JULY 30, 2010

FEATURE ARTICLE, PAGE 7

Stressing About Credit

Creation, Not Test Results

• U.S. Growth Middling as Consumer Confidence Fades

• Canadian Economic Momentum Slowing

• Basel Banking Rules Relaxed

• Solid July for Global Equities

• India, New Zealand, Israel Hike Rates

 Our Thoughts
The Pall of Uncertainty
Economic activity in Canada is clearly ebbing, in line with the slowdown
in the rest of the world. Consequently, business and consumer
confidence is shaky, edging downward as great uncertainty continues to
weigh on sentiment. Canadian and U.S. businesses are holding record
volumes of cash, and while investment in machinery, equipment and
software is very strong in the U.S., and rising in Canada, job growth in the U.S. remains
a sore spot. The U.S. long-term unemployment rate is extremely high, plaguing a
recovery in confidence and consumer spending.
Businesses, especially in the U.S., are mired in the negative feedback loop of tepid
consumer spending leading to disappointing orders, which discourages job creation
and rehiring. As long as 14.6 million workers are unemployed in the U.S., everything
from housing to auto sales to spending on clothing and even necessities is muted.
Inevitably, this weakens Canadian economic activity both directly—through
weaker exports—and indirectly, through reduced confidence. The news has been
dominated of late by mounting concerns of a double dip. Canadians can’t help but be
impacted by this, even though employment has been very strong here.
Fear of a double dip can be self-fulfilling. First among the causes for concern is
the effect of falling business and household confidence, the glue holding the global
recovery together. The initial sign came in May when the global purchasing managers’
index for both manufacturing and services fell from the April peak as activity and new
orders dropped. The declines continued in June, fuelling fears that the rapid phase of
the recovery could be short-lived. But July’s results for Europe—the main cause for
concern in the spring—were much more encouraging.
Households have also shown signs of a slide back into a fear of spending. In most
recession-hit countries, consumers have been saving much more than before the crisis
and they are reducing debt. In the U.S., housing activity has slumped after the
homeowner’s tax credit expired and the overhang of unsold homes, boosted by
continuing foreclosures, remains a longer-term shroud on the market. Even in Canada,
housing has slowed since earlier this year.
As the newly released Q2 GDP results show, the U.S. economic recovery remains
patchy and heavily reliant on government support and inventory rebuilding. We are
expecting even softer growth in the second half—at roughly a 2% pace, which means
that the jobless rate will barely budge. Optimism would improve if companies shifted
spending and retained earnings toward hiring, helping consumers overcome their rut.
But, something needs to spur business confidence for that to happen.
The murky outlook is also reflective of European bank exposure to sovereign risk
and economic slowdown. The recent stress tests helped to mitigate this concern, but
the unwinding of temporary boosts to growth and the massive fiscal restraint in
Europe are raising the prospects of a further slowdown.
In the U.S., the debate is raging between Democratic (Keynesian) calls for fiscal
stimulus and Republican (Supply-Side) calls for government spending cuts. Ironically,
the Dems are also supporting the expiry of the Bush tax cuts for households earning

PAGE 2 – FOCUS – JULY 30, 2010

 Our Thoughts

$250,000 or more, an act of fiscal restraint, while the Republicans want to see the
continuation of the tax cuts (due to expire January 1, 2011), an act of fiscal stimulus.
Bottom Line: As Bernanke says, these are “unusually uncertain” times, and that
does not bode well for business or consumer confidence. We will continue to spiral
through this negative loop, raising the prospects of a double dip, until something
penetrates the gloom and spurs confidence in a brighter outlook. What this
something might be is once again uncertain. My view is that some additional fiscal
stimulus is necessary—hopefully in the form of corporate tax cuts and additional
federal assistance to state and local government, an enormous source of new layoffs. I
believe a double dip is unlikely, but we are clearly in store for sub-par growth and only
a very slow rise in hiring.

What in the world has happened to the greenback? It has done a

reverse Charles Atlas, and is now the 90-pound weakling on the beach. An
8% plunge from June’s peak has erased all of its trade-weighted gains this
year. Meantime, the euro has bulked up 10% since early June, the British
pound is at five-month highs, and the Canadian dollar is taking aim at
SAL GUATIERI parity again. Four factors have conspired to deflate the greenback’s
stature. First, double-dip recession and deflation fears are no longer the purview of
Europe. A string of soft U.S. numbers and a glum Beige Book confirm the patchy nature
of this recovery, and even one inflation hawk on the FOMC (St. Louis President Bullard) is
warning that the U.S. could be headed for Japanese-like deflation and may need
another jolt of monetary caffeine. While we don’t expect a recession, the U.S. economy
isn’t likely to vastly outrun Europe, which has taken on a slightly rosier hue in light of
surprisingly perkier data. The sluggish U.S. recovery should keep the Fed—like other
members of the benchwarmer’s club (ECB, BoE and BoJ)—on the sidelines well into next
year, if not, 2012. Second, fiscal concerns are also not limited only to Europe. Both the
U.S. and Europe have awful fiscal finances, but at least Europe is addressing its problems.
ECB President Trichet is warning advanced nations not to delay fiscal dieting, while the
new U.K. government is wielding an axe at its budget. Meantime, the U.S. Administration
has yet to draw up a credible plan to stabilize the debt, drawing a rebuke from one
Moody’s official, while California’s muscular governor warns it is at risk of a “fiscal
meltdown” if it doesn’t pass an overdue budget soon. Third, the U.S. trade deficit
continues to expand (slashing almost 3 ppts from Q2 growth), in part because fiscal
incentive programs pumped spending and imports. Fourth, Europe’s financial backstop
plan and bank stress tests, though not perfect, have at least soothed investor concerns
about sovereign default, damping safe-haven demand for dollars. Meantime, the IMF’s
own stress tests reveal that U.S. banks, though stable now, remain vulnerable to weak
housing and commercial real estate markets.
Looking ahead, although the dollar might regain some of its muscle if Europe’s
credit woes re-emerge, its prospects for the year ahead look dim. The U.S. economy is
expected to slow further in the second half of the year, as the boosts from inventory
restocking and fiscal stimulus wane. Meantime, the federal government is unlikely to
seriously tackle its deficit until after the November elections, and possibly much later if

PAGE 3 – FOCUS – JULY 30, 2010

 Our Thoughts

the new Congress is gridlocked. The dollar’s weakness should be most pronounced
against the Asian and commodity-based currencies, as many of these countries will
continue to raise interest rates. On the bright side, a weak dollar should facilitate a
necessary rebalancing of the U.S. economy by encouraging savings and production
over consumption.

Maybe it’s me but it felt a little like “bizzaro world” on the economic data
front on Friday. Canadian real GDP rose only 0.1% in May, which, following
up a flat April reading, points to growth of around 2.5% a.r. in Q2. That’s
right in line with the U.S. figure of 2.4%. Isn’t Canada supposed to outpace
the U.S. through the recovery? While Canada’s outperformance on growth
will likely take a hiatus in the second half of the year, the picture remains
much brighter north of the border. Employment is the key differentiator, with Canada
nearly back to pre-recession levels, while the U.S. is still down 7.5 million jobs. However,
there was a bit of a dampener on the employment front in Canada, as the establishment
survey for May (not to be confused with the Labour Force Survey) showed nonfarm
employment actually dropped 25k. Coupled with a 22k gain in April (the LFS reported a
record increase in that month), Canada’s establishment survey seems to be more
consistent with recent GDP figures. It looks as though the record job growth in Q2,
according to the LFS, was too good to be true.
Despite the current soft patch, financial markets are showing some signs that
conditions might already be perking up. Dr. Copper climbed 11.1% in July, the strongest
gain in nearly a year. China’s CSI 300 equity index gained 11.9%, its best month in a year,
as policy tightening fears subsided. Chinese equities have been a decent leading
indicator for global equities and the economy over the past two years. Indeed, despite
all the gloom of the double-dippers, with some upping their odds of such an event, July
was an excellent month for stocks, while bond yields were little changed. As of this
morning, the Dow, S&P 500, and Europe’s Stoxx 50 were up over 6% for the month. The
TSX is on pace for a more modest 3.5% gain, as gold stocks weighed. Solid earnings
results, with nearly 80% of S&P 500 companies beating bottom line estimates, provided
a boost to markets. However, with earnings season winding down and the global
economic data likely to reflect a soft patch in activity, commodities and equities might
have a tough time repeating those gains in August.

Dividends are in style again, and for good reason. For one, the S&P
500 is at about the same level it was more than 12 years ago. While
investors have made nothing through price appreciation since early-
1998 (and actually lost money in real terms), they would have racked up
a 22% gain by re-investing their dividends, highlighting the importance
ROBERT KAVCIC of an income stream in a secular bear market. Meantime, the alternatives
for investors desiring income are not all that compelling given the low level of bond
yields. In fact, the dividend yield on the TSX sits just below the yield on 10-year
government bonds, after crossing above last year for the first time since the 1950s. The
same happened to the S&P 500 and, though now yielding less than 10-year Treasuries,

PAGE 4 – FOCUS – JULY 30, 2010

 Our Thoughts

the spread is as narrow as it has been since the 1950s. At the same time, very healthy
corporate balance sheets are making dividend hikes possible as we pull out of
recession—see the recent increases by GE, Caterpillar, Barrick Gold and others.
Indeed, one benefit of dividends over bond coupons is their ability to grow and
provide inflation protection over time. Among S&P 500 companies with dividend yields
currently above the 10-year government bond yield, and that have not missed a quarterly
payment in the past decade, 40 firms have produced 10-year annual growth in per-share
dividends above the rate of inflation. Impressively, every major sector of the market is
represented in that list, giving investors ample opportunity to create a diverse portfolio of
stocks, with a steady track record of real dividend growth, that yield more than
government bonds. In Canada, there are 17 companies that fit the same bill, mostly
concentrated in the financial sector, but with representation also in energy, utilities,
industrials and telecom. After being rendered nearly obsolete in 1999, dividends matter
again, and there are plenty of stocks in North America that offer a higher yield than
government bonds, while providing inflation protection at the same time.

PAGE 5 – FOCUS – JULY 30, 2010


Jennifer Lee, Senior Economist
CANADA
• Economic growth still on track
for >2% gain in Q2…
• …but growth has clearly
slowed
UNITED STATES
• Economy continues to grow,
but unevenly
• Beige Book shows no solid pick-
up in economic activity
• Hawkish St. Louis Fed President
Bullard sounds deflation
warning bell
• $104 bln Treasury auctions
generally met with strong
demand—but 7-year sloppy
EUROPE
• ECB’s Bank Lending Survey
shows credit standards
tightened (Q2)
• ECB makes lending rules more
stringent, raises cost of using
weaker-rated assets as
collateral to borrow from the
ECB
JAPAN
• Strong JPY an issue for
exporters
PAGE 6 – FOCUS – JULY 30, 2010
Recap
GOOD NEWS BAD NEWS
CANADA
Real GDP at Basic Prices +0.1% (May) Conference Board’s Consumer Confidence
Industrial Product Price Index -0.9% (June) Index -3.7 pts to 80.0 (June)
Raw Materials Price Index -0.3% (June) Establishment Survey of Employment -25,018 (May)
U.S.
Real GDP +2.4% a.r. (Q2 A) Conference Board’s Consumer Confidence
Core Durable Goods Orders +0.6% (June) Index -3.9 pts to 50.4 (July)
Chicago PMI +3.2 pts to 62.3 (July) Redbook -0.7% (July 24 wk)
New Home Sales +23.6% to 330,000 a.r. (June)
S&P Case-Shiller Home Price Index +4.6% y/y (May)
Homeowner Vacancy Rate -0.1 ppts to 2.5% (Q2)
Initial Claims -11,000 to 457,000 (July 24 wk)
Employment Cost Index +0.5% (Q2)
EUROPE
Eurozone—Economic Confidence +2.3 pts to Eurozone—Jobless Rate unch at 10.0% (June)
101.3 (July) Eurozone—Consumer Prices +1.7% y/y (July P)—
Eurozone—Smoothed M3 flat from a year ago accelerating but due to energy
(July)—first non-negative reading since October 2009 Germany—Retail Sales -0.9% (June)
Germany—GfK Consumer Confidence +0.3 pts to U.K.—Nationwide House Prices -0.5% (July)
3.9 (Aug.) U.K.—GfK Consumer Confidence -3 pts to -22 (July)
Germany—Unemployment -20,000 (July)
France—Producer Prices unch (June)
Italy—Jobless Rate -0.1 ppts to 8.5% (June)
JAPAN
Retail Sales +0.4% (June) Manufacturing PMI -1.1 pts to 52.8 (July)
Household Spending +0.5% y/y (June) Industrial Production -1.5% (June P)
Exports +27.7% y/y, Imports +26.1% y/y (June) Jobless Rate +0.1 ppts to 5.3% (June)
Consumer Prices-0.7% y/y (June)—deflation easing
Indications of stronger growth and a move toward price stability are good news for the economy.
 Feature

Stressing About Credit Creation, Not Test Results

Michael Gregory and Benjamin Reitzes

Last week’s stress test results for 91 institutions, representing two-thirds of Europe’s
banking system, elicited a sigh of relief among global investors. It wasn’t that only
seven banks failed with a mere €3.5 bln (US$4.5 bln) in collective capital deficiency, or
that the test itself was foolproof (it wasn’t). Instead, investors appeared encouraged by
the rays of light shone on previously opaque bank balance sheets. It also helped that
some global banks reported strong earnings this week, along with the news that
international regulators had watered down their previously draconian
recommendations on new bank capital requirements. Nevertheless, as was the case
after last year’s U.S. bank stress test, investors appear to put a high premium on
balance sheet clarity (Chart 1).

The stress test results and methodology prompted a

cynical reaction from analysts. The small number of failures
CHART 1 in the European test stood in contrast to the U.S. test of
INVESTORS LIKE BANK BALANCE SHEET CLARITY May 2009, in which 10 of 19 large banks failed and needed
(bps) to raise US$75 bln in capital (Chart 2). The more negative
Bank Credit Default Swap Spreads U.S. results appeared to afford the European test less
800 credibility, although there were cynics of the U.S. test too.
North
America U.S. Stress Note that the larger U.S. capital deficiency also reflected
600 Test
the fact that the focus was on tier 1 common capital, while
European regulators looked at a broader measure of tier 1
400 European
Stress Test capital (most U.S. banks would have fared well using the
200 Europe broader measure).

0
Criticisms of the European test’s methodology were
08 09 10 broad based. They included the assertion that the
Source: Markit Group recession scenario was too mild and therefore
unemployment didn’t rise enough and home prices
CHART 2 didn’t fall enough, a sovereign credit default scenario was
EUROPEAN TEST NOT SO STRESSFUL not included, and only trading books were subject to
Bank Stress Test Results haircuts on sovereign securities. However, European
United States Europe officials insist their stress scenarios were more severe
than the U.S. ones. Considering the Euro Area contracted
4.1% in 2009, a double-dip recession scenario with
further moderate declines in real GDP in 2010 and 2011
would be a very negative outcome, especially
10 9 7 Failed 84
Failed Passed Passed considering positive growth seen through the first half of
this year. The U.S. test modelled a 3.3% drop in GDP in
2009, with 0.5% growth in 2010 (so only a deep one-year
recession), and the scenarios were publicized well before
Capital Shortfall: US$75 bln Capital Shortfall: US$4.5 bln the test results were released.

PAGE 7 – FOCUS – JULY 30, 2010

 Feature

We judge that excluding a sovereign credit default was not

CHART 3 a weakness of the testing exercise. The Greek and pan-
WORST BANK CREDIT CONTRACTION SINCE WWII European support packages put in place in recent months
United States (y/y % chng) will guard against this outcome for at least the next couple
Bank Lending of years. However, beyond the bail-out period (and well
30 beyond the testing horizon), we believe that Greece might
still have to restructure its debt if it can’t secure another
20 support package (the penultimate problem with Greece is
the sheer size of its debt and the massive primary budget
10 surplus that must be maintained just to pay the interest).
As long as meaningful fiscal consolidation continues in the
0
S&L crisis other countries in question (such as Portugal, Spain and
-10
recession the U.K.), this will go a long way in limiting any future
48 53 58 63 68 73 78 83 88 93 98 03 08 sovereign contagion. Meantime, European banks will have
a few more years to build even more capital to absorb any
CHART 4 potential sovereign debt restructuring.
LENDING STANDARDS STARTING TO STABILIZE...
AT LOFTY LEVELS Since 2007, European banks have raised US$570 bln in
Banks Reporting Tighter Credit Standards – United States (net : percent) capital vs. US$565 bln in losses, while U.S. banks raised
Mortgages Other Consumer Loans Business Loans US$812 bln in capital vs. US$1192 bln in losses. Total
120 80 100 Real
Estate potential losses in the European test were about 5% of risk-
100 Subprime 80 Large weighted assets or US$735 bln, less than the 7.7% of risk-
60
Firms
80 60 weighted assets or US$600 bln in the U.S. test. However,
60 40 40
Credit when added to writedowns already booked, potential
Non-Traditional Cards
40 20 20 European losses would rise above actual losses in the U.S.
Prime
20 0 Recall that the U.S. test was conducted at the height of the
0
0 -20 Small global recession, while European banks have had an extra
All Mortgages Other Firms
-20 -20 -40 year to heal, which is why the larger potential losses didn’t
90 95 00 05 10 96 99 02 05 08 90 95 00 05 10
translate into more failures. Moreover, considering the huge
Source: Federal Reserve Senior Loan Officer Survey
losses already taken, future losses aren’t likely to be as
severe in any adverse scenario (the worst credits have
CHART 5
already been erased, although there remains concern that
CREDIT DEMAND DECREASING ACROSS THE BOARD
Banks Reporting Increasing Demand for Loans – United States (net : percent) European banks have lagged in writing down their
Mortgages Other Consumer Loans Business Loans exposures to U.S. real estate).
80 40 60
All
Mortgages
Small There is no doubt that favourable stress test results or
40 Firms
40 Tax 20 quick remedial actions to shore up deficient capital go a
Credits 20
long way in boosting bank investor confidence, and
0 0 0
Prime contribute to lower bank funding costs than would
-40 -20 -20
Non- otherwise be the case. But, if banks aren’t actively tapping
Traditional -40 Real wholesale funding markets owing to a dysfunctional credit
-80 -40 Estate
-60 Large creation process, then the entire testing exercise becomes
Subprime Firms
-120 -60 -80 a moot point as far as economic prospects are concerned.
00 05 10 00 05 10 00 05 10
Source: Federal Reserve Senior Loan Officer Survey
This is the case on both sides of the Atlantic.

PAGE 8 – FOCUS – JULY 30, 2010

 Feature

In the United States, bank credit continues to contract at a

CHART 6 record pace, more than a year after the test results were
BANK CREDIT BARELY EXPANDING released (the recent uptick to less negative growth reflects
Euro Area (y/y % chng) an accounting change that required banks to consolidate
Loans to Non-Financial Private Sector loans in off-balance sheet vehicles) (Chart 3). Shrinking bank
15 intermediation reflects factors on both the supply and
demand side. Banks are guarding their capital carefully in
10 light of past losses, potential future losses and forthcoming
regulatory changes. Only in loans to large businesses (that
5 have access to competing capital market funding) and in
consumer credit cards (perhaps reflecting small business
0 migration into this personal product) have U.S. banks even
begun to ratchet down their very tight lending standards
-5 (Chart 4). Meantime, U.S. banks face a shrinking demand for
84 86 88 90 92 94 96 98 00 02 04 06 08 10
loans across the board (Chart 5), as balance sheet
restructuring and economic uncertainty take their tolls.
CHART 7
TURNING THE TIGHTENING SCREWS In Europe (the ECB’s survey was released this week) , bank
Banks Reporting Tighter Credit Standards – Euro Area (net : percent) lending to households and non-financial corporations
80 50 inched up just 1.1% y/y in June, still hovering in its slowest
40 range since the early 1980s (and after contracting for the
60
first time on record) (Chart 6). Faced with comparable
30
40 capital issues to U.S. institutions, European banks are still
Large 20 tightening lending standards and, lately, at an upping
Firms Mortgages
20 pace—likely reflecting concerns not only about sovereign
SMEs 10
0
credit but also the private sector credit ramifications of
0
Other Consumer fiscal consolidation (Chart 7). However, unlike their U.S.
Loans
-20 -10 counterparts, European banks are seeing signs of
03 05 07 09 03 05 07 09
increasing household loan demand (but not among
Source: ECB Bank Lending Survey
businesses), allowing bank credit to inch up (Chart 8).
CHART 8 Bottom line: The funny thing about stress testing is that
MIXED CREDIT DEMAND: HOUSEHOLDS UP, FIRMS DOWN you can always construct a more adverse scenario.
Banks Reporting Increasing Demand for Loans – Euro Area (net : percent)
Individual banks around the world no doubt conduct some
30 60
pretty extreme scenarios for internal use only. But when
20 SMEs 40 Other looking at an entire banking system, and its inherent
10 Consumer
20 Loans diversification of individual bank risk, it’s more appropriate
0
0 to focus on an array of more probable adverse scenarios.
-10 Large
Firms -20 Besides, any debate about stress test modelling diverts
-20
Mortgages attention from the much more serious problem of
-30 -40
dysfunctional credit creation. If European regulators were
-40 -60
hoping that their stress test would stoke bank credit growth,
-50 -80 the U.S. experience would suggest otherwise.
03 05 07 09 03 05 07 09
Source: ECB Bank Lending Survey

PAGE 9 – FOCUS – JULY 30, 2010

 Economic Forecast

2010 2011 ANNUAL

CANADA I II III IV I II III IV 2009 2010 2011
Real GDP (q/q % chng : a.r.) 6.1 2.7 2.0 2.7 3.0 3.4 3.7 3.5 -2.5 3.3 3.0
Consumer Price Index (y/y % chng) 1.6 1.5 2.2 1.9 1.8 2.3 1.7 1.6 0.3 1.8 1.9
Unemployment Rate (%) 8.2 8.0 7.9 7.8 7.6 7.5 7.4 7.3 8.3 8.0 7.5
Housing Starts (000s : a.r.) 198 199 170 162 169 179 182 185 149 182 179
Current Account Balance ($blns : a.r.) -31.3 -44.0 -42.4 -42.4 -41.8 -42.9 -43.3 -44.0 -43.5 -40.0 -43.0
Interest Rates
(average for the quarter : %)
Overnight Rate 0.25 0.33 0.83 1.00 1.33 1.50 1.83 2.33 0.40 0.60 1.75
3-month Treasury Bill 0.19 0.41 0.68 v 0.83 v 1.19 v 1.37 1.71 v 2.22 v 0.33 0.53 v 1.62 v
10-year Bond 3.47 3.47 3.15 3.04 u 3.15 u 3.38 u 3.60 u 3.83 u 3.23 3.28 3.49 u
Canada/U.S. Interest Rate Spreads
(average for the quarter : bps)
90-day 8 26 52 v 67 v 103 v 121 v 122 v 119 v 18 38 v 116 v
10-year -25 -2 18 u 19 u 15 u 7u 0 u -8 u -3 3u 4u
UNITED STATES
Real GDP (q/q % chng : a.r.) 3.7 2.4 2.0 2.4 v 2.8 v 3.0 v 3.1 v 3.3 v -2.6 2.9 2.7 v
Consumer Price Index (y/y % chng) 2.4 1.8 0.9 0.7 0.6 1.1 1.4 1.4 -0.3 1.4 1.2
Unemployment Rate (%) 9.7 9.7 9.5 9.3 u 9.1 u 8.9 u 8.7 u 8.5 u 9.3 9.5 8.8 u
Housing Starts (mlns : a.r.) 0.62 0.60 0.56 0.60 0.65 0.68 0.71 0.74 0.55 0.59 0.70
Current Account Balance ($blns : a.r.) -436 -483 v -488 v -494 v -495 v -493 v -495 v -497 v -378 -475 v -495 v
Interest Rates
(average for the quarter : %)
Fed Funds Target Rate 0.13 0.13 0.13 0.13 0.13 0.13 0.46 1.00 0.13 0.13 0.43
3-month Treasury Bill 0.11 0.15 0.16 u 0.16 u 0.16 u 0.16 u 0.49 u 1.03 u 0.15 0.14 u 0.46 u
10-year Note 3.72 3.49 2.97 v 2.84 3.00 3.30 3.60 3.90 3.26 3.25 v 3.45
EXCHANGE RATES
(average for the quarter)
US¢/C$ 96.0 97.3 96.0 94.8 95.9 98.9 100.3 100.8 88.0 96.0 99.0
C$/US$ 1.041 1.028 1.042 1.055 1.043 1.011 0.997 0.992 1.141 1.041 1.011
¥/US$ 91 92 89 v 94 97 99 102 104 94 91 v 100
US$/Euro 1.38 1.27 1.27 u 1.26 u 1.27 u 1.29 u 1.28 u 1.26 u 1.39 1.30 u 1.28 u
US$/£ 1.56 1.49 1.54 u 1.51 u 1.52 u 1.54 u 1.53 u 1.51 u 1.57 1.53 u 1.53 u
Note: Blocked areas represent BMO Capital Markets forecasts
Up and down arrows indicate changes to the forecast uv

PAGE 10 – FOCUS – JULY 30, 2010

 Key for Next Week

CANADA Sal Guatieri, Senior Economist

Employment Following the best quarter in 23 years, Canada’s labour market should moderate in the
Friday, 7:00 am summer as the economy downshifts. Look for a modest 5,000 increase in July
July (e) +5,000 (+0.03%) following June’s blow-out 93,200 gain. Ongoing strength in services should be
Consensus +15,000 (+0.1%)
June +93,200 (+0.6%) tempered by weakness in manufacturing (high C$) and construction (cooler housing
Unemployment Rate market). The labour market is only 14,400 workers shy of regaining all of the jobs
July (e) 8.0% (417,400) shed during the recession, one of the fastest recoveries on record. After
Consensus 7.9%
June 7.9% touching a 17-month low in June, the unemployment rate is expected to climb for the
Average Hourly Wages first time in nine months, by one tenth to 8.0%. That’s still comfortably below last
July (e) +1.7 % y/y summer’s peak (8.7%) and not much higher than the 45-year average (7.8%). Steady
June +1.7% y/y
job growth should coax the Bank of Canada to raise rates again in September.

UNITED STATES Sal Guatieri, Senior Economist

ISM Manufacturing Regional surveys suggest the national ISM measure slipped for the third straight
Monday, 10:00 am month in July after hitting a six-year high in April, likely a result of slowing inventory
Prices-Paid investment and exports. The expected level (55.0) would still indicate healthy growth
July (e) 55.0 55.0
Consensus 54.2 55.0 in the sector. However, further slowing in new orders or jobs would be disconcerting,
June 56.2 57.0 since manufacturing has been one of the few consistent bright spots in the recovery.

Personal Spending and Lower auto sales and a modest gain in “core” retail sales suggest personal
Income consumption rose only slightly in June. Hampered by high joblessness and debts,
Tuesday, 8:30 am consumer spending remains subdued. Census layoffs likely held personal income to a
Personal Personal
Income Spending
modest gain. The core PCE deflator is expected to edge higher, though that should
June (e) +0.2% +0.1% still shave a tenth from the yearly rate to 1.2%, putting it a hair above the 1963 low.
Consensus +0.2% +0.1% The Fed expects core inflation to slip to 0.8%-to-1.0% later this year, further below its
May +0.4% +0.2%
presumed price-stability zone of 1.7%-to-2.0%.

ISM Non-manufacturing After reaching four-year highs in the spring, the non-manufacturing composite index
Wednesday, 10:00 am slipped in June and likely eased further in July, owing largely to renewed weakness in
July (e) 53.5 housing. The expected level (53.5) would indicate modest GDP growth, consistent
Consensus 53.0
June 53.8 with our 2% estimate for Q3. According to survey respondents, new orders have
slowed in recent months and employment remains weak.

Nonfarm Payrolls Private sector employment likely rose a modest 90,000 in July, little changed from the
Friday, 8:30 am prior month (83,000) or the H1 average (99,000). Total nonfarm payrolls likely shrank
July (e) -60,000 60,000 due to the loss of roughly 150,000 census workers. While manufacturing and
Consensus -60,000
June -125,000 temporary services should remain solid, construction and retail trade will continue to
Unemployment Rate drag. The unemployment rate is expected to inch up to 9.6%, just one-half percentage
July (e) 9.6% point below its cycle peak. Until companies restore average work hours to pre-recession
Consensus 9.6%
June 9.5% levels, hiring could remain weak. Meantime, the economy is caught in a classic catch-22
Average Hourly Earnings situation: firms won’t commit to hiring until the recovery strengthens, but (given the
July (e) +0.1% deleveraging headwinds) the recovery likely won’t strengthen until employment picks
Consensus +0.1%
June -0.1% up and supports consumer spending.

PAGE 11 – FOCUS – JULY 30, 2010

 Financial Markets Update
CHANGE FROM: (BASIS POINTS)
JUL 30 * JUL 23 WEEK AGO 4 WEEKS AGO DEC. 31/09
Canadian Money Market
Call Money 0.75 0.75 0 25 50
Prime Rate 2.75 2.50 25 25 50
U.S. Money Market
Fed Funds (effective) 0.25 0.25 0 0 0
Prime Rate 3.25 3.25 0 0 0
3-Month Rates
Canada 0.65 0.62 3 15 46
United States 0.14 0.15 -1 -2 9
Japan 0.20 0.12 9 9 8
Eurozone 0.90 0.89 1 11 20
United Kingdom 0.75 0.74 1 1 14
Australia 4.81 4.85 -4 0 79
Bond Markets
2-year Bond
Canada 1.48 1.59 -11 4 0
United States 0.57 0.59 -2 -6 -57
10-year Bond
Canada 3.13 3.23 -10 3 -48
United States 2.93 3.00 -7 -5 -91
Japan 1.06 1.08 -1 -4 -23
Germany 2.67 2.71 -3 9 -71
United Kingdom 3.32 3.44 -11 -3 -69
Australia 5.20 5.20 0 10 -44
Risk Indicators
VIX 24.7 23.5 1.2 pts -5.4 pts 3.0 pts
TED Spread 31 35 -3 -6 11
Inv. Grade CDS Spread ** 104 106 -2 -19 18
High Yield CDS Spread ** 554 569 -15 -97 37
Currencies (% CHANGE)
US¢/C$ 97.01 96.54 0.5 3.1 2.2
C$/US$ 1.031 1.036 — — —
¥/US$ 86.50 87.46 -1.1 -1.4 -7.0
US$/Euro 1.3026 1.2909 0.9 3.7 -9.0
US$/£ 1.564 1.543 1.4 2.9 -3.3
US¢/A$ 90.46 89.57 1.0 7.5 0.8
Commodities
CRB Futures Index 269.15 266.62 0.9 5.8 -5.0
Oil (generic contract) 77.30 78.98 -2.1 7.2 -2.6
Natural Gas (generic contract) 4.82 4.56 5.5 2.8 -13.6
Gold (spot price) 1172.35 1189.20 -1.4 -3.2 6.9
Equities
S&P/TSX Composite 11684 11714 -0.3 4.4 -0.5
S&P 500 1098 1103 -0.4 7.4 -1.6
Nasdaq 2240 2269 -1.3 7.1 -1.3
Dow Jones Industrial 10434 10425 0.1 7.7 0.1
Nikkei 9537 9431 1.1 3.6 -9.6
Frankfurt DAX 6138 6166 -0.5 5.2 3.0
London FT100 5301 5313 -0.2 9.6 -2.1
France CAC40 3656 3607 1.4 9.2 -7.1
S&P ASX 200 4494 4458 0.8 6.0 -7.7
* as of 10:30 am ** One day delay

PAGE 12 – FOCUS – JULY 30, 2010

 AUGUST 2 – AUGUST 6 Global Calendar
MONDAY AUGUST 2 TUESDAY AUGUST 3 WEDNESDAY AUGUST 4 THURSDAY AUGUST 5 FRIDAY AUGUST 6
EUROZONE JAPAN

Leading Index
June P (e) 98.7
May 98.6

EUROZONE EUROZONE EUROZONE GERMANY GERMANY

Manufacturing PMI Producer Price Index Services PMI Factory Orders Industrial Production
July F (e) 56.5 June (e) +0.4% +3.1% y/y July F (e) 56.0 June (e) +1.4% +21.6% y/y June (e) +0.5% +11.6% y/y
June 55.6 May +0.3% +3.1% y/y June 55.5 May -0.5% +24.8% y/y May +2.6% +12.4% y/y
Retail Sales FRANCE
June (e) -0.1% +0.1% y/y Trade Deficit
May +0.1% +0.2% y/y ECB Monetary Policy Meeting June (e) €4.4 bln
May €5.5 bln
ITALY
Real GDP
U.K.

Manufacturing PMI Services PMI Q2 P (e) +0.4% +1.2% y/y

July (e) 57.0 July (e) 54.5 Q1 +0.4% +0.5% y/y
June 57.5 June 54.4
Industrial Production
June (e) +0.5% +9.2% y/y
May +1.0% +7.3% y/y
Bank of England Monetary Policy Meeting (August 4-5)

Industrial Production
OTHER

CHINA CHINA AUSTRALIA June (e) +0.1% +1.9% y/y

Manufacturing PMI * Non-manufacturing PMI Trade Surplus May +0.7% +2.6% y/y
July (e) 51.4 July June (e) A$1.8 bln Manufacturing Production
June 52.1 June 57.4 May A$1.6 bln June (e) +0.4% +4.1% y/y
AUSTRALIA House Price Index May +0.3% +4.3% y/y
Retail Sales Q2 (e) +2.0% +17.2% y/y Producer Price Index—Output
June (e) +0.4% Q1 +4.8% +20.0% y/y July (e) unch +4.9% y/y
May +0.2% June -0.3% +5.1% y/y
Building Approvals
June (e) +2.0% +16.0% y/y
May -6.6% +26.6% y/y

Reserve Bank of Australia Monetary Reserve Bank of Australia Monetary

Policy Meeting Policy Statement

* date approximate
 AUGUST 2 – AUGUST 6 North American Calendar
MONDAY AUGUST 2 TUESDAY AUGUST 3 WEDNESDAY AUGUST 4 THURSDAY AUGUST 5 FRIDAY AUGUST 6
CANADA

Auto Sales * 8:15 am Foreign Reserves 7:00 am Employment

July July July (e) +5,000 (+0.03%)
June +11.6 % y/y June -$634 mln Consensus +15,000 (+0.1%)
8:30 am Building Permits June +93,200 (+0.6%)
June (e) -2.0% 7:00 am Unemployment Rate
Civic Holiday May -10.8% July (e) 8.0%
(markets closed) Consensus 7.9%
June 7.9%
10:35 am 3, 6 & 12-month T-bill 12:05 pm 3-year bond auction 7:00 am Average Hourly Wages
auction $13.0 bln $3.2 bln July (e) +1.7% y/y
(New cash -$2.1 bln) (New cash $3.2 bln) 2-year bond auction announcement June +1.7% y/y
10:00 am Ivey Purchasing Managers’
UNITED STATES

10:00 am ISM Prices-Paid 8:30 am Personal Personal 7:30 am Challenger Layoff Report 8:30 am Initial Claims Index
July (e) 55.0 55.0 Income Spending July July 31 (e) 455,000 (-2,000) *** July (e) 56.0 ***
Consensus 54.2 55.0 June (e) +0.2% +0.1% June -47.1% y/y July 24 457,000 (-11,000) June 58.9
June 56.2 57.0 Consensus +0.2% +0.1% 8:15 am ADP National 10:30 am DoE’s Natural Gas Status
10:00 am Construction Spending May +0.4% +0.2% Employment Report Report (July 30 week)
June (e) -0.5% 8:30 am Core PCE Deflator July (e) +70,000 Chain-Store Sales
Consensus -0.5% June (e) +0.1% +1.2% y/y June +13,000 July (e) +2.2 % y/y 8:30 am Nonfarm Payrolls
May -0.2% Consensus +0.2% +1.3% y/y 10:00 am Nonmfg ISM June +3.0% y/y July (e) -60,000
May +0.2% +1.3% y/y July (e) 53.5 Consensus -60,000
10:15 am Fed Chairman Bernanke June -125,000
8:30 am Savings Rate Consensus 53.0
speaks on “Challenges for June (e) 6.2% June 53.8 8:30 am Unemployment Rate
the Economy and State May 4.0% July (e) 9.6%
10:30 am DoE’s Petroleum Status
Governments” in 8:55 am Redbook Report (July 30 week) Consensus 9.6%
Charleston, SC July 31 June 9.5%
July 24 -0.7% 8:30 am Average Hourly Earnings
4:00 pm Treasury Secretary 10:00 am Factory Orders July (e) +0.1%
Geithner speaks on June (e) unch *** Consensus +0.1%
May -1.5% June -0.1%
financial reform in
10:00 am Pending Home Sales 3:00 pm Consumer Credit
New York June (e) +3.0% June (e) -$6.0 bln ***
Total Vehicle Sales * Consensus -1.5% May -$9.1 bln
July (e) 11.8 mln a.r. May -30.0%
Consensus 11.6 mln a.r. 5:00 pm ABC News Consumer
June 11.1 mln a.r. Comfort Index
Aug. 1
July 25 -48

1:00 pm 3 & 6-month T-bill

auction $60.0 bln
(New cash $10.0 bln) 3, 10 & 30-year note auction announcement

* date & time approximate ** time approximate *** consensus Upcoming Policy Meetings Bank of Canada: Sept. 8, Oct. 19, Dec. 7 FOMC: Aug. 10, Sept. 21, Nov. 2-3
 The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice.
Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Bank of Montreal
(“BMO”) and its affiliates make every effort to ensure that the contents thereof have been compiled or derived from sources believed to be reliable and to contain
information and opinions which are accurate and complete. However, neither BMO nor its affiliates have independently verified or make any representation or
warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which may be contained herein or accept any liability
whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied
upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to BMO
and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an
offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other
financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation
to enter into any transaction. Additional information is available by contacting BMO or its relevant affiliate directly. BMO and/or its affiliates may make a market or
deal as principal in the products (including, without limitation, any commodities, securities or other financial instruments) referenced herein. BMO, its affiliates,
and/or their respective shareholders, directors, officers and/or employees may from time to time have long or short positions in any such products (including,
without limitation, commodities, securities or other financial instruments). BMO Nesbitt Burns Inc. and/or BMO Capital Markets Corp., subsidiaries of BMO, may act
as financial advisor and/or underwriter for certain of the corporations mentioned herein and may receive remuneration for same. “BMO Capital Markets” is a trade
name used by the Bank of Montreal Investment Banking Group, which includes the wholesale/institutional arms of Bank of Montreal, BMO Nesbitt Burns Inc., BMO
Nesbitt Burns Ltée/Ltd., BMO Capital Markets Corp. and Harris N.A., and BMO Capital Markets Limited.

TO U.S. RESIDENTS: BMO Capital Markets Corp. and/or BMO Nesbitt Burns Securities Ltd., affiliates of BMO NB, furnish this report to U.S. residents and accept
responsibility for the contents herein, except to the extent that it refers to securities of Bank of Montreal. Any U.S. person wishing to effect transactions in any
security discussed herein should do so through BMO Capital Markets Corp. and/or BMO Nesbitt Burns Securities Ltd.

TO U.K. RESIDENTS: The contents hereof are not directed at investors located in the U.K., other than persons described in Part VI of the Financial Services and
Markets Act 2000 (Financial Promotion) Order 2001.

™ - “BMO (M-bar roundel symbol) Capital Markets” is a trade-mark of Bank of Montreal, used under licence. © Copyright Bank of Montreal.

PAGE 15 – FOCUS – JULY 30, 2010