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US Fixed Income Strategy 2 May 2011

US Fixed Income Weekly
Cross Sector Srini Ramaswamy, Kimberly Harano
We remain cautiously overweight risky assets given our expectation of an improvement in economic growth, strong corporate profits, and ongoing stimulative monetary policy. Two exceptions are high grade and high yield markets, where we take a neutral stance in the near term.
Contents
Cross Sector Overview Economics Treasuries Agencies Corporates Municipals Special Topic Forecasts & Analytics Market Movers 2 5 8 13 15 19 24 31 35

Governments Terry Belton, Meera Chandan, Kim Harano, Renee Park
Expect higher rates, targeting 3.60% in 10-year yields. Expect 7s/10s and 7s/30s curve steepening into supply. We like 8% Nov-21s more than 2.5% Apr-15s and 6.625% Feb-27s. Stay long TIPS breakevens.

Investment-Grade Corporates Eric Beinstein
We stay tactically cautious as near-term risks are skewed more to the downside. However, positive fundamentals highlighted by recent earnings reports keep us bullish in the longer term, and we keep our YE spread target of 120bp.

Municipals Alex Roever, Chris Holmes, Josh Rudolph
Issuance is likely to pick up in May, but heavy June coupon and redemption income should help mitigate some of the supply-induced cheapening.

Special Topic: The Domino Effect of a US Treasury Technical Default T. Belton, S. Ramaswamy
We explore the systemic risks that would result from a technical default in the US Treasury market. While unlikely, a default would have large systemic effects with long-term adverse consequences for Treasury finances and the US economy.

Terry Belton Srini Ramaswamy Alex RoeverAC
AC

Indicates certifying analyst. See last page for analyst certification and important disclosures.

US Fixed Income Strategy US Fixed Income Weekly May 2, 2011 Srini RamaswamyAC Kimberly L. Harano J.P. Morgan Futures Inc., J.P. Morgan Securities LLC

Cross Sector Overview
 We remain cautiously overweight risky assets given our expectation of an improvement in economic growth, strong corporate profits, and ongoing stimulative monetary policy Risks to our positive view include higher energy prices as well as renewed concerns about peripheral Europe; in most spread product sectors we view these risks as being outweighed by the positives and we remain overweight on balance. Two notable exceptions are high grade and high yield markets, where we take a neutral stance in the near term Stay bearish on duration; the rally over the past month has provided attractive entry levels, and we expect rates to rise as the supply/demand imbalance worsens, Fed commentary likely turns more hawkish, and carry trades are unwound in front of payrolls

Exhibit 1: Bonds and equities rallied, while credit spreads widened over the past two weeks
Current level,* change since 4/15/11, QTD change, and change over 1Q11 for various market variables
Current Chg from 4/15 QTD chg 1Q11 chg Global Equities (level) S&P 500 E-STOXX FTSE 100 Nikkei 225 Sovereign par rates (%) 2Y US Treasury 10Y US Treasury 2Y Germany 10Y Germany 2Y JGB 10Y JGB 5Y Sovereign CDS (bp) Greece Spain Portugal Italy Ireland Funding spreads (bp) 2Y EUR par swap - par gov't spd 2Y USD par swap - par gov't spd EUR FRA-OIS spd USD FRA-OIS spd 1Y EUR-USD xccy basis Currencies EUR/USD USD/CHF USD/JPY JPM Trade-weighted USD Spreads (bp) 30Y CC MBS L-OAS JULI spd to Tsy JPM US HY index spd to worst EMBIGLOBAL spd to Tsy MAGGIE (Euro HG spd to govies) US Financials spd to Tsy Euro Financials spd to govies 10Y AAA muni/Tsy ratio (level) 30Y AAA muni/Tsy ratio (level) Commodities Gold futures ($/t oz) 33.5 131.3 521.6 303.9 42.2 148.6 144.6 84% 104% 1517.10 0.6 -1.8 3.5 4.1 0.8 0.2 2.3 -6.1% -3.1% 44.70 5.3 -4.2 4.6 5.1 0.1 -7.9 -5.1 -6.4% -2.7% 93.30 -2.4 -11.7 -66.0 10.3 -6.8 -13.7 -29.4 -3.0% -0.9% 17.90 1.482 0.873 81.62 77.03 0.040 -0.022 -1.50 -1.18 0.063 -0.042 -1.15 -2.03 0.092 -0.023 1.46 -1.71 57.4 19.6 21.5 16.4 -16.3 0.8 2.6 -4.9 1.0 3.6 -4.5 1.1 -4.7 -4.3 9.9 -18.3 -3.8 -7.2 1.3 22.7 0.586 3.416 1.760 3.277 0.190 1.262 1560 232 659 144 683 -0.102 -0.092 -0.073 -0.147 -0.010 -0.088 258 1 51 3 96 -0.185 -0.122 0.033 -0.119 -0.005 -0.042 468 -1 67 -3 21 0.197 0.148 0.939 0.391 0.034 0.138 86 -116 101 -86 57 1360.5 2977.6 6068.2 9849.7 40.8 58.5 72.1 258.2 34.7 66.7 159.4 94.6 68.2 118.1 8.8 -473.8

Wedding bells and warning bells
In the two weeks since we last published, a number of historic events have taken place. First, Standard & Poor’s revised its US sovereign ratings outlook to negative (while also preserving the current rating). S&P also lowered its ratings outlook on Fannie Mae, Freddie Mac and several Federal Home Loan Banks, as well as its ratings outlook for Japan. Second, Wednesday’s FOMC statement was followed by the first ever post-FOMC meeting press conference, where Chairman Bernanke fielded questions from the media. Third, Greek bond and CDS spreads widened to record highs. All of these events seemed to be eclipsed by the British royal wedding on Friday, however, with equities as well as bonds rallying globally. The celebratory mood proved insufficient to spur a rally in fixed income spread product, however; over the past two weeks, most spreads are modestly wider, while peripheral Europe spreads widened by considerably larger amounts (Exhibit 1). Meanwhile, the tone of data has improved somewhat. The preliminary 1Q GDP report showed that the economy grew at a 1.8% annualized rate, better than our forecast for 1.4% growth, while personal consumption

Oil futures ($/bbl) 112.86 2.64 6.14 15.34 * 4/28/11 level for Europe and US corporate credit spreads, Europe and Japan yields, UK and Japan equities, and the J.P. Morgan trade-weighted USD index; 4/29/11 level for all others.

rose 2.7%, much stronger than expected. In addition, housing data looked better, with housing starts, existing home sales, and new home sales all rising in March, though house price indices continued to decline. On the

2

US Fixed Income Strategy US Fixed Income Weekly May 2, 2011 Srini RamaswamyAC Kimberly L. Harano J.P. Morgan Futures Inc., J.P. Morgan Securities LLC

other hand, the improvement in labor markets seems to have slowed, as initial claims rose to 429K in the latest week. Overall, however, the tone of data has improved, leading our index of economic data surprises to rebound from its lows, though it remains in negative territory (Exhibit 2). Going forward, we expect risky assets to continue to outperform, for several reasons. First, we expect growth to accelerate through the remainder of the year; we think 1Q growth was held back by severe winter weather and rising energy prices, so we expect growth to pick up as we move into the second half of the year. Second, despite weaker growth of the overall economy, corporate profit growth remains robust. As Exhibit 3 shows, so far in the reporting season, earnings have been beating estimates by about 7%, which is a larger margin than the previous two quarters. Indeed, our equity strategists have raised their full-year 2012 EPS estimate for the S&P 500 by $3 to $105. As a result, they have also raised their year-end target for the S&P 500 from 1425 to 1475. A continued rally in equities as we expect will likely help other risky assets outperform as well. Finally, monetary policy appears likely to remain stimulative for some time. While this week’s FOMC statement acknowledged that “inflation has picked up in recent months,” it also noted that “the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low.” The statement also maintained its “extended period” language. Finally, Chairman Bernanke’s comments in the post-meeting press conference were generally in line with the view that the Fed will maintain monetary stimulus for some time. Thus, we expect monetary policy to remain supportive, and as we have often noted, stimulative monetary policy amidst tame core inflation and positive growth (even if somewhat lackluster) makes for a supportive macroeconomic backdrop for risky assets. To be sure, risks to our positive view remain. First, the ongoing crisis in the Middle East remains far from resolved, and the risk of a further increase in energy prices remain a headwind for economic growth. However, our Middle East crisis index suggests that the situation is stabilizing rather than worsening (Exhibit 4). Second, peripheral Europe returned to the spotlight this week, with Greece spreads widening significantly (by

Exhibit 2: The tone of economic data has improved somewhat
J.P. Morgan EASI*; level

30 20 10 0 -10 -20 -30 -40 Apr 10 Jul 10 Sep 10 Dec 10 Feb 11 Apr 11

* EASI is the J.P. Morgan Economic Activity Surprise Index and measures the number of positive surprises minus the number of negative surprises divided by the total number of data releases over the past 6 weeks.

Exhibit 3: 1Q earnings have been beating estimates by about 7%
% beat actual EPS vs. forecast for S&P 500; 1Q11E % beat is median % beat of companies reported so far; 1Q11E as of 4/28/11; %

20%

0%

-20%

-40%

-60% 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11E

258bp to 1560bp) as markets continue to anticipate an eventual debt restructuring. However, contagion from Greece seems limited thus far, since spreads in Spain and Italy have remained rangebound. As a result, the sensitivity of US spread markets to peripheral European risks has declined to near zero (Exhibit 5). Last, to the extent that political deadlock around increasing the debt ceiling intensifies in coming weeks, it poses a risk. Although we fully expect the debt ceiling to be increased by late June or early July (see Special Topic), the absence of a quick and immediate resolution is likely to temper risk appetite in the near term.

3

In most other sectors. 10Y AAA CMBS spread to swaps. Qatar and Saudi Arabia benchmark stock indices in USD terms. In Treasuries. Morgan Exhibit 5: US markets have become insensitive to peripheral Europe concerns Rolling 3-month beta of 2-week changes in our cross-sector spread index* regressed against index of peripheral CDS spreads**. we stay bearish on duration.0005 Dec 10 Feb 11 Apr 11 * Cross-sector spread index is calculated as average of 2-year z-scores for 5-year swap spreads.P.318 * Front Crude Oil Px) +2126.084 * DAX Index) – (101.0020 0. Higher values of the index indicate a worsening of the crisis. We remain overweight subordinates.0000 -0. Israel.0 Apr 11 * Index calculated as -1* [Middle Eastern stock index** – (15.85]/1938.. In CMBS.0 2. although we do not see a nearterm catalyst for a rally.P. our first Consumer ABS investor survey showed that investors generally believe that credit losses would decrease and that spreads would be flat to tighter this year. ** Weighted average of Bahrain. Exhibit 4: Our Middle East crisis index suggests that the situation is stabilizing Rolling front Brent oil futures price versus Middle East crisis index*. we remain cautiously overweight. 4 . we expect the top of the capital structure to continue grinding tighter and expect investors to add exposure to wider-spread A4s.0010 0.US Fixed Income Strategy US Fixed Income Weekly May 2. Kuwait. but low yields and mounting risks leave prices vulnerable (see High Yield). Harano J. Level 3 2 1 0 -1 -2 Peripheral spread index -3 Apr 10 Jul 10 Sep 10 Beta 0. JPM Domestic HY index spread to worst. Source: Bloomberg. 2011 Srini RamaswamyAC Kimberly L. In ABS. ** In-sample z-score of 5-year sovereign CDS for Greece. we remain somewhat agnostic toward high-yield bonds at these levels over the near term as spreads remain wide relative to the expected default rate on one hand. and a continued benign prepayment environment. We also keep our overweight view on MBS. $/bbl level 130 120 110 100 Middle East crisis index 4.95 * S&P 500 index) + (2.5 3. we think these risks balance the positive factors.0 3. and unwinds of carry trades in front of payrolls (see Treasuries). more hawkish Fed commentary. particularly in Non-Prime Auto Loan and expect spreads to set new tights this year.5 Brent oil price 90 80 Nov 10 Dec 10 Jan 11 Feb 11 Mar 11 2.5 1. J.P.0015 0.0005 0. Portugal and Spain. and 2005/6 vintage AJs.0 1. 2Y AAA credit card ABS spread to swaps and EMBIGLOBAL strip spread to Treasury. J. Oman. We view this month’s rally as providing an attractive entry level to reset short duration positions. Morgan Securities LLC In some sectors such as high grade. JULI I-spd to Treasury. Morgan Futures Inc. Similarly. Nigeria. and we think next week is likely to bring a worsening supply/demand imbalance in Treasuries. highlighting stronger demand from banks and REITs. in high yield. Weights determined by market values of the indices (in USD terms) as of year-end 2010. however. 2006/7 vintage AMs. Ireland. so we are currently neutral on corporates (see Corporates).

7 11.1% saar in 4Q10 to 1.5 1Q 2011 Feb.8% last quarter and domestic final sales slowed from 3.40 Claims 395 3.7 4. including this week’s unexpectedly large increase to 429.8% in 1Q11 with weakness concentrated in construction Forecast looks for 3. To be sure.0 -0.0% saar plunge in real government construction activity). The forecast had looked for 4. Res. declining 5. The continued squeeze on real income from rising fuel prices threatens the forecast of 2. Government Net trade contr.2 4.70 445 420 3.0 0. real government spending had its weakest quarter since 1983. higher fuel prices and supply-chain problems pose risks Forecast looks for a drop to 59. Exhibit 2: Retail price of gasoline and initial jobless claims Dollars per gallon.5 11. In addition.8 -4.1 The government’s first estimate of 1Q11 real GDP shows that growth slowed from 3.3 -1.000.8 2.4 3. nsa '000s. sawr 4. investment Nonres. 4Q 2010 3.6 1.0% growth path through the rest of this year.8 0.0% growth as recently as February.000 Exhibit 1: Tracking the 1Q11 slowdown in real GDP Q/q saar  Real GDP Final sales Consumption Equip.2% to only 0. Morgan Chase Bank Economics   Real GDP growth slows to 1.6 -0. Memo: IP.1 0.2 -0. and the other major reason for the disappointing outcome was a downturn in construction activity that was at least partly weather-related.9 9.7 3. The recent upturn in initial jobless claims.7 3. payrolls slowing to 165. Output of nonresidential construction plunged last quarter.5 1Q 2011 actual 1.0% growth this quarter. supply-chain disruptions: The forecast views much of the weakness in construction to be weather-related and looks for GDP growth to return to a 3.P.1 6.7 7. manuf.0 2.0 10.6 -21. The continued rise in fuel prices through the quarter dampened real consumer spending. hints that supply interruptions in the auto industry may be spreading to supplier industries (or that effects of higher fuel prices are starting to weigh on labor markets).7 in ISM mfg. And shortages of parts sourced in Japan are leading to significant production cutbacks in the auto output this quarter. so the outcome was well below relatively recent expectations. and housing activity fell as well. constr. Drags on 2Q growth from fuel prices. the news so far this quarter has tended to highlight downside risks to this forecast.0 in ISM non-mfg.1 -5.Economic Research US Fixed Income Weekly May 2.8 3.0 7.9%.10 Jan 11 Feb 11 Mar 11 Apr 11 370 Exhibit 3: Stock prices and value of the dollar Index Real broad index.5% growth in real consumer spending this quarter. 2011 Robert MellmanAC Michael Feroli J.00 Price of gasoline 3. Inventory contr.3 -3. rise to 58. forecast 4.2% saar (that included a 19. constr. 2000=100 1400 S&P 500 86 84 1300 82 1200 80 78 1100 Trade-w eighted dollar 76 74 Sep 10 Nov 10 Jan 11 Mar 11 May 11 1000 Jul 10 5 .

Morgan Chase Bank Support for 2Q growth from higher equity prices.1% samr following a downwardly revised 0. and improved payroll growth were misleading guides to growth last quarter).Economic Research US Fixed Income Weekly May 2.5% saar in 1Q11 and only 0. the forecast of 2.5pts to 59.7%oya and only 0. Cross-currents hitting the consumer Real consumer spending rose 2. In addition. The ISM manufacturing survey is forecast to decline 1.5% growth through the previous expansion but is down to 1. while real. While there are obvious downside risks to the spending forecast. 2011 Robert MellmanAC Michael Feroli J. Exhibit 4: Price of medical services %ch saar. the upside risks to growth this quarter.9%oya.P. the financial markets could well provide some lift. The PCE price measure for medical services had been averaging about 3. are more amorphous. In addition.8% saar in 1Q11. they are not overwhelming. two earlier hints of stronger housing markets did not pan out:  Mortgage applications for purchase had been trending higher through the week of April 15. but the size of the bounce is still highly uncertain. about equal to the 1Q11 average. The S&P 500 is now 13% (not annualized) above its 4Q10 average.1% pop in March new home sales from upwardly revised levels also seems to send an encouraging message. The core PCE price index rose 0. PCE price index 6 5 4 3 2 1 0 00 01 02 03 04 05 06 07 08 09 10 11 From prev ious quarter Upcoming data important Upcoming early reports on activity in April should condition views on activity this quarter (with the caveat that upbeat ISM surveys. spending did rise 0. Moreover. Wealth and confidence effects of stock market gains may boost consumer spending. providing a decent trajectory into the quarter. but this is only relative to the dismal report in February.000 from 216.7pt to 58. Industry guidance points to April car and light truck sales of 13. And the forecast looks for nonfarm payroll employment to slow to 165. March construction figures (out Monday) will provide some early guidance. Thus. and it had been unclear whether this rise reflected the front-loading of 6 . about in line with the 2. Construction should bounce back from weatherdepressed 1Q11 levels. Real consumer More disappointing news on housing March pending home sales increased 5.0. a weaker dollar: Meanwhile. the continued slowing in the price of medical care is providing an offset. increased auto sales. This news points to at least modest nearterm increases in existing home sales.2% in March.9% growth of real disposable income. While the passthrough of higher commodity prices and an end to declining rents is lifting core prices. Disposable income will not have the benefit of tax cuts again this quarter but will face a drag from the continued rise in the price of oil to date.000 in March. but two-thirds of the acceleration in nominal disposable income last quarter was offset by higher inflation. consistent with readings from the Homebuilders survey.5% saar growth of real consumer spending will likely require some decline in the saving rate to be realized. reflecting some effects of higher fuel prices on overall activity and of supply-chain disruptions on manufacturing employment. Nominal disposable income had been boosted by the reduction in payroll taxes starting in January.13% in March and is up 1.7% increase the month before. The trend in new home sales is still flat at very low levels. although it is unclear how much acceleration we might get this quarter. supply disruptions and associated shortages of new motor vehicles (especially Japanese nameplates) will likely depress auto sales modestly in May and June. And the lower dollar should be helping exports. This 11.0mn saar. And wealth effects from equity market gains provide reason to expect a lower saving rate.7 and the nonmanufacturing survey is forecast to increase 0.7% saar last quarter.

Economic Research US Fixed Income Weekly May 2. an item that can make for volatile 1Q readings. within the 1.6% saqr in 1Q11 and has held in the 1.1% saqr in recession quarter 1Q09.6%oya in 1Q11. Hourly wages and salaries for all workers rose 0. Morgan Chase Bank sales ahead of the April 18 increase in FHA insurance premiums or a genuine uptrend in housing demand.  The 4Q10 Census survey of housing vacancies had shown a sharp acceleration to a 1.5% saqr and 2. and the housing vacancy rate fully reversed the prior quarter’s drop. Benefits also rose 1.9%-2.5%oya in 1Q10 and 5.9%-2. The number of occupied housing units and households declined 1.1% saqr and 3. This result fits with the slowing trend in the PCE price index for medical services.1% last year but rose only 0.9% saar increase in occupied housing units.P.6% decline in purchase applications in the week of April 22 indicates that the rise had been merely a front-loading of sales.1%oya range for the past four quarters. But the 1Q11 housing vacancy report shows a partial reversal of the prior quarter’s progress. The above-trend rise in benefits last quarter appears to reflect unusually large non-production bonuses. 2011 Robert MellmanAC Michael Feroli J. 7 . a like-sized increase in household formation. The 13. The ECI for all workers rose 0.0%oya range for the last four quarters. and a decline in the housing vacancy rate.0% trend.0% saar. Labor cost increases holding at 2% Labor costs are being closely watched for signs of any change in this important influence on inflation and household income. Evidence that an improving economy was leading to a sustained acceleration in household formation would be good news for the housing market. The ECI for private sector workers rose 0. The latest quarterly reading of the employment cost index shows this fixed-weight measure of hourly labor costs continuing to rise at about a 2.4%oya last quarter. Benefits rose 1.0% saar. The trend in employer costs of health benefits (reported only on an over-year-ago basis) slowed from 4.4%saqr and 1.0%oya in 4Q10 to only 3.0%oya.

625% Feb-27s Stay long TIPS breakevens Exhibit 1: Risk appetite has increased as inflows into equities have increased while bond fund inflows have been muted Weekly mutual fund flows.000 US equities Source: EPFR Global This w eek YTD av erage  HY+IG Treasuries Munis    Exhibit 2: Medium-term inflation expectations have moved lower over the last few weeks but remain above their 1-year average Fed’s measure of the 5Yx5Y breakeven inflation rate.000 -2. Similarly.5% Apr-15s and 6.3 and durable goods orders rebounded.0 Jul 10 Source: Federal Reserve Oct 10 Jan 11 Apr 11 production has slowed but still suggests solid growth going into 2Q. With rates now falling for 3 consecutive weeks.8% in 1Q11. % 3.0 2. 10-year yields have moved back towards the bottom of this year’s trading range.. and 30-year yields declining 6 bp. was supported by investors adding exposure to yield curve carry trades and by economic data that generally confirmed the modest pace of economic growth. more hawkish Fed commentary. above our 1. the drop has occurred as headline risk on the debt ceiling has moved to the forefront and as public statements from foreign officials on the need to diversify their FX reserves has increased Expect a steeper 7s/10s and 7s/30s curve heading into supply Buy 8% Nov-21s versus a weighted combination 2. Economic data over the last 2 weeks generally confirmed this year’s slowdown in U. a little softer than we had expected and leaves the annualized 3-month run rate at 1.8 2. rising 2.4% forecast and helped by a better than expected 2. was modestly better than expected with our economic activity surprise index increasing 14 points.2 2.000 0 -1.4 3. 10-year yields declining 11 bp. Manufacturing survey data confirmed that industrial 3. the Philadelphia Fed survey fell to 57.29% on only three days this year. J.4 2. having closed below its current level of 3. Despite the slightly elevated core inflation numbers.000 2. Morgan Securities LLC Treasuries  We increase our duration shorts as this month’s rally is likely to retrace quickly. which occurred despite increased investor risk appetite and a pickup in asset allocation flows from fixed income into equities (Exhibit 1).13% m/m. Thursday’s advance estimate of real GDP showed growth of 1. and unwinds of carry trades in front of payrolls This week’s disappointing 7-year auction showed a significant drop in foreign sponsorship in intermediate Treasuries. Core PCE prices rose 0. on balance.000 5. Harano J.000 4. $mm 6.000 1.6 2. 5-year yields declining 19 bp. The rally. while one bad auction does not make a trend.9%.US Fixed Income Strategy US Fixed Income Weekly May 2.P.5% in March following weak reports in January and February. 2011 Terry BeltonAC Meera Chandan Kimberly L. with 2-year yields declining 12 bp.P.7% increase in real consumption. growth but. the Fed’s measure of 5Yx5Y forward inflation expectations from the TIPS market has fallen 20 8 .5%. next week should show signs of a worsening supply/demand imbalance in Treasuries. longer-term inflation expectations have softened over the last few weeks with the University of Michigan’s measure of 5-year ahead inflation expectations falling 30 bp to 2. Morgan Futures Inc.2 Market views The Treasury market performed strongly during the last two weeks.S.000 3.

Treasuries and Agency debt markets averaged by month between 2007 and 2010.70 4.85 3.90 4.09 0. " 26-Apr 230 220 210 200 190 180 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec "Expect RMB will appreciate 5%-7% this year. We should strengthen the flexibility of RMB exchange rate and reduce imported inflation.S. investment grade corporates.35 0. $bn of 10-year equivalents 19-Apr "Curbing inflation is our primary task. this week’s surprisingly poor results in the 7-year auction.$1 trillion of FX reserves is sufficient" Research of State Council) Tang Shuang Ning (Chairman of China Everbright Group.22 0. Although one bad auction does not make a trend. which rose 25 thousand to 429 thousand. Morgan Securities LLC Exhibit 3: J. Recommend diversifying foreign currency reserve and reduce the dependence on the US dollar. dollars" member of CPPCC National Committee) bp to 2. One way to manage is diversification.10 0. RMB 19-Apr Policy Commission. raises a red 9 .P.20 2." Hu Xiao Lian (Vice Governor.61 1. Four near-term factors suggest this month’s rally is due for a pause as we look for 10-year yields to move back towards 3.55 0.45 4. especially investing in natural Bank Currency resources and technology projects.US Fixed Income Strategy US Fixed Income Weekly May 2.27 0. People's Bank of China) mentioned that we need to reduce excess FX reserves. We need to manage it well.05 0.98% over the last two weeks but is still 20 bp above its 1-year average (Exhibit 2).10 0. Director of Finance appreciation is one way.05 0. RMB should no longer only peg USD.15 0.60 4.P. Municipal." 29 Apr 11 29 May 11 30 Jun 11 31 Dec 11 31 Mar 12 0. People's Bank of China) Fan Gang (Vice Commissioner of China Economic System Reform Commission) Exhibit 4: After a light April. strengthening its flexibility.60% by mid-year (Exhibit 3). The state council has 18-Apr (Governor.04 0.. but a basket of currencies. (Member of Central increase strategic investment. According to market condition.75 2.70 2.41 0. Morgan Futures Inc. and worsening inflation pressures in Asia as a growing negative for foreign sponsorship of Treasuries.15 3. Looking ahead. we maintain our outlook for modestly higher Treasury rates.29 4. but not the only method.25 1.97 3.70 0.70 0.90 2. Corporate issuance has accelerated in May in nine out of the last ten years. "The amount of foreign exchange reserves should be restricted 23-Apr to between 800 billion to 1. First.50 3. fixed income duration supply is poised to increase in May Monthly duration supply via MBS. 2011 Terry BeltonAC Meera Chandan Kimberly L. It caused excessive liquidity and increased the pressure of the central bank. with May typically being the heaviest month of the year for overall fixed income duration supply (Exhibit 4). We need to consistently reform RMB exchange rate.70 27-Apr Wen Jia Bao (Premier) "Foreign exchange reserves have exceeded the country's Zhou Xiao Chuan reasonable demand. The biggest disappointment of the week was initial jobless claims.12 0. we need to strengthen its flexibility. .30 3. To curb inflation. However. Morgan interest rate forecast % Actual Rates Effective funds rate 3-mo LIBOR 3-month T-bill (bey) 2-yr Treasury 5-yr Treasury 10-yr Treasury 30-yr Treasury 1m ahead 2Q11 4Q11 1Q12 Exhibit 5: Public comments by Chinese officials signaling potentially weaker demand for US Treasuries have become more frequent recently Date Speaker Comments "We need to progressively reform RMB exchange rate. we view the combination of increased headline risk around the debt ceiling (see Special Topic). we expect an uptick in fixed income duration supply in May as corporate issuance accelerates from the light levels seen in April.. we must be careful and the reform should be step by step. Harano J. the 4-week average increased to 409 thousand and is at its highest level since mid-February." Xia Bin " We need to adjust our FX reserve Investment regulation.P.12 0.3 trillion U.. implementing manageable floating exchange rate system. J. where foreign sponsorship has been quite strong. and view this month’s rally as providing an attractive entry level to reset duration shorts.30 0. Second.22 0.

Fedspeak is defined as any speech. CFTC data indicate net speculative positions are the longest they have been since November.8 percent for 2012. or FOMC minutes. Morgan Securities LLC Exhibit 6: The Chairman’s press conference was not a market mover this week but upcoming speeches from the rest of the FOMC should have a more hawkish tilt Fed sentiment index* excluding Bernanke versus Bernanke’s sentiment index. FOMC statement.06 Jan 11 Feb 11 Mar 11 Apr 11 week.12 2.10 2. Fed speeches following FOMC meetings have had a clear bearish bias this year as core inflation has drifted higher.18 2. Beginning with Kansas City Fed President Hoenig’s speech on Tuesday. we note that seasonal patterns also support weaker sponsorship in the near term. As discussed in our last publication (see US Fixed Income Weekly. Third.12 2.16 2.20 2. Morgan Futures Inc.P.16 2.22 2. biasing yields higher. Finally.20 2.US Fixed Income Strategy US Fixed Income Weekly May 2. On average. with May the weakest month of the year on average during the last 10-years. The FOMC central tendency forecasts for core inflation released this week show a 0. Exhibit 8: The 7s/30s curve hedged for 2s is close to its flattest level this year… Par 30-year .3 and 1.22 2.10 2.08 -10 -8 -6 -4 -2 0 2 4 6 8 Number of business days around payroll release 10 Oct 10 Jan 11 Apr 11 Source: CFTC * The Fed sentiment index is computed as the cumulative sum of yield changes in 5Y Treasury futures in the 15-minute period following the first Fedspeak headline on Bloomberg. Indirect bids in the 7-year auction fell to 39% (the lowest since June 2009) while indirects in the 2-year auction increased to 38%. ex Bernanke 35 30 25 20 15 10 5 0 -5 -10 2. % flag.3 percentage point increase from January.3 and 1. despite the recent decline in medium-term inflation expectations evident in both survey and market-based measures. 2011 Terry BeltonAC Meera Chandan Kimberly L.14 2. with six different senior officials commenting on the topic since April 18 (Exhibit 5). 13 different FOMC members will speak in the next two weeks. position squaring biases yields higher into next week’s payrolls report Par 5-year Treasury yields averaged in the business days around last four payroll releases. Public statements by Chinese officials highlighting increased support for faster RMB appreciation and diversifying away from the USD have also picked up markedly. bp Exhibit 7: With spec longs at the highest since November. % -25 -30 -35 -40 -45 -50 Jul 10 Bernanke's sentiment index Fed sentiment index. 10 .18 2.24 2.6 percent for 2011 and between 1. These positions are likely to be pared back next week.24 2. J. 4/15/11). While the Chairman’s comments did not produce much of a market response this 2. position squaring leading into next week’s labor market report is supportive of higher yields.08 2.P. comments from the rest of the FOMC have been decidedly more hawkish this year (Exhibit 6) and we expect that pattern to hold next week. While real money investors still appear to be short.. with core PCE projected between 1.6 * 2-year Treasury rate. Finally.7-year + 0. Fed custody data show central bank buying of Treasuries typically slows in the spring. we expect commentary from Fed officials to remain somewhat hawkish in the coming weeks as they attempt to keep inflation expectations well anchored.14 2. suggesting foreign investors are reducing risk by moving further in the curve. Harano J. since 7/3/06.

Treasury is scheduled to announce the details of the May Quarterly Refunding. 20-. First. In a similar vein. breakevens have tracked the S&P 500 very closely since the middle of last year (Exhibit 10). bp 120 100 80 60 40 20 0 Apr 08 Dec 08 Jul 09 Feb 10 Sep 10 Apr 11 narrowed 4. 9. hedged for the level of rates. This curve is currently on the flatter end of its range this year (Exhibit 8). The 10. Harano J. the resurgent rally in oil prices helped 5-year TIPS and the front end of the breakeven curve outperform.US Fixed Income Strategy US Fixed Income Weekly May 2. the TIPS breakeven curve flattened sharply. Exhibit 11: The 10s/30s breakeven curve has flattened to close to multi-year lows… 10s/30s hot-run breakeven curve.to 11-year sector of the bond curve has cheapened relative to the wings in recent weeks.4bp. This weighted spread has steepened by an average of 2. Five-year breakevens (Apr-15 TIPS) widened 12.4bp.. At the long end of the curve.5bp. and expect $32bn.6 * 2-year Treasury rate averaged in business days around the last twelve 30-year auctions. $24bn and $16bn of new-issue 3-. and the yield errors of these bonds indicate they are at the cheaper end of their six month trading range.7bp. % 216 214 212 210 208 206 -10 -8 -6 -4 -2 0 2 4 6 8 Business day s around 30y auction Exhibit 10: TIPS breakevens have closely tracked equities since late last year 10-year TIPS breakevens versus S&P 500. and long-end supply on the horizon. we expect 7s/10s steepening as well.and 30-year Treasuries. Morgan Securities LLC Exhibit 9: …and has historically steepened going into long-end supply Par 30-year . Despite the poor auction performance. respectively. 5.7-year + 0. Second.625% Feb-27s.P.and 7-year supply is now behind us.P. given that our equity strategists have raised TIPS Over the past two weeks. we also like 8% Nov-21s more than 2. and the issue tailed 2.5% Apr-15s and 6. Moreover. bp level 280 260 240 220 200 180 160 140 Apr 10 Jul 10 Sep 10 10Y breakev en S&P 500 1400 1300 1200 1100 1000 Dec 10 Feb 11 Apr 11 5-year yields have risen 12 bp in the week leading into payrolls this year as investors unwind front-end carry trades (Exhibit 7). 10. We expect Treasury to keep coupon sizes unchanged. Morgan Futures Inc. our bearish view on nominal rates will likely be supportive of wider breakevens. in our view. With the 5-year auction now behind us. we maintain our bullish view on breakevens for several reasons. this steepening occurred after each of the last six 7-year auctions. while 10-. Last week’s 5-year auction was somewhat poorly received: the bid-to-cover ratio was the lowest for a 5-year auction since October 2008.1bp and 9.5bp. Next week. Trading around auctions continues to be an interesting theme. we expect 7s/30s steepening. and 30-year breakevens 11 . Given that 2-. J. 2011 Terry BeltonAC Meera Chandan Kimberly L. and has historically steepened going into nine out of the last twelve long-end auctions (Exhibit 9) by an average of 7.7bp in the week after the 7-year auction.

78(oil) + 63. However. once we account for the shape of the nominal curve as well as oil prices. 2011 Terry BeltonAC Meera Chandan Kimberly L. bp 20 10 0 -10 -20 -30 60 Y = 0. which may tempt investors to expect breakeven curve steepening. the 10s/30s breakeven curve has flattened to close to multiyear lows. given that our oil strategists believe that the risks to oil prices remain to the upside.0. Morgan Futures Inc.6 R-sq = 79% Current 70 80 90 100 110 Rolling front WTI futures contract price. Morgan Securities LLC their year-end S&P target to 1475. we think breakevens can continue to track equities wider. unless they are hedged for oil prices. $/bbl 120 12 . as Exhibit 11 shows. Finally.29(Nominal curv e) . Harano J. carry in long TIPS breakeven positions remains highly attractive.P. Exhibit 12: …but looks fairly priced relative to the 10s/30s nominal curve and oil prices 10s/30s hot-run breakeven curve regressed against rolling front WTI futures contract price and the 10s/30s hot-run nominal curve. Furthermore. we think the 10s/30s breakeven curve could continue to flatten. past 1 year. we would caution against expecting breakeven curve steepening at this time.US Fixed Income Strategy US Fixed Income Weekly May 2. the curve looks fairly priced (Exhibit 12). J. As for the breakeven curve. Thus.. which impact shorter-maturity TIPS more than longer-maturity TIPS.P.

while liquidity in the Agency market has worsened… …Thus. Second.US Fixed Income Strategy US Fixed Income Weekly May 2. the Agency spread curve versus swaps steepened while the performance of Agencies versus Treasuries was mixed.and 30-year Agencies each cheapened by 2. and are rich relative to our estimates of fair value. for three reasons. FHLMC. Notwithstanding supportive technicals. Agency debt also now looks rich to other comparable asset classes such as Agency MBS: as seen in Exhibit 2. FHLB debt outstanding* ($bn) 3200 3000 2800 2600 2400 2200 2000 Nov 02  Market views Since we last published two weeks ago. valuations are close to record tight levels. with 5-year Agencies at around a mere 18bp spread to Treasuries. it has become relatively less sensitive to headlines. liquidity has begun to deteriorate. Morgan Securities LLC Agencies  Agency valuations are at record tight levels versus Treasuries. First. and ended up tightening even further in the subsequent days. 2011 Meera ChandanAC Renee Park J.5bp. with the 3- May 04 Nov 05 May 07 Nov 08 May 10 * Note that April 2011 is an estimated number based on monthly net issuance Exhibit 2: The Agency debt/ MBS OAS basis has widened to its widest level since December CC 30-year MBS Libor OAS minus 5-year Agency spread to swaps (bp) 36 34 32 30 28 26 24 22 20 18 16 14 Jan 11 Feb 11 Mar 11 Apr 11 Exhibit 3: Trading volumes have dropped to the lowest levels in a decade 3-month moving average of coupon Agency debt daily trading volumes ($bn) 35 30 25 20 15 10 2002 Source: Federal Reserve 13 2005 2008 2011 . we find little value in owning Agency debt versus Treasuries at current valuations. negative for the 10th consecutive month. the Agency debt market remains in shrinkage mode.5bp. 10. FHLMC. 2bp. We estimate that net issuance for FNMA.5bp. bringing the amount of debt outstanding to its lowest level in 8 years (Exhibit 1). and 10 of 12 FHLB banks to negative from stable.and 30year Agencies cheapened by 0. On the spread curve versus Treasuries. The mixed performance of Agencies versus Treasuries came amidst headlines of S&P’s downward revision of their ratings outlook on FNMA.P. given the strong technicals in the Agency market. Indeed. 2-. 2-year Agencies richened by 2bp. and FHLB totaled -$39bn in April. we stay underweight Agencies versus Treasuries Exhibit 1: The Agency debt market is now at its smallest size in 8 years FNMA. while 10. however. with net issuance again negative this month. respectively. and 1. FHLMC. spreads barely reacted to the revision of S&P ratings outlook to negative. As is well known. Technicals continue to be a key support for the Agency market. On the spread curve versus swaps. Last. the Agency debt/ MBS basis is now at its widest level this year.

While not a high frequency driver of spreads. Exhibit 4: Our framework of scoring liquidity in highquality markets suggests poorer liquidity results in cheaper valuations. This is true even adjusted for the size of the market. Note that pre-refunded munis are labeled as “Prere. 2011 Meera ChandanAC Renee Park J.P. see US Fixed Income Markets Outlook 2011. In sum.” 14 . This is seen in Exhibit 4. relative to our fair value estimates and relative to other related asset classes.P.” and off-the-run Treasuries are labeled as “Off Tsy. 11/24/10). Morgan framework for scoring liquidity in high-quality markets (US Fixed Income Markets Outlook 2011.” on-the-run treasuries are labeled as “Tsy. Morgan Securities LLC month moving average of daily trading volume now at its decade low for coupon Agency debt (Exhibit 3). which compares a liquidity metric for various high quality markets to their valuations (for further details. both within and across markets 1-month moving average of matched-maturity asset swap spreads (bp) versus liquidity scores across various asset classes and maturities* 100 80 60 40 20 0 -20 -40 0 5 10 Liquidity score 15 20 Pre-re 5y FDIC Pre-re 2y REFCO 30y Agy 15y MBS 10y AgyTIPS 5y Agy 2y Agy Off Tsy 10y Tsy 30y 30y MBS Pre-re 8y Off Tsy 20y Tsy 10y * based on the J. and also given the longer term threat to valuations from declining liquidity. given the richness of Agency debt valuations relative to history.US Fixed Income Strategy US Fixed Income Weekly May 2. the likely slow deterioration in liquidity represents a longer term threat to valuations. we find little value in Agency bullets versus Treasuries at current valuations despite favorable technicals. 11/24/10).

300 1. Still. The factors on which we are focused include: 1) Energy prices remain a threat to growth. One of the reasons for caution we noted two weeks ago has proven incorrect as. and Portugal have each about EUR $150bn of sovereign market debt outstanding not owned by the ECB. which has become even more of a headwind since.High Grade Strategy US Fixed Income Weekly May 2. so the upside/downside risk seems unfavorable in the near term. However. this quarter will also likely deliver a sharp downshift in industry even as global GDP rebounds.500 1. helping to lift growth back toward 3%. underperforming equities. Morgan Securities LLC D. and we keep our YE spread target of 120bp Exhibit 1: Peripheral European debt spreads have soared recently… 1. however. $105. First quarter growth was negatively impacted by the jump in energy prices. after a slow start to earnings season. Ireland. About one month ago.0%.50/bl in 4Q10. Greece.100 900 700 500 300 Jan 11 Feb 11 Mar 11 Apr 11 Portugal:683bp Ireland:695bp bp Greece CDS P o rtugal CDS Ireland CDS Greece: 1. There are several reasons which. Despite the rise in energy prices we continue to believe that growth will accelerate from 1Q to 2Q. contribute to our view that in the near term spreads are unlikely to tighten and could widen 5-10bp before resuming their tightening trend later in the year. and the restructuring debate is heating up once again. The recent disconnect between production and GDP performance will thus remain in place as production and business surveys move lower this quarter. and valuations are quite full already. JPMorgan reduced its 2Q and 3Q US GDP growth forecast from 3. low UST yields. and we maintain this view. rising spreads in peripheral Europe.60/bl in 1Q11 and $122. we believe that other factors remain a threat. but still returning to their YTD low We lowered our view on HG credit to Neutral last week on the back of tight valuation and risks.5% to 3. which would still constitute a rebound from growth of 1. and rising energy prices.609bp    Exhibit 2:… while those of Spain and Italy have not changed appreciably 400 350 300 bp Spain CDS Italy CDS Spain: 249bp Two weeks ago we turned tactically Neutral on HG bond spreads. Our perspective is that a fundamental 250 200 150 100 Jan 11 Feb 11 Mar 11 Apr 11 Italy : 153bp improvement in private sector spending and hiring took hold last quarter but overall growth was tempered by drags related to winter weather. Brent averaged $87. and higher bond supply YTD than originally expected The positive fundamentals highlighted by recent earnings reports and still strong technicals for all spread products keep us bullish in the longer term. 2) European peripheral debt spreads have recently risen sharply.9/bl MTD in April. which we believe are skewed more to the downside than upside These include higher energy prices negatively impacting economic growth.P. JPMorgan continues to believe 15 . High energy prices place downside risks on the magnitude of the rebound.8% in 1Q. The intensity of these drags is expected to fade as we move toward mid-year. equities have rallied on the back of strong earnings. combined. 2011 Dominique Eric BeinsteinAC Miroslav Skovajsa Anna J.700 1. public sector spending. Toublan Cherepanova Corporates  HG bond spreads have been mostly stable this week.

0 0. This is clearly a long journey from last year’s primary deficit of Exhibit 3: JPMorgan has revised the forecast on Japan GDP downwards for the first half of 2012 but upwards for the second half of 2011 8.0 4. As we argued in our Global Issues Report published last December—“A way out of the EMU fiscal crisis”—this path involves a significant fiscal consolidation in Greece and ever more concessional liquidity support from the core (lower borrowing costs and longer maturities). Morgan Securities LLC D.0 -6. A “voluntary” restructuring of market debt is a bit of an oxymoron.000 28. but in addition the rest of the region has to be pretty generous too. There are different kinds of debt (market and official). we have taken something of a minority view about the likelihood of a substantial “involuntary” restructuring of Greek market debt. The impact of potentially significant cuts at the Federal level have yet to be felt 40. or reductions in coupons or principal amounts).5% of GDP. not only does Greece have to put in a lot of hard work.000 20. The election result in Finland on Sunday suggests a growing opposition to the fiscal transfers that are implied by concessional liquidity support.000 Feb 11 Mar 11 -15.000 -60.0 2.0 % previo us Japan GDP fo recast current Japan GDP forecast 7.0 2. but it is worth remembering that the Greek primary deficit did narrow by around 6.0 -3.000 Monthly change in Gov ernment employ ment around 3. the government repeated its commitment to achieve sustained primary surpluses of close to 6%.000 0 -20. as outlined by recent research notes from our European Economists. at least. Indeed.000 -14.High Grade Strategy US Fixed Income Weekly May 2. The Greek government remains committed to delivering the required fiscal consolidation.P.0 Note: previous forecast is as of 12/30/10 Exhibit 4: Government cutbacks at the state and local level have already been evident in the monthly employment data. 2011 Dominique Eric BeinsteinAC Miroslav Skovajsa Anna J.0 1Q11 2Q11 3Q11 4Q11 -1.0 -2. However. equally important is the political mood in the core countries. an “involuntary” restructuring of market debt would be very disruptive to both Greece and the rest of the region. If the Finnish election result is any kind of portent of things to come in the core countries.000 -46. We believe that a near term restructuring of Greek market debt makes little sense and that there is a misunderstanding in some of the press about what the issues on the table are. which can be restructured in a variety of ways (delayed coupon or principal payments. The debate around a near term debt restructuring in Greece continues. in the new medium term fiscal strategy published last Friday. Our view. But. However.5%-pts last year.000 -40. Toublan Cherepanova that a restructuring is neither the best outcome nor our base case—over the next two years. market commentators and some officials are increasingly discussing this option. we doubt very much that the Greek government is trying to get an agreement to restructure its market debt in the near term.5 2. and would not achieve very much. with the latest stories in the Greek press about the government asking the IMF and EU to restructure its debt. Recent developments suggest that the likelihood that the region takes this alternative path is declining (many would argue that the likelihood was never that high in the first place). and that policymakers will try and take that path. by a number of different means (voluntary or involuntary with varying degrees of coercion).5 2. is summarized below. It looks 16 . For Greece to avoid an “involuntary” restructuring of its market debt. The latter is both a restructuring of the official debt and a fiscal transfer.000 -26. it is worrying.000 Oct 10 Nov 10 Dec 10 Jan 11 -35.0 6. We have argued that a path does exist which would avoid such an event.0 6.5 1. Over the past year.0 -4. which are embedded in the IMF/EU program.

April has been a slower month for issuance. with a sharp contraction followed by a sharp rebound. A technical default raises the risk of a flight to liquidity out of government money funds. As we move into an intensifying period of fiscal debate around increasing the debt ceiling. and the negative message of our government’s inability to avoid such an outcome. Risky assets would all likely suffer in such a scenario. In a note published on April 19. our colleagues in Rates research explored the systemic risks that would result from a technical default in the US Treasury market. 2011 Dominique Eric BeinsteinAC Miroslav Skovajsa Anna J. Still. The 2010 fiscal year budget. Foreign demand for Treasuries could be adversely impacted. but supply in May is likely to accelerate. so the economic impact will likely be limited. These cuts would likely not start until the new fiscal year begins October 1. Our analysis suggests that any delay in making a coupon or principal payment by Treasury would almost certainly have large systemic effects.High Grade Strategy US Fixed Income Weekly May 2. and low all-in yields will be tempting. and federal spending seems poised for a cutback as well. called for about $40bn of spending cuts. Repo market haircuts would likely rise sharply. See Special Topic. because daily liquidity and stable NAV are of paramount importance to these investors. YTD there has been $303bn of supply issued. but May 2011 is likely to see greater supply than this month as earnings blackout restrictions fade 120 100 80 60 40 20 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec $bn 2010 gross HG issuance 2011 gross HG issuance increase in redemptions similar to that seen in 2008. Morgan Securities LLC D. Last year May issuance was light due to the European sovereign crisis. Supply is not usually a driver of spread widening—supply comes when there is demand. but depending on the size of the cuts. Toublan Cherepanova increasingly challenging for the rest of the region to deliver the kind of fiscal transfers that are necessary. the likelihood is that agreement will be reached on cutting fiscal deficits more drastically. will impact growth expectations for 2012. causing deleveraging in lending markets. and because of higher yields from wider Treasury spreads. High grade credit would likely suffer less than other markets. both because of its status as a safe haven versus riskier assets. we would expect spreads to widen. 3) Japanese growth has been hit harder than originally expected from the earthquake and nuclear disaster. JPMorgan’s current and prior quarterly GDP growth forecasts are illustrated in Exhibit 3. however. we revised our 1Q Japan’s GDP growth forecast to -1. Though we view a default as extremely unlikely. The flipside is that a deeper “V” shaped recovery is now expected. 5) Rhetoric and posturing in Washington on the debt ceiling debate are increasing and may remain heated until the last minute. 6) HG bond supply has been heavier than expected and we raised our 2011 supply estimate a couple of weeks ago to $710bn from $625bn. Estimates of the economic impact of the earthquake and tsunami have continued to become more negative. a worrisome precedent is the 40% decline in foreign holdings of GSE debt following conservatorship. or 43% of our new forecast. assessing these tail risks is an important part of risk management and is useful in understanding how markets might behave in advance of a potential default. with long-term adverse consequences for Treasury finances and the US economy. 4) Fiscal stimulus likely to decline. This is both because companies will have reported 1Q earnings so will not be constrained by blackout periods. but an expected pickup in supply is likely to 17 . as is usually the case. a Treasury default could trigger an Exhibit 5: 2011 issuance has exceeded 2010 supply in every month so far this year. Some of these cuts involved the cancellation of spending authorizations that were unlikely to have been actually spent in any event. These are not likely to impact near-term growth. and the timing of the cutbacks is unknown. Government spending has been reduced at the state and local level. as markets access both the unknown consequences of a technical default on other market participants. despite Treasury assurances that it stands behind the GSEs. on which agreement was reached a couple of weeks ago.P.0% last week.

The negatives of rapidly rising energy prices and increasing peripheral European stress outweigh the positive earnings for HG credit. trade-weighted basis since the Fed's QE2 announcement last August alone. perhaps after the pace of earnings reports slows next week. interest coverage will have gotten stronger. The drivers of the weakness are both the large current account deficit and worsening international investment position. The dollar at the end of March stood about 2% above its weakest level since the end of the Bretton Woods era of fixed exchange rates in 1973. when April data becomes available the weakness will likely have intensified. On the technical side. in our view. Most sectors are exceeding EPS estimates. Canada. so higher earnings and EBITDA will mean that leverage has likely declined further. and this is supporting the strong revenue and EPS growth for many companies being reported now. fundamentals for HG credit were already widely perceived as very strong and this is therefore already mostly priced into current spreads.High Grade Strategy US Fixed Income Weekly May 2. as well as extremely easy US monetary policy compared to the rest of the world. With USD corporate credit fundamentals quite strong. earnings have been strong and the rally in equities is supporting all risky markets. 2011 Dominique Eric BeinsteinAC Miroslav Skovajsa Anna J. an estimated 30% of the revenue of S&P500 companies comes from nondomestic sources. Spreads are already pretty fully valued.P. though revenue growth has outperformed expectations by less. They tightened 1bp on the week even with the S&P up 1. Taiwan. The average USD real effective exchange rate was 4% lower in 2010 vs. including 14% vs. Morgan Securities LLC D. Brazil and Mexico. however. On the fundamental side. From the perspective of US corporates the weak dollar is mostly positive for credit fundamentals and negative for technicals.2% on an inflationadjusted. Korea. More importantly. Overall maintain our view that caution is warranted in the near term regarding HG bond spreads. and are at risk for some softening. as reported in the TIC data by the Treasury.9%. so US exporters should benefit further from the rapidly weakening currency over the past eight months in future quarters. While this is positive. from a non-US investor's perspective.5%/year in a currency which is depreciating near 1%/month. and 5% against China. 18 . it is these low yields which are limiting further spread tightening. From a HG credit perspective the strong earnings reported will likely mean that credit metrics improved further from their already strong levels last quarter. 2009 while the non-Financial companies in our HG bond index had revenue growth of 11. It takes time for a weaker currency to translate into greater export strength. Since August the dollar has weakened against most currencies. Already in 2011 the USD is 6% weaker than the 2010 average (as the dollar weakened throughout last year). These exporters are getting a boost both from the increased competitiveness of their products from the weak USD exchange rate and the translation benefits of converting non-USD profits into their USD financial statements. This is through March. Weakening dollar has positive and negative impact on HG credit The US dollar has weakened 10. Toublan Cherepanova limit spread tightening and contributes to our Neutral view. and cash balances will have increased. 10-12% vs. we believe. the weakening dollar is likely contributing to the slowdown in foreign buying of USD corporate bonds over the past couple of months. Domestic non-financial net debt issuance was near flat in 1Q. to buy bonds yielding about 4. the low rate environment that is contributing to the weak dollar is also contributing to low HG bond yields from the perspective of US-based investors.4% over this period. the Euro. On the positive side. It is not a compelling argument.

00 2. and fund outflows continuing.95 4.10 3.00 4.20 10y AAA MMD y ield 30y AAA MMD y ield Wednesday Week Casual observation of recent trading levels would show that muni rates have declined alongside Treasuries (Exhibit 1). public pension liabilities coming into focus.55 Source: Thomson Municipal Market Data Exhibit 3: Primary market supply remains depressed Weekly municipal bond issuance ($bn) 15 Tax-exempt Taxable 10 * 5 * * * 0 * * * Less than $3bn weekly average tax-exempt issuance * * * * * Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec JanFeb MarApr 2010 2011 * Holiday week Source: Bloomberg CDRA 19 .0% -5.60 4. J.90 2.50% 2.29% 4. With economic data weakening.e.58% -6bp -22bp -30bp -20bp Yield Change 0.40 3.80 03 Jan 24 Jan 14 Feb 07 Mar 28 Mar 18 Apr 5.75 4.80 4. Tax-exempts traded into their lowest yields YTD Despite Treasury rates increasing by 5-6 basis points on Wednesday.9% -5. change since closing on Thursday 4/14/11 AAA tax -ex empts Treasuries AAA tax -ex empts / UST Year 2 5 10 30 Yield Change 0.85 4. breaking through their YTD lows (Exhibit 2).8% -2. These observations collectively show that not only is the muni market pricing away from fundamentals. but we lower our 2011 supply forecast to $260bn from $300bn.10 5.05 5. 3.65 4. but the rally is also being driven by only one side of the technical equation (i.70 4. 2011 Alex Roever CFA Chris Holmes CFAAC Josh Rudolph J. some investors on Wednesday looked to profit from the rally by releasing sizable bid-wanted lists.30 3.90 4. low supply rather than low demand).97% 3.50 3. munis richened. this rally is well over-done Issuance is likely to pick up in May.60% 1.US Fixed Income Strategy US Fixed Income Weekly May 2. Morgan Exhibit 2: Tax-exempt 10s and 30s broke through their YTD interest rate lows on Wednesday %  3.57% 1. Heavy June coupon and redemption income totaling $50bn should help mitigate—but not eliminate—supply induced cheapening We don’t expect advanced refunding volume to decline drastically if the US Treasury closes the SLGS issuance window to delay reaching the debt ceiling Exhibit 1: The tax-exempt rally has out-paced Treasuries over the past two weeks Yields as of closing on Friday 4/29/11. With limited primary market supply available to purchase (Exhibit 3).9%  Source: Thomson MMD. Sizable bid-wanted lists emerged With rates having fallen so much recently. this rally has significantly outpaced Treasuries.40% -9bp -15bp -12bp -7bp Yield Change 95% 76% 87% 104% +3. with 10-year and 30year tax-exempt/Treasury ratios now down to 87% and 104%.P.85% 4. a small handful of buyers did not shy away from quickly absorbing this secondary market supply (bid lists).P. But the specific drivers behind the muni market can be isolated by looking more closely at Wednesday’s market activity. respectively (Exhibit 1). Morgan Securities LLC Municipals  The strong rally in munis can only be explained by continued limited supply. Moreover.

it simply means “and indefinite small number.55%). and by our calculations. New Jersey’s total state and local tax burden is already the highest in the country. The Fed held a press conference Another important event on Wednesday for all US financial markets was Ben Bernanke’s first ever postFOMC press conference. as is a tapering off of QE2. Nevertheless. without providing any major changes to FOMC views on the likely timing and path of that exit. This characterization elevates the communication significance of this decision when it does come.3%-point uptick in 2012 core PCE inflation (to 1. exemplifying the fact that off balance sheet leverage is not yet priced into the muni bond market.4%-pt to fully fund the pension system (unless either other resources are dedicated to paying for pensions or benefits are reduced for existing employees). But New Jersey is certainly not alone in having to face this issue.US Fixed Income Strategy US Fixed Income Weekly May 2. Morgan Securities LLC New Jersey was downgraded The rating agencies are in the process of increasing the weight they place on unfunded pension and OPEB liabilities and they have decided to make an example out of New Jersey. the Chairman did say that “the tradeoffs are getting less attractive. by our calculations (discounting liabilities at the states’ respective cost of capital and including future increases in workers’ service and salaries). 2011 Alex Roever CFA Chris Holmes CFAAC Josh Rudolph J. His goal was probably to establish a new communications forum that will be useful as the Fed approaches its exit strategy.” Apparently. the necessary fiscal adjustment is significant (only two states will need more fiscal consolidation).” meaning that a new QE3 is unlikely. the FOMC did not change the “extended period” language. This is important.  QE3 unlikely: For those hawkishly inclined. All three agencies’ press releases prominently featured the scale of the state’s unfunded liabilities. A “couple” meetings: As expected. but our economists made a few interesting observations:  Overall success: Bernanke succeeded in making this a relatively friendly and uneventful day. Core inflation in 2012: The most interesting change our economists noticed in the revised FOMC economic forecast was the 0. at 12. Fitch revised its outlook from stable to negative (currently rated AA). Our economists noted that higher core inflation in 2012 is hard to justify on    20 .2% of personal income. Instead. Although he also explained that the Fed intentionally uses such vague terminology because it’s uncertain how quickly tightening will actually be required. Reinvestment signaling: Another new development noted by our economists was that Bernanke said that the eventual decision to stop reinvesting proceeds (coupon and interest payments from the Fed’s already substantial balance sheet holdings) into additional Treasury purchases would itself represent a monetary tightening event.P.” Thus all we can conclude is that the Chairman avoided spelling out the exact timeframe of the monetary exit. thus raising the bar for the FOMC to alter its current reinvestment policy. the phrase “a couple” raised eyebrows in the market because before Wednesday the only useful precedent was Chicago Fed President Evans periodically saying that an “extended period” means “three to four meetings. New Jersey is not the most leveraged state (six other states have more combined on and off balance sheet debt relative to the size of their respective economies). We expect other states and cities with significant off balance sheet leverage to see downgrades in the coming months. because changes in monetary policy need to come in accordance with the FOMC’s forecasts. market economists immediately whipped out their dictionaries as Bernanke was speaking to look up the precise definition of “a couple. One hour later. Otherwise. The Fed Chairman hewed closely to previous Fed communications. In fact. it only necessarily means “two” when specifically referring to people. QE2 is expected to come to a full stop in June.” Thus. it would have to increase another 1. He said it would mean that the Committee is “a couple of meetings probably” away from subsequent action. But Bernanke did comment on what exactly it means when they do eventually remove that language. But because New Jersey has not been making its full annual required contribution. S&P downgraded the state on February 9 (from AA to AA-) and Moody’s followed suit this week on Wednesday (from Aa2 to Aa3). The market shrugged off Wednesday’s downgrade.

Morgan equity strategists.8% and jobless claims come in high at 428k (Exhibit 4). but also include the latest economic data (which is an important leading indicator for state and local revenue growth). we do not expect a near-term catalyst that would jump-start issuance to the magnitude necessary to reach our previous target. equities have been hot. Meanwhile. Investors’ risk sentiment will be another key factor in determining how they invest June cash flows. claims higher. despite weakening fundamentals and weak underlying demand. the drastically slow pace of issuance through the end of April Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Bloomberg leads us to reduce our 2011 forecast from $300bn to $260bn (Exhibit 6). according to J.US Fixed Income Strategy US Fixed Income Weekly May 2. The weakness of underlying demand was illustrated on Thursday by another week of outflows from mutual funds. Strong equities will likely seduce some retail muni investors to park their muni 21 .6bn of taxexempt bonds will mature in the month of June in addition to $17bn of coupon payments for a total of $50. especially given that long maturity muni yields are at the lowest level of the year. Muni sentiment has stayed negative over the last six months as indicated by investors’ unabated exodus from tax-exempt mutual funds. We won’t know which explanation is correct until the minutes are released in three weeks time. and 8% higher than June 2010. The visible supply calendar is meager. The dovish explanation would be that the higher 2012 inflation would be the result of continued easy policy. outflows continue The events on Wednesday illustrate the themes driving the municipal bond market: rates continue to fall as investors reach to the secondary market to find bonds. see Economics. but we foresee more issuance on the horizon. who on Thursday raised their 2011 year-end target for the S&P index from 1425 to 1475. 2011 Alex Roever CFA Chris Holmes CFAAC Josh Rudolph J. initial weekly jobless claims (k) 5% State tax receipt grow th Initial jobless claims 200 300 400 500 600 0% -5% -10% 2005 2006 2007 2008 2009 2010 700 Source: US Census Bureau. Morgan Securities LLC the grounds of either headline pass-through or a reduction in resource slack. The added cash will help support an increase in issuance volume expected in May and June. Exhibit 4: Claims are suddenly heading in the wrong direction State quarterly tax receipt growth (%). Thursday mattered too: GDP growth lower. $bn 60 50 40 30 20 10 0 Tax -ex empt maturities Tax ex empt coupon pay ments June coupons and redemptions Muni investors will enjoy a spike in their cashflows in June due to the seasonal influx of redemptions and coupon payments. simply.P. For more details.6bn (Exhibit 5).P. and will likely stay that way for the remainder of the year. Nonetheless. which is a significant increase from the $23. The hawkish explanation for the revised forecast would be that the Committee is concerned that the now elevated level of headline inflation will pull up inflation expectations. Thursday saw 1Q11 GDP growth come in low at 1. now totaling nearly 10% of fund holdings over the past six months. We estimate that $33. Weak fundamentals are not limited to unfunded public pension liabilities. Bloomberg Exhibit 5: Tax-exempt coupon payments and maturities will spike in June Estimate of monthly tax-exempt bond coupon payments and maturities in 2011.3bn monthly average year to date. How much the added cash will impact muni relative value will largely depend on the amount of new bonds sold over the next couple of months.

Morgan Securities LLC coupon and redemption cash in stocks instead of taxexempt bonds. Moreover. As described on the Treasury Direct website1. Exhibit 6: Total 2011 issuance forecast reduced from $300bn to $260bn Actual and estimated 2011 monthly municipal bond issuance (excluding Notes). Morgan Exhibit 7: Trading activity in pre-refunded bonds spiked 5-day moving average of daily count of trades > $1mn of pre-re bonds 200 160 120 80 40 4/29/10 Source: MSRB 6/29/10 8/29/10 10/29/10 12/29/10 2/28/11 4/29/11 Exhibit 8: Pre-refunded bonds have outperformed 5-year pre-refunded yields minus 5-year AAA MMD. and more importantly. Treasury Secretary Timothy Geithner outlined several extraordinary measures that the federal government could take to extend the date the debt ceiling is reached to July 8. despite the typical seasonal increase in coupon payments. but it will be just one factor in the cocktail of independent variables.P. what will happen if the Treasury temporarily stops issuing State and Local Government Series (SLGS) to delay reaching the federal debt limit (which is expected to be reached by May 16 without extraordinary measures)? In a letter to Congress last January. For example. there is no consistent trend in relative valuations in the weeks around June 1 of the last ten years. when it faced the unwelcome prospect of reaching the debt limit.htm 4/28/09 8/28/09 12/28/09 4/28/10 8/28/10 12/28/10 4/28/11 Source: Municipal Market Data 22 .gov/govt/resources/faq/faq_slgs. The federal government has resorted to this measure on six different occasions since 1995. and this week there was a sharp increase in the number of institutional sized transactions of pre-refunded bonds (Exhibit 7).P.treasurydirect. unredeemed Demand Deposit securities have usually been rolled over into special 90-day certificates of indebtedness. 1 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: J. which is a trend we have already witnessed anecdotally over the last six months. $bn 35 30 25 20 15 10 5 0 Total : $260bn Pre-re bonds and the debt ceiling The federal debt ceiling debacle has sparked questions over its potential impact on the pre-refunded bond market. and a corresponding tightening of prerefunded yields relative to MMD (Exhibit 8). bp 6 4 2 0 -2 -4 -6 -8 http://www. each period that the SLGS window was closed in the past is unique and the Treasury might have special procedures relating to the administration of unredeemed SLGS. 2011 Alex Roever CFA Chris Holmes CFAAC Josh Rudolph J. the Treasury continued to pay debt service on outstandings. A common question regarding pre-refunded bonds and the debt ceiling is. This idea is evident when examining historical data. negative news headlines on the fiscal hardships of states might intensify as we near the fiscal year-end of June 30. The June cash injection should help mitigate supply induced cheapening.US Fixed Income Strategy US Fixed Income Weekly May 2. issuers (that invest in SLGS) were able to redeem SLGS early before the window closed. One of these measures involves closing the SLGS issuance window.

However. Moreover. a potential drop in volume would not be a sudden shock to a market already subdued by light volumes.7/7/01 2/19/02 . This notion was likely one of the catalysts behind the increased transaction volume and richening of pre-re yields this week.5/26/02 10/14/03 .gov * SLGS: State and local government series 2 See Special Topic 23 . At this point.151 -549 Source: Thomson Reuters.US Fixed Income Strategy US Fixed Income Weekly May 2.3/28/95 5/15/01 .9/28/07 Issuance. bp 10 -1 1 -2 0 0 Prior year period 10/18/94 .353 -5. Of the six prior periods that the SLGS window was closed for debt ceiling reasons. falling 44% from 2010 levels.11/21/04 2/16/06 . like most types of munis.281 4. 2011 Alex Roever CFA Chris Holmes CFAAC Josh Rudolph J. which would be a positive for pre-re valuations. Morgan Securities LLC Recent speculation is that advanced refunding issuance would be hampered if the SLGS issuance window is closed. issuers can opt to buy marketable Treasuries or Agencies instead of SLGS to fund escrows. however.597 1. $mn 8.9/28/06 Issuance $mn 1.3/16/05 9/27/06 . Hence.332 2. Exhibit 9: Advanced refunding volume did not always decline in previous periods when the SLGS issuance window was closed by the US Treasury Advanced refunding issuance and change in 5-year Pre-re spreads over MMD during previous periods when SLGS* issuance window was closed by the Treasury SLGS suspension period 10/18/95 . www.3/28/96 5/15/02 .7/7/02 2/19/03 .819 2. $mn 6. if the debt ceiling were eventually reached. However. The reason is that despite tougher bidding requirements of Treasuries and some administrative challenges.445 2.11/21/03 2/16/05 . we do not expect advanced refunding volume to decline significantly if the US Treasury decides to close the SLGS issuance window.5/26/03 10/14/04 . has already been very light this year.839 -1.665 979 7.408 83 Chg in 5y spread.780 1. which would clearly have negative implications for holders of outstanding pre-refunded bonds. advanced refunding supply was actually higher on three occasions than it was in the similar period the previous year (Exhibit 9). advanced refunding issuance.Treasurydirect. we view the likelihood of a technical default as extremely unlikely2. MMD.3/16/06 9/27/07 .558 632 Issuance diff. the potential repercussions would be more severe given that outstanding SLGS could experience a technical default.758 2.P.538 1. The current focus is on the potential decline in pre-re issuance if the Treasury embarks on extraordinary measures to delay reaching the debt ceiling.

By technical default. the Treasury repo market.treasury. J. potentially triggering an increase in redemptions similar to that seen in 2008  Repo markets will be severely disrupted as haircuts are raised and could result in a significant deleveraging event  Even if the technical default is cured immediately. Treasury Secretary Geithner wrote that without congressional action. Finally. causing growth to slow and deficits to rise July 8. Morgan Securities LLC Special Topic: The Domino Effect of a US Treasury Technical Default  We explore the systemic risks that would result from a technical default in the US Treasury market. despite Treasury assurances that it stands behind the GSEs A 20% decline in foreign demand would have a dramatic impact on Treasury borrowing costs. foreign demand for Treasuries could be permanently impaired.” In this research note. and the foreign investor community. and that only extraordinary measures would allow the Treasury to avoid defaulting on its obligations until http://www.1 He further warned that “default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover. although we view a default as extremely unlikely. we emphasize that even if the debt ceiling is ultimately raised before a technical default 1      Overview In an April 4 Letter to Congress. we note that even without any kind of default.aspx 24 . 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. we explore the systemic risks that are likely to follow a technical default in the US Treasury market.P. Treasury would reach the statutory debt limit on May 16. Morgan Futures Inc. because daily liquidity and stable NAV are of paramount importance to these investors.gov/connect/blog/Pages/letter-to-congress. Fannie Mae and Freddie Mac’s move into conservatorship has led to permanently lower foreign sponsorship of GSE debt. which holds nearly half of all Treasury securities. a Treasury default could trigger an increase in redemptions similar to that seen in 2008 Repo market haircuts would likely rise sharply.US Fixed Income Strategy US Fixed Income Weekly May 2. a worrisome precedent is the 40% decline in foreign holdings of GSE debt following conservatorship. Our main conclusions are as follows:  A technical default raises the risk of a flight to liquidity out of government money funds. Harano J.. we mean a situation where the failure to raise the debt ceiling causes the Treasury to miss a coupon or principal payment on an outstanding obligation. assessing these tail risks is an important part of risk management and is useful in understanding how markets might behave in advance of a potential default Our analysis suggests that any delay in making a coupon or principal payment by Treasury would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy A technical default raises the risk of a flight to liquidity out of government money funds. As a case in point. we estimate Treasury yields would rise 50bp. causing deleveraging in lending markets Foreign demand for Treasuries could be adversely impacted. These effects would be transmitted through three primary channels: US money funds. Although we view a default as extremely unlikely.P. Our analysis suggests that any delay in making a coupon or principal payment by the Treasury—even for a very short period of time—would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy. We explore these channels in detail in the discussion below. but where the delay is quite short-term (less than a few days) and is not viewed by the market as reflecting a real deterioration in the solvency of the US. assessing these tail risks is an important part of risk management and is useful in understanding how markets might behave in the period leading up to a potential Treasury default.

” To “United States of America ‘AAA/A-1+’ Rating Affirmed. The fund quickly ran through its cash reserves and then sought to liquidate portfolio holdings. the hurdle for NAVs to fall below the $0. As the report of the President’s Working Group on Money Market Funds Reform3 noted. Given that these investors are primarily concerned with liquidity. the delay in raising the debt ceiling is likely to negatively impact markets. they are likely to be most impacted by a technical default. 3 http://www. 4/18/11.995 threshold is high. which held less than $1bn (1. As a 25 . 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. demand for Agencies could falter. reflecting a higher concentration of Agency FRNs (Exhibit 1). and Agency or Treasury yields would have to spike by a considerable amount.” Nikola G Swann. “[money market funds’] history of maintaining stable value has attracted highly risk-averse investors who are prone to withdraw assets rapidly when losses appear possible. even one viewed as temporary.” A potential adverse reaction from money market investors appears likely to stem from two sources.. Nor would the Agency product be alone. regardless of how quickly it cures. While we believe that a technical Treasury default would not automatically trigger selling. while we think most funds would continue to buy shortdated bills and roll over Treasury repo.0: money markets and the risk of redemptions Government money funds currently hold $760 bn of Treasury and Agency securities and repo. et al.00 could put extreme pressure on fund sponsors and possibly lead one or more to halt redemptions. received redemption requests totaling $40bn.2 Exhibit 1: Some government money funds that hold a higher proportion of Agency FRNs have WALs close to 120 days Distribution of weighted average life for government money funds as of February 2011. much as it did in late 2008. But while the average government fund has a weighted average maturity (WAM) of only about 45 days. Because daily liquidity and a stable NAV are what money fund shareholders care most about. Morgan Futures Inc. % 30% 25% 20% 15% 10% 5% 0% 0-12 1224 2436 3648 4860 6072 7284 8496 96. as liquidity across all money market instruments would likely be impaired following a Treasury default.P. Harano J. In the two days following the Lehman failure in 2008. J.5% of its $62bn in assets) in Lehman debt.gov/rules/other/2010/ic-29497. The second concern stems from the impact of rising yields on net asset values (NAV). the pressure of liquidating assets at a NAV below $1. Delay could also reaffirm the notion that the political compromise necessary to forge longer-term fiscal solutions is lacking. Morgan Securities LLC occurs. and yields would climb as a result.108. This reflects our best judgment that short-dated Treasury securities will remain relatively more liquid than Agencies (which are implicitly supported by Treasury) in the event of a technical default.pdf 2 # of day s Source: Crane Data be sure. If yields rise enough.sec. Standard & Poor’s.97. a halt in redemptions at one fund is likely to cause broader outflows. the Reserve Primary Fund. For these funds.120+ 108 120 Lehman 2. Even if yields don’t rise enough to cause funds to break the buck. as investors undertake risk-management actions in preparation for a potential Treasury default. something that S&P noted in its decision to move its US ratings outlook to negative on Monday the 18th of April. First.US Fixed Income Strategy US Fixed Income Weekly May 2. The fund announced on September 16 that they had broken the buck with an NAV of $0. a 150-175 bp spike in front-end yields could lower NAVs below $0. further depressing the price of those securities.P.995. Outlook Revised to Negative. concern over a possible surge in shareholder redemptions would probably lead funds to build cash or limit investing to overnight obligatons. asset values could theoretically “break the buck. even if the Treasury’s technical default is recognized as temporary and not a credit issue. some funds have weighted average lives (WAL) as long as between 110 and 120 days.

ultimately preventing losses to the investors. prime money funds began to again see inflows.P. we think relative value hedge funds and Asian banks may also delever. potentially inducing others to sell.5%. We estimate that over $4 trillion of Treasuries—nearly half of the outstanding stock—are used as collateral for repo agreements. futures clearinghouses and OTC derivatives (Exhibit 3). In the event of a default. a technical default may nonetheless trigger a flight to liquidity that could ultimately be profoundly disruptive.943 114 118 4. Although leverage among market participants is considerably lower than in 2008. haircuts on Agency MBS doubled from 5% to 10%. some forced deleveraging. prime institutional money market funds faced enormous redemption pressure. we emphasize that any deleveraging activity may be damaging for markets: as we saw in 2008. In the week following the Lehman bankruptcy. A sharp repricing of this collateral in response to a Treasury default would likely increase haircuts. their selling of MBS would likely push mortgage rates higher. In sum. The run on prime money funds was halted only by extraordinary measures undertaken by Treasury and the Federal Reserve. a status which has made them the vehicle of choice in collateralized lending agreements. For example. we would expect to see haircuts rise on Treasuries as higher volatility forces lenders to increase collateral requirements. the average level during the financial crisis. listed derivatives are estimated from clearinghouse margin data and J. announced they would close the fund. In addition. forced deleveraging begets further deleveraging. but we could see haircuts rise toward 1. while most money market investors will likely not view a technical default as a credit issue.P. one week later Federated announced it was acquiring the Putnam fund. These actions helped stabilize the outflows and by mid-October. Exhibit 2: A single fund halting redemptions could trigger a broader run on money funds. similar to the aftermath of the Lehman failure Prime money market fund balances (Taxable funds). $ bn Repo agreements OTC derivatives Listed derivatives Total 3. causing significant deleveraging by investors. 26 . On September 19. as declining prices force more and more investors to liquidate their positions. over $300bn of assets exited prime institutional money market funds as institutional investors no longer felt safe holding their money in these funds.US Fixed Income Strategy US Fixed Income Weekly May 2. REITs. and a decline in lending capacity in financial markets. On September 17. We estimate that the average haircut for Treasury repo (across all durations) is currently 0. which finance their MBS purchases with repo. Morgan Deleveraging in Treasury repo markets Treasuries have historically been viewed as the highest quality and safest asset.. and these outflows eventually reached nearly $500bn before recovering (Exhibit 2). OTC derivatives are from 2010 ISDA Margin Survey. 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. would likely need to delever.5%. due to significant redemption pressure. Morgan Futures Inc.175 Source: Repo data are for primary dealers as reported to the Federal Reserve Bank of New York. Morgan Securities LLC result. and a liquidity facility extending credit to banks to finance their purchases of ABCP (AMLF). the Treasury and the Fed jointly announced a temporary guarantee of money market funds (TGP). $ bn 2100 2000 1900 1800 1700 1600 1500 Jun 07 Source: iMoneyNet Oct 07 Mar 08 Aug 08 Jan 09 Jun 09 Exhibit 3: Over $4tn of Treasuries are used as collateral in the repo and derivatives markets Estimated Treasury securities in use as collateral. Harano J. and this activity caused mortgage spreads to widen 150 bp (Exhibit 4). J. we would still expect to see some forced deleveraging as a result of increased haircuts. Regardless of the initial magnitude. potentially leading to significant margin calls. Putnam’s institutional money market fund. Other related collateral would likely be affected as well: during the repo market crisis of 2008.P.

5 7.US Fixed Income Strategy US Fixed Income Weekly May 2. Only one of these defaults was not directly related to a solvency issue. given the political scandal around President Fujimori that erupted shortly thereafter. however. We asked 45 of our large rates clients how much they thought 10-year Treasury rates would increase if Treasury temporarily missed a coupon payment but announced it planned to make payment as soon as the debt ceiling is raised. Even without ratings agency action. Peru chose to not pay a coupon on September 7 in order to avoid deleterious consequences in its legal battle with the hedge fund Elliott Associates. there have been four such “grace period defaults. Exhibit 5: Past grace period defaults Summary of past grace period defaults* Country Pakistan Peru Moldova Dominican Republic Date Ratings action Deteriorating credit? Nov-98 Downgraded: B3 to Caa1 Yes Sep-00 Downgraded: Ba3 to B1 Jun-01 Downgraded: B3 to Caa1 Jan-04 Downgraded: B2 to B3 No Yes Yes * Indicates that the default was cured within the grace period Exhibit 6: We estimate that the missed coupon in September 2000 caused Peruvian yields to rise about 50bp Peru government bond index strip spread to Treasuries in 2000.P. J. the coupon was promptly paid. we look to other examples of technical sovereign defaults that have cured rapidly. Notably.0 4. Morgan Futures Inc.. Morgan Securities LLC Impact on Treasury funding costs When assessing the potential impact of a default on Treasury yields. 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. and the narrowing after the coupon was paid.5 01 Sep 08 Sep 16 Sep 24 Sep 02 Oct 10 Oct Missed coupon Scandal breaks very high (Exhibit 7).P. % bp 12 MBS nominal spreads 10 250 200 150 8 100 6 Haircut 4 Jan 07 Aug 07 Mar 08 Oct 08 May 09 0 Dec 09 50 * J. As a result of the missed payment. In the short run. we would expect to see an immediate rise in yields on the back of a technical default. we estimate the short-term impact on yields to be about 50bp (Exhibit 6). and the mean response was a 37 bp increase in yields. Peru’s credit rating was lowered from Ba3 to B1 and then restored to Ba3 immediately after the coupon payment was made. which will likely lead to higher borrowing costs and larger deficits. although uncertainty was Exhibit 4: During the repo market crisis of 2008.5 6. pay s 5.P.0 6. Harano J. once the lawsuit was settled. making it somewhat analogous to the current US situation—the Peru experience of 2000. % 7. however. Over the past twenty years.0 5. 27 .” and in each case.5 Peru settles. Although it is difficult to isolate the impact of the missed coupon on yields. This estimate is also roughly in line with investors’ current expectations of the impact of a potential Treasury technical default. the doubling of Agency MBS haircuts led to significant deleveraging and a sharp widening of spreads Vol-adjusted Agency haircuts* and MBS nominal spreads to Treasuries. the default was accompanied by a ratings downgrade (Exhibit 5). however. Morgan estimate for 1-month term repo. a technical default will likely push yields higher as investors absorb negative headlines. To gauge the near-term impact. we think it is useful to differentiate between the immediate market response and the likely long-term consequences. foreign investors expected a significantly larger initial increase— 55 bp—than domestic investors. however. it could leave lasting damage in its wake due to a permanent decline in foreign demand. Even if such a near-term rise in yields is retraced after an eventual increase in the debt ceiling. In that event. the Peru experience nonetheless gives us some guidance. based on the widening of Peru spreads in the immediate aftermath of the missed coupon.

28 . 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. thus. GDP would likely be reduced by about 0. % of respondents in each category 20 18 16 14 12 10 8 <10 10-20 20-30 30-40 40-50 50-75 >75 Mean increase = 37 bp Std. we 4 “Macroeconomic Implications of Changes in the Term Premium. July/August 2007. Despite Treasury’s assurances that the US stands behind GSE debt. Rudebusch et al. We have previously estimated that a 1-notch downgrade could trigger a 100 bp rise in yields (see Treasuries. January 21. and these investors never returned. the experience with GSE debt in 2008 suggests a technical default could permanently impact demand Estimated foreign holdings of Agency debt* around the announcement of GSE conservatorship. data between release dates is estimated using weekly Agency custody holdings data released by the Federal Reserve implications of changes in term premium4 suggests that a 100 bp rise in term premium lowers GDP by 0. Morgan Futures Inc. something S&P already has alluded to in explaining its decision to move the US sovereign ratings outlook to negative. On that day. the equity market would likely sell off sharply in response to a technical default. 2011).” Glenn D. dev = 36 bp Projected change in 10-y ear Treasury y ields. US Fixed Income Weekly. A 50 bp increase in yields would increase annual deficits by $10bn in the short run. and they have held steady at around half the size of their 2008 peak. we can estimate the impact of the associated rise in rates as well as the wealth effects of an accompanying sell-off in equities. foreign holdings of Agency debt steadily declined after conservatorship. and by $75bn per year over time as outstanding debt rolls over.8%. bp Exhibit 8: We think the bigger risk to the Treasury market is from foreign investors..P. In addition.4%. similar to what happened to GSE debt holdings after the Agencies entered conservatorship. Even a modest decline in foreign holdings of Treasuries following a default would have a dramatic impact on Treasury borrowing costs. using this as a rough guide. foreign investors liquidated nearly 40% of their holdings of GSE debt in the year following the placement of Fannie Mae and Freddie Mac under conservatorship. J. the S&P 500 fell 9%.US Fixed Income Strategy US Fixed Income Weekly May 2. Harano J. Louis Review. is the risk of lasting damage from a loss of sponsorship from foreign investors.P. Federal Reserve Bank of St. Morgan Securities LLC Beyond any potential near-term impact. A congressional deadlock around increasing the debt ceiling could be viewed as increasing the long-term risk of inaction on fiscal policy reform. Although it is difficult to quantify the total impact on GDP from a technical default. As Exhibit 8 shows. A Federal Reserve paper on the macroeconomic * Agency debt holdings are the TIC annual survey data for release dates (June 30) for each year through 2010. if Treasury yields were to rise 50 bp as we project. as it did on the day that Congress initially failed to pass TARP in September 2008. the failure to raise the debt ceiling in a timely fashion and a potential default would have real negative consequences for growth. Exhibit 7: Our clients expect a 37 bp rise in rates in the event of a technical default Estimated increase in 10-year Treasury rates following technical default. We estimate that a 20% decline in Treasury holdings by foreign investors completed over a 1-year period would push Treasury yields higher by 50-60 bp (see grey box). $bn 800 700 Conservatorship initiated 600 500 400 300 Jun 06 Mar 07 Dec 07 Sep 08 Jun 09 Mar 10 Dec 10 The impact on economic growth Beyond the impact on borrowing costs. Even more significant. the long-term damage is likely to come in two forms. however. One is the risk of ratings downgrades down the road.

we think the delay in raising the debt ceiling is likely to negatively impact markets.21 25. % of GDP + Exhibit 9: With the caveat that trading volumes are not large.45 0. which is estimated using 20 years of data. These effects could include liquidity shortages over the late June/July period as borrowers attempt to raise additional cash and increase the tenor of 29 .44 12. Already. J. % Real funds rate**.US Fixed Income Strategy US Fixed Income Weekly May 2. % Budget deficit .01 1.30 0. models 10-year Treasury yields as a function of (a) core inflation. and the budget deficit all result in higher 10-year Treasury yields.25 0. (c) one-year ahead consensus growth forecasts and (d) the budget deficit as a percentage of GDP. increases in the real funds rate. Morgan Securities LLC Measuring the impact of foreign selling: J. 0. core inflation. Since increases in the budget deficit lead to an increase in Treasury supply. Specifically.37 1. Morgan long-term model for 10-year Treasury yields To estimate the impact of a structural change in foreign demand on Treasury yields. a prolonged delay in raising the debt ceiling seems likely to impact markets well before a default actually occurs.6bp. even without a default Even if Treasury avoided a default. we can use the model to estimate the yield impact from a net supply shock due to foreign selling of Treasuries. Harano J. $0 otherwise.7 0. Thus. As shown in the table below.64 0.P. 10-year Treasury yield model parameters:* Variable Intercept Core CPI yoy*.1 8.com Exhibit 10: Delays in scheduled bond auctions have historically caused Treasuries to underperform Average spread between 3.5% off of GDP growth due to lower consumption. we use the parameter estimates from our long-term model of 10-year yields. 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. Because the tail risks from a technical default are so large. as investors undertake risk-management actions in preparation for a potential Treasury default.P. Source: www. error of regression = * 3-month moving average of yoy core CPI rate ** 3-month moving average of the real funds rate as measured by rate implied by 1st Eurodollar contract minus yoy core CPI *** 3-month moving average of 1-year ahead Blue Chip real GDP growth forecast + 3-month moving average of budget deficit as percentage of GDP estimate that a decline of a similar magnitude on a sustained basis in the aftermath of a default would take an additional 0.4 1. (b) the real funds rate.066 3.and 10-year swap spreads (bp) in 1995 % bp Current level Coefficient T-statistics 0.35 0. R2= 80%.1T or more before midnight ET 30 Jun 2011.15 20 Oct 28 Oct 05 Nov 14 Nov 22 Nov 01 Dec The impact of the battle over the debt ceiling. the consensus growth outlook. our model suggests that an increase in Treasury supply of $148bn annually (i.and 10-year US Treasury yield minus Bund yields (%) versus 3. one online market suggests there are considerable odds that the debt ceiling won’t be raised by June 30 Odds that the debt ceiling won’t be raised by June 30 as implied by Intrade contract* 50 40 30 20 10 0 28 Jan 15 Feb 05 Mar 23 Mar 10 Apr 29 Apr * Contract payoff is $10 if Congress approves increase in US debt ceiling to $15.Intrade. A 20% decline in foreign holdings over 1-year amounts to a net increase in monthly supply of $100 bn ($65 bn per month of selling versus $35 bn per month of buying currently).8 3. This implies an increase in the fair value of 10-year yields of 56 bp (6. 1% of GDP) or $12 bn per month is likely to cheapen 10-year Treasuries by 6.34 0.6 x 100/12).38 6. Morgan Futures Inc. The model.e. the quantifiable effects of a default alone would likely take about 1% off of GDP growth. some market indicators are showing considerable odds that the debt ceiling won’t be raised by July (Exhibit 9).0 -0. % Real GDP forecast***.20 Av g of 3Y and 10Y Tsy /bund spread 24 25 26 27 28 Av g of 3Y and 10Y sw ap spread (inv erted ax is) 29 30 Model estimated over last 20-years.P. Std..40 0. and the ultimate damage could be far greater.33 0.

10year Treasuries cheapened 25 bp (Exhibit 10). Finally. Morgan Securities LLC their borrowings. Indeed. Harano J. J. we highlight that these seemingly prudent riskmanagement activities in preparation for a potential default could unintentionally bring about the very run on liquidity that these activities are meant to prevent. As a result. and generally weaker demand for Treasury securities as uncertainty on whether the debt ceiling will be raised grows. 30 . as one firm raising additional cash provokes similar action by other large firms. Treasury delayed the 3-year and 10-year note auctions by eight days.P.. when the government shut down in November 1995 due to similar debt ceiling issues.US Fixed Income Strategy US Fixed Income Weekly May 2.P. Morgan Futures Inc. increases in option volatility that cover the June/July period. 2011 Srini Ramaswamy Terry BeltonAC Meera Chandan Alex Roever CFA Kimberly L. large auction concessions especially if Treasury were to postpone an auction.

35 0. 2011 4Q11 Forecast 0.05 0. Morgan Securities LLC Forecasts & Analytics Interest Rate Forecast Apr 29. 2011 1m ahead Forecast 0.75 2.P.29 4.45 4.22 0.US Fixed Income Strategy US Fixed Income Weekly May 2. 2011 Srini RamaswamyAC J.10 0.27 0.125% for Fed funds/3m Libor calculation.70 * Fed funds assumed to be 0.22 0.15 3.61 1.50 3.30 0. 2011 1M Forecast 2-year sw ap spread 5-year sw ap spread 10-year sw ap spread 30-year sw ap spread *Forecast uses matched maturity spreads 17 19 5 -24 18 19 3 -21 Jul 28. 2011 3M Forecast 20 19 2 -18 Oct 26.70 2.04 0.90 2. 2011 2Q11 Forecast 0.97 3.85 3.90 4.70 Mar 31.10 0.70 4.05 0.30 3.41 May 29.15 0. 2011 6M Forecast 21 21 7 -14 31 .12 0.09 0.55 Jun 30. Swap spread forecast* Apr 29.70 Dec 31.60 4.12 0. 2011 May 29.20 2. 2011 Rates Effective funds rate 3-month Libor 3-month T-bill (bey) 2-year T-note 5-year T-note 10-year T-note 30-year T-bond Curves 3m T-bill/3m Libor 2s/5s 2s/10s 2s/30s 5s/10s 5s/30s 10s/30s 23 136 268 379 132 243 111 17 145 275 385 130 240 110 17 155 285 395 130 240 110 15 160 280 380 120 220 100 10 165 270 350 105 185 80 0. 2012 1Q12 Forecast 0.25 1.

7 1.6 1.8 0.1 6.1 -0. unless otherw ise noted 10Q3 Gross Domestic Product Real GDP Final Sales Domestic Final Sales Business Inv estment Net Trade (% contribution to GDP) Inv entories (% contribution to GDP) Prices and Labor Cost Consumer Price Index Core Producer Price Index Core Employ ment Cost Index Unemploy ment Rate (%.48 81.2 0.6 10Q4 3.6 0.5 8.5 -0.0 2011* 2.0 3.0 1.4 2.9 1.3 -3.8 9.2 -0.0 0.6 2009* 0.5 8.3 7.4 2.7 3.7 8. Morgan Securities LLC Economic forecast %ch q/q.0 1.7 3.0 -1. saar. 2011 Srini RamaswamyAC J.1 0.7 11Q4 3.6 8.4 0.2 1.0 3.4 -12.9 1.5 0.6 3.4 2.5 0.2 3.3 3.4 2.1 1.5 1.8 2.5 0.8 11Q3 3.2 2.1 1.6 10.2 1539 1.P.3 1.4 1.6 0.1 3.2 1.0 2.2 9.5 3.7 2.4 1.9 5.0 2.4 2010* 2.8 - Financial markets forecast Credit Spread 10Y sw ap spread* 30Y current coupon MBS L-OAS** 10Y AAA 30% CMBS (2007 vintage)** 3Y AAA Credit Cards fixed** JULI I-Spread* High Yield Index* Em erging Market Index* Corporate Em erging Market Index (Broad)* * spread to Treasuries ** spread to swaps Current 5 33 180 21 131 521 302 275 Mid-year 2011 7 30 140 15 130 515 250 260 Current S&P* ($) Brent** ($/bbl) Gold** ($/oz) EUR/USD USD/JPY ** 2Q1 quarterly average fo recast 1 Mid-year 2011 1475 118.6 -0.6 6.3 -1.9 2.1 2.8 1.2 7.8 -0.6 1.5 0.5 1.2 7.0 9.3 0.0 1.9 11Q2 3.0 1450 1.8 0.5 3.3 1.43 80 1360 125.7 1.8 1.US Fixed Income Strategy US Fixed Income Weekly May 2.1 1.0 1.8 9.7 12.0 0.5 2.4 1.2 -0.7 2.1 0.2 4.1 0.9 1.4 3. sa) * Q4/Q4 change 2.6 11Q1 1.8 0.7 1.8 -0.5 * S&P 500 fo recast is fo r year-end 201 1 Gross fixed-rate product supply* 350 300 250 200 150 100 50 0 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 ABS CMBS MBS Corporate Agency * amount in $ billions 32 .9 10.

82 Spread Outlook 1.6 Mar 08 Nov 08 Jun 09 Jan 10 Sep 10 Apr 11 MBS Investor Survey 40% 20% 0% -20% -40% -60% Jul 09 Overweight . 2011 1.2 1. 2011 1.Underweight Oct 09 Feb 10 May 10 Aug 10 Nov 10 Feb 11 Apr 1 33 . the spread outlook index is the ratio of the sum of positiv e and neutral outlooks to the sum of negativ e and neutral outlooks.22 0. the cash position index is the ratio of the sum of high and medium cash positions to the sum of low and medium positions.P.6 1.US Fixed Income Strategy US Fixed Income Weekly May 2.28 3-month average 1.90 0. 2011 3-month average Long 6 6 10 Neutral 65 65 69 Short Changes 15 4 15 8 17 13 Treasury Client Survey 30 Longs minus shorts 20 10 0 -10 Credit Corporate Bond Weighting Apr 14.27 -20 Apr 10 Jun 10 Sep 10 Nov 10 Feb 11 Apr 11 Credit Client Survey 1.82 1. Morgan Securities LLC Client surveys Duration Apr 25.8 *Corporate bond w eighting index is the ratio of the sum of ov erw eights and neutral positions to the sum of underw eights and neutral positions.22 Mar 9.8 Corporate Bond Weighting 1. 2011 Apr 18.0 0. 6 3 7 4 8 5 MBS April 2011 March 2011 3-survey average Overweight 37% 29% 38% Flat Underweight 48% 15% 53% 18% 42% 20% 0.4 1.75 0.38 Cash Position 0. 2011 Srini RamaswamyAC J.

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Louis Fed President Bullard speaks to bankers in Little Rock.3%oya) Chain store sales Apr Chicago Fed President Evans (9:15am) and Fed Chairman Bernanke speak at Chicago Fed banking conference (9:30am) Minneapolis Fed President Kocherlakota speaks on monetary policy in California (1:15pm) 6 May Employment (8:30am) Apr 165. 2011 Market Movers Monday Tuesday Wednesday Thursday Friday 2 May ISM manufacturing (10:00am) Apr 59.9% (1. and (2) no part of his or her compensation was. Finland (7:30am) NY Fed President Dudley speaks at a regional economic briefing in New York (10:00am) St.2%oya) Unit labor costs 0. except that his or her compensation may be based on the performance of the views expressed. Morgan information sources. or will be directly or indirectly related to the specific recommendations or views expressed by him or her in this material.3 Consumer credit (3:00pm) Mar Fed Vice Chair Yellen speaks on Economic growth at Bank of Finland conference in Helsinki.000 Productivity and costs (8:30am) 1Q preliminary 1.1% Senior loan officer survey (2:00pm) 2Q 3 May Factory orders (10:00am) Mar 2.8% Average weekly hours 34.7% (1. Louis (9:30am) Richmond Fed President Lacker speaks on US economic outlook in Arlington.0 Announce 3-year note $32 bn Announce 10-year note $24 bn Announce 30-year bond $16 bn Boston Fed President Rosengren speaks at a Real Estate Conference in Boston (8:00am) SF Fed President Williams speaks on policy in Los Angeles (3:30pm) Dallas Fed President Fisher speaks in New Mexico (4:00pm) Atlanta Fed President Lockhart speaks on US economic outlook in Atlanta (7:00pm) 5 May Initial claims (8:30am) w/e prior Sat 435.0mn Kansas City Fed President Hoenig speaks to community bankers in Washington (8:30am) 4 May ADP employment (8:15am) Apr ISM nonmanufacturing (10:00am) Apr 58. tables and exhibits contained in this publication have been sourced via J.3% Light vehicle sales Apr 13.7 Construction spending (10:00am) Mar -0. VA(12:45pm) 11 May International trade (8:30am) Mar JOLTS (10:00am) Mar Federal budget (2:00pm) Apr Auction 10-year note $24 bn Atlanta Fed President Lockhart speaks on US economic outlook in Atlanta (12:15pm) Minneapolis Fed President Kocherlakota speaks on monetary policy in New York (1:00pm) 12 May Initial claims (8:30am) w/e prior Sat Retail sales (8:30am) Apr PPI (8:30am) Apr Business inventories (10:00am) Mar Auction 30-year bond $16 bn Announce 10-year TIPS (r) $11 bn Philadelphia Fed President Plosser speaks on US economic outlook in Florida (8:30am) 13 May CPI (8:30am) Apr Consumer sentiment (9:55am) May preliminary 16 May Empire State survey (8:30am) May TIC data (9:00am) Mar NAHB survey (10:00am) May 17 May Housing starts (8:30am) Apr Industrial production (9:15am) Apr 18 May FOMC minutes (economic projections) St. AR (11:45am) 9 May 10 May NFIB survey (7:30am) Apr Import prices (8:30am) Apr Wholesale trade (10:00am) Mar Auction 3-year note $32 bn Fed Governor Duke speaks on community development in St.000 Unemployment rate 8. Louis Fed President Bullard speaks in New York (7:00pm) 19 May Initial claims (8:30am) w/e prior Sat Existing home sales (10:00am) Apr Philadelphia Fed survey (10:00am) May Leading indicators (10:00am) Apr Auction 10-year TIPS (r) $11 bn Announce 2-year note $35 bn Announce 5-year note $35 bn Announce 7-year note $29 bn Chicago Fed President Evans speaks at forum in Chicago (1:30pm) 20 May “Unless otherwise expressly noted.US Fixed Income Strategy US Fixed Income Weekly New York.P. May 2. .” __________________________________________________________________________________________________________________________ Analyst Certification: The strategist(s) denoted by (AC) certify that: (1) all of the views expressed herein accurately reflect his or her personal views about any and all of the subject instruments or issuers. all data and information for charts. is.

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