The US outlook: growth, with malaise

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Michael Feroli
Chief US Economist
JPMorgan
November 2010

1
Economic outlook
Forecast: gradual improvement in growth, low inflation

Forecast: Sustained, but unexciting, economic growth

Economy has lost momentum since April

Look for gradual improvement from here

Profits are up, and business is spending and hiring

Financial markets are improving, reduced chance of tax increases

Labor income is expanding, saving rate has already lifted

But…
— Inventory situation is challenging
— Fiscal drags continue, intensify

Low core inflation and a Fed wanting to help the economy

The unemployment will be high for years

Core inflation is down to 1% and probably still falling

The Fed wants to be growth-supportive; another QE program

Fed easing will be helpful, but no panacea

2
Another year of dull growth

US economic forecast
%ch, saar
1H10 2H10 1H11 2H11

Real GDP 2.7 1.8 2.5 3.5

Real consumer spending 2.0 2.0 2.1 2.9

Core CPI 0.4 0.9 0.5 0.9

Unemployment (%, eop) 9.5 9.8 9.7 9.5

Fed Funds rate (%, eop) 0.13 0.13 0.13 0.13

10-year Treasury (%, eop) 2.88 2.25 2.25 2.25

3
The recovery in pictures: dull growth
gradually firming over time
Real GDP Unemployment rate
%ch at annual rate over 1 quarter percent, sa
Forecast Forecast
10 12

10
5

-5
4

-10 2
80 85 90 95 00 05 10 80 85 90 95 00 05 10

4
Two near term drags: inventories and
fiscal withdrawal
Impact of 2009 fiscal stimulus package
Inventories and sales Percentage point contribution to annualized GDP
% ch, saar growth
Business final sales 3
10

2
5

-5
-1
Private inventories

-10 -2
98 00 02 04 06 08 10 2009 2010 2011 2012

5
Recessions plant the seeds for recovery
Business
Business costs
costs and
and prices
prices
%
% ch,
ch, oya
oya Business
Business output
output prices
prices
15
15

10
10
Unit
Unit labor
labor
costs
costs

5
5

0
0

-5
-5 48
48 53
53 58
58 63
63 68
68 73
73 78
78 83
83 88
88 93
93 98
98 03
03 08
08

6
Profit margins, labor costs should eventually
lift hiring
Profits
Profits and
and em
em ploym
ploym ent
ent
%ch.,
%ch., oya
oya %
% of
of GDP
GDP
8
8 Private
Private payrolls
payrolls
14
14
Profits
Profits

12
12
4
4

10
10

0
0

8
8

-4
-4
6
6

-8
-8 60 4
4
60 65
65 70
70 75
75 80
80 85
85 90
90 95
95 00
00 05
05 10
10

7
Labor market following the modern
template
Private payrolls around recessions Job finding probability
Trough employment = 100
108 Index, trough=1
1982
107 1.4
Range of 6 prior post-
106
1.3 WWII recoveries
1975
105
1.2
104

103 1.1
2009
102
1.0
101 1991 2001

100 0.9

99
2001 0.8
1991
98 2009
-8 -4 0 4 8 12 16 20 0.7
Months from trough
1 3 5 7 9 11 13 15 17 19 21 23 25
Months after

8
Income, unemployment may tell differing
stories in coming months

Average
Average weekly
weekly hours
hours share
share of
of working
working age
age pop.
pop.
35.0 Participation
Participation rate
rate
35.0

67.0
67.0
34.5
34.5

34.0
34.0 66.0
66.0

33.5
33.5
Workweek
Workweek 65.0
65.0
33.0
33.0

32.5
32.5 64.0
64.0
88
88 93
93 98
98 03
03 08
08

9
Unemployment mostly cyclical, not
structural
Long-term unemployed
Job-related
Job-related moving
moving
000s, sa, unemployed 27 weeks or more Nonfarm
000s
000s Job-related Nonfarm %ch,
%ch, oya
oya
Job-related employment
1200 8500
8500 internal
internal employment 6
6
migration
migration 4
8000
8000 4
2
2
1000 Construction 7500
7500
0
0
Manufacturing 7000
7000 -2
-2
6500
6500 -4
800 -4
6000
6000 -6
-6
Trade 98
98 00
00 02
02 04
04 06
06 08
08

600
Ratio:
Ratio: unskilled/skilled
unskilled/skilled unemp.
unemp. rate
rate
4.5
4.5
400
4.0
4.0

Health and 3.5

3.5
200 education
u-rate, less than high school / u-
u-rate, less than high school / u-
rate, college degree
rate, college degree
3.0
3.0

0 2.5
2.5 92
2005 2006 2007 2008 2009 2010 92 94
94 96
96 98
98 00
00 02
02 04
04 06
06 08
08 10
10

10
Labor market critical for consumers
Em
Em ploym
ploym ent ent expectations
expectations and
and real
real consum
consum er
er
spending
spending
Index,
Index, %
% less-%
less-% m
m ore
ore %
% ch,
ch, oya
oya
140
140 30
30
U
U M
M ich
ich survey,
survey, expected
expected unem
unem ploym
ploym ent
ent over
over next
next year
year

120
120 20
20

100
100
10
10

80
80

0
0
60
60

Real
Real durables
durables spending
spending -10
-10
40
40

20
20 -20
-20
78
78 83
83 88
88 93
93 98
98 03
03 08
08

11
Consumers have been adjusting
Saving
Saving rate
rate Household wealth-to-income ratio
percent,
percent, sa
sa ratio
10
10 650

8
8 600

6
6 550

4
4 500

2
2 450

0
0 89 400
89 94
94 99
99 04
04 09
09 89 94 99 04 09

12
Household leverage to keep declining
Forecast
Forecast of
of residential
residential mortgage
mortgage debt
debt
$$ bn, Household debt to income ratio
bn, except
except as
as noted;
noted; ex
ex home
home equity
equity loans
loans
% Forecast
2009
2009 2010
2010 2011
2011 2012
2012
New
New home
home sales
sales (000s,
(000s, saar)
saar) 374
374 340
340 374
374 411
411 140
Existing
Existing home sales (000s, saar)
home sales (000s, saar) 5,160
5,160 5,150
5,150 5,408
5,408 5,678
5,678
Average price ($000s)
Average price ($000s) 220
220 220
220 220
220 220
220
Dollar 120
Dollar spending
spending on
on houses
houses 1,217
1,217 1,208
1,208 1,272
1,272 1,340
1,340
Loan
Loan to
to value
value 0.75
0.75 0.75
0.75 0.75
0.75 0.75
0.75
Share 100
Share of
of purchases
purchases with
with mortgage
mortgage (%)
(%) 0.95
0.95 0.95
0.95 0.95
0.95 0.95
0.95
Mortgage
Mortgage loan
loan originations
originations 867
867 861
861 906
906 954
954
Amortization+curtailment
Amortization+curtailment 199
199 187
187 185
185 183
183 80
Home
Home sellers'
sellers' cancellation
cancellation 484
484 483
483 508
508 533
533
Net
Net foreclosure cancellation
foreclosure cancellation 345
345 344
344 361
361 379
379
-- Total repayments
Total repayments 1,028
1,028 1,015
1,015 1,054
1,054 1,095
1,095
60
+Cash-out
+Cash-out refis
refis 70
70 40
40 40
40 40
40
+Other
+Other 66 66 66 66
40
=Change
=Change in
in regular
regular mortgage
mortgage debt
debt -85
-85 -108
-108 -101
-101 -95
-95
Mortgage
Mortgage debt
debt outstanding
outstanding (ex
(ex home
home equity)
equity) 9,353
9,353 9,245
9,245 9,143
9,143 9,049
9,049
Percent change
Percent change -0.9
-0.9 -1.2
-1.2 -1.1
-1.1 -1.0
-1.0 20
70 75 80 85 90 95 00 05 10

13
Deleveraging doesn’t need to imply contraction
Personal
Personal saving
saving --
-- gross
gross flows
flows Household leverage
%
% of
of disposable
disposable income,
income, 4qtr
4qtr ave
ave debt/income, %
30
30 200
Asset
Asset accumulation
accumulation

20
20 Norway
150

10
10

Debt 100
Debt accumulation
accumulation Sweden
0
0
US

-10 50
-10 52 57 62 67 72 77 82 87 92 97 02 07
52 57 62 67 72 77 82 87 92 97 02 07 70 75 80 85 90 95 00 05

14
Business has been spending
Real
Real spending
spending on
on equipment
equipment and
and software
software Business spending on information processing equipment,
Business spending on information processing equipment,
software
during expansions
during expansions software
$
$2005 bn, saar $ bn,
bn, saar
saar
Sa, $2005
700 bn, saar
Sa, level
level at
at trough
trough of
of recession=100
recession=100 700
Real
Real 610
610
130 1982
1982 spending
130 spending
585
585
650
650
560
560
600
600 Nominal
Nominal 535
spending 535
120 550 spending
120 550 510
2009 510
2009
500
500 485
485
2006
2006 2007
2007 2008
2008 2009
2009 2010
2010
1991
1991
Real
Real business
business spending
spending on
on business
business equipment
equipment ex
ex high
high tech
110
110
tech
Industrial
Industrial
Index, 1Q05=1.00
Index, 1Q05=1.00
1975
1975 1.25
1.25
equipment
equipment

1.00
1.00 Other
Other
100
100 equipment
equipment
0.75
0.75
2001
2001
Transportation
Transportation
0.50
0.50 equipment
equipment
90
90 0.25
0.25
-2 0 +2 +4 +6 2005
-2 0 +2 +4 +6 2005 2006
2006 2007
2007 2008
2008 2009
2009 2010
2010
qtrs
qtrs qtrs
qtrs qtrs
qtrs qtrs
qtrs
15
Shadow inventory a risk to house prices
Distressed
Distressed sales
sales and
and hom
hom e
e prices
prices
%change
%change over
over year-ago
year-ago %
%
Distressed
Distressed sales
sales as
as %
% of
of all
all hom
hom e
e sales
sales
20
20 40
40

LoanPerform
LoanPerform ance
ance House
House Price
Price Index
Index
10
10 30
30

0
0 20
20

-10
-10 10
10

-20
-20 0
0
2006
2006 2007
2007 2008
2008 2009
2009 2010
2010

16
Slow grind toward more normal housing
inventories
Construction
Construction and
and demographics
demographics Vacant,
Vacant, for-sale
for-sale housing
housing units
units
thousands,
thousands, saar thousands,
saar thousands, sa
sa
3500
3500 2500
2500

3000
3000

New 2000
2000
New housing
housing units
units started
started
2500
2500

2000
2000 1500
1500

1500
1500
1000
1000
1000
1000
Household
Household growth
growth (10-yr
(10-yr average)
average)

500
500 69 500
500 95
69 74
74 79
79 84
84 89
89 94
94 99
99 04
04 09
09 95 97
97 99
99 01
01 03
03 05
05 07
07 09
09

17
Bank credit turning slightly less restrictive
Lending standards, C&I loans
net % tightening

100

75
Large firm

50

25

-25 Small firm

-50
90 95 00 05 10

18
Unsteady improvement in state & local finances

State and local tax receipts State and local deficits

% ch, saar % of GDP

20 1.0

0.5

10
0.0

0 -0.5

-1.0

-10
-1.5

-20 -2.0
97 99 01 03 05 07 09 60 65 70 75 80 85 90 95 00 05 10

19
Election impact is a wildcard
Small
Small business'
business' biggest
biggest problem
problem
%
%
35 Poor
Poor sales
sales
35

30
30
Gov't
Gov't requirements
requirements

25
25

20
20

15
15

10
10

5
5 86
86 91
91 96
96 01
01 06
06

20
No ambiguity about inflation trends
CP
CP II
%
% ch
ch ,, oy
oy a
a
6
6

5
5

4
4 M
M ed
ed ian
ian

3
3

2
2

Co
Co re
re
1
1

0
0 9
900 9
955 0
000 0
055 1
100

21
Core inflation forecast to stay under 1%
CPI: core services and core goods
%oya

7 6 Core
Core PCE
PCE price
price index
index
%oya
%oya
6 Core End
End of
of 22 years
years Change
Change Unemployment
Unemployment
recession later rate,
rate, 22 years
years later
goods 4 recession later later
1960-1961
1960-1961 1.30
1.30 1.21
1.21 -0.09
-0.09 5.8
5.8
5 1969-1970 4.82 3.06 -1.76 5.4
1969-1970 4.82 3.06 -1.76 5.4
1973-1975
1973-1975 10.12
10.12 6.12
6.12 -4.00
-4.00 7.5
7.5
2
4 1981-1982 5.91 3.89 -2.01 7.3
1981-1982 5.91 3.89 -2.01 7.3
1990-1991
1990-1991 4.27
4.27 2.56
2.56 -1.71
-1.71 7.1
7.1
3 2001
2001 1.73
1.73 1.48
1.48 -0.25
-0.25 5.8
5.8
0
Core
2
services
-2
1

0 -4
89 94 99 04 09

22
No ambiguity about inflation trends

Two key influences on core inflation

Percent over year ago, both scales
4.0 3.0
C PI meas ure of
hous ing cos ts (OER )
2.5
3.5
2.0

3.0
1.5

1.0
2.5 Averag e hourly
earning s
0.5
2.0
0.0

1.5 -0.5
2008 2009 2010

23
Fed to expand balance sheet by $600bn to $1tr
The Fed balance sheet
$ billions
2500 Total
assets

2000

1500

Liquidity programs

1000

Securities held
500
outright

0
2007 2008 2009 2010

24
Economy stuck in a liquidity trap
Private
Private saving
saving and
and investment
investment
%
% of
of GDP
GDP
22
22

20
20

Saving
Saving
18
18

16
16

14 Investmen
Investmen
14
tt

12
12

10
10 60
60 65
65 70
70 75
75 80
80 85
85 90
90 95
95 00
00 05
05 10
10

25
QE2 already working

Inflation
Inflation
%,
%, both
both scales
scales index, both scales
breakeven
breakeven nominal broad
1.8
1.8 (Fed
(Fed measure
measure 3.2
3.2 effective
92 1250
5yr-5yr
5yr-5yr exchange rate
1.6 forward)
forward)
1.6
3.0
3.0 90 1200
Jackson Jackson Hole
1.4 Jackson Hole
Hole
1.4

2.8
2.8 88 1150
1.2
1.2
Real
Real yield
yield
(10-year)
(10-year)
1.0
1.0 2.6
2.6 86 1100

0.8
0.8
2.4 84 S&P 500 index 1050
2.4
0.6
0.6

0.4 2.2
82 1000
0.4 2.2
Jan Jan 1 Mar 6 May 10 Jul 14 Sep 17
Jan 1
1 Mar
Mar 6
6 May
May 10
10 Jul
Jul 14
14 Sep
Sep 17
17

26
The US economic forecast in brief

Sub-par growth in 2010

Business gradually turns more expansive

Europe shock dissipates

Fiscal tightening, monetary accommodation in 2011

Expansion continues at subdued pace

Second half of 2011, drags fade

Output gap stays large

Disinflation continues

27
The US economic forecast in detail % q /q , s a a r % q 4 /q 4 % y /y
% q /q , s a a r % q 4 /q 4 % y /y
2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 2009 2010 2011 2009 2010 2011
2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 2009 2010 2011 2009 2010 2011
G r o s s d o m e s t ic p r o d u c t
G r o s s d o m e s t ic p r o d u c t
R eal G D P 1 .7 2 .0 2 .5 2 .0 3 .0 3 .0 4 .0 0 .2 2 .5 3 .0 -2 .6 2 .7 2 .5
R eal G D P 1 .7 2 .0 2 .5 2 .0 3 .0 3 .0 4 .0 0 .2 2 .5 3 .0 -2 .6 2 .7 2 .5
F in a l s a le s 0 .9 0 .6 4 .1 2 .1 3 .0 3 .2 4 .0 -0 .3 1 .6 3 .1 -2 .1 1 .2 2 .6
F in a l s a le s 0 .9 0 .6 4 .1 2 .1 3 .0 3 .2 4 .0 -0 .3 1 .6 3 .1 -2 .1 1 .2 2 .6
D o m e s t ic 4 .3 2 .5 2 .7 1 .7 2 .7 3 .0 3 .8 -1 .4 2 .7 2 .8 -3 .1 1 .8 2 .6
D o m e s t ic 4 .3 2 .5 2 .7 1 .7 2 .7 3 .0 3 .8 -1 .4 2 .7 2 .8 -3 .1 1 .8 2 .6
C o n s u m e r s p e n d in g 2 .2 2 .6 2 .5 1 .5 2 .5 2 .8 3 .3 0 .2 2 .3 2 .5 -1 .2 1 .7 2 .3
C o n s u m e r s p e n d in g 2 .2 2 .6 2 .5 1 .5 2 .5 2 .8 3 .3 0 .2 2 .3 2 .5 -1 .2 1 .7 2 .3
B u s in e s s in v e s t m e n t 1 7 .2 9 .8 7 .0 5 .4 7 .8 8 .3 1 0 .1 -1 2 .7 1 0 .4 7 .9 - 1 7 .1 5 .7 8 .0
B u s in e s s in v e s t m e n t 1 7 .2 9 .8 7 .0 5 .4 7 .8 8 .3 1 0 .1 -1 2 .7 1 0 .4 7 .9 - 1 7 .1 5 .7 8 .0
E q u ip m e n t 2 4 .8 1 2 .0 1 0 .0 7 .0 8 .0 8 .0 1 0 .0 -4 .9 1 6 .6 8 .2 - 1 5 .3 1 5 .0 9 .7
E q u ip m e n t 2 4 .8 1 2 .0 1 0 .0 7 .0 8 .0 8 .0 1 0 .0 -4 .9 1 6 .6 8 .2 - 1 5 .3 1 5 .0 9 .7
S tru c tu re s -0 .5 3 .9 -3 .0 0 .0 7 .0 9 .0 1 0 .0 -2 6 .5 -4 .7 6 .4 - 2 0 .4 -1 3 .4 2 .9
S tru c tu re s -0 .5 3 .9 -3 .0 0 .0 7 .0 9 .0 1 0 .0 -2 6 .5 -4 .7 6 .4 - 2 0 .4 -1 3 .4 2 .9
R e s id e n t ia l in v e s t m e n t 2 5 .6 - 2 9 .1 5 .0 1 0 .0 1 5 .0 2 0 .0 2 0 .0 -1 3 .4 -4 .8 1 6 .2 - 2 2 .9 -3 .2 6 .7
R e s id e n t ia l in v e s t m e n t 2 5 .6 - 2 9 .1 5 .0 1 0 .0 1 5 .0 2 0 .0 2 0 .0 -1 3 .4 -4 .8 1 6 .2 - 2 2 .9 -3 .2 6 .7
G o v e rn m e n t 3 .9 3 .3 1 .1 -0 .6 -1 .0 -1 .0 0 .4 0 .8 1 .7 -0 .5 1 .6 1 .1 0 .4
G o v e rn m e n t 3 .9 3 .3 1 .1 -0 .6 -1 .0 -1 .0 0 .4 0 .8 1 .7 -0 .5 1 .6 1 .1 0 .4
N e t e x p o r t s ( $ b n , c h a in e d $ 2 0 0 5 ) -4 4 9 -5 1 5 -4 7 5 -4 6 2 -4 5 6 -4 5 4 -4 5 2 - - - - - -
N e t e x p o r t s ( $ b n , c h a in e d $ 2 0 0 5 ) -4 4 9 -5 1 5 -4 7 5 -4 6 2 -4 5 6 -4 5 4 -4 5 2 - - - - - -
E x p o r t s ( g o o d s a n d s e r v ic e s ) 9 .1 5 .0 7 .0 7 .0 8 .0 8 .0 8 .0 -0 .1 8 .1 7 .7 -9 .5 1 1 .4 7 .3
E x p o r t s ( g o o d s a n d s e r v ic e s ) 9 .1 5 .0 7 .0 7 .0 8 .0 8 .0 8 .0 -0 .1 8 .1 7 .7 -9 .5 1 1 .4 7 .3
I m p o r t s ( g o o d s a n d s e r v ic e s ) 3 3 .5 1 7 .4 -2 .0 3 .0 5 .0 6 .0 6 .0 -7 .2 1 4 .3 5 .0 - 1 3 .8 1 3 .5 6 .3
I m p o r t s ( g o o d s a n d s e r v ic e s ) 3 3 .5 1 7 .4 -2 .0 3 .0 5 .0 6 .0 6 .0 -7 .2 1 4 .3 5 .0 - 1 3 .8 1 3 .5 6 .3
I n v e n t o r ie s ( c h $ b n , c h a in e d $ 2 0 0 5 ) 6 8 .8 1 1 5 .5 6 5 .6 6 1 .2 6 3 .1 5 8 .2 5 8 .0 - - - - - -
I n v e n t o r ie s ( c h $ b n , c h a in e d $ 2 0 0 5 ) 6 8 .8 1 1 5 .5 6 5 .6 6 1 .2 6 3 .1 5 8 .2 5 8 .0 - - - - - -
C o n t r ib u t io n t o r e a l G D P g r o w t h ( % p t s ) :
C o n t r ib u t io n t o r e a l G D P g r o w t h ( % p t s ) :
D o m e s t ic f in a l s a le s 4 .4 2 .6 2 .7 1 .7 2 .7 3 .0 3 .8 -1 .5 2 .7 2 .8 -3 .2 1 .9 2 .6
D o m e s t ic f in a l s a le s 4 .4 2 .6 2 .7 1 .7 2 .7 3 .0 3 .8 -1 .5 2 .7 2 .8 -3 .2 1 .9 2 .6
N e t e x p o rts -3 .5 -2 .0 1 .3 0 .5 0 .3 0 .2 0 .2 1 .1 -1 .1 0 .3 1 .0 -0 .6 0 .0
N e t e x p o rts -3 .5 -2 .0 1 .3 0 .5 0 .3 0 .2 0 .2 1 .1 -1 .1 0 .3 1 .0 -0 .6 0 .0
I n v e n t o r ie s 0 .8 1 .4 -1 .6 -0 .1 0 .0 -0 .2 0 .0 0 .4 0 .8 -0 .1 -0 .6 1 .5 - 0 .1
I n v e n t o r ie s 0 .8 1 .4 -1 .6 -0 .1 0 .0 -0 .2 0 .0 0 .4 0 .8 -0 .1 -0 .6 1 .5 - 0 .1
I n c o m e a n d p r o f it s ( N I P A b a s is )
I n c o m e a n d p r o f it s ( N I P A b a s is )
A d ju s t e d c o r p p r o f it s 1 2 .7 8 .0 5 .0 3 .0 4 .0 7 .0 7 .0 4 2 .5 1 7 .4 5 .2 -0 .4 2 9 .0 5 .5
A d ju s t e d c o r p p r o f it s 1 2 .7 8 .0 5 .0 3 .0 4 .0 7 .0 7 .0 4 2 .5 1 7 .4 5 .2 -0 .4 2 9 .0 5 .5
R e a l d is p o s a b le p e r s o n a l in c o m e 4 .4 0 .5 1 .0 -0 .5 2 .5 3 .0 3 .5 0 .4 1 .8 2 .1 0 .6 1 .1 1 .5
R e a l d is p o s1a b le p e r s o n a l in c o m e 4 .4 0 .5 1 .0 -0 .5 2 .5 3 .0 3 .5 0 .4 1 .8 2 .1 0 .6 1 .1 1 .5
S a v in g r a t e 1 5 .9 5 .5 5 .1 4 .6 4 .6 4 .7 4 .8 - - - 5 .9 5 .5 4 .7
S raicv einsg ar na dt e la b o r c o s t 5 . 9 5 .5 5 .1 4 .6 4 .6 4 .7 4 .8 - - - 5 .9 5 .5 4 .7
P
P r ic e s a n d la b o r c o s t
C o n s u m e r p r ic e in d e x -0 .7 1 .5 1 .6 1 .1 1 .0 1 .1 1 .1 1 .5 1 .0 1 .1 -0 .3 1 .6 1 .1
C o n s u m e r p r ic e in d e x -0 .7 1 .5 1 .6 1 .1 1 .0 1 .1 1 .1 1 .5 1 .0 1 .1 -0 .3 1 .6 1 .1
C o re 0 .9 1 .2 0 .8 0 .5 0 .6 0 .7 0 .8 1 .7 0 .7 0 .6 1 .7 1 .0 0 .7
C o re 0 .9 1 .2 0 .8 0 .5 0 .6 0 .7 0 .8 1 .7 0 .7 0 .6 1 .7 1 .0 0 .7
P r o d u c e r p r ic e in d e x -0 .4 0 .8 1 .0 1 .0 0 .7 0 .8 1 .3 1 .5 2 .4 0 .9 -2 .5 3 .9 0 .8
P r o d u c e r p r ic e in d e x -0 .4 0 .8 1 .0 1 .0 0 .7 0 .8 1 .3 1 .5 2 .4 0 .9 -2 .5 3 .9 0 .8
C o re 1 .7 2 .2 0 .8 0 .6 0 .5 0 .5 1 .0 0 .9 1 .8 0 .6 2 .6 1 .3 0 .9
C o re 1 .7 2 .2 0 .8 0 .6 0 .5 0 .5 1 .0 0 .9 1 .8 0 .6 2 .6 1 .3 0 .9
G D P c h a in - t y p e p r ic e in d e x 1 .9 2 .3 1 .3 1 .0 1 .0 1 .0 1 .0 0 .5 1 .6 1 .0 0 .9 1 .0 1 .3
G D P c h a in - t y p e p r ic e in d e x 1 .9 2 .3 1 .3 1 .0 1 .0 1 .0 1 .0 0 .5 1 .6 1 .0 0 .9 1 .0 1 .3
C o r e P C E d e f la t o r 1 .0 0 .8 0 .8 0 .6 0 .6 0 .7 0 .8 1 .7 1 .0 0 .7 1 .5 1 .4 0 .7
C o r e P C E d e f la t o r 1 .0 0 .8 0 .8 0 .6 0 .6 0 .7 0 .8 1 .7 1 .0 0 .7 1 .5 1 .4 0 .7
S & P / C - S h o u s e p r ic e in d e x ( % o y a ) 3 .6 -1 .2 -2 .1 -2 .5 -1 .0 1 .0 2 .5 -2 .4 -2 .1 2 .5 - 1 1 .4 0 .6 0 .0
S & P / C - S h o u s e p r ic e in d e x ( % o y a ) 3 .6 -1 .2 -2 .1 -2 .5 -1 .0 1 .0 2 .5 -2 .4 -2 .1 2 .5 - 1 1 .4 0 .6 0 .0
P r o d u c t iv it y -1 .8 1 .9 1 .0 1 .0 1 .5 2 .0 2 .0 6 .2 1 .2 1 .6 3 .5 3 .4 1 .2
P r o d u c t iv it y -1 .8 1 .9 1 .0 1 .0 1 .5 2 .0 2 .0 6 .2 1 .2 1 .6 3 .5 3 .4 1 .2
O t h e r in d ic a t o r s
O t h e r in d ic a t o r s 1
H o u s in g s t a r t s ( m n u n it s , s a a r ) 1 0 .6 0 2 0 .5 8 9 0 .6 2 5 0 .6 7 5 0 .7 2 5 0 .8 0 0 0 .8 7 5 - - - 0 .5 5 4 0 .6 0 8 0 .7 6 9
H 0 .6 0 2 0 .5 8 9 0 .6 2 5 0 .6 7 5 0 .7 2 5 0 .8 0 0 0 .8 7 5 - - - 0 .5 5 4 0 .6 0 8 0 .7 6 9
I n od uu ss in g ls pt ar or tds u( cmt io
t r ia n nu,nmit sf g, .s a a r ) 9 .1 3 .6 2 .0 2 .0 3 .0 4 .5 5 .0 -4 .1 5 .2 3 .6 - 1 1 .1 5 .8 3 .3
I n d u s t r ia l p r o d u c t io n , m f g . 1 9 . 1 3 .6 2 .0 2 .0 3 .0 4 .5 5 .0 -4 .1 5 .2 3 .6 - 1 1 .1 5 .8 3 .3
C a p a c it y u t iliz a t io n , m f g . ( % ) 1 7 1 . 6 7 2 .2 7 2 .2 7 2 .3 7 2 .6 7 3 .1 7 3 .7 - - - 6 7 .2 7 1 .5 7 2 .9
C a p a c it y u t iliz a t io n , m f g . ( % ) 1 7 1 .6 7 2 .2 7 2 .2 7 2 .3 7 2 .6 7 3 .1 7 3 .7 - - - 6 7 .2 7 1 .5 7 2 .9
L ig h t v e h ic le s a le s ( m n u n it s , s a a r ) 1 1 1 . 3 1 1 .6 1 2 .0 1 2 .1 1 2 .2 1 2 .4 1 2 .5 - - - 1 0 .4 1 1 .5 1 2 .3
L ig h t v e h ic le s a le s ( m 1 n u n it s , s a a r ) 1 1 .3 1 1 .6 1 2 .0 1 2 .1 1 2 .2 1 2 .4 1 2 .5 - - - 1 0 .4 1 1 .5 1 2 .3
U n e m p lo y m e n t r a t e 1 9 .7 9 .6 9 .6 9 .6 9 .5 9 .5 9 .4 - - - 9 .3 9 .6 9 .5
U 9 .7 9 .6 9 .6 9 .6 9 .5 9 .5 9 .4 - - - 9 .3 9 .6 9 .5
N no em minpalol G y mD eP n t r a t e 3 .7 4 .2 3 .8 3 .0 4 .0 4 .0 5 .0 0 .6 4 .1 4 .0 -1 .7 3 .8 3 .8
N o m in a l G D P 1 3 .7 4 .2 3 .8 3 .0 4 .0 4 .0 5 .0 0 .6 4 .1 4 .0 -1 .7 3 .8 3 .8
C u r r e n t a c c o u n t b a la n c e ( $ b n ) 1 -1 2 3 .3 -1 2 7 .9 -1 1 7 .5 - 1 2 1 .2 -1 2 4 .7 - 1 2 6 .6 -1 3 0 .5 - - - -3 7 8 .4 -4 7 7 .9 -5 0 2 .9
C u rre n t a c c o u n% t b ao la n c e ( $ b n ) -1 2 3 .3 -1 2 7 .9 -1 1 7 .5 - 1 2 1 .2 -1 2 4 .7 - 1 2 6 .6 -1 3 0 .5 - - - -3 7 8 .4 -4 7 7 .9 -5 0 2 .9
f GDP -3 .4 -3 .5 -3 .2 -3 .2 -3 .3 -3 .3 -3 .4 - - - -2 .7 -3 .3 - 3 .3
% of G D P 1 -3 .4 -3 .5 -3 .2 -3 .2 -3 .3 -3 .3 -3 .4 - - - -2 .7 -3 .3 - 3 .3
F e d e r a l b u d g e t b a la n c e ( $ b n ) 1 - - - - - - - - - - -1 4 1 5 .7 - 1 2 9 4 .1 -1 2 0 0 .0
F e d e r a l b u d g e t %b aolaf nGcDe P( $ b n ) - - - - - - - - - - -1 4 1 5 .7 - 1 2 9 4 .1 -1 2 0 0 .0
- - - - - - - - - - - 1 0 .0 -8 .8 - 7 .9
% of G D P - -
1 . E n tr ie s a r e a v e r a g e le v e l fo r th e p e r io d . F e d e r a l b a la n c e fig u r e s a r e fo r
-
fis c a l y e a r s .
- - - - - - - - 1 0 .0 -8 .8 - 7 .9
1 . E n tr ie s a r e a v e r a g e le v e l fo r th e p e r io d . F e d e r a l b a la n c e fig u r e s a r e fo r fis c a l y e a r s .

N ov 5 4Q 10 1Q 11 2Q 11 3Q 11
N ov 5 4Q 10 1Q 11 2Q 11 3Q 11
I n t e r e s t r a t e f o r e c a s t ( e n d o f p e r io d )
I n t e r e s t r a t e f o r e c a s t ( e n d o f p e r io d )
F e d fu n d s ta rg e t 0 .1 3 0 .1 3 0 .1 3 0 .1 3 0 .1 3
F e d fu n d s ta rg e t 0 .1 3 0 .1 3 0 .1 3 0 .1 3 0 .1 3
3 -m o L IB O R 0 .2 9 0 .2 8 0 .2 8 0 .2 8 0 .2 8
3 -m o L IB O R 0 .2 9 0 .2 8 0 .2 8 0 .2 8 0 .2 8
3 - m o n t h T - b ill ( b e y ) 0 .1 3 0 .1 5 0 .1 5 0 .1 5 0 .1 5
3 - m o n t h T - b ill ( b e y ) 0 .1 3 0 .1 5 0 .1 5 0 .1 5 0 .1 5
2 -y r T re a s u ry 0 .3 7 0 .3 5 0 .3 5 0 .3 5 0 .3 5
2 -y r T re a s u ry 0 .3 7 0 .3 5 0 .3 5 0 .3 5 0 .3 5
5 -y r T re a s u ry 1 .0 9 1 .2 5 1 .2 5 1 .2 5 1 .2 5
5 -y r T re a s u ry 1 .0 9 1 .2 5 1 .2 5 1 .2 5 1 .2 5
1 0 -y r T re a s u ry 2 .5 3 2 .2 5 2 .2 5 2 .2 5 2 .2 5
1 0 -y r T re a s u ry 2 .5 3 2 .2 5 2 .2 5 2 .2 5 2 .2 5
3 0 -y r T re a s u ry 4 .1 2 3 .5 0 3 .5 0 3 .5 0 3 .5 0
3 0 -y r T re a s u ry 4 .1 2 3 .5 0 3 .5 0 3 .5 0 3 .5 0

28
Copyright 2005 J.P. Morgan Chase & Co. All rights reserved. JPMorgan is the marketing name for J.P. Morgan Chase & Co., and its subsidiaries
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JPMorgan uses the following recommendation system: Overweight. Over the next six to twelve months, we expect this bond to outperform the
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Underweight. Over the next six to twelve months, we expect this bond to underperform the average total return of the bonds in the analyst’s
(or analyst’s team’s) coverage universe.

JPMorgan uses the following rating system: Improving (I) The issuer’s long-term credit rating likely improves over the next six to twelve
months. Stable (S) The issuer’s long-term credit rating likely remains the same over the next six to twelve months. Deteriorating (D) The
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falls to junk over the next six to twelve months. Defaulting (F) There is some likelihood that the issuer defaults over the next six to twelve
months.

Conflict of Interest: This research contains the views, opinions and recommendations of research strategists with JPMorgan US Fixed Income
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This report should not be distributed to others or replicated without prior consent of JPMorgan.

29
 2011 US SHORT–TERM FIXED INCOME OUTLOOK

The Year of the Regulator

December 2010
STRICTLY PRIVATE AND CONFIDENTIAL

Alex Roever, CFAAC

(212) 834-3316
[email protected]
2011 US SHORT–TERM FIXED INCOME OUTLOOK

2011 outlook publications

1
 Key themes for 2011

„ Regulation will drive change in the liquidity markets

„ Basel III’s Liquidity Coverage Ratio
„ President’s Working Group Report on money fund reform proposals
„ Dodd-Frank

„ Issues in 2010 will continue into next year

„ Low short-term interest rates will persist through 2012, perhaps beyond
„ Sensitivity between Libor and European sovereign risk
„ Challenges for municipal money funds
2011 US SHORT–TERM FIXED INCOME OUTLOOK

„ Demand will continue to outstrip the supply of liquid products

„ Temporary run off of SFP bills in 1Q:2011 will push bill/GC repo yields down
„ Discount note outstandings are to decline modestly, pushing yields lower
„ USCP outstandings have stabilized but may move lower due to new regulations
and rising bank fees. Non-financial CP is an exception
„ 1-3y bank note supply may increase, but structural mismatch between supply and
demand may cause 1-3y bank credit spreads to widen significantly

2
 Timeline of potential and final regulatory changes that affect
the short-term markets
FDIC
FDIC (Jan)
(Jan) FDIC
FDIC (Jan)
(Jan) FDIC
FDIC (Jan)
(Jan) FDIC
FDIC (Jan)
(Jan) FDIC (Jan)
FDIC (Jan)
Non-interest-bearing The original 3bp Comments to the new New safe harbor rule The process for an
Non-interest-bearing The original 3bp Comments to the new New safe harbor rule The process for an
transaction accounts increase in proposed rulemaking of becomes effective. US orderly liquidation of a
transaction accounts increase in proposed rulemaking of becomes effective. US orderly liquidation of a
will begin receiving assessment rates will a new deposit bank sponsored ABCP covered financial
will begin receiving assessment rates will a new deposit bank sponsored ABCP covered financial
unlimited insurance be eliminated as part of assessment base and programs with IDI sellers company has not been
unlimited insurance be eliminated as part of assessment base and programs with IDI sellers company has not been
coverage for the next the new restoration plan rate schedules are due will be most affected finalized. All comments
coverage for the next the new restoration plan rate schedules are due will be most affected finalized. All comments
two years to restore DIF are due by January 18
two years to restore DIF are due by January 18

1H
2011 SEC
SEC (Jan)
(Jan) SEC
SEC (Jan)
(Jan) Administration
Administration BIS
BIS (Jan)
(Jan) BIS
BIS (Q1?)
(Q1?)
(Jan)
(Jan)
Comments to PWG’s Public companies may Observation period for Local regulators,
Comments to PWG’s Public companies may Observation period for Local regulators,
money fund proposals be required to disclose A comprehensive Basel III’s LCR begins including the FFIEC in
money fund proposals be required to disclose A comprehensive Basel III’s LCR begins including the FFIEC in
(including the adoption additional info. to proposal for GSE reform in 2011. Implementation the US, will further clarify
(including the adoption additional info. to proposal for GSE reform in 2011. Implementation the US, will further clarify
of a floating NAV money investors about their is expected, most likely date is 2015 rules as they relate to
of a floating NAV money investors about their is expected, most likely date is 2015 rules as they relate to
fund model) are due short-term borrowings as part of the broader Basel III’s LCR
fund model) are due short-term borrowings as part of the broader Basel III’s LCR
throughout the quarter housing reform proposal
throughout the quarter housing reform proposal
2011 US SHORT–TERM FIXED INCOME OUTLOOK

SEC
SEC (Feb)
(Feb) FDIC
FDIC (Apr)
(Apr) FDIC
FDIC (Jul)
(Jul) FSB
FSB (Jul)
(Jul) Dodd-Frank
Dodd-Frank (3Q)
(3Q)
2H
Money market funds will Barring significant As part of Dodd-Frank, G-20 urges FSB and All federal agencies are
2011 Money market funds will
be required to disclose
Barring significant
revisions, the new
As part of Dodd-Frank,
the repeal of Reg Q will
G-20 urges FSB and
other int’l regulators to
All federal agencies are
required to remove
be required to disclose revisions, the new the repeal of Reg Q will other int’l regulators to required to remove
their shadow NAVs to deposit assessment allow banks to start strengthen regulation references to credit
their shadow NAVs to deposit assessment allow banks to start strengthen regulation references to credit
the public base and rate paying interest on and oversight of the ratings and substitute
the public base and rate paying interest on and oversight of the ratings and substitute
schedules will become demand deposit shadow banking an alternative measure
schedules will become demand deposit shadow banking an alternative measure
effective accounts system by mid-2011 of creditworthiness
effective accounts system by mid-2011 of creditworthiness

SEC
SEC (4Q?)
(4Q?) FASB/IASB
FASB/IASB (4Q?)
(4Q?) S&P/MDY
S&P/MDY (TBD)
(TBD) FED
FED (2011)
(2011) FSB (2011-2012)
FSB (2011-2012)
2011
and Rules to Reg AB have G-20 urges the S&P proposed changes Changes to the tri-party G-20 endorsed a new
Rules to Reg AB have G-20 urges the S&P proposed changes Changes to the tri-party G-20 endorsed a new
beyond yet been finalized. convergence of to counterparty ratings repo market as outlined policy framework
yet been finalized. convergence of to counterparty ratings repo market as outlined policy framework
ABCP issuers are accounting standards criteria. Moody’s in the White Paper by proposed by FSB to
ABCP issuers are accounting standards criteria. Moody’s in the White Paper by proposed by FSB to
hopeful that ABCP be finished by end of proposed to change its the Payment Risk address SIFIs and
hopeful that ABCP be finished by end of proposed to change its the Payment Risk address SIFIs and
conduits are exempt 2011. Notion of cash money fund Committee are work in global SIFIs, including
conduits are exempt 2011. Notion of cash money fund Committee are work in global SIFIs, including
from this rulemaking equiv. will go away methodology progress higher capital standards
from this rulemaking equiv. will go away methodology progress higher capital standards

3
 US Economy: Low inflation + High unemployment = Low rates

Economic
Economic and
and interest
interest rate
rate forecast
forecast
% change Q/Q, saar 10Q3 10Q4 11Q1 11Q2 11Q3 FY'10 FY'11
Real GDP 2.50% 2.50% 2.00% 3.00% 3.00% 2.60% 3.00%
Core CPI 1.20% 0.40% 0.60% 0.60% 0.70% 0.60% 0.70%
Core PPI 2.20% 1.00% 0.60% 0.50% 0.50% 1.80% 0.60%
Unemployment rate (%, 9.60% 9.60% 9.60% 9.50% 9.40% - -
23-Nov 10Q4 11Q1 11Q2 11Q4
Fed funds rate 0-0.25% 0-0.25% 0-0.25% 0-0.25% 0-0.25%
3m LIBOR 0.28% 0.28% 0.28% 0.28% 0.28%
3-month T-bill (bey) 0.15% 0.14% 0.15% 0.18% 0.21%
2yr UST 0.45% 0.50% 0.55% 0.75% 0.95%
2011 US SHORT–TERM FIXED INCOME OUTLOOK

5yr UST 1.42% 1.40% 1.55% 2.00% 2.40%

10yr UST 2.76% 2.50% 2.65% 3.00% 3.45%
30yr UST 4.17% 3.85% 3.95% 4.25% 4.70%
3m T-bill/LIBOR Spread 0.13% 0.14% 0.13% 0.10% 0.07%
2s/10s curve 231 bps 200 bps 210 bps 225 bps 250 bps
10s/30s curve 141 bps 135 bps 130 bps 125 bps 125 bps
J.P. Morgan forecast as of 11/24/2010; forecasts are for quarter-end
1 4Q/4Q change

4
 Money market supply has decreased, especially excluding
Treasuries

Supply
Supply of
of money
money market
market instruments
instruments
$tn
12 11.5

11

Jul 2010 % of Total Change Change since

Total
10 Assets ($tn) Level Oustanding 9.6
YTD Sep 2008
T-Bills 1.79 24% 0.00 0.30
Repo 2.89 38% 0.37 -1.45
9.3
Agency DN 0.66 9% 0.02 -0.28
9
Unsecured CP 0.67 9% 0.00 -0.17
ABCP 0.40 Oct5%
2010 -0.05
% of -0.30
Total Change Change since
Negotiable Assets
CDs ($bn)
0.89 Level Oustanding
12% -0.09 YTD
-0.17 Sep 2008
8 Bonds <1y T-Bills 1,768 19% -25 279
2011 US SHORT–TERM FIXED INCOME OUTLOOK

0.29 4% -0.10 -0.23

Repo 3,189 34% 675 -1,143
Total 7.58 100%
620
0.157% -2.29
-12 -322
Agency DN
Total ex-UST 5.79
Unsecured CP 76%
655 0.157% -2.59
2 -181
7 ABCP 396 4% -75 -302
Negotiable CDs 939 10% -47 -126
6.6
Bonds <1y 331 4% -53 -183
Treasury Coupon 899 10% 142 211
6 Agency Coupon 511 5% -58 -98
Total 9,309 100% 550 -1,864
ex Treasuries
Total ex-UST 6,641 71% 433 -2,353

5
Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10

Source: J.P. Morgan; Data through October 31, 2010

Note: Supply data includes UST bills & coupons, agency discount notes & coupons, repo sold, unsecured commercial paper, ABCP, negotiable CDs, and bonds < 13 months

5
 Money fund balances have stabilized
Breakdown
Breakdown of
of taxable
taxable money
money market
market funds
funds
2,500 $bn Prime Treasury Govt/Agency 2,500 $bn Retail Institutional

2,300

2,000 2,100

1,900

1,500 1,700

1,500

1,000 1,300
2011 US SHORT–TERM FIXED INCOME OUTLOOK

1,100

500 900

700

0 500
Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10
Source: iMoneyNet Source: iMoneyNet

6
 Some Moody’s-rated banks are flirting with P-2 level ratings

Holdco
Holdco and
and bank
bank level
level baseline
baseline and
and support
support lift
lift ratings
ratings
Holdco baseline Holdco support lift Bank baseline Bank support lift
Aaa

Aa1

Aa2
P-1
Aa3

A1

A2

A3

Baa1
2011 US SHORT–TERM FIXED INCOME OUTLOOK

Baa2

Baa3

Ba1

Ba2

Ba3

B1
BK JPM USB STT WFC BAC C GS MS PNC

Source: Moody’s

7
 Non-US banks still heavily reliant on US money markets
J.P
J.P Morgan
Morgan estimates
estimates of
of US
US prime
prime money
money fund
fund unsecured
unsecured CP,
CP, CD,
CD, and
and ABCP
ABCP
1Q 2010 2Q 2010 3Q 2010 Oct 2010
$bn $bn $bn $bn 1Q 2010 2Q 2010 3Q 2010 Oct 2010
Total Prime Fund Assets 1,668 1,563 1,610 1,623 Total Prime Funds 1,668 1,563 1,610 1,623
Total Bank CP/CD/ABCP 969 802 921 957

Non-Bank CP 33 34 46 40 Eurozone 493 331 412 437

Austria 1 1 1 1
Belgium 16 14 12 13
Bank CP/CD 870 669 816 859
France 216 142 183 206
Eurozone 451 288 372 400
Germany 70 59 76 73
Other Regions 272 237 284 311
Ireland 3 2 0 0
United Kingdom 94 97 120 94
Italy 41 19 29 28
United States 41 33 27 31
Lux embourg 6 5 1 1
Sw itzerland 11 15 15 23
Netherlands 101 64 88 93
Spain 40 25 22 22
ABCP 99 133 103 98 Other Europe 187 224 243 230
Eurozone 43 43 40 37
2011 US SHORT–TERM FIXED INCOME OUTLOOK

Denmark 22 21 18 18
United States 27 36 26 22 Norw ay 9 12 13 12
United Kingdom 25 47 34 36 Sw eden 26 31 41 45
Other Regions 5 6 2 2 Sw itzerland 11 16 17 24
Sw itzerland 0 1 1 1 United Kingdom 120 143 154 131
Rest-of-World 289 248 266 291
Other money market Australia/NZ 79 59 69 82
instruments 665 727 645 626 Canada 70 62 68 80
Chile 0 0 0 0
India 3 1 0 0
Japan 69 57 77 76
US 68 69 52 52
Note: J.P. Morgan estimates of geographic exposure in prime money market funds are based on a sample of large funds at March 31, 2010, June 30, 2010, September 30, 2010,
and October 31, 2010 including funds managed by Fidelity, BlackRock, Vanguard, Dreyfus, Federated, Wells Fargo, Goldman Sachs, J.P. Morgan, and UBS (June 30 only).
Allocation percentages are calculated from the sample and then applied to current total prime fund outstandings. Portfolios totaling about $750bn were sampled for March 31,
$623bn for June 30, $740bn for September 30, and $746bn for October 31. Prime Fund total assets as of March 31, 2010, June 30, 2010, September 30, 2010, and October 31,
2010 according to iMoneyNet.
Source: J.P. Morgan & company reports

8
 Securities lenders: investments are smaller and shorter
Balances
Balances ($bn)
($bn) Investments
Investments of
of Securities
Securities Lenders
Lenders
Q4 Q4 Q4 Q3 % Q2 Q2 Q3
2007 2008 2009 2010 Change 2007 2009 2010
Securities Lenders Credit Tiering
Repurchase Agreements 27% 31% 28%
Bank of New York 618 326 247 280 -55%
A-1/P-1 or better 92% 99% 89%
State Street 573 333 376 361 -37%
Other MMkt Instruments (<397 days) 41% 41% 62%
J.P. Morgan 391 170 173 186 -52% A-1/P-1 or better 95% 87% 67%
Northern Trust 270 110 115 112 -59% Other Fixed Income (>397 days) 32% 28% 11%
AAA 57% 58% 58%
Total 1,851 939 911 938 -49%
AA or A 43% 39% 31%
Source: Company annual reports and 10-Qs;
Note: % change is from Dec 2007 to Sep 2010
Asset Mix
Fixed Rate Instruments 18% 15% 20%
Commentary
Commentary Unsecured CP 28% 41% 40%
ABCP 71% 17% 13%
2011 US SHORT–TERM FIXED INCOME OUTLOOK

„ We estimate US SL reinvestment portfolios Other Corporates 2% 42% 46%

measured $2.5 - $3.0Tn in mid-2007 and are now Floating Rate Instruments 36% 38% 23%
around $1.1 - $1.3Tn ABS 38% 35% 24%
Other Corporates 54% 64% 73%
„ Historically SL have been major purchasers of Repurchase Agreements 26% 29% 30%
money market and longer term floating rate US Treasury 2% 12% 18%
securities like ABS and corporates Agency 39% 51% 39%
Corp 57% 28% 24%
„ Median maturities have shortened dramatically Deposits (CD & other) 15% 9% 15%
Money Market Funds 2% 7% 12%
„ Holdings of ABS and FRNs has fallen from about Other 3% 2% 1%
$1.0Tn to about $400bn
Median WAM (final maturity) 170 77 61
Source: Risk Management Association

9
 Risk aversion may be back in the Libor market, but not to the
degree in 2Q
3m
3m Libor
Libor surges
surges on
on both
both cash
cash and
and forwards
forwards Inset:
Inset: Change
Change in
in Libor
Libor in
in basis
basis points
points
%
5.0
70 bps
4.5 60
50
40
4.0 30
20
3.5 10
0
(10)
3.0 (20)
Mar- Mar- Apr- May- Jun- Jul-16 Aug- Sep- Oct- Nov- Nov-
3mL Spot
2.5 01 28 24 22 18 12 08 06 02 30
3mL 3m fwd
2.0 3mL 6m fwd
2011 US SHORT–TERM FIXED INCOME OUTLOOK

1.5

1.0

0.5

0.0
Sep-08 Nov-08 Feb-09 May-09 Jul-09 Oct-09 Jan-10 Mar-10 Jun-10 Sep-10 Nov-10
Source: Bloomberg

10
 Three month LIBOR has declined to pre-Euro crisis levels
but uncertainty lingers amongst USD LIBOR panel banks

Weekly
Weekly 3-month
3-month LIBOR
LIBOR posting
posting dispersion
dispersion and
and trimmed
trimmed mean
mean LIBOR,
LIBOR, bp
bp

65
3m LIBOR
11/30 - 11/24
60 Middle 50% Panel Banks 11/30/2010 Change
Top/Bottom 25% Barclays 31 3
55 Bank of Tokyo Mitsubishi 32 0
RBS 30 1
50
Deutsche 27 0
RBC 31 2
45
Norinchukin 35 2
40 UBS 27 2
West LB 40 1
35 HSBC 27 0
2011 US SHORT–TERM FIXED INCOME OUTLOOK

Credit Suisse 31 2
30 Citibank 29 1
Lloyds 31 1
25 JP Morgan 27 0
Rabo 29 1
20 Bank of America 30 0
07 Jul
21 Jul
06 Jan
20 Jan
03 Feb
17 Feb

09 Jun
23 Jun

13 Oct
27 Oct
03 Mar
17 Mar
31 Mar

12 May
26 May

10 Nov
24 Nov
01 Sep
15 Sep
29 Sep Soc Gen 30 2
04 Aug
18 Aug
14 Apr
28 Apr

Source: Bloomberg, J.P. Morgan

11
 Tax-exempt money funds lose cash as investors reach for yield

Cumulative
Cumulative monthly
monthly flows;
flows; $bn
$bn Tax-exempt
Tax-exempt money
money fund
fund AuM
AuM and
and as
as %
% of
of total
total muni
muni
market
market
200 550 25

Direct
150 household money funds %
500 of all Muni
holdings
20
100
Tax-exempt 450
mutual funds
50
15
400

0 Tax-exempt
money funds
2011 US SHORT–TERM FIXED INCOME OUTLOOK

350 AUM $bn 10

-50

300
-100
Projected 2011 5

-150
250 decline
Tax-exempt
money funds
-200 200 0
Aug 08 Jan 09 Jun 09 Nov 09 Apr 10 Sep 10 Dec 04 Dec 06 Dec 08 Dec 10

Source: Federal Reserve Flow of Funds, Lipper FMI, iMoneyNet Source: J.P. Morgan, iMoneyNet, SIFMA

12
 VRDOs look attractive given higher SIFMA levels relative to
Libor
1w
1w Libor
Libor vs.
vs. SIFMA
SIFMA vs.
vs. S&P
S&P Muni
Muni VRDO
VRDO
%
0.55
1w Libor
0.50 SIFMA
S&P Muni VRDO
0.45

0.40

0.35

0.30
2011 US SHORT–TERM FIXED INCOME OUTLOOK

0.25

0.20

0.15

0.10
Dec-09 Feb-10 Apr-10 Jul-10 Sep-10 Nov-10
Source: Bloomberg

13
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16