bernanke faces inquisition

8/3/2019 Bernanke Faces Inquisition

http://slidepdf.com/reader/full/bernanke-faces-inquisition 1/17PLEASE SEE IMPORTANT DISCLAIMER AND DISCLOSURES AT THE END OF THE DOCUMENT `

30 September 2011

Cross Asset ResearchWeekly

www.sgresearch.com

Focus US Bernanke faces the Inquisition

Fed Focus Current performance does not guarantee future results p.3

[email protected] Incoming activity data continue to hold up well despite the nosedive in sentiment. Q3 GDP is now tracking

slightly above 2%. The problem is that solid growth today does not guarantee solid results in the future. Indeed,

financial conditions continue to point to further downside risks. In recent weeks, financial contagion appears to

have spread to US banks and the risk is that non-financials may be next. This is precisely what the Fed tried to

hedge against with “Operation Twist”. The question is what else can the Fed do if the situation deterioratesfurther? Bernanke’s testimony before the Joint Economic Committee next week will hopefully offer some

guidance. However, we do not expect the Chairman to offer strong new policy signals at this stage. Bernanke

has to walk a fine line between showing readiness to act and not stirring up further controversy on the Fed’s

aggressive actions.

Eco Focus The usual suspects p.5

[email protected] The statistical calendar for the first week of October will be bracketed by the Institute for Supply Managment’s

(ISM) survey of manufacturing conditions and the Bureau of Labor Statistics’ update on the employment situation

in September. We expect both reports to surprise to the upside compared to current Street projections. Between

Monday and Friday, figures on private job growth from ADP employer services, non-manufacturing activity from

the ISM and jobless claims from the Department of Labor may also thinking heading into the all-important

nonfarm payroll report.

Rates Focus Quo vadis? p.7

[email protected] Financial markets continue to sail into unchartered territory. Apart from the stress coming from the European

front, the Fed is about to further dislocate the US Treasury curve with “Operation Twist”. We discuss the impact of

this on long-dated rates and suggest a trade that benefits from a normalization going forward.

Fiscal Focus How to balance a budget in a few steps p.9

[email protected] Over the next two months news flow and speculation will steadily increase with regards to the US debt super

committee’s ability to crank out a bipartisan deficit reduction proposal by November 23. Gi ven the highly partisan

nature in Washington, it is unlikely that we will see a grand deal that includes tax increases and entitlement reform

that is more than a token gesture. Our baseline scenario is for stabilization of the debt, but at a higher level than

the President’s plan or the CBO’s base line forecast. In this article, we go through a few steps that could balance

the budget while addressing entitlement reform and including revenue into the equation.

Credit Focus Five Trade Ideas in the U.S. Financials Space p.12

[email protected] After a week of significant spread widening and downgrades by Moody’s of Citigroup, Bank of America, and Wells

Fargo, the last week of 3Q11 is starting off on a relatively quiet note. And while we expect this quiet tone to

continue for most of the week, quiet should not be mistaken for stable, as volatility continues to be the theme in

the US financials space. Indeed, after last week’s 26 -118 bps widening in 5 year CDS for the major banks, most

names are now at their widest point in the last 12 months. Unfortunately, there seems to be little to arrest this

volatility in the short-term, making it extremely difficult for longer-term oriented investors to put money to work.

However, this volatility does continue to create interesting relative value opportunities in both the cash and CDS

space for investors who are looking to take advantage of certain situations where specific relationships have

become dislocated. Therefore, we provide five trade ideas that have popped up on our screens this afternoon.

Calendar/Forecasts p.14

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Focus US

30 September 2011 2

ECONOMIC DATA PREVIEW

Release date Reference Period SG Forecast Consensus Previous

Construction spending (%mom) 10/03 10:00 August 0.0 -0.2 -1.3

ISM manufacturing/ISM-price paid 10/03 10:00 September 52.0/57.0 50.5/53.8 50.6/55.5

Total vehicle sales (mln saar) 10/03 17:00 September 13.0 12.6 12.1

Factory orders (%mom) 10/04 10:00 August -0.5 0.1 2.4

ADP employment (thous. sa) 10/05 08:15 September 45 75 91

ISM Non-Manf. Composite 10/05 10:00 September 54.2 52.8 53.3

Initial jobless claims/continuing (thou. sa) 10/06 08:30 30 Sep / 24 Sep 395/3745 410/3725 410/3765

ICSC Chain Store Sales (%yoy) 10/06 September 5.0 na 4.6

Nonfarm payrolls (thous. Sa) 10/07 08:30 September 115 58 0

Nonfarm /priv. payrolls Ex strikers (thous. Sa) 10/07 08:30 September 70/110 na 46/63

Unemployment rate (%) 10/07 08:30 September 9.0 9.1 9.1

Avg hourly earnings (%mom) 10/07 08:30 September 0.5 0.2 -0.1

Wholesale Inventories (%mom) 10/07 10:00 August 1.0 0.6 0.8

Consumer Credit (USD bn) 10/07 15:00 August 8.84 7.50 11.97

Source: SG Cross Asset Research, Bloomberg. For more forecasts, see the Calendar at the end of the publication.

F173936



Focus US

30 September 2011 3

Fed Focus

Current performance does not guarantee future resultsIncoming activity data continue to hold up well despite the

nosedive in sentiment. Q3 GDP is now tracking slightly

above 2%. The problem is that solid growth today does not

guarantee solid results in the future. Indeed, financial

conditions continue to point to further downside risks. In

recent weeks, financial contagion appears to have spread

to US banks and the risk is that non-financials may be

next. This is precisely what the Fed tried to hedge against

with “Operation Twist”. The question is what else can the

Fed do if the situation deteriorates further? Bernanke’s

testimony before the Joint Economic Committee next weekwill hopefully offer some guidance. However, we do not

expect the Chairman to offer strong new policy signals at

this stage. Bernanke has to walk a fine line between

showing readiness to act and not stirring up further

controversy on the Fed’s aggressive actions.

So far, so good … but downside risks mount Hard

activity data continue to hold up well despite the nosedive

in confidence. Business investment in particular remains

resilient and appears on track for a significant gain in Q3.

This puts our Q3 GDP tracking estimate at 2.2%. This is

still too close to trend for the Fed’s comfort, but certainlybetter than the average growth of 0.8% in the first half of

the year.

The problem is that solid growth today is no guarantee

that it will hold up in the coming months. Financial

conditions continue to pose a significant risk to the

outlook. We have already shaved more than a percentage

point off of our 2012 forecast on the back of tighter credit,

but the lack of improvement in conditions poses further

downside risk. Indeed, in the past week, our financial

conditions index has deteriorated further and now

exceeds two standard deviations (see chart 1.3). The hitmay start adversely impacting the economy as early as

Q4.

Financial contagion spreads to US banks Until

recently, funding problems were seen as largely

concentrated in the European banking sector. However,

over the past two weeks, US financials have seen their

CDS spreads widen considerably even as European bank

spreads narrowed modestly (see Chart 1.1). This is in part

driven by concern about US exposure to European

institutions. As a result, CDS spreads for US financials are

now at levels last seen in early 2009. Corporates fine so far, but how long? The contagion

to the US financial sector will no doubt be seen with

alarm at the Fed. One consolation may be the fact that

the non-financial sector so far has only seen modest

contagion. However, it is hard to believe that the gap

between financials and non-financials (see Chart 1.2) can

remain this wide for a sustained period of time. It is true

that corporate America has substantial amounts of cash

and is less dependent on banks and capital markets than

it was back in 2008. However, the financial sector is still

the life blood of the economy. Small businesses, in

particular, are highly dependent on financial institutions.

Chart 1.1: Financial contagion spreads to US banks

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400

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600

07 08 09 10 11

bps

US Banks

European Banks

5yr CDS spreads

Source: Bloomberg, SG Cross Asset Research/Economics

Chart 1.2: Corporates still fine, but for how long?

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US Financials

US Industrials

5yr CDS spreads

Source: Bloomberg, SG Cross Asset Research/Economics

The gap between financials and nonfinancials was

similarly wide in mid-2008, but eventually non-financialspreads widened sharply as the crisis became systemic

F173936



Focus US

30 September 2011

4

and spread to the broader economy. Could the gap close

via

contraction in financial spreads? It is certainly possible,but the longer the European sovereign crisis goes

unresolved, the greater the risk that contagion will

eventually spread to the broader US economy.

Ongoing debate on what the Fed can and should do

With this backdrop in mind, Bernanke heads to Congress

next week to testify on the US economy before the Joint

Economic Committee. The FOMC statement sounded

decidedly downbeat on the outlook, with significant

downside risks emanating from tighter financial

conditions. Bernanke is likely to reiterate this position,

with heavy discussion of financial sector developments.Doubtless, Bernanke also will be grilled on the “twist”,

particularly by those in Congress who are opposed to any

further Fed stimulus. By taking the recent unprecedented

steps, the Fed has put itself at the cross hairs of an

unpleasant political debate.

Leaving politics aside, the more pressing question is what

else the Fed can do? We look forward to Bernanke’s

guidance on that. We see QE3 as the most likely next

step, but our central scenario is that it will not happen

until 2012 when inflation moderates. As far as nuclear

options, several Fed officials have mentioned price leveltargeting as an option, but Bernanke has been cautious

not to endorse it publicly. We do not expect a change in

his stance for now.

[email protected]

Recent Fedspeak Highlights

Bernanke – Recent weakness only in part due to temporary factors.

However, believes that recent spike in inflation is transitory and

should dissipate. Labor market is still key.

Dudley – Long way to go for Fed to meet dual mandate. In recent

speeches, he stuck with the official FOMC statement, though

highlighted that the Fed considered further easing options. He is

satisfied with the drop in rates post-FOMC announcement, but still

concerned about the fragile equity markets. Clearly biased toward

further easing. In the past, Dudley also expressed support for price

level targeting.

Fisher – Voted against the commitment to keep rates low through

2013. Believes that the Fed should not respond to swings in equitymarkets. Also suggested that the commitment to low rates removes

the incentive for businesses to invest in the short-rum.

Kocherlakota – Also voted against the latest Fed decision. Believes

that unemployment will be close to 8.5% at end of year. Given his

forecasts he views that the Fed funds rate target should be raised by

50bps before the end of the year.

Plosser – The third dissenter. Believed that the decision was

premature and would like to have seen more data (though after

seeing the Philly Fed survey for August, he may have changed his

mind). Anyway, Plosser is comfortable with the deeply negative real

interest rates and favors faster normalization of monetary policy.

Evans – Very dovish. Believes the US is in a balance sheet

recession. Believes that high unemployment is not structural, but

rather an outcome of weak demand. Like Dudley, Evans also

endorsed price level targeting as a policy option.

Lockhart– Economy is halting and showing lack of conviction. Wary

of tightening policy unless absolutely necessary. Would like an

explicit inflation target of 2%.

Chart 1.3 SG weekly financial conditions index Chart 1.3 Doves still in the voting majority

-9

-8-7

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-5

-4

-3

-2

-1

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2

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Index

SG Financial Conditions Index

-1

-3

0

-1

0

-3

3

3

-4

4

-4

2

-1-1

2

5

-4

*Bernanke

*Yellen

* Tarullo

* Duke

*Raskin

* Dudley

**Fisher

**Kocherlakota

**Evans

**Plosser

***Pianalto

***Lacker

***Lockhart***Williams

Bullard

Hoenig

Rosengren

D O V I S H H A W K I S H

2011 voters

* perma nent voters; ** 2011 voters; *** 2012 voters Source: Global Insight, SG Cross Asset Research/Economics Source: Global Insight, SG Cross Asset Research/Economics

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Focus US

30 September 2011 5

Eco Focus

The usual suspectsThe statistical calendar for the first week of October will be

bracketed by the Institute for Supply Managment’s (ISM)

survey of manufacturing conditions and the Bureau of

Labor Statistics’ (BLS) update on the employment situation

in September. We expect both reports to surprise to the

upside compared to current Street projections. Between

Monday and Friday, figures on private job growth from

ADP employer services, non-manufacturing activity from

the ISM and jobless claims from the Department of Labor

(DoL) may also color thinking heading into the all-

important nonfarm payroll report.

National purchasers’ gauge rose in September

Manufacturing reports from district Federal Reserve

Banks, combined with auto-related pickups in a variety of

midwestern ISM gauges, suggest that the national

purchasing managers’ index climbed to a three-month

high of 52.0 in September (see Chart 2.1). Wider reports

of stepped-up hiring at factories probably will provide a

lift to the headline measure in next week’s report. We

would be very careful about projecting any change in the

ISM employment gauge to movements in factory payrolls

in the BLS’ report, however. Although the correlationbetween the ISM hiring barometer and the monthly

change in manufacturing employment is high (0.89%), the

former has accurately called the direction of the latter just

half of the time since 1988. Consistent with the expected

improvement in demand, the prices-paid diffusion index

likely climbed by 1½ percentage points to 57.0 – the first

rise since April.

Chart 2.1: Regional surveys point to rise in national factory index

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45

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55

60

65

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2007 2008 2009 2010 2011

ISM National Mfg IndexDis trict Fed Bank AvgRegional ISM AvgFed & ISM Avg

Source: SG Cross Asset Research

Returning strikers boosted nonfarm job count Buoyed by the return of 45,000 striking workers at

Verizon Corporation, nonfarm payrolls probably climbed

by 115,000 in September – the largest job gain since

April. Net of the boost related to the resolution of the

aforementioned labor dispute, private entities likely added

110,000 positions, a touch above the 98,000 average

posted over the June-August span. Reflecting continued

pink-slipping by cash-strapped states and municipalities,

government payrolls probably contracted by 40,000 last

month, boosting cumulative public job losses over the

past three years to an eye-popping 654,000.

The remaining portions of the BLS’ September survey are

expected to be comparatively positive as well. Echoingthe observed downtick in our augmented insured

unemployment rate between establishment surveys, the

civilian jobless percentage likely dipped to a five-month

low of 9.0%. Meanwhile, the average workweek of all

employees probably expanded by six minutes to 34.3

hours, erasing the reported August decline. If our

forecasts are on the mark, the index of aggregate hours

worked climbed by 0.4% during the reference period.

Barring any prior-month revisions, our estimate would

place hours worked over the July-September span level

with the second-quarter average, hinting at a summerrebound in nonfarm business productivity. Reflecting

quirks associated with the timing of the September

establishment survey, average hourly earnings likely

jumped by 0.5%, pushing the year-to-year growth of this

closely followed nominal compensation gauge three ticks

higher to 2.2%.

Chart 2.2: Drop in continuing claims hints at pickup in private jobs

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Jan Feb Mar Apr May Jun Jul Aug Sep

thousands

Decline in Total Continuing Claims Private Payroll Change Ex Strikers

Ests


Another head-fake from ADP?

The ADP National Employment Report may once againwrongly color expectations heading into the official BLS

release. The 19,000 rebound in the average number of

F173936



Focus US

30 September 2011 7

Rates Focus

Quo vadis?Financial markets continue to sail into unchartered

territory. Apart from the stress coming from the European

front, the Fed is about to further dislocate the US Treasury

curve with “Operation Twist”. We discuss the impact of

this on long-dated rates and suggest a trade that benefits

from a normalization going forward.

Heading into unchartered territory . The lack of

progress in defusing the European sovereign debt crisis,

the ongoing banking financing troubles and the

continuing concerns regarding the US recovery have

already caused a significant deterioration in liquidity.Now, the approaching quarter-end has even led to a

worsening of the situation. Quarter-end window

dressing is plaguing the market even more than usual, as

a large number of financial institutions want to present

investors with a lean and clean balance sheet. This

involves moving risky assets off the books, as much as

this is possible. There used to be a number of broker-

dealers with fiscal years different from the rest of the

Street. Those institutions provided liquidity by taking

some of the “unfavourable” assets on their balance sheet

during periods of balance sheet window dressing.However, those broker-dealers either went out of

business (Bear Stearns) or transformed themselves into

bank holding companies in 2008 (Goldman Sachs,

Morgan Stanley). This means that pretty much everyone

is trading in the same direction, which hurts liquidity in the

market and causes risky assets to trade at a larger-than-

usual discount.

As we noted in Wednesday’s Daily, one noticeable victim

in this respect has been GSE paper which, on an asset

swap spread basis, cheapened some 10bp from a week

ago.1

With GSEs essentially being less-liquid Treasuries,in our view, this creates an opportunity for investors to

position for a renewed GSE spread tightening past

quarter-end. We discuss this theme in more detail in the

Agency section of our latest Rates Weekly. The

corporate new issuance market is yet another example

of the peculiar market situation: While high quality issuers

(single-A or better) enjoy strong funding opportunities,

lower-ranked ones (triple-B or lower) either can’t issue at

all (as happened in the previous week) or only at a

sizeable concession (as in this past week).

Global uncertainty, lack of market participation andbalance sheet restrictions of liquidity providers are

1 Curve flattening and the poor performance of many duration hedges may havecontributed to this move.

causing market prices to trade in a much wider range

than usual. This is true not only for stocks (see Chart 3.1),

but also for most fixed-income products.

Chart 3.1: Global uncertainty causes oscillating prices in all majormarkets, including the equity market

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Jan Apr Jul Oct

S & P I n d e x

Source: SG Cross Asset Research, Bloomberg

30-year TSY - Mind the gap! “Operation Twist” has

changed the dynamics of the 10- to 30-year sector of the

Treasury curve, forcing market participants to re-calibrate

their models and to adjust their thinking about the back

end of the yield curve. Until recently, the very long end of

the Treasury curve was widely considered to be orphaned

as few investors dared to express a view on this relatively

illiquid and difficult-to-hedge part of the curve.

With the Fed stepping in as a potent incremental buyer,

a number of things have happened.

First, the market instantaneously reduced the term-risk

premium, causing 30-year yields to gap lower (see

Chart 3.2).

Second, 10s30s slope flattened significantly, as the

Fed’s buying program is focused on the 20- to 30-year

part of the curve. This reverses the previous steepening

trend caused primarily by market participants’ lack of

balance sheet and their ability to invest in long-dated

Treasuries (see Chart 3.3).

Third, implied volatility on 30-year tails has shot higher

and now trades at a significant premium over volatility

on shorter tails (see Chart 3.4).

While both the anticipation and the announcement of

“Operation Twist” had a pronounced bull-flattening effect

on the back end of the yield curve, it now remains to beseen whether the execution of the program will cause a

continuation of the trend, or (as happened during QE1) a

reversal of the initial market reaction will take place.

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Focus US

30 September 2011 9

Fiscal Focus

How to balance a budget in a few stepsOver the next two months news flow and speculation will

steadily increase with regards to the US debt super

committee’s ability to crank out a bipartisan deficit

reduction proposal by November 23. Given the highly

partisan nature in Washington, it is unlikely that we will see

a grand deal that includes tax increases and entitlement

reform that is more than a token gesture. Our baseline

scenario is for stabilization of the debt, but at a higher level

than the President’s plan or the CBO’s baseline forecast. In

this article, we go through a few steps that could balance

the budget while addressing entitlement reform andincluding revenue into the equation.

Closing in on November 23 With the President’s

deficit reduction plan now out in the open, it is now up to

the debt super committee to agree on a proposal by

November 23. While it is highly unlikely that the

committee will adopt Obama’s plan, the proposal does

act as one flag post to help navigate to an agreement.

In terms of deficit reduction, Obama’s plan is somewhere

between his Deficit Commission’s proposal which

assumes a return to a balanced budget; and the S&P

baseline that assumes a high level of deficits over the

next 10-years. From a policy perspective, Obama’s heavy

reliance on tax increases puts it to the left of the Debt

Commission and even further left from House Budget

Chairman Paul Ryan’s plan which reduced the deficit with

no tax increases.

Obama’s plan called for one dollar of tax increases for

every two dollars in spending cuts. The Debt Commission

looked for one dollar in tax increases for every three

dollars in spending reductions. As we said in our initial

analysis of the Obama deficit plan, we were disappointed

by the heavy reliance on Tax cuts, as well as little on the

side of entitlement reform.

Looking over the instruction manual. Over the

coming weeks we will likely see more plans on how to

reduce the deficit to add to our collection. Not to miss out

on all the fun we will briefly illustrate what type ofmeasures could be taken to bring the budget close to

balance over the next 10-years. The CBO provides a

comprehensive analysis of various budget options that

could reduce the deficit and we use this as the framework

in which we will slice up the deficit. We will look first at

the CBO’s baseline assumption, a worst case scenario,

and our current fiscal baseline before examining a

hypothetical scenario that balances the budget.

CBO’s errs on the side of current law. The CBO’s baseline

scenario is on the optimistic side, as it assumes that the

Bush tax cuts are left to expire, no AMT relief and a doctor

payment rates reduction. It does include $2.1bn in austerity

measures outlined in the Budget Control Act of 2011, the

debt ceiling deal. The result is a ten-year cumulative deficit of

$3.1tn with a deficit-to-GDP of a manageable 1.2% versus

8.5% today. Debt-to-GDP under these assumptions

Chart 4.1: Extension of expiring policies will move debt-to-GDP todangerous levels

Chart 4.2: Hypothetical deficit reduction scenario moves towardsbalancing the budget.

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All tax cuts extendedSG BaselineObama def icit reductionSG hypothetical scenarioCBO baseline

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2009 2011 2013 2015 2017 2019 2021

All tax cuts extendedSG Baseline

Obama def icit reductionSG hypothetical scenarioCBO baseline


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Focus US

30 September 2011 10

should fall to 61% of GDP from a peak of 73% in 2013.

The main issue with the CBO baseline is that it assumes

that there is no reform to entitlement spending. This

suggests that beyond 2021 the deficit could revert back

to an adverse path.

Bad habits are hard to break. Under the worst case,

we assume that the Bush tax cuts will be made

permanent, AMT is indexed to inflation, other expiring tax

measures are made permanent, and doctor-payment

rates are maintained. We also assume that there is $2.1tn

in spending cuts from the Budget Control Act of 2011 (the

debt ceiling agreement). This would result in a cumulative

ten-year deficit of $8.2tn. By 2021 debt-to-GDP should

rise to 83% from 68% today with the deficit checking inat 4.4% in 2021 and rising.

We sit somewhere in the middle. Our baseline

assumes that the Bush Tax cuts are only extended for

those making under $250k, $180bn in fiscal stimulus in

2011, and $2.4tn in deficit reduction over the next 10

years. Under our scenario, we should see the debt-to-

GDP rise to 77.1% by the end of 2021. The SG baseline

follows a similar path to the deficit reduction plan outlined

by President Obama. Neither of the scenarios assumes

significant enough entitlement reform to stem costs

related to demographics after 2021. One for every three. We have always maintained

that the framework to follow for deficit reduction should

be the President’s Deficit Commission’s proposal. But

even the President has not followed his own

Commission’s advice. But we will in this exercise on how

a few steps can bring the budget closer to balance.

Using a framework that relies on $1 of revenue for every

$3 of spending reduction, our scenario suggests that a

$4.2tn deficit reduction plan could bring the budget

almost to balance by 2021. Discretionary spending cuts

account for about 40% of the total deficit reduction withmost of the gains made through the $900bn first stage of

cuts outlined in the BCA and ending of overseas wars

($1.3tn). We also assume that the full amount of the

Obama’s Jobs Act, $447, is implemented.

The lack of progress on mandatory spending reform has

been disappointing, particularly given that there are

several straightforward fixes available. With respect to

Social Security, the current inflation assumption

overstates actual inflation. A shift from CPI-W (wage

earners and clerical workers) to CPI-U (all urban

consumers), which captures a greater portion of thepopulation, could save the tax payer $110bn over the

next ten years. As well, raising the limit of taxable

earnings for Social Security reduces the deficit by about

$460bn. Increasing eligibility and full retirement ages

saves about $260bn. These and other small fixes could

shave off about $1.1tn off the deficit between 2012 and

2021.

With respect to health care spending there a combination

of four policies could shave off about $600bn. The

biggest is to change Medicaid payments to block grants.

Switching the payment method would deter gaming of the

Medicaid funding formula by states and the result would

be about $300bn in savings over ten-years. House

Budget Committee Chairman Paul Ryan included this

idea in his deficit plan earlier this year. Raising the

Medicare eligibility age to 67 would save $125bn. The one

caveat to our choice of cuts is that there is some risk that

it will do enough to restrain long term growth in

healthcare costs.

On the tax side, our scenario would raise revenue by

almost $1.1tn. Although we would prefer to see

comprehensive tax reform, we have excluded them to

keep the illustration simple. The partial extension of the

Bush tax cuts for those making under $250k should

increase revenues by $500bn. Limiting itemized

deductions to 15% of income should raise $1.2tn in new

revenue. We also include the repeal of LIFO and treat

carried interest as ordinary income, both combined they

reduce the deficit by $100bn. Elimination of the AMT

should give ease some of the increased tax burden, but

increases the deficit by $800bn.

Chart 4.3: Under the hypothetical scenario US should have noproblem meeting obligations

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2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Unch. Fwd Fwd + 50bp

Fwd + 100bp Fwd + 150bpFwd + 200bp

Aaa

Aa space

Debt reversibility band

%, inte rest payment to revenue

Source: Bloomberg, CBO, Global Insight, SG Cross Asset Research/Economics

F173936



Focus US


America, - 3 bps for Citigroup, +6 bps for JPMorgan, and

-1 bps for Morgan Stanley.

Trade Idea #5 — Buy GECC 5 yr CDS (+295/302

bps), Sell Sallie Mae 5 yr CDS (+565/590 bps). Despite

the 8-notch ratings differential at Moody’s, we believe

Sallie Mae is fundamentally better positioned than GECC

in the current market. Over the past several years, Sallie

Mae has done much to improve its fundamental profile

including reducing its reliance on the unsecured debt

markets and an overall deleveraging, improving its

underwriting standards within its private loan portfolio,

and transforming its business model from low margin

FFELP originations to more of a servicing-oriented

business model. And while GECC has also made

meaningful progress in improving its credit profile since

the depths of the credit crisis, GECC is still very reliant on

the wholesale funding markets. Therefore, in this period of

market stress, we believe the current 270 bps bid-side

spread differential is too much and should compress in

the current volatile market.

[email protected]

F173936



Focus US


Calendar

3

Jul Auge

Constructionspending (%m)

-1.3 0.0

Aug Sepe

ISM mfg. 50.6 52.0

ISM-prices paid 55.5 57.0

Aug Sepe

Total vehiclesales (mln saar)

12.1 13.0

4

Jul Auge

Factory orders 2.4 -0.5

5

Jul Auge

ADPemployment

91 45

Aug Sepe

ISM Non-Manf.Composite

53.3 54.2

6

9/24e 9/30e

Initial joblessclaims

410 395

9/17 9/24e

Contin. claims 3765 3745

Aug Sepe

ICSC ChainStore Sales(%yoy)

4.6 5.0

7

Aug Sepe

Nonfarmpayrolls, (thous.sa)

0.0 115

Nonfarmpayrolls ex.strikers (thous.sa)

46 70

Private payrollsex. strikers(thous. sa)

63 110

Unempl. rate 9.1 9.0

Avg hourlyearnings (%m)

-0.1 0.5

Avg weeklyhours

34.2 34.3

Jul Auge Consumercredit ($bn)

11.965 8.84

Fed Beige Book

Kocherlakota, Kohn Evans, Williams

$2.75-$3.50bn; Apr’14 - Sep’15 FED MBS reinvestment begins $3.25-$4.00bn; Nov’18 - Aug’21

ann 3Y/10Y/30Y (32/21/13)

10 11

NFIB Small Bus. Optimism

IBD/TIPP Economic Optimism

Monthly Budget Statement

FOMC Minutes

12

JOLTs Job Openings

13

Trade Balance

Jobless claims

14

Import Price Index

Retail Sales

Michigan Confidence Index

Business Inventories

$3.25-$4.00bn; Apr’17 - Sep’18 Fed’s Treasury operation

schedule TBA 2pm

ann 30Y TIPS® ($7bn)

17

Empire Manufacturing IndexIndustrial Production

Capacity utilization

18

Producer Price IndexTIC Flows

NAHB Housing Index

19

FED Beige BookCPI

Housing Starts

Building permits

20

Jobless ClaimsLeading Indicators

Philadelphia Fed.

Existing Home Sales

21

ann 2Y/5Y/7Y (35/29/29)auc 30Y TIPS® ($7bn)

24

Chicago Fed. Activity Index

25

S&P/CaseShiller Index

Consumer Confidence

House price Index

Richmond Fed. Mfg Index

26

Durable Goods Orders

New Home Sales

27

Jobless Claims

GDP 3Q (A)

Personal Consumption

Core PCE

Pending Home Sales

Kansas City Fed Index

28

Personal Income/Spending

Core PCE

U. of Michigan Index

auc 2Y Note ($35bn) auc 5Y Note ($29bn) auc 7Y Note ($29bn) Source: SG Cross Asset Research, NY Federal Reserve, Bloomberg. Forecasts are subject to change according to incoming data – ® Reopening.

October Economic data, Fed speakers, Fed’s Treasury purchases and Treasury auctions previews

Monday Tuesday Wednesday Thursday Friday

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Focus US


Forecast summary

Economics

Economic Forecasts: The US outlook at a glanceNominal GDP 2010 $13 088bn Q310f Q410f Q111f Q211f Q311f Q411f Q112f Q212f 2009 2010f 2011f 2012f

GDP (% qoq ann) 2.5 2.3 0.4 1.3 1.6 2.2 1.4 1.7 -3.5 3.0 1.6 1.8

Consumer expenditure 2.6 3.6 2.1 0.1 1.4 2.0 2.1 2.0 -1.9 2.0 2.0 1.8

Government expenditure 1.0 -2.8 -5.9 -1.1 -0.5 -0.9 -1.3 -0.7 1.7 0.7 -2.0 -0.9

Investment 2.3 7.5 1.2 6.5 6.0 8.1 1.4 3.2 -18.8 2.6 5.5 4.5

Exports 10.0 7.8 7.9 6.0 5.0 5.0 4.0 4.0 -9.4 11.3 7.3 4.6

Imports 12.3 -2.3 8.3 1.3 1.0 3.0 3.5 3.0 -13.6 12.5 4.8 2.6

Nominal GDP (% yoy) -2.5 4.2 3.8 3.8

CPI headline (% yoy) 1.2 1.2 2.2 3.3 3.5 3.1 2.2 1.5 -0.3 1.6 3.0 1.6

CPI core (% yoy) 0.9 0.6 1.1 1.5 1.8 2.0 2.0 1.8 1.7 1.0 1.6 1.7

Unemployment rate (%) 9.6 9.6 8.9 9.1 9.2 9.3 9.3 9.4 9.3 9.6 9.1 9.4

Employment (%yoy) 0.1 0.7 1.0 0.8 1.1 0.9 0.6 0.5 -4.4 -0.4 1.0 0.5

Average hourly earnings (% yoy) 2.3 2.3 2.1 2.1 2.0 1.9 2.0 2.0 3.0 2.4 2.0 2.0

Savings rate (%) 5.6 5.2 4.9 5.1 5.3 5.4 5.3 5.3 5.2 5.3 5.2 5.2

Fiscal stance* (% of GDP) -1.6 -0.2 1.2 0.5

Output gap (% of GDP) -6.4 -6.3 -6.7 -6.9 -7.0 -6.9 -7.0 -7.1 -7.8 -6.6 -6.9 -7.0

Corporate profits before tax (% yoy) 27.4 18.2 8.8 5.0 3.2 2.5 2.8 4.1 9.1 32.2 4.8 3.9

Current account (% of GDP) -2.7 -3.2 -2.7 -2.8

Budget balance (% of GDP) -3.3 -9.7 -8.2 -7.8

Federal Debt (% of GDP) 54.3 61.8 67.8 73.9

Public Debt (% of GDP) 75.3 82.8 88.8 94.9

Fed Funds Target (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25

Source: S G Cross Asset Re search. * Fiscal stance is de fined as the change in the cyclically adjusted budge t balance

Ratesfigures as of end of period 30-Sep Q411 Q112 Q212 Q312 Q412 2013 2014 2015

Fed fund target 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.31%

FF e ffe ctiv e - FF targ et sp re ad -0 .17% -0 .17% -0 .17% -0 .17% -0 .17% -0 .17% -0 .17% -0 .0 5% -0 .0 5%

3mo OIS spread - FF effective 0.01% 0.00% 0.00% 0.00% 0.05% 0.05% 0.05% 0.05% 0.05%

3mo LIBOR - 3m OIS spread 0.29% 0.25% 0.30% 0.30% 0.30% 0.30% 0.30% 0.20% 0.10%

3mo LIBOR 0.37% 0.33% 0.38% 0.38% 0.43% 0.43% 0.43% 0.45% 0.41%

2-year Treasury yield 0.26% 0.10% 0.10% 0.10% 0.10% 0.10% 0.10% 0.25% 0.50%




2-year swap spread 31.4bp 30bp 30bp 30bp 30bp 30bp 35bp 35bp 35bp



2s10s slope 1.68% 1.90% 1.65% 1.90% 2.15% 2.15% 2.15% 2.25% 2.00%

2s5s slope 0.71% 0.70% 0.60% 0.70% 0.80% 0.80% 0.80% 0.85% 0.75%

5s10s slope 0.96% 1.20% 1.05% 1.20% 1.35% 1.35% 1.35% 1.40% 1.25%

10s30s slope 1.03% 0.95% 0.83% 0.95% 1.08% 1.08% 1.08% 1.13% 1.00%

3m-into-2y swaption vol (bp/year) 44.7 43 48 53 58 63 68 73 78

5y-into-5y swaption vol (bp/year) 104.2 105 108 105 103 100 100 100 100

Treasury auctions

Announcem ent date Security type Auction date Settlem ent date Es tim ated am ountChange in s ize from

previous auctionMaturing amount New Cash

6-Oct 3-Year Note 11-Oct 17-Oct $32bn $0bn6-Oct 10-Year Note (R) 12-Oct 17-Oct $21bn $0bn

6-Oct 30-Year Bond (R) 13-Oct 17-Oct $13bn $0bn $0bn $66bn

13-Oct 30-Year TIPS (R) 20-Oct 31-Oct $7bn $0bn $0bn $7bn

20-Oct 2-Year Note 25-Oct 31-Oct $35bn $0bn

20-Oct 5-Year Note 26-Oct 31-Oct $29bn $0bn

20-Oct 7-Year Note 27-Oct 31-Oct $29bn $0bn $57bn $42bn

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Focus US


APPENDIX

ANALYST CERTIFICATIONThe following named research analyst(s) hereby certifies or certify that (i) the views expressed in the research report accurately reflect his or her personal views about any and all of thesubject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly , to the specific recommendations or views expressed in this report: JohnGuarnera

EXPLANATION OF CREDIT RATINGSU.S. Credit Research does not currently maintain ratings or credit opinions on individual companies. Trade ideas may be short term in U.S. Credit Research does not currently maintainratings or credit opinions on individual companies.

CONFLICTS OF INTERESTThis research contains the views, opinions and recommendations of Société Générale (SG) credit research analysts and/or strategists. To the extent that this research contains trade ideasbased on macro views of economic market conditions or relative value, it may differ from the fundamental credit opinions and recommendations contained in credit sector or companyresearch reports and from the views and opinions of other departments of SG and its affiliates. Credit research analysts and/or strategists routinely consult with SG trading desk personnel informulating views, opinions and recommendations in preparing research. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports.Therefore, this research may not be independent from the propr ietary interest of SG trading desks which may conflict with you r interests. In addition, research analysts receive compensationbased, in part, on the quality and accuracy of their analysis, client feedback, trading desk and firm revenues and competitive factors. As a general matter, SG and/or its affiliates normallymake a market and trade as principal in fixed income securities discussed in research reports.

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.

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F173936

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