Fed puts policy back into high gear with quantitative easing

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1 Volume 9, Issue March Fed puts policy back into high gear with quantitative easing Unprecedented monetary intervention by the Fed helped stocks sustain their resurgence as policymakers unambiguously showed renewed vigour in their efforts to fix credit markets and end the global financial crisis. But the bigger effect of the Fed s stunning decision to buy US$300 billion of government debt was felt in bond and currency markets as investors scrambled for US Treasuries and fled US dollars. This week, further action on the policy front is likely, with the spotlight squarely on the US Treasury. After drawing much criticism for the paucity of detail when he first announced its financial stabilisation plan, Treasury Secretary Geithner can expect much scrutiny when he elaborates on how the programme will galvanise both public and private funds to help banks get back on their feet. Mar 20 (USD) S&P 500: % % % DJ Euro STOXX: % % % Nikkei 225: % % % MSCI Asia ex Japan: % -4.68% -5.55% In this issue: US equities: Financials battered and bruised, but potential for rebound remains Euro economy: Fall in credit growth may signal that a credit crunch is underway Asia equities: Awaking bull or snoozing bear?

2 S&P 500 (16/3/09 to 20/3/09) Monday Mar 16th Tuesday Mar 17th Wednesday Mar 18th Thursday Mar 19th Friday Mar 20th S&P: -0.35% S&P: +3.21% S&P: +2.09% S&P: -1.30% S&P: -1.98% STOXX: +2.82% STOXX: -0.85% STOXX: +0.25% STOXX: +0.83% STOXX: +0.52% Nikkei: +1.78% Nikkei: +3.18% Nikkei: +0.29% Nikkei: -0.33% Nikkei: Closed MSCI Asia ex Japan: +1.94% MSCI Asia ex Japan: +1.13% MSCI Asia ex Japan: +0.55% MSCI Asia ex Japan: +2.49% MSCI Asia ex Japan: -1.08% US: The Empire State manufacturing index reports a worse-than-expected in Mar, down from in Feb. But expectations for general business conditions 6 months ahead improved to 3.1 in Mar, up from US: Industrial production fell 1.4% in Feb, a fourth straight month of decline. But motor vehicle assembly rebounded to rise 10.2%, after a 24.7% contraction in Jan. US: The NAHB/Wells Fargo Housing Market index was unchanged in Mar at 9, the fifth straight single-digit reading for the monthly homebuilders sentiment gauge. US: American Express says credit defaults and delinquencies by its cardholders rose in Feb. US: Lawmakers seek to stop AIG from paying out US$165m in executive bonuses. EU: Eurostat reports a 0.3% QoQ fall in employment in 4Q08. The decline was not as large as expected, but highlights that falling employment is likely to become a strong headwind for consumption in. US: Housing starts surged 22.2% in Feb from an all-time low in Jan, which rounded up a cumulative drop of 56% over the previous 7 months. Winter construction data is prone to big swings and survey data on floor traffic and builder sentiment suggests a flattening out, rather than a big rebound, after 3 years of continuous decline. US: Producer prices rose a less-than-expected 0.1% in Feb, held down by a big drop in finished food prices. With core import prices falling and consumer demand flat at best, core consumer prices are likely to continue decelerating. JP: The tertiary industry activity index surprised with a 0.4% MoM rise in Jan, the first increase since Oct 08. AP: The Bank of Korea leaves the policy rate unchanged at 2%. This is likely just a breather and cuts will resume in Apr with a 25bp reduction before the rate hits 1.5% eventually in 2Q09. AP: Hong Kong s unemployment rate rose to 5% in Dec-Feb, from 4.6% previously. The jobless rate is likely to exceed 6% by mid-, resulting in private consumption shrinking in the first nine months of the year. US: The Fed surprises with aggressive quantitative easing measures, which include buying up to US$300b in Treasuries over the next 6 months. USD and Treasury yields plunged in response. While the Fed s balance sheet is set to rise sharply, more crucial is whether borrowing costs will come down as needed for a broader recovery. US: Consumer prices rose 0.4% in Feb, more than expected, with core inflation at 0.2%. US: The current account deficit narrowed to US$132.8b in 4Q08, from US$181.3b in the third quarter. JP: Bank of Japan says it is raising outright purchases of Japanese government bonds from to 21.6t per year from 16.8t. AP: The World Bank cuts its China GDP growth forecast to 6.5% from 7.5%. AP: China s foreign exchange reserves reportedly fell US$30b in Jan from US$1,95b in Dec, the biggest monthly drop ever. The fall was likely due to portfolio revaluation. Further decline is likely, given falling trade surplus and FDI inflows but China s external liquidity position remains strong. US: Initial jobless claims fell 12,000 last week but the fourweek average rose to a new cycle high of 655,000, pointing to a sharp jump in the unemployment rate. Production seems to be falling faster than demand. If this persists, layoffs may taper off before long as inventories are run down and factory activity resumes. US: The Philadelphia Fed index rose to 35 in Mar, beating expectations, and Feb s reading. This adds to evidence that production is approaching a bottom, setting the stage for layoffs to peak soon. US: The Conference Board leading economic indicators fell 0.4% in Feb, beating expectations for a 0.6% decline. US: The Treasury will provide up to US$5b in financing for auto parts suppliers as part of efforts to avert an auto industry collapse. JP: The all-industry activity index fell 1.7% in Jan to its lowest level since The index has nosedived since Nov 08. Others: The IMF officially cuts its forecast for global growth to between -0.5% and -1% in, with a gradual recovery to between +1.5% and +2.5% in EU: The European Union pledges more than US$100b in new loans to the IMF to bail out countries in the global recession and agrees to double to 50b euros a crisis fund which can be used by struggling member states that do not use the euro currency. EU: Euro area industrial production shrank 3.5% in Jan, slightly better than expected. But revisions to past data imply that in annual terms output is down 17.3%, well below expectations for a 15.5% contraction. EU: Italy s unemployment rate rose to 6.9% in 4Q08, the highest level since 2Q06. Monthly indicators point to a much more severe deterioration in the labour market at the beginning of this year. AP: Consumer inflation in Hong Kong eased less than expected to 0.8% in Feb, the slowest since Mar 07. Citi analysts cut their CPI forecast to 1% from 1.5%. Weak domestic demand is likely to keep inflation in check, with CPI likely to turn negative in coming months. US: The Obama administration says the US economy will rebound within a year, ahead of an expected US Treasury announcement of details of its financial stabilisation plan. Please note: Citi analysts' comments are in italics., Reuters, Citi Investment Research Over the Weekend Saturday Mar 21st & Sunday Mar 22nd EU: Daimler says it is selling a 9.1% stake to Abu Dhabi's Aabar Investments, a move that will raise 1.95b euros in fresh capital for the German carmaker and make Aabar Daimler s biggest shareholder.

3 S&P 500 (19/12/08 to 20/3/09) Dec-08 Jan-09 Feb-09 Mar-09 Economic Outlook Federal Reserve launches Quantitative Easing (QE) The Federal Reserve (Fed) announced last week that it will buy up to US$300 billion of US government debt over the next six months in a massive bid to boost liquidity and reduce borrowing costs for households and businesses. The Fed's latest attempt at accommodation reflects increasing determination to overcome a deflationary recession. Indeed, prospects for recovery in 2010 hinge on success in reviving investor confidence in financial firms and a loosening in broad financial conditions, which now are the key policy focus. Going forward, Citi analysts believe that Fed support for longer-dated Treasuries are likely to continue or even intensify depending on how effective the overall policy thrust is in establishing greater financial stability. The Week Ahead 23/3 Consensus expects existing home sales in February to decline to 4.45 million, down from 4.49 million in the previous month. Citi analysts anticipate a larger drop to 4.38 million. 24/3 The Richmond Fed Manufacturing survey for March is expected to remain unchanged at /3 Citi analysts anticipate new home sales to fall from 309,000 in January to 295,000 in February. Consensus expects a smaller drop to 300,000. Durable goods orders in February could probably post a better reading of -2.4% in February, compared to -4.5% in January. 26/3 Initial jobless claims may hit 660,000, up from 646,000 in the previous week. 4Q08 GDP may post a steeper decline of 6.6%, compared to -6.2% previously. 27/3 Both Citi analysts and consensus expect personal income in February to register a 0.1% decline, down from 0.4% in January. Equities Financials battered and bruised, but potential for rebound remains Prior week S&P % % DJIA % % Nasdaq % -7.59% In recent weeks, financial stocks have rallied hard on news of better earnings trends in core businesses, along with speculation regarding changes to the uptick rule and the possibility of a change to mark-to-market accounting treatment for illiquid securities. However, the sustainability of the recent bounce remains in question. Investor confidence on the sector remains depressed with many preferring to avoid the sector until more visibility emerges, especially on the value of illiquid assets. Although the Financials sector is unlikely to provide new equity market leadership, Citi analysts believe that potential for the sector to post a sharp rebound remains. Prefer: Consumer Discretionary, Financials, Industrials, Information Technology, Energy Less in favour: Consumer Staples, Utilities Bonds High grade corporate bonds favoured for attractive risk-reward trade-off Mar 20 Mar 13 Mar 6 2-yr Try: 0.875% 0.964% 0.955% 5-yr Try: 1.643% 1.868% 1.882% 10-yr Try: 2.638% 2.894% 2.875% Treasuries: Citi analysts remain underweight US treasuries, as historically low interest rates offer investors with little opportunity for significant s. High-grade corporates: Risk-taking and liquidity have improved, bolstering expectations that spreads are unlikely to retest recent highs. At current spreads, these securities are more attractive than government debt but investors are still wary of financial sector credits. High-yield corporates: Given the weak economic outlook, high-yield defaults are likely to increase. Citi analysts are thus cautious about the sector, favouring to wait on the sidelines until volatility subsides. EMD: Citi analysts remain neutral on emerging-market bonds. For investors seeking exposure, Citi analysts prefer countries with sound economic fundamentals and minimal political risk. Currencies USD: Dollar supports have remained strong in early, but may fade somewhat by 2H09 June forecasts EUR/USD USD/JPY USD/CAD The launch of quantitative easing by the Fed is unequivocally longer term negative for USD and the initial reaction to this week s imminent release of key details of the US Treasury s financial stability plan should add to the near term negative tone on USD.

4 STOXX (19/12/08 to 20/3/09) Dec-08 Jan-09 Feb-09 Mar-09 Economic Outlook Fall in credit growth may signal that a credit crunch is underway In Citi s opinion, the sharp decline in credit flows to the euro area private sector reflects both a decline in demand but quite importantly also a reduction in credit supply by banks, faced with distressed funding conditions. As the corporate sector is mainly financed via banks, Citi analysts believe that reviving the bank credit channel is of foremost importance in order to ease financial conditions and put a floor on the current plunge in economic activity. While the European Central Bank (ECB) does not seem to share the view that a credit crunch is underway, there appears to be emerging signs of a potential change in their stance. In Citi s opinion, such a change could pave the way for interest rates to be cut to zero and for further unconventional measures to be introduced. The Week Ahead 23/3 Denmark: Consumer confidence indicator in March is likely to come in at -10.8, better than in the previous month. Euro Area: The trade balance in January could swell to a large deficit of nine billion euros, from 700 million euros in the previous month. 24/3 France: Industrial confidence in March is expected to remain unchanged at 68. Sweden: Producer price inflation in February is anticipated to slow to 3.4%, from 3.9% in January. 25/3 Germany: The IFO Business Climate may see a slight fall to 82.1 in March, down from 82.6 in February. 26/3 Italy: Business confidence likely declined from 63.2 in February to 60 in March. UK: Retail sales volume in February could worsened to 2.9% (YoY). 27/3 Euro area: Citi analysts expect industrial new orders in January to shrink 29.7%, YoY, after falling 25% previously. France: 4Q08 GDP could likely fall into negative territory (-1.2% QoQ). Equities Stick to high dividends, strong balance sheets and positive earnings trends Prior week STOXX % % FTSE % % DAX % % Macroeconomic conditions are poor and deteriorating across the world, with Citi analysts now expecting global nominal GDP growth to be negative this year. The search for signs of life in the macro data goes on but there are limited signs of light in the gloom. Indeed, the recent earnings results season underscores this poor backdrop. Nevertheless, Citi analysts continue to prefer high dividend-yielding companies with strong balance sheets and positive earnings trends in the longer term. Prefer: Basic Resources, Health Care, Insurance, F&B, Media, Telecoms Less in favour: Industrials, Construction, Utilities Bonds Weak economic fundamentals and falling inflation could push yields lower Mar 13 Mar 6 Feb 27 2-yr Try: 1.319% 1.176% 1.311% 5-yr Try: 2.211% 2.065% 2.234% 10-yr Try: 2.974% 2.925% 3.112% Weak economic fundamentals as well as declining inflation could push bond yields lower and prices higher. Citi analysts expect a steepening of the Euro zone government bond market, with yields in the short end of the curve falling more than yields in the long end. Currencies EUR: May be capped in the short term GBP: Likely to remain weak June forecasts EUR/USD GBP/USD USD/CHF The euro economy appears to be heading for a more severe downturn than that of the US, and concerns are only likely to build in the days ahead as policymakers grapple with questions on an Eastern Europe bailout. Even as the fears on a breakdown of the monetary union should ultimately prove unfounded, this may continue to cap EUR in the short-term. Sharp deterioration in the UK's economic outlook and severe strains within the financial sector have been the key forces behind pound depreciation. However, the deterioration in the outlook is now better discounted. Nevertheless, going forward, the advent of quantitative easing may further erode support for GBP over time.

5 Nikkei 225 (19/12/08 to 20/3/09) Dec-08 Jan-09 Feb-09 Mar-09 Economic Outlook The Week Ahead 25/3 The trade balance probably shrank to 460 billion in February from billion previously. After adjusting for seasonality, February s trade balance likely stood at billion, up from billion. 27/3 Nationwide consumer prices excluding fresh food likely stayed flat in February for a second straight month. Headline CPI probably slipped 0.1% from a year ago. Consumer price inflation in Tokyo probably slowed to 0.2% in February, from 0.5% previously, on lower oil prices. March Tankan survey likely to confirm grim business outlook The March Tankan survey, scheduled for release on April 1, is expected to confirm the grim realities that Japanese companies face currently. The monthly Bank of Japan report is expected to highlight a collapse in business confidence, especially among large manufacturers; further restraint in capital expenditure (capex); and increasing tightness in corporate financing. Of particular interest is what the survey will reveal about sales and profit forecasts for fiscal (ending March 2010) as that will show how grim the business environment is from the corporate eye. Citi analysts expect manufacturing sales to drop some 20% year-on-year and an operating loss of 14 trillion (on a Tankan basis which includes medium-sized and small firms) based on the outlook for the macroeconomy. The negative outlook in turn is likely to prompt firms to reduce their fiscal 2008 spending as well as their capex plans. Citi analysts expect rather bleak numbers for both large (-15%) and small companies (-30%). Equities Pricing power increasingly important amid global deflation and yen weakness Prior week Nikkei % % Topix % % Conditions for share price appreciation are gradually coming together. Some bright spots on the fundamentals front include: A shift to a weakening yen trend; The implementation of major stimulus measures in the US; A bottoming in US housing starts; Progress in adjusting inventories of cars, electronic components and other manufactured goods; Global monetary easing; and Declining resource prices. Citi analysts expect share prices to rise substantially from the April June quarter, led by companies that boast large world market shares for their principal products and enjoy strong pricing power. In a global deflationary environment, a weak yen may not translate automatically into profit growth for Japanese exporters. Pricing power, and hence market share, is likely to be crucial for profit growth. Bonds Low yields likely to remain amid heightened risk aversion Mar 13 Mar 6 Feb 27 2-yr Try: 0.402% 0.406% 0.405% 5-yr Try: 0.721% 0.739% 0.705% 10-yr Try: 1.268% 1.300% 1.280% Citi analysts believe prospects for Japanese bonds remain poor. With the Japanese policy rate at 0.1%, and 10-year bond yields at 1.3%, there is little more that monetary policy can do to stimulate the economy. At the same time, with Japanese equities at 20-year lows, Citi analysts believe that Japanese bond yields may remain low, as investors remain averse to risk. Currencies JPY: Could face pressures in near term June forecast USD/JPY The intensification of the slowdown in Japan helped to kick off JPY weakening, even as global equities declined. Underlying capital flows have likewise become less favourable for the yen, given an acceleration in outflow to foreign bonds and heavy selling of Japanese equities by foreigners. Some further depreciation may be in store, even as Citi analysts believe a reversal of the long-term trend is not forthcoming.

6 MSCI Asia ex Japan (19/12/08 to 20/3/09) Dec-08 Jan-09 Feb-09 Mar-09 Economic Outlook Tentative signs of stabilisation While economic data is expected to continue deteriorating, this week s figures are expected to show some moderation in the pace of decline. Industrial production in Singapore is likely to have improved a tad in February. Although still very much in the red, February s output, especially how it compares with January s, may yield hints that the economy is approaching a bottom. In Hong Kong, trade activities probably continued to plunge in February but year-on-year contractions likely eased off from January s numbers. The Week Ahead 23/3 Singapore: Consumer inflation probably slowed to 1.9% (Consensus: 2.6%) in February, from 2.9% in January. Taiwan: The unemployment rate likely inched up to 5.5% in February, from 5.3% previously. But Citi analysts still expect the jobless rate to hit 6% in mid-. 24/3 Taiwan: Export orders likely shrank 30.1% in February, improving from a 41.7% slump in January. Contraction in industrial production also expected to ease to a 30.5% rate from 43.1%. 26/3 Hong Kong: Exports probably slipped 5% in February, better than January s 21.8% tumble. Singapore: Factory output likely fell 23.6% in February, after diving 29.1% previously. 27/3 Taiwan: Leading indicators for February probably rose to 0.7%, after clocking in at -4.9% previously. A similar picture is expected in Taiwan. February exports and industrial output likely declined again, but less so than in January, due to rush orders, which appear to have held back headcount reduction plans at some large technology companies. Leading and coincident indicators are also likely to improve, a possible early signal that the economy is bottoming out. Nonetheless, Citi analysts say that these are still early days and further signs in coming months are required before they see a clear picture of recovery. Equities Awaking bull or snoozing bear? Prior week MSCI Asia ex Japan % -4.68% Is the new bull market starting? Equity markets have risen sharply in the past two weeks, anticipating a recovery. But if so, why did policymakers feel compelled to roll out drastic measures like quantitative easing, which suggests further downside ahead? Citi analysts are thus sceptical that the current rally marks the end of the downturn and note that stocks have not reached valuation lows of 0.9 times book value, seen in the 1975 and 1982 recessions. Still, countries and sectors that are underowned and widely seen as underweight may offer opportunities. Indeed, markets like Korea and Taiwan have been outperforming the region, as have sectors like Technology, Banks and Energy. Bonds Remaining cautious on the corporate bond outlook The financial crisis is starting to hurt real Asian economies, suggesting that growth is likely to decelerate in the region. This should favour high-grade corporate bond issuers as they should be better positioned generally to deal with tighter economic and liquidity conditions, even as earnings and high-grade credit quality are likely to weaken. Investor de-leveraging and a near capitulation in the US and EU financial systems have seen Asian high-grade spreads soar even into uncharted territory. But Citi analysts believe credit spreads could potentially widen more in the first quarter of as poor economic news continues to stream in. Citi analysts thus remain cautious on the Asian fixed income space and prefer corporate bonds issued by defensive, stable/ cash generative, unleveraged sectors. For investors with a longer-term perspective, the region s investment-grade corporate bonds may still offer select opportunities despite expected volatility in the immediate future. Currencies AUD: Near term outlook remains down June forecasts AUD/USD USD/SGD USD/CNY The broad decline in AUD this fall outpaced both the pullback in the terms of trade and deterioration in the domestic economy. However, over the medium term, any improvement in risk appetite or sign of stabilisation in the local and global economy is likely to help the AUD regain lost ground against the USD.

7 Global Indices (As at 20 March ) United States Previous Week's Close 52-Week High 52-Week Low Weekly Return Return Return (USD) DJIA % % % S&P % % % Nasdaq % -7.59% -7.59% Europe DJ Euro STOXX % % % FTSE % % % DAX % % % Japan Nikkei % % % TOPIX % % % Asia MSCI Asia ex Japan % -4.68% -5.55% Hong Kong Hang Seng % % % Shanghai Composite Index % 24.45% 25.24% Taiwan Weighted Index % 8.12% 4.97% Korea KOSPI % 4.13% 0.33% Mumbai Sensex % -7.06% % Singapore Straits Times Index % -9.35% % Kuala Lumpur Composite % -2.27% -7.74% Thai Stock Exchange % -4.52% -6.03% Jakarta Composite Index % 0.40% -6.63% Philippines Stock Exchange Index % -2.08% -3.50% Australia All Ordinaries % -6.95% -9.25% Commodities Gold % 8.98% 7.95% Oil % 14.48% 14.48% Fixed Income Citigroup World Government Bond Index % -0.14% -0.14%

8 Global Currencies (As at 25 February ) Source: CitiFX Asian Currencies (As at 20 March ) Source: Reuters, Citi estimates

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