Markets Roundup. Research. US data show that deflation risks are rising

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1 Markets Roundup August 24 t h, 29 C O N T E N T S Market Movers 2 Economics Weekly Calendar 5 Central Bank Policies 6 US data show that deflation risks are rising Research Although Chinese equities have plummeted since early August on Thursday, US and European equities have held up very well (p.2 & p.3). This week, the focus will be on durable goods orders on Wednesday in the US, and on the German Ifo index also on Wednesday (p.2 & p.3). Interest Rate Forecasts 7 Interest Rates (3M 1yr) 8 Govt Bond Yields (2yr 1yr) 9 Interest Rate & Bond Futures 1 Equities, Currencies & Commodities 11 The Chart of the Week shows the capacity utilisation rate and core CPI in the United States. Only a few months ago, we were in the midst of a severe recession, with the Fed pumping unprecedented amounts of money into the system. At that time, some started to fear a massive inflationary impact from these actions. As equity markets soared the last few weeks, one would expect inflation fears to start rising again. Yet, inflation expectations of consumers and financial market participants have not started to rise. Indeed, these expectations were justified by last weeks macroeconomic figures. In fact, these figures even pointed to deflation. Producer prices fall at a breathtaking pace, while the industrial capacity utilisation rate signals that core consumer prices may even fall into negative territory, as is shown by the Chart of the Week. Meanwhile, wage growth is falling, bank lending is declining and broad money growth is decelerating. Therefore, deflationary pressures still have the upper hand, making an outburst of inflation over the medium-term unlikely, in our view. Chart of the Week: Deflation risks still dominate Percentage % change on a year ago Research Erwin Langewis Duncan de Vries E: nibc.research@nibc.com Capacity utilisation rate (advanced 16m, LS) Core CPI (RS)

2 MARKET MOVERS: REVIEW & PREVIEW United States As we discussed 2 weeks ago, the recession has probably ended in June. However, incoming data has been mixed. Business surveys point to a stabilising economy, which is a sharp improvement after the sharp contractions in Q1 and Q2. Last week, the Empire State manufacturing index improved to positive territory for the first time since April 28: to 12.1 in August from -.6. Also the Philly Fed index rose to 4.2 in August from These indices now point to an ISM manufacturing index (which will be released next week) level of about 5 (see chart). So, although the temporary positive effects from the Cash for Clunkers scheme have likely helped to boost these indices, the manufacturing sector should continue to pick up over the coming months, partly due to inventory building. Yet, if demand remains weak, no strong recovery should be expected. More importantly, data from the important consumer sector disappointed: retail sales excluding autos and gas have declined for 5 consecutive months and consumer confidence fell for 2 months in a row. Clearly, consumer spending fundamentals are not that good to get consumers to increase their spending, despite government support. Last weeks survey from the Fed showed that lending standards are still tightened by the majority of banks, while demand continue to weaken in the 3 months to July. Yet, it is not only the consumer sector that is not really recovering (but stabilising). Housing market activity has risen from very low levels, but it certainly cannot be called a recovery. The NAHB housing index rose to 18 in August from 17, which is still close to its all-time low level of 8 in January. Furthermore, housing starts fell to 581k in July from 587k, while permits declined to 56k from 57k. The weakness in this report was in the multi-family sector, while single-family starts rose for a 5 th consecutive month. Although this means that starts are 12k above an all-time low level in April, they are well below the peak of 2,273k in January 26. Also, existing home sales surged 7.2% (mom) in July to 5.24m annualised. All in, then, housing market data shows housing market activity is stabilising, but not much more than that. In addition, prices are expected to fall further, partly due to continuing rising delinquencies and foreclosures. With respect to deflationary pressures: PPI fell.9% (mom) in July to -6.8% (yoy), while core PPI declined.1% (mom) to +2.6% (yoy). In addition, as Business surveys suggest stabilising activity Diffusion index Broad money growth still easing Change on a year ago M2 Average Philly Fed and Empire Fed (LS) ISM M anufacturing index (RS) Diffusion index intermediate (-.2% mom) and crude (-4.5% mom) good prices fell, this points to further downward pressure on inflation in the coming months. Meanwhile, as broad money growth is still decelerating (see chart), the injection of money in the system does still not have the desired effect. The end of the purchase of Treasuries in October by the Fed will have a downward effect on the growth of the monetary base. So, if broad money measures do not start to rise, the Fed may decide to increase its pace of asset purchases again, or if Treasury yields start to rise sharply, the Fed may even decide to expand its purchases of Treasury securities. M onetary base This weeks focus will be on durable goods orders. Orders are expected to increase strongly in July, driven by transport orders. Furthermore, consumer confidence is expected to rise by the consensus, but there seems to be downside risks here, especially as income growth is weak. That said, personal spending will probably be soft, despite the cash for clunkers scheme. Euro zone The euro zones macroeconomic agenda was focused on the ZEW survey and PMI indices. The ZEW improved markedly to 56.1 in August, the highest

3 level since April 26, from 39.5, reflecting the almost unprecedented surge of stock markets. Yet, the current conditions index is still at very low levels, despite that it rose 12.1 points. As the index has not been a good predictor of economic growth, we attach greater importance to the PMI indices and this weeks released Ifo survey, which have been better predictors of economic conditions. Encouragingly, the French manufacturing PMI rose to 5.2 in August from 48.1 and the German index increased to 49. from In addition, the French service PMI rose to 48.9 from 45.5 and the German index rose to 54.1 from For the whole euro zone, the manufacturing index rose to 47.9 from 46.3, while the services index ticked up to 49.5 from Although the composite index rose markedly to 5. in August from 47. this does not indicate a strong recovery. Therefore, it is no surprise that central bankers remain cautious on the economic outlook, especially as the current recovery is driven by fiscal and monetary policy stimuli. So, although euro zone GDP growth may be positive in Q3, it remains doubtful if the economic recovery is sustainable. This week the focus will be on the German Ifo index, which has been rising for 4 consecutive months. After the rise in the PMI index, the Ifo index may also improve markedly in August from still low levels. Furthermore, German headline CPI data is expected to pick up after the 1 st annual decline (mainly due to energy and food prices) in July since This is good news for consumers purchasing power, for now at least. As the base effect wanes, headline CPI may turn positive again in the coming quarters. United Kingdom The minutes of the MPC meeting showed that the Committee voted 6-3 (this was the first split vote since February) for a GBP 5bn increase in the size of the asset purchase scheme to GBP 175bn. There are no indications that the BoE wants to tighten monetary policy in the near term, especially as Governor King said last week that well keep that stock of asset purchases there until we see some signs of growth in nominal spending in the economy returning. In addition, King, Besley and Miles favoured a GBP 75bn extension. This shows that the MPC is ready to do even more to support the economy as it seems that the MPC is focusing on past economic data instead of better forward-looking indicators. In contrast, financial markets seem to realise that UK public debt soars Ratio Public sector net debt/gdp ultimately someone has to pay for too aggressive monetary policy as an expansion of at most GBP 5bn was expected. Admittedly, the Inflation Report projection showed that the MPC saw inflation above target at the 2-year horizon with the current policy and also CPI inflation remained at 1.8% (yoy) in August, while core CPI picked up to 1.8% after 1.6%. Inflation figures will probably be volatile over the coming quarters, impacted by the reversal of the VAT cut and energy price cuts, while the disinflationary impact from the recession may keep inflation muted. Yet, deflation seems to be an unlikely outcome, partly due to the past depreciation of sterling. In addition, the BoE will not be in a hurry to tighten policy facing a weak labour market and probably rising pressures to bring down the governments fiscal deficit after the elections. Already, public sector net borrowing was GBP 8bn in July (a month that traditionally records a surplus amongst other due to corporation tax), the largest figure for July since records began in Consequently, public sector net debt grew to GBP 8.8bn (56.8% of GDP), which is the highest percentage since records began in 1974/1975. Indeed, the UK sought an emergency loan from the IMF in This underlines the risk of sharp fiscal tightening in the coming year(s) and therefore should no action by the BoE be expected in the coming quarters, in our view. On a positive note, retail sales volumes increased.4% (mom) in July after 1.3%, implying that the less volatile quarterly change improved to 1.2% from 1.%. All in, then, although there are indications that conditions are improving, public finances will be a constraint on the economic recovery. This week, the Nationwide house price index will be released. Prices are expected to rise.5% (mom) by the consensus. We remain cautious about these price increases given weak economic fundamentals. That said it will be interesting to see if the by BBA reported loans approved for house purchases pick up.

4 ECONOMIC CALENDAR 24 AUGUST 28 AUGUST, 29 Date Time Indicator BN Survey Prior Monday 24 August 14:3 Chicago Fed Nat Activity Index JUL Tuesday 25 August 15: S&P/CS Composite-2 YoY JUN % -17.6% 15: S&P/Case-Shiller US HPI YOY% 2Q % 16: Consumer Confidence AUG Wednesday 26 August 14:3 Durable Goods Orders JUL % -% 14:3 Durables Ex Transportation JUL 1.% 1.1% 16: New Home Sales JUL 39K 384K 16: New Home Sales MoM JUL 1.6% 11.% Thursday 27 August 14:3 GDP QoQ (Annualized) 2Q P -1.4% -1.% 14:3 Personal Consumption 2Q -1.2% -1.2% 14:3 GDP Price Index 2Q.2%.2% 14:3 Core PCE QoQ 2Q 2.% 2.% Friday 28 August 14:3 Personal Income JUL.1% -1.3% 14:3 Personal Spending JUL.2%.4% 14:3 PCE Deflator (YoY) JUL -.9% -.4% 14:3 PCE Core (MoM) JUL.1%.2% 14:3 PCE Core (YoY) JUL 1.3% 1.5% 16: U. of Michigan Confidence AUG F EURO ZONE Date Time Indicator BN Survey Prior Monday 24 August 11: EC Industrial New Orders SA (MoM) JUN 1.6% -.2% 11: EC Industrial New Orders SA (YoY) JUN -28.6% -3.1% Tuesday 25 August 8: GE GDP s.a. (QOQ) 2Q F.3%.3% 8: GE GDP wda (YoY) 2Q F -5.9% -5.9% 8: GE Private Consumption 2Q.3%.5% 8: GE Domestic Demand 2Q F -.7% -1.7% 8: GE Imports 2Q F -4.% -5.4% 8: GE Exports 2Q F -1.3% -9.7% 15: BE Business Confidence Level. sa AUG Wednesday 26 August 1: GE IFO - Business Climate AUG : GE IFO - Current Assessment AUG : GE IFO - Expectations AUG Thursday 27 August : GE Consumer Price Index (MoM) AUG P.%.% : GE Consumer Price Index (YoY) AUG P -.2% -.5% : GE CPI - EU Harmonised (MoM) AUG P.% -.1% : GE CPI - EU Harmonised (YoY) AUG P -.4% -.7% 8:1 GE GfK Consumer Confidence Survey SEP 3.6 1: EC Euro-Zone M3 s.a. (YoY) JUL 3.2% % 1: EC Euro-Zone M3 s.a. 3 mth ave. JUL % 4.1% Friday 28 August 11: EC Business Climate Indicator AUG : EC Euro-Zone Consumer Confidence AUG : EC Euro-Zone Economic Confidence AUG : EC Euro-Zone Indust. Confidence AUG : EC Euro-zone Services Confidence AUG UNITED KINGDOM Date Time Indicator BN Survey Prior Monday 24 August AUG Nat'wide House prices sa (MoM) AUG.5% 1.3% AUG Nat'wide House prices nsa(yoy) AUG -3.9% -6.2% Tuesday 25 August 1:3 BBA Loans for House Purchase JUL Thursday 27 August 1:3 Total Business Investment(QoQ) 2Q P -3.6% -7.6% 1:3 Total Business Investment(YoY) 2Q P -12.2% -9.7% Friday 28 August 1:1 GfK Consumer Confidence Survey AUG :3 GDP (QoQ) 2Q P -.8% -.8% 1:3 GDP (YoY) 2Q P -5.6% -5.6% 1:3 Exports 2Q P -1.6% -6.9% 1:3 Imports 2Q P -2.6% -6.7%

5 CENTRAL BANK POLICIES United States FOMC Policy interest rate: Federal funds target rate Last action: -75/1 bps on 16 December 28 Forward Fed funds rate implied by futures M Eurodollar rate implied by futures August August Current Sep-9 Dec-9 Mar-1 Jun-1 Next Meetings: 23 September, 4 November, 16 December Policy Outlook: The Fed funds rate has been cut by a massive 4 bps in 28 to an unprecedented target range of -.25%. The Fed announced since its FOMC statement of December that rates will remain at these levels for some time. The Fed expanded the purchases of agency debt and MBSs, while it also started to purchase longer-term Treasuries. Nevertheless, deflation remains the largest risk given huge overcapacity and surging unemployment. FOMC minutes: 2 September, 14 October, 25 November Euro zone ECB Policy interest rate: Main refinancing rate Last action: -25 bps on 7 May 29 Next Meetings: 3 September, 8 October, 5 November, 3 December Forward Refi rate implied by futures 3M Euribor futures rate minus 5bps* Current Sep-9 Dec-9 Mar-1 Jun-1 Policy Outlook: The ECB cut rates on 8 October in a coordinated effort by 5 bps, by 5 bps on 6 November, by 75 bps on 4 December and again in January, in March by 5 bps and by 25 bps in April. Rates were cut again by 25 bps in May, which has brought the policy rate to 1.%. In addition, announcements on non-standard measures were made, including the purchase of up to EUR 6 bln of covered bonds. However, no rate changes are expected this year. United Kingdom - Bank of England Policy interest rate: Repo rate Last action: -5 bps on 5 March 29 Next Meetings: 1 September, 8 October, 5 November, 1 December Forward Repo rate implied by futures 3M Sterling futures rate minus 5bps Policy Outlook: The BoE continued to cut rates in 29 after rates were already cut by a massive 35 bps in 28 as the economy deteriorates and inflation eases. Given deteriorating economic fundamentals and easing inflation, we expect the BoE to keep rates at.5% for the foreseeable future. Current Sep-9 Dec-9 Mar-1 Jun-1 Update August 24, 29 7:56h * Estimated average spread between 3-month rate and policy rate BOE minutes: 19 August, 23 September, 21 October, 18 November, 23 December

6 INTEREST RATE FORECAST TABLE SEP 9 DEC 9 MAR 1 % Current* Futures** Forecast Futures Forecast Futures Forecast United States Fed funds target rate*** yr treasury yield Euro zone ECB refi rate*** yr govt bond yield United Kingdom BoE repo rate*** yr Gilt yield * 8/24/9 9:5 ** Futures rates derived from 3m interest rate and 1yr bond futures contracts ***Derived from 3-month interest rate futures, adjusted for an estimated average spread of 15 bps between 3-month rate and policy rate

7 INTEREST RATES (3M 1YR): ACTUALS & CURVE Policy Interest Rates (%) 3m Interest Rates minus Policy Rate (bps) m Interest Rates (%) 12m minus 3m Interest Rates (%) USD Libor Euribor GBP Libor m Interest Rates (%) 1 yr Interest Rate Swap Spread (bps) USD Libor Euribor GBP Libor Eurozone United Kingdom Source: Bloomberg Update: 8/24/9 8:8

8 GOVERNMENT BOND YIELDS (2YR 1YR): ACTUALS & CURVE 2 yr Benchmark govt Bond Yields (%) 1 yr minus 2 yr govt Bond Yields (%) yr Benchmark govt Bond Yields (%) 1 yr Interest Rate Sw ap Spread (bps) Real govt indexed Bond Yields (%) Estimate of Inflation Expectations (%)* US TIPS 213 (indexed to CPI) FR OATei 213 (indexed to Euro CPI) UK IL Gilts 213 (indexed to RPI) * Difference between nominal government bond yield and inflation-indexed bond yield ("breakeven inflation") with the same maturity (213) Source: Bloomberg Update: 8/24/9 8: United States (CPI) United Kingdom (RPI) Eurozone (CPI)

9 INTEREST RATE & BOND FUTURES: MARKET EXPECTATIONS United States: 3m Eurodollar* United States: 1yr treasury yield* Current SEP 9 DEC 9 MAR 1 JUN 1 SEP Current SEP 9 DEC 9 MAR 1 JUN 1 Euro zone: 3m Euribor Euro zone: 1yr govt Bond Yield Current SEP 9 DEC 9 MAR 1 JUN 1 SEP 1 Current SEP 9 DEC 9 United Kingdom: 3m Sterling United Kingdom: 1yr GILT Yield Current SEP 9 DEC 9 MAR 1 JUN 1 Current SEP 9 DEC 9 MAR 1 Current ** Two weeks ago One month ago * Forward interest rates and bond yields implied by futures contracts. Source: Bloomberg ** 8/24/9 8:1

10 EQUITIES, CURRENCIES AND COMMODITIES Major Equity Markets Major Currencies /25/27 8/25/28 8/25/27 8/25/28 S&P 5 (LS) FTSE Eurotop3 (LS) FTSE1 (RS) EUR/USD (LS) EUR/GBP (RS) USD/GBP (RS) Commodity Prices Oil Price* /3/27 1/3/28 1/3/29 AIG Commodity Excess Return Index /25/27 8/25/28 Spot price (USD) Spot price (EUR) Source: Bloomberg; Update: 8/24/9 8:11 * West Texas Intermediate (WTI) Cushing Crude Oil Spot Price D is c laimer This document that has been prepared by NIBC Bank N.V. includes forward-looking statements. All statements other than statements of historical facts contained in this document are forward-looking statements.the words may, will, estimate, continue, anticipate, expect and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect the economy and interest rates. These forward-looking statements are subject to a number of risks, uncertainties and assumptions. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this document may not occur and actual developments could differ materially and adversely from those anticipated or implied in the forward-looking statements. NIBC Bank N.V. has not verified the information contained herein. Accordingly, no representation, warranty or undertaking, express or implied, is made and no responsibility or liability is accepted by NIBC Bank N.V. as to the accuracy or completeness of the information contained in this document. By providing this general information, NIBC Bank N.V. makes neither a recommendation as to the appropriateness of investing nor is it providing any specific investment advice for any particular investor.