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1 September 2010

GlobalStra

tegy

Research Team

Global Strategy

www.rbsm.com/strategy

Global ViewsThis material should be regarded as amarketing communication and may have

been produced in conjunction with the RBS

trading desks that trade as principal in the

instruments mentioned herein.

The View Ahead: Not enough buffer

It has been a choppy morning in Europe as the market awaits the first of this

week's big data releases; ADP and ISM. Clearly this will set the tone going into

NFP so the choppy range trading seen thus far today should come as no

surprise. We have, however, had some interesting data out of Europe. The euro

area PMI came in at 55.1 just 0.1 above the flash estimate, showing continued

resilience but the UK and Norwegian PMIs both fell much more than expected. I

think a few months ago as the euro area crisis was kicking off you would have

been hard pressed to find anyone who would say that the euro area would be

outperforming the UK and (especially) Norway in late Summer so where does

this resilience come from? Partly of course it is the currency but that has nowstabilised in the high 1.20s and so will be less of a marginal boost in coming

months. More generally, however, I think it just shows the natural lags that exist

between core Europe and the global economy given the former's reliance on

exporting to the latter. To that extent, euro area data should be seen as a lagging

or coincident indicator at best, so buying EUR/USD on the back of stronger

European data is a dangerous game.

While we are discussing the Euro, worth looking at EUR/GBP and my simple

correlation with bank share prices and 1y swap rate differentials. Using this little

model the recent stabilisation / bounce in EUR/GBP is entirely justified, and

indeed fair value for the pair is a touch above current levels at 0.8350. However,

with the RBS view that the stress tests have failed to ring fence the euro areabanking system from peripheral worries, I would expect a risk that the relative

bank share prices part of the model starts to push in favour of EUR depreciating

against GBP in coming weeks and months.

The only other thing that matters over the next few days is how the data comes

out and market sensitivities to it. As a strategist it is the latter that interests me

and I loved a comment that our US economist Michelle Girard made when

talking about NFP (though the same applies to ADP) that given the volatility of

the series, there is not enough of a buffer between expectations and the 0k level

to be confident that we can avoid a negative number. Let's say that this

afternoon's number for ADP, expected +15k, is 25k out (the average miss so far

in 2010). I am pretty confident that the market reaction is bigger to a -10k printthan to a +40k print, because of the psychological importance of the 0k level.

And of course the same applies to NFP but on a bigger scale. The data will be

what the data will be, but be aware of this potential skew to reactions. Andy

Chaytor

Ahead today

US ADP employment change, Aug (8:15 EDT): ADP employment should post a

small 15K rise, though down from last months 42k rise.

US ISM, Aug (10:00 EDT): We expect a further moderation in the August PMI,

with the composite falling to a still more than respectable 56.8.

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The Royal Bank of Scotland

Commodities: Bellwether metal copper has begun September trading at its

highest level in over 4 months. The red metal took comfort from the Chinese

manufacturing PMI for August which indicated that economic stabilisation is

taking place for the worlds biggest consumer of copper. The PMI rose to 51.9

from 49.4 in July with new orders rising 2.2 points to 53.1. Three month copper

surged to US$7,580/tonne (US$3.44/lb), its best price level since end April. In

addition, I am heartened by coppers price resilience over the seasonally weaker

summer months. LME copper inventories declined for the 6th consecutive month

in August shedding nearly 15,000 tonnes. Remember that LME copper

inventories hit an over 6 year high of 0.555mt in February this year and have now

been eroded by a handsome 28% or 0.156mt. Indeed, copper inventories

normally rise in August and the drop this August was only the second time in 25

years that LME copper inventory did not rise in August. Macro issues do remain

and high flying copper would be vulnerable to poor upcoming macro data from

the US. I am forecasting a Q4 copper price average of US$7,400/tonne and a full

year average of US$7,160/tonne (US$3.25/lb), 40% higher than the dismal 2009

average of US$5,163/tonne (US$2.34/lb).

GlobalStrategy|1September2010

Emerging markets LatAm: RBS expects the Brazilian BCB to keep rates on

hold at 10.75%, finalizing the tightening cycle that started in April-10 for a

cumulative 200bp in hikes. We believe that the policy rate at this level is

compatible with the neutral rate, which in our view would suffice to guarantee the

attainment of the inflation target next year, although inflation expectations are

currently at 4.87% and the output gap remains in the positive territory. In our

view sub-par world economic growth along with tamed inflation abroad should

give a hand to the CB while the output gap slowly moves towards normality.

Moreover, the recent downward surprises in inflation as well as in activity might

have led to a reduction of CB's inflation forecasts for 2011, although they might

remain above the mid-band target, while the Committee is likely to see lower

risks to this forecast, meaning an improvement in the balance of inflations risks.

Emerging markets CEEMEA: Its the time for PMIs in this region (Turkey, S.

Africa, Poland, Czech R, Hungary and Russia). August PMIs are all above the

expansion line (50). Turkey and Hungary are down on the previous month,

Russia, Poland, Czech and S Africa are up on the previous month (this is back

up above the expansion line). With EC and GE August PMI also out this morning

and remaining in expansion territory, this bodes well for CEEMEA FX in an

otherwise jittery market.

Emerging markets NJA: Robust Aug China PMIs and Australian Q2 GDP

growth buoyed risk sentiment. Asian currencies strengthened, led by the KRW.

Exports growth and CPI inflation out of South Korea continued to paint a healthy

macro picture, against which the KRW should remain supported. IDR saw some

relief buying after the August CPI came in slower than market expectation. The

MYR IRS curve shifted 3-4bp lower ahead of Thursday's policy meeting where

the central bank is widely expected to stand pat. We remain long 10Y MGS and

recommend extending duration further out the curve. KRW front-end rates traded

5bp higher following the introduction of the term deposit facility on Tuesday. We

view the move as a confirmation that the central bank is preparing to accelerate

the pace of policy tightening and recommend paying 1y KRW IRS (see Trade

idea | KRW IRS | New BOK term deposit facility). Separately, the central bank

began its 2Y MSB buyback operations this morning, buying back KRW400bn

worth of 2Y MSBs this morning against KRW630bn worth of offers submitted.

Note, however, that the intention here is to smooth out the current maturity profile

of the outstanding MSB stock and for that the central bank will be issuing

shorter-dated MSB to offset the buy-backs. In Indonesia, we expect IDR recap

bonds to retrace part of its recent losses after the August inflation print came in

lower than expected at 6.44%.

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The Royal Bank of Scotland

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