OCTOBER 28, 2011

FEATURE ARTICLE, PAGE 6

The Many Dangers of Low-for-Long Interest Rates

EU Deal Promising, But Lots of Work Ahead BoC Lowers Growth and Inflation Outlook U.S. Economy Back to Pre-Recession Levels Finally! BoJ Boosts Asset Purchases; RBI Tightens

Our Thoughts
European Debt: Progress Made, Long Road Ahead
European leaders took an important step this week in corralling the sovereign debt crisis. The difficulty in reaching an agreement, with earlier meetings postponed and running through the night, suggests that the relevant players were forced to compromise and that this agreement could be the beginning of the end of the crisis. Euro Area leaders agreed on three main points: 1) Greece bondholders face a voluntary 50% haircut. 2) Leveraging the European Financial Stability Facility (EFSF) up to 1 trillion by offering first loss insurance as a part of primary debt sales and providing the initial equity (also first loss) for Special Purpose Vehicles (SPVs) designed to attract funds from private and public sector financial institutions and investors. The SPVs would be directed to extend loans, for bank recapitalization and for buying bonds in the primary and secondary markets. 3) A plan to recapitalise banks to the tune of 106 billion. Markets reacted extremely positively, with equities surging the day of the announcement, led by financial stocks (which had been pounded by the crisis). While the actions from Europe are encouraging, markets may be getting ahead of themselves. The problems are far from fully solved, as some cracks can be found in each of the three main points of agreement. The haircuts may not be enough to put Greece on a sustainable path; theres no guarantee investors will be attracted by the EFSFs insurance or SPVs and there still arent sufficient funds to bail out Spain and/or Italy if that becomes necessary; and, the bank recapitalization plan falls well short of IMF and private sector estimates, and wont necessarily keep banks from shrinking their loan books in an effort to boost capital ratios. And, many details still need to be ironed out. The results from the latest European Summit are an important step toward taming the sovereign debt crisis. However, all three main decisions will take weeks, if not months, to finalize. That leaves the region at risk of another flare up perhaps as early as next year, if something unexpected happens (e.g. larger-than-expected fiscal deficits). Implementation risks remain a key potential hurdle to overcoming this crisis. Greece, Ireland, Portugal, Spain and Italy have to follow through with budget cuts, asset sales, and economic reforms or recent efforts will have been for naught. France could be included in that list as well, with its AAA credit rating at risk according to ratings agencies. This package should at best mark the beginning of the end of the crisis. At worst it will buy Europe more time to implement economic reforms and strengthen the monetary union before another inevitable crisis flares up. Considering that we remain concerned about Greece, bank recapitalisation appears lacking in size, and the EFSF is not of sufficient size to bail out Italy and/or Spain, the debt troubles will likely linger well into 2012 and perhaps beyond, even if the acute phase of the crisis has passed.

PAGE 2 FOCUS OCTOBER 28, 2011

Our Thoughts
Things are starting to look up again for the U.S. economy, though its too soon to uncork the champagne. A brisk 0.6% gain in personal spending in September, alongside a stellar gain in business spending in Q3, allowed real GDP growth to double to 2.5% annualized that quarter. Final domestic sales rose the most (3.2%) in over a year. While it has taken the SAL GUATIERI U.S. economy nearly four years to return to pre-recession levels (the longest in the last six decades and twice as long as for Canada), the expansion phase has at least officially started. Moreover, we have revised up our Q4 growth estimate a full percentage point to 2.5% in light of surprisingly weak inventory investment in Q3. With equities reversing their year-to-date losses (which were tracking double-digits earlier this month), the adverse wealth effect on spending should subside. Recession risks have ebbed, and will continue to do so as long as Europe can make further progress in resolving its debt crisis. Still, guarded optimism appears warranted. First, consumers have reached deep into the savings well to sustain spending in the face of weak incomes. The savings rate dropped to 3.6% in September, a level not seen since late 2007 when shoppers were still draining their housing ATM. As then, thats not a recipe for sustainable growth. Disposable personal income has flat-lined in the past three months, and has dropped nearly 4% annualized after accounting for inflation and population growth. Second, consumer confidence has sunk to Great Recession levels, suggesting many households will be in a Grinch-like mood this holiday shopping season. Third, three consecutive declines in pending home sales (and a hefty one at -4.6% in September) suggest the housing market remains depressed. Fourth, the surprising acceleration in business investment in Q3 almost surely reflects the possible year-end expiration of the accelerated depreciation allowance (unless Congress votes otherwise). Fifth, oil prices are moving up again, halting the recent drop in gasoline prices. And sixth, current hefty cuts in federal nondefense and state/local spending are likely to continue for some time. All in, economic growth will likely pick up only modestly in coming quarters from the current 1.6% pace of the past year. That beats the dreaded double dip, though its no reason to celebrate, not with 14 million job seekers still looking for work. One seemingly massive disconnect for investors is the fact that North American consumer confidence is plumbing the depths while spending just keeps chugging along. For instance, U.S. confidence slid in October to lows not seen since March 2009, which coincided with the very pit of the financial crisis, and yet retail sales are up almost 8% from a year ago. DOUGLAS PORTER The divergence is unprecedented but also no big mystery. We managed to whip ourselves into a frenzy of negativity over the summer and early fallU.S. Default! S&P Downgrade! European Debt Crisis! Bear Market! Recession Risks Rise!yet most of the fundamentals simply did not change for consumers. Job growth continued to churn along, albeit at a modest pace. Consumer prices didnt suddenly bolt higher for necessities; in fact, gasoline prices eased a tad. An already miserable housing backdrop didnt get materially worse. Taxes did not suddenly rise.
PAGE 3 FOCUS OCTOBER 28, 2011

Our Thoughts
The only meaningful shift for spending was the heavy damage to equity prices in August and September. And yet even that has been largely reversed with Octobers massive rebound (which has brought the S&P 500 back into positive terrain for 2011). The simple answer thus is that, while the headlines were in a paroxysm of pessimism, the situation on the ground did not significantly change for consumers. The big issue now is how does this unprecedented gap between consumer perceptions and actions close? Confidence is likely to gradually recover, especially with equity markets on the mend, and if employment keeps grinding ahead. However, as a wise man once said, confidence grows like a coconut tree, but falls like a coconutin other words, the repair job will likely be slow, and could be susceptible to new shocks. Meantime, actual spending is likely to cool somewhat in the months ahead, after the surprisingly upbeat performance of recent months. As quickly as they melted down in August, stocks have stormed back this month. The S&P 500 has rallied more than 13% since the end of September, putting it on pace for the best month since October 1974, while all major U.S. indices broke above their 200-day moving averages after the details of the European Summit were announced. Sentiment ROBERT KAVCIC had become so depressed since the spring that the prevailing mood was about as bad as it was in early 2009, at the tail end of the worst recession of the postwar era. For example, net expectations for stock price performance 12 months hence were a near record low in October, according to the Conference Board Survey, leaving the equity market looking like a dry pile of tinder just waiting for any kind of a spark. The market got two sparks this week, with Europe stepping back from the brink and U.S. recession fears subsiding further amid a pickup in Q3 growth. Meantime, the Q3 earnings season continues to play out quietly in the background, and while results have been a little choppier than in recent quarters, they continue to point to modest growth ahead. To date, 75% of S&P 500 companies have beaten earnings expectations, about in line with the performance at this point in recent quarters, while the share of misses is tracking slightly higher. The view from the front lines appears slightly foggier, generally pointing to modest, but somewhat uneven, economic growth. On the positive side, industrial bellwether Caterpillar trounced expectations this week, saying that although there is a good deal of economic and political uncertainty in the world, we are not seeing it much in our business at this point we believe continued economic recovery, albeit a slow recovery, is the most likely scenario as we move forward. But that relatively upbeat report was tempered somewhat by the likes of 3M, which noted that the economic softening we experienced late in the second quarter continued into the third. All told, the quick snapback in equity markets likely reflects an unwinding of extremely negative sentiment, and current valuations now look close to what seems appropriate given a slowing earnings growth environment.

PAGE 4 FOCUS OCTOBER 28, 2011

Recap
Jennifer Lee, Senior Economist

GOOD NEWS
Retail Sales +0.5% (Aug.)and +0.3% in real terms

BAD NEWS

CANADA U.S. EUROPE JAPAN AUSTRALIA

CANADA
BoC on hold a neutral policy bias now in place MPR cuts growth and inflation forecasts

Conference Boards Consumer Confidence Index -3.3 pts to 71.8 (Oct.)

UNITED STATES
Recession fears ease Housing still the weak spot Run down in consumer savings rate worrying

Real GDP +2.5% a.r. (Q3 A) Core Durable Goods Orders +2.4% (Sep.) Real Personal Spending +0.5% (Sep.) New Home Sales +5.7% to 313,000 a.r. (Sep.) Initial Claims -2,000 to 402,000 (Oct. 22 wk) U of M Consumer Sentiment Index +1.5 pts to 60.9 (Oct. F)preliminary decline erased

Conference Boards Consumer Confidence Index -6.6 pts to 39.8 (Oct.) S&P Case-Shiller House Prices -3.8% y/y (Aug.) FHFA House Prices -4.0% y/y (Aug.) Pending Home Sales -4.6% (Sep.) Employment Cost Index +0.3% (Q3)smallest increase in two years Savings Rate falls to 3.6% (Sep.)lowest in nearly four years Redbook -0.8% (Oct. 22 wk)

EUROPE
EU leaders hammer out a deal, addresses haircut on Greek debt (50%), leveraging EFSF (to 1 trln) and bank recapitalization (106 bln) Details sketchy; need foreign investors

EurozoneIndustrial New Orders +1.9% (Aug.) EurozoneSmoothed M3 +2.6% y/y (Sep.) GermanyGfK Consumer Confidence +0.1 pts to 5.3 (Nov.)first gain in 8 months GermanyConsumer Prices unch (Oct. P) ItalyRetail Sales unch (Aug.)

EurozoneEconomic Confidence -0.2 pts to 94.8 (Oct.) EurozoneManufacturing PMI -1.2 pts to 47.3; Services PMI -1.6 pts to 47.2 (Oct. A) FranceConsumer Spending -0.5% (Sep.) U.K.GfK Consumer Confidence -2 pts to -32 (Oct.)

JAPAN
BoJ raises asset purchases by 5 trln to 20 trln as recovery slows

Exports +2.4% y/y (Sep.) Household Spending +0.9% (Sep.) Jobless Rate -0.2 ppts to 4.1% (Sep.)

Industrial Production -4.0% (Sep. P) Retail Sales -1.5% (Sep.) Consumer Prices unch from a year ago (Sep.)

AUSTRALIA
RBA rate cut next week still a possibility

Core Consumer Prices +0.3% (Q3) Producer Prices +0.6% (Q3)below expected

Indications of stronger growth and a move toward price stability are good news for the economy.

PAGE 5 FOCUS OCTOBER 28, 2011

Feature

The Many Dangers of Low-for-Long Interest Rates

Douglas Porter and Benjamin Reitzes

This weeks Bank of Canada decision to leave rates on hold for the ninth consecutive meeting (and thirteenth straight month) left the impression that policy may well be on hold for the next nine meetings as well. In other words, the Bank seems in precisely no rush to lift borrowing costs with: a) the deeply uncertain global economic backdrop, b) the highly fluid European debt situation, and c) the Federal Reserve likely on hold until at least mid2013. While the prevailing wisdom is that this is absolutely the correct course of action, and many are cheering the prolonged period of ultra-low borrowing costs, the policy does carry a variety of important risks which should not be lightly brushed aside. Moreover, if the acute crisis phase of the European debt drama is overand that is still a big ifthen how long will the current Canadian interest rate setting remain appropriate? After all, BoC Governor Carney recently stated that Europe is the biggest threat facing Canada. Low-for-long interest rates risk triggering broad financial imbalances. This is a purposely vague risk, because almost by definition if officials knew where potential problem areas were brewing, they would address these issues. Suffice it to say, a long period of deeply negative real interest rates is quite CHART 1 simply abnormal, and can quietly encourage risky behaviour MONEY FOR NOTHING among borrowers and investors (Chart 1). The following are Canada (ppts) some of the potential imbalances that might arise: BoC Overnight Rate minus CPI
8 6 4 2 0 -2 -4 93 94 96 98 99 01 03 04 06 08 09 11
CPI = (y/y % chng)

CHART 2

A GROWING CONCERN
(ratio to personal disposable income)
1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 95 97 99 01 03 05 07 09 11
Household credit and mortgages plus unincorporated business mortgages

U.S.

Crossover

1) It encourages households to take on potentially excessive debt: While an extended period of low interest rates can give the illusion that a hefty debt load is manageable, even a small rise in rates can cause problems for many borrowers. Of course, this is a fact the Bank itself has oft mentioned, stressing that borrowers should not be lulled into a false sense of security that low rates are permanent, thus heightening the shock when rates inevitably rise. However, actions speak much louder than words for the Bankit doesnt really matter how much the Bank scolds Canadians if it continues to offer the heavy-duty lure of near-record low borrowing costs. Household debt has risen almost non-stop over at least the past 20 years and to a record share of personal disposable income (Chart 2). Indeed, the Banks concern about household debt is likely one key reason near-term rate cuts are unlikely. 2) It risks inflating a housing bubble: Average home prices have more than doubled in the past ten years, and are up more than 20% in the past three years alone, both far above personal income growth. While affordability remains reasonable, the long stretch of solid gains could set the stage for more speculative activity.

Canada

PAGE 6 FOCUS OCTOBER 28, 2011

Feature
3) It discourages saving: We suggested earlier this year that, based on current expected financial market returns, Canadians on average should be aiming to save roughly 10% of income to ensure adequate retirement savings (Focus February 11, 2011: Are Canadians Saving Enough?). The savings rate has instead weakened to just 4.2% so far this year (Chart 3). There really is little mystery behind why savings are so weak: Between volatile financial markets and deeply negative real interest rates, there is precious little incentive to save. While the TFSA was an entirely welcome addition to the savings landscape, it appears to have made little net impact on the level of household savings rates. 4) It encourages inappropriate risk taking: For those who have no choice but to save, the paltry returns from savings accounts, GICs, and Government of Canada bonds (sub-2.5% ten-year yields), could prompt some to reach for yield. But this reach carries risk, and there are no free lunches. Indeed, Boomers closing in on retirement, or even retirees, who might be tempted to boost the risk profile of their investment portfolio, could irreparably harm their expected retirement income if financial markets go south. 5) It threatens the health of pension plans: The combination of weaker equity markets and sliding longterm interest rates has delivered another hammer blow to the financial position of pension plans globally. Aon Hewitts Pension Risk Tracker shows that Canadian private pension plans currently have a shortfall of about $18 billion, and that their assets covered only 89% of their obligations. U.S. private plans are in worse shape, with a US$314 billion deficit, with assets covering only 82% of liabilities.1 (Chart 4) The deep dive in long-term government bond yields pumps up the present value of liabilities for pension plans. While GOC yields have nudged up slightly from their Q3 lows, the 10-year yield is still down roughly 75 bps since the start of the year (Chart 5). Bank of Canada policy does not directly drive these long-term rates, but a less-loose policy could nudge yields slightly higher, taking some pressure off pension funds.
Record Lows
1

CHART 3

LITTLE INCENTIVE TO SAVE

Canada (% of disposable income : 4-qtr m.a.)

Personal Savings Rate

25 20 15 10 5 0 61 66 71 76 81 86 91 96 01 06 11
forecast

CHART 4

TIME FOR A TOP-UP?

(assets as a percent of liabilties : as of October 26, 2011)

Pension Funding Ratio

120 surplus 110 100 90 80 70 60
deficit

Canada

U.S.
07 08 09 10 11

Source: Aon Hewitt

CHART 5

MEAGRE RISK-FREE RETURNS

Canada (percent)

Benchmark Bond Yields

12 10 8 6 4 2 90 92 94 96 98 00 02 04 06 08 10

30-Year 10-Year

Note that the Canadian Institute of Actuaries recently harmonized the methodology for calculating the discount rate (lowering Aon Hewitts rate 0.2-to-0.5 ppts). The new policy, which has yet to be implemented, will weaken Canadian funding levels.

PAGE 7 FOCUS OCTOBER 28, 2011

Feature
6) It poses a risk to inflation: This may be the most contentious of the risks. However, it seems probable that the prolonged bout of very loose global monetary policies is playing at least a small part in pumping up widespread headline inflation. The fact that core inflation is grinding gradually higher almost everywhere is evidence that there is more at play than simply supply-related issues for some key commodities. While we are not ringing the warning bell on stagflation, it is fair to say that the trade-off between growth and inflation has become much less favourable in recent years. In other words, even the meek industrial world recovery has generated a surprising degree of inflation pressure. And at least some of that pressure in Canada has come in the form of a hot housing marketwhich, in turn, has been fired up by the extended period of ultra-low borrowing costs. Bottom Line: Ultimately, an extended period of negative real interest rates is a heavy punishment for savers and a juicy reward for debtors. Can there be any doubt that the end result will be a household sector that is overburdened by debt and undersupported by savings?

PAGE 8 FOCUS OCTOBER 28, 2011

Economic Forecast
2011 CANADA Real GDP (q/q % chng : a.r.) Consumer Price Index (y/y % chng) Unemployment Rate (%) Housing Starts (000s : a.r.) I II III IV I II 2012 III IV 2010 ANNUAL 2011 2012

3.6 2.6 7.7 178

-0.4 3.4 7.5 192 -61.3

2.0 3.0 7.2 205 -56.2

1.5 2.6 7.2 185 -62.3

1.8 2.2 7.4 184 -59.9

2.0 2.0 7.3 181 -57.8

2.3 2.3 7.3 181 -57.7

2.5 2.0 7.2 182 -56.8

3.2 1.8 8.0 192 -50.9

2.2 2.9 7.4 190 -55.0

1.8 2.1 7.3 182 -58.0

Current Account Balance ($blns : a.r.) -40.3 Interest Rates (average for the quarter : %) Overnight Rate 3-month Treasury Bill 10-year Bond Canada/U.S. Interest Rate Spreads (average for the quarter : bps) 90-day 10-year UNITED STATES Real GDP (q/q % chng : a.r.) Consumer Price Index (y/y % chng) Unemployment Rate (%) Housing Starts (mlns : a.r.) Current Account Balance ($blns : a.r.) Interest Rates (average for the quarter : %) Fed Funds Target Rate 3-month Treasury Bill 10-year Note EXCHANGE RATES (average for the quarter) US/C$ C$/US$ /US$ US$/Euro US$/

1.00 0.95 3.31

1.00 0.95 3.16

1.00 0.88 2.53

1.00 0.86 2.31

1.00 0.86 2.27

1.00 0.86 2.25

1.00 0.86 2.40

1.00 0.86 2.63

0.60 0.56 3.24

1.00 0.91 2.83

1.00 0.86 2.39

82 -15 0.4 2.2 8.9 0.58 -478

90 -5 1.3 3.3 9.1 0.57 -472

86 10 2.5 3.8 9.1 0.62 -467

84 18 2.5 3.8 9.2 0.60 -444

84 23 1.7 3.2 9.2 0.61 -439

84 25 2.1 2.9 9.1 0.62 -435

84 23 2.6 2.7 9.0 0.63 -435

84 21 2.9 2.4 8.9 0.64 -431

42 2 3.0 1.6 9.6 0.58 -471

85 2 1.8 3.3 9.1 0.59 -465

84 23 2.2 2.8 9.1 0.63 -435

0.13 0.13 3.46

0.13 0.05 3.21

0.13 0.03 2.43

0.13 0.02 2.13

0.13 0.02 2.03

0.13 0.02 2.00

0.13 0.02 2.17

0.13 0.02 2.42

0.13 0.14 3.21

0.13 0.05 2.81

0.13 0.02 2.15

101.4 0.986 82 1.37 1.60

103.4 0.967 82 1.44 1.63

102.1 0.979 78 1.41 1.61

98.3 1.017 76 1.37 1.58

96.7 1.034 75 1.35 1.54

95.2 1.050 75 1.33 1.50

96.8 1.033 77 1.35 1.53

99.2 1.008 79 1.39 1.58

97.1 1.030 88 1.33 1.55

101.3 0.987 79 1.40 1.60

97.0 1.031 77 1.35 1.54

Note: Blocked areas represent BMO Capital Markets forecasts Up and down arrows indicate changes to the forecast

PAGE 9 FOCUS OCTOBER 28, 2011

Key for Next Week CANADA

Real GDP at Basic Prices
Monday, 8:30 am Aug. (e) +0.1% Consensus +0.2% July +0.3%

Michael Gregory, CFA, Senior Economist

The Canadian economy likely expanded modestly in August (+0.1%), as the factory sector continued to rebound from its spring setback. Along the distribution chain, however, the decrease in real wholesale activity overwhelmed the increase in retail sales volumes. Meantime, the housing sector took a breather; starts were down sharply as resales were essentially flat (and it was a breather because both metrics bounced back in September). Overall, employment was also essentially flat, which was partly offset by fatter hours, but job creation turned out to mimic the housing metrics, recording a strong rebound in September. Given this modest monthly GDP gain, after a 0.2%-0.3% June-July handoff to start the quarter, and assuming we get at least another modest September gain, there should be no problem living up to our 2.0% annualized growth call for Q3 GDP. While this is still slightly below potential, at least Q2s fractional contraction (-0.4% annualized) wasnt repeated. Temporary jobs related to a slew of provincial elections should support employment growth in October, amid paybacks for historically extreme industry-specific moves. The prior months job losses in the finance, insurance, real estate and leasing industry (-35.3k) were the worst for this sector (for any month) since the Labour Force Survey began in 1976. Any positive payback here will probably be at least partly offset by negative paybacks in professional, scientific and technical services along with nonfarm natural resources for these sectors second-strongest months on record (+35.6k and +17.1k, respectively, in September), although the latter was likely legitimately flattered by catch-up hiring in the oil patch. Meantime, underlying labour demand likely cooled amid the months escalating economic uncertainty and ebbing business confidence. We look for total employment to grow 15,000, which should keep the unemployment rate at 7.1% (with a net risk of a tenth tip up).

Employment
Friday, 7:00 am Oct. (e) +15,000 (+0.1%) Consensus +20,000 (+0.1%) Sep. +60,900 (+0.4%) Unemployment Rate Oct. (e) 7.1% Consensus 7.2% Sep. 7.1% Average Hourly Wages Oct. (e) +1.6% y/y Sep. +1.5% y/y

UNITED STATES
Manufacturing ISM
Tuesday, 10:00 am PMI Oct. (e) 52.0 Consensus 52.2 Sep. 51.6 Prices 55.0 55.0 56.0

Sal Guatieri, Senior Economist

Improved regional surveys suggest the ISM manufacturing index rose modestly to 52 in October, a second monthly gain after nearly slipping below 50 (neutral) in August. Auto production has rebounded from the supply-chain glitch, while business capital spending is speeding up ahead of the possible year-end expiration of the accelerated depreciation allowance. A pickup in the employment sub-index could indicate the first increase in factory payrolls in three months. After announcing unconventional easing moves at the last two meetings (low-forlonger pledge and Operation Twist), the Fed could take a breather, comforted by firmer economic data. Still, given our view that more stimulus will eventually be required to reduce the unemployment rate, and given recent comments from key officials (Vice Chair of the Board of Governors Yellen, Vice Chair of the FOMC Dudley, and Governor Tarullo) that suggest a bias to do more, we cant rule out another move next week. In the event, reviving the MBS purchase program (a feature of QE1) could

FOMC Announcement
Wednesday, 12:30 pm

PAGE 10 FOCUS OCTOBER 28, 2011

Key for Next Week

be the next tool that Bernanke pulls out of his policy toolkit. The resulting downward pull on mortgage rates would complement the Administrations revamped program that allows more underwater homeowners to refinance at lower rates. Should the FOMC vote for more stimulus, three members (Fisher, Plosser and Kocherlakota) will likely rebel again.

Nonmanufacturing ISM
Thursday, 10:00 am Oct. (e) 54.0 Consensus 53.5 Sep. 53.0

Although the ISM nonmanufacturing index took a step back in September, it should more than retrace to 54 in October, indicating continued economic growth. The business activity sub-index reached a six-month high in September, and a further advance would suggest some economic momentum in Q4. Conversely, the jobs measure fell to a 1-year low last month, suggesting companies are trying to milk the productivity cow again in the face of heightened economic uncertainty. A further decline in the jobs measure would flag a weak October payrolls report. Just nine industries reported growth last month, the fewest in over a year, and the tone of the responses reflected increased concerns about the economic outlook and Europe. Nonfarm payrolls probably rose a modest 70,000 in October, down from 103,000 in September, a gain flattered by the return of 45,000 striking Verizon workers. Private sector payrolls should show some modest underlying improvement, rising 100,000 after a Verizon-adjusted increase of 92,000 in September. Governments likely chopped 30,000 positions in October, in line with the norm of the past six months. Job growth is too weak to reduce the jobless rate, which likely edged up to 9.2% in October. Of note, the effective unemployment rate of 16.5% has turned up recently, as more job seekers have been forced to accept part-time work and/or have given up looking. Meantime, the average duration of unemployment hit a new high of 40.5 weeks in September. Despite the economic pickup, the national crisis (according to Bernanke) continues.

Nonfarm Payrolls
Friday, 8:30 am Oct. (e) +70,000 Consensus +95,000 Sep. +103,000 Unemployment Rate Oct. (e) 9.2% Consensus 9.1% Sep. 9.1% Average Hourly Earnings Oct. (e) +0.2% Consensus +0.2% Sep. +0.2%

PAGE 11 FOCUS OCTOBER 28, 2011

Financial Markets Update

OCT 28 * OCT 21 CHANGE FROM: (BASIS POINTS) WEEK AGO 4 WEEKS AGO DEC. 31/10

Canadian Money Market

Call Money Prime Rate

1.00 3.00 0.25 3.25 0.91 0.00 0.20 1.59 0.99 4.82

1.00 3.00 0.25 3.25 0.88 0.02 0.10 1.59 0.98 4.86

0 0 0 0 3 -2 10 1 1 -3

0 0 0 0 11 -2 10 4 3 -2

0 0 0 0 -6 -12 8 59 23 -8

U.S. Money Market

Fed Funds (effective) Prime Rate

3-Month Rates
Canada United States Japan Eurozone United Kingdom Australia

Bond Markets
2-year Bond Canada United States 10-year Bond Canada United States Japan Germany United Kingdom Australia

1.09 0.30 2.41 2.32 1.04 2.18 2.60 4.54 25.7 43 114 619 100.55 0.995 75.73 1.4165 1.610 107.08 322.92 92.79 3.90 1743.53 12497 1280 2729 12198 9050 6320 5691 3341 4353

1.08 0.27 2.36 2.22 1.01 2.10 2.53 4.49 31.3 40 131 718 99.34 1.007 76.29 1.3896 1.595 103.76 311.08 87.40 3.83 1642.38 11949 1238 2637 11809 8679 5971 5489 3171 4142

1 3 5 10 3 8 7 5 -5.6 pts 3 -17 -99 1.2 -0.7 1.9 0.9 3.2 3.8 6.2 1.9 6.2 4.6 3.3 3.5 3.3 4.3 5.8 3.7 5.3 5.1

21 5 26 40 1 30 17 32 -17.2 pts 8 -31 -207

(% CHANGE)

-59 -30 -71 -98 -9 -78 -80 -100 8.0 pts 25 29 189 0.4 -6.6 5.8 3.1 4.6 -3.0 1.5 -11.5 22.7 -7.0 1.7 2.9 5.4 -11.5 -8.6 -3.5 -12.2 -8.3

Risk Indicators
VIX TED Spread Inv. Grade CDS Spread ** High Yield CDS Spread **

Currencies
US/C$ C$/US$ /US$ US$/Euro US$/ US/A$

5.6 -1.7 5.8 3.3 10.8 8.3 17.2 6.4 7.4 7.5 13.1 13.0 11.8 4.0 14.9 11.0 12.0 8.6

Commodities
CRB Futures Index Oil (generic contract) Natural Gas (generic contract) Gold (spot price)

Equities
S&P/TSX Composite S&P 500 Nasdaq Dow Jones Industrial Nikkei Frankfurt DAX London FT100 France CAC40 S&P ASX 200
* as of 10:30 am ** One day delay

PAGE 12 FOCUS OCTOBER 28, 2011

OCTOBER 31 NOVEMBER 4
MONDAY OCTOBER 31 TUESDAY NOVEMBER 1 WEDNESDAY NOVEMBER 2 THURSDAY NOVEMBER 3
Culture Day (Markets Closed)

Global Calendar
FRIDAY NOVEMBER 4

JAPAN EUROZONE

Manufacturing PMI Oct. Sep. 49.3

EUROZONE

EUROZONE

EUROZONE

EUROZONE

Consumer Price Index Oct. P (e) +2.9% y/y Sep. +3.0% y/y Jobless Rate Sep. (e) 10.0% Aug. 10.0%
GERMANY

Manufacturing PMI Oct. F (e) 47.3 Oct. A 47.3 Sep. 48.5

GERMANY

Retail Sales Sep. (e) +1.0% Aug. -2.7%

FRANCE

+1.6% y/y +2.2% y/y

Unemployment Oct. (e) -10,000 Sep. -26,000 Jobless Rate Oct. (e) 6.9% Sep. 6.9% Real GDP Q3 A (e) +0.3% Q2 +0.1% Manufacturing PMI Oct. (e) 50.0 Sep. 51.1 Nationwide House Prices Oct. (e) unch Sep. +0.1% Construction PMI Oct. (e) 50.0 Sep. 50.1

ECB Monetary Policy Meeting

Services PMI Oct. F (e) 47.2 Oct. A 47.2 Sep. 48.8 Producer Prices Sep. (e) +0.2% Aug. -0.1% Factory Orders Sep. (e) +0.1% Aug. -1.4%

+5.8% y/y +5.9% y/y

GERMANY

+7.5% y/y +3.9% y/y

Producer Prices Sep. (e) +0.1% Aug. unch

ITALY

+6.1% y/y +6.3% y/y

+0.4% y/y +0.6% y/y

Services PMI Oct. (e) 52.0 Sep. 52.9

Consumer Prices Oct. (e) +0.6% Sep. +2.0% Producer Prices Sep. (e) +0.4% Aug. +0.1% Jobless Rate Sep. (e) 7.9% Aug. 7.9%

+3.5% y/y +3.6% y/y +4.7% y/y +4.8% y/y

+0.5% y/y -0.3% y/y

CHINA

AUSTRALIA

CHINA

U.K.

Oct. (e) Sep.

Manuf. PMI HSBC PMI 51.8 n.a. 51.2 49.9

AUSTRALIA

Retail Sales Sep. (e) +0.4% Aug. +0.6%

OTHER

Reserve Bank of Australia Monetary Policy Meeting Building Approvals Sep. (e) -4.9% Aug. +11.4% +0.1% y/y -5.5% y/y

Non-manufacturing PMI Oct. Sep. 59.3 HSBC Services PMI Oct. Sep. 53.0

OCTOBER 31 NOVEMBER 4
MONDAY OCTOBER 31 TUESDAY NOVEMBER 1
9:30 am RBC Manufacturing PMI (Oct.) Auto Sales ** Oct. Sep. -0.4% y/y

North American Calendar

THURSDAY NOVEMBER 3 FRIDAY NOVEMBER 4
7:00 am Oct. (e) Consensus Sep. 7:00 am Oct. (e) Consensus Sep. 7:00 am Oct. (e) Sep. 8:30 am Sep. (e) Aug. 10:00 am Oct. (e) Consensus Sep. 8:30 am Oct. (e) Consensus Sep. 8:30 am Oct. (e) Consensus Sep. 8:30 am Oct. (e) Consensus Sep. Employment +15,000 (+0.1%) +20,000 (+0.1%) +60,900 (+0.4%) Unemployment Rate 7.1% 7.2% 7.1% Average Hourly Wages +1.6% y/y +1.5% y/y Building Permits +4.0% -10.4% Ivey PMI (s.a.) 54.5 55.0 55.7 Nonfarm Payrolls +70,000 +95,000 +103,000 Unemployment Rate 9.2% 9.1% 9.1% Average Hourly Earnings +0.2% +0.2% +0.2%

WEDNESDAY NOVEMBER 2

CANADA

8:30 am Aug. (e) Consensus July 8:30 am

Real GDP at Basic Prices +0.1% +0.2% +0.3% Industrial Raw Product Materials Price Index Price Index Sep. (e) unch -0.8% Consensus -0.1% -1.9% Aug. +0.5% -3.2%

12:05 pm 3-year bond auction $3.0 bln (New cash $3.0 bln)

2-year bond auction announcement 8:30 am Oct. 29 (e) Oct. 22 8:30 am Oct. 22 Oct. 15 8:30 am Initial Claims 400k (-2k) * 402k (-2k) Continuing Claims

UNITED STATES

9:45 am Oct. (e) Sep. 10:00 am Oct. (e) Sep. 10:30 am Oct. (e) Sep.

Chicago PMI 59.0 * 60.4 Milwaukee PMI 56.0 * 55.4 Dallas Fed Mfg. Activity -5.0 * -14.4

7:45 am ICSC Same-Store Sales Oct. 29 Oct. 22 (mtd) -1.2% m/m +3.1% y/y 8:55 am Redbook Same-Store Sales Oct. 29 Oct. 22 (mtd) -0.8% m/m +4.5% y/y 10:00 am Manufacturing ISM PMI Prices Oct. (e) 52.0 55.0 Consensus 52.2 55.0 Sep. 51.6 56.0 10:00 am Construction Spending Sep. (e) +0.3% * Aug. +1.4% Total Vehicle Sales ** Oct. (e) 13.2 mln a.r. Consensus 13.2 mln a.r. Sep. 13.1 mln a.r.

7:00 am Oct. 28 Oct. 21 7:30 am Oct. Sep. 8:15 am

MBA Mortgage Apps +4.9% Challenger Layoff Report

+211.5% y/y ADP National Employment Report Oct. (e) +100,000 Consensus +100,000 Sep. +91,000 10:00 am Homeowner Vacancy Rate Q3 Q2 2.5% 12:30 pm FOMC Announcement 2:15 pm Quarterly FOMC Press Briefing

FOMC Meeting Begins 11:00 am 4-week bill auction announcement 11:30 am 13- & 26-week bill auction $56.0 bln 2:00 pm Fed repurchase schedule update * consensus ** date approximate

3,645k (-96k) Productivity Unit Labour Costs Q3 P (e) +2.5% a.r. unch Consensus +2.7% a.r. -0.5% a.r. Q2 -0.7% a.r. +3.3% a.r. 9:45 am Bloomberg Consumer Comfort Index Oct. 30 Oct. 23 -51.1 10:00 am Factory Orders Sep. (e) -0.4% Consensus -0.1% Aug. -0.2% 10:00 am Nonmanufacturing ISM Oct. (e) 54.0 Consensus 53.5 Sep. 53.0 ICSC Chain-Store Sales Nov. (e) +4.5% y/y Oct. +5.5% y/y

11:00 am 11:30 am 4-week bill auction

3 & 10-year note, 30-year bond auction announcement

G20 Summit in Cannes, France (November 34)

Upcoming Policy Meetings Bank of Canada: December 6, January 17, March 8 FOMC: December 13, January 24-25, March 13

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