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8/3/2019 Bernanke Faces Inquisition
http://slidepdf.com/reader/full/bernanke-faces-inquisition 1/17PLEASE SEE IMPORTANT DISCLAIMER AND DISCLOSURES AT THE END OF THE DOCUMENT `
30 September 2011
Cross Asset ResearchWeekly
www.sgresearch.com
Focus US Bernanke faces the Inquisition
Fed Focus Current performance does not guarantee future results p.3
[email protected] Incoming activity data continue to hold up well despite the nosedive in sentiment. Q3 GDP is now tracking
slightly above 2%. The problem is that solid growth today does not guarantee solid results in the future. Indeed,
financial conditions continue to point to further downside risks. In recent weeks, financial contagion appears to
have spread to US banks and the risk is that non-financials may be next. This is precisely what the Fed tried to
hedge against with “Operation Twist”. The question is what else can the Fed do if the situation deterioratesfurther? Bernanke’s testimony before the Joint Economic Committee next week will hopefully offer some
guidance. However, we do not expect the Chairman to offer strong new policy signals at this stage. Bernanke
has to walk a fine line between showing readiness to act and not stirring up further controversy on the Fed’s
aggressive actions.
Eco Focus The usual suspects p.5
[email protected] The statistical calendar for the first week of October will be bracketed by the Institute for Supply Managment’s
(ISM) survey of manufacturing conditions and the Bureau of Labor Statistics’ update on the employment situation
in September. We expect both reports to surprise to the upside compared to current Street projections. Between
Monday and Friday, figures on private job growth from ADP employer services, non-manufacturing activity from
the ISM and jobless claims from the Department of Labor may also thinking heading into the all-important
nonfarm payroll report.
Rates Focus Quo vadis? p.7
[email protected] Financial markets continue to sail into unchartered territory. Apart from the stress coming from the European
front, the Fed is about to further dislocate the US Treasury curve with “Operation Twist”. We discuss the impact of
this on long-dated rates and suggest a trade that benefits from a normalization going forward.
Fiscal Focus How to balance a budget in a few steps p.9
[email protected] Over the next two months news flow and speculation will steadily increase with regards to the US debt super
committee’s ability to crank out a bipartisan deficit reduction proposal by November 23. Gi ven the highly partisan
nature in Washington, it is unlikely that we will see a grand deal that includes tax increases and entitlement reform
that is more than a token gesture. Our baseline scenario is for stabilization of the debt, but at a higher level than
the President’s plan or the CBO’s base line forecast. In this article, we go through a few steps that could balance
the budget while addressing entitlement reform and including revenue into the equation.
Credit Focus Five Trade Ideas in the U.S. Financials Space p.12
[email protected] After a week of significant spread widening and downgrades by Moody’s of Citigroup, Bank of America, and Wells
Fargo, the last week of 3Q11 is starting off on a relatively quiet note. And while we expect this quiet tone to
continue for most of the week, quiet should not be mistaken for stable, as volatility continues to be the theme in
the US financials space. Indeed, after last week’s 26 -118 bps widening in 5 year CDS for the major banks, most
names are now at their widest point in the last 12 months. Unfortunately, there seems to be little to arrest this
volatility in the short-term, making it extremely difficult for longer-term oriented investors to put money to work.
However, this volatility does continue to create interesting relative value opportunities in both the cash and CDS
space for investors who are looking to take advantage of certain situations where specific relationships have
become dislocated. Therefore, we provide five trade ideas that have popped up on our screens this afternoon.
Calendar/Forecasts p.14
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Focus US
30 September 2011 2
ECONOMIC DATA PREVIEW
Release date Reference Period SG Forecast Consensus Previous
Construction spending (%mom) 10/03 10:00 August 0.0 -0.2 -1.3
ISM manufacturing/ISM-price paid 10/03 10:00 September 52.0/57.0 50.5/53.8 50.6/55.5
Total vehicle sales (mln saar) 10/03 17:00 September 13.0 12.6 12.1
Factory orders (%mom) 10/04 10:00 August -0.5 0.1 2.4
ADP employment (thous. sa) 10/05 08:15 September 45 75 91
ISM Non-Manf. Composite 10/05 10:00 September 54.2 52.8 53.3
Initial jobless claims/continuing (thou. sa) 10/06 08:30 30 Sep / 24 Sep 395/3745 410/3725 410/3765
ICSC Chain Store Sales (%yoy) 10/06 September 5.0 na 4.6
Nonfarm payrolls (thous. Sa) 10/07 08:30 September 115 58 0
Nonfarm /priv. payrolls Ex strikers (thous. Sa) 10/07 08:30 September 70/110 na 46/63
Unemployment rate (%) 10/07 08:30 September 9.0 9.1 9.1
Avg hourly earnings (%mom) 10/07 08:30 September 0.5 0.2 -0.1
Wholesale Inventories (%mom) 10/07 10:00 August 1.0 0.6 0.8
Consumer Credit (USD bn) 10/07 15:00 August 8.84 7.50 11.97
Source: SG Cross Asset Research, Bloomberg. For more forecasts, see the Calendar at the end of the publication.
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Focus US
30 September 2011 3
Fed Focus
Current performance does not guarantee future resultsIncoming activity data continue to hold up well despite the
nosedive in sentiment. Q3 GDP is now tracking slightly
above 2%. The problem is that solid growth today does not
guarantee solid results in the future. Indeed, financial
conditions continue to point to further downside risks. In
recent weeks, financial contagion appears to have spread
to US banks and the risk is that non-financials may be
next. This is precisely what the Fed tried to hedge against
with “Operation Twist”. The question is what else can the
Fed do if the situation deteriorates further? Bernanke’s
testimony before the Joint Economic Committee next weekwill hopefully offer some guidance. However, we do not
expect the Chairman to offer strong new policy signals at
this stage. Bernanke has to walk a fine line between
showing readiness to act and not stirring up further
controversy on the Fed’s aggressive actions.
So far, so good … but downside risks mount Hard
activity data continue to hold up well despite the nosedive
in confidence. Business investment in particular remains
resilient and appears on track for a significant gain in Q3.
This puts our Q3 GDP tracking estimate at 2.2%. This is
still too close to trend for the Fed’s comfort, but certainlybetter than the average growth of 0.8% in the first half of
the year.
The problem is that solid growth today is no guarantee
that it will hold up in the coming months. Financial
conditions continue to pose a significant risk to the
outlook. We have already shaved more than a percentage
point off of our 2012 forecast on the back of tighter credit,
but the lack of improvement in conditions poses further
downside risk. Indeed, in the past week, our financial
conditions index has deteriorated further and now
exceeds two standard deviations (see chart 1.3). The hitmay start adversely impacting the economy as early as
Q4.
Financial contagion spreads to US banks Until
recently, funding problems were seen as largely
concentrated in the European banking sector. However,
over the past two weeks, US financials have seen their
CDS spreads widen considerably even as European bank
spreads narrowed modestly (see Chart 1.1). This is in part
driven by concern about US exposure to European
institutions. As a result, CDS spreads for US financials are
now at levels last seen in early 2009. Corporates fine so far, but how long? The contagion
to the US financial sector will no doubt be seen with
alarm at the Fed. One consolation may be the fact that
the non-financial sector so far has only seen modest
contagion. However, it is hard to believe that the gap
between financials and non-financials (see Chart 1.2) can
remain this wide for a sustained period of time. It is true
that corporate America has substantial amounts of cash
and is less dependent on banks and capital markets than
it was back in 2008. However, the financial sector is still
the life blood of the economy. Small businesses, in
particular, are highly dependent on financial institutions.
Chart 1.1: Financial contagion spreads to US banks
0
100
200
300
400
500
600
07 08 09 10 11
bps
US Banks
European Banks
5yr CDS spreads
Source: Bloomberg, SG Cross Asset Research/Economics
Chart 1.2: Corporates still fine, but for how long?
0
50
100
150
200
250
300
350
400
450
500
06 07 08 09 10 11
bps
US Financials
US Industrials
5yr CDS spreads
Source: Bloomberg, SG Cross Asset Research/Economics
The gap between financials and nonfinancials was
similarly wide in mid-2008, but eventually non-financialspreads widened sharply as the crisis became systemic
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Focus US
30 September 2011
4
and spread to the broader economy. Could the gap close
via
contraction in financial spreads? It is certainly possible,but the longer the European sovereign crisis goes
unresolved, the greater the risk that contagion will
eventually spread to the broader US economy.
Ongoing debate on what the Fed can and should do
With this backdrop in mind, Bernanke heads to Congress
next week to testify on the US economy before the Joint
Economic Committee. The FOMC statement sounded
decidedly downbeat on the outlook, with significant
downside risks emanating from tighter financial
conditions. Bernanke is likely to reiterate this position,
with heavy discussion of financial sector developments.Doubtless, Bernanke also will be grilled on the “twist”,
particularly by those in Congress who are opposed to any
further Fed stimulus. By taking the recent unprecedented
steps, the Fed has put itself at the cross hairs of an
unpleasant political debate.
Leaving politics aside, the more pressing question is what
else the Fed can do? We look forward to Bernanke’s
guidance on that. We see QE3 as the most likely next
step, but our central scenario is that it will not happen
until 2012 when inflation moderates. As far as nuclear
options, several Fed officials have mentioned price leveltargeting as an option, but Bernanke has been cautious
not to endorse it publicly. We do not expect a change in
his stance for now.
Recent Fedspeak Highlights
Bernanke – Recent weakness only in part due to temporary factors.
However, believes that recent spike in inflation is transitory and
should dissipate. Labor market is still key.
Dudley – Long way to go for Fed to meet dual mandate. In recent
speeches, he stuck with the official FOMC statement, though
highlighted that the Fed considered further easing options. He is
satisfied with the drop in rates post-FOMC announcement, but still
concerned about the fragile equity markets. Clearly biased toward
further easing. In the past, Dudley also expressed support for price
level targeting.
Fisher – Voted against the commitment to keep rates low through
2013. Believes that the Fed should not respond to swings in equitymarkets. Also suggested that the commitment to low rates removes
the incentive for businesses to invest in the short-rum.
Kocherlakota – Also voted against the latest Fed decision. Believes
that unemployment will be close to 8.5% at end of year. Given his
forecasts he views that the Fed funds rate target should be raised by
50bps before the end of the year.
Plosser – The third dissenter. Believed that the decision was
premature and would like to have seen more data (though after
seeing the Philly Fed survey for August, he may have changed his
mind). Anyway, Plosser is comfortable with the deeply negative real
interest rates and favors faster normalization of monetary policy.
Evans – Very dovish. Believes the US is in a balance sheet
recession. Believes that high unemployment is not structural, but
rather an outcome of weak demand. Like Dudley, Evans also
endorsed price level targeting as a policy option.
Lockhart– Economy is halting and showing lack of conviction. Wary
of tightening policy unless absolutely necessary. Would like an
explicit inflation target of 2%.
Chart 1.3 SG weekly financial conditions index Chart 1.3 Doves still in the voting majority
-9
-8-7
-6
-5
-4
-3
-2
-1
0
1
2
00 01 02 03 04 05 06 07 08 09 10 11
Index
SG Financial Conditions Index
-1
-3
0
-1
0
-3
3
3
-4
4
-4
2
-1-1
2
5
-4
*Bernanke
*Yellen
* Tarullo
* Duke
*Raskin
* Dudley
**Fisher
**Kocherlakota
**Evans
**Plosser
***Pianalto
***Lacker
***Lockhart***Williams
Bullard
Hoenig
Rosengren
D O V I S H H A W K I S H
2011 voters
* perma nent voters; ** 2011 voters; *** 2012 voters Source: Global Insight, SG Cross Asset Research/Economics Source: Global Insight, SG Cross Asset Research/Economics
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Focus US
30 September 2011 5
Eco Focus
The usual suspectsThe statistical calendar for the first week of October will be
bracketed by the Institute for Supply Managment’s (ISM)
survey of manufacturing conditions and the Bureau of
Labor Statistics’ (BLS) update on the employment situation
in September. We expect both reports to surprise to the
upside compared to current Street projections. Between
Monday and Friday, figures on private job growth from
ADP employer services, non-manufacturing activity from
the ISM and jobless claims from the Department of Labor
(DoL) may also color thinking heading into the all-
important nonfarm payroll report.
National purchasers’ gauge rose in September
Manufacturing reports from district Federal Reserve
Banks, combined with auto-related pickups in a variety of
midwestern ISM gauges, suggest that the national
purchasing managers’ index climbed to a three-month
high of 52.0 in September (see Chart 2.1). Wider reports
of stepped-up hiring at factories probably will provide a
lift to the headline measure in next week’s report. We
would be very careful about projecting any change in the
ISM employment gauge to movements in factory payrolls
in the BLS’ report, however. Although the correlationbetween the ISM hiring barometer and the monthly
change in manufacturing employment is high (0.89%), the
former has accurately called the direction of the latter just
half of the time since 1988. Consistent with the expected
improvement in demand, the prices-paid diffusion index
likely climbed by 1½ percentage points to 57.0 – the first
rise since April.
Chart 2.1: Regional surveys point to rise in national factory index
30
35
40
45
50
55
60
65
70
2007 2008 2009 2010 2011
ISM National Mfg IndexDis trict Fed Bank AvgRegional ISM AvgFed & ISM Avg
Source: SG Cross Asset Research
Returning strikers boosted nonfarm job count Buoyed by the return of 45,000 striking workers at
Verizon Corporation, nonfarm payrolls probably climbed
by 115,000 in September – the largest job gain since
April. Net of the boost related to the resolution of the
aforementioned labor dispute, private entities likely added
110,000 positions, a touch above the 98,000 average
posted over the June-August span. Reflecting continued
pink-slipping by cash-strapped states and municipalities,
government payrolls probably contracted by 40,000 last
month, boosting cumulative public job losses over the
past three years to an eye-popping 654,000.
The remaining portions of the BLS’ September survey are
expected to be comparatively positive as well. Echoingthe observed downtick in our augmented insured
unemployment rate between establishment surveys, the
civilian jobless percentage likely dipped to a five-month
low of 9.0%. Meanwhile, the average workweek of all
employees probably expanded by six minutes to 34.3
hours, erasing the reported August decline. If our
forecasts are on the mark, the index of aggregate hours
worked climbed by 0.4% during the reference period.
Barring any prior-month revisions, our estimate would
place hours worked over the July-September span level
with the second-quarter average, hinting at a summerrebound in nonfarm business productivity. Reflecting
quirks associated with the timing of the September
establishment survey, average hourly earnings likely
jumped by 0.5%, pushing the year-to-year growth of this
closely followed nominal compensation gauge three ticks
higher to 2.2%.
Chart 2.2: Drop in continuing claims hints at pickup in private jobs
0
50
100
150
200
250
300
350
400
Jan Feb Mar Apr May Jun Jul Aug Sep
thousands
Decline in Total Continuing Claims Private Payroll Change Ex Strikers
Ests
Source: SG Cross Asset Research
Another head-fake from ADP?
The ADP National Employment Report may once againwrongly color expectations heading into the official BLS
release. The 19,000 rebound in the average number of
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Focus US
30 September 2011 7
Rates Focus
Quo vadis?Financial markets continue to sail into unchartered
territory. Apart from the stress coming from the European
front, the Fed is about to further dislocate the US Treasury
curve with “Operation Twist”. We discuss the impact of
this on long-dated rates and suggest a trade that benefits
from a normalization going forward.
Heading into unchartered territory . The lack of
progress in defusing the European sovereign debt crisis,
the ongoing banking financing troubles and the
continuing concerns regarding the US recovery have
already caused a significant deterioration in liquidity.Now, the approaching quarter-end has even led to a
worsening of the situation. Quarter-end window
dressing is plaguing the market even more than usual, as
a large number of financial institutions want to present
investors with a lean and clean balance sheet. This
involves moving risky assets off the books, as much as
this is possible. There used to be a number of broker-
dealers with fiscal years different from the rest of the
Street. Those institutions provided liquidity by taking
some of the “unfavourable” assets on their balance sheet
during periods of balance sheet window dressing.However, those broker-dealers either went out of
business (Bear Stearns) or transformed themselves into
bank holding companies in 2008 (Goldman Sachs,
Morgan Stanley). This means that pretty much everyone
is trading in the same direction, which hurts liquidity in the
market and causes risky assets to trade at a larger-than-
usual discount.
As we noted in Wednesday’s Daily, one noticeable victim
in this respect has been GSE paper which, on an asset
swap spread basis, cheapened some 10bp from a week
ago.1
With GSEs essentially being less-liquid Treasuries,in our view, this creates an opportunity for investors to
position for a renewed GSE spread tightening past
quarter-end. We discuss this theme in more detail in the
Agency section of our latest Rates Weekly. The
corporate new issuance market is yet another example
of the peculiar market situation: While high quality issuers
(single-A or better) enjoy strong funding opportunities,
lower-ranked ones (triple-B or lower) either can’t issue at
all (as happened in the previous week) or only at a
sizeable concession (as in this past week).
Global uncertainty, lack of market participation andbalance sheet restrictions of liquidity providers are
1 Curve flattening and the poor performance of many duration hedges may havecontributed to this move.
causing market prices to trade in a much wider range
than usual. This is true not only for stocks (see Chart 3.1),
but also for most fixed-income products.
Chart 3.1: Global uncertainty causes oscillating prices in all majormarkets, including the equity market
1100
1150
1200
1250
1300
1350
Jan Apr Jul Oct
S & P I n d e x
Source: SG Cross Asset Research, Bloomberg
30-year TSY - Mind the gap! “Operation Twist” has
changed the dynamics of the 10- to 30-year sector of the
Treasury curve, forcing market participants to re-calibrate
their models and to adjust their thinking about the back
end of the yield curve. Until recently, the very long end of
the Treasury curve was widely considered to be orphaned
as few investors dared to express a view on this relatively
illiquid and difficult-to-hedge part of the curve.
With the Fed stepping in as a potent incremental buyer,
a number of things have happened.
First, the market instantaneously reduced the term-risk
premium, causing 30-year yields to gap lower (see
Chart 3.2).
Second, 10s30s slope flattened significantly, as the
Fed’s buying program is focused on the 20- to 30-year
part of the curve. This reverses the previous steepening
trend caused primarily by market participants’ lack of
balance sheet and their ability to invest in long-dated
Treasuries (see Chart 3.3).
Third, implied volatility on 30-year tails has shot higher
and now trades at a significant premium over volatility
on shorter tails (see Chart 3.4).
While both the anticipation and the announcement of
“Operation Twist” had a pronounced bull-flattening effect
on the back end of the yield curve, it now remains to beseen whether the execution of the program will cause a
continuation of the trend, or (as happened during QE1) a
reversal of the initial market reaction will take place.
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Focus US
30 September 2011 9
Fiscal Focus
How to balance a budget in a few stepsOver the next two months news flow and speculation will
steadily increase with regards to the US debt super
committee’s ability to crank out a bipartisan deficit
reduction proposal by November 23. Given the highly
partisan nature in Washington, it is unlikely that we will see
a grand deal that includes tax increases and entitlement
reform that is more than a token gesture. Our baseline
scenario is for stabilization of the debt, but at a higher level
than the President’s plan or the CBO’s baseline forecast. In
this article, we go through a few steps that could balance
the budget while addressing entitlement reform andincluding revenue into the equation.
Closing in on November 23 With the President’s
deficit reduction plan now out in the open, it is now up to
the debt super committee to agree on a proposal by
November 23. While it is highly unlikely that the
committee will adopt Obama’s plan, the proposal does
act as one flag post to help navigate to an agreement.
In terms of deficit reduction, Obama’s plan is somewhere
between his Deficit Commission’s proposal which
assumes a return to a balanced budget; and the S&P
baseline that assumes a high level of deficits over the
next 10-years. From a policy perspective, Obama’s heavy
reliance on tax increases puts it to the left of the Debt
Commission and even further left from House Budget
Chairman Paul Ryan’s plan which reduced the deficit with
no tax increases.
Obama’s plan called for one dollar of tax increases for
every two dollars in spending cuts. The Debt Commission
looked for one dollar in tax increases for every three
dollars in spending reductions. As we said in our initial
analysis of the Obama deficit plan, we were disappointed
by the heavy reliance on Tax cuts, as well as little on the
side of entitlement reform.
Looking over the instruction manual. Over the
coming weeks we will likely see more plans on how to
reduce the deficit to add to our collection. Not to miss out
on all the fun we will briefly illustrate what type ofmeasures could be taken to bring the budget close to
balance over the next 10-years. The CBO provides a
comprehensive analysis of various budget options that
could reduce the deficit and we use this as the framework
in which we will slice up the deficit. We will look first at
the CBO’s baseline assumption, a worst case scenario,
and our current fiscal baseline before examining a
hypothetical scenario that balances the budget.
CBO’s errs on the side of current law. The CBO’s baseline
scenario is on the optimistic side, as it assumes that the
Bush tax cuts are left to expire, no AMT relief and a doctor
payment rates reduction. It does include $2.1bn in austerity
measures outlined in the Budget Control Act of 2011, the
debt ceiling deal. The result is a ten-year cumulative deficit of
$3.1tn with a deficit-to-GDP of a manageable 1.2% versus
8.5% today. Debt-to-GDP under these assumptions
Chart 4.1: Extension of expiring policies will move debt-to-GDP todangerous levels
Chart 4.2: Hypothetical deficit reduction scenario moves towardsbalancing the budget.
50%
55%
60%
65%
70%
75%
80%
85%
90%
2009 2011 2013 2015 2017 2019 2021
All tax cuts extendedSG BaselineObama def icit reductionSG hypothetical scenarioCBO baseline
-1%
1%
3%
5%
7%
9%
2009 2011 2013 2015 2017 2019 2021
All tax cuts extendedSG Baseline
Obama def icit reductionSG hypothetical scenarioCBO baseline
Source: SG Cross Asset Research
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30 September 2011 10
should fall to 61% of GDP from a peak of 73% in 2013.
The main issue with the CBO baseline is that it assumes
that there is no reform to entitlement spending. This
suggests that beyond 2021 the deficit could revert back
to an adverse path.
Bad habits are hard to break. Under the worst case,
we assume that the Bush tax cuts will be made
permanent, AMT is indexed to inflation, other expiring tax
measures are made permanent, and doctor-payment
rates are maintained. We also assume that there is $2.1tn
in spending cuts from the Budget Control Act of 2011 (the
debt ceiling agreement). This would result in a cumulative
ten-year deficit of $8.2tn. By 2021 debt-to-GDP should
rise to 83% from 68% today with the deficit checking inat 4.4% in 2021 and rising.
We sit somewhere in the middle. Our baseline
assumes that the Bush Tax cuts are only extended for
those making under $250k, $180bn in fiscal stimulus in
2011, and $2.4tn in deficit reduction over the next 10
years. Under our scenario, we should see the debt-to-
GDP rise to 77.1% by the end of 2021. The SG baseline
follows a similar path to the deficit reduction plan outlined
by President Obama. Neither of the scenarios assumes
significant enough entitlement reform to stem costs
related to demographics after 2021. One for every three. We have always maintained
that the framework to follow for deficit reduction should
be the President’s Deficit Commission’s proposal. But
even the President has not followed his own
Commission’s advice. But we will in this exercise on how
a few steps can bring the budget closer to balance.
Using a framework that relies on $1 of revenue for every
$3 of spending reduction, our scenario suggests that a
$4.2tn deficit reduction plan could bring the budget
almost to balance by 2021. Discretionary spending cuts
account for about 40% of the total deficit reduction withmost of the gains made through the $900bn first stage of
cuts outlined in the BCA and ending of overseas wars
($1.3tn). We also assume that the full amount of the
Obama’s Jobs Act, $447, is implemented.
The lack of progress on mandatory spending reform has
been disappointing, particularly given that there are
several straightforward fixes available. With respect to
Social Security, the current inflation assumption
overstates actual inflation. A shift from CPI-W (wage
earners and clerical workers) to CPI-U (all urban
consumers), which captures a greater portion of thepopulation, could save the tax payer $110bn over the
next ten years. As well, raising the limit of taxable
earnings for Social Security reduces the deficit by about
$460bn. Increasing eligibility and full retirement ages
saves about $260bn. These and other small fixes could
shave off about $1.1tn off the deficit between 2012 and
2021.
With respect to health care spending there a combination
of four policies could shave off about $600bn. The
biggest is to change Medicaid payments to block grants.
Switching the payment method would deter gaming of the
Medicaid funding formula by states and the result would
be about $300bn in savings over ten-years. House
Budget Committee Chairman Paul Ryan included this
idea in his deficit plan earlier this year. Raising the
Medicare eligibility age to 67 would save $125bn. The one
caveat to our choice of cuts is that there is some risk that
it will do enough to restrain long term growth in
healthcare costs.
On the tax side, our scenario would raise revenue by
almost $1.1tn. Although we would prefer to see
comprehensive tax reform, we have excluded them to
keep the illustration simple. The partial extension of the
Bush tax cuts for those making under $250k should
increase revenues by $500bn. Limiting itemized
deductions to 15% of income should raise $1.2tn in new
revenue. We also include the repeal of LIFO and treat
carried interest as ordinary income, both combined they
reduce the deficit by $100bn. Elimination of the AMT
should give ease some of the increased tax burden, but
increases the deficit by $800bn.
Chart 4.3: Under the hypothetical scenario US should have noproblem meeting obligations
6
10
14
18
22
26
30
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Unch. Fwd Fwd + 50bp
Fwd + 100bp Fwd + 150bpFwd + 200bp
Aaa
Aa space
Debt reversibility band
%, inte rest payment to revenue
Source: Bloomberg, CBO, Global Insight, SG Cross Asset Research/Economics
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America, - 3 bps for Citigroup, +6 bps for JPMorgan, and
-1 bps for Morgan Stanley.
Trade Idea #5 — Buy GECC 5 yr CDS (+295/302
bps), Sell Sallie Mae 5 yr CDS (+565/590 bps). Despite
the 8-notch ratings differential at Moody’s, we believe
Sallie Mae is fundamentally better positioned than GECC
in the current market. Over the past several years, Sallie
Mae has done much to improve its fundamental profile
including reducing its reliance on the unsecured debt
markets and an overall deleveraging, improving its
underwriting standards within its private loan portfolio,
and transforming its business model from low margin
FFELP originations to more of a servicing-oriented
business model. And while GECC has also made
meaningful progress in improving its credit profile since
the depths of the credit crisis, GECC is still very reliant on
the wholesale funding markets. Therefore, in this period of
market stress, we believe the current 270 bps bid-side
spread differential is too much and should compress in
the current volatile market.
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Calendar
3
Jul Auge
Constructionspending (%m)
-1.3 0.0
Aug Sepe
ISM mfg. 50.6 52.0
ISM-prices paid 55.5 57.0
Aug Sepe
Total vehiclesales (mln saar)
12.1 13.0
4
Jul Auge
Factory orders 2.4 -0.5
5
Jul Auge
ADPemployment
91 45
Aug Sepe
ISM Non-Manf.Composite
53.3 54.2
6
9/24e 9/30e
Initial joblessclaims
410 395
9/17 9/24e
Contin. claims 3765 3745
Aug Sepe
ICSC ChainStore Sales(%yoy)
4.6 5.0
7
Aug Sepe
Nonfarmpayrolls, (thous.sa)
0.0 115
Nonfarmpayrolls ex.strikers (thous.sa)
46 70
Private payrollsex. strikers(thous. sa)
63 110
Unempl. rate 9.1 9.0
Avg hourlyearnings (%m)
-0.1 0.5
Avg weeklyhours
34.2 34.3
Jul Auge Consumercredit ($bn)
11.965 8.84
Fed Beige Book
Kocherlakota, Kohn Evans, Williams
$2.75-$3.50bn; Apr’14 - Sep’15 FED MBS reinvestment begins $3.25-$4.00bn; Nov’18 - Aug’21
ann 3Y/10Y/30Y (32/21/13)
10 11
NFIB Small Bus. Optimism
IBD/TIPP Economic Optimism
Monthly Budget Statement
FOMC Minutes
12
JOLTs Job Openings
13
Trade Balance
Jobless claims
14
Import Price Index
Retail Sales
Michigan Confidence Index
Business Inventories
$3.25-$4.00bn; Apr’17 - Sep’18 Fed’s Treasury operation
schedule TBA 2pm
ann 30Y TIPS® ($7bn)
17
Empire Manufacturing IndexIndustrial Production
Capacity utilization
18
Producer Price IndexTIC Flows
NAHB Housing Index
19
FED Beige BookCPI
Housing Starts
Building permits
20
Jobless ClaimsLeading Indicators
Philadelphia Fed.
Existing Home Sales
21
ann 2Y/5Y/7Y (35/29/29)auc 30Y TIPS® ($7bn)
24
Chicago Fed. Activity Index
25
S&P/CaseShiller Index
Consumer Confidence
House price Index
Richmond Fed. Mfg Index
26
Durable Goods Orders
New Home Sales
27
Jobless Claims
GDP 3Q (A)
Personal Consumption
Core PCE
Pending Home Sales
Kansas City Fed Index
28
Personal Income/Spending
Core PCE
U. of Michigan Index
auc 2Y Note ($35bn) auc 5Y Note ($29bn) auc 7Y Note ($29bn) Source: SG Cross Asset Research, NY Federal Reserve, Bloomberg. Forecasts are subject to change according to incoming data – ® Reopening.
October Economic data, Fed speakers, Fed’s Treasury purchases and Treasury auctions previews
Monday Tuesday Wednesday Thursday Friday
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Forecast summary
Economics
Economic Forecasts: The US outlook at a glanceNominal GDP 2010 $13 088bn Q310f Q410f Q111f Q211f Q311f Q411f Q112f Q212f 2009 2010f 2011f 2012f
GDP (% qoq ann) 2.5 2.3 0.4 1.3 1.6 2.2 1.4 1.7 -3.5 3.0 1.6 1.8
Consumer expenditure 2.6 3.6 2.1 0.1 1.4 2.0 2.1 2.0 -1.9 2.0 2.0 1.8
Government expenditure 1.0 -2.8 -5.9 -1.1 -0.5 -0.9 -1.3 -0.7 1.7 0.7 -2.0 -0.9
Investment 2.3 7.5 1.2 6.5 6.0 8.1 1.4 3.2 -18.8 2.6 5.5 4.5
Exports 10.0 7.8 7.9 6.0 5.0 5.0 4.0 4.0 -9.4 11.3 7.3 4.6
Imports 12.3 -2.3 8.3 1.3 1.0 3.0 3.5 3.0 -13.6 12.5 4.8 2.6
Nominal GDP (% yoy) -2.5 4.2 3.8 3.8
CPI headline (% yoy) 1.2 1.2 2.2 3.3 3.5 3.1 2.2 1.5 -0.3 1.6 3.0 1.6
CPI core (% yoy) 0.9 0.6 1.1 1.5 1.8 2.0 2.0 1.8 1.7 1.0 1.6 1.7
Unemployment rate (%) 9.6 9.6 8.9 9.1 9.2 9.3 9.3 9.4 9.3 9.6 9.1 9.4
Employment (%yoy) 0.1 0.7 1.0 0.8 1.1 0.9 0.6 0.5 -4.4 -0.4 1.0 0.5
Average hourly earnings (% yoy) 2.3 2.3 2.1 2.1 2.0 1.9 2.0 2.0 3.0 2.4 2.0 2.0
Savings rate (%) 5.6 5.2 4.9 5.1 5.3 5.4 5.3 5.3 5.2 5.3 5.2 5.2
Fiscal stance* (% of GDP) -1.6 -0.2 1.2 0.5
Output gap (% of GDP) -6.4 -6.3 -6.7 -6.9 -7.0 -6.9 -7.0 -7.1 -7.8 -6.6 -6.9 -7.0
Corporate profits before tax (% yoy) 27.4 18.2 8.8 5.0 3.2 2.5 2.8 4.1 9.1 32.2 4.8 3.9
Current account (% of GDP) -2.7 -3.2 -2.7 -2.8
Budget balance (% of GDP) -3.3 -9.7 -8.2 -7.8
Federal Debt (% of GDP) 54.3 61.8 67.8 73.9
Public Debt (% of GDP) 75.3 82.8 88.8 94.9
Fed Funds Target (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25
Source: S G Cross Asset Re search. * Fiscal stance is de fined as the change in the cyclically adjusted budge t balance
Ratesfigures as of end of period 30-Sep Q411 Q112 Q212 Q312 Q412 2013 2014 2015
Fed fund target 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% 0.31%
FF e ffe ctiv e - FF targ et sp re ad -0 .17% -0 .17% -0 .17% -0 .17% -0 .17% -0 .17% -0 .17% -0 .0 5% -0 .0 5%
3mo OIS spread - FF effective 0.01% 0.00% 0.00% 0.00% 0.05% 0.05% 0.05% 0.05% 0.05%
3mo LIBOR - 3m OIS spread 0.29% 0.25% 0.30% 0.30% 0.30% 0.30% 0.30% 0.20% 0.10%
3mo LIBOR 0.37% 0.33% 0.38% 0.38% 0.43% 0.43% 0.43% 0.45% 0.41%
2-year Treasury yield 0.26% 0.10% 0.10% 0.10% 0.10% 0.10% 0.10% 0.25% 0.50%
5-year Treasury yield 0.97% 0.80% 0.70% 0.80% 0.90% 0.90% 0.90% 1.10% 1.25%
10-year Treasury yield 1.94% 2.00% 1.75% 2.00% 2.25% 2.25% 2.25% 2.50% 2.50%
30-year Treasury yield 2.97% 2.95% 2.58% 2.95% 3.33% 3.33% 3.33% 3.63% 3.50%
2-year swap spread 31.4bp 30bp 30bp 30bp 30bp 30bp 35bp 35bp 35bp
5-year swap spread 29.1bp 28bp 26bp 28bp 30bp 30bp 33bp 34bp 34bp
10-year swap spread 18.4bp 11bp 6bp 11bp 15bp 15bp 15bp 20bp 20bp
2s10s slope 1.68% 1.90% 1.65% 1.90% 2.15% 2.15% 2.15% 2.25% 2.00%
2s5s slope 0.71% 0.70% 0.60% 0.70% 0.80% 0.80% 0.80% 0.85% 0.75%
5s10s slope 0.96% 1.20% 1.05% 1.20% 1.35% 1.35% 1.35% 1.40% 1.25%
10s30s slope 1.03% 0.95% 0.83% 0.95% 1.08% 1.08% 1.08% 1.13% 1.00%
3m-into-2y swaption vol (bp/year) 44.7 43 48 53 58 63 68 73 78
5y-into-5y swaption vol (bp/year) 104.2 105 108 105 103 100 100 100 100
Treasury auctions
Announcem ent date Security type Auction date Settlem ent date Es tim ated am ountChange in s ize from
previous auctionMaturing amount New Cash
6-Oct 3-Year Note 11-Oct 17-Oct $32bn $0bn6-Oct 10-Year Note (R) 12-Oct 17-Oct $21bn $0bn
6-Oct 30-Year Bond (R) 13-Oct 17-Oct $13bn $0bn $0bn $66bn
13-Oct 30-Year TIPS (R) 20-Oct 31-Oct $7bn $0bn $0bn $7bn
20-Oct 2-Year Note 25-Oct 31-Oct $35bn $0bn
20-Oct 5-Year Note 26-Oct 31-Oct $29bn $0bn
20-Oct 7-Year Note 27-Oct 31-Oct $29bn $0bn $57bn $42bn
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APPENDIX
ANALYST CERTIFICATIONThe following named research analyst(s) hereby certifies or certify that (i) the views expressed in the research report accurately reflect his or her personal views about any and all of thesubject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly , to the specific recommendations or views expressed in this report: JohnGuarnera
EXPLANATION OF CREDIT RATINGSU.S. Credit Research does not currently maintain ratings or credit opinions on individual companies. Trade ideas may be short term in U.S. Credit Research does not currently maintainratings or credit opinions on individual companies.
CONFLICTS OF INTERESTThis research contains the views, opinions and recommendations of Société Générale (SG) credit research analysts and/or strategists. To the extent that this research contains trade ideasbased on macro views of economic market conditions or relative value, it may differ from the fundamental credit opinions and recommendations contained in credit sector or companyresearch reports and from the views and opinions of other departments of SG and its affiliates. Credit research analysts and/or strategists routinely consult with SG trading desk personnel informulating views, opinions and recommendations in preparing research. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports.Therefore, this research may not be independent from the propr ietary interest of SG trading desks which may conflict with you r interests. In addition, research analysts receive compensationbased, in part, on the quality and accuracy of their analysis, client feedback, trading desk and firm revenues and competitive factors. As a general matter, SG and/or its affiliates normallymake a market and trade as principal in fixed income securities discussed in research reports.
IMPORTANT DISCLOSURESBank of America SG acted as co-manager in Bank of America's bond issue.Bank of America SG acted as co-manager in BAML's senior HG bond issue.Citigroup SG acted as co-manager in Citigroup's senior bond issueGoldman Sachs SG acted as co-manager of Goldman Sachs' HG bond issue.Goldman Sachs SG acted as co manager in Goldman Sachs' senior high grade bond issue.Morgan Stanley SG acted as co-manager of Morgan Stanley's HG bond issue (4.5% 23/02/16 EUR).
.
SG or its affiliates act as market maker or liquidity provider in the equities securities of Mediaset.SG or its affiliates expect to receive or intend to seek compensation for investment banking services in the next 3 months from Mediaset.SG or its affiliates had an investment banking client relationship during the past 12 months with Bank of America, Citigroup, Goldman Sachs, Morgan Stanley.SG or its affiliates have received compensation for investment banking services in the past 12 months from Bank of America, Citigroup, Goldman Sachs, Morgan Stanley.SG or its affiliates managed or co-managed in the past 12 months a public offering of securities of Bank of America, Citigroup, Goldman Sachs, Morgan Stanley.SGAS had a non-investment banking non-securities services client relationship during the past 12 months with Bank of America, Citigroup, Goldman Sachs, Morgan Stanley, Wells Fargo.SGAS had a non-investment banking securities-related services client relationship during the past 12 months with Bank of America, Citigroup, Goldman Sachs, Morgan Stanley, Wells Fargo.SGAS received compensation for products and services other than investment banking services in the past 12 months from Bank of America, Citigroup, Goldman Sachs, Morgan Stanley,Wells Fargo.SGCIB received compensation for products and services other than investment banking services in the past 12 months from Bank of America, Citigroup, Goldman Sachs, Morgan Stanley.
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