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Latvia − Situation Update

Mon, Oct 5 2009, 13:53 GMT
by Lars Christensen, Pär Magnusson

Danske Bank A/S

Growing concerns

On 17 September the Latvian Parliament surprisingly voted 52-28 against a bill containing fiscal fulfilment of the binding loan conditions laid down by the EU/IMF. This signalled a strong opposition to accepting the terms laid down. Notably the largest party in Latvia voted against the bill and even expelled an MP from its own party for having voted in favour of the bill (i.e. for doing the right thing in the eyes of the lenders). 

The lenders have loudly protested this political refusal to live up to the loan conditions, and have so far remained adamant about Latvia’s obligation to comply with the terms agreed upon. The Swedish Finance Minister, Anders Borg, has warned that the lenders’ patience is wearing thin and that they will accept nothing less than complete fulfilment on the part of Latvia.

The Latvian government needs to improve its fiscal position by some LVL500m. The government has said that it can go as far as 225m in spending cuts and 100m in tax increases, but it will still fall well short of the lender demands.

Consequently, we are in a stand-off situation where the lenders seem to have tied themselves to the mast by refusing to change the loan terms, while at the same time the borrowers fail to show the political will to comply with these terms. Something has to give – in this case the ball seems to be in Latvia’s court – in order for the situation to be resolved.

A major Swedish newspaper has during the weekend published an article alleging that the Swedish Finance minister has contacted the management of Swedish banks with large Baltic exposure and warned them of an imminent collapse in the talks in Latvia. Moreover, the same article states that the IMF is pushing hard for a devaluation as the only viable solution. The contents of the article have not been confirmed by any government source, and must therefore be considered as hearsay until further notice.

No later than 23 October the Latvian government must submit its budget proposal for 2010 to the Parliament. The Latvian Parliament thus has another 2.5 weeks to gather support for further austerity measures, or face the consequences of failing to meet with its obligations.

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Published on  Mon, Oct 5 2009, 13:53 GMT

What cover prices can tell us about EMEA FX valuation

Mon, Aug 17 2009, 13:08 GMT
by Lars Christensen

Danske Bank A/S

The financial magazine The Economist has made the so-called ‘Big Mac Index’ famous. The Big Mac Index uses the price of a Big Mac to illustrate the so-called Law of One Price, by comparing the price of a Big Mac in different countries and thereby saying something of the valuation of the respective currencies. The Law of One Price basically says that any (tradable) good should have the same price in all countries in the long run. Hence, simply put, if a Big Mac is more expensive in Poland than Hungary (measured by those currencies) then the Polish zloty is overvalued relative to the Hungarian forint.

What the good people at The Economist may not realise that the magazine itself provides a good – and easy assessable illustration of the Law of One Price. The price of the magazine in different countries is printed on the cover of every edition of The Economist. For example, its price is PLN26.5 in Poland and EUR5.5 in all euro countries. So for the Law of One Price to hold EUR/PLN should be trading at 4.82 – somewhat higher than the actual EUR/PLN rate. Therefore, either the zloty is around 17% overvalued against the euro or The Economist needs to reduce its price by a similar amount in Poland for the Law of One Price to hold.

We naturally do not suggest that this in any way is a scientific measure of the valuation of the zloty or any other currency, but it is nonetheless an illustration of the Law of One Price that might provide some insight about currency valuation. We have therefore, used the cover price of the latest edition of The Economist to look at the valuation of a number of EMEA currencies. To provide one more measure we have made the same calculation by using the cover price of the Financial Times. The results of our calculations are shown on the right-hand side of the page. According to the cover prices of both The Economist and the Financial Times, most of the EMEA currencies are “overvalued” relative to the euro. It is particularly notable when the calculations are based on cover prices of The Economist.

Again we stress that this exercise is done for illustrative purposes and is not intended as an exact measure of currency valuation anywhere. Some interesting patterns nonetheless emerge from the calculations. Hence, the cover prices of both magazines indicate a quite significant overvaluation of all three Baltic currencies, in line with the common perception in the financial markets. From this study, the Lithuanian lita is the most overvalued of all the EMEA currencies. Another notable result is that the currencies most closely linked to the euro either through a fixed exchange rate policy (the Baltic States and Bulgaria) or have quasi-fixed or managed floating exchanges (for example Romania and Croatia) tend to be more overvalued than the currencies that are freely floating – and this is especially the case for the none-European currencies – the Turkish lira and the South African rand.

Concluding, this is only an illustration of the Law of One Price and is not a scientific excise, but if one believes that the cover prices of The Economist and the Financial Times provide a good measure of the fair valuation for the EMEA currencies (we do not say they do) then one might buy a the lira and the rand against a basket of CEE currencies.

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Published on  Mon, Aug 17 2009, 13:08 GMT

Historic inventory cycle to boost growth

Fri, Jul 3 2009, 08:39 GMT
by Allan von Mehren

Danske Bank A/S

• A key factor behind our above-consensus global growth forecast is our view on the inventory cycle. Our thesis is that, even if the demand recovery is slow during 2009, we will still see a significant production rebound in H2 09.
• This is the main difference between our forecast and, for example, those of OECD and IMF, which predict a considerably slower and later recovery.
• The inventory cycle is a very important cyclical driver and in this downturn it has been much more forceful than we have seen historically.
• Production has been cut at a record pace in order to deplete inventories. However, with inventories lean, production substantially below demand and demand rising due to massive stimulus, we believe the ground is laid for a rapid production rebound in H2 09.
• It is important to note that inventories will continue to fall in H2 09 even as production rises. Hence it is not a case of rebuilding of inventories but a case of aligning production with demand.
• We already see recovery in Japan and other Asian countries and we expect to see it soon in US and Europe. The auto sector should be a prime example of this.

Since the beginning of the year we have argued that the strong force of the inventory cycle in this downturn would lay the ground for a manufacturing recovery during 2009 (see Research – US: Manufacturing recovery ahead, Jan 09). We have already seen signs that this is materialising, in surveys such as ISM and leading indicators, but we believe the story has further to run. Hence we expect ISM and global leading indicators to continue to surprise on the upside. Importantly we should also start to see improvement in the hard data over the coming quarters. This is about six months earlier than, for example, OECD and IMF are predicting; they also forecast a much slower recovery. We don’t disagree that the recovery in demand will be slow as headwinds linger for a long time due to the financial crisis and wealth destruction. However, that does not mean we don’t see a strong rebound in production.

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Published on  Fri, Jul 3 2009, 08:39 GMT

Gratulacje Polska

Thu, Jun 4 2009, 07:59 GMT
by Lars Christensen

Danske Bank A/S

June 4 is an historic day for Poland, Europe and the world, as it marks the 20-year anniversary of the first free elections in Poland in 1989. The elections, which gave the Solidarity movement a landslide victory and brought an end to Communism in Poland, marked the start of an enormously successful economic and political transition that has transformed Poland from a backward country, with an inefficient economy on the fringes of Europe, to a thriving modern economy at the centre of Europe. Poland joined NATO in 1999 and the EU in 2004, returning the country to its rightful position at the centre of Europe.

Poland’s economic and political transformation has been truly remarkable. No matter what economic indicator one chooses to look at, the same picture emerges: Poland’s transformation from a depressing Communist society to a free-market economy has been a resounding success. Since the end of Communism, GDP growth in Poland has averaged more than 6% and GDP per capita has grown from USD3,097 in 1989 to USD5,935 today. GDP per capita has risen from just 30% of German GDP to 50% of German GDP.

How has this been done? We are in no doubt that Poland’s very strong economic reform effort over the past two decades is the real reason behind the Polish success story. Most notable were the early reforms to stabilise the post-Communist economy and free it from the crippling shackles of Communism. Here, Leszek Balcerowicz, who was instrumental in pushing through tough but necessary reform as finance minister – first from 1989 to 1991 and then later from 1997 to 2000 – no doubt played a key role. Even though Dr Balcerowicz’s contribution to the reform effort is surely unique, it is notable that while Poland’s political stability has not always been the greatest in the world – to say the least – most Polish finance ministers (and there have been more than a few) over the past two decades in general have understood the importance of economic reforms and have worked to continue the reform process. The present finance minister, Jacek Rostowski, is yet another example of just such a Polish finance minister who keeps pushing the reform process forward. There are undoubtedly many heroes in Poland’s remarkable political and economic transformation – whether Lech Walesa, who famously led the Solidarity movement’s struggle against Communism and served his country as its first freely elected president from 1990 to 1995, or the first Polish pope, John Paul II, who gave the Poles enormous moral support, both in the fight against Communism and in the period of hard economic reforms, or Leszek Balcerowicz, the finance minister responsible for the crucial economic reforms. However, to us, the real heroes are the Polish population who, despite having endured serious economic hardship, continued to support the transformation from Communism to democracy and a free-market economy. These are the people we will celebrate with on June 4. Gratulacje Polska.

Below we present some overview graphs that highlights the Polish economic development over the last 20 years.

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Published on  Thu, Jun 4 2009, 07:59 GMT

Lessons from the Great Depression

Mon, Feb 23 2009, 10:12 GMT
by Allan von Mehren

Danske Bank A/S

• The current economic and financial crisis is often compared to the Great Depression, which lasted more than three and a half years between August 1929 and March 1933. During this period US unemployment rose from 3% to 25% and real GDP declined by 30%. In this paper we look more closely at why the Great Depression became so protracted and look at similarities and differences between it and the current crisis.

• Both crises were preceded by high credit growth and an asset price bubble, which led to substantial losses in the banking sector once the credit boom was over. A material break-down in credit intermediation has been a key characteristic of both crises. As research by Fed Chairman Bernanke has pointed out, this was a key reason why the Depression became so protracted. Hence the current crisis has the ingredients to become very long and deep as well.

• It can be argued that the shock hitting the US economy in this recession was bigger than the one that led to the Depression. The asset price bubble bursting this time was in the housing market, which tends to have larger economic impact than a bursting equity market bubble. The growth in credit running up to the crisis is likely to have been spread across more sectors as well and the development of complex financial products has added to the difficulties in solving the crisis.

• A key difference this time, however, is the policy response. While both monetary and fiscal policy was actually tightened during the Depression, adding to the downward spiral, policy has been eased substantially during this crisis. Efforts to ease the meltdown in credit intermediation were also absent during the Depression. Today, authorities have focused strongly on fighting the financial crisis and continue to make efforts to provide liquidity and capital to the banking system to get credit flowing again.

• The countries that left the Gold Standard first and eased monetary policy were the first to get out of the Depression. This gives further evidence to the thesis that the size of the policy response is of significance. The risk of Depression is highest in countries that don't realise the need for a substantial response - or realise it too late.

• The current financial crisis is clearly the most severe since the Depression. However, we believe the lessons learned from the mistakes made in the 1930s are a key reason why the US and global economies should avoid a depression this time. A continued deleveraging in the financial sector should continue to put strong downward pressure on the economy, however, and the road back to sustainable growth around trend will be slow. With an expected length of 20 months (we expect it to end in mid-2009) this is likely to turn out to be the longest recession since the Depression.

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Published on  Mon, Feb 23 2009, 10:12 GMT

Emerging Markets: Countries at risk amid the global credit crunch

Fri, Oct 17 2008, 08:29 GMT
by Lars Christensen, Lars Rasmussen, Flemming J. Nielsen

Danske Bank A/S

The credit crisis is spreading and after the economic and financial collapse in Iceland, the markets are asking the question - which country will be the next to fall? The markets seem to have decided that Hungary will be the next 'Iceland' and the Hungarian forint has plummeted in recent days. However, there are other countries that share some unpleasant similarities with Iceland.

In this note we list 15 countries that we think are in the 'danger zone' in the present environment. That is not to say that these countries will undergo the same fate as Iceland, but they are all at risk of a significant slowdown in the economy and of increased financial distress - as we have seen in Iceland and Hungary recently.

We focus on three factors when deciding which countries should be included in the 'danger zone': • Large current account deficit, high credit growth in recent years, asset market bubbles, large reliance on foreign currency funding

• Increased political risks - both domestic and geo-political

• Commodity exporters that failed to used to the 'good years' to save for the bad years Once again, it is not a given that these countries will undergo a similar collapse as Iceland, but we think market participants should be very careful in these markets.

Below we list the countries with a few key facts on each. There is no ranking of the countries and it is not an 'Iceland look-alike contest', but rather a general list of countries with heightened risks in the present deleveraging environment.

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Published on  Fri, Oct 17 2008, 08:29 GMT

Pakistan: Badly in need of foreign assistance

Mon, Oct 13 2008, 13:12 GMT
by Flemming J. Nielsen

Danske Bank A/S

The Pakistani economy has deteriorated sharply since late 2007 on the back of a poisonous cocktail of higher energy and food prices and political uncertainty. The current account deficit is approaching 10% of GDP and because of exploding expenditure on food and energy subsidies, the government budget deficit will most likely exceed 6% of GDP in 2008. Political uncertainty and a weak government have prevented the necessary adjustment in economic policy, thus contributing to the recent deterioration in the economy.

The official FX reserves have more than halved since late 2007, and we estimate that the real FX reserves currently amount to less than USD 5bn. This is dangerously low in light of the monthly trade deficit currently being close to USD 2bn and the need to repay close to USD 1bn of foreign debt in early 2009. The risk of Pakistan defaulting on its foreign debt payments can no longer be ignored.

Pakistan will need foreign assistance to avoid a default in its foreign debt and a sharp slow down in the economy. Because of Pakistan’s importance in the war on terror, foreign assistance will probably be available. We see two possible solutions. First, Pakistan can ask the IMF for assistance. Access to IMF liquidity will most likely be conditional on some tightening of fiscal policy and include some restructuring on foreign debt payments. Second. Pakistan can be “bailed out” by Saudia Arabia and other Middle Eastern countries. This will probably include deferred payments for crude oil imports and some commitments on direct foreign investments in Pakistan.

More political stability is a necessary condition for a sustainable development in Pakistan. This includes the formation of a majority government able to implement necessary adjustments in economic policy. Though Muslim fundamentalism might continue to be a destabilising force as a political force, it is becoming increasingly marginalised.

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Published on  Mon, Oct 13 2008, 13:12 GMT

CP market and money markets gridlocked

Tue, Oct 7 2008, 07:52 GMT
by Danske Research Team

Danske Bank A/S

• Following the passing of the USD 700bn bailout package, the key problem in the financial crisis remains the deadlocked money markets. In this paper we look at the problems in the commercial paper (CP) market and the implications for money markets.
• The combination of increased fear and uncertainty about bank survival, combined with the drying up of funding via the CP market, has created massive problems in dollar money markets.
• The Fed announced its latest initiatives to combat the money market problems today. Further initiatives will probably be needed. We would not be surprised to see the US authorities targeting the problems in the CP market going forward.

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Published on  Tue, Oct 7 2008, 07:52 GMT

Euroland: Can exports ignore the euro?

Wed, Nov 14 2007, 10:06 GMT
by Niels-Henrik Bjørn

Danske Bank A/S

• The strengthening of the euro poses a serious risk to Euroland’s exports in 2008. However, it is worth recalling that the euro has not strengthened as much on a trade-weighed basis. Also, the more subdued development in unit labour costs will neutralise some of the competitiveness deterioration stemming from the stronger euro. Finally, large exposure to fast growing markets also supports exports.
• This means that Euroland is set to lose only a little of its share on export markets throughout 2008, and Euroland exports are thus set to grow only a little slower than global imports. Unless global trade falters one should not expect exports to drag down Euroland’s growth dramatically in 2008.
• Moderate export growth will be one of the key ingredients in assuring a soft landing for Euroland through 2008, as tight financing conditions and negative real wage growth will dampen the domestic economy further. Tight financing conditions will dampen Euroland’s business confidence gradually throughout most of 2008, but business confidence could easily rebound in the short term if sentiment effects related to the credit crisis fade.
• The strength in Euroland’s exports is primarily related to Germany. Germany’s export miracle over the past few years has mainly been driven by cost improvements. Germany will continue to outperform the rest of Euroland also during 2008.
• Moderate export growth could keep the ECB sidelined for a long time. On a 3-6 month horizon risks are still skewed towards further rate hikes, as global industry could push up business confidence. However, on a 12-month horizon they may start to be skewed towards rate cuts if the credit crisis continues and if the US economy keeps on posting only moderate growth.

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Published on  Wed, Nov 14 2007, 10:06 GMT

Denmark: Does the Danish housing market imitate the US?

Thu, Oct 18 2007, 08:54 GMT
by Frank Øland Hansen

Danske Bank A/S

• The Danish housing market has experienced a prolonged boom and a subsequent slowdown, which in many ways resembles the housing market boom and deceleration in the US - albeit with a delay of about one year. Does this imply that the troubles in the US sub-prime market are a forewarning of what is yet to come for Denmark? Due to important differences in the financing structure we do not think so.
• There are several striking similarities in recent Danish and US housing market developments. House price increases peaked in 2004-05 followed by a sudden slowdown. Housing supply has reacted considerably to demand, although later in Denmark than the US. And the number of homes available for sale has increased sharply. The main drivers of the housing boom have indeed been the same in Denmark and the US, namely falling interest rates, financial innovation and growth in disposable incomes.
• There are, however, important differences in the financing structure of the two housing markets. First, there is no sub-prime sector in Denmark. Credit evaluation is fairly uniform and it is more thorough than in the US sub-prime market. Secondly, credit risk is typically not resold and repackaged. Danish mortgage institutions put the mortgage loans on their books and finance them by the issuance of bonds with corresponding coupon and maturity. As a result, teaser loans are almost non-existent.
• Due to the abovementioned differences the Danish housing market does not face the same headaches as the US. On the other hand, the Danish housing market has become slightly more sensitive to interest rate increases than the US because of a widespread use of ARMs.

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Published on  Thu, Oct 18 2007, 08:54 GMT

CEE/CIS: The engine is cooling down

Fri, Oct 12 2007, 10:41 GMT
by Lars Christensen, Lars Rasmussen

Danske Bank A/S

• • Growth is set to slow down in Central and Eastern Europe and in Eurasia. Luckily the slowdown is set to be fairly soft in the larger economies in the region such as Russia and Poland, while the smaller economies in the Baltics and south-eastern Europe are set for a significantly harder landing.
• • The slowdown in growth is especially driven by significantly tighter credit conditions in the region - especially in the Baltic states and Kazakhstan.
• • The slowdown will particularly be visible in domestic demand and we expect a fairly strong slowdown in private consumption, property prices and construction activity.
• • Rising inflation and wage growth is a problem everywhere in the region. The acceleration in inflation on the back of in particular, higher food and energy prices, could weigh on private consumption.

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Published on  Fri, Oct 12 2007, 10:41 GMT

US: A labour market health check

Wed, Sep 19 2007, 13:24 GMT
by Allan von Mehren, Carsten Valgreen

Danske Bank A/S

• The August payrolls data has cast doubt over the resilience of the US labour market and motivated fears of a more serious downturn in economic activity. Not only did the labour market experience a net loss of jobs in August, the labour market report also included a negative revision to previous months, implying a considerably weaker trend in hiring than previously.

• There is no doubt that the trend in payrolls has softened over recent years in response to softer eco-nomic growth. That said, the pronounced weakness in the job market during the summer months seems more subtle.

• Firstly there are limited signs of a negative overhang from excessive job creation in recent quarters. The labour market quite closely followed the path laid out by GDP data. Secondly, while the signals from other labour market data remain very mixed, these indicators are on average not able to account for such a noticeable weakening. Finally, the slowdown in payrolls has been amplified by a sudden re-trenchment in government hiring and a conspicuous drop in manufacturing payrolls in August. Nei-ther of these developments should be sustainable.

• In summary, we find the recent slowing in employment growth somewhat excessive. Most likely the labour market will manage to recover in the coming months. The recent growth pattern as well as the common message from other labour market indicators suggest an underlying trend in hiring close to 100K per month.

• If the job market does not recover, the economy will be facing a quite different scenario. In this case a more serious slowdown could be on the cards. Such a scenario could easily involve more Fed easing than we are currently anticipating.

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Published on  Wed, Sep 19 2007, 13:24 GMT

Awash with Cash 9: After the "credit run"

Tue, Sep 11 2007, 08:22 GMT
by Allan von Mehren, Carsten Valgreen

Danske Bank A/S

• The present financial market crisis is not just about US sub-prime mortgages. It is about deleveraging after a period of extremely easy financial conditions, about faith in credit rating? agencies and it is about trust in the system of complex fixed income products built up over a number of years.
• We benchmark the crisis against similar financial distress in 1987, 1998 and 2001. This crisis resembles 1998 the most, with the difference being that the present crisis seems more systemic and in that sense more fundamental. We think it could be called a “credit run” - a “bank run” in a modern version.
• In financial markets the crisis could mark a watershed. As in 1987 and 1998 the crisis marks a rising trend in equity volatility. We think risk aversion will increase permanently, even as the dust settles. In a sense it marks the end of the “awash with cash” period. From now on perceptions of risk will change and markets will scrutinise lending and positions much more. This means credit spreads are not likely to come back to the same tight levels and swap spreads will likely stay wide for some time. And it also implies permanently higher risks of an emerging market crisis.

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Published on  Tue, Sep 11 2007, 08:22 GMT

Financial crisis: Why the contagion?

Mon, Aug 20 2007, 07:52 GMT
by Pär Magnusson

Danske Bank A/S

• We are amidst a financial crisis. We attempt in this note to give a stylised explanation as to why the negative effects on assets are amplified and why this entails contagion effects
• Balance sheet contractions are an important factor behind the spreading of the financial crisis.
• Since we do not know for how long this crisis will last, we believe caution is warranted.

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Published on  Mon, Aug 20 2007, 07:52 GMT

U.S: How can the Fed avoid a "credit run"?

Fri, Aug 17 2007, 16:44 GMT
by Carsten Valgreen

Danske Bank A/S

• Liquidity provisions by Fed and other central banks have, so far, failed to calm markets. Instead, financial markets remain stressed and dislocated. Hence, it is no wonder many are calling for Fed cuts, to restore “normality” in the markets.
• In many ways this crisis is a close parallel to the 1998 LTCM credit crisis. But the lesson learned by the Fed back then was that Fed cuts worked in the short term – but contributed to the notion of a “Greenspan put” in the longer run.
• We think there are other interesting venues that the Fed could explore before cutting rates. One way to deal with the situation is to widen the list of assets eligible as collateral in the discount window. This would broaden the channel through which the Fed is able to provide liquidity to the financial sys-tem.
• The signal and the effect of such type of action will in our opinion be just as strong as a rate cut, as it effectively shows that the Fed is willing to deliver liquidity on all assets it takes, to restore the well functioning of markets. Of course if this doesn’t work, rate cuts will be on the agenda. But the Fed will not tread down this road lightly.

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Published on  Fri, Aug 17 2007, 16:44 GMT

Oil market: Lower oil inventories going forward

Tue, Aug 14 2007, 11:52 GMT
by Danske Research Team

Danske Bank A/S

• Even if OPEC might step up its quotas at the September 11 OPEC meeting, the market will experience a counter seasonal draw in stocks in this quarter. The market balance is almost inevitably going to tighten this autumn.
• Hence, we continue to expect oil prices to remain at the current level for the rest of 2007. We also see a tighter oil market in 2008, and raise our 2008 forecast slightly.
• If the current turmoil in the financial markets continues it will negatively affect the oil price and other commodities, not least if it spreads to the real economy. However, this is not our main scenario, but oil is a “risk asset” that will suffer if risk appetite evaporates further. In that respect, note that he market is “long” oil today.

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Published on  Tue, Aug 14 2007, 11:52 GMT

Ukraine: Huge potential, but reform needs to speed up

Mon, Aug 13 2007, 15:54 GMT
by Lars Rasmussen

Danske Bank A/S

• Growth has been extremely strong in recent years – driven by buoyant domestic demand. Economic growth potential for the coming years looks positive, but much will depend on the pace of reform.
• The political situation has stabilised after pro-Western President Yushchenko and pro-Russian Prime Minister Yanukovych agreed at the end of May to hold parliamentary elections on 30 Septem-ber. Agreeing an election date diffused the wrangling between the president and the parliament that had intensified after Yushchenko dissolved parliament in early April.
• Investing in the Ukrainian market involves a number of risk factors. Among the most important are corruption, bureaucratic hurdles and insufficient protection of property rights.
• Looking to the longer term, it is positive that Ukraine is getting closer to WTO membership (perhaps as early as this year), as this will “force” Ukraine to continue its reform process. We also welcome Yu-shchenko’s announcement that EU membership is Ukraine’s long-term goal.

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Published on  Mon, Aug 13 2007, 15:54 GMT

The return of risk

Wed, Aug 8 2007, 15:31 GMT
by Peter Possing Andersen, Niels-Henrik Bjørn, Flemming J. Nielsen

Danske Bank A/S

• Over the past few weeks, risk aversion has increased on financial markets driven by the fear of deteriorating credit quality, primarily in the US mortgage market. We believe the recent turmoil is a market correction and not a prelude to a major meltdown on financial markets
• Panic in credit markets rarely lasts long, unless it is driven by macro-fundamentals. Corporate financing requirements are still too low to generate any longer-term significant widening of credit spreads. The net resulting tightening of credit should be manageable for the global economy as economic fundamentals are unusually strong and global monetary policy is broadly neutral.
• That said, the ongoing tightening of global monetary policy should eventually lead to a normalisation of the pricing of risk. It seems likely that the current events are the first steps in this normalisation and a full-blown return to the goldilocks situation of the last few years with extremely high returns and low volatility will be difficult.
• While event risk is here to stay, and financial market turmoil could continue for some more weeks, we believe that on a three- and a twelve-month horizon our financial forecasts will not be significantly affected. We expect further monetary tightening in Europe and Japan, the Fed to be on hold well into next year before tightening, higher global bond yields, and a narrowing of credit spreads. Furthermore we see a continuation of funding/carry trades on FX markets, moderate but positive returns on equity markets, and we expect emerging markets to remain strong.

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Published on  Wed, Aug 8 2007, 15:31 GMT

Awash with cash 8: Is the bond yield conundrum fading?

Tue, Jun 19 2007, 08:26 GMT
by Teis Knuthsen, Pär Magnusson, Carsten Valgreen

Danske Bank A/S

• Long bonds have sold off globally over the past couple of weeks. This has reignited the discussion about the bond yield conundrum - or rather whether the bond yield conundrum is disappearing and yields are “normalising”.
• However, so far the sell-off can be fully explained by a macro reappraisal, as investors have realised that the US economy looks a lot better than was consensus just a short while ago. Usually the simplest explanation should be preferred. This being the case, we are reluctant to call for an end to the bond yield conundrum in the short run. Even so, we revisit our bond yield forecasting models from past Awash With Cash papers and take a look at the Asian flow situation, in order to see if this is indeed the big thing.
• Taking the latter first, a shift in Asian monetary and FX policies towards greater currency flexibility will reduce the recycling of FX reserves into Western capital markets and, indirectly, contribute to higher bond yields. However, we find no conclusive evidence that a repatriation of Asian funds is be-hind the latest increase in US bond yields.
• Secondly, our bond models are clearly saying that the bond yield conundrum should start to wane now. However, they also signal that this is a long-term trend story. We would not expect bond markets to re-price themselves in one big move.
• Cautiously, we conclude that the sell-off in bonds is more a cyclical story than a structural one, which might imply some relief in the short term. However, the long-term story continues to be one of higher bond yields and less bond yield conundrum driven by plenty of growth, tightening monetary policy and receding liquidity.

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Published on  Tue, Jun 19 2007, 08:26 GMT

Switzerland: SNB keeps sleeves rolled up

Tue, Jun 12 2007, 16:02 GMT
by Christian Hilligsøe Heinig, Tobias Thygesen

Danske Bank A/S

• We expect the Swiss National Bank (SNB) to raise its policy rate by 25bp to 2.5% at the monetary policy meeting on 14 June. The financial markets largely share this expectation - at present only a very small chance of a 50bp hike is being discounted.
• We have revised our SNB forecast upwards. We previously expected the bank to go on hold after the June meeting, whereas we now anticipate further 25bp hikes at the September and December meetings. This means that we expect the policy rate to hit 3% before the SNB goes on hold. The financial markets are currently pricing in an additional hike in H1 next year.
• Despite the clear softening of the SNB’s rhetoric at the last meeting in March, the economic outlook seems to have improved since, and the inflation outlook has deteriorated slightly. Other things being equal, this spells a higher monetary policy rate. However, as things stand, we find it hard to see the SNB’s policy rate moving above 3% in the coming year, and there seems to be a greater risk of the SNB calling it a day at 2.75%.
• This has not had any great effect on our CHF forecast. We still expect the SNB to tighten monetary policy less than the market anticipates, while our expectation for the ECB is the reverse. Relative interest rates will not therefore drive up the CHF in the coming months. An increase in global risk aversion remains the big joker in the pack.

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Published on  Tue, Jun 12 2007, 16:02 GMT

China: Should we care about the stock market?

Fri, Jun 8 2007, 08:22 GMT
by Flemming J. Nielsen

Danske Bank A/S

• The boom in the mainland stock market is caused by a combination of catch-up, aggressive valuation of emerging markets in general and excessive valuation of the Chinese market in particular. In our estimate the Chinese stock market is overvalued by less than 30%, and on some measures the Chinese stock market is still far from the valuations of the previous market high in 2001.
• A market correction of 30% would probably have limited effects on global financial markets and will mainly depend on its impact on the Chinese economy. Although the importance of the Chinese stock market has increased in recent years, household share ownership is still modest. Further we see only limited danger of a negative spillover to the banking system because of the clear separation of commercial banking and securities business in China.
• There is a new commitment to the development of the stock market from the Chinese leadership. It will probably try to perform the very difficult balancing act of avoiding a major market correction be-fore the all important Communist Party Congress in October and not risking blowing more air into the stock market bubble by inaction.

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Published on  Fri, Jun 8 2007, 08:22 GMT

Ukraine: Political noise will not derail economy

Wed, May 23 2007, 07:35 GMT
by Lars Rasmussen

Danske Bank A/S

• On April 2, 2007, President Viktor Yushchenko decided to dissolve the parliament and sign a presidential decree ordering early parliamentary elections to be held on May 27, 2007.
• Early elections will clear the air, but it will not really change the composition of the parliament as the governing coalition will retain power.
• We argue that the political noise in the short run will not derail the economy and the ongoing upswing, as to a large extent it is driven by a strong global demand for Ukrainian export goods and an undervalued currency.
• We would welcome it if Orange Viktor and Blue Viktor could approach one other and go forward with reforms putting Ukraine on track for EU and WTO membership, as this could help unlock the long-term enormous growth potential in Ukraine.

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Published on  Wed, May 23 2007, 07:35 GMT

Turkey: The end of stability

Thu, May 10 2007, 08:55 GMT
by Lars Christensen

Danske Bank A/S

• Turkey is in the midst of the biggest political crisis in the country since 2001.
• The situation is far from over and the most likely political outcome of the crisis indicates a much less stable political situation than has been the case for the last five years.
• The parliamentary elections are likely to lead to a less-reformist and much more unstable government - most likely a coalition government.
• The Turkish military’s meddling in Turkish politics has tainted Turkey’s democratic image and has set back EU negotiations further. The election of Mr Nicolas Sarkozy as France’s president does not help Turkey’s EU ambitions either.
• Until now, the Turkish financial markets have taken the outbreak of political uncertainty surprisingly calmly. We doubt, however, that this will continue and fear that sooner or later a large sell-off in the Turkish markets will occur.
• We strongly recommend investors to reduce their exposure to the Turkish markets significantly - at least until after the Turkish elections (both parliamentary and presidential).

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Published on  Thu, May 10 2007, 08:55 GMT

Latvia: A plan to fight inflation, but a bit (too) late

Thu, Mar 8 2007, 16:01 GMT
by Lars Christensen

Danske Bank A/S

• The Latvian government has presented a plan to reduce inflation via the tightening of fiscal and credit policies. While we welcome the plan, which is long overdue, we fear a case of “too little too late”.
• We think the plan will contribute to reducing domestic demand and hence inflationary pressures, but only very moderately. Furthermore, we find the government’s projections for inflation overly optimistic and are puzzled that the government has basically not changed its inflation forecast relative to the Convergence Programme published in January - i.e. prior to the plan.
• We do not believe the plan will in any significant way reduce the risks facing the Latvian economy and markets, nor will it reduce the risk of rating downgrades of Latvian sovereign debt.
• We continue to recommend increased hedging of exposure not only to the Latvian markets but also to the other Baltic markets.

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Published on  Thu, Mar 8 2007, 16:01 GMT

Global: Business confidence to trough out

Wed, Feb 28 2007, 09:54 GMT
by Peter Possing Andersen, Thomas Harr, Niels-Henrik Bjørn

Danske Bank A/S

• In a report published in late May last year (Research Global: Business confidence heading down), we argued that business confidence would slow down in H2 2006 and keep slowing into 2007. This out-look has indeed materialised, as average G3 PMI has dropped from its peak of 56.4 in May to 52.7.
• All in all, the correction in business confidence is over. The remaining negative effects of the inventory correction are now being offset by the positive effects of the sharp drop in energy prices last autumn. We expect global business confidence to remain stable at around its current level before gradually picking up in H2 2007.
• However, this development will mask a divergent regional picture. In the US, the ISM index has troughed out and should begin to recover gradually. In Japan, the PMI will be roughly stable, while the euro zone PMI still has some way to go before it bottoms out.
• Trends will become more synchronised during H2, and a broader-based recovery in business confi-dence will mature as Euroland leaves the temporary slowdown behind it and Japan gathers further momentum. However, as the business cycle is in the late stages of its upswing, PMIs are not likely to exceed the highs of last year.
• The relative cyclical improvement in favour of the US supports our call for a widening of Euroland-US yield spreads. It also lends support to our outlook for a gradual strengthening of the US dollar this year. Finally, global central banks are expected to take monetary policy towards a tight stance, not least in response to the broad-based recovery during H2.

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Published on  Wed, Feb 28 2007, 09:54 GMT

Emerging Markets: It ain't over till the fat lady sings

Wed, Feb 28 2007, 09:51 GMT
by Thomas Harr, Lars Christensen

Danske Bank A/S

• The Emerging Markets’ sell-off has continued overnight and it is still far too early to say that this is over
• It should be noted that there has not been any significant policy or macro economic trigger behind the sell-off in Emerging Markets
• ...it is simply a matter of too many Emerging Markets assets being too expensive and overvalued
• Therefore the sell-off could persist for some time to come
• The extent and length of the sell-off is hard to predict, but this could be the initial phase of a sell-off and we therefore clearly recommend to reduce exposure to Emerging Markets - particular in high-beta/high-carry markets like Turkey and Brazil and Central and Eastern Europe. Emerging Asian FX markets look like the only safe haven in Asia and even here exposure to the high-yielders should be reduced.

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Published on  Wed, Feb 28 2007, 09:51 GMT

New Europe: A warning not to be ignored

Fri, Feb 23 2007, 15:33 GMT
by Lars Christensen, Lars Rasmussen

Danske Bank A/S

• Standard & Poor’s decision to change the outlook for Latvia’s long-term debt to “negative” from “stable” is a warning sign not only in relation to the situation in Latvia, but also in other Baltic and Central and Eastern European countries.
• We examine 11 vulnerability indicators for the 10 Central and Eastern European economies in the EU in order to assess the risk of a hard landing and/or financial unrest in these economies.
• The vulnerability indicators clearly show that Latvia is not alone in the danger zone. It also includes two other Baltic States, Estonia and Lithuania and the two South Eastern EU members Bulgaria and Romania. Slovakia looks vulnerable as well. On the other hand, Poland, the Czech Republic, Hungary and Slovenia look much less vulnerable.
• Based on our analysis we recommend paying extra attention to the risks raised in the analysis and in general recommend investors exposed to the countries that look most vulnerable to consider increasing their hedging of risk in these countries.

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Published on  Fri, Feb 23 2007, 15:33 GMT

Oil on troubled waters

Thu, Jan 25 2007, 11:25 GMT
by Peter Possing Andersen, Niels-Henrik Bjørn

Danske Bank A/S

• Just as the global economy is absorbing the positive effect of the sharp decline in energy prices during the autumn, oil prices are heading south once again. Since January 1 a renewed downtrend in oil prices has emerged, with prices down by more than 10%. This is like oil on troubled waters boosting growth and lowering inflation.
• The immediate effect of lower oil prices will be a significant drop in both US and Euroland headline in-flation in the coming months. And given the plunge in energy prices during the autumn, energy mar-kets have been providing a significant boost to consumer purchasing since last summer. While the first effects have already been seen in the data, there is definitely more positive news in the pipeline for H1.
• In the US, the re-acceleration in consumer spending late last year was a reflection of the decline in oil prices during the autumn. The effect of the most recent drop in the oil price is, however, still feeding into the data and will not show up before late Q1. US consumption spending looks very strong all the way into Q2. Combined with the maturing stabilisation in the housing market, this has strengthened our call for a positive US growth surprise in H1.
• In Euroland, the “tax relief” from the lower oil price will offset much of the negative effects of the Ger-man VAT hike. Provided the Eurozone labour markets continue to strengthen, the net effect on real in-comes of the VAT rise, the fall in the oil price and more people in work is significantly positive – and even for Germany the net effect is at least slightly positive.
• The monetary implications of a lower oil price normally tend to be asymmetric between the Fed and the ECB. In the USA, the lower oil price will tune the Fed into a more hawkish mode, as it boosts growth but will only have a limited impact on core inflation. In the Eurozone, the net impact is likely to be more subtle, as the ECB will suddenly be presented with inflation forecasts somewhat below 2%.
• Combined with our expectation of a relatively positive surprise in US versus Euroland industry in H1, the net impact of the lower oil prices on relative monetary policy supports our call for a rebound in the US vs. Euroland long bond yield spread.

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Published on  Thu, Jan 25 2007, 11:25 GMT

Awash with cash 7: When will it ever end?

Wed, Jan 17 2007, 09:01 GMT
by Peter Possing Andersen, Carsten Valgreen

Danske Bank A/S

• Since early 2005, we have published a series of research reports with the common lead title “Awash with cash”. These reports have focused on the financial market consequences of unusually easy US monetary policy in the 2002-05 period - in particular - the very low long bond yields.
• In an earlier “Awash with cash” report we introduced a “Smooth Transition Regression” (STR) model of long bond yields. This was able to account for the current low long bond yields by implementing changing regimes in the bond market. Updating our STR model has revealed that it has generally been correct since we introduced it in 2005.
• According to the STR model, the period of unusually easy US monetary policy, is behind the very low long bond yields. However, the model also shows that this effect will gradually begin to reverse during 2007, as the effect from tighter liquidity feeds into the bond market. This implies a modest - but in-creasing - upward pressure on bond yields throughout 2007.
• Another interesting result of the model is that the effect from tighter liquidity will prevent a sharp de-cline in US long bond yields in 2007 - even when assuming a hard landing in the US economy. Hence, from this perspective, there is a limited downside to long bond yields in 2007.
• The easy liquidity conditions work with a lag in the model. This implies that within the model’s frame-work the full impact from the recent tightening of US monetary policy will not arrive before 2008-09. By then we could be facing a substantial rise on long bond yields.

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Published on  Wed, Jan 17 2007, 09:01 GMT

Sweden: Labour supply and labour demand

Fri, Nov 3 2006, 16:42 GMT
by Roger Josefsson

Danske Bank A/S

• The government’s announced measures are generally believed to increase both supply of, and demand for, labour. But will supply increase more than demand?
  
  
• From a theoretical standpoint, and in a longer run, the increase in supply and demand should cancel out. But on a shorter horizon, say the coming few years, this is not certain to be the case. The government itself believes that the supply will outpace demand by circa ¼ percentage point (p.p.) in 2007 and thereafter demand will outpace supply in 2008 and 2009 by a total of almost 1½ p.p..
  
  
• The Riksbank has a somewhat gloomier view on the new measures. In their latest forecast, the profile for supply and demand is reminiscent of the Ministry of Finance’s, but the net effect considerably less optimistic. In the Riksbank’s forecast over the period 2007 to 2009, demand outpaces supply by a total of above ½ p.p. compared to the Minstry’s estimate of 1¼ p.p. The difference of 0.6 p.p. may not seem much, but is the equivalent of more than 30000 jobs.
  
  
• However, most economic commentators stress the difficulties involved when estimating the effects on demand for labour given the proposed fiscal policy measures. The effects on demand is mainly a question on if the measures are perceived as sustainable or not, and in a shorter perspective also on the twists and turns of the business cycle.
  
  
• Our view is still that a marked slowdown will materialise no later than 2007. However, domestic demand shelters the Swedish economy from being too adversely affected. Nonetheless, our estimates point to demand only marginally outpacing supply with a net effect for the entire period of circa ¼ p.p.

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Published on  Fri, Nov 3 2006, 16:42 GMT

Sweden: The output gap conundrum

Fri, Nov 3 2006, 16:28 GMT
by Roger Josefsson

Danske Bank A/S

• The output gap is a measure of resource utilisation in an economy and is used as an indicator of inflationary pressures. In equilibrium, when the output gap is closed, inflation should be at the target, 2 %.
  
  
• If you have thoroughly studied the publications from the institutions (MoF, NIER, Riksbank), you might have noticed that they at times divide the output gap (resource utilisation) in two; a labour market gap and a productivity gap.
  
  
• Over the last few years a dichotomy has appeared. The labour market gap has been negative, whereas the productivity gap has been strongly positive, and the resulting output gap often closed (or very near being closed). But at the same time, inflation has been very much below target.
  
  
• The estimates of the output gap has - inter alia - lead the Riksbank to (erroneously) foresee rather swiftly rising inflation, and the NIER to “abandon” the output gap for the labour market gap as an indicator for inflation.
  
  
• But why do estimates of the output gap suddenly seem to fail, despite working quite nicely over several decades (at least when evaluated ex post)?
  
  
• Before loosing ourselves in theory (and wild speculations), what impact does this rather theoretical discussion have on financial markets? - Well, in short, if we can find a correct explanation to what we have chosen to label the “output gap conundrum”, than we will have a pretty good chance of identifying when the Riksbank goes wrong.

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Published on  Fri, Nov 3 2006, 16:28 GMT

U.S: The risk of a US recession

Wed, Oct 25 2006, 15:25 GMT
by Thomas Harr, Kasper Kirkegaard, Niels-Henrik Bjørn

Danske Bank A/S

• China’s role in the global economy is expanding rapidly. This paper explores whether the Chinese growth miracle is any different from those seem previously in other Asian economies
  
  
• At first glance there is not much difference between the catching-up process in China and those previously seen in Asia. China has grown only a little faster than other catching-up economies, though its export performance has been more impressive.
  
  
• However, two features stand out. China has experienced faster productivity growth and even stronger capital accumulation in its catching-up process than other Asian economies.
  
  
• We argue that the deep involvement of foreign firms in China’s export-oriented industries can explain China’s relatively high productivity growth. China has been moving rapidly upwards in the value chain, paving the way for fast productivity growth.
  
  
• In China, like in other Asian countries, strong capital accumulation has been supported by very high savings rates. Macroeconomic stability and public subsidies via the financial systems are important reasons for Asia’s and China’s high savings and investment rates.

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Published on  Wed, Oct 25 2006, 15:25 GMT

USA: US housing bottoming out

Tue, Oct 17 2006, 10:59 GMT
by Peter Possing Andersen, Carsten Valgreen

Danske Bank A/S

• Since late 2005, home sales have been plunging, homebuilding activity has slowed significantly and homebuilder sentiment has dropped to its lowest level since the early 90s.
  
  
• But, how much worse will it get? We expect that new home sales have reached a trough, as mortgage applications have been relatively stable in recent months and the S&P500 homebuilder index has re-bounded. Further, the pace of deterioration in the inventory-sales ratio for new home sales is slowing and new home sales now seem well aligned relative to fundamentals such as interest rates, income and unemployment.
  
  
• This implies that the negative impact of construction on economic growth will peak in Q3/Q4 and then gradually ease in H1 2007. Nevertheless, it will take a few quarters before residential construction spending has adjusted fully to the slower pace of sales.
  
  
• We also suspect that the NAHB housing market sentiment index is close to a turnaround. When signs of stabilisation in the housing market becomes visible in the data, the ramifications for the financial markets and fed thinking could be significant.
  
  
• While the exact timing of a stabilisation in the housing market is very difficult to determine, we think that the case for a stabilisation has strengthened of late, meaning such a scenario could very well play out during the coming months.

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Published on  Tue, Oct 17 2006, 10:59 GMT

Norway: Preview Norges Bank meeting

Tue, Sep 26 2006, 14:04 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

• Norges Bank expected to keep policy rates unchanged at 3.0% at tomorrow’s policy meeting.
  
  
• We see a fair chance that the central bank will indicate a steeper (more hawkish) interest rate path when it releases its next inflation report on November 1.
  
  
• The weaker NOK, combined with the tighter labour market, more than offsets the current low rate of inflation.

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Published on  Tue, Sep 26 2006, 14:04 GMT

What to expect from G7/IMF?

Fri, Sep 15 2006, 12:03 GMT
by Thomas Harr

Danske Bank A/S

The G7 meeting will take place this weekend followed by the annual meeting of the IMF/World Bank in the beginning of next week. Moreover, US Treasury Secretary Poulson will travel on to China talking to Chinese officials after attending the IMF/World Bank meeting. The last combined G7 and IMF/World Bank meetings in April sparked a major sell-off in the dollar and a strengthening of the yen. Apart from the meetings clearly coming at a soft time for the dollar, the trigger was that the G7 statement specifically mentioned China as a country where greater currency flexibility was needed, and an Annex which described the G7 view on how to address global imbalances. What can we expect from the coming meetings?

Last week, the yen briefly strengthened after German Deputy Finance Minister Thomas Mirow said that yen weakness will be a topic at the G7 meeting. This supported other Asian currencies like the SGD, MYR and TWD. However, it seems that it is mainly European politicians who have a problem with the weak yen – besides comments on the renminbi, there have been no strong comments from non-European politicians on Asian currencies. In our view, it is difficult to imagine the G7 being able to do much about the weak yen. Japan has not intervened in the currency markets since spring 2004 and the main reason behind the weak yen is the low interest rates in Japan. It is difficult to imagine that the G7 would demand that the Bank of Japan raises interest rates to support the currency. Moreover, recent efforts by the Chinese authorities to increase the flexibility of the renminbi will make it more difficult for G7 to wag a very critical finger at China.

Therefore, we do not expect that the yen will be specifically mentioned in the G7 statement – neither do we believe that the statement will include an annex on global imbalances. China is likely to once again be mentioned in the statement with the view that they should continue to allow for more flexibility in their currency. However, renewed calls for China to allow more currency flexibility are nothing new. There may be comments on Asian currencies in connection with the meeting, especially the yen and the renminbi. Besides, the IMF meeting is likely to make us wiser on the future role of the IMF in addressing global imbalances – although it is difficult to imagine that we will get a clear roadmap.

Market implication: We do not expect that the G7/IMF-World Bank meetings or Poulson’s visit to China will have any significant effect on the major currency crosses. However, the meetings pose some risk that the yen may strengthen briefly on the back of comments from politicians outside the formal meetings. If anything, the relatively strong reaction in the yen on the back of German Deputy Finance Minister Thomas Mirow's comments shows the markets are nervous ahead of the meetings. A strengthening of the yen may lift other Asian currencies such as the SGD, MYR, TWD and KRW. However, don’t expect any moves from China around the time of the meetings. Longer term, we don’t expect that the meetings will have any significant impact on either the yen or the other Asian currencies.

Published on  Fri, Sep 15 2006, 12:03 GMT

Sweden: A primer on post−election fiscal policy

Fri, Sep 1 2006, 13:35 GMT
by Roger Josefsson

Danske Bank A/S

• Thanks to the triangulation, or “third way”, of the four centre-right parties forming “the Alliance”, dif-ferences in economic policy compared to the incumbent Social Democratic government have been drastically reduced. For instance, more than a third (SEK 11bn) of the expenses in the recent “election manifestos” are identical. The level of additional expenses is also more or less identical between the two blocs, at around SEK 30bn.
  
  
• Hence, the economic effects of the policies proposed by the political adversaries are not as wide-ranging as in previous elections. Nevertheless, the outcome of the election is more uncertain than ever, demonstrating the appeal of the new policies adopted by the Alliance. The slim margins also highlight a need for thoroughly addressing the differences in economic policies and their impact.
  
  
• We agree with most economic commentators that a win by the centre-right coalition would probably imply a relatively stronger SEK, higher short rates and possibly also lower long rates (flatter yield curve). Furthermore, GDP effects are deemed to be marginally higher than if the incumbent Social De-mocratic government continues in office.

• Download full Global Research - Sweden: A primer on post-election fiscal policy

Published on  Fri, Sep 1 2006, 13:35 GMT

Oil Prices − Price drivers weaken

Fri, Sep 1 2006, 08:40 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

• We still see current oil prices as justified given the low effective spare capacity in the oil market. However, we question whether the apparently unstoppable rise in oil prices over the past four years will continue in 2007, as two of the main price drivers - economic growth and lower spare oil production capacity - are looking less supportive for 2007.
  
  
• We keep our 2006 average oil price forecast almost unchanged at USD 69 a barrel and revise our 2007 forecast marginally higher to USD 68 a barrel. In other words, we do not think oil prices will continue their impressive bull-run that started in 2002. On the other hand, we would certainly not forecast that a bear trend in oil prices is at hand.
  
  
• OPEC is expected to cut back production if oil prices drift below USD 65 a barrel. Further, an escalation in the nuclear dispute between Iran and the UN cannot be ruled out, and this could disrupt the flow of oil from Iran, putting upward pressure on prices. Hence, the risk to our price forecast is skewed to the upside.

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Published on  Fri, Sep 1 2006, 08:40 GMT

A balanced view on imbalances

Fri, Jul 21 2006, 09:11 GMT
by Carsten Valgreen

Danske Bank A/S

Abstract

This paper argues for a balanced – and rather non-alarmist – view on the threat to the world economy stemming from the large US current account deficit. Firstly, it shows that imbalances are not just a US phenomenon. The trend towards current account imbalances has generally been growing all over the OECD area during the past decades. This reflects the emergence of a truly global capital market as national and international financial restrictions have been dismantled. Secondly, the rapid growth of international capital markets has hugely expanded the size of gross international asset positions. This, combined with a currency mismatch in the US external position, implies that a weaker dollar has a very sizeable positive impact on the US net debt position. A 10% weaker effective dollar improves the US net debt position by app. 5% of GDP (up from 2% of GDP in the 1980s). Thirdly, the US tends to earn a larger return on its assets abroad than foreigners earn on their US assets (the “Dark Matter” income). This paper argues that this fact should be seen as a reflection of the US dollar’s position as the global reserve currency par excellence. As such, the US is probably able to run larger and more sustained deficits today than ever before (although 7% of GDP is clearly not sustainable). Moreover, the concept of current account “equilibrium” gets blurred in the presence of an excess return on assets abroad. Finally, the paper shows that the deterioration of the US current account deficit over the past five years is entirely due to increasing imbalances within the “dollar zone”, i.e. against currencies that are more or less pegged to the US dollar. This suggests that the eventual road to more balance is likely to go through a change in currency policy among peggers in Asia and OPEC countries and/or through tighter US monetary policy. Both these “roads” imply that balance is more likely to be reached through higher (US) interest rates than through a dollar crash.

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Published on  Fri, Jul 21 2006, 09:11 GMT

Middle East crisis: Contagion or containment?

Wed, Jul 19 2006, 05:32 GMT
by Arne Lohmann Rasmussen, Lars Christensen

Danske Bank A/S

• The military confrontation between Lebanon and Israel will have two economic effects on the global economy: Higher oil prices and higher risk aversion .
• The main risk to oil prices is not the Lebanese-Israeli conflict itself, but rather any Iranian involvement in the conflict and the on-going Iranian dispute with the West over the country’s enrichment of uranium. The current conflict in the Middle East has made it slightly more likely that Iran will use oil as a weapon. If Iranian oil exports are cut off, oil prices will surge to more than USD 100 a barrel.
• Risk aversion has increased in response to the crisis and the “victims” are the usual suspects – equity markets, credit markets and the Emerging Markets, while the beneficiaries are gold, oil, the Swiss franc and – more surprisingly – the dollar. We expect this trend to continue as long as the crisis is not showing signs of being contained.
• If the conflict is contained to Lebanon and Israel, the longer term impact on the global economy and the financial and oil markets will be negligible. Since this is our main scenario, we do not expect a new violent spike in oil prices, and so we maintain our forecast for oil prices to stay more or less unchanged at the current levels.

Oil prices and risk aversion

The direct global economic importance of the Israeli and Lebanese economies is insignificant. In our view, the link to the global economy goes through two other channels: Oil prices and heightened global risk aversion due to the risk of further contagion of the conflict to the rest of the region.

The question is if we will see further contagion of the crisis or if it will be contained. In the latter case – which we find the most likely - the economic and financial impact on the global economy will be negligible. However, if the crisis spreads to other countries, it might have a far more severe impact on global risk aversion and oil prices, we believe.

Iran is pivotal when it comes to oil prices

Oil prices have reacted the textbook way to the geopolitical unrest in the Middle East. The US NYMEX future is trading at close to USD 78 a barrel, up almost USD 3 since last Wednesday. Furthermore, we have seen an outward shift in the whole futures curve. The oil market now expects oil prices to trade at more than USD 80 a barrel by end-2006.

However, there is no oil in either Israel or Lebanon. Hence, the effect on oil prices comes through a potential contagion of the conflict: There is a risk of the conflict spreading to Syria. That would mean a rather serious escalation of the conflict, as it would increase the risk that other Middle East countries would intervene in the conflict.

In our view, the pivotal country is Iran. Both the Israeli government and several Middle East experts claim that Hezbollah is sponsored by Iran, and the Iranian government has made no secret of its – at least – political sympathy for the Hezbollah movement. As such, the conflict between Hezbollah and Israel is, at least indirectly, an Iranian-Israeli conflict.

The current conflict also affects the ongoing dispute between the world community and Iran over the enrichment of uranium. Iran is facing UN resolutions that might subsequently result in UN or unilateral trade sanctions. As it has evolved over the past months, the dispute has highlighted the risk that oil will stop flowing from Iran – either because the Iranians might use oil as a weapon, or because the UN might impose trade sanctions on Iran. The latter possibility is probably rather unlikely as the pain from the subsequent rise in oil prices would, not least, be felt by the Western oil-consuming nations.

However, we cannot rule out the possibility of Iran using the oil weapon. In our view, the current crisis in the Middle East makes it easier for Iran to play hardball in the ongoing nuclear negotiations. The world community has, so to say, its hands tied in Israel and Lebanon.

In this context, don’t forget that the higher the price of oil, the more powerful the “oil weapon”. If Iran should wish to underline its right to enrich uranium or, alternatively, wish to “punish” the West for its apparent support of Israel, this would be the perfect time to send oil prices higher.

The power of Iranian oil has to be seen in light of the tight oil market, where supply is just barely keeping up with demand. Global “spare capacity” is about 1 mb/d at the moment – but currently this spare capacity is quality constrained1. Hence, in reality, no country would be able to supply further oil to the market if we were to experience a supply disruption.

Iran is currently producing 3.8 mb/d and exporting approximately 2.5 mb/d. If the Iranian oil vanished from the world market, this would have an immediate and strong effect on oil prices, probably sending the price of a barrel of oil above USD 100.

We doubt, though, that this price level will be sustainable for very long. The demand side will suffer, and the oil-consuming countries will begin to tap into their strategic reserves. US strategic oil stocks alone could, in theory, make up for lost Iranian exports for almost two years.

No change in oil price forecast

Our main scenario for oil prices is still that Dated Brent will be trading at an average price of USD 73 a barrel for the rest of 2006. Don’t forget that Dated Brent normally trades one or two US dollars below WTI front month prices. Our forecast does not imply an escalation of the conflict in the Middle East. We are expecting the crisis to be contained. Furthermore, we do not expect a stop to Iranian oil export. But the geopolitical situation does indicate that volatility will be high going forward. Spot prices could very easily pass USD 80 a barrel.

Basically, we continue to see oil prices being supported by strong growth and the lack of spare capacity rather than by the geopolitical situation (see the analysis “Research Oil: Fundamentals, not Iran, explain prices” published in April 2006.

Risk aversion on the rise again

The months of May and June saw a significant increase in risk aversion, driven basically by rising global bond yields and nervousness in the financial markets about global liquidity drying up. Then risk aversion seemed to be easing off for a while before the eruption of the latest round of violence in the Middle East, but the past week’s events have clearly changed this picture, and so will have obvious implications for the financial markets.

There are a number of sources of growing risk aversion – among others expectations for the global economy, oil prices and global liquidity, but obviously also the fear of war and terror in the Middle East. Note, however, that terror and violence in the Middle East, in itself, seldom have any strong impact on global risk appetite. What global investors really fear are higher oil prices and a slowdown in the global economy. Hence, it is hard to distinguish directly between the direct effect of the violence in the Middle East and the indirect impact of higher oil prices on risk aversion. One thing is certain, however – risk aversion is again on the rise.

The increase in global risk aversion can be spotted in most of the global financial markets – and the reaction has been pretty much in line with the “textbook ”. The Swiss franc has strengthened, emerging markets have sold-off and so have the global stock markets – especially tech stocks – and oil and gold prices have risen. The only thing that is not like the “textbook” is the fact that the dollar has actually strengthened, although it normally weakens when risk aversion increases. However, the greenback’s recent strength probably reflects the impact of globalisation. While, in the “old days”, the primary “risky” asset in the world was the US stock market, today there are basically more risky assets to choose among – especially emerging markets and the global commodity markets.

There is no doubt that the rise in global risk aversion over the past week has primarily been driven by the outbreak of violence in the Middle East. We believe, however, that, if the violence is contained to a conflict between Israel and Lebanon (or rather Hezbollah), then global risk aversion would probably ease off fairly fast. But, as long as the conflict continues to develop in a more violent direction and as long as uncertainty about the “next step” persists, then risk aversion will continue to be on a heightened level. Therefore, we would not expect a rebound in the global equity markets and emerging markets (the asset classes most heavily affected by the rise in risk aversion) before there are fairly clear signs that the conflict has been contained and the conflict level has eased – for example, if peace talks are launched between the Israeli and Lebanese governments.

Global yields more important for risk aversion

Note also, though, that there clearly exist other sources of risk aversion than Middle Eastern violence. In the longer run, these other sources will probably be much more important – especially the continued tightening of monetary policy by the G3 countries and the prospects for a slowdown in the global economy.

• Download full Global Research - Middle East crisis: Contagion or containment?

Published on  Wed, Jul 19 2006, 00:32 GMT

Global Research − Turkey: Rebound set to continue, but risks remain high

Tue, Jul 4 2006, 14:21 GMT
by Danske Research Team

Danske Bank A/S

• The Turkish markets have sold off dramatically since the beginning of May, but we believe they have now staged a rebound that should continue in the coming months. Longer term, though, the Turkish marketswill face new challenges.
   
• The experience from other Emerging Markets sell-offs indicates that markets "overshoot". We believe this also has been the case in the Turkish market.
  
  
• There are, however, also fundamental reasons for the sell-off in the Turkish markets - primarily a worsening of global financial conditions. With global bond yields set to continue to rise over the coming year, the Turkish markets could come under renewed pressure, but for now the Turkish markets are moving in a more positive direction.
  
  
• Decisive policy action from both the Turkish central bank and the Turkish government has done a lot to stabilise the situation.
  
  
• Against this background, we have decided to revise our forecast for the lira in a more positive direction especially on a three months' horizon. We continue to stress, though, that the longer-term risks have increased.

• Turkey: Rebound set to continue, but risks remain high

Published on  Tue, Jul 4 2006, 09:21 GMT

Global Research − Global: Business confidence heading down

Tue, Jul 4 2006, 14:15 GMT
by Danske Research Team

Danske Bank A/S

• Global business confidence has surged since mid-2005 and now stands at its highest level in the present recovery. In part this is a reflection of strong GDP growth, but also a build-up of inventories in the global manufacturing sector. However, global economic and financial conditions have been tightening throughout H1 2006 and we believe this, along with a correction in inventories, will make the current elevated level of business confidence unsustainable in H2 2006.

• Tightening monetary policies, rising long bond yields and the high price of oil are all factors that will push down business confidence and global industry during H2 2006. The recent energy/gasoline shock, which is now feeding through to inflation, will also contribute to the fall in business confidence as consumers slow their spending on industrial goods.

• While we expect underlying GDP growth to lose some steam in the coming quarters, we do not believe that the global economy is entering a recession. Thus business confidence is unlikely to tumble to recessionary levels.

• The global industrial cycle is usually an important driver for financial markets. Weakening global industry and a decline in business confidence tend to lower yields and lead to reduced expectations for monetary policy tightening. Furthermore, business confidence is an important indicator of corporate earnings growth.

• Global: Business confidence heading down

Published on  Tue, Jul 4 2006, 09:15 GMT

Global Research − Global: Gasoline cools spending for a while

Tue, Jul 4 2006, 13:58 GMT
by Danske Research Team

Danske Bank A/S

• Gasoline prices have risen strongly over the past few weeks and they are now approaching the level observed in the aftermath of Katrina. Uncertainty about the future course of gasoline prices is clearly large, and gasoline prices could rise above the post-hurricane levels.

• We discuss three scenarios for the future development in gasoline prices. In the most likely scenario gasoline prices rise only a little more before retreating gradually in the coming months. In this scenario we will see a rather big rise in inflation and a temporary stagnation in consumer spending during the next 2-3 months. This could dampen business confidence during the summer.
• During the present recovery the surging price of oil has not damaged the underlying recovery nor created any significant upward pressure on underlying inflation. Central banks are therefore likely to play “wait-and-see”, as they digest the duration of the gasoline shock as well as the effects on activity and inflation.

• Bond market reactions to oil price movements over the past couple of years have been ambiguous, and it is hard to gauge the outcome of this event. However, on balance, a higher oil price tends to push bond yields higher at first, while a brake on the global industry later leads to lower bond yields. On FX markets, a higher price of oil has clearly benefited the euro relative to the dollar.

• Global: Gasoline cools spending for a while

Published on  Tue, Jul 4 2006, 08:58 GMT