pivot points for 2013 in the era of dissonance | january 2013

Pivot Points for 2013 in the Era of Dissonance

Pivot Points for 2013 in the Era of Dissonance The research views expressed herein are those of the author and do not necessarily represent the views of CME Group or its affiliates. All examples in this presentation are hypothetical interpretations of situations and are used for explanation purposes only. This report and the information herein should not be considered investment advice or the results of actual market experience.

Blu Putnam

Chief Economist

CME Group

January 2013

© 2013 CME Group. All rights reserved 3

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only. CME Group assumes no responsibility for any errors or omissions. Although every attempt

has been made to ensure the accuracy of the information within this presentation, CME Group

assumes no responsibility for any errors or omissions. Additionally, all examples in this

presentation are hypothetical situations, used for explanation purposes only, and should not be

considered investment advice or the results of actual market experience.

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© 2013 CME Group. All rights reserved

2012’s Themes are Old News

China’s growth deceleration has ended

European debt crisis will make some headlines

but the danger of implosion has passed

US avoided the worst of the fiscal cliff and will get

by the debt ceiling, too (very messy, though)

2013 is about Looking Forward to New

Challenges, New Opportunities

4


Themes for 2013

Market participants potentially start to embrace

increased risk-taking in search of higher returns

– bad for flight to quality exposures.

Improved investor confidence highlights

unintended consequences of Quantitative Easing

by US, UK, Europe, and Japan – potential for

emerging market currencies

Metals markets may be conflicted, as gold loses

support from the fear factor while copper benefits

from an improved global economic outlook.

Climate volatility may keep Agricultural markets

on edge.

5


China stabilizing in the 7% real GDP growth area for now, drifting down later in the decade

6

3.59%

6.22%

9.29%

10.42% 10.48%

6.50%

0%

3%

6%

9%

12%

1960s 1970s 1980s 1990s 2000s 2010s

An

nu

al A

vera

ge R

eal

GD

P G

row

th

Source: World Bank Real GDP Index from the Bloomberg Professional (WRGDCHIN). Estimates by CME Economics Research.

China: Real GDP Growth Rates by Decade

Estimate


European Bond Markets In Recovery

7

0%

3%

6%

9%

12%

1992 1995 1998 2001 2004 2007 2010 2013

An

nu

al Y

ield

(P

erc

en

t)

Source: Bloomberg Professional (GDBR10 and GSPG10YR)

Spain and Germany:10-Year Government Bond Yields

Spanish Bond

German Bond

Pre-Euro

Debt Debacle


Euro Has Recovered from Worst of Break-up Fears

8

1.10

1.20

1.30

1.40

1.50

1.60

1.70

USD

/EU

R

Source: Bloomberg Professional (EUR)

US Dollar per Euro

ECB to Markets --Whatever it takes!


US Tax Rate Uncertainty Resolved (for now)

9

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%1

91

3

19

19

19

25

19

31

19

37

19

43

19

49

19

55

19

61

19

67

19

73

19

79

19

85

19

91

19

97

20

03

20

09

20

15

Pe

rce

nt

Historical Highest US Marginal Income Tax Rate

Clinton

Bush

Source: Tax Policy Center, Urban Institute and Brookings Institute*Note: Income Bracket applied to Highest Tax Rate has changed over time


US Fiscal Cliff Avoided – Stocks Rally

10


US Fiscal Cliff Avoided – Bond Prices Fall

11


Current Economic Conditions in the United States

The US economy has reeled off 14 straight quarters of real

GDP growth since Q3 2009 averaging about 2.2% growth

per annum.

The unemployment rate has fallen from its peak of 10% to

below 8%, as 1.84 million net new jobs were created in

2012.

US large corporations are flush with very large cash holdings,.

The US banking sector has recapitalized itself since 2008 and

is now comfortably profitable.

Auto sales are booming

Housing is finally entered a recovery phase in 2012

12


US Labor Market Improving Slowly

13

0.00%

3.25%

6.50%

9.75%

13.00%

1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

Civ

ilian

Un

em

plo

yme

nt

Pe

rce

nta

ge R

ate

Source: St. Louis Federal Reserve Bank FRED Database (UNRATE)

US Unemployment Rate

Unemployment Headed Back Below 6.5% in 2014?


US Auto Sales Are Back to 15 Million Units per Year

14

0

5

10

15

20

25

1976 1980 1984 1988 1992 1996 2000 2004 2008 2012

Mill

ion

s o

f U

nit

s o

f C

ars

and

Lig

ht

Tru

cks,

A

nn

ual

Rat

e

Source: Federal Reserve Bank of St. Louis FRED Database (ALTSALES)

US Auto Sales

On the Road to Recovery


US Home Prices Finally Stabilized ….

15

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1988 1992 1996 2000 2004 2008 2012

Year

ove

r Ye

ar P

erc

en

tage

Ch

ange

Source: Case-Shiller index from the St. Louis Federal Reserve Bank FRED Database (SPCS10RSA , SPCS20RSA)

US Case-Shiller Home Price Percent Change

Home Prices Finally Stabilize in 2012


Leading to a Recovery in Single-Family New Home Sales …

16

-50%

-25%

0%

25%

50%

2002 2004 2006 2008 2010 2012

Year

-ove

r-Ye

ar P

erc

en

tage

Ch

ange

Source: St. Louis Federal Reserve "Fred" Database (HSN1F)

New Single-Family Home Sales in US


And a Rebound in Housing Starts from a Very Low Base

17

0

500

1000

1500

2000

2500

30001

96

0

19

64

19

68

19

72

19

76

19

80

19

84

19

88

19

92

19

96

20

00

20

04

20

08

20

12

Tho

usa

nd

s o

f H

ou

sin

g St

arts

, An

nu

al R

ate

Source: Federal Reserve Bank of St. Louis FRED Database (HOUST)

US Housing Starts

Housing Starts Show Lifein 2012 -- From a Very Low Base


US Real GDP Growth in the last 14 quarters has been comparable to pre-crisis growth.

18

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

2004 2005 2006 2007 2008 2009 2010 2011 2012

An

nu

aliz

ed

Re

al G

DP

Gro

wth

, Qu

arte

rly

Dat

a

US Real GDP Growth by Quarter

2.5% Average Annual Real GDP Growth, Q1/2004-Q4/2007, with support from solid growth overseas.

2.2% Average Annual Real GDP Growth, Q3/2009 - Q4/2012, with headwinds from a slowing China and stagnant Europe.


2013 -- Back to the Quantitative Easing Debate

Evaluating Why QE Did Not Help Create Jobs:

“Essential concepts necessary to consider when

evaluating the efficacy of quantitative easing,”

Review of Financial Economics, 2013, (Bluford H.

Putnam)

Unintended Consequences of QE: “Ultra easy

monetary policy and the law of unintended

consequences,” Federal Reserve Bank of Dallas

Globalization and Monetary Policy Institute, 2012,

Working Paper no. 126 (William R. White).

19


US & Japan are the Two Countries Most Concerned about Raising Economic Growth

20

4.19%

3.24%

3.23%

3.43%

1.55%

9.22%

4.46%

4.64%

1.13%

0.74%

0% 2% 4% 6% 8% 10%

1960s

1970s

1980s

1990s

2000s

Source: World Bank Real GDP Dataprovided through the Bloomberg Professional

US and Japan Real GDP Growth by Decade

Japan:AverageAnnual RealGDP GrowthRate ByDecade

US: AverageAnnual RealGDP GrowthRate ByDecade


Japan’s Population Growth Rate Peaked in 1971, the US in 1991

21

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

An

nu

al P

erc

en

tage

Ch

ange

in P

op

ula

tio

n

Source: US Census Bureau: International Database

US & Japan Population Growth: 1951-2011

United States

Japan

United States

Japan


Population Pyramids

The next charts represent a country’s age

profile in 5 year segments, with the

children at the base, the working age

population in the middle, and the retirees

at the top. Men are in blue on the left, and

women in red on the right.

Source: US Census Bureau: International

Database.

22


Population Pyramids: Japan United States

23


US Federal Balance Sheet Expansion

24

$927

$480

$0

$0

$447

$2,965

$1,689

$75

$948

$254

$0 $1,000 $2,000 $3,000 $4,000

Total Assets

US Treasury Securities

Federal Agency DebtSecurities

Mortgage-BackedSecurities

Other Assets

Source: Federal Reserve Release H.4.1, Table 8.

Assets of the US Federal Reserve ($Billions)

Wednesday,January 16,2013

Wednesday,September 10,2008


US 10-Year Treasury Inflation-Adjusted Yields

25

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014

Re

al P

erc

en

tage

Yie

ld:

10-

Year

Yie

ld m

inu

s Ye

ar-o

ver-

Year

In

flat

ion

Source: Data from the Bloomberg Professional.

How Low Can Inflation-Adjusted

10-Year Treasury Bond Yields Go?


Japan Embarks on Currency Depreciation Policy and Expanded Quantitative Easing

26


Japan Embarks on Currency Depreciation Policy and Expanded Quantitative Easing

27


Emerging FX in ZIRP World

The central banks in the US, UK, Euro-Zone, and Japan are all

committed to extended periods of near-zero short-term

interest rate policies (ZIRP).

The mature commodity producing countries, such as

Australia, and the emerging market nations, from Mexico

and Brazil in Latin America to India to China are likely to

maintain interest rates between 3% and 6% (or more) above

those in the US, UK, Euro-Zone, and Japan.

This makes investments in the currency carry trade very

attractive, even relative to the substantial risks. However,

when market fears (i.e., Europe debt crisis, China

slowdown, US fiscal cliff, etc.) dominate, risk-off trading will

close these positions down. These carry positions will get

reestablished as global market fears calm.

28

© 2013 CME Group. All rights reserved 29

Emerging Market

Country Short-

term Interest

Rate

US Federal Funds

Rate

Spot FX/USD RateFutures FX/USD

Rate

Joint Interest Rate & Exchange Rate Market

Volatility


Mexican Peso Traded US Fiscal Cliff Debate

30

12.4

12.6

12.8

13.0

13.2

13.4

1-O

ct-1

2

8-O

ct-1

2

15-O

ct-1

2

22-O

ct-1

2

29-O

ct-1

2

5-N

ov-1

2

12-N

ov-1

2

19-N

ov-1

2

26-N

ov-1

2

3-D

ec-1

2

10-D

ec-1

2

17-D

ec-1

2

24-D

ec-1

2

31-D

ec-1

2

7-Ja

n-13

14-J

an-1

3

21-J

an-1

3

28-J

an-1

3

Mex

ican

Pes

os p

er U

S D

olla

r

Source: Bloomberg Professional (MXN)

Mexican Peso Sold Off on Election Fears of US Fiscal

Cliff -- Then Rallied with the Tax Deal


Brazil Narrowing Rate Spread Over Inflation

31

0%

5%

10%

15%

20%

25%

30%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Year

-ove

r-Ye

ar In

flat

ion

, Pe

rce

nt

An

nu

al R

ate

Source: CPI (BZPIIPCA) and Overnight Rate (BZSELICA) from the Bloomberg Professional.

Brazil: Inflation versus Overnight Rates

SELIC Overnight Money Market Rate

Inflation


China & Brazil Exchange Rate Paths

32

40

60

80

100

120

140

160

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

RM

B p

er

USD

& B

RL

pe

r U

SD In

de

xed

to M

ay

20

02

= 1

00

Source: Brazilian Real (BRL) and Chinese Renminbi (RMB)from the Bloomberg Professional.

Comparing Paths of the Renminbi and the Real

(Falling line indicates strength versus the US Dollar)

Chinese RMB - Managed FX

Brazilian Real -- Managed Rates, Volatile FX


Rate Comparisons: Why Yield-Seekers may consider the FX Carry Trade in Risk-On Markets

33

0% 2% 4% 6% 8% 10%

Russia

India

Brazil

Mexico

China

United Kingdom

United States

Japan

Euro-Zone

Source: Bloomberg Professional(Most liquid overnight rates to 1-month interbank rates)

Short-Term Interest Rates


Gold Gold benefits from zero rates, which are here for

another year in the US, UK, Europe, and Japan.

Gold benefits from stronger demand if China and

India show solid growth. Both countries should

do a little better in 2013 than in 2012. But India is

raising taxes on gold imports.

Gold benefits from investor fears, which are

dissipating.

The question for investors is how much demand

comes out of the market as fears recede?

34


Gold Price Has Hit Choppy Waters Above $1600/ounce

35

$0

$400

$800

$1,200

$1,600

$2,000

1992 1995 1998 2001 2004 2007 2010 2013

US

Do

llars

pe

r O

un

ce

Source: Bloomberg Professional (GOLDS)

Gold


Copper

Copper demand stems from infrastructure building.

China is critical. China slowed infrastructure

spending plans in 2011 and 2012, but there are

signs that China will start spending again to get

the economy moving faster 2013.

India is a big buyer of gold jewelry. India’s

economic growth slowed in 2012, but may

rebound modestly in 2013.

Copper is likely to be very volatile, with potential

support if a more optimistic global economic

outlook gains credence.

36


BRIC Economies may Improve in 2013, led by China and Brazil

37

9.0%

7.0%

5.4%6.1%

0%

2%

4%

6%

8%

10%

2010 2011 2012 2013

We

igh

ted

Ave

rage

of

An

nu

al R

eal

GD

P G

row

th

Source: World Bank Real GDP Data provided through the Bloomberg Professional. Q4/2012 and 2013 estimated by CME Economics Research.

BRIC Real GDP

Estimate


Copper Has Become a Risk-On, Emerging Market Growth Story

38

$0

$1

$2

$3

$4

$5

1992 1995 1998 2001 2004 2007 2010 2013

US

Do

llar

pe

r P

ou

nd

of

Co

pp

er

Source: Bloomberg Professional (HG1 <Comdty>)

COMEX Copper Nearby Contract Futures Price


Energy Market Potential Surprises for 2013

US economic growth dividend for increased oil/gas supply

More infrastructure progress in the US than market

participants appreciate

Possibly less geo-political fears

Syria and Egypt do not have oil

Iran tensions appear to be lessening

Market participants may shift from demand focus to supply

focus which has possible implications for a narrower Brent-

WTI spread and a narrower WTI-Natural gas spread.

39


Natural gas offers a low cost per BTU

40

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

2001 2003 2005 2007 2009 2011 2013

BTU

's o

f Ene

rgy

per 1

US

Dol

lar

Source: Bloomberg Professional for prices (USCRWTIC, NGUSHHUB, UNYMM1), CME Economics Research for BTU conversion.

BTU's per US$1 by US Energy Source

Coal

Oil

Natural Gas


Weather Volatility

Weather volatility can easily disturb agricultural

markets

Q1/2013 already has seen:

Frigid Temperatures in Russia and China

Extreme Heat in Australia and New Zealand

Continuation of US Midwest Drought (although

there is some snow cover now)

41


US Drought Monitor Charts -- Source

The U.S. Drought Monitor is produced in

partnership between the National Drought

Mitigation Center at the University of

Nebraska-Lincoln, the United States

Department of Agriculture, and the

National Oceanic and Atmospheric

Administration.

http://droughtmonitor.unl.edu/

42


The Texas Drought emerged over time in 2010-2011

43


In 2012, the US Midwest Drought Emerged Very Quickly

44


Corn and the Drought

45

$0

$2

$4

$6

$8

$10

1997 1999 2001 2003 2005 2007 2009 2011 2013

USD

A Il

lin

ois

No

rth

Ce

ntr

al N

o.2

Ye

llo

w C

orn

Sp

ot

Pri

ce p

er

Bu

she

l

Source: Bloomberg Professional (CORNILNC)

Corn Spot Price


Pivot Points for 2013: Politics & Weather

•US Spending and Debt Ceiling Debates (February-

April, and possibly beyond)

•Formation of New Coalition Government in Italy

(February-March)

•Development of Midwest US Drought (Spring-

Summer)

•German Elections (September 2013) – Merkel will

probably need a new coalition partner

46


Economic Points to Watch

US Unemployment Rate Dips Below 7%

China reports Real GDP Growth above 7% in

2013 for two quarters in a row, along with

supporting export data

Brazil reports Real GDP Growth the first half of

the 2013 increasing into the 3%-4% range

47


Confirming Signs We May Be Entering a “Risk-On” Market Environment?

•FX:

–Yen/$ cross 100

–Brazilian Real cross 2.00 (BRL per USD)

•Bonds

–JGB 10-Year Yields cross 1%

–US 10-Year Treasury Yields cross 2%

–Spanish 10-Year Bond Yields remain

close or under 5%

48

pivot points for 2013 in the era of dissonance | january 2013

Economy & Finance

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