S

Second-Quarter

SecondJuly 201

Summary

Real GDrestrainedtemporarrecessionmonths. Wage ancontinuesthe seconTrade shoInflation most sectcredit sprregulatorthe horizhunger fo

Figure 1:Economic IReal GDP, CReal PersonReal Busi InReal ResideCorporate PCurrent AccFederal BudUnemploymHousehold ENonfarm PaNonfarm PrCapacity UtGDP Price IConsumer PCPI ex foodNominal PePersonal SaRate or SpFederal Fun3-month LIB10-Yr Trea30-Yr TreaMoody's Ba10-Yr Intere* Figures are

Legend for

r U.S. Econom

-Quarter U1

y of Recent E

DP is expectd by global ry. GDP gron risks haveIn the secon

nd income s to bounce nd half. Busiould add to moved up,

tors of the ecreads were

ry frameworkzon, preferreor yield and

Key MacroIndicator*Chg QoQ (%)nal Consump Expnvestmt, Eqp & Sential Investmt, CProfits, After Taxcount Balance, Adget, 12-mo Def

ment Rate (%)Employment, Chayrolls, Chg QoQroductivity, Chg Qtilization (%)Index, Chg QoQPrice Index, Chg d & energy, Chg rsonal Income, C

avings Rate (%)pread (End of Qnds Rate Target (BOR (%)sury Note Yield sury Bond Yield aa Long Corp Spest Rate Swap Seither quarterly or,

all Figures: AR

mic Update

U.S. Econ

Economic an

ted to growsupply chaiowth is exp

e increased, nd quarter, growth waalong the biness investmGDP growthbut core in

conomy, butmixed, but k continue t

ed prices arelimited new

oeconomic In

pnds, Chg QoQ Sftware, Chg Qohg QoQ (%)

x, Chg YoY (%)Annualized (% of f or Surp (% of G

hg QoQ (000)Q (000)QoQ (%)

Q (%)YoY (%)YoY (%)

Chg YoY (%)

Quarter)(%)

(%)(%)

pread (bp)Spread (bp), if more frequent, q

R = Annual Rate

nomic Upd

nd Market D

w by a disapn disruptionpected to reand we wilemploymens sluggish, ottom. Indument is sturdh in Q2, althnflation shout governmencredit funda

to benefit pre likely to b issue supply

ndicators and2009:3

1.6(%) 2.0

oQ (%) 4.210.6

0.4f GDP) -2.8GDP) -10.0

9.8-1187

-7676.5

69.50.7

-1.31.5

-2.45.7

2009:30.250.293.314.05212

15quarterly averages.

e; SA = Seasona

Page 1

date

evelopments

ppointing 2.4ns and sharpebound to oll be monito

nt growth slleading to

strial producdy but slowihough it mayuld remain snt borrowingamentals conreferred invebe bumpy. Hy will suppo

d Interest Ra3 2009:4 206 5.00 0.92 14.66 -0.8 -4 41.98 -2.80 -10.38 9.97 -8317 -4065 6.75 70.87 -0.23 2.75 1.84 0.47 5.83 2009:4 205 0.259 0.251 3.845 4.642 1755 13

f = Forecast1;

ally Adjusted; M

s

4% in the sply higher oiover 3% in oring the dalowed and t

tepid persction sloweding. Governy be a drag osubdued. De

g is still surgntinue to imestors. With However, weort the prefer

ates 10:1 2010:2

3.7 1.71.9 2.2

20.4 24.812.3 25.727.0 26.5-3.3 -3.3-9.4 -9.19.7 9.5

992 140118 5434.6 -1.7

72.8 74.51.0 1.92.3 1.11.1 0.92.8 2.95.3 6.3

10:1 2010:20.25 0.250.29 0.533.83 2.934.71 3.89160 216

-2 7a = Actual through

MA = Moving A

second quaril prices, wh

the secondata closely the unemploonal consumd but is poisnment consumon growth ineleveraging

ging. Treasurmprove. Cha

a number oe anticipate rred market g

2010:3 20102.6 32.4 4

15.4 7-27.3 316.2 13-3.3 -3-8.8 -89.6 9

286 -1-137 4

2.3 275.7 76

2.1 01.1 10.8 03.6 35.8 5

2010:3 20100.25 0.0.29 0.2.51 3.3.69 4.189 1

6h May 2011

Average; C.O.P.

Jul

rter. Growthhich should pd half. Howover the co

oyment rate mption. Hosed to reboumption is fan the secondcontinues a

ry rates fell wanges to the of risks visib

that the onggoing forwar

0:4 2011:1 23.1 1.94.0 2.27.7 8.83.3 -2.03.7 8.83.0 -3.28.6 -9.49.4 8.872 65816 497

2.9 1.86.8 77.00.4 2.01.5 2.70.8 1.23.6 4.85.4 4.90:4 2011:1 225 0.2530 0.3029 3.4734 4.5164 154

9 11Source: Reuters E

= Change over

ly 15, 2011

h was prove

wever, oming

rose. ousing und in alling. d half. across while bank

ble on going rd.

2011:22.4f0.5aNANA6.6fNA

-8.6a9.2

-530260NA

76.7NA3.61.6

4.2a5.0a

2011:20.250.253.164.3815212

EcoWin r Period

S

Second-Quarter

Economi

The U.S.growing product (Consensu3.0% grofor 2012

One overglobal ecof Japan.global suare the “Aregion resignificanof the fircurrently

Althoughconfidentrecovery likely to continue term. Horecessionmonths.

Figure 2:3-mo

EmployEmployJobles

Jul Nov M06

Em

ploy

men

t C

hang

e (t

hous

ands

)

-900

-800

-700

-600

-500

-400

-300

-200

-100

0

100

200

300

400

1 Forecasts

r U.S. Econom

c Outlook

. economy cby just 1.9%

(real GDP) tous forecasts owth in 2012if a federal b

rarching theconomy. The. Not only wupply chain aArab Springeduced oil ont oil exportrst quarter t

y.

h we cannot that the bufrom them

look soft whto grow at a

owever, if gn will increa

Job Marketonth moving average of Employm

Emp

yment, Overall, Nonfarm payroll, tyment, By Sector, Overall, Total (s Claims, National, 4-week movin

Mar Jul Nov Mar Jul07 08

s from The Livi

mic Update

continued its% in the firo expand byimprove aft

2. We think budget deal

eme for the e first shock was this a terand, in turn,” uprisings i

output in a nter. West Teto $110-115

t predict wulk of their im

should be vhen it is firsta moderate pgrowth and,ase meaning

t Weakened ment changes; 4-week moving aveployment Overview

total [c.o.p val 1 month, ma 3](civilian, household survey) [c.o.p ng average, initial

Nov Mar Jul Nov09

ingston Survey

s sluggish prst quarter, ey 2.4% in Q2ter that: 3.2%those are reincludes siza

second quawas the Ma

rrible human, on the globin the Middlnumber of thxas Interme

5 per barrel

when the immpact on thvisible in tht reported latpace, with re, particularlgfully. This

in Q2 erage of Jobless Claims

val 1 month, ma 3]

Source: Reute

Mar Jul Nov Mar10 11

, Federal Reser

Page 2

pace of groweconomists e2, with risks % real GDPasonable forable spendin

arter is the arch 11 earthn tragedy, itbal economye East. Demhe affected diate oil pricin April, on

mpact of thehe U.S. econhe second hater this monteal GDP groy, employm

s will requir

Figu

ers EcoWin

Jobl

ess

Cla

ims

(tho

usan

ds)

200

250

300

350

400

450

500

550

600

650

700

750

800

850

UnemEarni

90 91 9

Une

mpl

oym

ent

Rat

e, P

erce

nt

3

4

5

6

7

8

9

10

11

rve Bank of Ph

wth in the seexpect inflatto that forec

P growth in recasts, thoung cuts next

impact of twhquake and tt had a rapidy. The secon

mocratic uprinations, espces rose fromnly to drop

ese shocks nomy occurrealf of this yth, but we bowth averag

ment do notre careful m

ure 3: WagesAverage Hourly E

mployment, Rate, Totalings, Average Hourly, Nonfarm pa

92 93 94 95 96 97 9

hiladelphia, Jun

econd quarteation-adjustecast skewed the second

ugh perhaps year.

wo temporatsunami thatd and negatind, less discsings throug

pecially in Lm $85-90 peback to $9

will dissipaed in the secyear. Secondbelieve the Uging 2.5-3% t rebound smonitoring o

s Flat, UnemEarnings and Unemployme

ayroll, total private, USD [c.o.p 12

98 99 00 01 02 03 04

ne 9, 2011.

Jul

er of 2011. d gross domto the downhalf of 201a little optim

ary shocks tt devastated ive impact orete set of e

ghout much oLibya, whicher barrel for 95-100 per b

ate fully, wcond quarterd-quarter GD

U.S. economyover the me

soon, the riover the co

mployment Uent Rate, SA

2 months]Source:

4 05 06 07 08 09 10

ly 15, 2011

After mestic nside.1 1 and mistic

to the parts

on the events of the h is a most

barrel

we are r, and DP is y will edium sk of

oming

Up

Reuters EcoWin

0 11

Ear

ning

s, P

erce

nt

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

S

Second-Quarter

The labomeasured497,000 picture: 5rose to 9productioemploymcontinue.weakness

For nowrecovery,earlier. Arecede, pgasoline pick up iworth nothan it dpayrolls ijobs in Qto reveal an earthqthese seebetter sea

Nonethelthe U.S. if growthrenewed the third

Figure 4:

PersonalPersonalPersonal

90 91 92

Sav

ings

Rat

e, P

erce

nt

0

1

2

3

4

5

6

7

8

9

10

r U.S. Econom

or market wd by nonfarnew jobs in

530,000 job 9.2%, up fron and consu

ment shrunk . Although ws is discoura

, we attribu, especially Although goproduction aprices downin the seconting that the

does on the increased by

Q2. Of courseunderlying

quake/tsunamm like decenasonally-adju

less, we haveeconomy co

h does not precession wquarter unfo

Income, SpPersonal Incom

l Income Account, Overall, Total, l Outlays, Overall, Total, Current Pl Saving, Rate

93 94 95 96 97 98

mic Update

weakened inm establishm

n Q1 (Figurelosses in Q2

rom 8.8% aumer spendi(-111,000 p

we anticipateaging.

ute this pooa moderate

overnment jand manufan by about $nd half of the Q2 employseasonally-a

y almost 2.2 e, the reasontrends, or ch

mi and a surgnt job gains,usted perform

e to acknowould drop bacpick up as th

will rise signiolds.

pending Growme, Consumption and Sav

Current Prices, USD [c.o.p 12 mPrices, USD [c.o.p 12 months]

99 00 01 02 03 04 0

n the secondment payrole 2). The ho2 compared

at the end oing, both ofpayroll jobs ed slower job

or performanrecovery likob losses a

acturing emp15 per barrehe year, whi

yment news ladjusted bas

million andn we normallhanges in thge in oil pri even if theymance over

ledge that thck into receshe temporaryificantly. Th

wth Slowedings

months]

Source: Reute

05 06 07 08 09 10 1

Page 3

d quarter. Jlls grew by

ousehold emto 658,000 j

of Q1. Suppf which weig

in Q2), anb growth und

nce to the nke this one, are likely toployment shel from the Aich should llooks much bsis quoted ead household ly focus on

hose trends, mces (which hy appear slugthe coming m

he sharp slowssion. We doy shocks we

his is someth

Figu

ers EcoWin

11

Inco

me

& S

pend

ing

Gro

wth

, P

erce

nt

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

United Home

90 91

Con

sum

er C

redi

t Gro

wth

(P

erce

nt)

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

20.0

Jobless claimy just 260,00mployment su

job gains in ply chain anghed on hiri

nd job lossesder these cir

normal ebb and to the t

o continue, hould rebouApril peak, rlead to highbetter on a narlier. On aemploymenseasonally-amore clearlyhad nothing ggish relativmonths.

wdown in emo not see thae have descrhing we will

ure 5: Debt R"Home Equity W

States, Consumer credit, total, SMortgage Borrowing - Residenti

92 93 94 95 96 97 9

ms rose, and00 jobs, dowurvey paints

n Q1. The unnd oil priceing. In addis in this secrcumstances

and flow otemporary ras supply c

und. Similarreal consumher employmnon-seasonaan unadjustent grew by juadjusted datay. However,

to do with ve to the Q2

mployment rat as the mosribed recedel be watchin

Reduction CoWithdrawal" and Consume

SA, USD [ar 1 quarter]ial Investment

98 99 00 01 02 03 04

Jul

d employmewn sharply s an even wnemploymene shocks redtion, governctor are like, the extent o

of any econrestraints outchain disruprly, with oil

mption shouldment. Finallylly-adjusted d basis, non

ust under 900a is that theywhen faced

seasonal facnorm. We e

raises the riskst likely casee then the ring very close

ontinues er Credit

Source: R

4 05 06 07 08 09 10

ly 15, 2011

ent as from

weaker nt rate duced nment ely to of the

nomic tlined ptions l and d also y, it’s basis

nfarm 0,000 y tend d with ctors), expect

k that e, but isk of ely as

Reuters EcoWin

11

Hom

e E

quity

With

draw

al, A

R (

billi

ons)

-1000

-750

-500

-250

0

250

500

S

Second-Quarter

With only1.75% in4.2% grorunning acceleratonly slowThus, wait is the cincome –

This tepialso have1.9% gro2.1% Yothan that,

In the pasin order trate is hoto increathe requirjust startito save mwill meanbalance sgrowth. OconsumpWe are n

Figure 6:

New + ExNew + ExUnited St

90 91 92

mill

ions

0

1

2

3

4

5

6

7

8

9

10

2 All rates i

r U.S. Econom

y limited pan Q2), nominowth year-onat 1.2% exes as we expwly. As Figage growth icombination – and that com

id growth ine been growowth in real GoY. Retail sa, but Q2 real

st, consumerto support colding up arose savings, (rement for ming to increa

more and born only modesheets. That Once househtion growth

not there yet,

Housing BoNew & Existing Home

xisting Home Sales, AR, SAxisting Homes for Sale, AR, SAtates, Consumer Surveys, Nationa

93 94 95 96 97 98 9

in this report a

mic Update

ayroll gains anal personan-year (Figuxcluding foopect over theure 3 indicais likely to rof rising emmbination is

n personal inwing only sloGDP in the fales data for l PCE growt

rs facing sluconsumptionound 5%. W(2) the great

much larger dase (mainly rrow less, esest growth in

is going toholds have will catch ubut it shoul

ouncing Aloe Sales, Inventories and Af

al, Housing Affordability Index, co

99 00 01 02 03 04 0

are presented on

and slow groal income gure 4).2 This od and enere coming quaates, high unemain subdu

mployment as unlikely to

ncome meanowly. Real Pfirst quarter. June sugge

h probably w

ggish incomn, but that is

We think this ter difficultydown paymedue to autom

specially in n consumpti

o take a gooincreased sa

up to incomed not take a

ng Bottom ffordability

omposite, IndexSource: Reute

05 06 07 08 09 10 11

n a seasonally-

Page 4

owth in wagrowth sloweis very slow

rgy prices aarters, the unnemploymenued. Althougnd faster waarrive for so

ns that persPCE was up

In Q2, real st that PCE will be slowe

me growth minot happenreflects (1) a

y that most hents on homemobile loanthe form of on while ho

od deal of timavings and re growth, andgeneration t

Figur

ers EcoWin

1

Aff

orda

bilit

y In

dex

100

110

120

130

140

150

160

170

180

190

200

Real Re

95 96

Per

cent

of

Rea

l GD

P

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

-adjusted annua

ges (average ed to just 3.w income grand 2.5% onemploymennt tends to gh employmage growth tome time to

onal consumby 2.2% anPCE is up bfor the full

er than in Q

ight have being (much) a greater deshouseholds he purchases.

ns), householf mortgage douseholds rebme but doesreduced debd the economto correct the

re 7: LimitedResidential I

esidential Investment / GDP

97 98 99 00

alized basis, un

hourly earn.4% in Q2 trowth whenoverall. Event rate is likekeep a lid o

ment gains wthat really pucome.

mption expnd accountedby just 0.5%

quarter will1.

een tempted in this recovsire on the phave obtaini. Although clds genuinel

debt (Figure build savings not imply

bt to more sumy can growese imbalanc

d GDP ImpacInvestment as a Percent

01 02 03 04 05

nless otherwise

Jul

nings rose bythrough May

n PCE inflatien if job grely to come on wage gro

will boost incushes up per

penditures (d for 1.5% othrough Mal be a little b

to reduce savery: the sav

part of houseing credit anconsumer crely appear to 5). We think

gs and repairdecades of

ustainable lew at a faster ces.

ct from Houof GDP

Source: R

5 06 07 08 09

e noted.

ly 15, 2011

y only y and ion is rowth down owth. come, rsonal

(PCE) of the

ay and better

avings vings

eholds nd (3) edit is want

k this r their f slow evels, pace.

using

Reuters EcoWin

10 11

S

Second-Quarter

The housholding asales pactoday’s pyears intinventoriPoor’s/C

Althoughto GDP gend of 1Qare runnigrowth, oto drop mGDP nowprices sthouseholthere is saffordabilonger –

Figure 8:Rea

ManufacManufacManufacManufac

99 00

Per

cent

-50

-40

-30

-20

-10

0

10

20

30

40

Businessearthquakgoods ordgrowth ingoods orwe expeBusinessCapacity positive

r U.S. Econom

sing markeabout steadyce of the midprices and mto the econoes are still ase-Shiller H

h the housinggrowth. As FQ2011, dowing well belobsolescencemuch furtherw that even ill matter fold. Lower hostill risk to tility, and a galthough a r

Manufactural Factory Orders and Ship

cturers New Orders, Total manufacturers New Orders, Nondefensecturers Shipments, Total manufaccturers Shipments, Nondefense c

01 02 03

s investmentke and tsunders and shipn the range ders and shict they willes investmeutilization

but somewh

mic Update

et continues y a little abod-1990s, whmortgage ratomic recoveexerting so

Home Price I

g market is nFigure 7 sho

wn from overlow the lone, and replacr from herea large drop

for the econome prices rthe economy

growing popuebound is no

red Goods Ppments (3-mo moving ave

acturing [ / Producer Prices, Mane capital goods excluding aircraftcturing [ / Producer Prices, Manufcapital goods excluding aircraft [

04 05 06 0

t continues tami make epments (nonof 7-12% o

ipments, howl rebound aent is closelis still risin

hat slower i

to bounce aove a 5 millhich is not btes. As a re

ery and sixme downwaIndex (20-ci

not likely tows, residentr 6% at the png-term replacement after. Even if it

p in it wouldnomy, since reduce housy from the hulation, we tot imminent.

icture Mixederage, annualized)

ufactured goods, Index, 1982=10t [ / Producer Prices, Capital equfactured goods, Index, 1982=100[ / Producer Prices, Capital equip

Source: Reute

07 08 09 10

to look relatestimates forndefense capon an inflatiwever, slippas the supplly correlatedng, but the investment s

Page 5

along the bolion unit annbad, but it is sult, inventoyears after ard pressureity) down 3.9

o turn upwartial investmepeak of the hacement rater fire or othedoes, reside

d have only a home is

sehold wealthousing marthink that ho.

d Figu

00, ar ma 3 months]uipment, manufacturing i ndustrie0, ar ma 3 months]pment, manufacturing in dustriesers EcoWin

11

99

Cap

acity

Util

izat

ion

(12-

mo

Cha

nge,

Per

cent

age

Pts

)

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

tively strongr the second

pital goods eion-adjusted ped into negly chain recd with chanpace of impspending ov

ottom. New nual rate (Fi low given hories of unsthe peak of

e on home p9% YoY in A

rd soon, it doent representhousing booe for housin

er loss), homential investa small effe

s usually thth, which afrket. Howevome prices w

ure 9: Invest

es, Index, 1982=100, ar ma 3 mo

s, Index, 1982=100, ar ma 3 mon

Capacity U

United States, Capacity Utilization, TPrivate Fixed Investment, Nonresiden

00 01 02 03

g, although dd quarter hiexcluding aird basis (Figuative territorcovers in thnges in capprovement hver the near

and existingigure 6). Thhow afforda

sold homes f the housinprices, withApril.

oes not posets just 2.4% om. Given thng (derived

mebuilding actment is sucect on GDP. he largest asffects consuver, with littwill stabilize

tment Sturdy

onths]

nths]

Utilization vs Business Inve

Total index, SA [c.o.p val 12 months]ntial, Eq & sw, Constant Prices, AR, S

04 05 06

disruptions frighly uncertrcraft) continure 8). Overry in April

he second hpacity utilizahas slowed, r term. In a

Jul

g home salehis is close table homes aremain high

ng market. Th the Standa

e much direcof GDP as o

hat housing from popul

ctivity is unlh a small paOf course, h

sset owned umer behaviotle building,e before too m

y but Slowinstment

SA, USD, 2005 prices [c.o.p 12 monthSource: R

07 08 09 10

from the Japtain. Core cnue to show rall manufacand May, th

half of this ation (Figurwhich poin

addition, bus

ly 15, 2011

es are to the are at h two Those ard &

ct risk of the starts lation likely art of home by a

or, so , high much

ng

hs]Reuters EcoWin

11

Bus

ines

s In

vest

men

t (P

erce

nt, Y

oY)

-30

-25

-20

-15

-10

-5

0

5

10

15

20

anese apital solid

ctured hough

year. re 9). nts to siness

S

Second-Quarter

constructdecline. Ogrowth (i

In the indJapan. Tmanufactperspectimonth ofa shock ovisible in(IP) grewHowevercorner. In

Figure 10Ja

Jun Aug Oct08

Inde

x

70

75

80

85

90

95

100

105

110

Governmjoins statQ1, whicfederal, sstate andbalance.3estimate the federwill not bgovernmon the ou

3 State andgovernmenThus, fisca

r U.S. Econom

tion spendinOn balance, it added 0.2%

dustrial sectoThis slowdoturers in the ve, overall i

f March, andof that size inn both produw by just 0.r, the ISM mndustrial out

0: Japanese Ipan, All Industrial Activity,

Dec Feb Apr Jun Au09

ment consumte and local ch subtractestate, and locd local gove However, fits impact un

ral debt limibe a default oent consump

utcome in ne

d local governmnts need to cut al drag from sta

mic Update

ng (which is we continue

% in Q1), bu

or, industriaown shouldglobal supp

industrial prod it recoveren such an imuction and su8% in Q2,

manufacturintput should r

IP Plunged iIndustrial production, SA,

ug Oct Dec Feb Apr

mption will governmen

d 1.2% fromcal governmeernment spefiscal drag fntil Congrest. We expecof any kind ption will drxt quarter’s

ments in the Uspending and/

ate and local go

part of busie to think buut not to the s

al productiod come as ply chain. Tooduction in d only sligh

mportant expourvey data inand IP excl

ng survey forebound nice

n MarchIndex, 2005=100

Source: Reuter

Jun Aug Oct Dec Feb10 1

continue to nts in belt tigm GDP growents over thending shoul

from the fedss and the adct the debt con Treasury

rop. The queUpdate.

U.S. generally /or raise taxes tovernments ten

Page 6

iness investmusiness invessame extent

on slowed inno surpris

o put the 3/1Japan fell by

htly in April ort economyn the U.S. (Fluding motoror June suggely in the thir

Figure 1

rs EcoWin

Apr1

ProdProdBusin

Jul Nov06

ISM

Man

ufac

turin

g In

dex

30

35

40

45

50

55

60

65

be a drag onghtening. Gowth. We looe balance of ld begin to eral governm

dministrationceiling will by obligationsestions are: h

operate under to bring those nds to pass fair

ment in the stment will bas in 2010.

n response tse given th1 earthquaky more than(Figure 10).

y will not be Figure 11). r vehicles a

gests that prord quarter.

11: US IndusIndustria

uction, Aggregates, Manufacturinuction, Overall, Total, Volume, 20ness Surveys, ISM Manufacturing

Mar Jul Nov Mar07 0

n GDP growovernment cok for furthf the year. Th

wane as thment is just n agree on a be raised by. Whatever d

how much an

a balanced bubudgets back i

rly quickly, if n

GDP accoube a solid co

to supply chahe importanke and tsunamn 15% (not a. There is sim felt broadlyOverall indu

and parts waoduction is

strial Producal Production & ISM Surve

ng total ex. motor vehicles and pa007=100 [ar ma 3 months]g, PMI total

Jul Nov Mar Jul No08 09

wth as the fedconsumption

her spendinghereafter, theheir budgets

beginning. budget deal

y early Augudeal is strucknd how soon

udget mandateinto balance, unot painlessly.

Jul

unts) continuontributor to

ain disruptionce of Japmi into econannualized) imply no way

y, and indeedustrial produas up only 1about to tur

ction Slowedeys

arts, Volume, 2007=100 [ar ma 3

Source: R

ov Mar Jul Nov Mar10 1

deral governn fell by 5.8g reductionse fiscal drag

move backWe cannot ras part of ra

ust and that k, it’s certainn? We will r

e. If deficits deusually within a

ly 15, 2011

ues to GDP

ons in anese

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nment 8% in

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evelop, a year.

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Figure 12

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alan

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ons)

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and Japan areg markets stonal investorm debt probdemand whilof the curren

as a (relativea modest hea

2: Trendless Uni

Real Trade Balan

lance, Total, Goods, census basis, ConGoods and services [c.o.p 12 months]Goods and services [c.o.p 12 months]

Mar Jun Sep Dec Mar Jun07 08

ation outloowith the con

ther hand, co.6% YoY anwill trend d

ces pull up cnemploymens, and relatirong foothol

highly accomr, a lot of ecoot see the ecmuch longer

ance sheet trbt-to-GDP c

mic Update

it, which naecovery, hasto add to Gwever, the reion to the tre facing weatill look quirs surroundi

blems, U.S. le the Europnt account b

ely) safe havadwind to fas

Trade Deficited States, SA, USDnce and Export & Import Gr

nstant Prices, 2005 prices

Sep Dec Mar Jun Sep De09

ok remains nsumer pricore inflationnd the core down towardcore inflationnt, large invively low cald. We recog

mmodative monomic growconomy rear. In the mea

rends that wcontinues to

arrowed duris moved esse

GDP growth elative growrend in the trak growth anite strong. Ling Europeafinancial asean debt cri

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cit rowth

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ec Mar Jun Sep Dec Mar10 11

a tale of twe index (CPI

n (excluding PCE deflatods core inflan slightly. Thentories of u

apacity utilizgnize that th

monetary polwth can occuaching that pantime, core

we have desco fall in the

Page 7

ing the receentially side– perhaps

wth outlook arade balancend possibly Less ambigu

an sovereignssets are liksis plays ou

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Impo

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th (

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-40

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10

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4

5

6

wo indices. I) up 3.6% Yfood and en

or up 1.2% Yation, even here is still tunsold homezation rates ae Federal Relicy and thatur before inflpoint for at inflation sho

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uous is the n debt problekely to contut. Since the ccount deficcit is likely tsecond half o

Deflation RiUnited States, Overall a

Index, PCE, Overall, Total, SA, 2005=Index, PCE, Overall, Personal consum

umer Prices, All items, 1982-1984=10umer Prices, All items less food and e

Apr Aug Dec Apr07 0

On one hanYoY and thenergy prices)YoY. We coif higher entoo much sl

es, elevated vat industrial eserve probat higher inflalation becomleast anotheould remain

ior Updates conomy (bl

widened in ththe past year 1 to 1½ ptrading partnn the U.S. shand non-Japa

nervousnesems. Despittinue to bentrade balancit widens beto widen as of this year.

sk Recedes; and Core Inflation Indice

=100 [c.o.p 12 months]mption expenditures less food and en

00 [c.o.p 12 months]energy, 1982-1984=100 [c.o.p 12 mon

Aug Dec Apr Aug08 09

nd, overall e PCE deflat) remains suontinue to exnergy and, toack in the evacancy ratecompanies

ably will be ation will be

mes a more ser 12-18 mo

n subdued.

remain larglack line in

Jul

he early stagr (Figure 12)ercentage pners is mixehould be moan Asia and ss on the pae the U.S.’snefit from sce is (mostlyecause the Uwell. Thus,

Inflation Ahes, Year-Over-Year

nergy, SA, 2005=100 [c.o.p 12 month

nths]Source: R

Dec Apr Aug Dec10

inflation remtor up 2.5% ubdued, withxpect that ovo a lesser exconomy – ves for comm– for inflatilate in exitin

e the likely rserious threatonths – and

ely intact (Fn the graph)

ly 15, 2011

ges of ). For oints. d and odest; most

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mains YoY.

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Figure ), the

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householsector (grslightly hgood shamodest tnonfinan

We anticto replacto fall onshould althe housiAnd govmuch.

Figure 14

55

Total D

ebt, P

ercent

of Nom

inal G

DP

125

150

175

200

225

250

275

300

325

350

375

Even thoEuropeanGreece alarger ecvictim tomake sizinterest rand IrelaEMU as over the which we

Market O

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r U.S. Econom

ld sector (redreen). Nonfihigher last quape (as we through moscial corporat

cipate contine governmenn tighter reglso continueing market,

vernment bor

4: HouseholdD

Total DebDomesticDomesticDomesticDomestic

60 6

ough this is an economic and subsequconomies, Ita the crisis, thable cuts to ates brought

and and are a whole winear term. T

e discuss bel

Outlook

m Treasuryar benchmar

mic Update

d), and the financial busiuarter as theshow in grest of the bote debt is a h

nued delevernt borrowingulatory oveto trend lowand generalrrowing see

d and BusineUnited S

Debt to GDP:

bt Outstanding / c nonfinancial sec financial sectorc nonfinancial sec nonfinancial se

65 70

a U.S. econooutlook. In

ently engulfaly and Spahey and the their budge

t on by the clikely to do

ill escape reThis raises rlow.

y rates fell rk Treasury

financial seciness debt-toe economy ceater detail oom in levehealthy deve

raging in theg as the recersight and wer on tightlly greater dms poised t

ess DeleveraStates, Flow of FTotal, Financ

Nominal Gross Dctors, nonfederars total debt / Noctors, federal goctors, nonfedera

75 80

omic outlookn short, it’s fed Ireland ain. While wrest of the E

et deficits oncrisis have alo so in Portucession, therisks to the

in the secony yield drop

Page 8

ctor (blue). Ito-GDP (marocontinued to

below), anderage since elopment as l

e economy oovery continhigher capi

ened lendingdesire on theto decelerate

aging ContinFunds Debt Outscial, Househo

Domestic Produal, households toominal Gross Doovernment total dal,nonfinancial bu

85

k, we will clnot good. Tand Portuga

we do not thEuropean Mon a short timlready precipugal, Italy, re is no douglobal econ

nd quarter aped by 13

t is increasinoon) has flatrecover. Co

d nonfinancthe mid-19long as it do

overall, withnues. Financital requiremg standards,e part of houe, although

nues standing, SA, USold, Business

uct otal debt / Nominomestic Product debt / Nominal Gusiness total deb

90 95

lose this sectThe sovereial now threhink Italy anonetary Unio

me-frame. Thpitated or prand Spain.

ubt that the nomy and ha

as the econobasis points

ng rapidly inttened out anorporate balacial corporat80s. We be

oes not run to

h business bocial leveragements. Hous a long bottuseholds to it’s too soo

SDs, Federal

nal Gross Dome

Gross Domestic bt / Nominal GDP

00 05

tion with a fgn debt crisatens to ovend Spain ulon (EMU) arhis fiscal drarolonged receAlthough itgrowth outl

as implicatio

omy slowed s (bp) to en

Jul

n the governnd actually eance sheets ate debt remelieve the rioo far or too

orrowing stae should consehold borrotoming proceincrease sav

on to say by

estic Product

Product P Source: Reuters E

5 10

1

1

1

1

few words osis that begertake two mtimately wilre being forcag and the hessions in Gt appears thalook has dimons for inve

(Figure 15)nd the quart

ly 15, 2011

nment edged are in

mained ise in fast.

arting ntinue owing ess in vings. y how

EcoWin

Sector

Debt,

Percen

t of No

minal G

DP

0

10

20

30

40

50

60

70

80

90

100

110

120

130

on the gan in much ll fall ced to higher

Greece at the mmed estors,

. The ter at

S

Second-Quarter

4.38%, anan even Reserve lFed comFed bougQE2. Theand mortrepresentprincipal not antici

Figure 15

Policy RaGovernmGovernm

Jul06Nov Mar

Fed

Fun

ds R

ate

(Per

cent

)

0

1

2

3

4

5

6

Figure 17

CorpoCorpoCorpoCorpo

60 62 64 66 6

Pro

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hare

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DP

(%

)

3

4

5

6

7

8

9

10

11

12

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r U.S. Econom

nd it has fallarger declinleft the fede

mpleted its Lght $600 bile Fed has intgage portfot some tightreinvestmen

ipate such a

5: Treasury YUnited States,Be

ates, Fed Funds Target Rateent Benchmarks, Bid, 10 Year, ent Benchmarks, Bid, 30 Year,

07Jul Nov

08Mar Jul N

7: CorporateCorporate Profit

rate Profits, With IVA and CCAdj, Totarate Profits, With IVA and CCAdj, Totrate Profits, With IVA and CCAdj, Profrate Profits, With IVA and CCAdj, Pro

68 70 72 74 76 78 80

mic Update

len further tne, falling b

eral funds tararge Scale Allion in Trea

ndicated that olios in ordtening of mnts likely wistep anytime

Yields Downenchmark Interest Rates,

Yield, CloseYield, Close

Nov09

Mar Jul Nov Ma

Profits Risits (w IVA & CCAdj) as Shar

al before tax, Percent of GDP, Current tal before tax, Percent of GDP, Post-Wfits after tax total, Percent of GDP, Cuofits after tax total,Percent of GDP, Po

82 84 86 88 90 92 94

Postwar Averages

o 4.25% as by 52 bp in rget rate at 0Asset Purchasury securiit will conti

der to prevemonetary poill be the firse soon.

n USD

Source: Reute

10ar Jul Nov

11Mar Jul

ing e of GDP

t Prices, AR, SA, USD [ / National IncoWWII Average, Current Prices, AR, SA

urrent Prices, AR, SA, USD [ / Nationaost-WWII Average, Current Prices, AR

Source: Reute

96 98 00 02 04 06 08

Page 9

of July 15. TQ2 and ano

0.25%, wherhase programities in this inue to reinv

ent its balanolicy. It furtst step in rem

Figure

rs EcoWin

Tre

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Jul06Nov M

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100

150

200

250

300

350

400

450

500

550

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Figure 18: D

ome Acco unt, National Product AccouA, USD [ / National Income Account, Nl Inco me Account, National Product A

R, SA, USD [ / National Income Accouners EcoWin

8 10 12

CorpNonfTotal

90 91 9

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/EB

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cent

)

10

15

20

25

30

35

40

45

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The five-yeaother 32 bpre it has bee

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vest principance sheet frther indicate

moving mone

e 16: CorporUnited States, Lon

ody's Baa-Rated Long-Term, Yierrill Lynch, High Yield Master Ind

07Mar Jul Nov

08Mar Jul

Debt Burden

unt, Gross Domestic Product, Overall, National Product Account, Gross DomeAccount, Gross Domestic Product, Ovent, National Product Account, Gross D

Nonfinancial Corporate H

porate Nonfinancial Interest, USDfinancial Corporate Securities anl liquid assets / Short-term Liabil

92 93 94 95 96 97 9

ar Treasury yp month-to-den since Decule in June. nd of quantal proceeds from shrinkined that suspetary accom

rate Spreads g-Term Corporate & High

eld Spread to 30-yr Treasury, Mdex, Yield Spread to 10-year Tre

Nov09

Mar Jul Nov

n Low, Balan

Total, Current Prices, USD * 100]estic Product, Overall, Total, Current Prerall, Total, Current Prices, USD * 100]Domestic Product, Overall, Total, Curre

Health: LTD/Credit, Liquidit

D [ / Nonfinancial Corporate EBIT,nd mortgages / Total Borrowing lities

98 99 00 01 02 03

Jul

yield experiedate. The Fecember 2008In aggregate

titative easinfrom its Treng, which wpension of

mmodation. W

Flat to Wideh Yield Spread

onthly Average easury, Yield to Worst

Source: R

10Mar Jul Nov

11Mar J

nce Sheets S

rices, USD * 100, mean]]ent Prices, USD * 100, mea n]

ty, and Interest/EBIT

, AR, SA * 100]

Source: R

04 05 06 07 08 09

ly 15, 2011

enced ederal 8. The e, the ng, or easury would those

We do

er

Reuters EcoWin

Jul

Hig

h Y

ield

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ead,

bp

0

250

500

750

1000

1250

1500

1750

2000

2250

2500

trong

Reuters EcoWin

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LT D

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Cre

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nd L

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T L

iabi

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s (P

erce

nt)

10

20

30

40

50

60

70

80

90

S

Second-Quarter

As TreasBaa-ratedspreads wDRD-eligbit. Thessovereigncredit spr

A primarquality cexpense rand the pfunding rand corpimprovemdata avadelinquenbears waare stable

Figure 19

DelinqueCharge-ODelinqueCharge-O

90 91 92

Per

cent

-1

0

1

2

3

4

5

6

7

8

9

10

11

12

13

This imphas beneconsumer(Figure 2to shrinkcommercThese treOutlook s

r U.S. Econom

sury yields fd corporate bwidened by 6gible preferrse wider pren debt crisisreads to rem

ry reason focontinues to relative to eproportion orisk (Figure porate bond ment in morailable). Earncies and fo

atching. None or improvin

9: Commerc Bank Commercial Loan

ncy rates, all banks, commercial Off Rates, all banks, commercial ncy rates, all banks, Real estate

Off Rates, all banks, real estate lo

93 94 95 96 97 98

roving crediefitted largerr mortgage l

21). Althougk modestly cial and induends mirror section.

mic Update

fell, credit spbond spread62 bp. Prefered stock andferred sprea

s in Europe ain volatile o

for our contimprove. Co

earnings befoof long-term18). Commedefault rat

rtgage delinqrly indicatiooreclosures anetheless, as ng.

ial Loan Pro

Delinquency & Charge-O

and industrial loansand industrial loans, ARloans, commercialoans, commercial, AR

8 99 00 01 02 03

it environmer commercialending stanh banks are (Figure 22

ustrial (C&Ithe aggrega

preads weres were essen

erred securitid retail hybrads reflect aand somewover the bala

tinued optimorporate pro

fore interest m debt to tot

ercial loan dtes continuequencies andons from seare improvin

we survey

oblems Easin

Off Rates, SA

Source: Reute

04 05 06 07 08 09

ent has promal borrowersndards are noincreasing l

2). Within oI) loans andate borrowin

Page 10

e stable to mntially flat inies’ prices wid securities variety of r

what greater ance of the y

mism on creofits continueand taxes co

tal debt are delinquenciee to drop. d foreclosurecond-quarte

ng again, so a broad rang

ng Fig

ers EcoWin

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All LoAll Lo

90 91 9

Per

cent

0

1

2

3

4

5

6

7

8

9

10

11

mpted banks s and even o longer tighending in ceoverall bankd – just receng trends we

moderately wn the secondwere about fls up slightly risks, chief recession ri

year but with

edit spreadse to reboundontinues to at record hs and chargeIn contrast,res paused ier bank eawe are not tge of credit

gure 20: Mo For

United States, Mortgage B

oans, Total Past Dueoans, Foreclosures Started

92 93 94 95 96 97

to ease lendcredit card

htening, theyertain areas, k credit, mently – crede discussed

wider (Figurd quarter, andflat on balanc

and capital among them

isk here at hh an overall

s is that fund briskly (Fiimprove. Coighs; both re-offs are fa, Figure 20n the first q

arnings repotoo worried statistics, n

rtgage Delinreclosures Fl

Bankers Assoc, Delinquen

All Loans in Foreclosure a

98 99 00 01 02 03

ding standardborrowers.

y have yet toverall bank

mortgages ardit card loan

at the end

Jul

re 16). Longd high yield ce, with pricsecurities do

m the broadhome. We enarrowing b

ndamental cigure 17). Inorporate liqureduce shortalling (Figure0 shows thaquarter (the orts suggest

about this, nearly all of

nquencies anlat ncies & Foreclosures

at End of Quarter, Discontinued

Source:

3 04 05 06 07 08

ds modestly.However, w

to ease matek credit contre shrinkingns are increaof the Econ

ly 15, 2011

g-term bond

ces of own a ening

expect bias.

credit nterest uidity t-term e 19), at the latest

t that but it them

nd

Reuters EcoWin

09 10 11

. This while

erially tinues g, but asing. nomic

S

Second-Quarter

The net rprovisionrebounderequire gformationmanages

Figure 21Uni

DomDomDomDom

90 91 92

Per

cent

-30

-20

-10

0

10

20

30

40

50

60

70

80

90

We will regulationexpect prThat willsometimeminimal

The onlyBasel Coplaced onbe a combanks wi“systemicimpose asystemicaform of clarger com

Putting ayields wregulatoron Treasbenefittin

r U.S. Econom

result of impns for loan loed on the fogrowth in lenn. We see ththat challen

1: Lending Sted States, Business Sur

m. resp. tightening standards fom. resp. tightening standards fomestic respondents tightening sm. respondents tightening stand

93 94 95 96 97 98

close with ns from thereliminary bl be followee in the fouruntil those r

y material baommittee onn systemicalmmon equityll be requirecally importanother 1% ally importacommon eqummon equity

all of this towith a fundry uncertaintsury securiting from both

mic Update

proving credosses but haormer, but pnding and/or his as one of nge is an imp

Standards Earveys, Senior Loan Office

r mortgages to individuals, primr mortgages to individuals, all (D

standards, consumer loans, creddards for C&I loans, large & med

8 99 00 01 02 03 0

a brief updae Fed requirbank capital d by a publi

rth quarter ofregulations a

ank regulatorn Banking Slly importany capital reqed to hold a Stant”) banks

common eant in the fuuity is morey cushion to

ogether, we damentally ity are limitinies are keeph. There are

it but mixedave not been provisions ca

higher interf the key chaportant part o

asing (Slightler Opinion Survey

eDiscontinued)dit cardsdium

Source: Reute

04 05 06 07 08 09

ate on bankred by last yrules from Uic comment f this year. W

are finalized.

ry developmSupervision nt financial iquirement oSIFI buffer awill be at thquity requir

uture. The re good news

o protect pref

think preferimproving ng the need ping investoe risks on th

Page 11

d loan demanable to incr

annot be lowrest margins allenges facinof the analys

ly)

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AsseAsse

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sum

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ans

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, U

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0.8

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1.2

1.3

1.4

1.5

1.6

regulatoryyear’s DoddU.S. bank reperiod, and

We expect b

ment in the son the add

institutions (f 1.0-2.5% at the higherhe lower endrement if a equirement t

for preferreferred credit

rred securiticredit backfor new prers on the h

he horizon, h

nd is that barease net intwered forev to continueng banks gosis we do on

Figure 22: BLendi

ets and liab of comm banks, commercets and liab of comm banks, consumer

09

sh

y matters. Wd-Frank finaegulators byfinal regula

ank issuance

second quartditional capi(SIFIs). Theof risk-weig

r end of the rd of the range

bank growthat the SIFed securitiestors.

ies continuekdrop. Subdeferred issuahunt for yielhowever, wh

anks have beterest marginver. Longer to drive ear

oing forwardeach bank in

Bank Lendining by Commercial Banks

cial & industrialr

Assets

10

Addition of previously off balaheet asset-backed securitizatio

bank balance sheets

We are still ancial reformy the end of ations shoulde of preferre

ter was the aital requireme so-called “ghted assetsrange, whilee. In addition

ws materiallyFI buffer mus, since there

e to offer indued economance, while lld elsewherhich may m

Jul

een able to rens. Earningsterm, banks

rnings and cd, and how a n our portfo

ng Mixed s

and liab of comm banks, bank credit to

Source: R

0 11

ance ons to

waiting for m legislation

the third qud be promuled securities

agreement bment that wi“SIFI buffer”s (RWA). Le smaller (bun, regulatorsy larger or ust be held ie will be an

nvestors attramic growthlow interest

re. Preferredmake for a bu

ly 15, 2011

educe have s will apital bank

lios.

otal

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al L

oans

Out

stan

ding

, U

SD

(th

ousa

nd b

illio

ns)

8.8

8.9

9.0

9.1

9.2

9.3

9.4

9.5

9.6

final

n. We uarter. lgated to be

by the ill be ” will

Larger ut still s may more

in the even

active h and

rates ds are umpy

S

Second-Quarter

summer. think the– and plesovereignthat curtarebellion in oil pric

It is a treto manag

Flaherty July 15, 2 © 2011, Fstatements.competitivany forecaIncorporatecopying, reinformationIncorporateFlaherty &discussed imade by Fl

r U.S. Econom

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enty of themn debt crisisails lendingin another l

ces.

eacherous woge those risks

& Crumrine2011

Flaherty & C. You are cautie uncertaintiesst; the opinioned. Further, tepublication orn contained hed does not rep

& Crumrine Incin this report mlaherty & Crum

mic Update

growth in thwill prove te

m are lurking , failure to r, another nalarge oil-pro

orld out thers and deliver

e Incorporate

rumrine Incorioned that suchs and actual rens stated here ahis document r redistributionerein has beenpresent or war

corporated and may not be suitmrine Incorpor

he U.S. has semporary, thout there. P

raise the fedeatural disastducing coun

re. Of courser on the port

ed

rporated. All h forward-lookiesults could beare subject to c

is for personan in whole or inn obtained frorrant that it is a

are subject totable for all invrated.

Page 12

slowed and he economy Potential shoeral governmer that chok

ntry that cuts

e, it always tfolio objecti

rights reserveing statements

e materially difchange at any tal use only ann part is expresom sources beaccurate or co change witho

vestors. No off

unemploymis currentlycks include

ment debt cekes off the s oil supplie

is. And as aives you hav

ed. This commare subject to

fferent. There time and are th

nd is not intendssly prohibitedelieved to be rmplete. The v

out notice. Thefer or solicitatio

ment has incry vulnerable

a worseningeiling, overzrebound in s and causes

always, we ave given us.

mentary contasignificant busare no guaran

he opinion of Fded to be inve

d without writtereliable, but F

views expressede securities or fon to buy or se

Jul

reased. Whilto further sh

g of the Eurozealous regul

production,s a renewed

are doing our

ains forward-losiness, economntees associateFlaherty & Cruestment adviceen prior consen

Flaherty & Crud herein are thfinancial instruell securities is

ly 15, 2011

le we hocks opean lation , or a spike

r best

ooking mic and

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