USA Interest rate update

July 2011

Economic forecasts
2009 2010 2011f 2012f
Real GDP, % yoy CPI, % yoy CPI core rate, % yoy Unemployment rate, % Employment*, % yoy C/A balance** EUR/USD -2.6 -0.4 1.7 9.3 -4.4 -2.7 1.39 2.9 1.6 1.0 9.5 -0.7 -3.2 1.33 2.7 3.1 1.3 8.7 1.0 -3.0 1.46 2.7 2.2 2.0 8.2 1.1 -2.7 1.30

Fed reduces its economic forecast interest rate hikes to start in mid-2012 at the earliest
At its monetary policy meeting on 22 June, the US central bank (Fed) had to admit that the economy has not been running smoothly lately. The committee noted that the economic recovery is proceeding at a slower pace than they had expected, and the latest labour market data were surprisingly weak. This assessment was also reflected in the new economic projections. For example, the forecasts for real GDP growth for the current year and 2012 were reduced considerably in comparison to April. The central bankers anticipate an increase of 2.8% in 2011 (previously 3.2%) and 3.5% in 2012 (previously 3.9%). Consequently, the current key interest rate level of 00.25% will be maintained for an extended period. The Fed announced that it would complete its purchases of US government bonds with a volume of up to USD 600 bn on schedule at the end of June. Another round of government bond purchases (QE3) is currently not under consideration, said Fed Chairman Bernanke at the press conference that followed. In light of the weak economic development in the first half of 2011 and the rapid deterioration of important economic indicators (ISM index, labour market report for May), we no longer expect the Fed to start raising interest rates this year. This economic slump may have served as a warning shot for most of the central bankers that they need to avoid a premature reversal of the expansive monetary policy. Even if the economy and the labour market offer upside surprises in the second half of the year, the Fed would probably continue to stand back and wait until they are quite certain that the economy is in a sustainable recovery. We therefore expect the first interest rate hike at the earliest in mid-2012. Yields on American government bonds have climbed a good 30bp since their most recent low on 24 June, rising to 3.2%. The reasons for this were the easing of the Greek debt crisis, with an imminent default averted, and the somewhat positive economic data coming in again recently. Since we expect further relief on the Greek front and we feel that market sentiment is now overly pessimistic with regard to the US economy, we anticipate further yield increases in the coming weeks. For example, we believe that market expectations are too negative when it comes to the labour market report coming up on Friday. However, in line with the changed prospect of key interest rate hikes, we have lowered our yield forecasts for the next 12 months.

* non-farm ** % of GDP Source: Thomson Reuters, Raiffeisen RESEARCH

Forecast for 3M USD LIBOR

1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00 Jul-11 Oct-11 Jan-12 Apr-12 Market consensus* Jul-12 Forecast 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00

* from FRAs, Prices as of 04 July 2011, 17:30 CET Source: Thomson Reuters, Raiffeisen RESEARCH

Yield curve*
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 3M 1J 2J 3J 4J 5J 6J 7J 8J Jun-12 9J 10J aktuell Dec-11 Sep-11

* 1-12 month: LIBOR, 2y+: US treasury marekt yield Prices as of 04 July 2011, 17:30 CET Source: Thomson Reuters, Raiffeisen RESEARCH

Analyst Jrg Angel, CIIA

joerg.angele@raiffeisenresearch.at

USA

Overview of rate forecasts

current
Fed Funds LIBOR 3M LIBOR 6M LIBOR 9M LIBOR 12M Treasury yield 2y Treasury yield 5y Treasury yield 10y Treasury yield 30y

Adapted Taylorrule*
0.30 0.50 0.70 0.90 1.10 2.40 3.70 4.70 0.80 0.90 1.20 1.40 1.50 2.80 3.70 4.70 Forecast
Taylorrule implied fed funds rate Fed funds target rate, quartely figures 95% confidence intervall

Sep-11 Dec-11 Mar-12 Jun-12 0.25 0.30 0.30 0.50 0.60 0.60 1.90 3.30 4.40 0.25 0.30 0.40 0.50 0.60 0.70 2.00 3.50 4.60 0.25 0.75

0.25 0.25 0.40 0.56 0.73 0.47 1.78 3.18 4.39

12 10 8 6 4 2 0 -2 -4 -6 Q1 89 Q1 92 Q1 95 Q1 98 Q1 01 Q1 04 Q1 07 Q1 10 Q1 13

Prices as of 04 July 2011, 17:30 CET Source: Thomson Reuters, Raiffeisen RESEARCH

FOMC Meeting Calendar

2011
9 Aug. 20 Sep. 1-2 Nov. 13 Dec. 24-25 Jan. 13 Mar. 24-25 Apr. 19-20 Jun.

2012
31 Jul. 12 Sep. 23-24 Oct. 11 Dec.

* based on real Gross Domestic Product, Labor market, CPI core inflation Source: Thomson Reuters, Raiffeisen RESEARCH

Source: Federal Reserve System

Interest rates - long term developement*

19912005 avg FED key rate Libor 1m Libor 3m Libor 6m Libor 12m Yield 2y Yield 5y Yield 10y
4.06 4.22 4.31 4.41 4.64 4.67 5.31 5.75

2006 avg
4.94 5.10 5.20 5.27 5.32 4.77 4.71 4.76

2007 avg
5.08 5.25 5.30 5.25 5.12 4.40 4.44 4.62

2008 avg
2.21 2.67 2.92 3.05 3.05 2.09 2.88 3.72

2009 avg
0.25 0.34 0.69 1.12 1.57 0.91 2.12 3.16

2010 avg
0.25 0.28 0.35 0.53 0.90 0.66 1.87 3.12

2010 eop
0.25 0.26 0.31 0.46 0.77 0.61 1.96 3.33

2011 avg
0.25 0.29 0.35 0.49 0.82 0.69 2.07 3.41

2011 eop
0.25 0.30 0.40 0.50 0.90 0.70 2.00 3.50

2012 avg
0.75 1.05 1.23 1.50 1.98 1.68 2.90 3.80

2012 eop
1.75 1.80 2.00 2.30 2.70 2.20 3.30 4.00

2013 avg
2.65 2.70 2.85 3.05 3.35 3.10 3.75 4.15

2013 2014-18 eop avg*

3.50 3.60 3.70 3.80 4.00 4.00 4.20 4.30 3.50 3.60 3.70 3.80 4.00 4.00 4.20 4.30

avgaverage; eopend of period Source: Thomson Reuters, Raiffeisen RESEARCH

*Assumption: Key rate rises to a fair level until the beginning of 2013 and remains there. That means: There has not been modeled any inflation or business cycle for the years after 2012. Instead from the year 2012 onwards it is assumed that GDP growth will match potential output-growth (about 2.5% yoy) and core inflation will be at 1.5% yoy (middle of the Feds comfort zone). From these two variables the neutral interest rate was derived at 4%. However, in the past the Fed held the Fed Funds Target Rate about 50bp below this level. We assume that this discount will be kept in the future too. The de facto economic development and accordingly the development of interest rates will deviate from the afore mentioned trend growth from some point after 2012. Since it is not possible to model peaks and troughs of the business cycle so far in advance, we consider the neutral interest rate level as the best approach for longterm forecasting. Our assumption of a normal slope of the yield curve (steep, but not as steep as at the moment) leads to some more implications for our estimation of the longterm neutral interest rate as forecasted in the table above.

Interest rate update

Acknowledgements
This report was completed on 6 July 2011

Editor
Raiffeisen RESEARCH GmbH A-1030 Vienna, Am Stadtpark 9 Tel: +43 1 717 07-1521 Head: Peter Brezinschek (1517) Research Sales: Werner Weingraber (5975) Economics, Fixed Income, FX: Valentin Hofsttter (Head, 1685), Jrg Angel (1687), Wolfgang Ernst (1500), Gunter Deuber (5707), Ingo Jungwirth (2139), Julia Neudorfer (5842), Andreas Schwabe (1389), Gintaras Shlizhyus (1343), Gottfried Steindl (1523), Martin Stelzeneder (1614) Credit/Corporate Bonds: Christoph Klaper (Head, 1652), Christoph Ibser (5913), Martin Kutny (2013), Peter Onofrej (2049), Gleb Shpilevoy (1461), Alexander Sklemin (1212), Jrgen Walter (5932) Stocks: Helge Rechberger (Head, 1533), Aaron Alber (1513), Christian Hinterwallner (1633), Jrn Lange (5934), Hannes Loacker (1885), Richard Malzer (5935), Johannes Mattner (1463), Christine Nowak (1625), Leopold Salcher (2176), Andreas Schiller (1358), Connie Schmann (2178), Magdalena Wasowicz (2169) Quant Research/Emerging Markets: Veronika Lammer (Head, 3741), Mario Annau (1355), Lydia Kranner (1609), Albert Moik (1593), Nina Kukic (1635), Manuel Schuster (1529) Technical analysis: Robert Schittler (1537), Stefan Memmer (1421)

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