit down 13%
Finally, we need to think about the initiatives needed both to accept the new growth regime and help it evolve into something more optimal. The experience of Europe in the late 1970s and the following decade should be borne in mind. Faced with slow growth that persistent unemployment and high inflation made permanent, Europeans sought solutions to their economic woes of a structural nature. The objective of greater European unification offered plenty of scope for ideas about reform and greater monetary stability, and the creation of a single market was the chosen avenue. One can, of course, endlessly debate exactly how much those reforms contributed to European growth. Their contribution was no doubt essential, even if other obstacles gradually surfaced. At all events, opening up fine prospects and getting economic agents on board make the idea of a slowdown in growth even a somewhat lengthy one more acceptable in the here and now. There is a lesson here that could be useful for the US, namely that it should adopt ambitious initiatives and choose structural policies over the more cyclical levers of fiscal and monetary policy. In passing, the actions taken in Europe 30 years ago or so could usefully resound in the ears of the present generation of US decisionmakers. After all, they are talking about the necessary reform of the international monetary system, and are people not worried above all else about the spectre of protectionist measures rearing its head? We now move on to Europe and the increased divergence in economic performance among Eurozone countries. There is little doubt that the divergence is increasing regardless of the chosen indicator used, whether growth or unemployment rates, the current account balance or the public accounts. The difference is significant compared with the situation pre-crisis. The creation of the European Union was perceived (and confirmed by the facts) as a machine to manufacture convergence. The markets backed the process to the hilt, with the virtual disappearance of spreads between government paper within the Eurozone. Other factors driving convergence were a pretty upbeat international economic environment, the existence of the structural funds, increased intraEuropean trade, restrictions imposed on excessive price increases and on levels of both long-term interest rates and public deficits, and a common monetary policy. As you might expect, the strength of the global environment masked the different rates of development in terms of price and product competitiveness and the economic model used, whether this involved geographic specialisation in sales, sector-specific specialisation in supply, or the springs of household demand (purchasing power or the combination of asset valuation/debt). At all events, it was only the reality of convergence that made it possible to comply (more or less closely, as it turned out) with common rules in terms of control over price inflation or balanced public accounts and pursue a unified monetary policy. That divergence (which began when? There is no definitive answer to that question, but the very fact that the question can be asked stokes fears, alas, that it is sufficiently advanced to be perfectly visible from where we stand) undermines the ability to observe a common rule, and makes it difficult to steer monetary policy (does average mean anything when the
Rebased to 100 in Aug 2008 Source: Datastream, Crdit Agricole CIB
EU Economic Sentiment Indices

stdev 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 05
06 GE NL
07 FR BG
08
09 IT PT
10 ES GR
Source: EC, Crdit Agricole CIB
Eurozone: dispersion in unemployment rates

4.5 4.0 3.5 3.0 2.5 2.0 1.5 16 14 12 10 8 6 4 99 00 01 02 03 04 05 06 07 08 09 10 Standard dev. in unemployment rates Min-Max (rhs)
standard deviation becomes important?). In the best of all possible worlds, the efforts of the European Union and its member states should focus, above all, on initiatives that help to create more convergence. Of course, they have a burning obligation to manage the sovereign debt crisis and force investors to be less naively optimistic in future when it comes to the economy and its effect on the quality of the public accounts in each of the Eurozone countries. The fact remains that recreating the conditions for economic convergence is an absolute necessity. Otherwise, it will be increasingly difficult to run a Eurozone whose gearbox lacks a reverse position. Creating renewed convergence means two things. It means having a model (multiple possible references), and it means marking out the routes that will take us there, country by country. With respect to the model, and regardless of the need to avoid treading on national toes, the reference model will be Germany, whether in terms of its economic model or the way it manages its public accounts. And Germany, on the strength of its success, has every intention of working to this end. But no-one should ignore the fact that the entrance price for quite a few of the member states is huge, whether we are talking about improving an economys competitiveness (which will involve, partly at least, internal devaluation efforts, ie, lower unit labour costs) or reducing imbalances in the public accounts. One has to be clear about this, even if one believes in the existence of a Ricardian equivalence environment in continental Europe (cutting public deficits would help boost household confidence and hence drive a more definite preference for spending over saving): nothing will be possible over the longer term unless we make sure that we sustain a certain level of growth. With the European Union, this means increased fiscal solidarity (this now exists, even if conditionally, for times of crisis. It would be logical to extend it to more normal periods, even if only as a means of warding off crises) and/or a desire to smooth out, partly at least, imbalances in relative external positions. In other words, countries with an external surplus vis--vis both the Eurozone and the rest of the world should make an effort to boost domestic demand. We finish by looking at the last two points highlighted in the introduction. When it comes to emerging countries taken en masse, regardless of the perfectly satisfactory character of the macroeconomic performance they are currently posting, we have to acknowledge that it is no easy matter to come up with the optimal setting to drive strong growth and at the same time preserve the main macroeconomic equilibria. With respect to growth, two observations emerge: The crisis is highly likely to restrict the rate of imports into industrialised countries for a number of years (as suggested in Chapter 4 of the October 2010 edition of the IMFs Global Economic Outlook). Changing the main engine of growth in emerging countries from exports to domestic demand will be a long and gradual process.
Source: ISM, Crdit Agricole CIB
EM real rates: very low

10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 04 05 06 07 08 09 10 EM average real policy interest rate EM Average policy interest rate EM Average inflation
Inflation and rate indices include 21 large EMs Source: Bloomberg, Crdit Agricole CIB
Private capital flows to EMs

USDbn 1200 1000 800 600 400 200 0 -200 1995 1998 2001 2004 2007 2010 Other private flows Commercial bank lending Portfolio flows FDI Private capital flows to EMs (total)
For these two reasons, there is a great temptation to maintain an extremely accommodative economic policy setting. Real interest rates are likely to remain too low for a very long time, and currencies should remain undervalued relative to USD. This combination of satisfactory growth levels and accommodative monetary policy drives large-scale capital inflows. At the end of the day, we will have to be attentive to the threat of inflation in terms of both goods & services and asset prices. Reforming the international monetary system is a worthy idea, given that excessive fluctuations on the currency markets and too many untimely capital flows are causing shocks to the unfolding of the global economic cycle. In this respect, a threefold goal should be assigned, namely: (1) the generalisation, as far as is objectively possible, of a system of floating exchange rates; (2) to ensure that capital flows have a less destabilising effect (which necessarily means minimising the phenomena at the root of these flows and hence tackling balance of payment imbalances); and (3) to ensure that central banks focus on curbing the risk of inflation as their first objective. But there is every likelihood that things will not go this way. In a disinflationary global environment characterised by low growth in industrialised countries and high levels of competition in a world economy that is still largely open, combined with excess production capacity in some sectors and countries, the temptation to
Source: Bloomberg, Crdit Agricole CIB
USDs dominance (%)

0 Foreignexchange International Reserves Bank deposits* Bank loans* Sales of debt US share of world GDP 50 100
devalue ones currency to create the conditions for achieving further growth will remain present in many countries. Similarly, even going far (too far?) along the road to accommodative settings of monetary policy will not be perceived as being excessively risky so long as the markets do not worry too much (but we also know that their mood can change without warning). Finally, rebalancing global growth will take time and Western investors will continue to be attracted by the yields available in emerging markets at the same time as they try to keep an eye on increasing risks, if such risks actually do emerge. The volatility of capital inflows is therefore unlikely to disappear. On the strength of these analyses, here is what investors should be thinking about: In the US the reality principle should force it to accept economic growth that is weaker than the usual historic benchmarks; that at the end of the day, this is less risky than embarking on a succession of relatively ineffective stimulus policies which it will subsequently be difficult to normalise; that there are opportunities for investors in a market environment characterised by longterm government bond rates of around 4%, an equity market PER of 13x and an increase in earnings per share of 7% pa. In Europe, the start of fiscal integration or at least of macroeconomic policy co-ordination should be put in place; it is absolutely vital to halt the process of diverging economic performance quickly. In emerging countries, the probability of surging inflation is low. As regards reform of the international monetary system, it would seem reasonable to have no hope whatsoever. If initiatives were to be launched, and if they were to contribute to rebalancing the global economy and to greater clarity, so much the better!
* Cross-border Source: Bloomberg, IMF
Monetary Policy: The Fed has its reasons, but the ECB orders things differently!
In their own way, the Fed and the ECB are sustaining growth in the US and the Eurozone. The means differ quantitative easing for one, liquidity easing for the other because their economic models and mindsets also differ. The Fed is above all worried about deflation, the ECB far less. The ECB, for its part, fears inflation real and financial while the Fed seeks it out. The Fed relies on measures of economic slack, the ECB on monetary aggregates. But, behind the dogma, there is also, and above all, pragmatism and central banks you can count on.
US: uncomfortably slow inflation

YoY, % YoY, % 6 6 forecasts 5 5 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 00 01 02 03 04 05 06 07 08 09 10 11 12 headline inflation core inflation grey areas: US recessions
The Fed has its reasons

The outcome of the FOMC meeting on 2 November was as expected as the Fed announced the resumption of quantitative easing (QE2), thereby ending the suspense that had lasted since the summer. The reasons for the move, as expressed by the Fed, were driven by the disappointingly slow progress towards the Feds dual mandate of maximum employment and price stability. From its point of view, by taking out an insurance policy against downside risks to growth and inflation, the Fed is not taking much of a risk by overdoing things, especially when the spectre of deflation is looming. A positive and significant impact on growth is certainly not guaranteed, but the multiple nature of transmission channels is boosting its chances of success. These include an easing of all monetary and financial conditions, efforts to counter risk aversion and anchor inflation expectations. This additional stimulus has given confidence a fillip, with the result that the risk-free interest rate for 10Y US Treasuries is now nudging 3%. This situation, at first sight paradoxical because it would naturally tighten credit conditions, is not that much of a surprise on closer examination. By reviving risk appetite, the Fed is obviously increasing the basis on which market rates are generated, but on the other hand this decreases the additional compensation investors require for holding riskier assets and in so doing increases their price. The rise in asset prices helps sustain wealth, one of the levers used to stimulate private demand, and thus employment, which helps guarantee that the virtuous circle of self-sustained growth is properly triggered. Moreover, by supporting inflation expectations, the Fed is acting on another lever, namely the reduction in real interest rates (or at the very least, their nonincrease), which is also likely to drive demand.
Source: BLS, Crdit Agricole SA
EMU: inflation towards target

YoY, % 5 4 3 2 1 0 -1 YoY, % 5 forecasts 4 3 2 1 0 -1 05 06 07 08 09 10 11 12 headline inflation core inflation
but the ECB orders things differently

The fact that the ECB has, for its part, already embarked on its exit strategy (temporarily put on hold by the uptick in tensions on European sovereign borrowers) reflects a genuine fault-line between the two central banks. The differences play out at a conceptual level. Whereas for the Fed deflation is a scourge to be avoided at all costs (like the pernicious mechanism observed during the Great Depression), the ECB sees the widespread fall in the general level of prices as a painful but necessary means of carrying out an internal devaluation in economies with a competitiveness deficit. Over at the Fed, wealth effects are sought after for themselves as a monetary policy transmission channel because asset prices are an intrinsic component of consumption behaviour among economic agents, according to a wealth-based growth model. Conversely, the ECB sees asset price rises against a backdrop of monetary stimulus as a potential source of instability, since all that liquidity being poured into the financial sphere could distort resource allocation and artificially boost some asset prices. The ECB is also loath to make any adjustments to its policy on the basis of fragile measures such as the output gap and, sensitive to Friedmans statement that inflation is always and everywhere a monetary phenomenon, it continues to pay special attention to credit and monetary aggregates, which definitively locks in its medium-term strategy. The Fed, for its part, continually points to the sheer scale of economic slack and the need for durably faster growth to soak it up. It may focus more on the cycle than the trend but its loose monetary finetuning in the near term helps it achieve its medium-term target.
Source: Eurostat, Crdit Agricole SA
Isabelle Job
isabelle.job@credit-agricole-sa.fr +44 20 7214 5767
Hlne Baudchon
helene.baudchon@credit-agricole-sa.fr +33 1 43 23 27 61
Interest Rates US: Ending crisis yields

Even if breakeven inflation rates have reached reasonable levels, real yields are still at crisis levels, being lower than Japanese or German levels. If the economy is robust enough to sustain rate hikes, then real yields will rise dramatically. Whilst trend growth is lower, real yields will be bumped higher by other factors such as volatility and supply/demand.
Real yields
% 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Jan-11
Looking far into the future for US yields We have been in this crisis so long that we have almost forgotten what a normal 10Y yield looks like. Yet, we think that we think we will get there on our two-year forecast horizon assuming that the economy is robust enough to sustain the first Fed hikes in the second half of 2012. Irrespective of the exact timing of Fed action, having an idea of the end-game for yields is important. Take the TIPS market. Real yields in the 10Y area are currently around 0.75%. In the past we used to think that TIPS yields provided a view of GDP growth over the life of the bond. Yet, the TIPS 10Y yield of 0.75% incorporates an exceptionally low expectation for growth.
Jun-16 Dec-21 Jun-27 TIPS yields JGBi Ylds
Source: Bloomberg
What would be a reasonable real yield? If we go back to the start of the 2000 and calculate average GDP growth, we see that the 10Y real yield has been around 2.25% against GDP growth of 1.9%. The general consensus is that US growth will be structurally weaker in the future but we have to go back to 2005 to get YoY growth above 3%. Trend US growth is likely to be a long way from 3%; 2.0-2.5% would be closer to the mark. While GDP growth is a good first guess at where real yields should be, there are other factors to consider: Demand: do not forget that the Fed is buying Treasuries at the moment but it will stop before hiking Fed rates. Supply: there is going to be a large budget deficit for many years. Plus, the market will fear that the Feds balance sheet is available for sale and there are billions of bonds. Economic volatility: Greenspan presided over what was called the Great Moderation. GDP and inflation volatility were exceptionally low and so all sorts of risk premia collapsed. The pendulum has swung decidedly in the other direction. Credit risk: Treasuries are no longer risk-free. Recent events suggest a small, but positive, credit risk premium although nowhere near the US 5Y CDS level of 41bp.
Growth vs real yield

% 6 4 2 0 -2 -4 -6 Jan-00
Jan-03 Jan-06 10Y Real Yield Jan-09 GDP %YoY
Source: Bloomberg
US 10Y Yield
% 10 8 6 4 2 0 Mar-90 Mar-96 Mar-02 10Y Yield Actual Mar-08 10Y Forecast forecast
Taking all the above into consideration, once the markets stabilise in a year or so we do not believe that real yields will be anywhere near their current levels. We think that once the Fed starts hiking rates then real yields should quickly reach levels of trend growth plus 50-75bp, above the historical 25bp over the level of trend GDP. The Great Moderation is over, welcome the world of volatility, credit risk and horrible supply/demand dynamics. The other component of the nominal yield is the breakeven. Currently, 10Y breakeven rates are 2.20%, which sounds high given that core inflation rates are 0.6%. However, what we are dealing with here is the kind of monetary expansion that has never been seen before. We think that breakeven yields will be fairly similar to, if not slightly higher than, where they sit today, say 2.25%. An equilibrium 10Y real yield of 2.50-2.75% would reflect a fairly contained trend growth rate but higher risk premium. This all adds up to an end-2012 10Y forecast of around 4.75%. Perhaps this sounds high but at end-2012 10Y bond yields will be looking at what the world will look like in 2013-23.
David Keeble
david.keeble@ca.cib.com +1 212 261 3274
Interest Rates Europe: The only way is up for euro yields

As long as the ECB continues to provide a backstop to the more extreme worries about EMU sovereigns, the EGB market can concentrate on the macro picture, which suggests higher yields. Core EGBs reached really rich levels this autumn, and need to sell off more, especially once supply starts to pick up in January.
Yield changes vs convergencedivergence

1.0 0.5 0.0 -0.5 60 40 20 0 -20 -40 -60 -80 -100 -1.0 Sep-09 Jan-10 May-10 Sep-10 1M chg 5Y OBL yield (rhs) 10Y IT-DE yield correl
The safe-haven effect has been eclipsed Although fears of a double dip had helped Eurozone core yields creep lower in the second half of 2009 and Q110, from April onwards the main justification for the sharp Bund rally was risk aversion in the wake of the EMU periphery sovereign debt confidence crisis. That dynamic is starkly illustrated by the concurrence of negative correlation between Bund and BTP yields, with the sharpest falls in Bund yields (see chart, left). That dynamic began to weaken as EU institutions stepped up their intervention, through either bailout loans or direct purchases by the ECB. Given the potentially very great costs associated with an even more pervasive Eurozone sovereign debt crisis, we believe the ECB and, ultimately, EC policy will continue to err on the side of supporting all EMU members, thus preventing a return of strong safehaven effects. Output growth and prices suggest further rises in yields In the absence of sufficient risk-related reasons to buy core paper, the market is increasingly looking at traditional macroeconomic considerations. The current rate level, even after the recent sharp sell-off in bonds, is roughly 50bp lower than has historically been consistent with the current level of output and inflation indicators. Simply put, core bonds remain overvalued and Euribor rates are expensive (too low). None of that would matter if prospects pointed to an economic slowdown. In reality, however, the new orders and backlog subcomponents of the Eurozone manufacturing PMI suggest continued strength in the Eurozone economy. This has been reflected by most confidence and actual output releases in recent weeks. In such an environment, yields will continue to be driven higher and, later next year, the market will begin to price in more aggressively the approach of ECB rate hikes. As things stand currently, we foresee the timing of the initial ECB moves as occurring in Q112. Supply is likely to be heavy in Q1 Overall, we expect supply of Eurozone government bonds in 2011 to be lower than in 2010. While redemptions are actually rising slightly, (from EUR513bn to EUR556bn), deficit funding requirements are expected to decrease by over 30%, resulting in lower gross as well as net supply. The supply side, however, is not entirely positive for the bond market. Gross supply of quasi-government and bank paper is likely to increase as a result of fund-raising for the bailout loans and as a result of substantial governmentguaranteed bond redemptions. On top of all that, specifically in Q1, the seasonal pattern is for all the main borrowers to come heavily into the market, and there is little reason to think it will be different next year. Historically, it has been difficult to establish strong empirical evidence that supply has a predictable impact on government bond price levels. However, if the current mood of disillusionment with US and Eurozone yield levels is sustained into January, the rapid increase in supply is unlikely to be taken down gracefully
EUR rates and nominal growth (%)

6 4 2 0 % -2 -4 99 00 01 02 03 04 05 06 07 08 09 10 11 EUR 5Y Nominal GDP
Source: Eurostat, Bloomberg
Growth outlook remains positive

60 55 50 45 40 35 30 25 03 04 05 06 07 08 09 10
Current subcomps Leading subcomps
Source: Markit, Crdit Agricole CIB
Luca Jellinek
luca.jellinek@ca.cib.com +44 207 214 6244
Exchange Rates: Traditional drivers to return

The USD is set to give up some ground in Q111 and record a mixed performance over 2011. High-yielding commodity currencies will be the best performers over the year, whilst the JPY and CHF will likely regain their mantle as funding currencies. The EUR is set to come under increasing pressure over the course of 2011.
USD to face some pressure over H111

% 12 8 4 0 -4 CHF JPY EUR CAD NOK AUD GBP NZD SEK 6m carry adjusted returns, %
FX market attention has been very fickle over recent months as attention has gyrated from one theme or issue to another and back again. Consequently, it appears that there has not been a clear driver of currencies, with both risk aversion and interest rates playing a role, but with neither being dominant. Indeed, the fact that the two best-performing major currencies over 2010 have been the high-yielding/riskier AUD and the low-yielding/safe-haven JPY highlights the schizophrenic nature of FX markets over 2010. This was particularly apparent with regard to USD sentiment as it began the year in strong form against the background of worsening Eurozone fiscal concerns, only for the USD to come under pressure for most of H210 as markets priced in Fed quantitative easing (QE2). Just as it looked as though the USD would end the year in poor form, worries about the Eurozone periphery resurfaced leading to a renewed decline in the EUR. The outlook for 2011 is no clearer but there will be two ongoing themes that are likely to have a major influence on currencies during the year. The issue garnering most attention is the crisis in peripheral Eurozone debt markets. Hopes that contagion could be contained through major aid packages for Greece and Ireland have been dashed, leaving officials scrambling to prevent bond market stress from spiralling. We had previously expected such concerns to resume during 2011 and had expected the EUR to strengthen into 2010 year-end but it appears that market patience has run out sooner than we anticipated. All is not lost, however, as there is a strong chance that the ECB will become more aggressive in its bond purchases and liquidity provision, helping to stabilise Eurozone bond markets and in turn provide the EUR with support. Such support may be temporary but it could at least allow the EUR some relief in Q111 before the currency succumbs to renewed pressure as weaker and diverging growth dampens appetite for the EUR. The second theme that will continue to have a significant impact on currency markets is US Fed quantitative easing and/or potential for QE in other countries. Although we would argue that a lot of QE2 is priced into the USD already, the prospect of QE3 has not yet been discounted by markets. Indeed, US data has been quite encouraging lately, suggesting less not more prospects of QE. Nonetheless, core inflation in the US is set to remain benign whilst the unemployment rate is likely to remain too high for comfort, leaving the prospects of further QE wide open. In any case the fact that the Fed is buying around USD110bn a month in US Treasuries may provide a headwind to the USD given the increase in USD supply this will create for some months to come. We would not discount the influence of interest rates returning over the coming months. Relatively high yields and positive growth prospects, helped by China directly via increasing trade and indirectly through higher commodity prices, will give commodity currencies a layer of resistance to subdued G3 growth. Alongside the CAD they will also benefit from greater diversification flows especially from Asian central banks as they shy away from the USD and the EUR. The pull-back in commodity currencies over recent weeks provides better levels to reinstate long positions for medium-term appreciation in our view. At the other end of the spectrum we expect the traditional funding currencies, in particular the JPY and CHF, to be the biggest underperformers in our forecast grid. They will re-inherit this role from the USD as relatively higher US yields will help the USD to shake off its mantle of funding currency even if the Fed keeps the Fed Funds rate low for a prolonged period. Additionally, in the case of Japan the prospect of more aggressive policy action by the Japanese authorities suggests greater potential for JPY weakness. So, overall, 2011 may turn out to be a year in which traditional FX drivers such as interest rate differentials regain importance, but judging by events in 2010 we should not rest on our laurels.
9
Source: Crdit Agricole CIB, Bloomberg
Weakest currencies over 12M will be traditional funding currencies

% 20 15 10 5 0 -5 -10 -15
JPY CHF EUR CAD NOK AUD GBP NZD SEK
12m carry adjusted returns, %
After short-lived weakness USD set to strengthen

125 115 105 95 85 75 65 00 02 04 06 USD index 08 10 12
forecasts
USD index (CA CIB forecast)
Mitul Kotecha
mitul.kotecha@ca-cib.com +852 2848 9809
Energy: Oil markets tightening at the end of the year

We have updated our oil balance forecast, and the market appears tighter than previously expected, justifying the recent run-up in prices. Oil demand is very strong, benefiting from a base effect and swift economic recovery in non-OECD countries. As a result, our supply/demand balances do not show a significant stock draw in H210, supporting higher prices.
World oil supply/demand (Mbd)

90 89 88 87 86 1Q102Q103Q104Q101Q112Q113Q114Q11 Total Demand Total Supply
Source: Crdit Agricole CIB
Christophe Barret
christophe.barret@ca-cib.com +44 20 7214 6537
We have revised up our demand growth estimates for 2010, to a stunning 2.5Mbd. Overall oil demand is estimated to have grown by more than 3Mbd in Q310, on a combination of base effect (comparison with very weak 2009 demand) and recovery in non-OECD economies. The revision concerns both OECD demand, expected to grow by 0.6Mbd, and non-OECD demand, expected to increase by 1.9Mbd. This very strong growth is expected to slow to 1.5Mbd in 2011. China will be the single main contributor to the 2010 and 2011 increase in oil demand, with demand growth expected at 850kbd in 2010 and 390kbd in 2011. The stimulus package implemented to fight the world recession appears to have strongly increased demand for petrochemical products. Diesel demand in China recently benefited from unexpected support from a policy aimed at reducing energy intensity, expected to come to an end in the coming weeks. As a result of recent revisions to demand, we now have a significant drop in world stocks in Q310 (-1.5Mbd) and Q410 (-0.6Mbd), supporting the recent increase in prices and justifying a revision to our price forecast in Q410 and Q111. Stocks are expected to draw by 0.6Mbd on average in 2010. In 2011, stocks are expected to remain roughly flat, assuming OPEC crude production increases by 0.7Mbd, stopping 2010 stock draw. We expect OPEC to continue to favour the USD70-80/bl range in the coming months, and to start increasing production at the end of 2010. Based on this assumption, we expect WTI prices to return to USD70-80/bl in 2011, after their incursion above USD80/bl in Q410 and Q111.
Metals: Buy aluminium

With copper the darling of metals it is easy to overlook aluminium, where the supply/demand fundamentals have improved considerably and favourable risk/reward points to further price upside in 2011. A yearning for hard assets to hedge against growing concerns about sovereign risk, currency debasement and potential inflation is supportive for the metals complex.
Copper/aluminium ratio
4 Cu/Al
With copper prices trading at new record highs and grabbing the news headlines it is easy to forget that risk/reward has improved considerably in the aluminium market. Aluminium is on course to register global demand growth in 2010 in excess of 20%, a marked turnaround from the 8% fall seen in 2009 and the best year-on-year growth in 30 years. Since the 1970s, the copper price has traded at 1.5-2.0x that of aluminium it is currently 3.8x as expensive. Aluminium bull factors for 2011 also include: Aluminiums competitive price advantage to that of copper is likely to see inroads being made in substitution of copper in key sectors; The launch of physically-backed aluminium ETFs, which could help erode the market of excess supply; Exchange inventories are no longer building and are falling steadily since peaking in mid-January 2010. Furthermore, at least 70% of LME stocks are tied up in long-term warehouse financing deals and are not available to the market. The potential closure of high-cost smelter capacity in Europe due to onerous power costs, and government-enforced power curbs in China that could result in production cuts/closures amounting to 20% of the total. China accounts for 40% of global capacity and dominates the top half of the industry cost curve.
0 Jan-80 Jan-87 Jan-94 Jan-01 Jan-08
Source: Reuters, Crdit Agricole CIB
Robin Bhar
robin.bhar@ca-cib.com +44 20 7214 7404
10
US: Gradual return to health aided by policy stimulus

The US economic recovery remains disappointingly slow with a gradual return to above-trend growth in 2011 helped by some timely budget stimulus. High unemployment and low inflation rates are key policy variables to follow. Policymakers are expected to maintain short-term growth-supportive policies, while addressing the unsustainable budget deficit trajectory in the years ahead.
Household financial situation improving 2011 year of transition

70000 60000 50000 40000 30000 20000 10000 0 14 12 10 8 6 4 2 0 H'holds & Nonprofit Orgs: Net Worth (NSA, USDbn) Personal Saving Rate (SA, %) (rhs)
A crucial part of the ongoing US economic recovery will be the transition in its sources of growth. The initial boost to activity from fiscal stimulus spending and inventory rebuilding in the early stages of the recovery is expected to be replaced by a pick-up in consumer spending and business investment outlays. The preconditions for stronger consumer spending are now present. Nonetheless, households face continued high levels of unemployment, and their reduced credit usage highlights the need for stronger income growth. Households suffered a major retrenchment during the recession. Their net worth declined by USD17trn and they faced persistently high levels of unemployment. The response was to reduce consumption, increase savings and pare debt use. As indicated in the charts, consumers have successfully built up a savings cushion of almost 6% of disposable personal income, and household net worth is now rising not falling, while the consumer debt service burden has declined due to lower interest rates and the process of deleveraging. What is more, the likely enactment of a 2 percentage point reduction in payroll taxes and extended unemployment insurance benefits through 2011 will give a solid boost to disposable personal income and household spending while adding about USD168bn to the Federal government deficit next year. Employment has begun to pick up but the pace remains below what is needed to bring the unemployment rate materially lower. Non-farm payrolls fell by 8.4 million during the two years ending December 2009. So far in 2010, private-sector payrolls have averaged monthly gains of 79K in Q1, and about 120K in both Q2 and Q3. However, Q4 job creation is likely to slow somewhat. Meanwhile, the unemployment rate has been relatively stable near 9.7% We believe the salient feature of current labour market conditions is a lack of aggregate demand. Some have argued that structural factors, such as geographical fixities, lengthened unemployment compensation and skill mismatch, are responsible for a rise in the natural unemployment rate. For example, worker relocation to a new job might be difficult if it required selling a home at a significant loss. Skills in the construction trades may not be a good match for jobs in sectors that are hiring. The longer period (up to 99 weeks in some states) of unemployment compensation might lead workers to postpone accepting a job in the hope of better future offers. However, when one considers the widespread nature of employment weakness across sectors and regions, and job vacancy rates that are low relative to historical experience, the principal factor appears to be insufficient aggregate demand. This is echoed in reports from businesses indicating weak sales demand for their products as a key reason for their reluctance to increase staffing. This is an important consideration, as stimulating aggregate demand would not be helpful if unemployment were explained by structural causes alone.
Q180Q185Q190Q195Q100Q105Q110
Source: BEA, FRB
Debt service burden declining

14.5 14.0 13.5 13.0 12.5 12.0 11.5 11.0 10.5 Q180 Q185 Q190 Q195 Q100 Q105 Q110 Household Debt Service Ratio (SA, %)
Source: Federal Reserve Board
Consumers reducing credit usage

2600 2550 2500 2450 2400 2350 2300 2250 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 11 10 9 8 7 6 5 4 3 2
Consumer Credit Outstanding (EOP, SA, USDbn) S&P: US Credit Card Quality Index: Charge Offs Rate (%) (rhs)
Jobs wanted
The recession ended with the return to growth in Q309, and reported corporate profits have been quite strong. What has been holding back hiring? We believe that firms have been very cautious in hiring due to uncertainties over the health of the recovery and anticipated demand (potential double dip). What is more, firms face continued uncertainty about future taxes, healthcare costs, and regulations. In addition, while firms have reported rising profits, the gains largely reflect costcutting, including labour costs, rather than top-line revenue growth. Moving forward, as uncertainty over the continuity of the expansion is reduced and the impact of regulatory and tax changes become more clear, businesses will
Source: Standard & Poor's, FRB
Mike Carey
michael.carey@ca-cib.com +1 212 261 7134
11
Employment growth disappointingly slow

400 200 0 -200 -400 -600 -800 -1000 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 11 10 9 8 7 6 5 4
feel more comfortable increasing staffing and investment, even though some of the gains may go to expanding capacity outside of the US. The concomitant rise in employment and incomes will support continued gains in household spending. Business investment in equipment and software has rebounded strongly from very weak levels during the recession when investment was insufficient to cover depreciation. The cost of capital to firms is low and new orders for nondefence capital goods continue at a healthy, albeit slowing, pace. This suggests that we are likely to see some slowing in the rate of capex spending over the forecast horizon, but real growth at a double-digit pace still appears likely for 2011 and 2012. Next year, full expensing of business investment spending and a 50% bonus depreciation scheme for 2012 should boost near-term business capex, while costing the Federal government about USD114bn in revenues over the next two years, although most of the foregone revenues are recouped in later years. Firms with credit availability and ample retained earnings are expected to continue to upgrade their capital stock in order to increase efficiency and remain competitive. We have some concerns that small and medium-sized firms that have no access to the capital markets may experience some credit restraint from smaller regional banks, whose lending is hampered by an elevated exposure to commercial real estate. This could dampen investment and hiring from small firms, which generally account for nearly half of net job creation. The transition to stronger consumer and business investment remains on track, in our view; however, we see headwinds that suggest the process will take time. Hiring will ramp up gradually and the healing of damaged balance sheets will also take time. In addition, there are other factors that will weigh on the pace of the recovery, such as the ailing housing sector. The economic impact of a housing bubble can take years to resolve. The peak of the US housing bubble occurred at the end of 2005 and we see no meaningful recovery before 2012, despite low mortgage interest rates and increased affordability. The absorption of excess supply takes time. While new home construction has declined to levels far below the demographically derived demand for homes, homebuyers have an ample supply of existing homes from which to choose. In addition to the official supply of homes currently on the market, there exists a large hidden supply of homes with seriously delinquent mortgages or in the process of foreclosure that will eventually end up on the market. This keeps downward pressure on home prices, which through the negative wealth effect hurts household spending. In addition, nearly 25% of homes with mortgages are currently worth less then the amount owed to the bank. These under-water homeowners will not find it easy to take advantage of current low interest rates to refinance their mortgages, freeing up more resources for spending. The lagged effect of past declines in the trade-weighted dollar is expected to help keep the real net export deficit roughly unchanged during the forecast horizon. However, a stronger USD in 2011 may limit export growth. The expected slowdown in emerging country growth in Asia and Latin America will also act to limit the contribution of net exports to US growth next year. To summarise, the faster pace of job growth and income generation next year will boost business and consumer confidence. Pent-up-demand, after a long period of belt tightening, will also surface. A reduction in headwinds facing the housing recovery along with improved credit conditions will also make positive contributions to GDP growth, leading to above-trend growth in both 2011 and 2012. Nonetheless, our forecast for 2012 is more cautious than the FOMC projections of 3.6-4.5% growth.
Chg in Total Private Employment (SA, '000) Civilian Unemploy Rate: 16 yr + (SA, %) (rhs)
Source: BLS
Lengthy periods of unemployment

40 35 30 25 20 15 10 5 0 Jan-65 Mar-74 May-83 Jul-92 Sep-01 Average {Mean} Duration of Unemployment (SA, Weeks)
Source: BLS
Job vacancy rates are low

Vacancy Rate %
4.0 3.5 3.0
Q400
Beveridge Curve Q101 beginning of 2001 recession
Q401 end of 2001 recession Q310
2.5 Q108 2.0 1.5 3 5
Q409 7 9 11 Unemployment Rate (%)
Inflation too low, unemployment too high

The deceleration in inflation is clear in the chart (left). The core CPI is currently running at 0.8% YoY a record-low. This is not all that surprising as excess slack generally leads to disinflation, which continues even as growth picks up because the output gap takes time to absorb. Our forecasts for core inflation just over 1.0% next year, rising to 1.7% in 2012, are based on the persistent unemployment gap we anticipate, as well as likely movements in import prices and the difference between current inflation and long-term inflation expectations.
Source: BLS
12
Strong business investment spending

30% 20% 10% 0% -10% -20% -30% -40% Q106 Q107 Q108 Q109 Q110
Mfrs' New Orders: Nondefense Capital Goods ex Aircraft (SA, USDmn) % Chg - Year to Year Real Private Nonres Investment: Equipment & Software (SAAR,USDbn Chn.2005) % Chg Annual Rate
The Fed would like to see core inflation in the 1.6-2.0% range. The FOMC is not comfortable with core inflation at current low rates because (1) it means the Fed is not meeting its mandate and (2) the FOMC does not want to risk a deflating economy, which would exacerbate debt-service problems. Japans deflationary experience is clearly something US policymakers are seeking to avoid. Moreover, a higher inflation rate (close to the mandate-consistent rate) would imply lower real interest rates that will help to stimulate growth
Fed focus on mandate

The Fed is not currently meeting its mandate to seek maximum employment, consistent with price stability. As noted above, inflation is too low and a 9.8% unemployment rate is well above what the Fed would like to see. However, with policy rates essentially at zero, the Fed has tried to stimulate economic activity by lowering long-term interest rates and promoting financial market conditions conducive to growth. The Feds USD600bn of Treasury security purchases through mid-2011 is the non-conventional policy tool employed to this end. The FOMC is aware of the risks in its quantitative easing (QE) policy. The Fed has outlined potential risks to its inflation-fighting credibility and has developed tools that can be implemented to minimise a problematic exit from QE. The FOMC is also aware that the policy will likely not be as effective as the traditional policy tool of changing the Fed funds target. It realises that the accommodative domestic monetary policy will have international ramifications in terms of a weaker USD or potential asset price bubbles. However, those risks can be partly addressed with other policies and must be assessed against the risks of a stagnating economy both domestically and globally. Mr Bernanke has argued the case that emerging-market countries growing faster than industrialised economies should let their currencies appreciate in order to reduce global imbalances and other systemic risks that could lead to slower growth for all. Recent criticism of the Feds policy, both internationally and domestically, and the improvement in US economic indicators have led some to question whether the Fed will complete its USD600bn asset purchase plan or stop earlier than planned. The sharp rise in long-term interest rates just as the Fed began its QE2 purchases led some to argue that the plan was flawed. Certainly, the differing views on the FOMC as to the effectiveness of QE2 and the risks related to the policy could raise doubts. However, we suspect that the majority of FOMC members believe that the policy is helpful and that the conditions that led the Fed to pursue QE (high unemployment and low inflation) will be slow to improve. The FOMCs own unemployment projections show a 9.0% rate at the end of next year, suggesting that the Fed will likely complete its QE2 policy as planned. When we look beyond 2011, growth in our macroeconomic forecasts looks solid enough in the second half of 2012 for the Fed to begin moving towards a normalisation of policy. This could begin with hikes in both the Federal funds rate and the interest rate paid on excess reserves. Raising the Fed funds target in 25bp increments, beginning late in Q3, would leave the funds rate at 1% at the end of 2012. At the same time the Fed could begin additional measures, such as reverse repos and term deposits at the Fed, to attenuate the potentially inflationary impact of excess reserves in the system.
Source: Census Bureau, BEA
Homeowners negative equity

Near Negative Equity (LTV 95 to 100%), 5%
Negative Equity (LTV 100 to 125%), 13%
Severely Underwater (LTV 125%+), 11%
Positive Equity, 71%
Source: IMF
Inflation is too low

3.0% 2.5% 2.0% 1.5% 1.0% 0.5% Jan-00 Jan-03 Jan-06 Jan-09
CPI-U: All Items Less Food and Energy (NSA, 1982-84=100) % Chg - Year to Year Market-Based PCE: Ex. Food & Energy: Chain Price Index (SA, 2005=100) % Chg - Year to Year (rhs)
2.4% 1.9% 1.4% 0.9% 0.4%
The budget deficit and the new Congress

Developments on the fiscal front will play an important role in the next Congress. The stimulus from the American Recovery and Reinvestment Act (ARRA) boosted 2010 growth. As it fades, it could have trimmed 0.5 percentage points from real GDP growth in both 2011 and 2012. However, the Bush tax cuts of 2001 and 2003, which were set to expire at the end of this year, are expected to be extended for all income groups next year. When the extensions of unemployment insurance, payroll and other targeted tax cuts (or extensions) and tax incentives for business investment spending are added to the cost of keeping the lower marginal tax rates, the government stimulus could total almost USD800bn over two years compared with current law. However, as most analysts had assumed the tax cuts would be extended, the impact on growth forecasts will reflect mainly the impact of the payroll tax holiday, extended unemployment insurance and favourable expensing rules for business investment.
Source: BLS, BEA
13
Large output gap

6% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% Forecast
The new Congress will seek to curb government spending in the years ahead, particularly as the Republicans are disinclined to raise revenues via higher taxes. Voters voiced their discontent with Washington in the mid-term elections. The Republican party won a solid majority in the House of Representatives on a tide of anti-big-government spending championed by Tea Party sympathizers. Given the concerns over the risks and efficacy of current monetary policy, several Fed policymakers, including Mr Bernanke, will no doubt be pleased to see that additional near-term fiscal stimulus from Washington is likely to complement the FOMCs accommodative monetary policy measures. However, in the months ahead, budget policymakers must be careful not to undermine current growth in some misguided deficit-reduction zealotry.
90 92 94 96 98 00 02 04 06 08 10 12 Real Potential GDP {CBO} (USDbn Chn.2005) % Chg - Period to Period Real GDP (SAAR, USDbn Chn.2005) % Chg - Period to Period
Source: CBO, BEA, Crdit Agricole CIB
Budget deficit unsustainable
The Fed will come under increased scrutiny by the next Congress, as the Fed is seen by some in the new Congress as an integral part of the big government complex they dont like. The Feds critics will characterise the aggressive policy response (both fiscal and monetary) to the crisis as a waste, a bailout of the big banks that did not bring down the unemployment rate for the folks on Main Street. The counterfactual argument: What would have happened if they hadnt done what they did? is rarely asked. Recent criticism of the Feds QE2 initiative by some Republican leaders appears to be a calculated political move to exploit the anti-Washington sentiment among Tea Party sympathizers. We do not believe that proposals to change the Feds mandate have much support in Congress, although some Fed policymakers might find the idea appealing. We believe the Fed will successfully guard its independence from the partisan politics of the day. The Federal government budget deficit is not on a sustainable trajectory. Decisions should be made in the next Congress to return it to a sustainable path over the next few years. There are many proposals on the table as to how to reduce the deficit and government debt. For example, the Presidents budget commission on fiscal responsibility and reform proposals include significant cuts in defence spending, caps on discretionary spending, raising the retirement age for social security and reducing some middle-class tax breaks such as the mortgage interest deduction. The plan seeks USD4trn in deficit reduction through 2020 that will reduce the budget deficit to below 2.5% of GDP by 2015 and bring the debt/GDP ratio down to 60% by 2023. So far, these plans have yet to gain significant traction but they provide the basis for starting the negotiations. However, a new crowd is riding into DC on an anti-big-government, antibusiness-as-usual platform. Will the Tea Party Republicans follow the party leadership as it seeks to negotiate a budget deal with the Democratic majority in the senate? Or will they reject compromise, which would lead to political gridlock or worse? The experience of the 1994 Republican Congress with its Contract with America suggests that a willingness to shut down the government as a negotiating tactic is unlikely. The electorate blamed Congress for the problem not President Clinton and the strategy backfired. Polls indicate that, while many voters view the Tea Party favourably, they do not generally support the extreme views of some of its leaders. The American people, and the financial markets, would have little patience for a do-nothing Congress, given the need to find solutions to long-term problems as well as deal with the current economic underperformance. The sovereign debt problems in the EU reinforce the idea that governments must take action now on the budget front or the markets will eventually force the issue. The budget commission entitled its proposal The Moment of Truth. We hope our politicians are up to the task.
Source: CBO
Two-year cost of budget deal

USDbn Extension of Bush Tax Cuts 286 Index AMT for Inflation 153 Estate Tax Changes 33 56 Extended Unemployment benefits 112 Payroll Tax Holiday Investment Incentives 114 Other Tax Provisions 43 Total 797 Source: Joint Committee on Taxation
14
Japan: Soft landing even without policy stimulus

As has been the case for many major economies, the Japanese economic recovery thus far has been amply supported by policy stimulus. With consumption and capex expected to account for the major part of economic growth, the pattern of economic growth in years ahead will be similar to thus far, but the economy will continue to grow stably without stimulus.
Soft landing (real GDP growth)

%YoY 6 4 2 0 -2 -4 -6 -8 -10 Q108 Q308 Q109 Q309 Q110 Q310 Q111 forecasts
Real GDP for Jul-Sep showed robust growth yet again and that the Japanese economy was continuing to grow above potential. With private consumption supported by a combination of special factors, including front-loading of automobile purchases prior to the expiry of the subsidy and unusually hot summer weather, we expect that the falling-off of these one-shot impacts in OctDec will result in a temporarily negative real GDP growth of -0.2% QoQ. However, our forecast for the Oct-Dec quarter still means that the Japanese economy will grow by +3.6% in 2010, which is well above its potential growth rate, and that it will outperform most of the major economies. As has been the case for many of the major economies, the Japanese economic recovery so far has been amply supported by policy stimulus, which has created a positive cycle with robust private consumption stimulating the demand for capex. In addition, similar schemes abroad have also supported exports despite adverse JPY exchange rates all the while. Thus, much of the present economic recovery is explained by private consumption, capex and exports. Looking ahead, we expect that the pattern of the economic growth will remain mostly the same but the three areas will contribute less positively with our economic growth forecasts for 2011 and 2012 envisaging +1.3% and +1.7%, respectively. On the consumption front, while we believe that the recent recovery in wages will support stable consumption growth, our view that the robust growth in consumption so far will not be sustainable is well summarised by the fact that the average propensity to consume has remained higher all the while. That is, households have supported their purchasing just by increasing the share of income spent on consumption, and this pattern needs to be normalised. On the capex front, cheap replacement costs for existing capital stock on the back of low interest rates will continue to stimulate the demand for capex. However, quarterly real GDP growth rates during the present recovery have been far more volatile than is usual in expansionary economic phases. Thus, firms might not really believe they are on a stable growth path and are likely to remain cautious with very large upswings, meaning large slumps thereafter. On the export front, with policy stimulus fading away in major economies, export growth will also stabilise to sustainable levels in such a way that sluggish exports to the US and EU will be compensated by steady demand from emerging economies. All of those factors lead to our view that those drivers will contribute less positively to growth. That said, however, our estimates suggest that the potential growth rate of the Japanese economy is a little more than +1% and thus actual growth into years ahead will still exceed the potential by a comfortable margin without policy stimulus. This is reflected in our inflation forecast, and a narrowing output gap will stabilise the core CPI inflation rate at -0.4% for 2011 and 0.0% for 2012. On the monetary policy front, inflation will stay short of levels that could justify the exit from what the Bank of Japan calls a comprehensive monetary easing, which is a combination of the Zero Interest Rate Policy and the creation of the asset purchase fund. When the BOJ decided upon the policy, the statement read that the policy would be maintained until the core CPI inflation rate approached around +1% there is likely to be a long way to go after the inflation measure turns positive. In addition, we believe the government will not be patient enough to wait for the inflation measure to approach the threshold and the BOJ will be required to do more than just look to the prospect of the exit strategy. We still believe that the BOJ will make further accommodative policies under the newly introduced asset purchase programme. The BOJ will increase the degree of diversification of the assets into more risky criteria such as corporate bonds and equities to stop asset deflation.
Source: Cabinet Office, Credit Agricole CIB
Easing deflationary pressures

% YoY 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 01 02 03 04 05 06 07 08 09 10
Source: Ministry of Internal Affairs and Communication, Crdit Agricole CIB
BOJs asset allocation (Oct 2010)

%share Foreign Bonds, 4.4% Others, 0.8% Gold, 0.4%
Loans, 29.3% Equities, 1.2% Corporate Bonds, TBs, 0.01% 16.9%
JGBs, 47.0%
Source: Bank of Japan, Crdit Agricole CIB
Susumu Kato
susumu.kato@ca-cib.com +81 3 45 80 53 36
15
Eurozone: A big if
The crisis affecting the Eurozones public finances has entered a new, deeper phase since mid-October, despite the fact that the economic fundamentals have improved in most countries since the summer, not just in Germany. Overall, the growth outlook is still fairly upbeat, but financial stability looks set to remain dependent upon new economic policy initiatives in 2011.
Public deficit set to tighten

%GDP 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 GermanyFrance 2010 Italy Spain Portugal 2011 2012
The entire paradox facing the Eurozone can be summed up in a single observation: macroeconomic, fiscal and even banking fundamentals are improving for close to 90% of the Eurozone, but financial tensions have never been so strong, to the point where extreme scenarios of a fiscal union issuing European bonds, or on the other hand an orderly restructuring of public debt, are now seen as less unlikely by a growing number of observers. Yet, everyone agrees on the means for emerging from the crisis in the medium term: these involve a significant reduction in public deficits and current account imbalances, structural reforms to stimulate competitiveness, and recapitalisation for ailing banks. In the near term, however, it is the response of economic policy that could determine the future of the Economic and Monetary Union (EMU). If new, credible measures are announced by governments and the ECB to limit contagion risks; if the permanent crisis resolution mechanism deployed after 2013 becomes more transparent; and if the banking system is strengthened, the conditions will have been created for a gradual easing of market tensions in 2011 and for the recovery to continue, especially as monetary conditions should remain largely accommodative and the EUR is set to resume its depreciation in trade-weighted terms. However, it must be admitted that it is far easier to resolve crises with a series of ifs. This paradox between economic fundamentals and the market perception of risk is thus a paradox in appearance only. In reality, it reflects the Eurozones inability to manage internally the prospect of a default by one of its member states. EMUs main conception design fault is precisely due to the fact that this eventuality was not thought through in the EU Treaty, which explains the ambiguity in the socalled no bailout clause. Since the Greek crisis and the deployment of the European Financial Stability Plan in May 2010, the clause has been replaced with de facto financial solidarity, combined with strict conditionality, but the more general issue of the extent of fiscal integration has yet to be resolved. The public finances of peripheral countries are still in a critical state despite the additional austerity measures announced since the spring and the initiatives taken by governments and the ECB to stabilise refinancing conditions. Our fundamental analysis of public finance trajectories suggests that in our central projection, all Eurozone countries are solvent: in other words, they can generate a sufficiently large primary surplus to stabilise and then bring down their medium-term public debt ratios. However, the sensitivity of the results to growth and interest rate assumptions is particularly high, to the extent that a new macroeconomic or financial shock, even on a modest scale, could undermine the solvency of the weakest countries, such as Greece, and to a lesser extent, Portugal and Ireland. In view of these risks, it is crucial for national governments to convince the markets rapidly of their ability to deliver the fiscal efforts scheduled for the years ahead. With the exception of Portugal, which began its consolidation process late in the day and is being penalised by poor growth prospects, recent fiscal indicators from Spain as well as from Ireland and Greece are relatively encouraging. At the fundamental level, not only has the recovery been confirmed since the summer, but it now seems more balanced in its components, fuelled by domestic demand as much as, if not more than, by exports. This trend should continue in 2011 despite the numerous headwinds, chief of which is the accelerating pace of fiscal consolidation. The high level of business confidence surveys and the sharp rise in corporate profits in late 2010 notably suggest an acceleration in investment spending over the coming quarters. The labour market is about to stabilise in most countries, and its forecast steady improvement in
Source: Eurostat, Crdit Agricole CIB
Public debt still rising

%GDP 140 120 100 80 60 40 20 0 GermanyFrance 2010 Italy 2011 Spain Portugal 2012
Rates of capacity utilisation

% 90 85 80 75 70 65 60 06 07 Germany Italy 08 09 France Portugal 10 Spain Greece
Frederik Ducrozet
frederik.ducrozet@ca-cib.com + 33 1 41 89 98 95
16
Corporate profits edging higher

QoQ,% 3 2 1 0 -1 -2 -3 -4 06 07 08 09 10 Gross Operating Surplus
2011 should sustain household incomes and consumption spending. Although short-term growth prospects are favourable, nevertheless they mask considerable cross-country differences and asymmetrical risks. Germany and to a lesser degree the countries of Northern Europe, France and Italy are benefiting from more modest but stronger growth, overall. Conversely, activity levels are only just stabilising in Spain, Portugal and Ireland, with a variable but non-negligible risk of a temporary GDP contraction in these countries. Greece is expected to remain anchored in recession until 2011, even if our forecasts are for an increasingly less severe contraction in GDP and a return to growth in 2012. Generally speaking, the deleveraging process is ongoing, but at varying rates from one country to another in the economic sectors where the recent imbalances originated. The real estate market, for example, is deteriorating at a slower pace in Ireland and Spain, even if more modest price falls are again expected in 2011. Spanish and Portuguese households continue to rebuild their savings at a relatively sustained rate, and businesses have started to pay down their stock of debt. At this stage, inflation is a non-subject, and price pressures are largely contained, but here too the risks vary considerably from one country to another. Core inflation in particular had begun to stabilise throughout the Eurozone, followed by a slight uptick above 1% YoY since the summer, but the trend can be partly put down to VAT increases in Spain, Portugal and Greece. Wages are not showing any strong signs of picking up except in Germany. Bank lending conditions should gradually ease in 2011 too, but demand also varies widely. As a result, national M3 monetary aggregates are growing at very differing rates. Faced with a dramatic increase in financial stress, the ECB has finally decided to defer the normalisation of its refinancing operations by extending its unlimited provision of liquidity for banks until the end of Q111 at the minimum, and for maturities of up to three months. The ECB is again showing considerable flexibility in its liquidity management, and its strategy can be quickly adjusted either way: if pressures persist, some ad hoc measures could easily be reintroduced, including longer-term repos; if the money market continues the normalisation begun this summer, the ECB could resume its exit strategy from April 2011, notably by allocating limited amounts of liquidity at variable rates. Conversely, it seems highly unlikely that the ECB will embark on full-blown quantitative easing by monetising public deficits, which is formally prohibited by its status. By maintaining a state of readiness to increase its (sterilised) purchases of public debt securities on the secondary market, through its dedicated Securities Market Programme, it is seeking to stabilise liquidity conditions rather than to bring long-term rates down. Moreover, the uncertainty about the amounts actually purchased by the ECB is again creating a form of constructive ambiguity similar to that seen in May, in the hope that market conditions will return to normal. In our central projection, characterised by a gradual fall in sovereign risk, more balanced growth, inflation fluctuating temporarily above its target and an acceleration in monetary aggregates and credit, it will be increasingly complicated for the ECB to keep its key policy rates unchanged at 1% after summer 2011, when the monetary policy rules ought to suggest interest rates above 2% in view of the weight of Germany. In practice, however, that sort of difference could be justified by the wide nominal and real divergences among Eurozone countries and the downside risks that fiscal austerity measures are creating for economic activity. In our central projection we are still forecasting a first increase in the refi rate in Q112, with the risk that a first move could come as early as end-2011 if conditions are met. But that is a big if indeed.
Inflation to hover around target

YoY,% 5 4 3 2 1 0 -1 06 07 08 09 10 11 12 HICP HICP ex Energy & Unproc. Food
Excess liquidity creeping lower

EURbn 400 300 200 100 0 -100 Jan-10 Apr-10 Jul-10 Oct-10 liquidity provision - liquidity needs
Source: ECB, Bloomberg, Crdit Agricole CIB
17
France: Good things come to those who wait

French GDP growth is firming up. In Q3, economic activity advanced 0.4% QoQ, buoyed by strengthening domestic demand. This more self-sufficient GDP growth will allow France to be better equipped to withstand the trials awaiting it in the medium term strong budgetary consolidation and a slowdown in the global economy. We are forecasting activity growth of around 1.5% in 2011 and 1.8% in 2012.
France: growth slows in Q3 but does not stall

GDP growth contributions QoQ, % 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 07 08 09 10 External balance Inventory changes Domestic demand (excl. inventories) GDP
French GDP growth advanced 0.4% QoQ in Q3, compared with 0.7% QoQ in Q2. Activity has thus slowed, but its components show that growth is progressively becoming more self-sufficient. In Q3, domestic demand largely sustained activity, while foreign trade had an adverse effect on growth due to higher imports. Little by little, factors that once allowed the French economy to emerge from recession are fading, and giving way to growth rates that, while undoubtedly lower, are also quite robust. Changes in inventories will continue to contribute to GDP growth, but only in the short term. Business leaders are acting cautiously, continuing to run down inventories in Q3. In a still-uncertain environment, the forthcoming restocking trend is likely to remain modest and short-lived. Foreign trade, the second factor behind the rebound in the French economy, is likely to weigh on activity in the coming quarters. French companies are experiencing structural issues regarding their international positioning, such as their weak capital levels, and tight export margins. Consequently, French firms will be even more exposed to the expected global economic slowdown. With only a modest restocking of inventories in sight and a limited international presence, domestic demand will undoubtedly drive economic activity in the medium term, albeit at a moderate pace. If private consumption sustained the French economy during the crisis, it was undoubtedly due to the positive role played by various governmental measures to prop up purchasing power. But, as public finances are restructured, the question remains whether French households will be able to go on consuming as much. In theory, yes. Post crisis, employment levels are expected to pick up and income to rise. But, for now, employment remains at a reduced level and incomes limited.
Source: Insee, Crdit Agricole SA
France: stability of the Q3 unemployment rate

% 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 00 01 02 03 04 05 06 07 08 09 10 Number of unemployed (rhs) Unemployment rate YoY, 000' 800 600 400 200 0 -200 -400 -600
Companies lost productivity gains during the recession, and the current rebound in productivity, achieved thanks to the lag between economic upturn and recovery in employment, has not yet closed the accumulated gap. To restore their lost productivity, businesses could delay hiring, as suggested by the stability of the Source: Insee, Crdit Agricole SA Q3 unemployment rate at 9.3% of the workforce in continental France. Households are convinced of this, and their morale is consequently still very poor, France: a sluggish investment recovery with the Insee index at -32 in November. In all, private consumption should grow at a modest rate, of around 1.8% in 2011, and then pick up in 2012 to YoY, % 2.1%. 10 Forecasts
5 0 2. The nearrecession of 2001 3. The recession -10 of 2008 90 92 94 96 98 00 02 04 06 08 10 12 Corporate investment -5 1. The 19921993 recession
Business investment should gradually gather pace. Business investment has picked up since Q210, with the replacement and modernisation of capital equipment which became obsolete during the recession. Companies are also taking advantage of very attractive financing conditions. Nevertheless, the overall trend is likely to remain sluggish. For one thing, demand expectations are extremely volatile as France emerges from recession. For another, a division of value-added that is more favourable to workers could dampen the outlook for profits. We are forecasting an increase in business investment of 2.7% in 2011 and 3.8% in 2012. In view of all these factors, the slow growth phase is likely to continue for several quarters. Only after that will the post-crisis period begin. As a result, French GDP growth should come in at 1.5% in 2011 and 1.8% in 2012.
Source: Insee, Crdit Agricole SA
Axelle Lacan
axelle.lacan@credit-agricole-sa.fr + 33 1 57 72 03 29
18
Germany: Inside strength

The pleasant surprises concerning Germanys economic activity and its self-sustaining character continue to come thick and fast at a time when external growth drivers are gradually losing impetus. Although this latest German economic miracle will benefit the Eurozone as a whole, it simultaneously highlights the divergence between countries.
Private consumption edging higher

index, volume m, annual rate 103 4.5 102 4.0 101 100 3.5 99 3.0 98 97 2.5 96 95 2.0 Jan-07 Jan-08 Jan-09 Jan-10 Retail sales New car reg (rhs)
The German economy continues to achieve greater balance as it moves over to domestic growth drivers. As in the previous cycle, the rapid rebound in exports has sustained corporate profits, as gross operating income rose by 4.6% QoQ in Q310. At the same time it created new prospects for investment spending by businesses, which continued to grow at the high rate of 1.3% QoQ in Q3, despite a correction in the construction sector. Several support factors should remain in place for next year, starting with the high level of order books, an industrial capacity utilisation rate that has bounced back towards its long-term average, and strong growth in emerging countries, which are seen as strategic trading partners, notably in Asia. In contrast to previous cycles, however, the labour market has been especially resilient since the start of the recession, with the initial assistance of public subsidies for short-time work, continued from early 2009 by genuine job creation. Total employment, in fact, currently stands at 40.5 million, its highest level since reunification. While manufacturing continues to be the main job-creating sector, confidence surveys and the other available cyclical indicators suggest that the service sector is also taking up some of the slack. Consequently, in November, household confidence surged to its highest level since the late 1970s, according to the European Commission survey, and consumer spending has been rising at trend levels for the past year and more, while the short-term outlook is largely positive. Wages are clearly trending upwards and inflation is being kept in check, suggesting a probable acceleration in income levels in real terms. Furthermore, the spending cuts scheduled for the next two years should have a less severe impact on private consumption than in most Eurozone countries, despite the fact that major tax incentives are set to expire in 2010 and 2011. Not only is the planned cumulative fiscal consolidation effort less than the average, but measures targeted towards cuts in public spending traditionally have a limited impact in Germany, notably as a result of its high savings ratios, which, on a harmonised Eurostat measure, stood at 17.2% in Q210 compared with the Eurozone average of 14.7%. Domestic demand is still the key factor driving activity, for the third quarter in a row, contributing all of the 0.7 percentage point of GDP growth in Q3, whereas the trade balance (0.3ppt) and inventories (-0.3ppt) cancelled each other out. If this trend continues, the gradual easing of lending conditions suggested by the latest edition of the Bundesbank survey of credit institutions could even act as an accelerator. Monetary and financial conditions are in fact still very accommodative relative to German fundamentals and seem likely to remain so in 2011. The increasingly self-sustaining growth is timely, since a number of growth drivers are set to fade out gradually. The manufacturing cycle is not finished, of course, but it shows signs of running out of steam. Although most confidence surveys have not deteriorated much since the end of Q3 (and in the case of the IFO survey, have even risen), data on activity (ie, industrial production, new orders, exports) has shown the first early signs of forecast moderation following the record growth rates observed until this summer. Although partly offset by the pick-up in domestic demand, the forecast fall-off in external demand should slow the pace of Germanys growth rate in 2011, even if new spurts are possible.
IFO up to new highs

YoY,% std dev. 10 4 8 3 6 2 4 1 2 0 0 -1 -2 -2 -4 -3 -6 -8 -4 95 97 99 01 03 05 07 09 11 GDP IFO (normalised, rhs)
Source: Eurostat, IFO, Crdit Agricole CIB
Rebound in corporate profits

QoQ,% 6 4 2 0 -2 -4 -6 -8 07 08 09 10 Gross Operating Surplus
Frederik Ducrozet
frederik.ducrozet@ca-cib.com + 33 1 41 89 98 95
19
Italy: Moderate but positive growth ahead

Political instability and Eurozone sovereign woes have recently heightened market risk perception towards Italy, but economic fundamentals remain stable and monthly budget figures are firmly on track. Despite a slowdown in GDP growth in Q3, the Italian economy is expected to expand by 1% in 2010 and 2011, with external demand remaining the main source of growth.
Italy: reduction of the public deficit on track

% of GDP 6 5 4 3 2 1 4.4 3.3 5.3 2.7 YTD Sept, 2010 Deficit goal 2010 : 5% of GDP
After a relatively robust growth performance in Q1 and Q210 (+0.4% QoQ and +0.5%, respectively), the Italian economy lost steam in Q3, progressing by only +0.2% QoQ. The slowdown was expected as demand had weakened in Italys main European trading partners. Net exports contributed 0.2 points to GDP growth in Q3 (after 0.6 in Q2). With regard to domestic demand, the turnaround in investment spending was also expected, in line with the expiry of certain fiscal incentives. Equipment investment fell from 3.9% QoQ in Q2 to 1.0% in Q3, while construction investment began to stabilise. Household consumption remained poor (+0.1% in Q3), reflecting the still-fragile state of the labour market.
In a context of rising uncertainty in Europe and weak demand, activity levels in Italy are expected to remain moderate until year-end. In particular, the exportled recovery in the industrial sector has dampened. Taking into account the 0 2.1% MoM drop in September, industrial production in Q3 progressed on average 2006 2007 2008 2009 2010 1.3% QoQ (compared with 2.0% in Q2). Recent survey data, notably the PMI index, has pointed to an ongoing expansion in manufacturing activity in Q4, but at Source: Eurostat, Bank of Italy, Crdit Agricole a slower pace. The national ISAE manufacturing survey has improved SA significantly, but nevertheless remains below its long-term average. Italy: ISAE national confidence index Against this background and despite favourable borrowing rates, investment plans are expected to remain prudent. Spare production capacity index 120 in the manufacturing industry has improved, but still remains largely below its long-term average (70.9 compared with 75.7). Furthermore, the employment 110 subcomponent in the PMI index fell below the 50-point barrier in November, 100 suggesting that the current level of activity in Italy is not currently strong enough to promote job creation and wean the economy off the government-supported 90 wage supplementation scheme. The unemployment rate began to rise again in 80 November (8.6% compared with an average 8.3% since the beginning of 2010), and is expected to remain above 8% throughout the forecast period. The number 70 of hours worked, which shrank considerably during the crisis in order to keep 04 05 06 07 08 09 10 employment stable, will need to return to pre-crisis levels before employment Household confidence picks up. Industrial confidence
Long term average (hld) Long term average (ind)
Source: SAE, Crdit Agricole SA
Italy: GDP growth forecast

QoQ % 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 2008
The slow recovery projected in the labour market will prevent any swift recovery in private consumption. However, fiscal austerity measures, which are not as harsh in Italy as in other European countries thanks to a tighter control of the budget deficit during the crisis, are expected to have a relatively limited impact on domestic demand. The current budget plan is to reduce the deficit from 5.3% of GDP in 2009 to 2.7% in 2012. Overall, Italy has a sturdy profile of moderate but positive growth. GDP growth is expected to expand an overall 1.0% this year, and is projected to keep the same moderate pace in 2011. A better-than-expected boost to export demand would pose an upside risk to our scenario. However, downside risks remain, notably through a strengthening of market risk aversion towards Italy, which would translate into an increase in the price of capital for the whole economy and would weigh on economic confidence.
Forecasts
2009
2010
2011
Source: ISAT, Crdit Agricole SA
Bndicte Kukla
benedicte.kukla@credit-agricole-sa.fr + 33 1 43 23 18 89
20
Greece: Even more effort is needed

The economy has entered a deep recession (Q310 GDP: -4.5% YoY). Domestic demand is not expected to start picking up before late 2011. Additional measures are needed to curb the public deficit to -7.4% of GDP in 2011.
General government figures (% of GDP)

55 50 45 40 35 30 25 20 2006 2007 2008 2009 2010 2011* 2012* 2013* 2014* -16 -20 -8 -12 0 -4
Greece's fiscal consolidation has progressed broadly as planned so far. The shortfall in tax revenue and to a lesser extent the incorporation of public enterprises into general government data and adjustments to social security accounts have led to a higher public deficit. However, it has decreased markedly as a percentage of GDP (2010: -9.4%, 2009: -15.4% of GDP). The general government debt has consequently been adjusted upwards (2010: 142.5%, 2009: 126.8% of GDP). The budget for 2011 is undoubtedly tight. It aims to offset the overrun in the deficit and provides for further measures to curb it to -7.4% of GDP, in line with the IMF/EU/ECB agreement. As there is not much scope for levying new taxes, the emphasis has shifted towards more structural changes. Crucial reforms are the streamlining of the tax-collection mechanism and the fight against tax evasion to make taxes a reliable funding source, as well as deep spending cuts in the health sector, municipalities and loss-making state-owned companies. The effort continues in an environment of ongoing recession. GDP contracted by 4.5% in Q310 and is expected to be down by 4.1% in all of 2010. Recession should be milder in 2011 as the measures taken are expected to gradually bear fruit. However, the additional austerity measures will likely drive growth lower (c.-3.0%) than we previously expected. Domestic demand will again be a drag on growth but should recover towards the end of the year as confidence is gradually restored and sentiment improves depending on the progress of fiscal consolidation. Recession has taken a severe toll on jobs, and the unemployment rate, which climbed to 12.2% in August, is set to continue to increase. As economic slack continues and conditions in the labour market worsen consumer price inflation should abate in 2011. Excise tax hikes as in 2010 will not be repeated. A reclassification of goods and services to higher VAT rates and an increase in the consumption tax rate on heating oil scheduled for 2011 should not severely affect prices upwards. The increase in private sector wages envisaged in the collective wage agreement to match the average Eurozone inflation rate should be mitigated by the introduction of in-house pay agreements. Thus, wages are not expected to exercise any substantial upward pressure on prices. Overall, we foresee an inflation rate, on average, slightly above 2.0%, from 4.6% in 2010. The upcoming months are critical. The country has to implement reforms that have been lingering for decades swiftly, in order to ensure the fourth tranche of the financial aid. Looking ahead, reforms are crucial to turn around the economy, strengthen productivity and enhance competitiveness. They should allow Greece to sustain the reduction in the public deficit and create primary surpluses in the state budget to alleviate the huge debt load. Downside risks could add to the difficulty of the task. The economic adjustment process has been based on the assumption of a benign external economic environment, which, continues to be characterised by considerable uncertainties. Moreover, should social tensions intensify, the much-needed reforms and fiscal consolidation could be delayed.
Expenditure Deficit (rhs)
Revenue
* Projections Source: Hellenic Ministry of Finance
Real GDP growth & unemployment rate (%)

6 4 2 0 -2 -4 -6 2006 13 12 11 10 9 8 7 6 2007 2008 2009 2010 GDP YoY Unemployment rate % (rhs)
Source: Hellenic Statistical Authority
Sovereign spreads (%)

10 8 6 4 2 0 2008 Greece Spain
2009 Ireland Italy
2010
Nov Portugal
Source: Bloomberg
Aikaterini Anagnostopoulou
anagnostopoulou.k@emporiki.gr + 30 2 10 32 51393
21
Spain: Government holds its course in the storm

Growth stabilised in Q310. The correction in the real estate market will continue to weigh on the Spanish economy. Foreign trade will help sustain growth in 2011. Public finances are on the mend.
GDP and contribution of its components

pp 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 Q108 Q308 Q109 Q309 Q110 Q310 inventories ext.trade domestic demand GDP (rhs) % 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5
GDP growth was stable in Q310, after a rise of 0.3% QoQ in Q2. Year-on-year, the Spanish economy has posted its first positive growth rate (0.2%) since Q308. The result can be attributed to the strong positive contribution from foreign trade (+1.8ppt, compared with 0.8ppt in Q2). Although favourable at first sight, this figure results from lower imports (down 5% QoQ, compared with a rise of 3.6% in Q2), and not from strong foreign demand. Exports have remained relatively flat this quarter (0.1% after 1.4%). The drop in imports is thus no more than a reflection of weak Spanish domestic demand, which flagged in Q3 (1.3% QoQ excluding inventories, compared with 0.9%). Households have slashed their consumption spending (down 1.1% QoQ) due to the two-point VAT hike in July (to 18%). The correction in real estate investment continues, down 3.2% QoQ, after 2.2% in Q2. Businesses have sharply reined in their spending (down 5.2% QoQ, compared with the previous 4.2%) due to sluggish domestic demand and upheavals on Europes capital markets. Headline inflation came out at 2.3% in October, reflecting earlier oil price increases and the hike in the VAT rate. Core inflation rose to 1.1%.
The first available data for Q410 (PMI indices, European Commission surveys, household surveys, retail sales) suggests that Spanish growth will remain weak Residential property prices as the year draws to an end (0.2% QoQ). The real estate market correction is likely to run on well into 2011. Spanish property prices have fallen by no more 400 than a cumulative 12% since the start of 2008, which is not much compared to Ireland, where house prices have fallen by 36%. Despite the sudden halt in new housing starts, it could take several more years to absorb the stock of unsold 300 housing, especially as, in addition to the finished programmes, many others are ongoing or halted as they stand. The labour market situation will also remain 200 tense. In Q310, Spains unemployment rate was the highest in the Eurozone, at 20.5% of the workforce. However, the labour market reform 1 , which has created greater flexibility, should help to bring unemployment down, in the second half of 100 2011 at the earliest. Following the bursting of the property bubble, Spain is 95 97 99 01 03 05 07 09 UK Spain also looking more beyond its borders. Even if Spain has to cope with a France Ireland structural competitiveness deficit, foreign trade should nevertheless allow the Index base 100=Q296 country to post GDP growth of 0.4% in 2011 (compared with -0.2% in 2010), and 1.0% in 2012. Source: Halifax, Ministerio de Fomento, Fnaim Furthermore, the pressure from the financial markets and the risk that the public Spain: employment and GDP finances might slide out of control have prompted the government of Jos Lus Rodriguez Zapatero to continue its fiscal restructuring efforts. Over the first ten YoY, % months of this year, its austerity measures enabled it to cut the state deficit by 6 over 40% and bring it closer to 3% of GDP, as opposed to 5.6% in 2009. If we 4 add in the deficits from other authorities notably those of the regional authorities 2 the deficit would come close to 9% of GDP in 2010, after 11.1% in 2009. Spain 0 is thus on track to respect its commitments in terms of budget cuts this -2 year, the governments target being 9.4% of GDP. The ratio of public debt to -4 GDP should come in at 63% at year-end, after 53.2% in 2009, far lower than the -6 Eurozone average. The 2011 Budget will be similar, featuring a 7.9% cut in state -8 spending.
Source: INE, Crdit Agricole SA
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 GDP Employment
Source: INE, Crdit Agricole SA
Sandrine Boyadjian
sandrine.boyadjian@credit-agricole-sa.fr + 33 1 43 23 65 42
Overall, even if the markets currently have Spain firmly in their sights, as illustrated by the widening interest rate spreads, the situation seems to be well under the control of a proactive government (it proposed privatising two airports and the national lottery on 1 December), which communicates regularly on the state of the public finances and the health of Spains banks.
The reform was approved in September 2010 and is particularly designed to bring down the punitive cost of redundancies and adjust the wage-setting mechanism to better take the specific situation of each company into account.
22
Scandies: European safe haven

Swedish and mainland Norways growth gained further momentum in Q3. Despite concerns of a slowdown in global trade, the outlook remains positive as there is no need for radical fiscal austerity plans and household spending remains strong. However, uncertainty about external demand has triggered more cautiousness from the Norges Bank, which will remain on hold in the coming quarters. The Riksbank will continue to raise its repo rate only gradually towards more normal levels.
Norway: PMI manufacturing survey

index 70 65 60 55 50 45 40 35 30 02 03 04 05 06 07 08 09 10 Sweden Norway
Norway: Productivity
% YoY 6 4 2 0 -2 -4 -6 02 03 04 05 06 07 08 09 10 Norway Sweden
The stellar performance of Swedish GDP in Q310 (2.1% QoQ, or 8.7% annualised), the fastest since 1993, exceeded our, consensus and the Riksbanks expectations. Most of the surprise came from the acceleration in inventories rebuilding, which accounted for 0.6ppt of growth. Less of a surprise was the strengthening in domestic demand, excluding stocks. The combination of relatively low interest rates, rising equity prices and improving labour market conditions contributed to the rise in household spending (1.4% QoQ in Q3). The near-term outlook for household spending remains positive. The monetary policy normalisation is set to continue only gradually and even to ease off if external growth remains a concern. Supportive fiscal policy reforms and lower labour costs (due to limited wage increases) should continue to stimulate employment. Notwithstanding some recent weakening, consumer confidence indicators stand at unprecedented high levels. The strengthening in investment growth (3.2% QoQ after 2.2% QoQ in Q2) is creating conditions for sustained growth ahead. Capacity utilisation and productivity continued to rise, suggesting investment should continue to grow even if the possible slowdown in external demand could lead to greater caution in the private sector and less support from global trade. We continue to expect growth above the long-term average in the coming quarters. The next repo rate hike by the Riksbank is expected in February 2011. Beyond that, weak core inflationary pressures (due to low labour costs and the appreciation of the SEK) point to a less aggressive repo rate path (we expect +0.25% per quarter on average in 2011 and 2012). Norwegian mainland GDP growth, which is relevant when formulating monetary policy, accelerated markedly in Q310 (0.9% QoQ after 0.5% QoQ in Q210). However, total GDP growth (which includes the offshore energy sector) contracted by 1.6% QoQ due to a sharp slowdown in petroleum activities (-10.2% QoQ). As expected, the main driver of growth was household consumption (up by 1.3% QoQ in Q310). Going forward, an environment of low interest rates, a relatively low unemployment, a high saving ratio and relatively high confidence indicators suggest solid growth in consumption. Nevertheless, we forecast somewhat lower growth in consumption in the medium term due to the prospect of tighter credit standards. Contrary to consumption, gross fixed capital formation was a significant drag to growth, especially in the petroleum sector where investments contracted severely (-13% in Q310), but also in the mainland economy (-2.1% QoQ). However, the Norges Bank investment intentions survey continues to indicate that petroleum investment will increase considerably from 2010 to 2011, assuming a 7% increase in 2011 and 4-5% in 2012 and 2013. Expectations of higher gas and oil prices are likely to boost offshore activity in Norway. We therefore continue to forecast a positive contribution from investment to growth during 2011 and 2012. The negative output gap and past appreciation of the NOK have contributed to a decline in underlying inflation (from 2.3% to 1.0% since the beginning of the year), undershooting the Norges Banks expectations. Reduced interest rate expectations abroad have been increasing the risk of further appreciation of the NOK and of a further fall in prices of imported goods. The Norges Bank has postponed future interest rate hikes to summer 2011. Accordingly, we have delayed the next rate hike to Q311. However, in order to avoid the risk of financial imbalances, the normalisation of monetary policy is set to continue thereafter and to bring the key policy rate gradually to 4% at the end of 2013.
Source: Statistics Norway, OECD, Crdit Agricole CIB
Norway: imported inflation

% YoY 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 01 02 03 04 05 06 07 08 09 10 Imported consumer goods CPI-ATE Target (2.5%)
Source: Statistics Norway, Crdit Agricole CIB
Slavena Nazarova
slavena.nazarova@ca-cib.com + 33 1 41 89 99 18
23
UK: The sober years

GDP growth has surpassed expectations over the past 12 months, averting the prospect of more quantitative easing from the BoE. However, because fiscal consolidation is set to intensify in 2011-12, some ambitious challenges remain at a time when consumption remains fragile.
UK: public finances (% GDP)

%GDP %GDP Budget 13 forecasts 80 11 70 9 60 7 50 5 3 40 1 30 -1 20 -3 1974-75 1984-85 1994-95 2004-05 2014-15 Net debt (rhs) Public sector net borrowing
Source: OBR November 2010 Economic and Fiscal Outlook, Crdit Agricole CIB
UK growth continued to surprise on the upside in Q310 (0.8% QoQ, or 3.1% annualised). GDP has thus grown by 2.8% over the past 12 months and recovered 40% of the sharp decline seen during the recession. Recent surveys of business confidence suggest that the expansion in economic activity is continuing in Q4. Exports, up by 2.2% QoQ in Q3, are benefiting from the rebound in foreign trade and strong demand from emerging markets. Exports of financial services in particular have increased for the first time since the start of the crisis. These are all upbeat signals for growth in the short term. It is not free of weaknesses, however. The construction sector in particular, up 4.0% QoQ compared with 9.5% QoQ in the previous quarter, is unlikely to continue expanding at such a high pace of growth. The outlook for the trend in exports is also uncertain due to austerity measures in the Eurozone, which takes close to 45% of UK exports. However, GBPs past depreciation should continue to support UK exports, and we are still forecasting that the trade balance will make a slightly positive contribution to growth over the next two years. Growth is expected to moderate throughout 2011, followed by a pick-up from the second half of 2012. Plans to cut the budget deficit will be a material drag to growth during the forecast period, given that the bulk of the budget cuts is front-loaded in FY11-12. Future growth will therefore depend on the ability of private demand to offset the retrenchment of government demand and the decline in the inventory cycle. Household spending is likely to remain subdued compared with its trend rate as austerity measures have an adverse impact on consumer confidence. But household consumption will above all depend on both how the labour market behaves and on wage growth. Employment grew by 0.6% QoQ in Q3 and has risen by 1% since the start of the year. However, the improvement in the employment situation is fragile because it can be attributed to part-time employment alone (up 4.2% since the start of the year). Full-time jobs have actually declined by 0.2%. The government is considering cutting 330,000 jobs in the public sector over the next five years. Even if productivity has rebounded since the crisis has bottomed out, it is still well below its pre-crisis trend. Employment is therefore likely to improve only gradually in the coming quarters. Growth in nominal wages should also remain low, as businesses need to cut unit labour costs after a period when jobs were preserved to the detriment of productivity. Investment rose for the third quarter in a row (0.6% QoQ), and BoE surveys of the private sector suggest a rise in investment spending over the months ahead. Firms are benefiting from improved profitability thanks to the rebound in demand and have been running substantial cash surpluses in recent quarters. While uncertainty about demand is seen less and less as a factor curbing business investment, according to a CBI survey, the ongoing deleveraging and tight lending conditions, especially for small and medium-sized companies, continue to be the major obstacle to investment growth. Inflation is likely to remain above the 2% target throughout 2011 due to several temporary factors, mainly the forthcoming increase in VAT to 20% in January 2011, GBPs past depreciation (the effective exchange rate has fallen by 23% since mid-2007), rising commodity prices and hikes in gas and electricity prices from end-November/early December. In the medium term, inflation is likely to fall back towards target (in the beginning of 2012 according to our forecasts) but the possibility of an increase in inflation expectations and of wage claims creates an upside risk. As a result, the BoE will, in our view, avoid extending its asset purchase programme and at the same time keep its key rate at the exceptionally low level of 0.5% for as long as possible in order to sustain domestic demand. We have pushed back the BoEs first rate increase to Q411.
UK: Household income

% YoY 10 8 6 4 2 0 -2 00 01 02 03 04 05 06 07 08 09 10 Total household resources Property income (rhs) % YoY 50 40 30 20 10 0 -10 -20 -30 -40
Source: ONS, Crdit Agricole CIB
UK: imported and headline inflation

%YoY 6 5 4 3 2 1 0 % YoY 20 15 10 5 0 -5 -10 02 03 04 05 06 07 08 09 10 CPI Import price index (rhs)
Source: ONS, Crdit Agricole SA
Slavena Nazarova
slavena.nazarova@ca-cib.com + 33 1 41 89 99 18
24
Australia: Resilience helped by China

Economic growth is likely to accelerate into 2011 to around 3.2%, with weaker public spending outweighed by strengthening private spending. The RBA will maintain a gradual pace of tightening, with another 50bp of tightening expected in 2011, whilst the AUD is set to continue to strengthen to around 1.06 versus USD by end-2011.
Pick-up in growth expected over 2011 driven by private spending

2.0 1.5 1.0 0.5 3 0.0 -0.5 -1.0 -1.5 2 1 0 00 01 02 03 04 05 06 07 08 09 10 11 12 QoQ QoQ F YoY (rhs) YoY F (rhs) Australian GDP, % 6 forecasts 5 4
Australia is likely to have achieved GDP growth of 2.8% in 2010, which means that the economy grew around trend. Growth was driven by public spending although its impact lessened towards the end of the year. We expect private spending to pick up the slack, helped in large part by the strengthening in Australias terms of trade. The labour market has been particularly strong and this is also likely to shore up consumer spending in 2011. We expect growth of 3.2% in 2011 followed by a slight uptick in growth in 2012 to around 3.4%. The strength of demand from China will continue to provide significant support for Australias economy, even if Chinas economy undergoes a slight moderation in 2011 as we expect. The impact of resilient demand from Asia will likely outweigh the effects of soft demand from developed economies. One headwind to growth will come from the strength of the AUD especially as we look for the currency to continue to strengthen into 2011. The strong AUD is already having a big impact on the tourism industry whilst manufacturing sentiment is clearly suffering under the strain. More positively, the strength of the currency will likely help to restrain inflationary pressures. However, wage growth is likely to continue to increase, pushing overall inflation higher over the coming months. Underlying inflation is likely to push towards the top end of the RBAs target band around 3%, pointing to more rate hikes. We expect the RBA to continue its policy of gradual monetary tightening, with the Bank set to hike rates by another 50bp in the current cycle following 175bp of rate hikes since October 2009.
Mitul Kotecha
New Zealand: Reconstructing growth

The economy will gain pace over 2011 to around 3.2% helped by reconstruction work following the Canterbury earthquake. Despite elevated near-term inflation, medium-term pressures remain well contained, implying the RBNZ will gradually raise rates, and we look for 100bp of tightening. NZD/USD will continue to perform well into 2011 to around 0.81 by year-end.
Earthquake reconstruction set to help growth recovery in 2011

2.0 1.5 1.0 0.5 2 0.0 -0.5 -1.0 -1.5 0 -2 -4 00 01 02 03 04 05 06 07 08 09 10 11 12 QoQ QoQ F YoY (rhs) YoY F (rhs) New Zealand GDP, % forecasts 8 6 4
New Zealands economy suffered a blow from the Canterbury earthquake in September, the impact of which has weighed on the recovery in economic conditions. However, reconstruction following the quake will likely contribute to firmer growth in 2011. We look for GDP growth of around 3.2% in 2011 following 2.3% growth in 2010. GDP is set to accelerate to 3.5% in 2012. Recovery has been slow, however, and there are downward risks to our forecasts. Household spending in particular, is lacklustre and shows little sign of strengthening given the softness in the housing market and weak demand for credit. Inflation pressures are likely to remain elevated in the short term, exceeding the RBNZs 1-3% target. Inflation will be impacted by the expansion of the governments emission-trading scheme, higher GST, the impact of the earthquake and higher tobacco taxes, which will continue to provide a boost to inflation in 2011. However, medium-term inflation expectations are likely to remain contained, suggesting that the RBNZ will hike rates gradually over the coming months. We look for another 100bp of rate hikes by late 2011, with the Cash Rate likely to peak at 4%. The NZD, like the AUD, will be one of the best performers over the next year, helped by relatively higher yield, firmer growth prospects, and improved risk attraction. Although there has been a pull-back in the NZD over recent weeks, it will provide investors with better levels to buy the currency.
Mitul Kotecha
25
Canada: Is it serious, doctor?

Uncertainty, signs of economic slowdown and CADs appreciation against USD have won out and put the BoCs monetary policy normalisation on hold. Following its last two meetings (19 October and 7 December), it has left its key overnight rate unchanged at 1%. Growth prospects are good, but have been revised downwards for 2011 and should encourage the BoC to mark time until Q311 before resuming its rate increases.
Canada: growth in tune with US

YoY, % 6 4 2 0 -2 -4 -6 00 01 02 03 04 05 06 07 08 09 10 Canada United States YoY, % 6 4 2 0 -2 -4 -6
Source: Statistics Canada, BEA, IHS Global Insight, Crdit Agricole SA
Canada: expensive loonie

1.05 1.00 0.95 0.90 0.85 0.80 0.75 Jan-09
In Q310, growth slowed to an annualised quarterly rate of 1% (after gaining 2.3% in Q2 and 5.6% in Q1). Year-on-year, growth is nevertheless stable at 3.4%, which puts the quarterly fall into proper perspective. The composition of growth also means we do not need to be particularly worried about the headline figure. This is because foreign trade has clipped at least four points off growth due to falling exports, at a time when imports only slowed. Public spending also made a less positive contribution. Consumption rose by 3.5%, however, accelerating compared with Q2, and business investment by 9.4% scarcely less than in the previous quarter. At the end of Q3, the loss of growth momentum is nevertheless obvious in a series of monthly activity indicators: the encouraging retail sales figures (up 0.6% relative to September) were offset by a 0.2% drop in the monthly GDP figure and the 1.2% fall in industrial production. The change over 12 months in these indicators is nevertheless comfortably positive, at 3.3%, 3.5% and 6.8%, respectively. The employment picture is somewhat mixed, too. Job creation is still modest and volatile, with a monthly average of scarcely 30,000 since the July 2009 employment low. But the unemployment rate is clearly on a downtrend, at 7.6% in November 2010 compared with a peak of 8.7% in August 2009. The BoC still has no worries on the inflation score. In October, inflation was running at just 1.8% YoY, according to its reference measure, ie, still at the low end of the target range. The BoC is now forecasting that it will return to the 2% target by end2012, when it also expects the output gap to have closed. The deterioration in the external accounts is the standout phenomenon in recent months. There are several reasons for this. In the first place, the US is not importing as much from Canada as it once did. This comes as no surprise, since the automotive and construction sectors have been hit particularly hard. The appreciation of CAD against USD has also been partly responsible, with a 25% rise since March 2009, which also corresponds to the scale of its overvaluation against its long-term value of 0.78. This appreciation is partly the result of the BoCs rate hikes and also a safe-haven currency effect, as Canada does not share the fiscal, banking, housing and debt problems of the US. The CAD is also a commodity currency. When commodity prices rise, it is in theory good for Canadian growth as the country is an exporter of commodities and therefore for CAD, whose appreciation in return nevertheless has a negative impact on growth and the external balance. This vicious circle is similar to a case of Dutch disease, except that the loonies appreciation is due not only to the commodity export effect. Because the same causes generally produce the same effects, the uncertainty, the sluggish nature of the recovery and CADs appreciation against USD should prompt the BoC to wait until Q311 before it resumes its rate hikes. The BoCs concerns about the vigour of global, US and Canadian recovery are obvious in its 19 October press release and in the downward revision to its growth forecasts between July and October (3% in 2010, 2.3% in 2011 and 2.6% in 2012). Insofar as our own growth forecasts are very close to these for 2010 and 2011 but slightly more optimistic for 2012, given what we are forecasting for the US and the fact that there is never a great gap between growth in the two countries, its conclusion that any further reduction in monetary policy stimulus would need to be carefully considered argues, in our view, for an extended pause before it gradually resumes its rate increases (+25bp per quarter, which would take its key overnight rate to 2.50% by end-2012).
Jul-09 Jan-10 CAD/USD
Jul-10 LT average
Source: Federal Reserve, Crdit Agricole SA
Canada: Current account

CAD bn 15 10 5 0 -5 -10 -15 -20 61 65 69 73 77 81 85 89 93 97 01 05 09
Source: Statistics Canada, Crdit Agricole SA
Hlne Baudchon
helene.baudchon@credit-agricole-sa.fr +33 1 43 23 27 61
26
Emerging countries: Short-term gain for long-term pain?

EMs face new external challenges, including the European crisis and Chinese tightening. We believe they can manage these. Still, two EM-specific headwinds will emerge in 2011. Deteriorating current account balances should limit FX appreciation, and the return of inflation should warrant rate hikes, with the risk some central banks fall behind the curve.
CDS spreads: Mexico and Turkey

250 230 210 190 170 150 130 110 90 70 50 Jan-10 5Y CDS spreads
Challenges to emerging markets have grown in recent weeks. Sovereign pressure in Europe combined with fears related to the impact of Chinese monetary tightening, not to mention political uncertainty on the Korean peninsula, have triggered waves of corrections across the board on EM currencies sovereign CDS spreads. Local currency yields have increased significantly along with USD and EUR bond yields. The lingering uncertainty in Europe suggests that the stress test may last. However, in our view, most emerging markets will pass it in the short term. The bullish EM story should remain valid in H111 at least. Fundamentals in EMs compare well with fundamentals in developed markets. This includes prospects for economic growth: we expect EMs to grow by 6.5% in 2011, compared with 2.2% for developed markets; it also includes higher interest rates, larger fiscal flexibility on average and improved external liquidity, with large amounts of reserves that would allow financial pressure to be cushioned in many countries. So, will it be enough? After all, even with strong fundamentals, EM asset prices went through a gigantic correction at end-2008, as the developed markets crisis spread to the rest of the world. Could it happen again as the stress has returned to Europe? In our view this would be the case only if in addition to financial pressure there was a collapse of the real economy in developed markets that would mean a collapse of exports from emerging markets. However, our base-case scenario does not envisage anything close to a recession in either the US or Europe in 2011. From that point of view, the current situation contrasts with 2008. In addition, although we expect the Chinese tightening to continue, we do not see it as a threat to economic growth. Wage growth should continue to support consumer demand in 2011. In addition, even the guidance for loan growth in 2011 should be consistent with credit growth being slightly above GDP growth during the next 12 months. This can hardly be described as a sharp tightening of monetary policy. We expect China to grow by a still-strong 9.0% in 2011. Even though EMs may remain supported, two challenges should gradually grow in 2011. Firstly, current account balances will likely continue to deteriorate on the back of rather strong domestic demand and mixed G3 growth. Also, higher commodity prices will weigh on importers (like India, Egypt or Turkey). On an aggregated basis, we expect the EM current account surplus to narrow from 3.0% of GDP in 2009 and 2.3% of GDP in 2010 to 1.6% of GDP in 2011. Some large EMs like Brazil, India, South Africa and Turkey will likely post sizeable deficits. The fact emerging markets run current account deficits is not a problem in itself, as long as these deficits remain limited. Such deficits are consistent with the rebalancing of the global economy, as well as the need for these countries to import capital goods that will eventually help to upgrade their economy. However, such a trend may have an FX impact. True, this impact may be muted in the short term. Against the backdrop of QE2, these deficits are likely to be financed without major difficulty. However, should global liquidity become less abundant, flows to EMs may become lighter, and as at this point those countries with a current account deficit could see their currencies depreciating. In our base-case scenario, this may happen in an orderly manner. However, the risk of sharper corrections will grow in coming months as hot money keeps on heading towards EMs (the larger the flows, the stronger the eventual correction when these flows reverse). Using a sample of four countries which provide timely data of flows, we find that, as at September, the stock of foreign money invested in EM equity markets topped pre-crisis levels, and was ten times
Apr-10 Jul-10 Turkey
Oct-10 Mexico
EM current account deficits: where?

12% 10% 8% 6% 4% 2% 0% -2% -4% -6% -8%
MXN CNY IDR BRL INR ZAR PLN KRW RUB SAR TRY
Current account balance: our forecasts for 2011
Deficit countries
Surplus countries
Hot money is back!

1200 1000 800 600 400 200 0 1995 1998 2001 2004 2007 2010 Foreign portfolio investment (stock) FX Res Sum for 4 large EMs (Brazil, India, Korea and Poland) More hot money than before the 2008 crisis
Sbastien Barb
sebastien.barbe@ca-cib.com +852 28 48 98 02
27
EM FX vs USD and EUR

140 130 120 110 100 90 80 70 Forecasts
larger than ten years ago (see chart). This is also slightly higher than the level of FX reserves in these countries. As flows continue to head towards EMs, EM asset prices and currencies will become even more vulnerable to possible spikes in risk aversion. This is clearly a risk for 2011, and could materialise partly when the market considers that a rate hike may be in sight in the US or Europe. Against such a backdrop, the intervention and regulatory risks will remain significant in coming quarters. This will be particularly so, we believe, in countries which post a widening current account deficit and whose currencies have already strongly appreciated on a real effective basis. Among large EMs, Brazil and South Africa, but also Turkey, stand out from that point of view. The deterioration of current accounts, combined with the intervention and regulatory threat, should cap the appreciation of EM currencies. With only limited appreciation versus USD, it may be a good idea to play the bullish EM FX story, not only versus USD in 2011, but against a basket of the major currencies, or EUR. Given our bearish EUR/USD view in most of 2011, we expect EM FX to gain more strongly versus EUR than USD (see chart). Apart from balance of payment concerns, inflation could also pose a challenge to some EMs. True, under our scenario of quasi-stability of oil prices at about USD75-80/bl in 2011, oil prices are unlikely to trigger the same inflation push EMs faced in 2007-08. Given the correlation between oil prices and EM inflation, it would likely take a consistent increase towards USD130/bl or USD140/bl to trigger a strong acceleration on EM inflation (see chart). This is not our base-case scenario, but it is a possible one under a risk scenario where global growth surprises on the upside. On top of that, food prices could also create inflation pressure. However, even under our base-case scenario, most EM central banks will have to carry on with rate hikes in 2011 (including China, Brazil, India for instance) or start to implement them in the event they have stayed put so far (including Indonesia, Poland, Russia, Turkey). Indeed, the increase in average EM policy rates has been limited so far and, with inflation being back to normal levels, real rates are particularly low. The GDP-weighted average real policy rate for 21 large EMs stood at about 0.6% in November (compared with about 3.0% before the crisis) not a level that is consistent with the current recovery period (see chart). That said, EM central banks will remain cautious when tightening given the remaining uncertainty about the pace of global demand. They will also try to avoid improving the carry attractiveness of their currencies too quickly. Hence, we expect them to use other instruments when they can like the reserve requirement ratio or regulatory measures. We expect EM central banks to increase policy rates by a modest 62bp on average in 2011. Russia is expected to tighten the most (200bp), whereas Mexico may be the exception to the rule and may refrain from hiking rates in 2011. The risk is that their reluctance to tighten keeps some EM central banks behind the curve in 2011.
03 04 05 06 07 08 09 10 11 12 Our EM 21 Fx index vs.

a USD-EUR-JPY-GBP composite basket USD EUR
EM inflation and oil prices

10% 8% 6% 4% 2% 0% 03 04 05 06 07 08 09 10 11
CPI YoY Change (EM23) Oil Prices YoY change (RHS) Oil prices CA-CIB assumption (RHS) Oil prices at 135 USD/b at end-2011 (RHS)
200% 150% 100% 50% 0% -50% -100% -150%
EM inflation and policy rates

10% 8% 6% 4% 2% 0% Inflation and rate indices -2% include 21 large EMs 04 05 06 07 08 09
10
EM average real policy interest rate EM average policy interest rate EM average inflation (CPI YoY)
28
Central Europe: Turnaround year

With the renewed Eurozone debt tensions, Central Europe is still feeling the heat. 2011 will be a turnaround year with fiscal consolidation being at the forefront of concerns, especially for Hungary and Poland, and with the start of the rate-hiking cycle. Still, the recovery has yet to be confirmed as not all countries Romania are out of the woods. Fiscal consolidation the key now
0 -2 -4 -6 -8 -10 % Poland 2009 Hungary 2010 2011 Czech Rep. Romania
Central Europe will have to confirm that the economy is well on track. Q3 GDP figures have disappointed and shown that the rebound in domestic demand is not yet enough to offset the slowdown in exports. 2011 will likely see lower growth figures due to negative base effects as well as still-muted internal demand and a lower contribution from exports. In a lower growth environment, fiscal consolidation will remain at the forefront of market concerns. Any disappointment will therefore put huge pressure on financial markets and will cap investors confidence and eventually the recovery. It is all the more worrying since CE4 countries will have significant issuance programmes. Such concerns may delay the rate-hiking cycle, which is expected to resume soon. Reducing the budget deficit will not be an easy task even for Poland, which is running a large budget deficit despite the positive growth observed over the past two years. However, even if Hungary runs a smaller deficit it will likely be the main source of concern within the region. The surprising and unsettling government decisions have disrupted markets and raised questions about the capability and commitment of the government to reduce the deficit. Still, transparency is low and the Hungarian issuance plan is quite challenging under current conditions. Any surprises would put the refinancing of the huge external debt at risk. Romania is struggling to come out of recession. While other countries may expect a brighter outlook; Romanias twin deficits are becoming larger, especially the current account, and there is little reason to expect a strong RON over the next year.
Source: Moodys, CF, Crdit Agricole CIB
Guillaume Tresca
guillaume.tresca@ca-cib.com +33 1 41 89 18 47
Russia: Back on the growth trend

The economy is recovering from the summer slump caused by drought and the decrease in gas export volumes. Retail sales growth slowed down in September-October, while investment growth accelerated to 10.7% YoY. We consider the overall internal demand growth outlook for next year very positive. Inflation and import growth pose risks to growth. Economy back on growth trend
115 110 105 100 95 90 Jan-07
This autumn the economy started to recover from the summer slump caused by drought (which led to a catastrophe in agriculture) and lower volumes of gas exports to Europe (problem of difference between gas prices in long-term contracts and on spot market). Both factors proved to be temporary; agriculture (4% of Russian GDP) will finally recover in 2011, while gas export volumes have been increasing constantly (adjusted for seasonality) since September. Retail sales slowed down in September-October on high food inflation, but strong growth in investments (10.7% YoY in October) continued to push internal demand higher. Easy monetary policy, an improving labour market, declining household savings ratio, growing government expenditure all point to a bright internal demand growth outlook for next year. Import growth remains one of the main drags on economic growth in Russia; moreover, strong expansion in imports on the back of stable oil prices (which remained below USD80/bl almost all of the period May to October) has resulted in a lower current account surplus. Combined with intensified capital outflows, this has resulted in RUB weakening in recent months. The main risk for the economy in coming years is the upward trend in inflation CPI is already above next years target and is growing. We expect the CBR to start monetary policy tightening within a few months with an increase in the obligatory reserve requirement ratios and the first rate hike in late February.
Jan-08
Jan-09
Jan-10
Base industries index, SA (Jan '07=100)
Source: FSSS, Crdit Agricole CIB
Maxim Oreshkin
maxim.oreshkin@ca-cib.com +7 495 937 0581
29
South Africa: Taking off slowly

The recovery remains soft and lags that in most other EMs, but economic growth should accelerate gradually. Interest rates are unlikely to be lowered further, as disinflation is coming to an end, whereas the ZAR may find it more difficult to appreciate significantly going forward.
A soft recovery
65 60 55 50 45 40 35 30 0.20 0.15 0.10 0.05 0.00 -0.05 -0.10 03 04 05 06 07 08 09 10 Investec PMI Retail sales YoY (constant prices)(rhs)
The recovery has remained modest over the past few months. On the demand side, households purchasing power has benefited from low inflation and relatively low interest rates. However, unemployment remains a strong constraint. The unemployment rate reached 25.3% in September. The strong ZAR appreciation has weighed on the export sector, but the pick-up in the PMI index to above 52.9 in November suggests the economy is gradually extracting itself from the post-World-Cup blues. Retail sales should continue to recover at a gradual pace. We expect GDP growth to accelerate modestly, to 3.5% in 2011 versus 2.5% in 2010. Fortunately, the government can continue to use the existing fiscal leeway to continue supporting infrastructure spending. Not only does this aim to support growth, but it also helps to upgrade the economys competitiveness. After cutting its policy rate by 50bp last month, we expect the SARB to stay on hold in coming quarters. The headline inflation figure has recovered slightly recently, and may gradually head north in the coming two to three months. Also, credit to the private sector seems to be re-accelerating gradually, and wage growth should lead the SARB to remain vigilant. The recent depreciation of the currency may add to the reasons not to lower the policy rate further.
Sbastien Barb
Sebastien.barbe@ca-cib.com +33 1 41 89 15 97
Turkey: The risky bet of monetary policy

The economy has bounced back in 2010. The slowdown will be limited in 2011. By keeping rates low for a long time, the CBRT is making a risky bet. It intends to limit hot money flows, but may eventually lose control of inflation expectations.
Capacity increasingly utilised will rates be hiked?

85% 80% 75% 70% 65% 60% 55% 50% 07 08 09 10 Capacity utilisation rate CBRT Repo rate (rhs) CBRT o/n rate (rhs) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2%
The recovery surprised on the upside in 2010. We expect GDP growth to accelerate from -4.7% in 2009 to 7.5% in 2010 one of the sharpest reaccelerations among EMs. Private consumption and then investment have surprised on the upside. True, such stellar performance has been partly due to a base effect and economic growth will likely decelerate in 2011. However, relatively strong loan growth and an improved job market should continue to support domestic demand, and negative real interest rates should buffer against a deceleration in investment. We believe economic growth could still reach 5.0%. After lowering its policy rate by more than 1,000bp during the financial crisis, the CBRT is keeping a dovish bias on interest rates, aiming to limit hot money inflows. This is a risky bet. Inflation remains low but could become a serious challenge in 2011. Indeed, capacity utilisation rates are up and could reach precrisis levels in H111. Strong consumer demand may be favourable to price pressure. Against such a backdrop, global food inflation would be a problem. The central bank could then lose control over inflation expectations. The TRY may find it more difficult to appreciate. The current account deficit has been widening, and it has been financed increasingly with volatile money. Hence the balance of payment is becoming increasingly vulnerable. In the short term, QE2-related liquidity may continue to support the TRY, but the TRY may soften by end-2011, once the market begins to price in the normalisation of US and European monetary policies.
Sbastien Barb
sebastien.barbe@ca-cib.fr +33 1 41 89 15 97
30
Asia: Powering ahead: will outperformance continue?

Emerging Asia had a stellar year in 2010. The question is: can such a performance continue despite the G3 slowdown, strong currencies and monetary tightening? We believe the answer is positive, due to strong domestic demand in China and India. The region will retain its attractiveness to foreign capital, leading to gains in currencies and bond yields.
Asian exports vs Chinese manufacturing PMI

45 30 15 0 -15 -30 -45 06 07 08 09 Asian exp. ex.China, %, YoY China man. PMI, 2M adv., pts (rhs) 65 60 55 50 45 40 35
2010 was a very positive year for emerging Asia, with stellar growth performances and price pressures largely under control. Average CPI inflation below 3.5% YoY was rather muted compared with GDP expansion of almost 9% YoY the third-fastest of the decade. The Chinese economy accelerated to about 10% YoY on the back of surging investments. India continued to catch up with its rival across the Himalayas, with expansion of nearly 9% YoY as both capital spending and consumption surged. Such strong results led to a pick-up in price pressure, initially in India and elsewhere towards year-end. The question on investors minds is whether Asian outperformance can continue in 2011 in the face of slowing growth in the developed world, strong gains in regional currencies, and the likely continuation of often-belated monetary tightening. The answer is yes, and the key lies in the strength of domestic demand in the regions biggest economies. Investments should remain buoyant in both India and China, despite some slowdown in the latter as policymakers try to curb excesses in the real estate sector and reduce credit creation. Both countries should also see strong private consumption on the back of years of double-digit growth in wages. A case in point is China, where nominal wage income rose at an average pace of 18% pa in 2005-09, with the first three quarters of 2010 seeing a 24% jump in minimum wages in most provinces. Certainly, much of the region is likely to experience some slowdown, with overall GDP growth easing to about 8% YoY. Base effects will become increasingly challenging, inventory rebuilding is largely over, and rate hikes should continue as we expect CPI inflation to average about 4.5% YoY. In particular, in 2011 both India and China are likely to raise key rates by 75bp, as mounting structural demand/supply imbalances will require higher real rates going forward. These imbalances are a product of the rising purchasing power of households and limited supply of food and housing. Moreover, large-scale currency gains against the USD, and even more so versus the EUR, may weigh on export growth at the margin. Several economies in the region have already seen a deterioration in trade balances notably Malaysia and Thailand where currency appreciation was relatively fast. Nevertheless, improving Chinese manufacturing PMI bodes well for shipments from the rest of emerging Asia, and exports growth after slowing early in 2011 due to base effects is likely to recover later in the year. Such a favourable outlook will sustain the attractiveness of emerging Asia for direct and portfolio investors, especially given the lack of compelling alternatives amid a sub-par recovery in the developed world. Capital flows into the region are likely to continue, fuelled by quantitative easing in the US. Although several countries in the region are trying to use regulatory measures to limit these inflows, we believe that by and large investors will continue to be attracted to emerging Asia. Flows will also be driven by the rise in government bond yields due to monetary tightening.
Source: CEIC, Crdit Agricole CIB
Asian growth to ease but remain high, inflation will rise

12 10 8 6 4 2 0 Forecast 6 5 4 3 2 1 0 Q109 Q409 Q310 Q211 Q112 Q412 CPI *, % YoY (rhs) * WPI for India GDP, % YoY
More tightening to come: expected policy rate changes

bp 250 200 150 100 50 0 CN IN KR ID TW TH MY PH VN now till end-2011 during 2012
Frances Cheung
frances.cheung@ca-cib.com +852 28 26 15 20
Dariusz Kowalczyk
dariusz.kowalczyk@ca-cib.com +852 28 26 15 19
As a result, most regional currencies are likely to appreciate, and we favour the KRW and the PHP. Both stand out by having recovered only partially from depreciation during the global crisis, and present attractive investment destinations on fundamental grounds. The CNY should be allowed faster gains as policymakers shift focus from growth to inflation. Historically, periods of mounting price pressures coincided with accelerated appreciation of the CNY, and we expect the USD/CNY exchange rate to end 2011 at 6.30. On the other hand, the INR may become vulnerable if portfolio flows slow after the Fed completes QE2, given Indias large trade and current account deficits.
31
Mexico: The sad bamba

Despite some improvement, Mexico is lagging the recovery in Latam. The feeble domestic demand will remain muted and is unlikely to prove strong enough to support growth in 2011. Therefore, Mexico will be dependent upon exports to the US. With a likely US slowdown, the Banxico will remain on the cautious side.
Domestic demand on the back foot

% 20 15 10 5 0 -5 -10 Nov-04 % 60 50 40 30 20 10 0 -10 -20 -30 Nov-10
Mexico has finally come out of recession in 2010, likely posting a GDP figure of 5.3%, partly helped by the US rebound. Nevertheless, Mexico is still a laggard within the Latam region, and the muted domestic demand will not prove to be strong enough to support growth significantly in 2011. Therefore, GDP will likely edge lower to 3.5% in 2011. Indeed, internal demand has barely rebounded and the poor employment conditions will continue to cap demand. Credit growth remains muted, especially consumer loans due to the bank sector reorganisation, and is hampering the recovery in demand. Hopefully, the export sector, 80% oriented to the US, will remain supportive. The first signs of an improvement in the US auto sector (GM and Ford have posted positive revenues) suggest a positive Mexican export outlook. Given this tepid environment, Banxico has remained on the cautious side and will do the same in 2011. The gradual appreciation of MXN through 2010 due to the rebound in capital inflows has helped to contain inflation and so limit the need for rate hikes. With the US Fed still on the sidelines, Banxico would have little interest in starting its hiking cycle in 2011. This inaction may lead inflation to exceed slightly the upper barrier of the target band. However, the robustness of MXN and the convalescent domestic demand will prevent the Banxico from hiking rates too early. Admittedly, Mexico will remain sensitive to US developments. Any double-dip or the extension of US quantitative easing might lead the central bank to lower rates.
Nov-06 Nov-08 Retail sales (YoY%)
Consumer loans (YoY%) (rhs)
Source: Banxico, INEGI, Crdit Agricole CIB
Guillaume Tresca
guillaume.tresca@ca-cib.com +33 1 41 89 18 47
Brazil: Time to slow down

After strong growth in 2010, inflationary pressures are increasing and it is clear that the pace of demand growth is unsustainable. Part of the necessary adjustment will come from fiscal policy but, even considering that, monetary policy will have to be tightened if inflation expectations are to be kept under control.
Inflation expectations: something must be done

5.40 5.20 5.00 4.80 4.60 4.40 4.20 4.00 Jan-10 Apr-10 Jul-10 Oct-10
We expect real GDP growth to have reached 7.5% in 2010. This remarkable rebound after the crisis has left very little slack in resources utilisation, causing inflation and inflation expectations to increase in recent months. Clearly, the slowdown in growth in H210 was not enough to keep inflation trending towards the target. Thus, a tighter policy mix will be needed in the short term. Part of the adjustment may come from fiscal policy. However, political and institutional constraints limit the ability of the government to implement a much tighter fiscal policy. Thus, monetary policy will, once again, be the main tool for controlling aggregate demand growth. While there is some uncertainty about the BCBs operational independence, we believe it will act soon to re-establish its credibility. We expect three consecutive hikes of 50bp, starting in January, bringing the Selic rate to 12.25%, where we see it staying until year-end. The combination of tighter fiscal and monetary policy will cause GDP growth to decelerate to 4.2% in 2011, a lower-than-potential rate. That will bring inflation down and, possibly, create the conditions for some easing in 2012. Regarding the BRL, we expect some appreciation through H111 as it will continue to benefit from higher IR rates in Brazil and accommodative monetary policies in developed markets. This trend will eventually be reversed as the Brazilian current account deficit increases and markets start to prepare for monetary policy normalisation in developed countries.
IPCA - 12 Months Expectation Target
Source: BCB (Focus Report)
Vladimir Vale
vladimir.vale@ca-cib.com +55 11 38966418
32
MENA: A two-speed recovery gets into gear

The MENA region is set for sound growth in 2011 but variation in output is a distinguishing mark. Most MENA oil exporters will see higher GDP growth whereas most oil importers will experience lower GDP growth. Inflation will remain benign. Improved risk perception should entice issuers to exploit better bond pricing as they seek to refinance maturing debt and raise funds.
Oil exporter GDP growth rates set to recover

% 16 14 12 10 8 6 4 2 0 -2 -4 Saudi UAE Kuwait Qatar OmanBahrain Arabia 2009 2010f 2011f 2012f
Most oil exporters of the MENA region will experience higher GDP in 2011. Gulf oil sector growth is likely in 2011, although non-oil private and government sectors will be the key catalysts for real GDP growth. Saudi Arabias private sector should expand 4.6% in 2011, with overall GDP growth of 4.2% in MENAs largest economy. The UAE will benefit from Abu Dhabis non-oil infrastructure and manufacturing expansion and revived trade, tourism and retail sales in Dubai. We expect UAE GDP growth of 3.4% in 2011, up from 2.5% in 2010. Kuwait is also poised for higher economic growth as it rolls out a USD104bn investment plan, yielding GDP growth of 3.5% in 2011 from 3.2% in 2010. The plan is susceptible to fragile political consensus. Still the highest in MENA, GDP growth of natural gas exporter Qatar may fall to 12.4% in 2011 from 16.1% in 2010. For the oil producers, downside risks to the outlook are linked to oil prices, weak private sector recovery (deleveraging), which could impact banks balance sheets, muted non-oil investments and deterioration in asset prices. Corporate and sovereign MENA bond yields have declined during 2010 as market conditions have improved and Dubai World reached a deal with creditors to restructure USD25bn in debt. With tens of billions of dollars in Gulf debt due for refinancing in 2011, robust Q4 bond market activity should continue in 2011. Helping the bond market along will be lower costs to insure MENA sovereign debt. Still, any missteps by Dubai in dealing with more than USD100bn in outstanding debt could weigh on risk appetite across MENA. Equity markets in the Gulf have witnessed slower performances than Egypt as confidence is still low. MENA oil importers among them Lebanon, Tunisia and Morocco should witness a decline in GDP growth in 2011 as non-agricultural sectors are decelerating. In contrast, Egypt should see a slight increase from 5.2% in 2010 to 5.3% in 2011. Workers remittances have increased steadily and foreign direct investment, down in 2010, is likely to pick up in 2011 as the global economy mends. Reducing Egypts budget deficit from 8.1% of GDP will be difficult without a reduction in subsidies unlikely in the short term as inflation rates remain near double-digit levels in 2011. MENA GDP growth is too low to support enough job creation, underpinning the need for more private sector engagement.
MENA equity markets rise, Egypt outpaces Gulf

1600 1500 1400 1300 1200 1100 1000 900 800 700 Jan-09 Jul-09 Jan-10 Jul-10 Saudi Arabia Kuwait Egypt Dubai Abu Dhabi (Stock market points)
(5Y CDS)
Tunisian and Moroccan currencies and their primary trade and remittance flows reflect their euro-centric dependence, which makes them vulnerable to a sluggish recovery in the Eurozone. EGP, although vulnerable to downside CDS default risk eases in MENA region risks, would be defended by the central bank at around the 5.78 mark. The other potential hazard for the EGP, Egyptian CDS and equities, is political 750 uncertainty about the succession plan of Egypts 82-year-old president ahead of 650 550 the 2011 presidential vote.
450 350 250 150 50 Jan-09 Jul-09 Egypt Qatar Abu Dhabi Jan-10 Jul-10 Lebanon Dubai Bahrain
USD strength in 2011 should give respite to imported inflation and subdue speculation for a change in Gulf currency pegs, already evidenced in the moderation of SAR forward rates since October. Inflation is likely to ease in North Africa, Egypt, Saudi Arabia and Lebanon in 2011, but in five Gulf countries it should rise on higher aggregate demand and base effects. Qatar, emerging from two years of deflation, could see inflation of 2.7% in 2011, the lowest in the Gulf. Despite political uncertainty, Lebanons construction sector, remittances and tourism have bolstered the economy, although national debt of 148% of GDP, sharp fiscal deficits and some speculative real estate prices overshadow the firm fundamentals. Questions about succession plans in Egypt and potential geopolitical tensions in Lebanon, Iraq and Iran could also lead to a revision of regional risk appetite in 2011.
John Sfakianakis
johns@alfransi.com.sa +966 1 276 46 11
33
Exchange rate forecasts

17-Dec Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12
USD Exchange rate

Industrialised countries Euro Japan United Kingdom Switzerland Canada Australia New Zealand Asia China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand Vietnam Latin America Argentina Brazil Mexico Africa South Africa EUR/USD USD/JPY GBP/USD USD/CHF USD/CAD AUD/USD NZD/USD 1.33 84 1.56 0.96 1.01 0.99 0.74 1.37 82 1.63 0.98 0.98 1.02 0.78 1.32 85 1.61 1.02 0.97 1.05 0.80 1.28 90 1.60 1.06 0.96 1.05 0.80 1.25 94 1.60 1.12 0.95 1.06 0.81 1.23 96 1.60 1.15 0.94 1.07 0.82 1.21 98 1.59 1.17 0.93 1.09 0.83 1.20 100 1.60 1.19 0.92 1.11 0.84 1.18 102 1.59 1.22 0.90 1.12 0.84
USD/CNY USD/HKD USD/INR USD/IDR USD/MYR USD/PHP USD/SGD USD/KRW USD/TWD USD/THB USD/VND
6.66 7.78 45.36 9035 3.14 44.2 1.31 1153 29.9 30.1 19495
6.51 7.76 44.79 8870 3.12 43.3 1.27 1110 29.9 29.7 20100
6.43 7.77 45.10 8860 3.11 42.7 1.27 1095 29.8 29.6 20100
6.36 7.77 45.33 8850 3.10 42.1 1.26 1075 29.6 29.4 20500
6.30 7.77 45.50 8850 3.09 41.5 1.26 1050 29.5 29.2 20500
6.24 7.77 45.12 8750 3.07 41.2 1.25 1035 29.3 29.0 21100
6.18 7.77 44.74 8700 3.05 41.0 1.24 1020 29.1 28.8 21100
6.11 7.77 44.36 8650 3.03 40.7 1.22 1005 29.0 28.6 21500
6.05 7.77 43.98 8650 3.01 40.5 1.21 990 28.8 28.4 21500
USD/ARS USD/BRL USD/MXN
3.97 1.70 12.39
4.05 1.67 12.00
4.10 1.65 12.00
4.15 1.65 11.90
4.20 1.70 11.90
4.25 1.70 11.85
4.30 1.70 11.80
4.35 1.75 11.75
4.40 1.80 11.70
USD/ZAR TRY/ZAR
6.81 4.48
6.95 4.76
6.70 4.65
6.70 4.65
6.90 4.73
7.00 4.76
7.10 4.80
7.20 4.83
7.30 4.87
Emerging Europe Poland Russia Turkey
USD/PLN USD/RUB Basket/RUB USD/TRY
2.98 30.66 35.28 1.52
2.92 28.89 33.70 1.46
2.95 30.59 35.00 1.44
3.01 31.71 35.70 1.44
3.00 32.45 36.10 1.46
3.04 31.22 34.45 1.47
3.07 32.69 35.78 1.48
3.08 33.48 36.49 1.49
3.14 34.14 36.90 1.50
Euro Cross rates

Industrialised countries Japan United Kingdom Switzerland Sweden Norway Central Europe Czech Rep. Hungary Poland Romania EUR/JPY EUR/GBP EUR/CHF EUR/SEK EUR/NOK 112 0.853 1.28 9.02 7.90 112 0.840 1.34 9.38 8.30 112 0.820 1.35 9.32 8.10 115 0.800 1.36 9.32 8.10 118 0.780 1.40 9.30 8.00 118 0.770 1.41 9.20 7.80 119 0.760 1.42 9.15 7.70 120 0.750 1.43 9.10 7.60 120 0.740 1.44 9.00 7.40
EUR/CZK EUR/HUF EUR/PLN EUR/RON
25.15 273 3.98 4.29
24.60 285 4.00 4.30
24.30 280 3.90 4.30
24.20 280 3.85 4.30
24.00 280 3.75 4.30
23.80 280 3.74 4.30
23.60 280 3.72 4.30
23.60 280 3.70 4.30
23.60 280 3.70 4.30
34
Interest rate forecasts developed countries

17-Dec USA Fed funds 3 month 2Y year 10 year Japan Call 3 month 2Y year 10 year Eurozone Repo 3 month 2Y year (Ger) 10 year (Ger) United Kingdom Base rate 3 month 2Y year 10 year Sweden Repo 3 month 10 year Norway Deposit Switzerland 3 month 10 year Canada Overnight Target Australia Cash Target New Zealand Official Cash Rate 0.25 0.30 0.63 3.40 Mar-11 0-0.25 0.40 0.75 3.30 Jun-11 0-0.25 0.40 0.95 3.50 Sep-11 0-0.25 0.40 1.45 3.80 Dec-11 0-0.25 0.40 1.70 4.00 Mar-12 0-0.25 0.45 1.80 4.20 Jun-12 0-0.25 0.50 2.00 4.35 Sep-12 0.50 1.00 3.00 4.50 Dec-12 1.00 1.40 3.50 4.75
0.08 0.18 0.21 1.21
0-0.10 0.34 0.20 1.10
0-0.10 0.34 0.20 1.10
0-0.10 0.34 0.20 1.15
0-0.10 0.35 0.22 1.20
0-0.10 0.35 0.23 1.25
0-0.10 0.35 0.25 1.30
0-0.10 0.37 0.25 1.50
0.25 0.40 0.30 1.60
1.00 0.95 1.05 3.03
1.00 1.20 1.25 3.10
1.00 1.30 1.40 3.30
1.00 1.40 1.75 3.55
1.00 1.50 2.00 3.75
1.25 1.75 2.25 3.85
1.50 2.00 2.50 4.00
1.75 2.25 3.00 4.15
2.25 2.75 3.50 4.25
0.50 0.75 1.19 3.57
0.50 0.85 1.00 3.70
0.50 0.85 1.20 3.90
0.50 1.00 1.75 4.10
1.00 1.50 2.50 4.25
1.50 2.00 2.80 4.25
2.00 2.40 3.10 4.40
2.50 2.80 3.40 4.55
3.00 3.30 3.60 4.65
1.25 1.88 3.26
1.50 2.10 3.70
1.75 2.35 3.90
2.00 2.60 4.15
2.25 2.85 4.35
2.50 3.10 4.45
2.75 3.35 4.60
3.00 3.60 4.75
3.25 3.85 4.85
2.00
2.00
2.00
2.25
2.50
2.75
3.00
3.25
3.50
0.17 1.90
0.25 2.75
0.25 3.25
0.50 3.40
0.50 3.50
0.75 3.67
1.00 3.74
1.00 3.89
1.25 3.99
1.00
1.00
1.00
1.25
1.50
1.75
2.00
2.25
2.50
4.75
5.00
5.25
5.25
5.25
5.25
5.25
5.25
5.25
3.00
3.50
3.75
4.00
4.00
4.00
4.00
4.00
4.00
Note: 3M rates are interbank, 2Y and 10Y rates are government bond yields Source: Crdit Agricole CIB
35
Interest rate forecasts emerging countries

17-Dec USA Fed funds 3 month 2Y year 10 year Japan Call 3 month 2Y year 10 year Eurozone Repo 3 month 2Y year 10 year (Ge-Fr) Asia China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam Latin America Argentina Brazil Mexico Emerging Europe Czech Rep. Hungary Poland Romania Russia Turkey 14D repo 2W repo 7D repo 2W repo O/N Deposit rate Overnight 0.75 5.50 3.50 6.25 2.50 6.50 0.75 6.00 4.00 6.25 3.00 7.00 1.00 6.00 4.25 6.50 3.50 7.50 1.25 6.00 4.25 6.75 4.00 8.00 1.50 6.00 4.50 6.75 4.50 8.00 1.75 6.00 4.75 7.00 5.25 8.00 1.75 6.00 4.75 7.00 6.00 8.00 2.00 6.00 4.75 7.00 7.50 8.50 2.00 6.00 4.75 7.00 9.00 9.00 3M deposit Overnight/Selic Overnight rate 10.30 10.75 4.50 10.00 11.75 4.50 10.50 12.25 4.50 11.00 12.25 4.50 11.00 12.25 4.50 11.00 11.75 5.25 11.25 11.25 5.50 11.50 10.75 5.75 11.50 10.50 6.00 1Y lending rate Base rate Repo rate BI rate Call rate OPR Repo rate 6M SOR Redisc Repo Prime rate 5.56 0.50 6.25 6.50 2.50 2.75 4.00 0.48 1.50 2.00 9.00 6.06 0.50 6.50 6.50 2.75 2.75 4.00 0.61 1.75 2.25 10.00 6.56 0.50 6.50 6.50 3.00 2.75 4.25 0.67 2.00 2.50 10.00 6.56 0.50 6.75 6.75 3.25 2.75 4.50 0.67 2.00 2.75 11.00 6.56 0.50 7.00 7.00 3.25 3.00 4.50 0.70 2.00 2.75 11.00 6.81 0.50 7.00 7.00 3.25 3.00 4.75 0.71 2.00 2.75 11.00 6.81 0.50 7.25 7.25 3.25 3.25 4.75 0.76 2.00 2.75 12.00 7.06 0.75 7.25 7.25 3.50 3.25 5.00 1.10 2.25 3.00 12.00 7.06 1.25 7.50 7.25 3.75 3.50 5.00 1.34 2.50 3.25 12.00 1.00 0.95 1.05 3.03 1.00 1.20 1.25 3.10 1.00 1.30 1.40 3.30 1.00 1.40 1.75 3.55 1.00 1.50 2.00 3.75 1.25 1.75 2.25 3.85 1.50 2.00 2.50 4.00 1.75 2.25 3.00 4.15 2.25 2.75 3.50 4.25 0.08 0.18 0.21 1.21 0-0.10 0.34 0.20 1.10 0-0.10 0.34 0.20 1.10 0-0.10 0.34 0.20 1.15 0-0.10 0.35 0.22 1.20 0-0.10 0.35 0.23 1.25 0-0.10 0.35 0.25 1.30 0-0.10 0.37 0.25 1.50 0.25 0.40 0.30 1.60 0.25 0.30 0.63 3.40 0-0.25 0.40 0.75 3.30 0-0.25 0.40 0.95 3.50 0-0.25 0.40 1.45 3.80 0-0.25 0.40 1.70 4.00 0-0.25 0.45 1.80 4.20 0-0.25 0.50 2.00 4.35 0.50 1.00 3.00 4.50 1.00 1.40 3.50 4.75 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12
Africa & Middle East South Africa UAE Saudi Arabia Repo Repo Repo 5.50 1.00 2.00 5.50 1.00 2.00 5.50 1.00 2.00 5.50 1.00 2.00 5.75 1.00 2.00 6.50 1.00 2.00 7.00 1.00 2.00 7.50 1.25 2.25 8.00 1.75 2.75
36
Economic forecasts
USA JAPAN EUROZONE Germany France Italy Spain Greece Norway Sweden Switzerland Canada Australia New Zealand United Kingdom Asia China Hong Kong India (2) Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Vietnam Latin America Argentina Brazil Mexico Emerging Europe Czech Republic Hungary Poland Russia Romania Turkey Africa & Middle East Algeria Egypt Kuwait Lebanon Morocco Qatar Saudi Arabia South Africa United Arab Emirates Tunisia Total Industrialised countries Emerging countries Real GDP (YoY. %) 10 11 12 2.8 3.0 3.5 3.6 1.3 1.7 1.7 1.5 1.8 3.5 2.6 2.4 1.6 1.5 1.8 1.0 1.0 1.4 -0.2 0.4 1.0 -4.1 -2.9 0.4 -0.4 1.5 2.8 5.3 4.6 3.1 1.6 1.9 2.2 2.9 2.3 3.2 2.8 3.2 3.4 2.3 3.2 3.5 1.8 1.9 2.1 9.1 8.0 8.0 10.0 9.0 8.6 6.8 6.3 6.8 8.9 8.4 8.3 6.3 5.8 5.8 6.1 6.1 6.5 7.3 4.1 6.8 7.5 5.0 6.6 13.6 8.8 9.5 10.0 5.8 6.3 8.0 5.3 6.0 6.6 6.5 7.4 6.6 3.9 4.5 7.0 4.0 4.0 7.5 4.2 4.5 5.3 3.5 4.8 4.1 3.8 3.4 2.0 2.5 2.3 1.0 2.3 2.0 3.3 3.5 3.0 4.2 3.7 3.3 -1.9 1.7 3.0 7.5 5.5 4.5 4.4 4.5 4.7 4.0 3.5 4.4 5.2 5.3 5.5 3.2 3.5 4.4 7.5 5.5 4.0 4.2 3.8 4.9 16.1 12.4 10.2 3.8 4.2 4.4 2.5 3.5 4.0 2.0 3.4 3.8 3.4 3.0 3.3 4.8 4.2 4.4 2.5 2.3 2.7 7.6 6.5 6.5 10 1.6 -1.1 1.6 1.1 1.5 1.7 1.7 4.6 2.3 1.2 0.7 1.8 3.2 2.3 3.3 4.4 3.4 2.5 8.3 4.9 3.1 1.6 3.8 2.5 0.9 3.3 9.0 6.6 17.0 5.5 4.2 6.6 1.5 4.9 2.8 8.0 6.2 8.3 5.2 5.0 11.1 4.0 4.6 2.5 -2.2 5.3 4.3 1.0 4.5 3.1 1.3 5.1 C PI (YoY. %) 11 12 1.4 1.6 -0.4 0.0 1.7 2.0 1.5 2.3 1.6 1.7 1.8 1.9 1.8 1.9 2.2 1.0 1.6 2.3 1.9 2.0 1.0 1.2 1.9 1.9 3.3 3.3 3.7 3.3 3.0 1.9 4.9 4.4 5.0 3.8 3.0 3.8 6.3 6.0 5.0 6.2 3.5 3.7 1.9 2.3 4.0 4.8 3.0 3.5 2.3 3.1 3.6 4.3 9.1 9.4 6.3 6.1 17.0 17.0 5.0 4.5 4.0 4.0 7.0 7.6 2.2 2.0 3.4 2.5 2.8 2.6 9.5 11.0 5.2 4.0 7.0 7.0 5.2 5.2 4.3 4.8 10.0 9.3 4.2 4.3 3.8 3.5 2.6 2.9 2.7 3.9 4.7 4.1 4.7 5.0 3.1 3.9 3.3 3.3 3.3 3.3 1.4 1.6 5.5 5.2 Current Account (% GDP) 10 11 12 -3.7 -3.9 -3.9 3.5 3.9 3.8 -0.3 0.3 0.5 4.5 5.5 5.5 -2.3 -2.3 -2.5 -3.2 -2.9 -2.5 -4.8 -3.8 -3.6 -10.0 -9.0 -6.0 14.0 15.0 13.1 7.0 7.0 7.3 9.5 8.0 9.0 -2.7 -2.8 -2.1 -4.0 -4.3 -4.2 -4.8 -5.8 -6.2 -2.2 -1.6 -1.2 3.2 2.7 2.3 5.2 4.0 2.9 8.7 10.5 11.2 -4.3 -3.8 -4.2 0.9 0.5 -0.1 3.3 3.5 4.4 10.1 6.9 8.9 9.6 8.9 8.1 19.4 24.7 27.6 9.3 9.0 9.4 3.7 3.9 4.4 -7.8 -8.6 -7.9 -1.4 -1.8 -1.9 1.5 1.5 1.1 -2.7 -3.3 -3.0 -0.6 -1.0 -1.5 0.6 -1.7 -2.0 -2.5 -2.8 -3.0 0.0 -1.6 -1.8 -2.5 -3.0 -2.8 5.6 1.0 0.0 -5.8 -6.9 -6.4 -6.0 -5.5 -4.5 4.2 4.3 4.9 2.0 1.2 2.5 0.3 0.4 1.8 32.1 29.1 28.3 -10.0 -10.7 -10.3 -8.4 -6.9 -5.9 21.8 26.5 27.6 9.5 9.7 9.9 -3.5 -4.0 -4.0 5.5 6.1 7.2 -4.0 -2.5 -2.3 0.4 0.1 0.0 -1.2 -1.1 -1.0 2.3 1.6 1.3
* For UK: HICP; for India: wholesale prices; for China, retail price index; for Brazil: IPCA, for South Africa: CPI-X ** For India: Fiscal year ending in March Source: Crdit Agricole CIB
37
Economic forecasts
USA JAPAN EUROZONE Germany France Italy Spain Netherlands Belgium Greece Ireland Portugal United Kingdom Government balance 10 11 12 -8.9 -8.8 -7.4 -10.3 -10.0 -9.7 -6.3 -4.8 -3.7 -3.8 -2.4 -1.5 -7.7 -6.2 -5.2 -4.8 -4.1 -3.1 -9.9 -7.8 -5.4 -5.8 -3.9 -2.9 -4.7 -4.5 -4.6 -9.4 -7.4 -6.5 -32.6 -10.0 -7.8 -7.3 -5.0 -4.0 -8.6 -7.8 -5.6 10 61.6 197.0 83.6 75.0 82.8 117.8 63.0 64.7 98.9 141.4 98.4 82.4 75.6 Public debt 11 66.5 206.0 86.4 75.1 86.7 120.0 69.1 66.4 101.1 153.9 103.6 87.1 80.6 12 66.0 210.0 87.8 75.1 89.2 121.8 72.8 67.7 102.4 162.0 106.4 88.3 82.7
38
Economic forecasts quarterly breakdown

2010 Q1 Real GDP growth, % USA (annualised) JAPAN EUROZONE Germany France Italy Spain United Kingdom Consumer prices, YoY % USA JAPAN EUROZONE Germany France Italy Spain United Kingdom Unem ploym ent rate, % USA JAPAN EUROZONE Germany France Italy Spain United Kingdom 9.7 4.9 9.9 8.1 9.5 8.4 19.3 7.9 9.7 5.2 10.0 7.7 9.3 8.5 20.0 7.8 9.6 5.2 10.0 7.6 9.3 8.3 20.6 7.7 9.7 5.0 10.0 7.4 9.4 8.3 20.6 7.7 9.6 5.0 9.9 7.3 9.3 8.3 20.3 7.7 9.4 4.9 9.9 7.2 9.2 8.2 20.1 7.7 9.2 4.8 9.8 7.1 9.2 8.2 20.0 7.7 9.1 4.6 9.7 7.0 9.1 8.2 20.0 7.6 8.8 4.5 9.6 7.0 9.1 8.1 19.5 7.5 8.6 4.5 9.4 6.9 9.0 8.0 19.0 7.3 8.3 4.3 9.3 6.7 8.9 7.8 18.5 7.2 8.0 4.3 9.2 6.7 8.8 7.6 18.0 7.0 2.4 -1.2 1.1 0.8 1.3 1.3 1.2 3.3 1.8 -1.1 1.5 1.0 1.6 1.6 1.6 3.4 1.2 -0.7 1.7 1.2 1.5 1.7 1.9 3.1 1.1 -0.7 2.0 1.5 1.6 2.1 2.1 3.3 1.2 -0.5 2.0 1.5 1.6 2.4 2.3 3.3 1.6 0.0 1.5 1.3 1.4 1.6 1.9 3.0 1.6 -0.3 1.6 1.5 1.6 1.9 1.6 3.1 1.4 -0.3 1.6 1.7 1.6 1.4 1.5 2.6 1.4 -0.1 1.8 2.1 1.5 1.7 1.9 1.9 1.6 0.1 1.9 2.3 1.6 1.9 2.0 1.8 1.6 0.1 2.1 2.4 1.7 2.1 1.9 1.9 1.7 0.4 2.0 2.3 1.9 2.0 1.9 1.9 3.7 1.6 0.4 0.6 0.2 0.4 0.1 0.4 1.7 0.4 1.0 2.3 0.7 0.5 0.3 1.2 2.5 0.9 0.4 0.7 0.4 0.2 0.0 0.8 3.0 -0.2 0.4 0.6 0.4 0.2 0.2 0.5 3.1 0.3 0.2 0.4 0.3 0.2 0.0 0.2 3.3 0.5 0.3 0.5 0.3 0.3 0.1 0.4 3.4 0.3 0.4 0.5 0.5 0.3 0.2 0.5 3.2 0.5 0.5 0.6 0.5 0.4 0.3 0.5 3.2 0.4 0.5 0.6 0.5 0.4 0.3 0.6 4.1 0.4 0.4 0.5 0.5 0.4 0.3 0.6 4.0 0.5 0.4 0.5 0.5 0.4 0.2 0.6 3.9 0.3 0.4 0.5 0.5 0.4 0.2 0.6 Q2 Q3 Q4 Q1 2011 Q2 Q3 Q4 Q1 Q2 2012 Q3 Q4
39
Commodities forecasts
Oil price forecasts
Average prices WTI Brent USD/bl USD/bl Q1 79 76 Q2 78 78 2010 Q3 76 77 Q4 81 82 Q1 80 81 Q2 76 75 2011 Q3 80 79 Q4 79 80 Q1 80 81 Q2 73 72 2012 Q3 77 76 Q4 80 81
End quarter prices WTI Brent USD/bl USD/bl Q1 84 80 Q2 76 75
2010 Q3 82 83 Q4 81 81 Q1 78 78 Q2 78 77
2011 Q3 80 79 Q4 80 80 Q1 77 76 Q2 75 74
2012 Q3 79 78 Q4 80 81
Metals forecasts
17-Dec Base metals Aluminium Copper Nickel Zinc Lead Tin Precious metals Gold Silver Platinum Palladium USD/oz USD/oz USD/oz USD/oz 1,376 29.0 1,704 742 1,350 27.0 1,740 700 1,350 29.0 1,760 750 1,340 28.0 1,750 800 1,260 26.0 1,810 850 1,325 27.5 1,765 775 1,425 29.0 1,725 700 1,500 31.0 1,765 750 1,475 29.0 1,750 800 1,400 27.0 1,820 850 1,450 29.0 1,765 775 1,375 27.0 1,850 875 1,350 26.0 1,875 925 1,325 25.0 1,925 950 1,250 24.0 1,950 1,050 1,275 25.5 1,900 950 USD/t USD/t USD/t USD/t USD/t USD/t 2,303 9,031 24,645 2,210 2,367 26,190 2,350 8,500 23,500 2,300 2,375 24,500 2,500 8,800 24,500 2,400 2,500 25,500 2,400 8,600 24,000 2,500 2,600 25,000 2,550 9,000 26,000 2,700 2,700 25,000 2,450 8,725 24,500 2,475 2,544 25,000 2,400 9,000 23,500 2,300 2,500 26,000 2,500 9,500 24,500 2,400 2,400 28,000 2,650 10,000 24,000 2,500 2,500 27,000 2,750 10,500 26,000 2,700 2,700 29,000 2,575 9,750 24,500 2,475 2,525 27,500 2,800 10,750 25,000 2,700 2,800 30,000 3,000 11,000 26,000 2,800 2,900 32,000 2,900 10,500 26,000 2,600 2,700 31,000 2,900 9,750 27,000 2,700 3,000 33,000 2,900 10,500 26,000 2,700 2,850 31,500 Q1 Q2 2010 Q3 2011 Q4 Year Q1 Q2 Q3 Q4 Year Q1 Q2 2012 Q3 Q4 Year
Publication Manager: Jean-Paul BETBEZE Chief Edition: Herv GOULLETQUER, Isabelle JOB Production and Sub-Editor: Fabienne Pesty Contact : publication.eco@credit-agricole-sa.fr Crdit Agricole S.A. Economic Research Department 75710 PARIS Cedex 15 Fax : +33 143 23 58 60
This publication reflects the opinion of Crdit Agricole S.A. on the date of publication, unless otherwise specified (in the case of outside contributors). Such opinion is subject to change without notice. This publication is provided for informational purposes only. The information and analyses contained herein are not to be construed as an offer to sell or as a solicitation whatsoever. Crdit Agricole S.A. and its affiliates shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising therefrom. Crdit Agricole does not warrant the accuracy or completeness of such opinions, nor of the sources of information upon which they are based, although such sources of information are considered reliable. Crdit Agricole S.A. or its affiliates therefore shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising from the disclosure or use of the information contained in this publication.
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Rules, Discretion and The Right Assessment: Copy Deadline: 17 December 2010

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131 1st quarter 2011 Copy deadline: 17th December 2010

Rules, discretion and the right assessment

Macroeconomic strategy: Too many local issues to tackle global problems

BRIC growth vs G3*

Potential versus actual GDP growth

Source: CBO, BEA, Crdit Agricole CIB

Rebased to 100 in Aug 2008 Source: Datastream, Crdit Agricole CIB

EU Economic Sentiment Indices

Source: EC, Crdit Agricole CIB

Eurozone: dispersion in unemployment rates

Source: ISM, Crdit Agricole CIB

EM real rates: very low

Private capital flows to EMs

Source: Bloomberg, Crdit Agricole CIB

USDs dominance (%)

* Cross-border Source: Bloomberg, IMF

st Macro Prospects No. 131 1 quarter 2011

US: uncomfortably slow inflation

The Fed has its reasons

Source: BLS, Crdit Agricole SA

EMU: inflation towards target

but the ECB orders things differently

Source: Eurostat, Crdit Agricole SA

st Macro Prospects No. 131 1 quarter 2011

Interest Rates US: Ending crisis yields

Jun-16 Dec-21 Jun-27 TIPS yields JGBi Ylds

Growth vs real yield

Jan-03 Jan-06 10Y Real Yield Jan-09 GDP %YoY

Source: Bloomberg, Crdit Agricole CIB

st Macro Prospects No. 131 1 quarter 2011

Interest Rates Europe: The only way is up for euro yields

Yield changes vs convergencedivergence

Source: Bloomberg, Crdit Agricole CIB

EUR rates and nominal growth (%)

Source: Eurostat, Bloomberg

Growth outlook remains positive

Source: Markit, Crdit Agricole CIB

st Macro Prospects No. 131 1 quarter 2011

Exchange Rates: Traditional drivers to return

USD to face some pressure over H111

Source: Crdit Agricole CIB, Bloomberg

Weakest currencies over 12M will be traditional funding currencies

12m carry adjusted returns, %

Source: Crdit Agricole CIB, Bloomberg

After short-lived weakness USD set to strengthen

USD index (CA CIB forecast)

Source: Crdit Agricole CIB, Bloomberg

st Macro Prospects No. 131 1 quarter 2011

Energy: Oil markets tightening at the end of the year

World oil supply/demand (Mbd)

Source: Crdit Agricole CIB

Metals: Buy aluminium

0 Jan-80 Jan-87 Jan-94 Jan-01 Jan-08

Source: Reuters, Crdit Agricole CIB

st Macro Prospects No. 131 1 quarter 2011

US: Gradual return to health aided by policy stimulus

Household financial situation improving 2011 year of transition

Source: BEA, FRB

Debt service burden declining

Source: Federal Reserve Board

Consumers reducing credit usage