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Important disclosures can be found in the Disclosures AppendixAll rights reserved. Standard Chartered Bank 2013 research.standardchartered.com

Thomas Costerg +1 212 667 [email protected]

Daniel Tenengauzer+1 645 845 [email protected]

John Davies, +44 20 7885 7640

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Sophii Weng +1 212 667 [email protected]

| Global Research | 15 August 2013

United States Tapering untangled

We expect QE to be tapered in September by USD 10bn, end in Q2-14; we see the first rate hike in Q3-15

Ourtaperingscenario depends on economic data, the Feds rhetoric, and the impact of the wealth effect

The risks to our call include weaker-than-expected growth and a shift in tone, with a new FOMC next year

Summary

We keep our tapering view unchanged after recent data and Federal Reserve (Fed)

bankers speeches. We still expect a reduction in the Feds quantitative easing (QE)

programme on 18 September, after the two-day Federal Open Market Committee

(FOMC) meeting. But the signals from both recent data and the Feds rhetoric are not

clear-cut: this is still a close call. We are changing our view about what we believe

the Fed will cut first. Rather than being evenly split between mortgage-backed

securities (MBS) and US Treasuries (USTs), we now think the first cut, which we

forecast to be USD 10bn, will be USTs only. We see subsequent cuts of

USD 10-15bn at each meeting, including meetings without press conferences. We

think the Fed will start cutting MBS in January 2014, and the QE programme looks

set to end by mid-2014, when the unemployment rate drops below 7%, in line with

Chairman Bernankes guidance in June. But the 7% threshold is soft; key is that

tapering will be gradual.

Once tapering has started, the focus will be on the next step of the Feds QE exit

plan. We expect the Fed to continue reinvesting maturing securities in the QE

programme for several quarters, something it is l ikely to increasingly emphasise in itscommunication. With further improvement in the economy, especially narrower output

and labour-market gaps, we see the Fed stopping these reinvestments from

Q1-2015, six months before the first rate hike, which we still forecast by Q3-2015. In

June, the Fed indicated that it will keep its MBS portfolio to maturity; we think it will

confirm this when it updates its exit strategy principles.

In this piece, we lay out the three factors which determine our tapering call: the data,

the Feds rhetoric, and the wealth effect. Upcoming data releases regarding the

labour market, private consumption and the housing market will be central. The Fed

would like to see more signs that the economy is withstanding the current fiscal

consolidation, and that the fiscal tail-risk has been reduced. Whether payroll datamaintains a trend above 175,000, which seems likely for the rest of H2-2013, is also

key. Another parameter is whether the housing market has absorbed the steep rise in

mortgage rates since May. The average 30Y fixed mortgage rate rose 76bps in two

months to 4.42% on average in July. Although we foresee a dip in the housing data in

the coming months in reaction to this steep increase, we expect a rebound later in

the year as the economy gains traction, the labour market continues to improve, and

wage growth accelerates. We do not expect tapering to derail the continued housing

recovery. This will warrant a cut in MBS purchases from Q1-2014, in our view.

Figure 1: Standard Chartered US rates forecasts

Q3-2013 Q4-2013 Q4-2014 Q4-2015 Q4-2016

Fed funds target rate, % 0.0-0.25 0.0-0.25 0.0-0.25 0.75 1.75

5Y US Treasury yield, % 1.55 1.70 2.50 3.10 3.70

10Y US Treasury yield, % 2.75 2.90 3.75 4.00 4.25

Source: Standard Chartered Research


2/19

On the Ground

15 August 2013 2

The Fed is changing its mix of tools, not the level of accommodation

A key uncertainty surrounding our call for September tapering is how the Fed will

reconcile a reduction in bond-buying with a likely downgrade of its 2013 growth

forecast. Even if Q2 growth is revised higher, the current Fed forecast of 2.3-2.6% y/yfor Q4-2013 growth (mid-point: 2.45%) implies growth north of 3.0% in H2, which

looks too optimistic. But we think the Fed can still argue that a sharp acceleration is

likely in 2014, with growth heading towards 3%. The new forecasts for 2016 are likely

to be upbeat as well. In other words, the outlook looks promising. Furthermore, the

inflation forecasts both for 2013 and 2014 are likely to stay broadly unchanged,

allowing tapering to proceed as the doves concerns about disinflation are addressed.

The second factor behind our tapering call is the Feds rhetoric. Since this spring it

has become clear that the Fed, including Chairman Bernanke, has become more

worried about the costs and risks of QE versus its benefits. Bernanke has signalled a

preference for conditional forward guidance, linked to a 6.5% unemployment rate,and separate from QE. The Fed will still provide the same level of accommodation,

but using a different mix of tools, as Bernanke emphasised at Julys congressional

testimony. Putting forward guidance in the drivers seat is also a way to keep market

expectations in check when tapering starts. Bernanke has reiterated the message

tapering is not tightening, which the market has gradually understood. Some doves

may argue that starting tapering now will prove that the exit of unconventional

policies is possible, and it can be smooth. QE remains relevant as a policy tool.

Bernanke, who has a theoretical bias towards the stock rather than flow approach to

policy accommodation, is expected to highlight the FOMCs decision taken in June to

keep the MBS portfolio to maturity as another way to provide accommodation.Bernanke is also likely to hint that the 6.5% unemployment rate threshold can be

lowered, as he said during Junes press conference.

Lowering the unemployment threshold would be a further way to send a dovish

signal, although we believe that in practice, the Fed is unlikely to change this

threshold in the short term. We see three main reasons: (1) This may create

confusion and affect the Feds credibility, as the current 6.5% target is quite recent;

(2) the FOMC will be reshuffled in 2014, and the Fed may want to avoid putting too

many ex-ante constraints on future members, and (3) lowering the threshold to 6%,

for instance, could mislead markets about the steepness of the rate-hiking path after

the first hike occurs. A 6% rate is close maybe too close to the full-employmentrate, which the Fed sees between 5.2% and 6.0%, a level which would in theory

warrant a neutral policy rate of around 4%.

The annual Jackson Hole meeting, on 22-24 August this year, usually provides the

Fed a platform for additional insight into its rhetoric, but this year the meeting may not

be as important as in the past. Bernanke does not plan to attend, while Vice

Chairman Yellen will only moderate a panel discussion, so there is no keynote

speech setting the tone for policy change.

A third factor for our tapering call is the level of asset prices, which plays an

important role via confidence and the wealth effect. One of QEs goals was areflation of assets following the global financial crisis, especially housing, specifically

through agency debt and MBS purchases. Our own index of the wealth effect shows

that in nominal terms, the level of wealth is back to pre-crisis levels, although house

September taper ing wi l l coincide

with a likely downgrade of the Feds

2013 growth forecast

The Feds rhetoric has evolved: QE

is losing i ts sh ine within the FOMC;

forward gu idance is preferred

Chairman Bernanke wi l l l ikely re-

emphasise tapering is not

tightening

Jackson Hole wi l l be no Delphi this

year

The weal th effect has worked, a

fur ther reason to expect QE

taper ing soon

We bel ieve the Fed is un l ikely to

change the 6.5% unemploym ent

threshold soo n


3/19

On the Ground

15 August 2013 3

prices are still lower. The Fed can now argue that there has been much progress in

this area, another reason to slow the QE programme.

Our prism for analysing QE taperingWe expect the first reduction in QE to happen in September (although this is still a

close call). We lay out below the three parameters that we believe will dictate the

timing and subsequent pace of QE reduction:

1. The data is key

The Fed has highlighted that it will take a holistic view of the data before tapering,

and the FOMC is at loggerheads about what constitutes enough improvement in the

economy. Still, we believe data on the labour and housing markets is particularly

important for the tapering outlook. We think there will be a steady acceleration in

growth, which supports a steady tapering path until Q2-2014, when QE is likely to

terminate.

In recent months, the Fed has emphasised its concern about the continued

undershooting of its employment mandate, which probably explains why it has tied its

policies more explicitly to the unemployment rate. Now, both the QE programme and

the forward guidance on rates have explicit unemployment-rate thresholds at 7.0%

and 6.5% respectively, although the 7.0% threshold was only given verbally by

Bernanke, and is probably softer than the 6.5% threshold, agreed by the FOMC.

The labour market is particularly central, especially for the first reduction in

purchases, in our view. Although the Fed scrutinises the unemployment rate, it is

aware that it can fluctuate based on the participation rate. Still, the unemploymentrate is a concept that the general public readily understands. The Fed is monitoring

monthly payrolls closely, we believe, as it is a more precise gauge of labour-market

dynamics than the monthly unemployment rate. In his recent statements, Chairman

Bernanke has made frequent references to the six-month average in private payrolls:

this average has been broadly constant at around 200,000 over the past few months.

The key level the Fed watches, in our view, is whether payroll additions can sustain a

level between at least 175,000 to 200,000 per month, which is broadly consistent

with reaching the 7.0% unemployment target rate by mid-2014. It seems that the Fed

assumes a constant participation rate from now on, as several regional Fed

Figure 2: Inflation may have bottomed out

Select inflation measures, % y/y

Figure 3: Market-based expectations have rebounded

Feds 5-year 5-year breakeven inflation rate, %

Source: Bloomberg, Standard Chartered Research Source: Bloomberg, Standard Chartered Research

Core CPI

1.7

Core PCE

1.2

Trimmedmean PCE

1.3

0.5

1.0

1.5

2.0

2.5

3.0

Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 Aug-13

The Fed is biased towards i ts

employm ent mandate as i t sees

inf lat ion gradual ly picking up

The Fed monitors th e level of

month ly payro l ls , on a moving

average basis

Key is whether payrol l addi t ions

remain ab ove 175,000

Labou r-market and housin g data

wi l l remain key


4/19

On the Ground

15 August 2013 4

researchers have shown. Fed Presidents Dennis Lockhart and Charles Evans have

recently cited these ranges in payrolls as key levels the Fed is scrutinising.

The payroll trend is likely to stay within the 175,000 to 200,000 range throughout H2on average, in our view, giving the green light to further reductions in QE. As an

aside, payrolls de-coupled to some degree from actual GDP growth in H1-2013, and

we expect both series to re-align in H2, with stronger growth but a slightly more

moderate level for payrolls. Both should accelerate in sync next year as growth

heads towards 3%.

Another area of focus is the housing market, which continues to post solid

performance, despite the recent rise in mortgage rates. According to Bankrate levels,

the average 30Y fixed mortgage rate moved from 3.66% in May to 4.42% on average

in July, a 76bps increase in two months. This comes as new homes sales for June

rose to the highest level since May 2008, while median prices were up 7.4%. Pricesfor existing homes were up 12.1% in May according to the Case-Shiller index.

Housebuilder confidence rose in August to the highest level since 2005.

This said, high-frequency data such as mortgage applications has dropped in recent

weeks, indicating that the rise in interest rates may have put off some purchasers.

But the overall trend in the housing market remains solid, something Chicago Fed

President Charles Evans acknowledged on 6 August when he said that higher rates

had not been as harmful as the Fed had feared. St Louis Fed President James

Bullard said that mortgage rates remained historically low despite their recent pick

up. Meanwhile, the level of foreclosures is on a continued downtrend, while banks

show both easier financing conditions and stronger demand for mortgages, as the

July 2013 Loan Officer Survey showed. Asset reflation is a significant part of QEs

goal and we think this dimension has been successful (see section 3).

Another area of scrutiny is how consumer spending evolves in the face of the fiscal

headwinds. Q2 GDP was up 1.7% q/q in the preliminary release, with private

consumption up 1.8%, down from 2.3% in Q1, but still a resilient performance given

the amount of fiscal tightening in the first half of the year. Key for the Fed tapering

outlook will be whether the Fed can be reassured that most of the fiscal headwinds

are going to dissipate, and that the fiscal tail risks are reduced.

Figure 4: Builders are enthusiastic, despite higher rates

NAHB survey (home builders) and new home sales, 000s

Figure 5: House prices are recovering from low levels

FHFA and Case-Shiller house price indices


New homesales, LHS

836

NAHB survey,RHS

59

0

20

40

60

80

0

500

1,000

1,500

2,000

2,500

Aug-04 Aug-06 Aug-08 Aug-10 Aug-12

Case-Shiller20, LHS

FHFA index(purchase),

RHS

180

190

200

210

220

230

120

140

160

180

200

220

Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12

The housing m arket is also in focus

as i t is seen as a major engine of

the recovery

The Fed wo uld l ike to see the US on

the other side of th e f iscal

cons ol idat ion hi l l

Our expectat ion is for the trend inpayrol ls to remain abov e 175,000

throughout H2


5/19

On the Ground

15 August 2013 5

Julys retail sales report showed that consumption was indeed resilient , with the

headline reading up 4.0% 3m/3m on a seasonally adjusted annualised rate (SAAR)

and up 5.4% y/y SA. We note that the Fed will have seen the August retail sales

report before the 17-18 September meeting, and with July and August data in hand, itwill have a good indication of how Q3 private consumption may be performing.

There are a number of important fiscal deadlines in October-November: (1) the new

fiscal year starting in October, which still has to be funded by a continuing resolution

bill, and (2) the debt-ceiling limit, probably reached sometime in November, which

needs to be raised. Congress is still at loggerheads over both issues, which is raising

anxiety as the deadlines approach. The Fed may want to wait to gauge the impact of

these events; but we think it may want to signal its independence from Congress by

proceeding with tapering. The Fed can still add to accommodation if risks materialise

down the road (and in the unlikely event of a debt default, it will probably need to do

more than QE).

Some FOMC members have recently highlighted the risks of low inflation. James

Bullard dissented from Junes decision due to these concerns; but the mention in

Julys meeting statement that low inflation is a risk the Fed is monitoring seemed to

have mollified him. The Fed has so far stopped short of announcing further

measures, such as explicitly setting a lower threshold for inflation as part of its

forward guidance.

Current low PCE inflation is not an obstacle for tapering, in our view. First, the CPI

measure is accelerating again: 2.0% y/y in July, up from 1.8% in June (core CPI

inflation was 1.7% y/y). Second, recent core PCE inflation prints were up slightly(1.2% y/y in June) after the revisions to GDP data. Third, the Fed can argue that the

current low PCE prints are transitory, while expectations are still well-anchored: the

Feds 5-year 5-year breakeven rate has rebounded since touching 2.33% on

20 June, trading above 2.60% since 31 July. Finally, it can argue that inflation is a

lagging indicator of economic activity, and growth is expected to continue to pick up.

2. The Feds rhetoric

Overall, we think that there is enough support from the core FOMC to taper,

although signals are still mixed.

Figure 6: The Feds balance sheet continues to increase

Split of Fed assets (in USD trn), and share of the total

Figure 7: Although it remains smaller than its peers

Selected central bank balance sheets as % of GDP


UST


6/19

On the Ground

15 August 2013 6

It has become clear over the past few months that the Fed would like to reduce its

QE programme soon, while it focuses its policy on the forward guidance on rates.

This is the confluence of two underlying factors. First, the stance developed by some

hawks on the costs and risks of QE, both in terms of risks to future inflation, financialstability and the Feds own growing balance sheet, have increasingly become

mainstream. Even Chairman Bernanke is showing increasing concern about the

risks to financial stability.

Second, the continual improvement in the data, despite headline growth remaining

below historical standards, has led some centrists to believe that the Fed can ease

off the QE pedal for now. In other words, monetary support is not as necessary as in

the past, as the recovery is strengthening and becoming more solid. The June FOMC

statement specifically mentioned that the downside risks had diminished since

September 2012, when the current QE programme began. Some centrists may also

believe that by reducing QE now in a smooth and orderly manner, the Fed couldincrease QE again later if the economy disappointed; in other words, QE has not lost

its relevance as a tool.

An important rhetorical shift is that the Fed is now saying that there has been enough

accumulated stock ofprogress since September last year to start reducing the QE

programme, as highlighted in a speech by Fed Governor Jeremy Stein in June, who

is seen as close to the FOMCs centre of gravity . This is also a way to downplay the

importance of the data over the summer, and contrasts somewhat with other

messages from the Fed that emphasise the importance of seeing more economic

momentum before tapering, something Bernanke underscores.

Some of the uncertainty about September tapering stems from the fact that its start

would coincide with the release of the updated FOMC forecasts, which are likely to

show a downward revision to 2013s numbers given weak H1 growth. But this is not

necessarily a barrier for the Fed, as we think it will probably argue that the outlook for

2014 still looks solid. This is confirmed by consensus forecasts, which consistently

show 2014 growth at 2.7% (also our forecast), a level unchanged for several months.

The downward revisions to 2013 have not affected 2014. Full-year growth of 2.7%

implies growth heading towards 3% in the coming quarters, broadly in line with the

Feds own forecasts. The Fed can therefore argue that it is confident in stronger

growth ahead, and that this is backstopped by the markets view, giving the green

light for tapering.

Figure 8: Markets still expect 2.7% US growth next year

Evolution of Bloomberg consensus forecast for GDP growth

Figure 9: The S&P is up c. 150% since its 2009 trough

S&P 500 equity index


2013

1.6

2014

2.7

1.0

1.5

2.0

2.5

3.0

3.5

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13

600

800

1,000

1,200

1,400

1,600

1,800

Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13

The centr ists have noted the

diminish ed effect iveness of the QE

pol icy

Var ious members have noted that

enough progress has b een m ade,

al though th e short- term signals are

st i l l mixed

Some FOMC members have

highl igh ted that enoug h progress

has been made

The Fed can argue that the ou t look

for 2014 looks p romising , with

growth w idely expected to

accelerate stron gly

Time forecast was made


7/19

On the Ground

15 August 2013 7

3. Asset-price reflation

An important role of the various QE programmes conducted since the eruption of the

global financial crisis in 2008-09 has been to reflate asset prices, both directly by

lowering borrowing costs and indirectly by boosting confidence. Stock markets, andfinancial assets more generally, have shown strong improvement since 2009. The

S&P 500, for instance, is up c. 150% since March 2009, its post-crisis low.

But houses rather than stocks are the most important assets for average Americans.

Most surveys, for instance the 2010 Fed Survey of consumer finances, show that

stock ownership, and wealth more generally, is particularly biased towards the upper

echelons. How house prices perform, rather than stocks, is the key to how the wealth

effect works, and therefore to the outlook for private consumption.

The housing market was the main driver of the current recession, and is now the

main driver behind the recovery, with its fortunes spilling over to the broadereconomy. House prices are on a steep uptrend, as is residential house construction,

although levels are still low in absolute terms. The median existing-home price was

up 12.2% y/y in Q2, the biggest y/y increase since 2005, according to the National

Association of Realtors.

Housing wealth is key. We illustrate the wealth effect for an average American

household by building an index of 70% house prices (FHFA house price index), 10%

a cash index (Barclays 3M USD LIBOR cash index), 10% a stock index (S&P 500

index), and 10% a bond index (Bloomberg Bond index: Treasuries over 1Y, total

return). This index is, on a nominal basis, back to its pre-crisis highs.

The gains in asset prices have been so strong that fears have grown, especially

within the hawkish camp, that Fed policy may be causing bubbles to form in some

segments, particularly financial markets. Earlier this month, Dallas Fed President

Richard Fisher warned of complacency, saying that markets need to be weaned off

the Fed put. Earlier this year, Fed Governor Jeremy Stein warned of the excesses in

some financial markets. The Fed is likely to argue that regulatory policy, not rate

policy, is the primary way to address concerns about potential bubbles. Given the

improvement in the housing market, though, it is probably more difficult for the Fed to

argue that it needs as much stimulation as in the past.

Figure 10: The middle class is back to breakevenNominal terms; simplified index representing the wealth effect

for a typical median household, rebased August 2006=100

Figure 11: The Fed is worried about the spreadSpread between the 30Y avg. mortgage rate (Bankrate) and

the 30Y US Treasury yield


90

92

94

96

98

100

102

104

Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12

Index composition:70% FHFA house price index10% Barclays 3M USD LIBOR cash index10% Bloomberg UST 1Y+, total return10% S&P 500 equity index Bankrate 30Y

mortgage rate(nat. avg.)

UST 30Y

Spread, bps(RHS)

0

50

100

150

200

250

300

350

400

0

1

2

3

4

5

6

7

Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

A key goal of the var ious QE

programmes was to boo st asset

pr ices

Houses are key for the m iddle class

Housing is rebound ing, benef i t t ing

the rest of the econom y

The Fed can argue that enoug h

impetus has been given


8/19

On the Ground

15 August 2013 8

Key in the short term is whether the housing market can withstand the increase in

mortgage rates since May 2013, which coincided with the sell-off in USTs driven by

fears of QE tapering and new expectations for the first rate hike. The mortgage-rate

rise may take some time to feed through to the data. We believe that concerns aboutthe housing market will probably keep the MBS side of the QE programme as it is.

This is why we think the Feds initial QE reduction will be of USTs only.

Although it may stumble a bit in the next few months, we believe that the housing

market will be able to withstand the increase in rates as the economy continues to

improve, the unemployment rate drops, and wages pick up. Residential construction

and other housing-related services should continue to boost GDP growth significantly

mediumterm and next year. A solid housing market, and a pickup in lending and

increased business investment, are the factors behind our expectation of above-

potential growth next year.

Figure 12: HY bond spreads are on a tightening trend

Bond spreads, in bps: US high-yield and investment grade

Figure 13: Mortgage refinancing has dropped recently

MBA mortgage activity: purchases vs. refinancing (indexes)

Source: Bloomberg, Standard Chartered Research (based on the spread of the respective

FINRA indices to the 5Y UST yield)

Source: Bloomberg, Standard Chartered Research

High yield

Inv. grade0

500

1,000

1,500

2,000

2,500

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Spreadwidening

Refinancing,LHS

Housepurchases,

RHS

0

50

100

150

200

250

300

350

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13

Short- term, the Fed probably w ants

to see the impact of the recent r ise

in mo rtgage rates


9/19

On the Ground

15 August 2013 9

Box 1. How big is the Fed in the UST and MBS markets?

The Fed is now a major player in the UST and MBS market, but we do not think the point of saturation has been reached.

Issues about market functioning and liquidity are surely a concern for many FOMC members. Some, particularly in thehawkish camp, have warned of potential market disruptions due to the Feds ongoing purchases. But we think these issues

are not the primary driver of the Feds decision to taper. Furthermore, we think that QE has not lost its relevance as a policy

tool. Restarting QE remains an option should the economy weaken significantly. Liquidity issues would not be a barrier, and

there would still be ample room to buy.

The duration of the UST portfolio is longer than for MBS holdings. This is important as once the Fed stops reinvesting (see

discussion below) in Q1-2015 as we expect, the MBS will mature first. According to the QE portfolios 2012 annual report,

61% of the USTs in its portfolio had maturities of six years or longer as of end-2012, partly a result of the previous Maturity

Extension Programme, also known as Operation Twist (September 2011 -December 2012). The weighted-average maturity

of the UST portfolio was c. 10.4 years; meanwhile, its duration was a bit more than eight years according to the report, or

twice that of the rest of the Treasury market. The Feds Q1 quarterly report mentioned that the estimated average remaininglife of its MBS portfolio, which factors in some scheduled payments and pre-payment assumptions, was c. 4.7 years, up from

3.3 years as of end-2012 (and up from 2.4 years as of end-2011). The duration of the MBS portfolio was c. 2.5 years as of

end-2012.

Even if we do not think the Fed has reached a point of saturation, there are still rising concerns among market participants

about the impact of the Feds purchases on market dynamics, particularly on liquidity and the availability of collateral. Som e

have also noted that the Treasury supply is shrinking rapidly as a result of the sharp decline in the deficit. These themes are

regularly discussed at meetings of the Treasury Borrowing Advisory Committee, a panel of primary dealers advising the

Treasury. The Fed, in particular the New York Fed in charge of the actual implementation of the purchases, downplays these

concerns.

In a 27 March speech, the New York Feds Simon Potter highlighted there seems to be little evidence that the current pace

of purchases is prompting deterioration in market liquidity or straining the markets ability to deliver securities. The Fed has

policies in place to limit its concentration in some securities. For instance the Fed cannot own more than 70% of the

outstanding stock of a specific Treasury bond. The Fed also slows purchases of a specific bond when it breaches 30% of

ownership. Furthermore, the Fed lends securities to the market to increase the availability of collateral.

As of end-2012, the Fed said it owned 19% of outstanding fixed-rate agency MBS. Looking at the Feds balance sheet as of

end-July, the Feds total MBS portfolio was USD 1.57tn, compared with total outstanding MBS debt of 8.15tn, according to

Securities Industry and Financial Markets Association (SIFMA) data. In other words, the Fed owned 19.3% of the total.

According to statistics mentioned by Potter, the Fed owns less than 20% of coupon Treasuries outstanding, but this ratio

increases for longer-term paper: it is 35% for paper of four years and more, and 41% for 30Y paper issued since 2009. On aflow basis, it purchases about 25% of monthly gross issuance of coupon securities. However, on a net basis, the picture

appears more stretched, especially considering recent statistics: in Q2, the Treasury issued USD 210 of coupon paper on a

net basis, which meant that the Fed bought 64% of net issuance. As far as the MBS market is concerned, the Fed buys c.

50% of gross issuance on average, as per the numbers in Simon Potters speech. However, the supply of MBS is highly

volatile due to the impact of refinancing activity.

Even though the Fed barely mentions the supply picture, particularly for Treasuries, it is clear that the unfavourable trend of

the supply-demand equation due to the shrinking deficit does pose some dilemmas to the Fed. All things equal, the Fed is

buying more Treasuries as a share of total supply given shrinking debt issuance. Some in the market may argue that by

keeping bond-buying constant, the Fed is actually providing more accommodation; but we think the Fed has more a balance-

sheet, rather than flow, perspective on the impact of the QE programme. The Fed also can argue than it is buying from thesecondary market, not directly from the Treasury, and the UST stock remains sizeable despite shrinking flows recently.


10/19

On the Ground

15 August 2013 10

The background of the tapering story

The Fed has clearly signalled that QE tapering will happen soon

Over the past few months, the Fed has signalled its intention to reduce its

bond-buying programme in the second half of the year, although it has remained

vague about the exact timing. The official Fed view, which Chairman Bernanke

reiterated in his June congressional testimony, is that a reduction in the Feds bond

purchases should happen later this year, and it will depend on the data.

A few FOMC members have recently hinted that the question would be on the

agenda at Septembers FOMC meeting, including Atlanta Fed President Dennis

Lockhart and Chicago Fed President Charles Evans, who said that tapering could be

potentially announced by then, depending on economic data in the meantime.

At Junes testimony, Bernanke emphasised that a reduction in QE would be tied to

the Feds own scenario of a pick-up in growth and acceleration in inflation, although it

remained unclear how the Fed will reconcile actual data and forward-looking

expectations, and the degree of acceleration expected. An interesting characteristic

of the Feds communication is that a numerical threshold has been set for QEs end,

but not for the start of the reduction. Indeed, in June, Chairman Bernanke said that

QE would be terminated by mid-2014, when the unemployment rate is expected to

breach 7.0%. But the criteria for the first cut to the QE programme remains vague, as

it depends on the outlook for the labor market and inflation.

Overall, this leads us to believe that the bar for tapering is lower than the bar for

ending the QE programme. The Fed will continue to look at the data very closely over

the next few months, and it will emphasise that in principle, tapering is not a pre-set

course (although we think that in practice, it is likely to be).

The Fed has hinted that tapering will be a gradual process. Therefore, the reduction

has to start soon not to be too abrupt, especially as the unemployment rate has been

on a steep downtrend in recent months: in July, it was 7.4%, down 0.5ppts from

Januarys level. The main risk to the Feds forecast of reaching 7 .0% by mid-2014 is

that it could happen earlier if the labour-force participation rate continues on its

current downtrend. This said, the 7% target is a soft target, in our view. We think that

the Fed would continue to taper gradually even if the 7% rate were breached earlier

than in Q2-2014: the Fed would just change this indicative target.

Figure 14: UST redemptions are biased towards after 2016

Redemption schedule of the Feds UST portfolio (USD bn)

Figure 15: Meanwhile, net issuance shows a downtrend

Projected net UST borrowing, USD bn (2Y-30Y paper)

Sources: Fed, Standard Chartered Research Sources: TBAC, Standard Chartered Research (NB: assumes constant future issuance)

0

50100

150

200

250

300

350

400

450

2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035

2036 and later

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2009 2011 2013 2015 2017 2019 2021 2023

QE taper ing is no w more a matter of

execut ion than comm unicat ion, as i thas b een wel l telegraphed

Several FOMC participan ts have

argued that taper ing could h appen

as soon as September

There is no clear guidance on the

thresholds fo r the f i rst cut topurchases; it is clearer for QEs end

Taper ing l ikely to star t soo n as the

unemp loyment rate is on a

down trend, heading towards 7%


11/19

On the Ground

15 August 2013 11

The tapering process will also be affected by the FOMCs politics

Another interesting fact is that the minutes of the June meeting show no concrete

mention of the hard thresholds of 7 .00% and mid-2014, although Bernanke hinted

that there was broad agreement before he named these at Julys press conference(he said he had been deputised by the FOMC). The June meeting minutes showed

that half of the FOMC participants, which includes non-voters, expected QE to end

before end-2013, while the other half saw an end in 2014. But overall the minutes

showed that most members were still in wait and see mode, and wanted to see

more data about the economy before tapering. The minutes of Julys mee ting will be

released on 21 August and could shed more light on this debate.

Key for the pace of tapering is the FOMCs politics, particularly going into next year.

Chairman Bernankes term ends in January 2014, and he is widely expected to step

down from the FOMC. His replacement is not expected to be announced before the

fall; the main contenders are Vice Chairman Janet Yellen and former TreasurySecretary Lawrence Summers, both seen as dovish (Yellen probably a touch more

than Summers), but the succession remains open to others, including outsiders. It is

worth noting that should Larry Summers be the new Chairman, he may be seen less

in the continuity of the current FOMC than Janet Yellen.

Beyond the Chairmanship, the FOMC is undergoing a wide reshuffle, with the

departure of Governors Elizabeth Duke and Sarah Raskin, and the end of Jerome

Powells mandate in early 2014. Their replacements have yet to be announced.

Cleveland Fed President Sandra Pianalto, a centrist, will also retire, with a

replacement expected to be announced by early 2014. The Cleveland Fed has voting

power next year.

Furthermore, the voting pattern will change in January as part of the annual rotation

among regional Fed presidents, which will be biased towards the hawkish members.

Philadelphia Fed President Charles Plosser and Dallas Fed President Richard

Fisher, who have been quite vocal over the past months, will get voting power.

However, this may be diluted by the fact that Minneapolis Fed President

Kocherlakota will also get voting power. Kocherlakota has expressed strong dovish

views in recent months, especially by insisting on lowering the 6.5% unemployment

threshold, something that Bernanke mentioned as a possibility in June.

Figure 16: The unemployment rate is drifting towards 7%

Unemployment rate, %

Figure 17: The trend in payrolls is solid despite a July blip

Gains in private payrolls, 000s (and six-month average)


7.4

4

5

6

7

8

9

10

11

Feb-04 Feb-06 Feb-08 Feb-10 Feb-12

Threshold for theend of QE: 7.0%

First rate hike: 6.5%

161

6-month avg.

201

-100

-50

0

50

100

150

200

250

300

350

Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13

The FOMC awaits more signs that

the economy can withstand less

accommodat ion

The subsequent pace of taper ing,

partic ularly in 2014, may b e affected

by how FOMC pol i t ics evolves

The FOMC wi l l have a more hawkish

bias from Janu ary 2014, at least

given the rotat ion among regional

Fed presidents


12/19

On the Ground

15 August 2013 12

September tapering: We expect a USD 10bn initial reduction in USTs only

Tapering, and the amount of tapering, will probably be a compromise between the

different camps on the FOMC. With doubts about the efficacy of the QE programme,

the hawks have long argued that tapering should have started already. Many in thedovish camp believe that more data is needed before tapering to ensure that the

economy can withstand the smaller stimulus, but some may also argue that starting

now is a good way to prove that that QE exit can be smooth, with the view that QE

remains relevant as a monetary policy tool.

In terms of how to split tapering MBS and USTs, many hawks have argued that the

Fed should start with MBS, as the Fed has done enough to stimulate the mortgage

market, and that the return to health of the housing market, coupled with the stronger

sentiment in banking and financial markets, warrants more private-sector

involvement in this market. Many doves argue that MBS buying has been the most

efficacious way to stimulate the economy compared with UST buying, and that theFed should cut on USTs first, while keeping MBS.

We expect the FOMC to start tapering by a relatively small amount of USD 10bn,

leaving QE at USD 75bn per month after the Septembers meeting. This is also the

consensus of a Bloomberg poll released on 13 August (two-thirds of the 48

economists polled expect a September tapering). While sending a message that the

Fed is resolved to taper, and that it is delivering on its promise to start tapering in H2-

2013, the Fed could still argue that the initial reduction is minimal. Even after the

reduction, the Fed is providing ample accommodation; i.e. it is still buying bonds and

adding to its balance sheet.

Septembers press conference provides a framework for the Fed to give its rationale,

and clarify the path for subsequent cuts. In our view, the Fed will cut by USD 10-15bn

at each FOMC meeting until June 2014, including at meetings where there is no

press conference. In other words, although the Fed will emphasise that tapering is

not systematic, in practice it is likely to be .

The Fed added Treasury purchases to QE3 at its December 2012 meeting, and we

think this is what it will start to cut at Septembers meeting. The Fed noted in its July

meeting statement, that mortgage rates were higher, a hint that it is concerned about

not derailing the mortgage market. This said, recent Fed speakers have noted that

Figure 18: A stronger recovery after Julys GDP revision

US GDP, rebased Q1-2008=100

Figure 19: A stronger recovery in US compared with peers

GDP, rebased Q1-2008=100

Source: Datastream, Standard Chartered Research Source: Datastream, Standard Chartered Research

Pre-revision

Post Julyrevision

94

96

98

100

102

104

106

Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013

Euro area

UK

US

Japan

90

92

94

96

98

100

102

104

106

Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013

Taper ing wi l l probably be a

com prom ise between the var ious

camps o n the FOMC

The doves wo uld prefer to cut USTs

fi rst as MBS pu rchases are seen as

more eff icacious

The fi rst cut shou ld be relat ively

smal l : w e expect USD 10bn

The press con ference wi l l help

clar i fy the subsequent taper ing p ath

The Fed is l ikely to cut MBS

purch ases later due to ongoing

concerns about the hous ing market


13/19

On the Ground

15 August 2013 13

the housing market has been resilient so far, including over the summer. But we think

that the Feds prudence about the housing market may lead to a delay in cutting

MBS, in particular as the impact of higher mortgage rates is gradually feeding

through to the data.

Most of the increase in mortgage rates was directly linked to the increase in

long-term rates, but the Fed may be concerned about adding to de facto tightening,

with a potential increase in the rate spread if the Fed withdraws MBS buying too

quickly. Given the current centre of gravity on the FOMC, we think the doves have

the upper hand, and that they may indeed choose to cut USTs first, while they await

more data about housing, and then start to cut MBS as well, probably next year.

Heading towards the exit: Next steps

Focus will turn to the QE reinvestment policy, then the first rate hike

Once QE tapering starts, the markets focus will probably shift to the timing of QEs

end, which we forecast to be in Q2-2014. As we enter 2014, and QEs end

approaches, attention will probably turn to the next step in the exit process: the

decision to stop reinvesting maturing bonds. This would lead to a smaller Fed

balance sheet, which would be widely seen as a signal of the first policy tightening.

We see the reinvestment policy ending by Q1-2015, approximately six months before

the first rate hike (Q3-2015, in our view). Although not many bonds will actually

mature in the immediate aftermath of the decision, as most USTs start to mature

from 2016, the decision would still send the signal that the Fed is ready to hike. Once

it stops reinvesting, we think it will stop reinvesting all maturing securities, USTs and

MBS. The MBS holdings will start to shrink first. Overall, we think the balance sheet

would decrease by 5-6% in the twelve months after the decision; i.e., it will be a very

gradual reduction.

The Fed wants the exit to be smooth, and we think that the Fed will go for a step-by-

step approach once it has terminated its bond purchases. We think that the

reinvestment policy will move higher on the Feds communication agenda in the

coming months as the Fed tapers, highlighting that balance-sheet shrinkage remains

distant, even after the end of the QE programme. By highlighting that the end of the

reinvestment process is not imminent, the Fed will reinforce its message that

tapering is not tightening; and that it could increase QE again if necessary.

When the time comes to increase rates, we expect the interest rate on excess

reserves (IOER) to play an increasingly important role. Given the size of the excess

reserves at the Fed, it is likely that the Fed funds target rate (FFTR) could take a

backseat as a policy tool; the IOER will be in the drivers seat. The Fed is indeed

likely to steer interbank market rates by moving the IOER.

Meanwhile, the Fed is likely to complement its action on the rate side by reserve-

draining operations such as reverse repos, and term deposits. The Fed has already

tested this framework to make sure it is ready when the time comes. This said, we do

not think the reverse repos will play a major role in the Feds policy, although the Fed

is likely to emphasise its ability to conduct these operations as a way to quell fears

about the possible inflationary consequences of having such large excess reserves.

But there are limits to the Feds ability to repo , given the unprecedented size of

current excess reserves; again, the IOER will be key.

The doves st i l l have the upper hand

on th e FOMC

The next decis ion involves the

Feds QE reinvestment policy

Most USTs actual ly mature from

2016, as a result of Operation

Twist

The Fed wi l l l ikely insist on a

smooth ex i t path

Interest rate on excess reserves is

l ikely to take thedrivers seat

Reserve repos could com plement

the rate-hik ing p rocess


14/19

On the Ground

15 August 2013 14

Risks around our Fed scenario

We see three main risks around our forecast.

The economy may not accelerate as we expect, delaying tapering

First, the economy may be weaker than expected in the coming months, which could

delay tapering, or even lead to increased QE if the downturn is sizeable. This might

result, for instance, from a drop in market and business confidence should the

political deadlock in Congress continue over the coming months. At worst, there

could be a government shutdown on 1 October if politicians fail to agree on a new

spending bill (continuing resolution). This seems unlikely to us, but it is still not

completely impossible: it happened in the 1990s.

A last-minute increase in the debt ceiling could also affect confidence; an actual debt

default seems improbable. The risk is also that politicians decide on a bigger cut to

government spending, and new taxes, which could result in stronger-than-expected

fiscal headwinds. Meanwhile, the Affordable Care Act, also referred to as

Obamacare, begins in January 2014. Some portions, for instance mandatory

coverage by firms, have been postponed by a year; but the mandatory coverage by

individuals is set to move ahead, and this could have a bigger-than-expected impact

on household confidence and could weigh on purchasing power.

There is also a risk that the de-facto domestic tightening observed since the spring,

particularly via higher mortgage rates, has had a bigger-than-expected impact on the

housing market and the economy. It is also possible that the global economy faces a

more prolonged period of softness, affecting global demand for US goods. But this

might bring a drop in commodity prices, which could be good news for domestic

commodity buyers (but not for US commodity and energy suppliers). A related risk is

a further inflation deceleration in the coming months. Although we think low PCE

inflation is unlikely to be a barrier for the first tapering decision, if it persisted, it could

delay further reductions as the FOMC waits for an uptick. Low inflation could also

affect the decision to hike the policy rate down the road.

By contrast, a faster acceleration in US growth compared to our forecast; for

instance, growth picking up to 3% in H2-2013, and heading above 3.5% in H1-2014,

would probably lead to a quicker tapering process. This would also probably mean

that the unemployment rate dropped faster than we expect (assuming the

participation rate is unchanged), which would warrant a first rate hike earlier than in

Q3-2015, and a steeper rate-hiking trend as the economy moves towards its

full potential.

The Fed may tweak its thresholds

A second possibility is a change in the Feds rhetoric. The Fed may backpedal on its

thresholds for QEs end, and Bernanke may tweak the current guidance of an

unemployment rate of 7% for ending the QE programme. Overall, we think the Fed

will prefer to tweak the guidance rather than the pace of tapering, which we think will

remain gradual. Still, there is limited leeway to the downside, as the potential next

step would be 6.5%, the threshold for the first rate hike. But lowering both thresholds

is still an option. It is important to emphasise that the 7% target is considerably

softer than the 6.5% target for the first hike, as the 7% target was simply mentioned

in a press conference, whereas the 6.5% threshold is in the official statement.

The economy may be weaker than

we expect: this would delay

taper ing; a mo re ser ious down turn

could tr igger an increase in QE

Var ious f iscal deadl ines wi l l

pun ctuate the second h al f of the

year

The degree to which th e housing

market wi l l be affected by higher

mo rtgage rates is st i l l unclear

A more pron ounc ed accelerat ion in

growth would lead to a quicker end

to the QE programm e


15/19

On the Ground

15 August 2013 15

Alternatively, the Fed may further refine its forward guidance, which has been a work

in progress since it was launched. It began as soft guidance; became calendar

guidance, itself tweaked twice; and then the Fed opted for threshold-based guidance.

As an aside, this option has also found traction overseas (e.g., with Governor Carneyat the Bank of England). We still think that the Feds current forward guidance linked

to the 6.5% unemployment rate is likely to be further refined, but we do not expect

any change before at least 2014 when the FOMC is reshuffled.

If the Fed decided to introduce a lower unemployment threshold, 6.0% instead of

6.5%, for instance, this might be seen as a dovish decision; i.e. accommodation for

longer as the new target may be reached several months later. But the impact on

rates could be mixed, as the Feds credibility could be affected, and the term

premium could increase. It is also possible that the market may infer a steeper rate-

hiking cycle if the Fed does not, in tandem, anchor expectations about the path of

subsequent rate hikes. The market may also price in the risk of future inflation.

If the Fed complemented its guidance with an inflation floor, this would probably take

the format of inflation at the 18- to 24-month horizon staying above a certain

threshold; for instance, 1.5%. In practice, this would have limited impact: the Feds

inflation forecast traditionally tends to be mean-reverting towards its 2% goal in the

medium term, so linking the two may assuage the concerns of those who believe that

the Fed does not pay attention to the second part of its mandate. But in practice it

would mean little in terms of the need to change policy (the labour market threshold

would still be the most important).

A different story would be to link policy to actual inflation; e.g., the y/y increase in

core PCE. But given the volatility of actual inflation, which does not necessarilyreflect the output gap, the Fed is very unlikely to use actual inflation rather than

inflations expectations as a guide. For instance, core PCE inflation climbed to 2.04%

y/y in March 2012, before falling back. It would be difficult to argue that the Fed

needed to tighten policy then.

Rhetoric may change due to the new leadership in 2014

It is also possible that the new Fed Chairman may revamp the FOMCs rhetoric in

early 2014. The risk is even greater as several 2013 FOMC members will have left

the Board then (see discussion above). 2014 will bring a lot of fresh blood to the

FOMC. Although they are likely to keep the overall framework of the previous FOMC,

there could be some subtle tweaks to policy, or the theoretical framework may bechanged; e.g. its perception of the output gap, the growth potential, or underlying

inflation. The new FOMC may put greater emphasis on one dimension of its mandate.

For instance, there may be more emphasis on inflation than currently is the case, or

more on financial stability. Some new members will be more in line with the current

FOMC than others.

Bottom line

New challenges are appearing as the Fed opens a new chapter of its QE

programme. Communication will have to be calibrated carefully to avoid a

disconnection between markets and the Feds thinking, and therefore avoid a

disorderly outcome. The two main risks are markets getting carried away ahead of

Fed action; or Fed action chasing the markets. In July, Bernanke hinted that the

market and the Fed were on the same page. QE tapering is only one stop on the

Fed's journey to QE exit. The risk is that there are more potholes along the way than

factored into our current forecast.

A lower unemployment threshold

would be seen as dovish at f i rst

glance; but the m arket react ion

could be more comp l icated

There is a r isk that the Fed may

ref ine i ts forward guidance

A Fed labour-market threshold may

com e with an inf lat ion f loor , but this

is unl ikely to affect pol icy


16/19

On the Ground

15 August 2013 16

AppendixThe Feds exit strategy

Figure 20: Timeline of the key Feds monetary-policy measures since the global financial crisis

Timeline Main events

25 November 2008Target rate cut to 0.0-0.25%

QE1 announced: Fed intends to purchase USD 100bn in agency debt and up to USD 500bn in MBS.

16 December 2008Fed hints it could start buying USTs.

Soft forward guidance introduced: The FOMC expects an exceptionally low FFTR for an extended period.

18 March 2009QE expanded, UST buying started. Total MBS target raised to USD 1.25trn, agency debt target up to USD200bn. Adds USD 300bn target for USTs, for the following six-month period.

23 September 2009 The FOMC slows the pace of MBS purchases, plans end by Q1-2010.

10 August 2010 Maturing bonds to be reinvested in USTs to avoid balance-sheet shrinkage.

27 August 2010 Chairman Bernanke hints at QE2 at Jackson Hole meeting.

3 November 2010 QE2 starts. UST buying target of 600bn (USD 75bn/month) by end Q2-2011.

9 August 2011 Calendar forward guidance introduced. Fed funds rate to stay at a floor until at least mid-2013.

21 September 2011 Operation Twist announced. Fed sells USTs with maturity below 3Y, invests into bonds with maturity of 6-30Y.

25 January 2012Calendar guidance refined again, promise to keeprates to stay low untillate 2014, from mid-2013 prior.

Fed releases long-term economic projections, clarifies its inflation target is 2%.

20 June 2012 Operation Twist extended until year-end.

31 August 2012 Chairman Bernanke hints at QE3.

13 September 2012QE infinity (QE3): open-ended purchases of MBS, USD 40bn per month.

Time guidance refined further: FFTR to stay low until at least mid-2015, from late-2014 prior.

12 December 2012Shift from time guidance to conditional, threshold-based guidance: threshold of 6.5% unemployment rate(as long as inflation stays below 2.5%).

Fed adds UST purchases (USD 45bn/month) on top of MBS purchases (USD 40bn/month).

22 May 2013 Chairman Bernanke hints the Fed could start reducing its bond purchases within the next few meetings.

19 June 2013Chairman Bernanke hints that QE could end by mid-2014 , when the unemployment rate drops to 7%.

Bernanke hints that the Fed may keep MBS until maturity, rather than actively sell, as part of the exit.

Source: Fed, Standard Chartered Research

Figure 21: How the Fed said it would sequence a QE exit, and our forecast for the timeline

The Fed said in June that it would keep MBS to maturity, rather than sell actively as part of the exit, as previously contemplated.The Fed has not yet released an updated exit strategy.

Expected timeline Event

September 2014

QE tapering starts.

We think the Fed will reduce USTs first (cut by USD 10bn to USD 35bn), keep MBS unchanged at USD 40bn. Wethen see a 10-15bn reduction in purchases at each subsequent meeting (including meetings with no pressconference), with a bias towards USTs throughout 2013, and a cuts to MBS from early 2014.

Q2-2014 The QE programme ends; i.e., the Fed stops buying bonds.

Q1-2015The Fed stops reinvesting maturing MBS and USTs. The Fed signals it is ready to hike rates in comingmonths if the economy and the labour market continue to improve. There is no significant UST redemption before2016 as a result of Operation Twist.

Q3-2015First rate hike, after the unemployment rate breaches 6.5%. The Fed steers the fed funds rate with theinterest rate on excess reserves. This is combined with reserve-draining operations.

2015 onwardsRate hikes continue (we expect 25bps incremental increase per quarter until neutral level of 4.5% by 2019). Noasset sales for several years, the overall portfolio erodes gradually as bonds mature and are not reinvested.

Source: Bloomberg, Fed, Standard Chartered Research


17/19

On the Ground

15 August 2013 17

Selected recent Fed speeches

Figure 22: Fed speakers have mentioned the possibility that the Fed could taper in September

Fed speaker Key excerpts

Richard Fisher

Dallas Fed President

(voter in 2014), hawk

When the right time comes, we must carefully remove the programs pole pin and gingerly unwind it so

as not to prompt market havoc. The FOMC should socialise the idea of the inevitability of our dialling

back and eventually ending our purchases. At Julys meeting, I suggested that we should gird our

loins to make our first move this fall.

Financial markets have become too accustomed to the Feds put.

Q&A after speech in Portland, Oregon, 5 August 2013

Dennis Lockhart

Atlanta Fed President

(voter in 2015), centrist with

hawkish bias

If we see a deterioration from this point and I would say my more realistic fear is just a kind of

ambiguous picture of mixed data that signal neither accelerating strength nor necessarily

deterioration, but that kind of moping along in the middle then I think its not a foregone conclusion

that the asset purchase program should be removed or removed rapidly.

Interview with Market News International, 6 August 2013

Charles Evans

Chicago Fed President

(voter this year), dove

We are quite likely to reduce the flow of purchases rate starting later this year. I couldn't tell you

exactly which month that will be. And it's likely to wind down over time in a couple or few stages.

I would clearly not rule out a September tapering.

Conference with reporters, Chicago, 7 August 2013

Sandra Pianalto

Cleveland Fed President

(Cleveland Feds voting

turn is next year, but Pianalto is

retiring), centrist

If the labor market remains on the stronger path that it has followed since last fall, then I would be

prepared to scale back the monthly pace of asset purchases.This is not to say that the labor market is

fully recovered; it is not.

Speech in Cleveland, Ohio, 7 August 2013

James Bullard

St Louis Fed President

(voter this year), dove (recently)

Rising yields are a concern, but I think that the level of yields now is still quite low by historical

standards. I also think that momentum in housing is stronger than any effects that are going to come

from higher yields, at least for now.

The bubble issue is a very alive and very salient issue for the FOMC. I dont see a bubble of thatmagnitude right now. [referring to the tech bubble in the 1990s and the housing bubble of the 2000s]

I am still undecided on whether to back QE taper in September.

Q&A after speech in Louisville, Kentucky, 15 August 2013

Source: Bloomberg, Reuters, Market News International, Standard Chartered Research


18/19

On the Ground

15 August 2013 18

Dashboard

Percent of jobs recovered

(3)

Real GDP growth, y/y

(1) Illustration inspired by a Dallas Fed 2013 presentation; (2) spread of the FINRA US high-yield corporat e index (yield to maturity) to the UST 5Y yield, in percent; (3) total non-farm

payrol ls, as of the latest data, compared to trough versus peak;Sources: Bloomberg, Standard Chartered Research

US Economic Dashboard(1)

9.67

High-yield bond spread(2)

Unemployment rate Core PCE inflation, % y/y10.04.0

4.5

5.0

5.5

6.0

6.57.0

7.5

8.0

8.5

9.0

9.5

7.4

10.03.0

3.5

4.0

4.5

5.0

5.56.0 6.5 7.0

7.5

8.0

8.5

9.0

9.5

4.90

5.0-1.0

-0.5

0.0

0.5

1.0

1.52.0 2.5

3.0

3.5

4.0

4.5

1.20

6.0-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.52.0 2.5

3.0

3.5

4.0

4.5

5.0

5.5

1.40


19/19

On the Ground

Disclosures Appendix

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Document approved by

John CalverleyHead of Macroeconomic Research

Document is released at

22:15 GMT 15 August 2013