Fixed Income: Weekly Strategy 11 October 2010 Assessing the impact of further QE on bonds and our forecasts We are revising our US bond forecasts to account for the probability that the Fed expands its QE program. A comparison of the 10Y US Treasury to the ZCS curve shows the QE risk is already well priced. We continue to look for the RBA to raise rates – which will flatten and invert the Australian curve. Our Chief FX Strategist also considers what impact the China/US currency dispute may have on bonds. The last week has been the tale of two employment numbers. In Contents: Australia we got the best of times: nearly 50K new jobs created. In the US, they got the worst of times: nearly 100K jobs destroyed. Key Trades ............................................................................ 2 Forecast revisions - Accounting for QE2 ............................... 3 This dynamic defined the week. Australian bonds were essentially holding the line as US yields hit new record lows. The Australian 10Y How much QE is already priced? .......................................... 8 bond is unchanged since last week to the basis point, while the 3Y bond US Protectionism and China’s Treasury Holdings ............... 11 has sold-off 3bp. The curve has flattened to 11.5bp. In the US, the 2Y bond has reached a new record low of 34bp (down 7bp). The 10Y has Key Views............................................................................ 13 finished the week at 2.40%, down 7bp from last week. CBA Forecasts: .................................................................... 14 While the employment data was pivotal for this week, it is also indicative Calendar – October 2010 .................................................... 15 of the general trend of both markets. It is this trend that is causing the market to expect a second round of Quantitative Easing by the Federal Reserve. The minutes of the FOMC meeting of 21 September will be released on Wednesday morning (Australian time). The discussion of QE is unlikely to be settled then, but the minutes will only intensify interest as to when exactly the Fed will lose patience and implement more QE. US unemployment is refusing to fall – and trying We are updating our forecast to reflect this new dynamic in an article by the Fed’s patience in the process Adam Donaldson on page 3. In brief, we are lowering our US bond forecasts and incorporating a flatter Australian curve as the US long end % 000s holds down Australian long end rates. 12.0 700 On page 8 Philip Brown takes up the challenge of figuring out how much QE is already priced by the market. Using a comparison to inflation 10.0 600 swaps he deduces that the market is already very significantly priced for BLS official unemployment rate QE. In fact, should the Fed not deliver QE (or do so in a smaller volume (LHS) than the market expects) it is possible the market could sell-off in 8.0 500 response. Despite the doom and gloom in the United States, the outlook for 6.0 400 Australia remains strong. A second result of our contrasting employment fortunes is that AUS-US bond spreads have been widening. 4.0 300 Last week’s data saw the AUD make the first stumbling attempts at reaching parity. So far the high remains USD99.18. Jobless claims unemployment rate (RHS) 2.0 200 Currencies are very much on policy-makers lips, too. The US is making 85 87 89 91 93 95 97 99 01 03 05 07 09 11 increasingly stern comments about Chinese policy, but so far the effect on bond markets has been small. Richard Grace takes a closer look at this issue on page 11. The coming week sees very few confirmed highlights. In the US, the Fed minutes and the US CPI data are released but in Australia there is only business and consumer confidence data. Most likely it will be another week devoted to analysing the prospects of further US QE. Adam Donaldson Head of Debt Research T. +612 9118 1095 E. firstname.lastname@example.org Philip Brown Quantitative Strategist T. +612 9118 1090 E. email@example.com Richard Grace Chief Currency Strategist T. +612 9117 0080 E. firstname.lastname@example.org Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and at www.research.commbank.com.au. This report is published, approved and distributed by Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945. Global Markets Research : Weekly Strategy Key Trades Trade Entry Curent Profit Target Stop Comment Buy the NSWTC -12bp -27bp 15bp -35bp 0bp Hold: A long term buy and hold Jun-20 (Government (3-Feb-10) trade. The NSWTC budget suggests Guaranteed) as an borrowing will reduce. QTC has ASW started to consolidate GG bonds. Sell the May-13 -11bp -6bp +5bp 3bp -20bp Hold: Taking longer than we thought ACGB against the (25 May) – but with Dec-13 included in March Nov-12 and Dec-13 2011 Basket should work eventually Pay 3yr AUD EFP 35bp 38bp +3 45bp 30bp Hold: Increased mortgage fixing may (9 August) force this wider as curve flattens. Sell the May-13 62bp 14.5bp 47.5bp 15bp 33bp Hold: Curve flattening as ACGB vs the Apr-20 (5 July) expectations of RBA action push up front end and US holds down long end. 10yr ACGB BEI 255 bp 271bp 16bp 280bp 240bp Hold: Spread has widened in the widening (18 August) sell-off OTM Conditional 3.75% and 5.31 and -0.4bp Hold: An insurance trade for a global Stepeener. 6M*2Y 4.28% 5.58 (prem- double dip. vs 6M*10Y. Buy 0.4bp ium) 100m 6M*2Y 3.75% premium receiver. Sell 24.1M (25 August) 6M*10Y 4.28% receiver. Buy the NSWTC 63bp 62bp -1bp 75bp 55bp Hold: We shift into the NSWTC to Apr-19 vs the EIB (8 Sep) EIB trade. Aug-19 Buy the Suncorp TM of 26.5bp +3bp 0bp 40bp Hold: This bond is Government Metway Govt 29.5bp Guaranteed. It should be much Guaranteed Apr-11 tighter. Can hold to maturity in 6 Floater. months. Sell the Mar-12 IR 17bp 16bp -1bp 50bp 0bp Hold: The market is underpricing the future against the (21 Sep) chance of an active RBA through Mar-11 2011 Buy NZGB May-21 29bp +3bp +26bp -10bp 14bp Hold: RBA speculation combined vs ACGB May-21 (5 July) with weak NZ GDP has helped the trade a lot. Pay 6M*2Y vs 111bp 105bp -5bp 50bp 135bp Hold: A number of influences have Buying the May-21 (30 August) cancelled out. Still look for further flattening. 2 Global Markets Research : Weekly Strategy Forecast revisions - Accounting for QE2 Adam Donaldson – Head of Debt Research – 61 2 9118 1095 – email@example.com We revise our US forecasts to take account of the likely Fed Quantitative Easing program. US bonds will be lower in yield, causing a secondary effect in Australian long end rates. However, the RBA will still be raising rates, leading to a sharper flattening and then inversion of the Australian curve. The contrast also points to wider AUS-US bond spreads, supporting our parity call for the AUD. Our last set of US and Australian bond forecast revisions a quarter ago included substantial CBA forecasts downward reductions in forecast bond yields. This took account of increased global focus on Dec- Jun- Dec- fiscal austerity and the unfolding slowdown in Current 10 11 11 the United States, which we assessed could Official Cash 4.50 4.75 5.25 5.75 bring Federal Reserve quantitative easing (QE) 90-day BBSW 4.83 5.10 5.60 6.10 back on to the agenda. 1-year swap 5.11 5.30 5.85 6.25 3-year swap 5.31 5.55 5.95 6.15 Fed poised to In the event, the Fed has already taken steps to 10-year swap 5.61 5.70 5.95 6.15 implement QE2 preserve the existing level of QE and seems Aus 3yr bond 4.87 5.10 5.40 5.60 poised to increase the scale of intervention in Aus 10yr bond 5.01 5.10 5.30 5.50 the bond market. Our 2.8% end-September Aus 3-10yr forecast for US 10yrs wasn’t aggressive Curve (bp) 14 0 -10 -10 enough. We are now lowering our Q4 and Q1 US 2yr bond 0.34 0.30 0.65 1.75 forecasts to 2.25% and pushing out the timing US 10yr bond 2.39 2.25 2.40 3.00 of the rebound. AUS-US 10yr spread (bp) 262 285 290 250 The strong US bond rally meant that Australia’s yield curve has flattened a little more than expected and AUS-US bond spreads have widened more than expected. While the RBA didn’t tighten monetary policy as the market had discounted in October, the fundamentals suggest a move is still likely before long. The contrast with the outlook in the benchmark US Chart 1: US GDP and Final Sales market suggests further AUS bond under- performance and curve flattening is likely, suggesting we could see an inverted yield curve % % in the near future. 6 6 Final sales US backdrop 3 3 US data no longer The weakening trend in US economic data trending weaker, but appears to have abated over the past month after a clear slowdown in July and August. This 0 0 not recovering either inflection in the momentum of the data provided Inventories powerful support to financial markets in early -3 contribution -3 September, when not-as-bad-as-expected August ISM and payrolls results prompted a surge in equities and a 35bp rise in 10yr GDP Treasury yields. -6 -6 85 88 91 94 97 00 03 06 09 But the outright level of activity remains anaemic. While annual growth in GDP accelerated to a respectable 3.0% in Q2, 1.9% points of this reflected a bounce in business inventories as firms recallibrated production in the wake of the GFC shock (Chart 1). The concern is that underlying sales growth remains very weak and that the inventory boost to orders is now fading (Chart 2). As confirmed 3 Global Markets Research : Weekly Strategy again on Friday, progress in lowering the Chart 2: US ISM versus wholesale unemployment rate has stalled (Chart 3). The risk of a double-dip in the US economy 6m % annualised ISM Index does not appear to have increased over the 30 80 past quarter (nor abated). But the Fed is clearly W'sale sales-inventories losing patience. Subdued growth points to lack growth gap (LHS) of job creation and therefore failure to address 15 ISM (RHS) 65 one of the Fed’s key responsibilities. But failure to absorb abundant spare capacity also intensifies the disinflationary pulse running through the US economy – very important 0 50 considering the Fed declared on September 21 that inflation already is too low (Chart 4). The upshot is that the FOMC: -15 35 “is prepared to provide additional accommodation if needed to support the economic recovery and -30 20 to return inflation, over time, to 95 97 99 01 03 05 07 09 levels consistent with its mandate”. QE speculation has US Treasuries have subsequently rallied seen US treasuries aggressively to new yield lows on the rally significantly expectation that the Fed will deliver further QE Chart 3: US unemployment rate & jobless when it next meets on November 2-3. In the claims absence of more information on timing, size and objectives from the Fed, it is very difficult to % 000s gauge just what impact this QE2 will have on 12.0 700 the Treasury market. 10.0 600 Recalibrating US bond forecasts BLS official unemployment rate (LHS) QE does not The initial March 2009 QE program jolted US 8.0 500 necessarily cause a 10yrs 50bp lower to 2.5%. But the impact was sustained rally short-lived because it coincided with the cycle low in the economy, equities, confidence and 6.0 400 risk appetite. 10yrs were back at 4.0% by June 2009 amid growing concern that fiscal and 4.0 300 monetary largesse were inappropriate and presented long-term inflation risk in the brighter Jobless claims unemployment rate (RHS) economic climate that was unfolding. But we 2.0 200 also assess that the defined size of the Fed’s 85 87 89 91 93 95 97 99 01 03 05 07 09 11 program and the fact most of this was directed towards the RMBS market limited the impact of QE1 on the yield curve. Chart 4: US inflation & unit labour costs The current situation bears some similarities in that equities are again rallying strongly on the y/y % y/y % elixir of monetary stimulus (Chart 5) and the 10 12 recent momentum in US economic data has been firmer. But the inventory and fiscal 8 9 Unit labour costs backdrop suggest a strong bounce in activity is (non-financial sector, much less likely this time around. More 6 RHS) 6 importantly, having apparently decided to act (though clearly not uniformly), we suspect the Fed will stay the course for at least six months 4 3 to ensure the recovery is locked in and deflation risks minimised. 2 0 Market has already Still, as detailed in the accompanying article, we Core PCE deflator (LHS) 0 -3 priced in further QE assess that QE2 is now largely priced in. That mainly reflects a view that real yields wont fall much further, though there is probably scope -2 -6 for the inflation premium to unwind some of its 70 74 78 82 86 90 94 98 02 06 10 4 Global Markets Research : Weekly Strategy recent increase (from 1.5% to 2.0% for 10yrs) as actual inflation remains very subdued. Chart 5: US bonds versus equities However, the larger near-term risk is probably market disappointment with the pace of Fed % Index easing that sparks a knee-jerk pull-back in bond 7 US 1,800 yields. 10yrs S&P 500 (rhs) 6 1,600 We have lowered our US 10yr forecast to 2.25% for both Q4-10 and Q1-11. After that 1,400 time, we currently look for yields to start 5 tracking significantly higher as the recovery 1,200 finally comes through and the Federal Reserve 4 withdraws back to the sidelines. Our 1,000 economists envisage that the Fed will start 3 lifting the Federal Funds rate from Q3-11, which 800 we think would signal the start of a return to a 2 more normal term structure of rates in the US. 600 1 400 Australian bond revisions 98 99 00 01 02 03 04 05 06 07 08 09 10 Australian bond Chart 6 highlights the powerful impact the US yields likely to go rally has had on the long end of the Australian higher bond curve. Aussie bonds have under- standably lagged the US rally given the strength Chart 6: US versus Australian 10yr bond yields of the local economy, but there has been substantial foreign buying of Australian bonds % % on a relative value basis – the local market 7 8 offers a large yield premium attractive to foreign investors, particularly those wishing to short expensive foreign markets and positive on the 6 7 outlook for the AUD (Chart 7). With the front end of the curve under upward pressure due to 5 6 the threat of domestic monetary tightening, this has also led to a marked flattening of the yield curve (Chart 8). Both of these developments 4 5 were in line with previous forecasts but went Australia further than expected. 3 (rhs) 4 United States Though the global There was, however, a short period in the (lhs) backdrop is still a second half of August when the price trends in 2 3 risk the domestic market altered somewhat. The 98 00 02 04 06 08 10 yield curve steepened and AUS-US bond spreads actually narrowed for a period despite the continued rally in US bonds, as concerns over a global double-dip intensified. The Australian market actually priced in some risk of Chart 7: Foreign buying has surged recently Reserve Bank monetary easing during this period, though that appeared to reflect $ bn $ bn smoothing out of the curve as 3yrs rallied down 120 120 to 4.25% amid global buying and a lack of domestic capacity to further short the market Foreigners (Chart 9). The episode shows the potential 90 90 impact of foreign investors on the local market and serves as a warning that re-emergence of Commonwealth, broad-based global economic weakness would 60 RBA 60 dramatically change the outlook for the Other domestic fixed income market. We have NBFIs (mainly custodial, advocated cheap OTM conditional steepening likely foreign) 30 30 trades as a useful hedge against this risk to our Banks core views. Trading patterns reverted back to normal 0 0 following the release of the key US ISM and 69 73 77 81 85 89 93 97 01 05 09 payroll reports in early September, which arrested fears of a dramatic slide in the US 5 Global Markets Research : Weekly Strategy economy. China’s monthly PMI was just as important, showing the first increase for several Chart 8: US 10yrs versus AUS-US 10yr spread months. But the kicker for the Australian market was exceptional strength in the Q2 % bp national accounts, which showed a much stronger than expected 1.6% rise in real GDP 8.0 -100 and an even more stunning 3.6% surge in 3-10yr curve nominal GDP (up 10.4% y/y, Chart 10). The (inverted, rhs) data has been followed by two very strong employment reports and a host of hawkish 6.0 0 speeches from RBA officials that convinced the market it would tighten policy in October. RBA’s surprise “no The RBA’s ‘surprise’ decision not to hike in 4.0 100 move” in October October introduced further volatility to the front- doesn’t change the end of the Australian curve. But the change in Cash rate trend sentiment has had a more enduring impact on (lhs) the bond market. The 3-10yr futures curve has flattened 36bp since the end of August (Chart 8) 2.0 200 and the 10yr AUS-US spread has widened 97 99 01 03 05 07 09 40bp. Chart 11 shows how the spread is being more impacted by domestic dynamics than just the US rally which largely explained previous spread widening. Chart 9: IB cash rate pricing Looking ahead, our economists continue to forecast that the Reserve Bank will lift the cash % % rate 25bp in November, and a further 100bp 5.50 5.50 over the course of 2011. Relative to our June 2011 forecast for US bond yields to drift and hold a Dec 2011 little lower, this points to a continuation of the curve flattening and spread widening dynamics 5.00 5.00 of recent months. An increase in our forecast for the AUS-US 10yr spread to a peak of 300bp in Q1 broadly offsets the impact of lower US 4.50 4.50 bond forecasts. The net impact is a 10-20bp December downward revision to our 10yr Aussie bond 2010 forecast in H1 2010 and a similar upward 4.00 4.00 revision to our 2-3yr bond forecasts. Cash rate Australian curve and market views 3.50 3.50 Jan-10 Apr-10 Jul-10 Oct-10 The combination One result of these forecast revisions is that we leads to an inverted are now forecasting the Australian yield curve to AUD bond curve invert from Q1, with the 2-10yr slope reaching -20bp and the 3-10yr reaching -10bp. On a Chart 10: Australian GDP growth measures trade view, with these curves already trading in a 10-15bp range, we wouldn’t be surprised to y/y % y/y % see inversion this year, subject to the Fed 12 12 implementing significant QE2 and the RBA hiking as forecast in November. Nominal GDP 9 9 But we can’t forget that both these central banks will be meeting on November 2nd, highlighting just how unusual such an outcome 6 6 would be. As discussed, there is clear capacity for the Fed to disappoint aggressive market pricing for QE. The RBA, meanwhile, has 3 3 already managed to surprise markets by not GDP tightening as expected, and a November move 0 0 would appear highly contingent on the inflation data to be released on October 27th. Our Real GDI economists forecast a 0.7% rise in underlying -3 -3 inflation and expect this would be enough to 93 95 97 99 01 03 05 07 09 11 push the RBA over the line in November, but 6 Global Markets Research : Weekly Strategy also caution that most of our internal indicators point to downside risk. Chart 11: US 10yrs versus AUS-US 10yr spread Our current trades Cash rate futures are currently pricing in a 54% already capture chance of a 25bp hike in November, which bp % these views probably understates the risk of a move. But 275 1 we are cognisant that the market is discounting AUS-US a 90% chance of a hike by December, and 10yr spread suspicious that the lack of any hike this year 250 (lhs) could have a profound impact on future market 2 expectations. We retain our core flattening trade exposure but don’t feel the need to 225 double-up with further trades at this stage given 3 relatively full pricing on the two key events 200 confronting the market over the next month. US 10yr 4 175 (inverted, rhs) 150 5 Jul-09 Dec-09 May-10 Oct-10 7 Global Markets Research : Weekly Strategy How much QE is already priced? Philip Brown – Fixed Income Quantitative Strategist – 61 2 9118 1090 – firstname.lastname@example.org The market is already reacting to the prospect of further Quantitative Easing. The spread between 10Y UST and 10Y ZCS measures the pricing of QE. The current levels of this spread show QE is already significantly (if not fully) priced. There must be risk of significant disappointment if the Fed doesn’t deliver in November. After Friday night’s Payrolls report the prospect of further quantitative easing remains unresolved. Although the headline figure was weaker Figure 1: Shock and awe in 2008/09 than expected (-95K) the discrepancy was mainly due to the continued fall in public employment (partly Census related). The trend of anaemic % QE1a QE1b UST US growth and associated Fed commentary suggests the Fed’s patience will soon wear thin and they will embark on further QE. 7.00 We believe that the there is already a significant chance of QE implicit in 6.00 the prices of US treasuries. However, lacking the clean instruments 5.00 available in money markets, we are forced to use more involved methods. Here, we compare the 10Y treasury yield to the 10Y inflation 4.00 ZCS to obtain a simple measure of term premium in the 10Y treasury. Since Fed QE purchases do not affect the ZCS, a tightening of the 3.00 premium indicates that the market is expecting QE. This approach 2.00 shows the most recent rally is taking US bonds into areas only seen briefly – and right at the height of QE1. 1.00 0.00 Background – QE as a technique Jul-04 Jul-06 Jul-08 Jul-10 QE is a technique that is still being refined. Monetary policy is often Source: CBA, Bloomberg described as a blunt instrument or as a sledge hammer – which must make QE something akin to a steam roller. The first set of QE (presumably QE1, if the next set is QE2) was actually split into two separate stages. What we’ll term QE1a began with the announcement of the intention to purchase $100b of GSE bonds (read Fannie and Freddie) and a further $500m of MBS on 25 November 2008. On March 18 2009, the Fed announced a second set of purchases (QE1b). The Fed extended the purchases of MBS by a further $750bn to Figure 2: 10Y UST and ZCS – long view $1.25 trillion and doubled the total value of GSE straight-debt purchases to $200bn. However, the Fed also began purchasing US Treasuries at bp this point, with a total of $300bn of purchases announced. Yield on 10Y Treasury less ZCS 260 240 The purchases of US treasuries were undertaken by a reverse tender 220 system, with the Fed announcing an approximate maturity span and 200 asking for tenders in that space. This is the same system they are using 180 to repurchase the maturities and coupons at the moment. 160 140 There was a knee-jerk 47bp rally in US 10yrs when the Fed announced it 120 100 would purchase Treasuries on 18 March 2009. However, the impact 80 was short-lived because it coincided with the cycle low in the economy, 60 equities, confidence and risk appetite. Three weeks later the 10Y bonds 40 were back with 10bp of the pre-announcement price and by June 2009 20 10yrs were back at 4.0%. The sell-off occurred amid growing concern 0 that fiscal and monetary largesse were inappropriate and presented -20 long-term inflation risk in the brighter economic climate that was Jul-04 Jul-06 Jul-08 Jul-10 unfolding. But the defined size of the Fed’s treasury purchase program likely limited the impact of QE1 on the yield curve. Source: CBA, Bloomberg 8 Global Markets Research : Weekly Strategy Measuring QE expectations Figure 3: UST and ZCS – short view The recent rally in bond markets and the volume of discussion of QE bp QE1a QE1b UST less ZCS give us a relatively clear indication that the bond market is reacting to 250 the prospect of QE. However, it is not easy to measure how much reaction has already occurred. 200 When assessing a cash rate profile money market futures and OIS make the process relatively exact, but here we’ve got less to go on. The 150 outright level of US treasury yields is not a particularly helpful measure (see Figure 1). Bonds rallied significantly as QE1a approached – but the 100 economy was tanking at the same time and there was a strong flight to quality bid. QE1b, in contrast, saw a sharp but temporary reaction in the 10Y yield as discussed above. 50 Although the outright yield of 10Y treasuries is not a good measure, all is 0 not lost. We have compared the 10Y US Treasury yield to the 10Y US Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 ZCS. Our rationale here is that the yield curve is often broken down into 1 : Source: CBA, Bloomberg rate = real rate + Figure 4: ZCS has sold-off in recent days inflation + % QE1a QE1b ZCS term premium + 4.00 inflation risk premium 3.50 Usually the inflation component is done with TIPS. But TIPS are 3.00 physical bonds and so are also exposed to secondary market effects as 2.50 the QE pushes up bond prices. In fact, there’s no guaranteed that QE2 wouldn’t involve TIPS directly. They have recently reinvested a small 2.00 share of maturities from their QE1 portfolio into TIPS. If the Fed 1.50 deliberately buys an instrument that receives inflation it sends a strong signal that the Fed thinks deflation isn’t a problem. 1.00 0.50 ZCS, however, are not affected by QE expectations as they are not a physical bond. As a derivative of the CPI only, they will not be used by 0.00 the Fed. ZCS still show, in our view, a fair representation of inflation Jul-04 Jul-06 Jul-08 Jul-10 expectations. Currently 10Y ZCS are yielding nearly the same as 10Y Treasuries – just 8bp less. That spread doesn’t leave much for real rate, term premium or inflation risk premium in our model. Unless, that is, we Figure 5: Australia to US bond spreads had a missing term above and the correct specification is: bp % rate = real rate + 300 2 US 10yr inflation + (inverted, rhs) 275 term premium + 250 3 inflation risk premium +/– 225 expected QE adjustment 200 4 Using this measure we find the periods of significant movement coincide AUS-US with the announcements of previous QE measures. After a period of 10yr spread 175 relative stability, the spread became highly volatile when QE become a (lhs) possibility. Although the spread has moved large amounts before (like in 150 5 2007/8 when there was a flight to quality), QE causes sharp gapping behaviour in the spread. (See figures 2 and 3.) QE1a coincided with a Jul-09 Dec-09 May-10 massive tightening in the spread and the lowest ever value was achieved two days after QE1b. Source: CBA, Bloomberg To our mind this shows relatively conclusively that this measure works 1 For example, in Don H Kim and Jonathon H Wright “An Arbitrage-free Three-Factor Term Structure Model and the Recent Behaviour of Long- Term Yield and Distant-Horizon Forward Rates”, Fed Discussion Paper FEDS 2005-33 9 Global Markets Research : Weekly Strategy and there is already a substantial QE action priced into the US 10Y treasury market. Which begs the question, what if we don’t get QE? Or only a smaller than expected one? A vicious sell-off, we assume. The rally in US 10Y has contributed to a widening in AUS-US bond spreads. This can be readily explained as a symptom of QE expectations. We took profit on a spread widening trade because we were concerned about getting our fingers burned. As it turned out we should have maintained the position, but our rationale for exiting is now doubly true – the scope for a US sell-off and contraction in the AUS-US 10Y spread is now just as real as the scope for the opposite, depending on whether or not QE eventuates – and in what size. How might QE be implemented? There are no clear “rules” as to how the Fed will undertake QE like there are for interest rate decisions. When banks seek to move the interest rate they almost always choose multiples of 0.25% - but QE is so rare that there is no real standard. So far, central banks have just been choosing nice, round numbers for QE announcements. Last time the Fed undertook QE in late 2008 / early 2009, the explicit intention was “shock-and-awe”. The Fed was deliberately noisy about the way they were purchasing bonds. So they announced a large number and went about buying the bonds and forcing the rate lower. But that was to restore confidence and avert a catastrophe. The focus on the GSE bonds and MBS was to also assist the housing market, not only to lower outright yields. The task confronting the Fed now is perhaps a little more nuanced than the steam-roller of QE1: to try to cajole a spluttering economy back to life. It is by no means certain that the best way to achieve this is with shock-and-awe. If the Fed implements QE2, we presume the NY Fed system of purchasing the bonds within a specified maturity bucket is likely to be retained. The process has worked well so far. The more difficult question will be whether or not the Fed announces any or all of: a total volume of purchases; a timeframe for said purchases; or a target rate. The total volume of purchases was the technique used in 2008 and 2009 As we have noted this situation is a slightly different problem and may require a more nuanced solution. It is likely that the Fed will announce a total volume, but not definite. Nor would an end-point seem entirely necessary. It is possible the Fed could suggest that they will purchase an approximate amount per month until the economy recovers – or “for an extended period”. Although the target price is superficially attractive, it fails in practical application. While the target works in FX when there is only one price, there are simply too many bonds with too many prices to be effectively targeting each one. Moreover, the purpose of QE is to lower the entire curve structure of interest rates in the whole economy – there is no reason not to buy all maturities. There are many possible reactions depending on what the Fed announces. The characteristics of QE2 will define the result – and while a rally is the most likely, it is not a foregone conclusion. If the Fed announces a small QE program the market may sell-off. However, we expect the announcement will be large enough to see bonds rally in response. Though, given a large amount is already priced, this rally may not be particularly large (or, at least, not large once the dust settles, as per QE1b). 10 Global Markets Research : Weekly Strategy US Protectionism and China’s Treasury Holdings Richard Grace – Chief Currency Strategist – 61 2 9117 0080 – Richard.Grace@cba.com.au US House of Reps. passed the Currency Reform Act. Chinese officials respond claiming non-compliance with WTO rules. Are the Chinese likely to further respond by dumping US treasuries and the USD ? We think not. Even if this unlikely event were to occur, the lasting net effect on the US bond market and the USD would be minimal. The US House of Representatives passed the Currency Reform for Fair Trade Act, by a vote of 348 to 79. To become law, the bill needs to be Figure 1: passed by the Senate (which is difficult before the November mid-term elections) and then signed by President Obama. China’s Commerce FOREIGN OWNERSHIP OF US Ministry representative, Yao Jian, responded by commenting that US$ PUBLIC DEBT US$ bn bn “starting a countervailing investigation in the name of exchange rates 14,000 14,000 does not conform with relevant WTO rules". Total Stock of US 12,000 Public Debt 12,000 Is China likely to retaliate by dumping US treasuries and the 10,000 10,000 USD ? 8,000 8,000 In short, the answer is no. Such a retaliatory action by China would not 6,000 6,000 Stock of Foreign Holdings (30%) be in China’s own interests. For that matter, it would not be in anybody’s interest, considering the announcement effect would create volatility. 4,000 Stock of China's Ownership 4,000 of US Public Debt (6.4%) 2,000 2,000 Of the US$13.6 trillion in US treasury debt on issue, China’s holdings of US treasuries is relatively small at 6.4%, or US$847 billion (chart 1). 0 0 China’s treasury portfolio comprises $431 billion in treasury bonds and Mar-00 Nov-02 Jul-05 Mar-08 Nov-10 $416 billion in treasury bills. If China were to retaliate by selling 10% of Source: CBA, Bloomberg their treasury holdings as a “protest” over the US House vote, it would amount to US$84 billion – equivalent to one-week’s supply of treasuries issued by the US government. The lasting impact of a Chinese portfolio Figure 2: adjustment on the US treasury market and the USD would be minimal. China has been in a process of reserve diversification for a number of US$ CHINA: FX RESERVES US$ bn (rolling twelve month addition) bn years. In fact, the rate of growth of China’s non-USD foreign exchange 600 600 reserves has been exponential compared to the rate of growth in USD Total China FX reserves (chart 2). This process of reserve diversification has left 48% (or 500 Reserves 500 (12 Month Rolling Total) US$1.2 trillion) of China’s foreign exchange reserves denominated in non-USDs. This non-USD proportion is mostly EUR, but it probably also 400 Gap equals net inflow 400 into non-USD contains GBP, JPY, AUD and other currencies (charts 2 and 3). currencies (eg. EUR, 300 GBP, JPY, KRW, 300 The remaining 52% (or $1.28 trillion) of China’s US$2.45 trillion in foreign AUD) exchange reserves is held in USD. Of this total, 34% or US$847 billion is 200 200 in US treasuries. The remaining US$271 billion is in agency bonds and US$157 billion is in corporate bonds (table below). 100 100 Net inflows to USD 0 0 Feb-97 Oct-99 Jun-02 Feb-05 Oct-07 Jun-10 China's Foreign Exchange Reserves (US$b) US$b % - Treasury Bills 416 - Treasury Bonds 431 Total Public US Treasury Debt 847 34 - Agency Bonds 271 - Corporate Bonds 157 Total USD Foreign Exchange Reserves 1,275 52 Total Non-USD Foreign Exchange Reserves 1,182 48 Total Foreign Exchange Reserves 2,456 100 0. A s at end June 201 So urce: P B o C, US Treasury, CB A Research. 11 Global Markets Research : Weekly Strategy Figure 3: Recent trends illustrate China is reducing US treasury CHINA'S FOREIGN holdings EXCHANGE RESERVES 100 3.0 The monthly Treasury International Capital (TIC) data illustrates that China has reduced its holdings of US treasuries over the last few 52% or $1.28tn in USD 80 (lhs) 2.4 months. But some of this capital has gone into agency bonds, so there has been no major currency impact. This development also indicates that a reduction in China’s treasury portfolio is not reflective of a loss of 60 1.8 confidence in US assets. In April 2010, the Chinese returned to be a net 48% or $1.2tn in Other Currencies (lhs) buyer of agency bonds for the first time since June 2008 (charts 4 and 40 1.2 5). While China is an important player in the US treasury market, one should 20 0.6 not over-estimate the net impact a portfolio adjustment by the Chinese Total Reserves (US$2.4tn) rhs would have on the very deep and liquid US treasury market (chart 6). 0 0.0 The very high risk of some additional Fed quantitative easing following Jan-04 Jan-06 Jan-08 Jan-10 the 3 November FOMC meeting is likely to have a much greater impact on US treasury yields and the USD (chart 7). Having said that, it is still worth mentioning than an on-going trade and exchange rate dispute between China and the US still risks being somewhat unsettling on market sentiment. Figure 4: Figure 5: CHINA'S HOLDINGS OF US CHINA NET PURCHASE OF US US$ US$ US$ US$ bn BONDS bn bn BONDS bn (rolling 3 month average) (rolling 6 month average) 600 600 20 20 Treasury Bills 500 500 15 15 Treasuries 400 400 10 10 Treasury Bonds Corporate bonds 300 300 5 5 Agency Bonds 200 200 0 0 Agency bonds Corporate bonds 100 100 -5 -5 Dec-07 Nov-08 Nov-09 Nov-10 Feb-97 Oct-99 Jun-02 Feb-05 Oct-07 Jun-10 Figure 6: Figure 7: US$ CHINA NET PURCHASES OF US US$ QUANTITATIVE EASING AS % OF bn TREASURIES bn GDP 400 400 20 20 US Fed 300 300 16 16 Monthly Change in Total US Treasury Debt 200 200 UK BoE 12 12 100 100 Eurozone ECB 8 8 0 0 Monthly Change in Total Chinese Net Purchases of US Treasury 4 4 -100 -100 Mar-00 Nov-02 Jul-05 Mar-08 Nov-10 Japan BoJ 0 0 03-Jan-07 03-Jul-08 03-Jan-10 03-Jul-11 12 Global Markets Research : Weekly Strategy Key Views Tactical Strategic (<1 mth) (>3 mths) United States The continued weakness of US data has brought the possibility of further QE into sharp Policy rate 0.1% 0.1% focus. Most recently, Payrolls registered another mediocre result (-95K). The negative headline figure was caused mostly by a contraction in Government employees (-159), 10yr bond 2.25% 2.25% private payrolls was positive (+64K). The contraction in Government payrolls was partly due to more of the temporary census 2/10 curve 195bp 190bp workers finishing their employment. The other contributing factor was the longer-term pattern of US Governments of all levels seeking to reduce their deficits by reducing wage USD/JPY 83.5 84 bills. The US bond market is already pricing a significant amount of Quantitative easing. Even EUR/USD 1.41 1.32 if the Fed does increase QE (which is far from certain) the market may struggle to rally too much more from here. The political sphere is starting to interact with the financial sphere in currency markets too. After the intervention by the BoJ, the Yuan fix has come under increased speculation. The House of Representatives has approved a bill allowing the US to increase duties on countries whose currencies are undervalued as a result of an intervention (read China). With volatility at the lower end of recent experience and the US economic data generally soft, we see the USD easing further. There is a high risk the Fed implements more QE at its November meeting which pushes down the USD. With the BoJ on the sidelines ready to sell yen, the EUR/USD is likely to be the main beneficiary of a softer USD. Tactical Strategic (<1 mth) (>3 mths) Australia The Australian economy continues to perform well. The most recent employment figures Policy rate 4.75% 4.75% were strong and over 50K new full time jobs were created. We expect the Q3 CPI on October 27 to make or break the case for tightening at the November RBA meeting, with 10yr bond 5.00% 5.20% a hike more likely than not at this stage. Ultimately, more tightening is likely through 2011 as policy-makers make room for the 3/10 curve 10bp 0bp resources boom and inherent inflation risks. The Aust-US spread will be dominated by the US QE question. The contrast between the 10yr EFP 57bp 65bp US and the Australian outlook points to a flatter Australian curve. 10yr v US 280 290 The combination of a softening USD, declining vol, and Australia’s relative economic health are providing upside risks to the AUD. Stronger than expected outcomes in China AUD/USD 0.97 0.99 and Asia’s economies and weaker than expected outcomes in the US and Europe will feed into future AUD strength, particularly if vol. can remain low. Tactical Strategic (<1 mth) (>3 mths) New Zealand The recent earthquake in Christchurch has left a significant re-building task. In economic Policy rate 3.0% 3.0% terms the result is that near-term growth is reduced, but medium term GDP is given a boost by the rebuilding effort. 10yr bond 5.0% 5.1% After a much weaker than expected Q2 GDP reading our economists look for the RBNZ to be on hold through to the March meeting in 2011, before again raising rates. The 2/10 swap 110bp 100bp RBNZ left rates unchanged at the September 16 meeting and issued a relatively Dovish curve statement. The increase in the NZ GST appears to have been implemented reasonably smoothly. 10yr v US 280 290 The data is starting to show some pull-forward in retail spending. 10yr v AUS 0 -10 The growing contrast between the Australian and New Zealand economies is likely to push AUD/NZD higher. The US economy and New Zealand economies are both rather NZD/USD 0.74 0.75 soft, suggesting NZD/USD will range-trade, though a weaker USD and firm dairy prices may work in the NZD’s favour. AUD/NZD 1.3100 1.3200 13 Global Markets Research : Weekly Strategy CBA Forecasts: Cash rate 11-Oct Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 US 0.25 0.25 0.25 0.25 0.50 1.00 1.50 1.75 2.00 2.25 Australia 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.00 6.00 6.00 New Zealand 3.00 3.00 3.25 3.75 4.25 4.50 4.50 4.50 4.50 4.50 Canada 0.50 1.25 1.75 2.25 2.75 3.25 3.25 United Kingdom 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 1.75 2.00 Eurozone 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.75 2.00 2.00 Japan 0.05 0.05 0.05 0.05 0.05 0.05 0.30 0.30 0.30 0.30 2-yr bond yield 11-Oct Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 US 0.34 0.30 0.35 0.65 1.50 1.75 2.00 2.30 2.60 2.75 Australia 4.84 5.10 5.30 5.45 5.60 5.70 5.60 5.60 5.60 5.60 New Zealand 3.80 4.00 4.20 4.60 4.90 5.00 4.80 4.80 4.70 4.70 United Kingdom 0.62 0.50 0.75 2.00 2.70 2.95 3.25 3.45 3.55 3.65 Eurozone 0.79 0.80 1.00 1.20 1.40 1.70 2.00 2.30 2.50 2.50 Japan 0.13 0.15 0.15 0.20 0.30 0.60 0.70 0.70 0.80 0.80 10-yr bond yield 11-Oct Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 US 2.39 2.25 2.25 2.40 2.80 3.00 3.20 3.30 3.40 3.50 Australia 5.01 5.10 5.20 5.30 5.40 5.50 5.50 5.50 5.50 5.40 New Zealand 5.08 5.10 5.20 5.30 5.50 5.70 5.50 5.50 5.40 5.40 United Kingdom 2.87 2.75 2.80 3.00 3.90 4.00 4.20 4.40 4.50 4.60 Eurozone 2.25 2.30 2.40 2.60 2.80 3.00 3.10 3.20 3.30 3.40 Japan 0.88 0.80 0.90 1.20 1.40 1.50 1.60 1.70 1.80 1.80 AUD Sw ap Rates 11-Oct Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 3-year 5.30 5.55 5.75 5.95 6.05 6.15 6.00 5.95 5.95 5.95 10-year 5.60 5.70 5.85 5.95 6.05 6.15 6.10 6.10 6.10 6.00 NZD Sw ap Rates 11-Oct Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 3-year 3.97 4.15 4.40 4.75 5.15 5.25 5.20 5.20 5.15 5.15 10-year 4.90 5.70 5.82 5.95 6.02 6.12 6.12 6.12 6.12 6.12 14 Global Markets Research : Weekly Strategy Calendar – October 2010 M onday Tuesday Wednesday Thursday Friday Early November Central Banking Meetings 1 A U Ho use price index, QIII (1No v) A U RB A (5 Oct) A U A I- G ro up P M I, S e p, Inde x, ( 5 1.7 ) A U RB A cash target, No v (2 No v) EZ ECB (7 Oct) CH P M I M anufacturing, Sep, Index, (51 .7) A U B uilding appro val, Sep (3 No v) UK B OE (7 Oct) JP CP I, A ug, y%ch, (-0.9), Vehicle sales, Sep, y%ch, (46.7) A U Retail trade, Sep, QIII (4 No v) JP B o J (4/5 Oct, 28 Oct) EU/GE/UK P M I manufacturing, Sep, Index, (53.6/55.3/54.3) A U Trade balance, Sep (4 No v) 9 CA B ank o f Canada (1 Oct) US P erso nal inco me/spending, A ug, m%ch, (0.2/0.4) A U RB A SM P (5 No v) NZ RB NZ (28 Oct) .5/1 US P CE deflato r/co re, A ug, y%ch, (1 .4) 0 A U Ho using finance, Sep (1 No v) US FOM C (2-3 No v) US Uni. Of M ichigan co nfidence, Sep, Index, (66.6) 1 A U Labo ur fo rce, Oct (1 No v) US ISM manufacturing, Sep, Index, (56.3) US Co nstructio n spending, A ug, m%ch, (-1 .0) 1 US To tal vehicle sales, Sep, mn, (1 .46) 4 5 6 7 8 A U La bo ur D a y ( N S W, A C T , S A ) A U C B A / A i- G ro up P e rf o f S e rv Inde x, S e p, ( 4 7 .5 ) A U A i- G ro up P C I, S e p, Inde x, ( 4 3 .2 ) A U La bo ur f o rc e , S e p A U R B A D e p G o v B a t t e llino s pe a k s in B ris ba n A U T D inf la t ga uge S e p, m / y%c h, , ( 0 .2 / 3 .0 ) A U A N Z J o b a ds , S e p, m %c h, ( 2 .6 ) A U R B A F in. S t a b. H e a d Luc i E llis s pe a k s in B ris ba ne e m plo ym e nt , ' 0 0 0 , 2 0 , ( 3 0 .9 ) JP Current acco unt/Trade balance, A ug EU P P I, A ug, m/y%ch, (0.2/4.0) A U R e t a il t ra de , A ug, m %c h, 0 .3 , ( 0 .7 ) .0/1 EU GDP , QII, q/y%ch, (1 .9) une m plo ym e nt ra t e , %, 5 .1, ( 5 .1) bn, 3.5) GE Trade bal, A ug, € (1 UK P M I co nstructio n, Sep, Index, (52.1) A U N A B B us c o nf / c o nd, S e p, Inde x, ( 11/ 5 ) GE Facto ry o rders, A ug, m/y%ch, (-2.2/1 7.7) pa rt ic ipa t io n ra t e , %, 6 5 .4 , ( 6 5 .4 ) UK P P I Input/Output/co re, Sep, y%ch, (8.1/4.7/4.6) US Facto ry o rders, A ug, m%ch, (0.1 ) A U R B A c a s h ra t e , %, 4 .7 5 , ( 4 .5 0 ) UK New car registratio ns, Sep, y%ch, (-1 7.5) JP Leading / Co incident index CI, A ug, US A vg hrly earnings, Sep, m/y%ch, (0.3/1 .7) US P ending ho me sales, A ug, m/y%ch, (5.2/-20.1 ) NZ NZIER B usiness o pinio n survey QIII, index, (1 8) IM F Wo rld Eco no mic Outlo o k released JP M achine to o l o rders, Sep US No n-farm payro lls, Sep, '000, (-54) 0, JP B o J target rate, %, 0.1 (0.1 0) CA Ivey purchasing manager index, Sep, (65.9) EU ECB anno unces int. rate, %, 1 .00, (1 .00) US Unemplo yment rate, Sep, %, (9.6) EU P M I services/co mpo site, Sep, Index, (53.6/53.8) GE/UK Industrial pro ductio n, A ug, y%ch, (1 0.9/1.9) US Who lesale invento ries, A ug, m%ch, (1 .3) EU Retail sales, A ug, m/y%ch, (0.1 .1/1 ) UK B o E anno unces rates, %, 0.50, (0.50) CA Net change in emplo yment, Sep, '000, (35.8) GE/UK P M I services, Sep, Index, (54.6/51 .3) US Co nsumer credit, A ug, $ bn, (-3.6) CA Unemplo yment rate, Sep, %, (8.1 ) US ISM no n-manufacturing, Sep, Index, (51 .5) CA B uilding permits, A ug, m%ch, (-3.3) CA Ho using starts, Sep, '000, (1 83.3) 11 12 13 14 15 A U H o us ing f ina nc e , A ug, m %c h JP Co nsumer co nfidence, Sep, Index, (42.5) A U M I/ WB C C o ns um e r S e nt , O c t , Inde x, ( 113 .2 ) A U M I C o ns um e r Inf la t io n E xp., O c t , %, ( 3 .1) JP Industrial pro ductio n/Capacity Utilisatio n, A ug No . o f o wn-o ccupiers, %, 2.0 (1.7) GE CP I, Sep, m/y%ch, (-0.2/1.3) NZ Fo o d prices, Sep, m%ch, (-0.1 ) A U M I Une m p. E xpt ., O c t , Inde x, ( 10 2 .0 ) EU New car registratio ns Sep, y%ch, (-1 2.9) .0, Value o f all lo ans, %, 1 (2.3) UK RICS ho use price balance, Sep, %, (-032) CH Trade balance Sep, US$ bn, (20.0) NZ Retail sales, A ug, m%ch, (-0.4) .6); EU CP I, Sep, m/y%ch, (0.2/1 co re, y%ch, (1 .0) NZ Card spending, Sep, m%ch, (-0.2) ); UK CP I, Sep, m/y%ch, (0.5/3.1 co re, y%ch, (2.8) JP M achine o rders, A ug, m/y%ch, (8.8/1 5.9) NZ B usiness P M I, Sep, Index, (49.3) bn, EU Trade balance A ug, € (-0.2) UK To tal trade balance, A ug, £bn, (-4.9) EU Industrial pro ductio n A ug, m/y%ch, (0.0/7.1) EU ECB M o nthly repo rt .1 US CP I, Sep, m/y%ch, (0.3/1 ); co re, (0.0/0.9) US FOM C M inutes UK ILO unemplo yment rate (3mths), A ug, %, (7.8) US P ro ducer price index Sep, m/y%ch, (0.4) US Retail sales, Sep, m%ch, (0.4) US Impo rt price index, Sep, m/y%ch, (0.6/4.1 ) US Trade balance, A ug, $ bn, (-42.8) US Empire manufacturing, Oct, Index, (4.1 ) CA Ho using price index, A ug, m%ch, (-0.1 ) US P ro ducer price index Sep, m/y%ch, (0.4/3.1 ) US Uni. Of M ichigan co nfidence, Oct, Index CA Trade balance A ug, C$ bn, (-2.7) US B usiness invento ries, A ug, m%ch, (1 .0) 18 19 20 21 22 A U N e w m o t o r v e h. s a le s , S e p, m / y%c h, ( 0 .3 / 10 A U R B A B o a rd M inut e s A U D E WR s k ille d v a c a nc ie s , O c t , m %c h, ( 0 .1) A U H IA H o us ing A f f o rd. Inde x, Q III, ( 10 8 .3 ) A U Int ' l t ra de pric e inde xe s , Q III, q%c h NZ CP I, QIII, q/y%ch, (0.3/1.8) bn, EU Current acco unt, A ug, € (-3.8) A U R B A A s s . G o v . E de y s pe a k s in S ydne y NZ Credit card spending, Sep, m/y%ch, (0.5/2.0) e xpo rt pric e s , 1.0 ( 16 .1) US Industrial pro ductio n, Sep, m%ch, (0.2) EU Co nstructio n o utput, A ug, m/y%ch, (-3.1/-7.5) JP Leading / Co incident index CI, A ug CH GDP , QIII, y%ch, (10.3) im po rt pric e s , 0 .0 ( 1.9 ) US Capacity utilisatio n, Sep, %, (74.7) EU/GE ZEW survey (eco n. sentiment), Oct, Index, (4.4/-4.3) GE P ro ducer prices, Sep, m/y%ch, (0.0/3.2) CH P P I/CP I, Sep, y%ch, (4.3/3.5) GE IFO - B usiness climate, Oct, Index US NA HB ho using market index, Oct, (1 3) US Ho using starts, Sep, '000, (598) UK B ank o f England minutes CH Retail sales/Ind P ro dn, Sep, y%ch, (18.4/13.9) /-1 CA CP I, Sep, m/y%ch, (-0.1 .7) US B uilding permits, Sep, '000, (569) US Federal Reserve B eige B o o k CH Fxd A ss Investment, Sep, y%ch, (24.8) CA Retail sales, A ug, m%ch, (-0.1 ) CA B ank o f Canada, %, 1 .00, (1.00) CA Who lesale sales, A ug, m%ch, (-0.1 ) UK Retail sales, Sep, m/y%ch, (-0.5/0.4) G20 Finance M inisters' meeting - 22-23 Oct, Ko rea CA B ank o f Canada M o netary P o licy Repo rt US Leading indicato rs, Sep, m%ch, (0.3) US Federal Reserve B eige B o o k CA Leading indicato rs, Sep, m%ch, (0.5) 25 26 27 28 29 A U P P I Q III, q/ y%c h, 0 .3 / 1.4 , ( 0 .3 / 1.0 ) UK GDP , QIII A U C P I, Q III, q/ y%c h NZ RB NZ o fficial cash rate, %, 3.00, (3.00) A U A nnua l N a t io na l A c c o unt s , 2 0 0 9 - 10 R B A G o v e rno r G le nn S t e v e ns s pe a k s in C a nbeUS S&P /Case-Shiller ho me price ind., A ug, - H e a dline 0 .8 / 2 .9 ( 0 .6 / 3 .1) JP Retail sales, Sep A U H IA ne w ho m e s a le s S e p JP Trade balance, Sep US Richmo nd Fed, Oct, Index - T rim m e a n 0 .6 / 2 .5 ( 0 .5 / 2 .7 ) 0 JP B o J target rate, %, 0.1 (0.10) A U P riv a t e s e c t o r c re dit , S e p EU Industrial new o rders, A ug, m/y%ch, (-2.4/1 .2) 1 - Wgt d m e dia n 0 .7 / 2 .6 ( 0 .5 / 2 .7 ) NZ B uilding permits/Trade B alance, Sep US Existing ho me sales, Sep, mn/m%ch, (4.1 3/7.6) NZ NB NZ B usiness co nfidence, Oct, Index JP Industrial pro ductio n, vehicle pro ductio n , Sep US Dallas Fed, Oct, Index GE CP I, Oct JP CP I/Ho using starts/Co nstructio n o rders, Sep US Durable go o des o rders, Sep UK Net co nsumer credit, Sep US New ho me sales, Sep US GDP , QIII CA Teranet Ho use P rices, A ug US Emplo yment co st index, QIII, q%ch, (0.5) US Uni. Of M ichigan co nfidence, Oct, Index Note: Figures in brackets represent previous result (if available). All information is preliminary and subject to revision. Chief Economist: Michael Blythe ph: 9118-1101 Economist: James McIntyre: 9118-1100 15 Global Markets Research : Weekly Strategy Research Commodities Telephone Email Address Luke Mathews Agri Commodities +612 9118 1098 email@example.com Lachlan Shaw Mining & Energy Commodities +613 9675 8618 firstname.lastname@example.org Economics Telephone Email Address Michael Blythe Chief Economist +612 9118 1101 email@example.com Michael Workman Senior Economist +612 9118 1019 firstname.lastname@example.org John Peters Senior Economist +612 9117 0112 email@example.com James McIntyre Economist +612 9118 1100 firstname.lastname@example.org Fixed Income Telephone Email Address Adam Donaldson Head of Debt Research +612 9118 1095 email@example.com Philip Brown Fixed Income Quantitative Strategist +612 9118 1090 firstname.lastname@example.org Alex Stanley Associate Analyst, Fixed Income +612 9118 1125 email@example.com Michael Bors Credit Research Analyst +612 9118 1108 firstname.lastname@example.org Steve Shoobert Credit Research Analyst +612 9118 1096 email@example.com Winnie Chee Securitised Product +612 9118 1104 firstname.lastname@example.org Tally Dewan Quantitative Analyst +612 9118 1105 email@example.com Kevin Ward Database Manager +612 9118 1960 firstname.lastname@example.org Foreign Exchange Telephone Email Address Richard Grace Chief Currency Strategist +612 9117 0080 email@example.com Joseph Capurso Currency Strategist +612 9118 1106 firstname.lastname@example.org Peter Dragicevich FX Economist +612 9118 1107 email@example.com Delivery Channels & Publications Telephone Email Address Monica Eley Internet/Intranet +612 9118 1097 firstname.lastname@example.org Ai-Quynh Mac Information Services +612 9118 1102 email@example.com New Zealand Telephone Email Address Chris Tennent-Brown CBA NZ Economist +64 9374 8819 firstname.lastname@example.org Nick Tuffley ASB Chief Economist +64 9374 8604 email@example.com Jane Turner Economist +64 9374 8185 firstname.lastname@example.org Christina Leung Economist +64 9369 4421 email@example.com Sales Institutional Telephone Equities Telephone Syd FX +612 9117 0190 Syd +612 9118 1446 +612 9117 0341 Asia +613 9675 6967 Credit +612 9117 0020 Lon/Eu +44 20 7710 3573 Japan Desk +612 9117 0025 NY +1212 336 7749 Melb +613 9675 6815 +613 9675 7495 Corporate Telephone +613 9675 6618 NSW +612 9117 0377 +613 9675 7757 VIC +612 9675 7737 Lon FX +44 20 7329 6266 SA +618 8206 4155 Debt & Derivatives +44 20 7329 6444 WA +618 9482 6044 Corporate +44 20 7710 3905 QLD +617 3015 4525 HK +852 2844 7538 NZ +64 9375 5738 Sing +65 6349 7077 Metals Desk +612 9117 0069 NY +1212 336 7739 Agri Desk (Corp) +612 9117 0157 Agri Desk +612 9117 0145 Global Markets Research : Weekly Strategy Please view our website at www.research.commbank.com.au. The Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 ("the Bank") and its subsidiaries, including Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 ("CommSec"), Commonwealth Australia Securities LLC, CBA Europe Ltd and Global Markets Research, are domestic or foreign entities or business areas of the Commonwealth Bank Group of Companies (CBGOC). CBGOC and their directors, employees and representatives are referred to in this Appendix as “the Group”. This report is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy any securities or financial instruments. This report has been prepared without taking account of the objectives, financial situation and capacity to bear loss, knowledge, experience or needs of any specific person who may receive this report. No member of the Group does, or is required to, assess the appropriateness or suitability of the report for recipients who therefore do not benefit from any regulatory protections in this regard. All recipients should, before acting on the information in this report, consider the appropriateness and suitability of the information, having regard to their own objectives, financial situation and needs, and, if necessary seek the appropriate professional, foreign exchange or financial advice regarding the content of this report. We believe that the information in this report is correct and any opinions, conclusions or recommendations are reasonably held or made, based on the information available at the time of its compilation, but no representation or warranty, either expressed or implied, is made or provided as to accuracy, reliability or completeness of any statement made in this report. Any opinions, conclusions or recommendations set forth in this report are subject to change without notice and may differ or be contrary to the opinions, conclusions or recommendations expressed elsewhere by the Group. We are under no obligation to, and do not, update or keep current the information contained in this report. The Group does not accept any liability for any loss or damage arising out of the use of all or any part of this report. Any valuations, projections and forecasts contained in this report are based on a number of assumptions and estimates and are subject to contingencies and uncertainties. Different assumptions and estimates could result in materially different results. The Group does not represent or warrant that any of these valuations, projections or forecasts, or any of the underlying assumptions or estimates, will be met. Past performance is not a reliable indicator of future performance. The Group has provided, provides, or seeks to provide, investment banking, capital markets and/or other services, including financial services, to the companies described in the report and their associates. This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject any entity within the Group to any registration or licensing requirement within such jurisdiction. All material presented in this report, unless specifically indicated otherwise, is under copyright to the Group. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior written permission of the appropriate entity within the Group. In the case of certain products, the Bank or one of its related bodies corporate is or may be the only market maker. The Group, its agents, associates and clients have or have had long or short positions in the securities or other financial instruments referred to herein, and may at any time make purchases and/or sales in such interests or securities as principal or agent, including selling to or buying from clients on a principal basis and may engage in transactions in a manner inconsistent with this report. US Investors: If you would like to speak to someone regarding the subject securities described in this report, please contact Commonwealth Australia Securities LLC (the “US Broker-Dealer”), a broker-dealer registered under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”) and a member of the Financial Industry Regulatory Authority (“FINRA”) at 1 (212) 336-7737. This report was prepared, approved and published by Global Markets Research, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 ("the Bank") and distributed in the U.S. by the US Broker-Dealer. The Bank is not registered as a broker-dealer under the Exchange Act and is not a member of FINRA or any U.S. self-regulatory organization. Commonwealth Australia Securities LLC (“US Broker-Dealer”) is a wholly owned, but non-guaranteed, subsidiary of the Bank, organized under the laws of the State of Delaware, USA, with limited liability. The US Broker-Dealer is not authorized to engage in the underwriting of securities and does not make markets or otherwise engage in any trading in the securities of the subject companies described in our research reports. The US Broker-Dealer is the distributor of this research report in the United States under Rule 15a-6 of the Exchange Act and accepts responsibility for its content. Global Markets Research and the US Broker-Dealer are affiliates under common control. Computation of 1% beneficial ownership is based upon the methodology used to compute ownership under Section 13(d) of the Exchange Act. The securities discussed in this research report may not be eligible for sale in all States or countries, and such securities may not be suitable for all types of investors. Offers and sales of securities discussed in this research report, and the distribution of this report, may be made only in States and countries where such securities are exempt from registration or qualification or have been so registered or qualified for offer and sale, and in accordance with applicable broker-dealer and agent/salesman registration or licensing requirements. The preparer of this research report is employed by Global Markets Research and is not registered or qualified as a research analyst, representative, or associated person under the rules of FINRA, the New York Stock Exchange, Inc., any other U.S. self-regulatory organization, or the laws, rules or regulations of any State. European Investors: This report is published, approved and distributed in the UK by the Bank and by CBA Europe Ltd (“CBAE”). The Bank and CBAE are both registered in England (No. BR250 and 05687023 respectively) and authorised and regulated in the UK by the Financial Services Authority (“FSA”). This report does not purport to be a complete statement or summary. For the purpose of the FSA rules, this report and related services are not intended for retail customers and are not available to them. The products and services referred to in this report may put your capital at risk. Investments, persons, matters and services referred to in this report may not be regulated by the FSA. CBAE can clarify where FSA regulations apply. Singapore Investors: This report is distributed in Singapore by Commonwealth Bank of Australia, Singapore Branch (company number F03137W) and is made available only for persons who are Accredited Investors as defined in the Singapore Securities and Futures Act and the Financial Advisers Act. It has not been prepared for, and must not be distributed to or replicated in any form, to anyone who is not an Accredited Investor. Hong Kong Investors: This report was prepared, approved and published by the Bank, and distributed in Hong Kong by the Bank's Hong Kong Branch. The Hong Kong Branch is a registered institution with the Hong Kong Monetary Authority to carry out the Type 1 (Dealing in securities) and Type 4 (Advising on securities) regulated activities under the Securities and Futures Ordinance. Investors should understand the risks in investments and that prices do go up as well as down, and in some cases may even become worthless. Research report on collective investment schemes which have not been authorized by the Securities and Futures Commission is not directed to, or intended for distribution in Hong Kong. All investors: Analyst Certification and Disclaimer: Each research analyst, primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the report. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing, and interpreting market information. Directors or employees of the Group may serve or may have served as officers or directors of the subject company of this report. The compensation of analysts who prepared this report is determined exclusively by research management and senior management (not including investment banking). No inducement has been or will be received by the Group from the subject of this report or its associates to undertake the research or make the recommendations. The research staff responsible for this report receive a salary and a bonus that is dependent on a number of factors including their performance and the overall financial performance of the Group, including its profits derived from investment banking, sales and trading revenue. Unless agreed separately, we do not charge any fees for any information provided in this presentation. You may be charged fees in relation to the financial products or other services the Bank provides, these are set out in the relevant Financial Services Guide (FSG) and relevant Product Disclosure Statements (PDS). Our employees receive a salary and do not receive any commissions or fees. However, they may be eligible for a bonus payment from us based on a number of factors relating to their overall performance during the year. These factors include the level of revenue they generate, meeting client service standards and reaching individual sales portfolio targets. Our employees may also receive benefits such as tickets to sporting and cultural events, corporate promotional merchandise and other similar benefits. If you have a complaint, the Bank’s dispute resolution process can be accessed on 132221. Unless otherwise noted, all data is sourced from Australian Bureau of Statistics material (www.abs.gov.au).