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    Gs global econ_weekly_(oct_6,_2010) Gs global econ_weekly_(oct_6,_2010) Document Transcript

    • Global Economics Weekly Issue No: 10/35 October 6, 2010 Goldman Sachs Global Economics, Commodities and Strategy Research at https://360.gs.com Beware Bogus Bond Bubbles Dominic Wilson In the face of a US slowdown, a commitment dominic.wilson@gs.com to keeping monetary policy easy for an +1 212 902 5924 ‘extended period’ and the prospect of QE2, US and global bond markets have rallied Kevin Daly over the past six months. In this Global Bond Valuation under Sudoku and Panel Regression* kevin.daly@gs.com +44 (0)20 7774 5908 Economics Weekly, we ask whether we are in Panel the midst of a bond bubble and, if so, how Actual 10-yr Sudoku Misvaluations Misvaluations using LT Michael Vaknin we can tell. Bond yields* (in Std. Dev.) expectations michael.vaknin@gs.com (in Std. Dev.) +44 (0)20 7774 1386 To this end, we supplement our existing US 2.37 -0.8 -0.4 bond valuation model, the GS Bond Sudoku, Japan 0.85 -0.2 -0.6 Aqib Aslam with an alternative framework to better Germany 2.22 -0.5 -0.7 aqib.aslam@gs.com detect whether macroeconomic fundamentals UK 2.90 0.0 -0.4 +44 (0)20 7774 1173 imply the formation of a bond bubble in the Canada 2.72 -0.6 -0.9 Constantin Burgi G-10. Norway 3.27 - -1.6 constantin.burgi@gs.com Sweden 2.44 0.3 -1.6 +44 (0)20 7051 4009 Conditioned on the current (relatively weak) Switzerland 1.42 -0.7 -1.2 macroeconomic backdrop and assuming that Source: Bloomberg, GS Global ECS Research *Last Close Stacy Carlson short-term policy rates are ‘appropriate’, our stacy.carlson@gs.com models suggest that the major bond markets +1 212 855 0684 are some distance from being in a bubble. Even in Japan—where it is commonly % 10-yr Rates Rally Over Time, % But No Bubble Yet perceived that the bond market is 10 9 overvalued—we find that the misvaluation is 9 10-yr USTs 8 fairly small. 8 10-yr German Bunds 7 7 However, we do find evidence that bond 10-yr JGBs 6 markets in the G-10 periphery are more 6 5 expensive than the core. This suggests that 5 4 the smaller open economies—such as 4 Sweden, Norway and Switzerland—are 3 3 importing lower rates from the core than are 2 2 justified by their (relatively strong) domestic 1 1 macroeconomic fundamentals. 0 0 90 92 94 96 98 00 02 04 06 08 10 In addition, a number of emerging markets Source: GS Global ECS Research with strong growth and inflation appear particularly sensitive to such spillovers from easy monetary policy in the G-10, leading to a policy mix that is arguably too loose. Policy-induced bubbles are a possibility in such countries. Important disclosures appear at the back of this document
    • Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly Beware Bogus Bond Bubbles Along with the oscillations of the business cycle, asset price of a (zero-coupon) bond can only increase to a bubbles are a recurrent feature of the economic ceiling of 100, given that any security only pays back par landscape. We turn in this Global Economics Weekly to at redemption. On the other hand, stock valuations are the recent surge in bond prices and the corresponding fall subject to greater degrees of freedom, such as the path of in yields (Chart 1), and ponder whether we are in the dividends and the choice of the discount factors, and, as midst of a bond bubble and, if so, how we can tell. such, valuations for equity markets are more loosely Furthermore, we assess whether the plunge in policy rates defined. In spite of such bounds, bond prices can still in the benchmark markets (Chart 2) has induced bubbles become disconnected from the underlying macro picture elsewhere, and look at how macro factors and and this is what we have attempted to gauge using a fundamentals can help us understand recent moves in series of valuation frameworks. bond markets. Yield Valuation: Detecting Bond Bubbles Bond Bubbles Have Bounds In theory, bond yields should be closely linked to the The common perception of bubbles is that assets trade at average of expected future short-term (policy) rates over a price above their current fundamental value only the life of the bond, according to the so-called because investors believe the price will be higher Expectations Hypothesis. Policy rates, in turn, are tomorrow. This suggests that a bond bubble can sensitive to changes in expectations for inflation and real potentially form in the same way as any other sort of growth, as specified by the standard Euler equation, used financial bubble. The worth of a bond becomes regularly in macroeconomic modelling. In particular, the disconnected from its actual value when investors prize it Euler equation establishes how bond yields should offer because it can be sold on at a profit as prices escalate. But an intrinsic compensation for the ex-ante real rate of how do bond bubbles differ from other financial asset return (proxied by growth expectations) and compensate bubbles? The answer to this question is related to two for the loss of purchasing power (captured via inflation issues: first, when bond bubbles can occur and, second, expectations). how divorced bonds can become from the macroeconomic backdrop. Our own valuation framework, the GS Bond Sudoku1, is based on this intertwined Expectations Hypothesis-Euler In the first case, government bonds represent (for most equation formulation. Specifically, we account for all of countries) the safest asset available, and so a bond rally the above factors (policy rates, inflation and growth), (and the possibility of bond bubbles) would typically be which enter the model as forward-looking expectations. associated with periods of economic downturn and In addition to these domestic factors, we go one step uncertainty, rather than with periods of growth recovery. further by including the foreign counterparts of these For instance, the recent dip in yields in the US does not macro factors. These global factors are meant to account constitute a bond bubble, in our view, since both the mid- for the additional macro spillovers between countries, cycle slowdown and the macroeconomic picture broadly especially in the inter-linked G-10 rates markets. justify current yields. In addition we consider an alternative framework for On the second point, unlike equities or housing markets bond valuation, which accommodates two potential (for which there is no limit to potential price rises), the shortcomings when detecting bubbles: % Chart 1: 10-yr Rates Rally Over Time % % Chart 2: Policy Rates Plunge In the Wake of % 10 9 the Recent Crisis 12 10-yr USTs BOJ Target Rate 9 8 10 ECB Refi Rate 8 10-yr German Bunds 7 Fed Funds Rate 7 10-yr JGBs 6 8 6 5 5 6 4 4 3 4 3 2 2 2 1 1 0 0 0 90 92 94 96 98 00 02 04 06 08 10 90 92 94 96 98 00 02 04 06 08 10 Source: GS Global ECS Research Source: GS Global ECS Research 1. See Foreign Exchange Annual 2006, Chapter 10. Issue No: 10/35 2 October 6, 2010
    • Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly Table 1: Bond Valuation under Sudoku and Panel exceeds this threshold, we have to be cautious about the Regression* interpretation. Panel Sudoku Misvaluations As such, if we follow some basic statistical assumptions Actual 10-yr Misvaluations using LT (regarding the normality of the regression residuals), the Bond yields* (in Std. Dev.) expectations likelihood of actual yields falling more than two standard (in Std. Dev.) deviations outside of the fitted yield is below 5%; US 2.37 -0.8 -0.4 therefore, for actual yields to deviate to such an extent Japan 0.85 -0.2 -0.6 must mean that there is a significant disconnect between Germany 2.22 -0.5 -0.7 yields and the macroeconomic context. UK 2.90 0.0 -0.4 Canada 2.72 -0.6 -0.9 A Rally But Not a Bubble... Norway 3.27 - -1.6 The results in Table 1 suggest that none of these markets Sweden 2.44 0.3 -1.6 are severely misvalued. Given that the Sudoku 1.42 -0.7 -1.2 misvaluations do not exceed one standard deviation, the Switzerland bond markets appear broadly ‘fair’ in the UK, Japan and Source: Bloomberg, GS Global ECS Research *Last Close Sweden, and that the remainder, including the US, are moderately ‘rich’. On this basis, most markets are in the Sudoku focuses only on expectations at shorter-term midst of a rally (with the exception of Sweden), but not a horizons (1 yr ahead). This is because Sudoku aims to bubble. capture high frequency dynamics. To accommodate this, our alternative model incorporates long-term This same message emerges from the panel estimation. consensus expectations over the 10-yr horizon for both Unlike Sudoku, all markets look relatively ‘expensive’, growth and inflation. providing some credence to a theme we have touched on in numerous recent pieces—that the US is leading a Detecting a bubble in a particular bond market global rally in rates by holding its policy rates at such low requires absolute benchmarking against the other G-10 levels. bond markets. Our Sudoku model, on the other hand, is estimated on a country-by-country basis. For this The panel regression also throws light on the clear reason we carry out a panel regression in the second dichotomy between the core and the peripheral markets model to reflect the notion that all bond yields are within the G-10, another theme we have highlighted in priced identically across all markets with respect to the recent research. More specifically, it suggests that macro factors. Switzerland, Norway and Sweden stand out as the most ‘expensive’ bond markets, although they remain below Within the setting of Sudoku and our second formulation, the vital two standard deviation threshold we use to we obtain two separate fitted yields, which can be used to define the possible existence of a bond bubble. These assess the extent to which bonds are bubbling over (see levels contrast strongly with those in the G-4 bond Table 1). Generally speaking, bonds are considered markets, which are much closer to the model fitted ‘cheap’ (‘rich’) when yields trade visibly above (below) values, and therefore not as suppressed relative to the their fitted yield. That said, the level of ‘expensiveness’ macro environment. at which one concludes that bonds are in a bubble is subjective. We believe the two standard deviation level is One important caveat to the preceding analysis is that a reasonable threshold, although even when misvaluation expectations of the underlying variables (growth, % Chart 3: 10-yr-Ahead Growth Expectations % Chart 4: 10-yr-Ahead Inflation Expectations 4.5 5.0 USD JPY DEM USD JPY DEM 4.5 4.0 GBP CAD NOK GBP CAD NOK SEK CHF 4.0 SEK CHF 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 90 92 94 96 98 00 02 04 06 08 10 12 90 92 94 96 98 00 02 04 06 08 10 12 Source: Consensus Economics. Source: Consensus Economics. Issue No: 10/35 3 October 6, 2010
    • Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly Std.Dev. Chart 5: GS Bond Sudoku Measure of 10-yr Bond Misvaluation* 3.0 USA Germany Japan UK +2 Std. Dev. 2.0 +1 Std. Dev. 1.0 0.0 S -1.0 -1 Std.Dev. -2.0 -2 Std.Dev. -3.0 90 92 94 96 98 00 02 04 06 08 10 Source: GS Global ECS Research * Latest data point used is last close; Sudoku is based on country-by-country estimations inflation, short-term rates) that form the foundations of inflation (Japan). Thus, the key theme of macro our valuation frameworks can themselves be incorrect. fundamentals driving bond markets prevails once again. Thus, bond bubbles driven by unrealistic expectations of these underlying macro factors cannot be ruled out by the Using long-term consensus forecasts results, bond yields analysis set out above. However, we do not believe that have been more prone to bubble episodes. This is current expectations of these factors are significantly interesting given that longer-term macroeconomic unrealistic. expectations are subject to much less variation and suffer from a greater degree of inertia. We draw the reader’s attention to two interesting points: ...And Little Evidence of Bubbles in the Past Charts 5 and 6 respectively display the historical Despite the common view that the Japanese bond misvaluations (in standard deviation terms) between market is bubbling over, misvaluation has been fairly realised yields and the fitted yield levels under both small, even in the panel regression. In this case, Sudoku and the alternative panel regression for the G-4 misvaluation has not greatly exceeded one standard economies within the sample. deviation since the start of the sample in 1989. Indeed, as Charts 3 and 4 show, the decline in JGB yields According to Sudoku, bonds have been close to bubble corresponds to depressed long-term expectations in territory in the past: they came closest in the early 1990s, growth and inflation. However, other markets, such as 1998-2000, 2005-2006 (the ‘conundrum’ years) and the UK, show a much greater tendency towards rallies recently around 2008. But even in these periods when and the beginnings of bubbles (notably in the panel misvaluation approached the bubble mark, regression). macroeconomic factors were strongly negative. Indeed, most of the G-4 economies were either in recession, or The current ‘overvaluation’ in US Treasuries is experiencing prolonged periods of stagnation and low considerably lower than the levels observed during the % Chart 6: Misvaluation of 10-yr Bonds Using Long-Term Expectations* 3.5 Germany UK Japan USA 2.5 +2 Std. Dev. +1 Std. Dev. 1.5 0.5 -0.5 -1.5 -1 Std. Dev. -2.5 -2 Std. Dev. -3.5 90 92 94 96 98 00 02 04 06 08 10 Source: GS Global ECS Research * Latest data point used is last close; This model uses panel estimation techniques Issue No: 10/35 4 October 6, 2010
    • Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly ‘conundrum’ period of 2005-2006 (we argued in a curve steepened, banks started to reallocate assets Global Viewpoint released at the time that official away from loans into securities (see Chart 7). The buying of US Treasuries had depressed intermediate advent of Basel III in the coming years is admittedly a yields by around 40bp). Although US yields are more secular force that should be taken into account. considerably lower than at that time, the ‘fair value’ But, given the long gestation period, the chances are was dramatically lower as well, given how low that most of the variation in demand by banks will still expectations on the macro backdrop are. be cyclically-motivated. Institutional investors have also been accumulating Ignore Endogenous Shifts in Supply and Demand securities at a rapid pace (see Chart 7). With respect to The interplay of supply and demand in fixed income insurers, worsening solvency positions (largely owing markets is often raised in the context of the potential to lower rates inflating the present value of existing emergence of bond bubbles. Only a year and a half ago, liabilities) have led to higher demand to duration. the main concern was that excessive government Likewise, pension funds have been accumulating fixed borrowing would lead to significantly higher yields. As a income securities as part of their liability hedging result, 10-yr Treasuries sold off from as low as 2% to 4% strategies. That said, it is conceivable that some in a short period of time. Fast-forwarding to the current portion of the demand from the institutional investor landscape, some investors appear to be concerned that base is unconnected to the current macro conditions; demand for fixed income from pension plans, insurers Solvency II (a framework for prudential regulation of and banks, coupled with the Fed’s intention to embark on insurance in the EU) may generate exogenous sources QE2, is pushing yields to the other extreme, and of demand, and so a small portion of the rally seen so potentially into bubble territory. far may be attributed to this. Our long-held view on this issue is that supply and Foreign investors’ acquisitions of G-10 bonds are demand respond endogenously to changes in the another important demand source often mentioned in economic landscape. So, just as the pick-up in the context of possible bond bubbles, as experienced government borrowing corresponds to a weak macro during the ‘conundrum’ years. Most recently, however, environment (vis-à-vis lower tax receipts and higher the accumulation of FX reserves by foreign central spending), bond demand is also likely to move higher in banks has mostly stalled. This seems to correspond to the face of weak real growth, subdued inflation and near- the rebalancing of many emerging markets away from zero interest rates. In this sense, the inclusion of these export-driven economic models and towards domestic macro factors in our fair value analysis means that these demand growth. In this respect, China, the largest endogenous demand shifts are already accounted for. holder of Treasury securities, has barely seen its stock of reserves increase over the past five months. Yet, In this context, we highlight several important demand despite the weakness in flows from foreign central factors: banks, private foreign investors continue to accumulate Historically, banks have tended to cyclically adjust the benchmark securities at a rapid pace. The substantial portfolio share they allocate to securities. The US steepening of the US yield curve last year offered good banking sector has entered the current cyclical value, particularly for Japanese asset managers. That downturn with an exceptionally low allocation to said, these flows are cyclical and as such already securities. And as loan quality worsened and the yield accounted for in our valuation frameworks. % Chart 7: Allocations Into Treasury, Agency and % Index Chart 8: Financial Conditions Looser, GSE-Backed Securities are Largely Cyclical* Except for Switzerland 20 22 104 18 US pension plans 20 US commercial banks 102 16 18 14 100 16 12 98 14 10 12 96 8 10 US FCI Europe FCI 6 94 Japan FCI UK FCI 4 8 Switzerland FCI Sweden FCI 90 92 94 96 98 00 02 04 06 08 10 12 92 99 00 01 02 03 04 05 06 07 08 09 10 Source: US Flow of Funds. * Percentage of total assets. Source: GS Global ECS Research Issue No: 10/35 5 October 6, 2010
    • Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly Policy-Induced Bubbles tightening via their exchange rates rather than through Finally, we focus on one particular input to both of our rates. bond valuation models: the near-term policy rate expectations (which in practice reflect the current policy More broadly, whether FX is dominating or not, real rates stance of the central bank). So far, we have assumed that in emerging markets have fallen dramatically, well below the short-term rates that feed into the regressions are the levels consistent with current growth rates. We have optimal relative to the macroeconomic backdrop2. already picked up on this theme of policy-induced bubbles when considering the negative misvaluations in Hence, to the extent that policy rates in certain markets the periphery relative to the core G-10 markets. But are kept artificially low, fair value bond yields might look emerging markets represent a special case as distortions artificially low as well. This means that bonds might look within debt markets in these countries can have much less expensive than is the case. In other words, bubbles stronger implications for their domestic economies, and are harder to detect, once the optimality of the policy set- in particular asset prices. up is called into question. Beware Bogus Bond Bubbles Currently, many non-core economies, particularly Assuming that policy rates are appropriately low, our emerging markets, are experiencing a stronger recovery models show that the major bond markets are not in or in both inflation and growth. Spare capacity in these close to a bubble state, given the current macroeconomic countries is typically smaller too. This macroeconomic backdrop. However, we are wary of the possibility that in backdrop would suggest the need for faster policy several emerging markets, policy rates are too low normalisation than has been seen so far. relative to the growth inflation mix. In some cases, the lack of policy tightening has been substituted by an appreciation of the exchange rate Michael Vaknin and Aqib Aslam (adopting a tighter interest rate policy, while core central banks remain on hold, can lead to a stronger currency). This is partly why some non-core central banks have been reluctant to embark on the hiking cycle. Switzerland is one example in the G-10 periphery (see financial conditions indicator in Chart 8), while in emerging markets, several Asian economies are also seeing 2. Subject to the constraint that nominal short rates cannot fall below zero, e.g., the optimal interest rate in the US is negative according to applications of the standard Taylor Rule. Issue No: 10/35 6 October 6, 2010
    • Goldman Sachs Global Economics, Commodities and Strategy Research Global Economics Weekly Equity Risk and Credit Premiums Current Estimates for the Equity Risk Premium* Real GDP Real Earnings Dividend Expected Real Real Bond Implied Expected Expected Growth Growth + Yield = Return - Yield = ERP Inflation Nominal Return US 3.0 3.0 2.0 5.0 0.7 4.3 2.0 7.0 Japan 1.5 1.5 1.9 3.4 0.4 3.0 0.5 3.9 UK 2.8 2.8 3.3 6.1 -0.9 7.0 2.0 8.1 Europe ex UK 2.3 2.3 3.0 5.3 -0.9 6.2 2.0 7.3 World 2.5 2.5 2.4 4.9 0.0 4.9 1.8 6.7 *Calculated as of 6 October 2010 Source: Datastream; real GDP grow th and expected inflation are GS Economics Research forecasts. The US ERP has increased by 105bp since its most recent In August, our ECP was 358bp higher than the most trough in early April, due to the fall in real bond yields. recent trough in November 2008. % US ERP % ECP 5 4.3 US ERP, calculated daily 4 Credit 3.9 relatively US ERP 200 Day Moving Average 3 1985-1998 average expensive 3.5 2 3.1 1 2.7 0 2.3 -1 1.9 -2 2 standard deviations 1.5 band -3 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 Source: GS Global ECS Research Source: GS Global ECS Research We, Michael Vaknin and Aqib Aslam, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm’s business or client relationships. Global product; distributing entities The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs & Partners Australia Pty Ltd (ABN 21 006 797 897) on behalf of Goldman Sachs; in Canada by Goldman Sachs &Co. regarding Canadian equities and by Goldman Sachs & Co. 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No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of The Goldman Sachs Group, Inc. © Copyright 2010, The Goldman Sachs Group, Inc. All Rights Reserved. Issue No: 10/35 7 October 6, 2010
    • The World in a Nutshell THE GLOBAL ECONOMY OUTLOOK KEY ISSUES UNITED STATES We continue to expect real GDP growth to average US data has been consistently weak in recent 1.5% (annual rate) in 2H2010 and to remain months, supporting our view of a growth slowdown sluggish in 2011, largely owing to the limited political due to soft final demand and the winding down of the appetite to extend fiscal stimulus. We forecast 2011 inventory cycle and fiscal stimulus. The FOMC has annual growth of just 1.8%. The labour market indicated a willingness to ease if needed and we should remain correspondingly weak, with expect additional QE later this year or early in 2011, unemployment averaging 9.7% in 2H2010 and 10% and perhaps as soon as November, in response to in 2011. weaker growth and inflation data. JAPAN We have revised our GDP forecasts, leaving 2010 The BoJ announced additional easing, but we growth at +2.9% but lowering our 2011 forecast to believe the caveats attached mean that the effect +1.0% from +1.3%. We have also altered our will be muted. We expect further easing, most likely quarterly growth path forecast to +1.4% (annual in December, in response to weakening conditions. rate) in 3Q2010 and –1.4% in 4Q2010, from +0.6% The MoF recently stepped in to stem Yen and +1.3% previously. We expect a temporary surge appreciation. The government is also currently in demand in 3Q2010 ahead of the expiry of considering a roughly ¥4 trillion supplementary government subsidies, but for growth to remain budget, which presents upside risks to our 2011 sluggish thereafter due to a pullback in consumption forecasts and may necessitate further forecast as these subsidies end and exports slow. revisions once explicit details are made available. EUROPE We expect real GDP growth in 2010 to be 1.8%yoy Recent European data indicate an easing in in EU-27 and 1.7%yoy in the Euro-zone. Overall, our momentum, confirming the start of the phase of European outlook remains above consensus but moderation and stabilisation that we expect there is significant variation in the cyclical positions throughout Europe in 2H2010. We expect the ECB of individual European countries. We do not expect to begin its exit strategy in early 2011. Fiscal affairs the slowdown in US growth to affect European have re-entered the spotlight in recent weeks—the growth significantly, given Europe’s limited exposure series of government consolidation measures that to US exports. However, the recent strengthening of have been announced so far seem credible, but we the Euro and other European currencies does pose believe that, depending on economic developments, a downside risk to our forecasts. even more may be needed. NON-JAPAN ASIA For Asia ex Japan we forecast 9.0% and 8.4% In China, recent activity data has been strong, growth in 2010 and 2011. We expect growth in most underpinned by inventory increases and a ‘stealth’ countries across the region to slow in 2011, albeit at easing in financial conditions from strong fiscal solid levels. In China, we expect real GDP growth of spending and credit growth. We believe robust 10.1% for 2010 and a return to its trend level of domestic demand and the current policy mix will 10.0% for 2011. contribute to a rebound in sequential growth in 4Q2010. LATIN AMERICA Our LatAm growth forecast is 6.3% for 2010 and We expect real GDP growth in Brazil to accelerate 4.6% in 2011. Our view is optimistic across most of to an above-trend rate of 7.8%yoy in 2010, due the region thanks to accommodative monetary policy mainly to expansionary macro policies. We expect stances, strong domestic demand growth, this to tighten labour market conditions and reduce strengthening labour markets, and firming credit unemployment to record lows, thereby reinforcing flows. upside risks to inflation in 2011. CENTRAL & EASTERN CEEMEA activity data has slowed in recent months We expect a broad-based slowdown across the EUROPE, MIDDLE EAST as industrial momentum has tapered and uncertainty region in 3Q2010, driven mainly by weakening about global growth has increased. We have revised external demand. This should lead monetary policy AND AFRICA down some of our forecasts in the region, but most stances to remain highly accommodative through remain above consensus. Economies with strong the rest of 2010. We see the necessary tightening of balance sheet structures and easy financial domestic financial conditions later in 2011 as the conditions should outperform. biggest challenge facing CEEMEA policymakers. CENTRAL BANK POLICIES CURRENT SITUATION NEXT MEETINGS EXPECTATION UNITED STATES: FOMC The Fed cut the funds rate to a range November 3 We expect the Fed to keep the funds rate of 0%-0.25% on December 16, 2008. December 14 near 0% through the end of 2011. JAPAN: BoJ Monetary The BoJ cut the overnight call rate to a October 28 We expect the BoJ to keep the policy rate Policy Board range of 0%-0.1% on October 5, 2010. November 16 near 0% through the end of 2011. EUROLAND: ECB The ECB cut rates by 25bp to 1.0% on October 7 We expect the ECB to keep the policy rate Governing Council May 7, 2009. October 21 on hold until 3Q2011. UK: BoE Monetary The BoE cut rates by 50bp to 0.5% on October 7 We expect the BoE to keep the policy rate Policy Committee March 5, 2009. November 4 on hold until a 50bp hike in 4Q2011. Issue No: 10/35 8 October 6, 2010