Global financial centres after the crisis

- Financial market size: "Traditional centres lose market shares, emerging markets up-and-coming. US and EU financial markets continue to provide around three-quarters of global financial services, albeit, after the crisis, at substantially lower overall levels of market activity in many market segments. Emerging financial markets, especially in Asia, have grown strongly in past years and are set to accelerate their catch-up process."
- Financial centre competition: "Established centres static, new centres rush up the league tables. Traditional financial centres are repeatedly found in top ranks as regards their international competitiveness, typically including London, New York, Hong Kong, Singapore, Tokyo, Chicago, and Zurich. Their competitiveness ratings have not changed significantly over the past years. Emerging financial centres such as Beijing, Seoul, Shenzhen, Shanghai, and Dubai have improved their global ranking strongly since 2007, raising their competitiveness ratings by 42% for Seoul, 27% for Beijing, 22% for Mumbai, and 16% for Shanghai."
- Europe: "Single financial market, but ailing financial centres. European financial market places are falling behind in the rankings. Cities such as Paris, Madrid, Milan, Frankfurt, Amsterdam and even London, have clearly lost ground compared to other advanced and emerging locations, and seem to be missing opportunities to enhance their competitiveness."
- Four drivers of financial centre competitiveness after the crisis:
1. Big is beautiful – and will remain so. "London, New York, Hong Kong, and Singapore are set to remain strongholds of global finance after the crisis, building on existing market strength and favourable economic conditions."
2. Towards a multi-polar financial industry. "In the long-run, emerging financial centres are likely to succeed in establishing the scale and scope in their market environment that will help them advance into the top group of global locations. The crisis may accelerate this trend."
3. National focus as transitory advantage for smaller centres. "Local and regional financial market places may hope for continued relevance owing to the re-focusing of market participants and policymakers on their national markets. However, this tailwind will likely be of limited duration."
4. Good regulation as a competitive advantage. "Providing a good regulatory framework will be a key determinant of competitiveness going forward. Financial centres not compliant with international rules are faced with increasing political pressure and stigmatisation. Well-regulated financial centres may be considered as safe havens. But increasing regulatory density may also give rise to regulatory arbitrage. Financial centres need to analyse the impact of regulatory developments and decide which types of business and business practices they wish to host in their location."

DeutscheBank EU Monitor 20100802

A summer break with no breakthrough

- FI Strategizer: "Next week, US data confirming the slowdown in the economic recovery should be supportive for Treasuries. In the EMU, solid figures on German IP and orders should keep investors moderately optimistic, with Bunds suffering slightly. We do not expect major
surprises from the ECB meeting."
- EU Portfolio Strategy: "We would return to a minor long duration stance of +0.5 years. We keep our positive view on Italy and we increase moderately our exposure on Spain, closing further the gap with EFFAS weightings. We remain moderately overweight on France."
- Trade Idea: "Over the last week, Spain tightened sharply vs. Italy, especially at the front end and at the extra long end. We prefer Italy, due to its sounder macroeconomic fundamentals and we thus suggest switching from Spain into Italy at the 3Y maturity."
- MM: "This week, results of the 3M auction sent a reassuring signal, confirming that the EU banking system is sound. Next week, only the 1W MRO is scheduled, with EUR 190bn expiring. In line with this week, we expect demand to be slightly lower than the amount expiring, leading to another modest drop in liquidity."
- Supply Corner: "Next week, primary market activity will slow down. There will be no redemptions or coupons in the EMU, while gross supply should be a modest EUR 4bn, coming from Austria and Spain. Activity should focus on the short end, with little action on the extra long end."
- FX Strategizer: "The USD took the full impact of soft US news, but we do not expect the current market scenario to improve sharply. Investors are likely to scale back their risk exposure, which should provide USD, JPY and CHF some relief and put AUD, NZD and EUR under pressure."
- EUR: "The EMU growth prospects will not be strong enough to completely offset the outstanding budget crisis. The EUR-USD strength should ease and the next key resistance level at 1.3125 won’t be broken easily."
- JPY: "The latent downward pressure in USD-JPY and the modest upside potential for EUR-USD will limit any EUR-JPY rebound. EUR-JPY is thus unlikely to break through, while USD-JPY should stay in the 86/88 band."
- CHF: "As feared, the EUR-CHF recovery proved to be quite capped above 1.38: as risk aversion might spark more demand for safe-haven currencies, a full break of the 1.36 base may prompt a further sell-off."
- GBP: "Sterling should stay firm also in August with risks that our mediumterm target for cable at 1.60 may be hit rapidly. EUR-GBP should offer a more constrained picture, as a full break towards 0.80 might require time."
- Pacific Rim & CAD: "Commodity units are now less supported by tighter monetary policy at home. The AUD, NZD and CAD should hold the line vs. the USD, but their recent rally is likely to stay frozen in August."
- Nordics: "A more pronounced plunge of EUR-SEK and EUR-NOK below 9.40 and 7.95 appears quite ambitious at this stage. The two Nordic units should thus struggle in the “land of nowhere” in the coming weeks too."

Unicredit Curves & Crosses 20100730

Global Metals, Mining & Steel: EVA Increasing Returns

- A global view — "We have completed a global EVA study on the metals, mining & steel companies under Citi’s global coverage. We aim to show which companies, regions and commodities generated the most shareholder value over the past five years and are likely to generate the most attractive return over the next three years."
- Profitability of the industry is improving — "The global mining companies have added c. 5% return above the cost of capital for each year between 2005-09. We expect this to improve to 9% for 2010-12. In contrast, the steel sector has added c. 2.4% above the cost of capital and this is anticipated to decline to 0.3% over the next three years. BHP Billiton has been the standout performer in absolute EVA terms and is expected to generate $47bn over the next three years, dwarfing any of its nearest rivals. On the steel side, POSCO has been the leader over the last four years, but is expected to be edged out by CSN over the forecast period."
- EM over DM — "We expect emerging markets to outperform developed markets over the next three years. The key regions of outperformance expected to come through are Latam and Australia. North America has delivered the lowest EVA returns for mining, while European steel has been the worst performer in the steel sector."
- Commodity exposure — "On a returns basis, coking coal has been the highest returning commodity over the past five years, followed by copper then iron ore. We expect iron ore, coking coal and copper to be the key outperformers with a large improvement coming through in gold. In contrast, we expect PGMs, steel and zinc to meet their cost of capital."
- Don’t do M&A — "Over the past five years, the mining sector has absorbed $258 billion in invested capital and the steel sector has absorbed $115 billion in invested capital. Most of this has occurred via M&A and our analysis shows that M&A done around 2007 transferred a large amount of value from the acquirers to those being acquired. Capital discipline by the mining sector will be a key driver in determining alpha within the sector."
- Rankings — "We have combined our rankings based on commodity exposure and EVA return to construct a key pick list globally of most favoured and least favoured companies. The key leading companies are Grupo Mexico, Antofagasta, PanAust Limited, OZ Minerals, Freeport-McMoRan, Cliffs Natural Resources, Fortescue Metals Group, Bumi Resources, China Coal Energy, Raspadskaya, Xstrata, BHP Billiton, Rio Tinto, JFE Holdings, Gerdau SA, Salzgitter, POSCO, Mechel and Voestalpine. Potential laggards are National Aluminium, Aluminium Corporation of China, Allegheny Technologies and Evraz."

Citigroup Global Metals Mining Steel 20100730

The Shifting Sands of Correlation

- The macro world dominates stock prices. "The relationship between small, mid and
large cap indices has only climbed further in the past quarter, with the S&P 600’s correlation coefficient climbing to 0.99 over the past three months when compared to the S&P 500 and the S&P 400’s coefficient rising to 0.97, compared with the past year’s 0.94 and 0.90, respectively. Moreover, these figures are meaningfully above the past 10-year levels implying that broader issues are affecting stock price moves and unique bottom-up stories are having far less impact, possibly reflecting the lack of money flows into US equities."
- Commodity prices have become even more highly correlated except for gold. "The CRB index’s coefficient spiked to 0.88 over the last 90 days, sharply above the 0.30-0.35 range seen looking back five and 10 years, most likely being the result of a keen focus on global economic potential. In contrast, gold remains the outlier with an inverse correlation of 0.65 recently, reversing its direct relationship of the last year. Some of this change is probably a sign of fiat currency debasement fears or the ongoing and often heated inflation/deflation debate."
- The trade-weighted dollar has become a tad less impactful to stocks. "While the
dollar’s inverse effect on the MSCI Emerging Market index is now much more inline with historical averages, it has shifted markedly in the past year. But the dollar’s relationship with the VIX volatility index has spiked and is far less sensitive to commodities than may be perceived. Similarly, the greenback’s correlation with 10-year Treasury bonds may not be as high as one might consider at first blush."
- A fix on the VIX is not that critical. "Many tend to see the VIX as the “fear gauge” but one would argue that gold is a defensive investment and thus should have a meaningful relationship with the VIX and that generally has not been the case. In contrast, there is a rising correlation with oil but the relationship with stocks as well as the 10-year Treasury is below levels seen over the past 10 years."
- Small cap stocks correlation has swung wildly. "The S&P 600 index’s correlation data have moved around a fair amount in the last couple of years. Specifically, the dollar is having more impact but in an inverse fashion while maintaining a strong directional relationship with commodities and emerging market stocks. Thus there is very little diversification being achieved when one buys small cap names, emerging markets and commodities even if it is thought of as spreading out across different asset classes."

Citigroup Correlation Quarterly 2010Q3

Bad and good heterogeneity in the euro zone

- "It is well known that heterogeneity between regions (countries in the case of the euro zone) raises problem in a currency area, since the monetary and exchange-rate policy is common."
- "This leads to a desire to limit heterogeneity as much as possible when it is useless, and in particular when it results from economic policy errors: abnormally expansionary fiscal policies, excessive pay rises relative to productivity gains, excess indebtedness and asset price bubbles."
- "However, part of the heterogeneity is a "good" and not a "bad" heterogeneity, i.e. that which results when countries take advantage of their different comparative advantages. So if a country specialises in industry and another in services, the first country will have higher productivity gains and a higher real growth in the long term, which is a problem in a currency area, especially if the degree of federalism is low, due to the divergence of real wages."
- "The issue of the trend in unit wage costs is complicated. Service economies keep an industry; nominal wages in industry converge in a currency area, which leads to a rise in unit wage costs and high inflation in economies primarily based on services if there is wage contagion between industry and services, while this is not an anomaly since it does not reveal a loss of competitiveness in industry. However, the sharper rise in unit costs in industry is an anomaly."

Natixis Flash Economics 377 20100723

A very dangerous situation: Having a high public debt when domestic savings become insufficient

- "The example of Japan shows that a country can have very high public debt if:
• it is financed by domestic savings;
• domestic savers do not demand high returns."
- "Non-resident lenders are normally more demanding in terms of return. This shows that the danger consists in:
• having accumulated a substantial public debt;
• then change over to a situation where domestic savings are no longer sufficient, which requires a sharp increase in long-term interest rates."
- "This may occur in particular because of population ageing, which reduces the household savings rate, and this is a threat for Japan, but also for other countries in the future, such as France, Germany and Italy."

Natixis Flash Economics 376 20100723