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RESEARCH
US Economics & Rates Strategy | June 25, 2009
 
PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 42
Forecasts and Summary of Views 2Data Review and Preview 7Trade Recommendations 38Bond Yield Forecasts 40 Economics
Dean Maki+1 212 526 1731dean.maki@barcap.com
Interest Rates Strategy
Ajay Rajadhyaksha+1 212 412 7669ajay.rajadhyaksha@barcap.com
MARKET STRATEGY AMERICAS
Still filling the punchbowl, but not making itbigger
Economics
Outlook 3
We have revised up our H2 09 GDP forecast based on the anticipated effects of the “cashfor clunkers” legislation. The Fed is less worried about deflation and did not expand itsasset purchase plan, but continues to fill the punchbowl by sticking to this plan.
Revving up production 5
Motor vehicle output looks set to jump higher in the second half of the year. This hasled us to revise up our forecast for GDP growth over the next two quarters.
Rates strategy
Overview: A continued normalisation trade 9
Rates should drift higher in most developed markets in the second half of 2009, drivenby supply pressures and further normalisation.
Treasuries: Status quo in foreign demand is not enough 17
US Treasury purchases by foreign accounts have been steady, but bill holdings haverisen and buying has not kept up with supply. Slowing reserve growth anddiversification away from the US would continue to be a risk to higher yields.
Inflation-linked markets: Put oil risk in check with oil puts 20
Front-end breakevens still have downside risk from a sharp energy decline. Werecommend long front-end breakevens with out-of-the-money puts on crude futures.
Agencies: MBS vs. callables revisited 23
We find MBS are generally cheap versus callables. This reflects adjustments toprepayment models, which now generally overstate the callability of the MBS universe.
Swaps: Front-end Eurodollars – More room to go 27
Front-end Eurodollar contracts offer value, as they are still pricing in the Fed to beginhiking too soon and the L-OIS basis to widen. We disagree with both.
Futures: Alternatives to long ED: Limited loss trades 30
We recommend call flys and bullish spreads struck in a range between 99.25 to 99.50strikes: they offer a good risk-reward profile and are protected by rate-vol directionality.
Volatility: Sell vol on short rates 33
Vol on short rates is still high. Sell low strike straddles on 3m*2y and 0EU9 straddles at98.375. Alternatively, we recommend a regression-weighted vol fly.
Money markets: Changing Regulation D 35
In early July, the Federal Reserve will amend the rule governing the payment of interest onreserves to close a few loopholes and smooth over troubled relationships between banks.
 
Barclays Capital | Market Strategy Americas
25 June 2009
 
2
 
FORECASTS
2008 2009 2010 Calendar year average% Change q/q saar Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2008 20092010
Real GDP 0.9 2.8 -0.5 -6.3 -5.5 -2.0 2.5 3.5 3.0 3.0 3.5 4.0 1.1 -2.4 2.8Private consumption 0.9 1.2 -3.8 -4.3 1.4 0.5 1.5 2.0 1.5 1.5 2.5 3.0 0.2 -0.5 1.7Public consumption 1.9 3.9 5.8 1.3 -3.1 5.0 4.8 3.5 1.6 1.8 1.9 2.1 2.9 2.1 2.7Residential investment -25.1 -13.3 -16.0 -22.8-38.8-25.0-5.0 12.0 22.0 30.0 35.0 35.0 -20.8 -22.6 16.7Equip. & software investment -0.6 -5.0 -7.5 -28.1-33.7-15.0-10.00.0 4.0 6.0 6.0 8.0 -3.0 -19.9 0.9Structures investment 8.6 18.5 9.7 -9.4 -42.9-10.0-18.0-10.0-8.0 -4.0 5.0 5.0 11.2 -17.1 -6.9Net exports ($bn, real) -462 -381 -353 -365-297 -295 -316 -313-317 -319 -327 -335 -390 -305 -325Final sales 0.9 4.4 -1.3 -6.2 -3.3 -0.6 0.0 2.2 1.7 2.3 3.2 3.7 1.3 -2.0 1.9Ch. inventories ($bn, real) -10.2 -50.6 -29.6 -25.8-87.1-125.0-55.0-20.015.0 35.0 43.0 50.0 -29.1 -71.8 35.8GDP price index 2.6 1.1 3.9 0.5 2.8 1.5 1.7 1.8 1.7 1.4 1.6 1.5 2.2 2.0 1.6Nominal GDP 3.5 4.1 3.4 -5.8 -2.9 -0.3 4.3 5.3 4.8 4.4 5.2 5.6 3.3 -0.4 4.5Industrial output 0.2 -4.6 -9.0 -13.0-19.0-10.08.0 8.0 5.0 6.0 7.0 7.0 -2.2 -9.4 5.5Employment (avg mthly chg, K) -113 -153 -208 -553-691 -400 -100 25 75 125 150 175 -257 -292 131Unemployment rate (%) 4.9 5.4 6.1 6.9 8.1 9.3 9.9 10.0 9.7 9.6 9.4 9.2 5.8 9.3 9.5CPI inflation (% y/y) 4.1 4.4 5.3 1.6 0.0 -1.2 -1.4 1.4 2.5 2.1 1.4 1.4 3.8 -0.3 1.8Core CPI (% y/y) 2.4 2.3 2.5 2.0 1.7 1.8 1.5 1.6 1.4 1.1 0.9 0.9 2.3 1.6 1.1Core PCE price index (% y/y) 2.2 2.3 2.3 1.9 1.8 1.6 1.3 1.3 1.1 1.0 0.8 0.8 2.2 1.5 0.9Current account (% GDP) -5.1 -5.3 -5.1 -4.4 -2.9 -3.3 -3.8 -4.0 -4.0 -4.3 -4.7 -4.9 -4.9 -3.5 -4.5Federal budget bal. (% GDP) -3.2 -12.0 -9.5Federal funds rate (%) 2.25 2.00 2.00 0-0.250-0.250-0.250-0.250-0.250-0.250-0.250-0.25 0-0.25
Note: All numbers expressed in q/q saar % unless otherwise specified. The budget balance is fiscal year. Source: Barclays Capital
VIEWS ON A PAGE
US
Direction
 
Supply has put significant pressure on long rates, and convexity hedging is adding to it.
 
The Fed could offset these pressures with increased QE, but is showing patience.
 
We recommend a neutral duration stance because of expected volatility.Curve
 
We recommend forward 2s-10s steepeners.
 
More QE could lead to flatteners, though, so be neutral in spot for now.SwapSpreads
 
LOIS basis priced to widen, which we do not agree with. Long EDZ9 or H0.
 
10y spread should grind tighter as mortgage convexity needs are now skewed toward receiving and Tsysupply persists.Otherspreadsectors
 
Overweight USD supras (EIB, KfW, SFEF) and 5y and 10y FHLB versus FNMA/FHLMC.
 
We favour 5-10y agencies versus Treasuries, particularly at new issue.
 
Overweight sectors ineligible for Fed purchase, eg, callables, non-bellwethers, FFCB, and TVA.Inflation
 
Breakevens remain structurally attractive, but are lower to fair value tactically.
 
The 5-7y sector offers the best value on the curve beyond the very short end.
 
Long Jan10 BEIs and hedge energy tail risk with 45 out-of-the money Dec crude puts (@ 40/bl).Volatility
 
Bearish top left. The FOMC reinforced the possibility of a long period of “on-hold”. While hike expectationshave decreased, the vol on short rates is still high. Sell low-strike 3m*2y straddles.
 
1y*10y is cheap relative to 3m*10yr and 3y*10y.
 
Barclays Capital | Market Strategy Americas
25 June 2009
 
3
 
OUTLOOK
Still filling the punchbowl, but not making itbigger
 
We have revised up our H2 09 real GDP forecast, based on the anticipated effects of  the “cash for clunkers” bill.
Dean Maki+1 212 526 1731dean.maki@barcap.com
 
As we expected, the Fed did not increase the size of its asset purchase programs,and it sounded less worried about deflation risks.
 
While we do not think the Fed will increase its asset purchases further, we stillexpect it to keep rates unchanged throughout 2010.
This week, we revised up our GDP forecast for Q3 09 (2.5% from 2.0%) and Q4 09 (3.5%from 3.0%). This was mainly in response to the “cash for clunkers” legislation, which waspassed by Congress and signed into law this week by President Obama, and givesconsumers up to $4,500 to trade in their old cars and light trucks for more fuel-efficientnew ones. The legislation provides $1bn for FY09, which ends in September, and we expectthis to increase motor vehicle sales by an annualized 1mn in Q3 09. We expect the other$3bn in the original proposal also to pass Congress and be used in FY10, and for that tohave an even larger effect on sales in Q4 09. As is discussed in the accompanying article
Revving Production,
in an environment in which motor vehicle inventories are already fallingrapidly, we expect the rise in sales to lead to a sizeable increase in production in H2 09. Wehave modestly lowered our forecast for early 2010 because we assume some of the salesare “pulled forward” from next year.We think the legislation will give a boost to an economy already set to recover. This weekbrought more evidence that the pace of contraction in Q2 09 is easing markedly. Core capitalgoods orders rose 4.8% in May, and even smoothing through the monthly volatility, the paceof decline is slowing rapidly (Figure 1). Computers and electronics orders have turned positiveon a 3m/3m annualized basis, a favorable sign because this is one of the more cyclical sectorsin the economy. Also, both new and existing home sales have been stable at low levels since January (Figure 2). This stability in the former is leading to steady declines in the months’supply of new homes, a trend we expect to continue.
Figure 1: Durable goods orders trend is improvingFigure 2: Home sales have flattened this year
-80-60-40-200204060800506070809Core capital goods ordersComputers and electronics orders3m/3m % chg, saar0.20.40.60.81.01.21.405060708093.54.04.55.05.56.06.5New home sales (lhs)Existing home sales (rhs)Mn, saar
Source: Census Bureau, Haver Analytics Source: Census Bureau, National Association of Realtors, Haver Analytics
We have raised our H2 09real GDP forecast Recent data suggest a lesser  pace of contraction in Q2 09
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