ecr20100826 point of recognition approaching

8/8/2019 ECR20100826 Point of Recognition Approaching

1/12

Thursday, 26 August 2010

Summary

For a speed-read versionof the report please read

the extracts in the left-hand margin.

Point of recognition approaching

In recent decades, we have become increasingly accustomed to central bankscoming to the rescue when stock prices and the economy slide too far. Despite thefact that economies everywhere have been stimulated fiscally and monetarily on alarge scale since the outbreak of the credit crisis, the recovery has only beenmodest. Worse still, the recovery in the US has already clearly declined again and it

looks as if this will shortly happen in Europe, too.

On the basis of experience over the past few decades, the assumption is that central

banks will come to the aid once more. Especially as it is evident that we cannotexpect much further help from the fiscal quarter. In theory, central banks arecertainly capable of helping. In practice, however, in our view they no longer havemuch room to maneuver. After all, the concern is that if monetary policy is loosenedmuch further confidence in the central banks will be lost. That swiftly leads to acurrency crisis and soaring long-term interest rates. In other words, a disaster forthe economy.

It will probably become clear this weekend how far central banks are willing to gowhen Bernanke delivers his speech on the situation the American economy is in andhow monetary policy should respond.

Implications for the financial markets

Assuming that there, indeed, turns out to be little room left for the monetaryauthorities, then we foresee the S&P 500 index rapidly falling below the crucial 1,010level. In our view, this will be accompanied by EUR/USD falling over the comingmonths to quarters towards approximately parity. We then also envisage yields on10-year US and German Treasuries falling further by around 0.75% before soaringdue to fears of further deteriorating public finances.

POINT OF RECOGNITION APPROACHING

The economy appears tobe swiftly declining after a

modest recovery.

Stocks have been under clear downward pressure again recently and investors are

fleeing to Treasuries from the economically strong countries and to the dollar and

Swiss franc. The underlying reason is evident. After the credit crisis broke out, large-scale fiscal and monetary policy was implemented everywhere. This would normallyhave generated an economic boom, but this time the recovery was very modest. Weshould not actually be too surprised by this; if you look at what happened afterprevious credit crises then what is happening now is not abnormal. The only thing isthat the modest recovery we have seen so far is already clearly tailing off in the USand looks set to do so in Europe shortly. This is contrary to the historical pattern. Inthe past, the economy might have been more difficult to get off the ground after acredit crisis, but growth grew rather than declined. Naturally, if the current decline ingrowth only lasts a couple of quarters and growth then picks up again, then there isnot much wrong, on balance. Things will only get difficult if growth carries ondeclining.


2/12

Investors do not believe in recovery: real return onTreasuries near zero

US, GDP (quarterly change)5-yr real yield US government bond

Source: Reuters EcoWin/ECR

Q1 Q3 Q1 Q3 Q1 Q3 Q107 08 09 10

%

-3

-2

-1

-0

1

2

3

4

5

This decline is creating

expectations of further

monetary stimulus, as thisis what happened in the

past.

This time, however,

stimulation will not beable to both promote

growth and compensate

for the tailing off of fiscal

stimulation.

So can central banks

actually do anything to

create a positive spiral?

This is exactly what investors and the financial markets are trying to work out. Inthis respect, however, it is evident that we cannot expect much help from the fiscalside. Virtually everywhere, governments are terrified of ending up in Greecessituation, so are attempting to prevent public debt from rising much furtherexpressed as a percentage of the total economy. This also means that now growth isdeclining the only help that can be expected is monetary. This is exactly what

investors and financial markets have been counting on for years. This has becomeknown as the Greenspan put. In other words, under Greenspan we got used to thefact that as soon as the economy and stock prices slid too far especially if thisgenerated a deflation threat central banks would loosen monetary policy until theeconomy started recovering. Over the past thirty years, this has even led to a firmconviction that central banks are always ready to make sure the situation does notget out of hand. This has been proved right this time, in as much as central banks

immediately started loosening monetary policy drastically as soon as the credit crisisbroke out. In the Far East with the exception of Japan this has, indeed, led tohigh economic growth. As we said, this is not the case in the West. The combinationof large-scale fiscal and monetary loosening has only led to a highly modest recoverythere, which now already appears to be reversing. The question is whether themonetary authorities still have sufficient weapons and ammunition in their arsenal tonot only compensate for the gradual waning of fiscal stimulation but also get the

economy growing more rapidly. There would be no doubt about this if the Westernand Japanese economies had meanwhile ended up in a self-perpetuating spiral ofmore consumption, increasing investments, rising employment and fallingunemployment, higher wage rises, even more consumption and so forth.Unfortunately, this is not the case and growth continually has to be managed fromoutside. This is not only amazing, but also concerning, as the monetary authoritieshave already lowered interest rates to 0%, created a great deal of extra money andstuffed the banks full of extra reserves (quantitative easing). Especially as, so far, allthis has also been accompanied by highly substantial fiscal stimulation. This justifiesthe question of whether central banks still have sufficient weapons and ammunitionto get a positive spiral off the ground. We will go into this in further detail below.


3/12

PRACTICE VERSUS THEORY

In theory, central banks

have plenty of stimulationoptions.

In theory, central banks can create extra money indefinitely. The first step hasalways been to lower interest rates. This encourages numerous parties to save lessand borrow more. In principle, this pushes up the money supply. In the 1960s and1970s this was often overdone, so excessive money creation led to rising inflation.Now, however, there is a risk of deflation. The ECB, the Fed and the Bank of Japanhave therefore already gone one step further: they have started quantitative easing,but only in a moderate form so far. In other words: apart from lowering interest

rates to around 0% central banks have also stuffed the banks in their own countrywith extra large reserves. This cuts both ways, though; to achieve this goal theyoften bought mortgage bonds and Treasuries from the banks. This not only gave thebanks more reserves so that it became increasingly appealing for them to extend

new loans; it also suppressed long-term interest rates. That way, the Fed, forexample, substantially brought down mortgage interest rates.

Stimulating by means of

buying bonds from banksis risky in practice,

though, as it encourages

inflation as soon aslending picks up.

This last course of action is exceptional, however. It has never been done sinceWorld War II, except in Japan. Lowering short-term interest rates has always provedsufficient. We also have to remember that these operations are highly risky. After all,

under normal circumstances, such a tremendously high growth of the money supplyand bank reserves would be extremely inflationary. This is not the case nowbecause, on one hand, banks remain reluctant to lend and, on the other, mostparties are attempting to repay old loans as far as possible rather than borrowingextra money. The idea of this monetary policy is to get the economy and lendinggoing again. As soon as this is the case, it will be quite a different story. There isthen too much money in circulation and bank reserves are too high. A highly

inflationary situation then arises. It is therefore absolutely necessary to immediatelywithdraw the extra money and reserves from the system as soon as the economyand lending recover. This is more easily said than done, however. Monetary policythen has to be drastically tightened in view of the recent tremendous loosening. Thisnot only entails great risks for economic growth; it will also encounter great politicalresistance. So the more monetary stimulation now, the greater the chance ofinflation ultimately rising rapidly.

Lower Fed policy rate no longer encourages consumerspending

U S, Fed funds rate U S, consumer creditSource: Reuters EcoWin/ECR

07 08 09 10

USD(thousandbillions)

2.375

2.400

2.425

2.450

2.475

2.500

2.525

2.550

2.575

2.600

%

0

1

2

3

4

5

6

Consumer credit

Fed funds rate


4/12

Rising inflation is actuallyan advantage for repaying

debts.

The result, however, is

rapidly-rising long-term

interest rates, whichwould be disastrous for

public finances.

It is often said that this would not be such a bad thing, as then debts start weighingless heavily (old loans can be repaid more easily with dollars or euros that have

depreciated in value, due to inflation). This is only one side of the coin, though.Inflation also means higher interest rates. In the current situation that would bedisastrous, especially for public finances. After all, the current high public debt, whichwill continue rising for the time being anyway, can only be maintained because thereis so little interest to pay on them. If interest rates rise, public finances will soon getout of hand in most Western countries.

This makes further

monetary stimulation

risky.

That is why it is so difficult to implement an even more aggressive form ofquantitative easing. After all, if all the forms of monetary loosening are stillinsufficient to help economic growth and lending, central banks can always buyTreasuries directly from the government. The indirect result is that extra moneycreated by the central bank is distributed to the population. That swiftly leads to

increased consumption and higher asset prices, against which more can beborrowed. A policy of increasing bank reserves also, however, leads far more quicklyto rising inflation.

This restricts central

banks room to maneuver.

No one knows just howmuch they can still do.

This is the great dilemma facing central banks at the moment: many investors and

financial markets are blindly assuming that the central bank will always save the dayif the economy and lending slide too far. After all, it is charged with the task ofensuring stable price levels and that does not include deflation. In other words: assoon as deflation threatens the central bank has to loosen monetary policy further.In theory, it has the means to do so indefinitely. If needs be, the central bank canbuy stocks, bonds, property and so forth directly from the private sector. In practice,however, that is not the case. The key word here is confidence: confidence amongst

investors and financial markets that the central bank will withdraw all the extra

money and reserves in time before the deflation threat turns into an inflation threat.As soon as this confidence disappears, long-term interest rates will discount the factand rise. The effect of monetary policy is then exactly the opposite of what it wasintended to achieve. Instead of helping the economy, it drives it into the ground. Thepractical problem this primarily presents is that nobody knows where that limit lies;at what level of quantitative easing will confidence wane and will interest rates riserather than fall. The only thing we do know is that you only find out once the limithas been exceeded and it is too late and that the more aggressive thequantitative easing, the greater the risk of the limit being exceeded and inflationsoaring.

Cash on banks' balance sheets have to be withdrawn assoon as they start lending again, to prevent inflation

US, banks' reserves (lhs)US, commercial and industrial loans (rhs)


07 08 09 10


1.10

1.20

1.30

1.40

1.50

1.60

1.70


0.0

0.2

0.4

0.6

0.8

1.0

1.2


5/12

MONETARY AUTHORITIES ROOM TO MANOEUVRERESTRICTED

According to a popular

technical method, stockprices are about to fall.

There are many ways of analyzing and predicting markets, both fundamentally andtechnically. One of the chart-technical methods we often follow ourselves is theElliott Wave method. This method assumes that every market rises or falls in a five-wave pattern, as long as this is the main direction, and every interim correctionfollows some kind of three-wave pattern. If you look at the way stock prices havebeen falling in the West over the past year, then you can clearly see the downturnsfollowing a five-wave pattern and the corrections a three-wave pattern. This leads usto believe that the main direction for stocks is downwards. This does not, however,say much as whether stock prices will now immediately start falling or whether there

will first be numerous rises - perhaps even to new highs - is impossible to predictwith the Elliott Wave method. Certainly not when it comes to the timing of thesemovements.

This becomes more certainwhen the S&P 500 index

slides below 1,010.

The fall will thenaccelerate as soon as the

remaining hope turns into

pessimism: The point ofrecognition.

This uncertainty would soon disappear as soon as the S&P 500 index fell below1,010. A point we are no longer far from. After all, as soon as this happens there is agood chance that the S&P 500 index is in the middle of the second major downwardwave (the fall from the high at 1,570 to 600 was the first major downward wave. Thesubsequent recovery to around 1,220 was the first major correction and the fall sinceis part of the second downward wave and no longer of the correction, as soon as theS&P 500 index falls below 1,010). From past experience and that is what concernsus now we now that two things almost always happen:

The fall accelerates.

This happens when the point of recognition is reached. Until that time,many market parties continue hoping that the fall so far is only acorrection within an uptrend. Many are now hoping that the S&P 500index is bottoming out just above 1,000, after which it will rise. As soon

as the point of recognition has been passed that hope will swiftlyevaporate. Generally, as it then quickly becomes clear why this hope wasunjustified, the downtrend accelerates. We repeat: this is a phenomenonthat almost always happens in the middle of the second majordowntrend. The third and last major downtrend is always based onpessimism. In other words, hope has then turned into fear of furtherdeterioration.

We will reach this point assoon as it becomes clear

that the central banks are

unable to do much, either,as has proved the case in

Japan.

We are going into so much detail here because we will not have to wait long to seewhere that point of recognition will be. We already mentioned above that from afiscal point of view we cant expect much new help from the Western and Japaneseeconomies. That will have to come from the monetary quarter, as has been the casefor the past thirty years. It is also quite possible, though, that too many hopes arebeing pinned to that now. We already saw that this week in Japan. In Japan,economic growth is declining rapidly, there is no more room for real fiscalstimulation, the central bank has been applying quantitative easing for years alreadyand they are still suffering from deflation. Actually, export is the only bright point forJapan, but this is now seriously threatened by the ever-increasing yen rate and theweakening of growth in the rest of the Far East. This is also aggravating deflation,through increasing import competition. The obvious solution would therefore beintervention to suppress the yen rate. There will be little point in attempting to do so,though, if the US and the EU do not follow suit. They have no intention of doing so;for them export is one of the few sectors generating growth. If Japan wants to turn


6/12

For years already, Japan

has failed to avertdeflation with a loose

monetary policy. Any

further loosening willdestroy confidence in the

yen.

This could also happen to

the dollar and euro.

the tide, then its already extremely loose monetary policy will have to be loosenedeven further. The Japanese government has been exerting great pressure on the

Japanese central bank in this sense for some time. With little success, so far. In thepast few weeks, however, the government announced ceremoniously thatnegotiations would take place between the government and the central bank lastMonday. Many assumed that such an event would only be announced on a grandscale if a considerable level of agreement had already been reached between theparties on the subject. The meeting that was to be held last Monday was lookedforward to with excitement. The disappointment was great, however, when the

negotiations proved to have been restricted to a fifteen-minute phone call betweenthe minister of finance and the head of the central bank. It was soon clear that thetwo parties had not discussed anything substantial. Naturally, this has nothing to dowith unwillingness on the part of the central bank. It is obvious that the central bank

is terrified that as soon as it loosens policy further even without political pressure it will lose the confidence of the markets and interest rates will rise. The point ofrecognition would be when the realization dawns that this also applies to the Fed andthe ECB. In other words: naturally, these central banks still have some room forfurther loosening, but it is insufficient to crank growth up to any real extent. Fromthis point of view, things are actually getting increasingly difficult for the Fed and theECB. More about that below.

Even with zero interest rates Japan cannot get itseconomy back on track

Japan, policy rate (lhs)Japan, GDP growth (rhs)


90 92 94 96 98 00 02 04 06 08 10

%

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

%

0

1

2

3

4

5

6 Growth averages

around zero

A BOND BUBBLE

Without monetary

stimulation, growth will

decline in the West.

Earlier in this report we already mentioned that no self-perpetuating spiral has beencreated in either the US or Europe. That is a real problem now growth is alreadyclearly declining in the US and looks as if it will shortly do so in Europe. After all,growth is now falling back to levels at which employment is increasing less quicklythan the working population. This means rising unemployment again and thereforedownward pressure on wage rises, especially now unemployment is already around

10%. Consumers therefore have no extra money to spend, unless:


7/12

There is help from the fiscal quarter. As we said, this is not on the cards.

Consumers borrow more. They are unwilling to do so, though, as theyare seeing a substantial proportion of their provision for retirement beinglost due to the fall in housing and stock prices. This is being partlycompensated for by rising bond prices, but on the other hand newinvestments in bonds yield hardly any return any longer. Additionally,apart from the fact that consumers prefer to repay old debts than enterinto new ones, banks are still reluctant to extend new loans. This picture

would, of course, change drastically if property and/or stock prices wereto rise substantially. Lending will have to recover first, though.

The danger of low growth in the current circumstances is that it quickly leads to

mounting unemployment and insufficient consumer spending. The next step is thatinvestments decline, causing overcapacity and deflation. The economy then slidesfurther. This will not happen if a self-perpetuating spiral is created, but then growthfirst has to be above 3% for some time. Otherwise, the economy will have theconstant tendency to slide, especially as we can expect property and stock prices tofall further.

Not much needed to create full-blown deflation

US, House prices indexUS, Consumer Prices less food and energy


08 09 10

Index(2007=100)

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

Monetary stimulation is

therefore the only

remaining hope forinvestors and central

banks cannot afford todisappoint them with their

plan of approach.

This brings us back to monetary policy. Now that the US economy is declining again,this week all eyes are on Fed chairman Bernanke, who will be delivering a speech inJackson Hole on Friday on the state of the American economy and how the centralbank should respond. Of course there are hopes that it will include anannouncement of further quantitative easing. This will probably happen, too, butwhat matters is the degree. Bernanke will undoubtedly realize that he would beplaying with fire to disappoint the financial markets in this respect. Stock priceswould then immediately drop, which could easily plunge the economy into arecession due to the negative wealth effect this entails. The point of recognition hasthen clearly been reached. He will attempt to avoid this. But what more can the Fed

do? The easiest thing is for the Fed to continue buying Treasuries from the banks.

This increases bank reserves even further, further suppressing long-term interestrates. Will this have much effect, though? After all, banks already have large


8/12

They will also realize that

pumping even more

money into the economycan lead to:

loss of confidence,

deflation and

a flight by foreign holders

of US Treasuries from the

dollar, creating a dollarcrisis.

reserves and long-term interest rates are already extremely low. It is unclear whyincreasing reserves further should suddenly be of much aid to the economy or asset

prices. If this fails to provide the necessary help, then there is just one remainingoption: distributing money via the government or, if needs be, directly. We alreadytalked about the great risks entailed. As soon as this leads to a loss of confidence inthe central bank all hell will break loose. Furthermore, at the moment there are twoextra complications in this respect:

Investors have recently been avoiding stocks en masse and deviating

into bonds. On one hand because this is probably the best protectionagainst deflation; on the other hand because the central bank isexpected to buy more bonds. This has now created a bond bubble. Inany event, yields on 10-year US Treasuries have responded by sliding to

around 2.5%. Yields can only remain so low as long as the nominalgrowth of the US economy remains at roughly the same level or fallsfurther. This is where the snag is, however. At the moment, core

inflation in the US is at around 1%. This means that to achieve 2.5%nominal growth, the economy has to grow in real terms by around 1.5%.That growth level is way below potential growth, though, which meanspersistent downward pressure on inflation. Especially as unemploymentwill then rise. In other words, it will then only be a question of timebefore the US experiences deflation. This can mean only two things.Either the deflation is accepted but then dwindling tax revenue willresult in public finances getting out of hand or the Fed will fightdeflation by distributing money. Both will probably send long-terminterest rates soaring sooner or later.

Due to years of large deficits on the American current account, the UShas become a major debtor to the rest of the world. In other words,innumerable foreign investors currently own US bonds. The central banksin China, Japan and the Middle East alone are sitting on thousands ofmillions of dollars worth of US bonds. Naturally, they will take action assoon as they see US public finances getting out of hand and/or the Fedhanding out dollars. In time, this will lead to an increased supply ofdollars on the currency market. Not only will bond prices fall; the dollarwill also plummet. A sharp fall in the dollar will aggravate the rise ininterest rates, however, so even more bonds are sold, creating an evengreater supply of dollars and so forth. In other words: there will soon bea dollar crisis.

They will then adopt a

highly reserved attitude to

monetary stimulation, sowe feel the point of

recognition is fastapproaching.

This is why we feel we are not far from the point of recognition. In our view, it willquite soon become clear that, like the Bank of Japan, the Fed cannot do an awful lotmore than it has already done. From this point of view, the Fed needs to take a goodlook in the mirror. Bernanke has always said that as soon as deflation threatens thecentral bank should go all out with monetary loosening. The longer it hesitates, the

more limited the options become. In retrospect, the Fed probably responded tooslowly. We should stress that, as long as the S&P 500 index remains above 1,010,things are not hopeless. Evidently, the market feels the Fed still has sufficient roomto save the situation. Let us hope that is indeed the case.


9/12

Distrust in Fed policy could induce large scale dumpingby big investors

US, TIC, Chinese holdings of Treasury SecuritiesUS, TIC, Japanese holdings of Treasury Securities


98 00 01 02 03 04 05 06 07 08 09


0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

Beginning of atrend reversal?

Japan

Back to summary ^

IMPLICATIONS FOR THE FINANCIAL MARKETS

We foresee growthweakening in Europe.

Europe experienced a strong second quarter. Germany, in particular. This surprisinglygood growth was, however, based on three developments that are now coming to anend.

Fiscal stimulation. This will gradually turn into fiscal tightening over thecoming quarters.

Stock build-up. This is now largely over.

Export. To the Far East, in particular. It looks as if growth will decline inthe Far East now, however, especially if growth fails to pick up in the nearfuture in the US.

There is an additional factor for Germany. Due to tensions within the EMU, a lot ofmoney has flowed from Southern to Northern Europe. This has considerably increasedthe availability of money in Germany, causing construction to pick up. This does notalter the fact that we soon expect the situation to deteriorate throughout Europe,including Germany.

The problems in

Southern Europe thenbecome more difficult to

solve and the differences

between North andSouth will increase.

Nevertheless, this shows the dilemma the ECB is facing. If the European economyweakens, this means the attempts being made in Southern Europe to reduce budgetdeficits will largely fail. After all, lower growth means lower tax revenue and highergovernment expenditure. Hence the recent widening of the spread between interestrates in Southern and Northern European countries. Investors are increasinglyassuming that if growth declines budget deficits in the Southern European countrieswill remain far too high. For Northern European countries, incidentally, this also appliesto low growth but to a far lesser degree. The public finance problem is simply less

serious there. This does cause major complications, though.


10/12

Ultimately, the ECB willhave to come to the

rescue. Probably

resulting in an overlytight policy for the South

and too loose a policy for

the North.

If the Southern European countries (and Ireland) are not to end up in a similarsituation to Greece if growth remains low, then they will have to make drastic cuts and

raise taxes. This will further brake their economies, making it more difficult to reducebudget deficits. Investors are aware of this, too, so they are withdrawing their moneyfrom Southern Europe. Interest rates in those countries will therefore not fall alongsidethose in Germany. For the Southern European countries, this means rising interestrates, which will suppress asset prices and make it increasingly difficult for banks toraise money, inhibiting economic growth even further. The only one that can halt thatspiral is the ECB. It can buy up bonds from the Southern European countries and

further loosen monetary policy. With the growth figures we have been seeing recentlyfrom Northern European countries Germany in particular it will be entirelyunnecessary to further loosen monetary policy, though. There is therefore a goodchance that the ECB will adopt a stance somewhere in the middle with its monetary

policy. In other words, they will implement too tight a monetary policy for theSouthern European countries and too loose a policy for the Northern Europeancountries.

Imposs ible for ECB to apply one-size-fits-all policy

Germany, GDP % Chg. YoYSpain, GDP % Chg. YoY

Greece, GDP % YoY


Q1 Q2 Q3 Q4 Q1 Q2

09 10

%

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Greece

Germany

A negative outlook forthe world economy is

exerting downward

pressure on EUR/USD.

If we transfer this picture to currency rates, there will evidently be a great deal ofdownward pressure exerted on EUR/USD if the world economy is viewed morenegatively and vice versa.

The worse the situation the world economy finds itself in, the more difficultit becomes for Southern European countries to reduce their budget deficits.Unfortunately, the ECB is unable to compensate for this adequatelythrough monetary policy. If the world economy becomes less buoyant thentensions within the European Monetary Union will increase, weakening theeuro.

When an economy weakens, a lot of old carry trades are reversed,increasing the demand for dollars (and yen).


11/12

The weakening of theeuro and the influence of

reversing carry trades

will be decisive for thecurrency market.

A common counter-argument is that if the world economy weakens the Fed will loosenmonetary policy further than the ECB. After all, as its economy and labor market are

more flexible, there will be more of a deflation risk in the US than in Europe. This hasalways been the case so far, which is why the dollar rate always falls. We alreadymentioned that the room for further loosening monetary policy has decreasedsubstantially. This time, we therefore see it playing a far smaller role. In any event, inour view it will be overshadowed by the weakening euro and the reversal of carrytrades.

Incidentally, the lengths the Fed dares to go to in further loosing monetary policy willprobably become clear this weekend. After all, recent economic figures have been farweaker than expected. We can therefore deduce that growth in the US economy hasdeclined to 1.5% or lower. As we already mentioned, this means that if new life is

breathed into the economy, there is a strong chance of a further slide and deflation.We certainly cannot expect anything from the fiscal authorities before the elections inNovember, so the Fed will have to take action. This weekends conference in Jackson

Hole is the ideal opportunity for announcing this.

We feel the Fed will be

unable to prevent

sentiment turning andthe S&P 500 index

falling to 800.

Clearly, we expect there to be disappointments. We therefore fear it will not be longbefore the S&P 500 index slides below the major support level of 1,010. The point ofrecognition will then quickly be reached and hopes of higher growth will turn into fearsof further weakening. The S&P 500 index could then fall further to around 800, atleast. Probably not in a straight line, though. After all, central banks all over the worldare probably going to announce a looser monetary policy as soon as they see stockprices plunging. Hopes will then be temporarily raised until it (quite quickly) turns outthat the monetary authorities are unable to do enough.

We foresee EUR/USDfalling towards parity.

Continuing along these lines, we expect EUR/USD to fall towards parity over thecoming months to quarters. Only if the Fed manages to pull a rabbit out of the hat canwe expect another recovery first. Most likely to no further than 1.31 1.33, but wedont think this will happen. We also envisage EUR/USD falling further with thefollowing support levels around 1.24 and 1.18. A fall in the S&P 500 index below1,010, in particular, would confirm that both stock prices and EUR/USD will probablycontinue their downtrends (a rise in the S&P 500 index would indicate a delay,though).

As long as there isinsufficient confidence in

the central banks abilityto save the situation,

Treasuries will remain

popular as safe havens.

We envisage yields on

10-year US and German

Treasuries falling to1.5%.

The situation is not much different for yields on 10-year US, German and JapaneseTreasuries. As long as there is still the feeling that central banks are unable to doenough to prevent the economy weakening further, deflation fears will grow and therewill be a continued flight to the safe haven of Treasuries. Especially as if there is anyfurther monetary loosening, it will probably be in the form of central banks buyingmore Treasuries. We therefore envisage yields on 10-year German and US Treasuries

(now around 2.2% and 2.5% respectively) to fall further in the coming months toquarters to around 1.5% (Japanese yields to around 0.5%). Here, too, the S&P 500index falling below 1,010 would confirm this, while a rise above 1,080 would indicate aslight further rise. In this respect, a lot depends on what Bernanke comes up with thisweekend. Incidentally, if he proposes a plan for a considerable further loosening ofmonetary policy, then long-term interest rates will rise sharply. We dont expect this,though. What we do have to allow for, however, is that as soon as the S&P 500 index

slides below 1,010, credit spreads will widen everywhere. The same applies to thedifference between interest rates in Northern and Southern Europe.


12/12

EUR / USD


Feb

10

Apr Jun Aug

EUR/USD

1.175

1.200

1.225

1.250

1.275

1.300

1.325

1.350

1.375

1.400EUR / JPY


Feb

10

Apr Jun Aug

EUR/JPY

105.0

107.5

110.0

112.5

115.0

117.5

120.0

122.5

125.0

127.5

130.0

USD / JPY


Feb

10

Apr Jun Aug

USD/JPY

84

85

86

87

88

89

90

91

92

93

94

95

Back to summary ^

ecr20100826 point of recognition approaching

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