Economic Analysis | US JAMES F. OSULLIVAN Chief Economist +1 212 589 6479 josullivan@mfglobal.com STEPHANIE S.

CHENG Economist +1 212 589 6373 scheng@mfglobal.com

JULY 15, 2011

INSTITUTIONAL USE ONLY

MF Global Weekly Report

MACRO FOR MARKETS

CONTENTS

Still Expecting H2 Pickup, but Growth Forecast Trimmed

As suggested last week, we have cut our estimate for Q2 real GDP growth following the release of several key sets of input data. We now estimate a 2.3% q/q annualized rate, slightly better than the 1.9% pace in Q1 but down from our earlier estimate of 3.5%. Whats next? On the positive side, we continue to believe recent weakening has been exaggerated by factors that will fade or reverse: gasoline prices have declined, auto production is scheduled to rebound by enough to add a point to Q3 growth, and claims are showing tentative signs of improvement. More broadly, some of the headwinds that have been holding back the recovery appear to be lessening over time. In the other direction, business and consumer confidence continues to be fragile, with risk aversion after the crisis more persistent than we anticipated. In part, that pattern reflects financial markets and fiscal policy concerns, some of which should fade. The net result: we still see the recovery improving over time, but we are trimming our GDP growth forecasts for coming quarters by around 0.5 point at an annual rate. We now expect real GDP to increase at a 3.5% pace over the next year and a half. We expect the unemployment rate (currently 9.2%) to be 9.0% in Q4 of 2011 (instead of 8.8%) and 8.3% in Q4 of 2012 (instead of 7.9%). We now forecast the first Fed rate hike in June 2012 (instead of March), with the funds rate up to 1.0% at the end of 2012 (instead of 1.5%).

Pg. 2 | Still Expecting H2 Pickup, but Growth Forecast Trimmed Pg. 7 | Forecast Summary Pg. 8 | Data Preview Pg. 13 | Calendar

Preview: More Clarity on Fiscal Issues?

A key focus in coming weeks will be how fiscal policy negotiations evolve. While the debt limit impasse does not appear to have directly affected financial markets significantly, we suspect the threat of default and a rating downgrade have weighed on consumer and business confidence. In a light week for data, we forecast near-flat readings for housing starts, existing home sales, the housing market index, and the FHFA home price index. We expect the current activity index in the Philadelphia Fed survey to show a reversal of some of last months weakening. We forecast little change in jobless claims after last weeks large drop. Jobless claims may be starting to decline again.
initial claims, 000s , sawr 670 570 470 Jul 9 370 270 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 4-week average
Source: Department of Labor and MF Global

Weekly

mfglobal.com

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

STILL EXPECTING H2 PICKUP, BUT GROWTH FORECAST TRIMMED As suggested last week, we have cut our estimate for Q2 real GDP growth following the release of several key sets of input data. We now estimate a 2.3% q/q annualized rate, slightly better than the 1.9% pace in Q1 but down from our earlier estimate of 3.5%. (See details on page 7.) Some other data have looked even weaker in recent months, most notably the last two employment reports. Whats next? On the positive side, we continue to believe recent weakening has been exaggerated by factors that will fade or reverse. Real spending power is being boosted by a drop in gasoline prices. After being depressed by Japan supply-chain effects, auto production is scheduled to rebound by enough to add about a percentage point to annualized Q3 GDP growth. Jobless claims are showing tentative signs of improvement. More broadly, we continue to believe that some of the headwinds that have been holding back the recovery since it began are lessening over time (e.g., banks have begun to ease lending standards, commercial construction is stabilizing, and the drag from household sector deleveraging appears to be moderating). In the other direction, business and consumer confidence continues to be fragile, with risk aversion after the crisis more persistent than we anticipated. In part, that pattern reflects financial markets and fiscal policy concerns, some of which should fade. The net result: we still see the recovery improving over time, with employment growth accelerating and unemployment trending lower, but we are trimming our GDP growth forecasts for coming quarters by around 0.5 point at an annual rate. For real GDP, we now forecast a 3.5% pace in the second half of 2011 (instead of 4.0%), and 3.5% on a Q4/Q4 basis in 2012 (instead of 3.9%). That is still somewhat stronger than expected by the consensus (3.2% in H2 11 and 3.0%, on average, in 2012according to Bloombergs survey). Growth averaged an estimated 2.7% pace in the first eight quarters of the recovery (including our 2.3% estimate for last quarter). We now expect the unemployment rate to drop to 9.0% in Q4 of 2011 (instead of 8.8%) and 8.3% in Q4 of 2012 (instead of 7.9%). At 9.2%, the June 2011 level was up from 8.8% three months earlier but still down from 9.6% in Q4 of 2010 and 10.0% in Q4 of 2009.

U.S. vehicle production dropped from 8.4 million units at an annual rate in Q1 to 7.9 million in Q2. It is scheduled to rebound to a 9.4-million pace in Q3.
millions of units, saar, unless noted otherwise LEVEL %q/q, saar 33.5 -15.8 36.7 -23.9 103.9 %m/m, sa 4.4 6.0 4.0 -10.8 0.9 -1.5 19.3 2.7 -1.8

10Q3 10Q4 11Q1 11Q2 11Q3-scheduled

8.1 7.8 8.4 7.9 9.4 LEVEL

JAN 11 FEB 11 MAR 11 APR 11 MAY 11 JUN 11 JUL 11 scheduled AUG 11 scheduled SEP 11 scheduled

8.0 8.5 8.8 7.9 7.9 7.8 9.3 9.6 9.4

Source: Federal Reserve Board, Ward's Automotive, and MF Global

The scheduled increase in auto production, if realized, would likely add a full point to annualized GDP growth in Q3.
pct. pts, q/q, saar 2 Q1 1 0 -1 -2 06 07 08 09 10 11 12 Contribution to real GDP growth (l) Change in U.S. motor vehicle production (r)
Source: Federal Reserve Board, Bureau of Economic Analysis, Ward's Automotive, and MF Global

millions of units, ch, q/q, saar Q3 2.8 1.4 production 0.0 schedule Q2 -1.4 -2.8

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

Despite the lowering of growth projections, we have raised slightly our inflation forecasts for 2011, mainly reflecting the pickup in recent months, including a second consecutive 0.3% m/m rise in the core CPI in June (more below). On a Q4/Q4 basis, we now forecast a 3.0% rise in the total CPI and a 2.0% rise in the core CPI in 2011 (instead of 2.8% and 1.8%, respectively). We have not changed our 2012 forecast (2.1% total, 2.0% core). For core PCE prices, we now forecast a 1.7% rise in 2011 (up from 1.5%) and 1.7% again in 2011 (as before). The change to the inflation forecast partly offsets the monetary policy implications of the change in the growth forecast, but we have pushed back the first Fed rate hike to June 2012 from March 2012, with the funds rate now expected to be 1.0% at the end of 2012 instead of 1.5%. (Fed funds futures contracts are currently priced for a 0.4% funds rate at the end of 2012.) Some tightening in 2012 will likely also come via balance sheet shrinkage. (We do not expect any new stimulus initiatives this year, with Fed officials effectively freezing their balance sheet through Q1 of next year.)

The architects billings index for commercial and industrial activity has been signaling a fading of weakness in private nonresidential construction. The plunge in construction in Q1 GDP was likely weather-related.
% from 3 months ago, saar 50 25 0 -25 -50 98 00 02 04 06 08 10 12 Private nonresidential construction (l) AIA commercial and industrial billings index (r) May index, sa 74 62 50 38 26

Source: Bureau of the Census and American Institute of Architects

The sharp drop in vehicle sales in May and June was concentrated in the Japanese brands, consistent with much of the weakening being due to inventory shortages related to supply-chain effects.
millions of units, saar 10 8 6 4 2 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 U.S. light vehicle sales: Japanese brands* U.S. light vehicle sales: ex-Japanese brands*
*Estimated by MF Global, applying same seasonal adjustment factors to Japanese brand sales as used by the Bureau of Economic Analysis for total sales. Source: Bureau of Economic Analysis, Automotive News, and MF Global

The Feds Senior Loan Officer Opinion Survey has been showing an easing of lending standards on most categories of loans, including commercial and industrial (C&I) loans (below). The main exception has been residential mortgages.
Net percentage of domestic respondents tightening standards for C&I loans, by size of business seeking loan

90 60

Jun

30 0 Apr -30 90 92 94 96 98 00 02 04 06 08 Small 10

Large and medium

Source: Federal Reserve Board

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

Still Waiting for More Clarity on Fiscal Issues Apart from the data, a key focus in coming weeks will be how fiscal policy negotiations evolve. We are assuming that the debt limit impasse will be resolved before it leads to any missed payments on principal or interest. (We expect the Treasury to prioritize those payments if needed.) We are also assuming that any new deficit reduction measures are spread out over many years, with only minimal impact prior to 2013, and that this years temporary payroll tax cut, and also extended unemployment benefits, will be renewed for another year. We are still allowing for some tightening of fiscal policy in the coming year, reflecting the phasing down of the 2009 stimulus package and the FY11 cut in budget authority for discretionary spending (which will be reflected in budget outlays with a lag). Our call for somewhatabove-trend growth in 2012, despite that drag, reflects our expectation that the private sector recovery will continue to gather momentum. While the debt limit impasse does not appear to have directly affected sentiment in financial markets significantly (with Treasury yields remaining low), we suspect the threat of default and a sovereign rating downgrade have weighed on business and consumer confidence. In turn, the brinkmanship has likely compounded the slowing in growth recently. The Michigan sentiment index fell in June and again in early July, mirroring weakness in the Rasmussen index. Other factors have clearly also affected confidence, including the weaker than expected employment data, but we believe resolution of the debt limit impasse would remove one important source of anxiety for consumers and business leaders. The household sector financial balance is down only marginally over the past year, although even a flattening in that measure is consistent with a fading of the drag from deleveraging.
10.5 7.0 3.5 0.0 -3.5 -7.0 60 65 70 75 80 85 90 95 00 05 10 Household sector financial balance 11Q1 % of disposable income

Business sector as well as consumer confidence has weakened recently.

index, both scales 110 105 100 95 90 85 80 81 84 87 90 93 96 99 02 05 08 11 14 NFIB optimism index (l) Conference Board CEO confidence index (r)
Source: National Federation of Independent Business (NFIB) and The Conference Board

80 70 Q2 60 50 40 30 20

The weakening in the Michigan sentiment index mirrors the pattern in the daily Rasmussen index.
index, monthly 80 index, daily 95

70

60

80 Jul prelim Jul 15 65

50 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 University of Michigan sentiment index (l) Daily Rasmussen consumer index (r)
Source: University of Michigan and Rasmussen Reports

50

Note: Shaded bars represent periods of recession. Source: Federal Reserve Board, Bureau of Economic Analysis, and MF Global

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

Labor Market Improving: Half-Year-by-Half-Year at Least As noted, we expect the private sector recovery to continue to gather momentum. Such positive momentum was clearly not evident in the May and June employment reports, although the weakening in those reports followed a significant pickup in the first four months of the year, and we suspect some of the slowing represented normal volatility. (Payrolls gains averaged just 22,000 per month in May and June following a 179,000 per month pace in the first four months of the year.) Employment growth was stronger in the first half of 2011 as a whole than in the second half of 2010, which continued the pattern in place since the recovery began two years ago (see table). We expect that pattern to continue, with more strength in employment growth in the second half of this year than in the first half of the year. Private payrolls gains averaged 158,000 per month in the first half of 2011, up from 125,000 per month in the second half of 2010, 71,000 in the first half of 2010, and -184,000 in the second half of 2009. Gains in total payrolls have been below those of private payrolls, mainly reflecting ongoing layoffs by state and local governments, but they show the same improving trend after adjusting for distortions related to last years census. On an excensus basis, total payrolls gains averaged 126,000 per month in H1 of 2011, following 103,000 in H2 of 2010, 56,000 in H1 of 2010, and -197,000 in H2 of 2009. We Expect Claims to Move Down Again, but Caution Against Extrapolating Drop in Latest Week As usual, the jobless claims data will be especially important for signaling whether an improving trend in employment growth is still on track. Claims averaged 416,000 per week in the first half of 2011, down from 448,000 in the second half of 2010, 470,000 in the first half of 2010, and 529,000 in the second half of 2009. Claims rose in Q2, consistent with employment growth finishing the first half weaker than it began. The four-week average was as high as 440,000 in mid-May. It then fell to 426,000 in late May before stabilizing around that level during June. While the precise relationship between the level of claims and the pace in payrolls can fluctuate, the recent four-week-average peak in claims was lower than the average level in the second half of 2010when the trend in payrolls gains was around 100,000 per month. The pattern is consistent with the May and June employment reports overstating the extent to which the trend in payrolls gains has slowed recently (Payrolls gains averaged just 22,000 per month in May and June.) In any event, claims will need to start falling again for payrolls to reaccelerate.

The employment data have been showing improvement since the recession ended in mid-2009, at least on a half-year-by-halfyear basis. The sharp weakening in payrolls in May and June followed a strong pickup in the first four months of the year.
000s, sa 09 H2 -197 -184 -13 -16 529 10 H1 56 71 -14 -18 470 10 H2 103 125 -22 -23 448 11 H1 126 158 -31 -28 416

EX-CENSUS PAYROLLS (ch, monthly average) PRIVATE GOVERNMENT STATE & LOCAL INITIAL JOBLESS CLAIMS (weekly average)
Source: Department of Labor and MF Global

Jobless claims may be starting to decline again.

initial claims, 000s , sawr

670 570 470

Jul 9 370 270 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 4-week average
Source: Department of Labor

Weekly

Along with new claims for unemployment benefits, the total number receiving unemployment benefits may be starting to signal some improvement again. (See regular + emergency/extended continuing claims series in the chart below.)
J millions, sa 17 J J J J J J J

14 11 8 5 2

Jun Jun 25

17 14 11 8 5 2

Jul 2

Jan-08 Aug-08 Mar-09 Oct-09 May-10 Dec-10 Jul-11 Regular continuing claims Regular + emergency/federal extended continuing claims Total unemployed in employment report
Note: extended claims are seasonally adjusted using seasonal factors for regular continuing claims. Source: Department of Labor and MF Global

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

Claims dropped from 427,000 to 405,000 in the first full week of July. Moreover, the latest reading included an 11,500 boost from budget-dispute-related furloughing of state workers in Minnesota. Unfortunately, the claims data are especially volatile and unreliable in early July, reflecting seasonal adjustment challenges related to annual summer shutdowns in the auto industry. While we expect claims to trend lower this quarter, we caution against extrapolating yet. Pickup in Core Inflation Makes QE3 Highly Unlikely As noted, the core CPI continued to show acceleration in June, despite the weaker growth data recently. The 0.3% m/m increase boosted the 2011-to-date increase (June vs. December) to 2.5% at an annual rate from 2.4% through May and 2.1% through April. The core CPI rose just 0.8% in 2010 (December to December). Some of the recent pickup in core inflation has reflected factors that have also contributed to the slowing in growth, notably Japan supply-chain effects (which led to inventory shortages and a sharp pickup in new and used vehicle prices) and higher commodity prices (which likely led to some pass-through effects on core items). In turn, core inflation is likely to slow significantly in coming months as those sources of acceleration fade or reverse. Even so, the net result is likely to be a clear pickup for 2011 as a whole; the pickup so far this year has been fairly broadbased. The pickup in inflation makes a third round of asset purchases by the Fed highly unlikely, in our view, unless the recovery truly falters. Indeed, while the Fed chairman raised the possibility of more stimulus in his testimony on July 13 and 14, he also made clear that new stimulus would require a significant reversal of the recent pickup in inflation and not just weakness in growth. Here is what Mr. Bernanke said in response to a question: I think the important point to make is that the situation today is somewhat different than it was in August of 2010, when we began to initiate discussion of further purchases of securities. At that time, inflation was dropping, inflation expectations were dropping. It looked like deflation was becoming a potential risk to the economy and a serious risk. At the same time, over the summer the recovery looked like it was stalling Today, the situation is more complex. Inflation is higher. Inflation expectations are close to our target. We are uncertain about the near-term developments in the economy, we'd like to see if in fact the economy does pick up as we are projecting. And so, you know, we're not prepared at this point to take further action.

The core CPI shows a 2.5% annual rate so far this year (June vs. December), up from 0.8% in 2010 (December to December).The pickup has been fairly broad-based, although three categories have been especially important contributors: shelter (mainly rents), vehicles (new and used), and apparel.
% ch, annual rate, unless noted 2010* 2011 THRU JUNE** 2.5 1.6 1.5 1.3 11.6 0.8 4.8 8.3 9.4 4.4 3.1 1.3 1.5 0.7 ACCEL/ DECEL. (2011 vs. 2010, pct pcts) 1.7 1.1 0.7 1.0 9.1 3.3 5.9 8.5 5.8 -1.4 -0.2 2.0 0.2 -1.2 CONTRIBUT. TO ACCEL/DECEL pct pts.) 1.7 0.5 0.1 0.3 0.1 0.2 0.3 0.5 0.2 0.0 0.0 0.2 0.0 -0.1

CORE CPI SHELTER (41.6%) RESIDL RENT (7.7%) OER (32.4%) LODGING (1.0%) FURNISH/OPS (5.9%) APPAREL (4.8%) NEW VEHICLES (5.6%) USED VEHICLES (2.6%) AIRFARES (1.0%) MEDICAL CARE (8.4%) RECREATION (8.3%) EDUC, COMMUN (8.3%) OTHER (4.5%)

0.8 0.4 0.8 0.3 2.5 -2.5 -1.1 -0.2 3.7 5.8 3.3 -0.8 1.3 1.9

*December 2010 vs. December 2009 (nsa) **June 2011 vs. December 2010 (sa) Source: Bureau of Labor Statistics and MF Global

Along with the core CPI, the core PCE price index has also been accelerating. Inflation expectations indicators have shown little net change from average levels in recent years; although last years drop in breakeven inflation rates priced into Treasury Inflation-Protected Securities (TIPS) has been reversed.
4 3 2 1 0 07 08 09 10 11 12 Core PCE prices (y/y) Core CPI (y/y) Michigan median 5-10 year inflation expectations TIPS 5-year, 5-year forward inflation compensation % 4 4 Jul 12 3 Jul prelim 3 2 Jun 2 May 1 1 0

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board, and MF Global

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

MF GLOBAL U.S. ECONOMIC FORECAST SUMMARY

% change from previous period, annual rate (ar), except where noted; forecasts in bold 2010 Q1 REAL GDP FINAL SALES DOMESTIC FINAL SALES NET EXPORTS (pct pt contr) INVENTORIES (pct pt contr) CONSUMPTION BUSINESS FIXED INVESTMENT STRUCTURES EQUIPMENT & SOFTWARE RESIDENTIAL INVESTMENT EXPORTS IMPORTS GOVERNMENT INVENTORIES (ch $bil ar) CPI CORE CPI CORE PCE PRICES UNEMPLOYMENT (%, level) FEDERAL BUDGET BAl ($bil, fy) % OF GDP INTEREST RATES (%, level, eop) FED FUNDS TARGET 2-YEAR TREASURY 10-YEAR TREASURY 0.13 1.0 3.8 0.13 0.6 3.0 0.13 0.4 2.5 0.13 0.6 3.3 0.13 0.8 3.5 0.13 0.5 3.2 0.13 0.9 3.5 0.13 1.2 3.8 0.1 0.7 3.2 0.1 0.8 3.5 0.6 1.9 4.0 0.13 0.6 3.3 3.7 1.1 1.3 -0.3 2.6 1.9 7.8 -17.8 20.5 -12.3 11.4 11.2 -1.6 44 1.3 0.0 1.2 9.7 Q2 1.7 0.9 4.3 -3.5 0.8 2.2 17.2 -0.5 24.8 25.6 9.1 33.5 3.9 69 -0.5 0.8 1.0 9.6 Q3 2.6 0.9 2.6 -1.7 1.6 2.4 10.0 -3.6 15.4 -27.3 6.7 16.8 3.9 121 1.4 1.1 0.5 9.6 Q4 3.1 6.7 3.2 3.3 -3.4 4.0 7.7 7.7 7.7 3.3 8.6 -12.6 -1.7 16 2.6 0.6 0.4 9.6 Q1 1.9 0.6 0.5 0.1 1.3 2.2 2.0 -14.8 8.7 -1.9 7.7 5.1 -5.8 56 5.2 1.7 1.6 8.9 Q2 2.3 2.0 1.1 0.9 0.4 0.5 6.9 7.0 7.0 1.0 9.0 2.0 0.1 68 4.1 2.5 2.3 9.1 2011 Q3 3.5 3.6 3.4 0.0 -0.1 3.2 8.9 3.0 11.0 5.0 8.0 6.0 1.5 65 1.4 2.1 1.8 9.1 Q4 3.5 3.8 3.6 0.0 -0.3 3.2 11.3 4.0 14.0 7.0 8.0 6.0 0.9 55 1.2 1.6 1.3 9.0

CALENDAR AVERAGE
2010 2.9 1.4 1.9 -0.5 1.4 1.7 5.7 -13.7 15.3 -3.0 11.7 12.6 1.0 63 1.6 1.0 1.3 9.6 -1294 -9.2 2011 2.6 2.6 2.1 0.4 0.0 2.4 7.3 -1.2 10.5 -1.3 8.1 3.9 -0.8 61 3.0 1.6 1.3 9.0 -1350 -8.9 2012 3.4 3.5 3.2 0.2 0.0 3.1 8.2 4.4 9.5 9.0 9.3 6.4 0.3 58 2.0 2.0 1.9 8.5 -1050 -6.5 2010 2.8 2.4 2.9 -0.6 -0.3 2.6 10.6 -4.0 16.9 -4.6 8.9 10.9 1.1 16 1.3 0.7 0.8 9.6

Q4/Q4 2011 2.8 2.5 2.1 0.3 0.3 2.3 7.2 -0.6 10.2 2.7 8.2 4.8 -0.9 55 3.0 2.0 1.7 9.0 2012 3.5 3.5 3.2 0.1 0.0 3.4 7.5 4.7 8.5 11.5 10.0 7.0 -0.2 57 2.1 2.0 1.7 8.3

End of year 0.13 1.2 3.8 1.0 2.3 4.1

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, US Treasury, Federal Reserve Board, and MF Global

FORECAST SUMMARY As discussed on page 2, we continue to forecast that the recovery will improve over time, although we have trimmed our growth projections somewhat. We expect real GDP growth to average 3.5% at an annual rate from Q3 of 2011 through Q4 of 2012. Growth averaged an estimated 2.7% annual rate in the first two years of the recovery (including our 2.3% estimate for last quarter). The weakening in employment growth in May and June followed a clear pickup in the first four months of the year. We expect momentum to pick up again soon, consistent with at least a gradual downtrend in the unemployment rate. Although the unemployment rate rose in Q2, the 9.2% level in June was down from 9.6%, on average, in 10Q4, and 10.0% in 09Q4.

While we believe ample slack will keep inflation fairly tame, even core inflation has moved higher this year. We expect the pace in the core PCE price index to move up from 0.8% in 2010 to 1.7% in both 2011 and 2012 (Q4/Q4). Overall inflation will likely be higher than core inflation this year, due to a net rise in food and energy prices. A still-high (but declining) unemployment rate and still-tame inflation will likely allow the Fed to be patient in unwinding stimulus; we forecast a still-low 1.0% funds rate at the end of 2012, with the first increase in June 2012. Some tightening in 2012 will likely also come via Fed balance sheet shrinkage; we expect Fed officials to hold the balance sheet constant through Q1 of next year. We expect Treasury yields will rise, with 10-year yields up to 3.8% at the end of 2011 and 4.1% at the end of 2012.

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

DATA PREVIEW
TREASURY INTERNATIONAL CAPITAL SYSTEM (MON, JUL 18, 09:00)
billions of dollars, nsa TOTAL NET INFLOWS NET LONG-TERM SECURITIES NET FOREIGN, US RESIDENTS* NET BY NON-US RESIDENTS TREASURY BONDS & NOTES PRIVATE OFFICIAL GOVT AGENCY BONDS PRIVATE OFFICIAL CORPORATE BONDS PRIVATE OFFICIAL EQUITIES PRIVATE OFFICIAL OTHER LONG-TERM SECURITIES SHORT-TERM SECURITIES TREASURY BILLS CHANGE IN BANKS' NET LIABILITIES FEB 83.4 27.2 -5.5 32.6 30.6 14.7 15.9 -1.5 -7.3 5.8 -2.5 -1.6 -0.9 6.1 6.6 -0.5 -11.1 -1.8 -9.3 69.2 MAR 127.1 24.0 -30.7 54.7 26.8 19.9 6.8 9.5 6.9 2.6 3.8 3.2 0.5 14.7 14.8 -0.1 -12.3 -18.3 -21.9 133.7 APR 68.2 30.6 -14.2 44.8 23.3 -1.0 24.4 7.5 5.8 1.7 -3.8 -2.8 -1.0 17.8 16.6 1.2 -11.7 -8.0 -13.4 MAY

The housing market index (HMI) had been at either 16 or 17 in each of the seven months prior to the drop to 13 in June. We expect at least some of that weakening will be reversed in the upcoming report. The S&P 500 homebuilding index fell in early June but has risen, on balance, since then. The trend-setting housing market index has been close to flat at a low level since early 2009, although it fell a bit more in last months report.
000s, saar 1450 1150 850 550 250 03 04 05 06 07 08 09 10 11 New single-family home sales (l) Housing market index (r)
Source: Bureau of the Census and National Association of Home Builders

index, sa 76 58 40 Jun May 12 22 4

The homebuilder portion of the S&P 500 is up, on balance, since early June.
080101

57.4

500 400 300 200 100

index, both scales

090101

100101

110101

27 22 17 Jul 14 Jun 12 7

*Negative sign for outflow. Source: Treasury Department

Net inflows into long-term U.S. securities have averaged $34.3 billion per month so far in 2011, down from $65.2 billion, on average, in 2010. Much of the dropoff has been in long-term Treasury securities: to $31.8 billion per month so far this year from $58.8 billion, on average, last year. Consistent with that pattern, long-term Treasury yields rose in Q1. However, yields began to fall in April and then dropped sharply in May.
HOUSING MARKET INDEX (HMI) (MON, JUL 18, 10:00)
JUL EST APR HOUSING MARKET INDEX CURRENT SALES EXPECTED SALES HOMEBUYER TRAFFIC 16 15 22 13 MAY 16 15 19 14 JUN 13 13 15 12 CONS 14 MF 14

08

09

10

11

Housing market index (r) S&P 500: homebuilding index (l)

Source: Standard & Poors and National Association of Home Builders

Source: National Association of Homebuilders, Bloomberg, and MF Global

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

WEEKLY STORE SALES (TUE, JUL 19, 07:45/08:55)

JUN 25 WEEKLY ICSC, %w/w, sa WEEKLY ICSC, %y/y REDBOOK, %y/y 2.9 3.0 2.5 MAY WEEKLY ICSC, %m/m, sa REDBOOK, %m/m, sa MONTHLY ICSC, %m/m, sa WEEKLY ICSC, %y/y REDBOOK, %y/y -2.3 -2.7 -2.6 3.0 3.9 JUL 2 1.5 3.5 5.2 JUN 0.1 0.9 1.8 2.7 3.8 5.5 5.4 JUL 9 0.4 5.5 5.4 JUL THRU 9 2.9 0.6 JUL THRU 16 JUL 16

(based on the differential with the average vacancy rate in the 1990s). Those inventories are likely to trend lower in coming quarters. The current trend in starts is probably close to one million (at an annual rate) below the long-term trend based on household formation and replacement building. The lack of decline through Q2 of last year, despite that arithmetic, reflected what appeared to be a largely cyclical slowing in household formation (consistent with weakness in the labor market). While the data have been volatile, household formation shows a net pickup since mid-2010. In turn, housing vacancies excluding seasonal use homes show a net decline of 150,000 in the last three quarters. We expect the rate of decline to pick up significantly in coming quarters. Housing starts have shown little net change since early 2009.
000s, saar 2400 1900 1400 900 400 05 06 07 08 09 10 11 May

MONTHLY ICSC, 5.4 6.9 %y/y Note: monthly data are based on the retail industry's fiscal calendar, the fiscal month of July ends on July 30. Source: International Council of Shopping Centers, Instinet, and MF Global

Both weekly store sales have accelerated in recent weeks, consistent with spending power being boosted by a reversal of some of the recent surge in gasoline prices. However, such a pickup was not evident in the June retail sales report, which showed sales excluding autos, gasoline, and building materials up just 0.1% m/m after 0.2% m/m in May.
HOUSING STARTS AND PERMITS (TUE, JUL 19, 08:30)
JUN EST CONS MF 575 560

Housing starts
Source: Census Bureau

Housing permits

000s, saar

MAR 593 418 175 574 392 182

APR 541 404 137 563 395 168

MAY 560 419 141 609 406

STARTS SINGLE-FAMILY MULTIFAMILY PERMITS SINGLE-FAMILY MULTIFAMILY

MORTGAGE APPLICATIONS (WED, JUL 20, 07:00)

MBA indexes 597 575 JUN 17 PURCHASE INDEX WKLY 185.8 180.3 188.9 183.9 4-WK AVG 187.8 185.0 186.5 184.7 REFI INDEX WKLY 2675.2 2604.4 2363.6 2217.3 4-WK AVG 2619.4 2659.8 2631.7 2465.1 30-YEAR MORTGAGE RATE % 4.57 4.46 4.69 4.55

203 JUN 24 JUL 1 JUL 8 JUL 15 Source: Mortgage Bankers' Association

Source: Census Bureau, Bloomberg, and MF Global

Starts rose in January (20.9% m/m), fell in February (-18.6% m/m), rose in March (14.5% m/m), fell in April (-8.8% m/m), and then rose in May (3.5% m/m). Through the volatility, the trend still looks roughly flat. Starts averaged a 570,000-unit annual rate in the first five months of this year, up marginally from the 562,000unit pace in the second half of 2010. Permits also averaged a 570,000-unit pace in the first five months of the year, down marginally from 577,000 in the second half of last year. The recovery in starts has been and probably will continue to be restrained by still-high inventories of vacant existing homes; we estimate the excess is currently just under three million homes

The purchase index continues to show little net change, consistent with a near-flat trend in home sales. It averaged 189.4 in Q2 following 186.4 in Q1.

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

EXISTING HOME SALES (WED, JUL 20, 10:00)

JUN EST MAR TOTAL (000s, saar) %m/m %y/y MONTHS' SUPPLY MEDIAN PRICE (%y/y) 5090 3.5 -6.4 8.3 -5.8 APR 5000 -1.8 -13.8 9.0 -6.5 MAY 4810 -3.8 -15.3 9.3 -4.6 CONS 4950 2.9 MF 4810 0.0 -8.0

JOBLESS CLAIMS (THU, JUL 21, 08:30)

NEW CLAIMS (000s, sa) WKLY JUN 11 JUN 18*** JUN 25 JUL 2 JUL 9 JUL 16*** CONS MF 420 429 432 427 405 410 405 4-WK AVG 426 426 428 427 423 418 417 CONTINUING CLAIMS (000s) REGULAR sa 3714 3724 3712 3727 EXTENDED* nsa 3935 3847 3831 sa** 4186 4079 3999 TOTAL sa** 7900 7803 7711

Source: National Association of Realtors, Bloomberg, and MF Global

After rising in March, existing home sales fell in April and May. Through the volatility, the trend continues to look close to flat. Our 4.810 million-unit-pace forecast for June is down marginally from the 4.908 million total for 2010. The level of existing home sales is still down sharply from the annual peak of 7.076 million in 2005. Moreover, post-2007 data are likely to be revised down soon (probably next month) to account for apparent double-counting. The expected revision will likely not affect the most recent trajectory significantlyjust the levels. Existing home sales have been exceptionally volatile during the last two years, likely reflecting tax credit and weather effects. The net result has been a near-flat trend: sales totaled 4.9 million in 2008, 5.1 million in 2009, and 4.9 million in 2010.
index, sa 130 118 106 94 82 70 01 02 03 04 05 06 07 08 09 10 11 12 May 000s, saar 7350 6620

*Sum of federal extended and emergency claims **Using seasonal factors for regular continuing claims ***Sample week for employment report Source: Department of Labor, Bloomberg, and MF Global

The 405,000 reading for new claims in the latest report was down sharply from 427,000, on average, in the prior four weeks. Moreover, the latest reading included an 11,500 boost from temporary furloughs of state workers in Minnesota (related to a budget dispute). Unfortunately, the claims data are especially volatile and unreliable in early July (including the period covered by the upcoming report), reflecting seasonal adjustment challenges related to annual summer shutdowns in the auto industry. While we expect claims to trend lower this quarter, we caution against extrapolating yet.

Jobless claims may be starting to decline again.

initial claims, 000s , sawr

670

5890 5160 4430 3700

570 470 Jul 9 370 270 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 4-week average
Source: Department of Labor and MF Global

PHSI (l)
Source: National Association of Realtors

Existing home sales (r)

Weekly

10

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

Along with new claims for unemployment benefits, the total number receiving unemployment benefits may be starting to signal some improvement again. (See regular + emergency/extended continuing claims series in the chart below.)
J millions, sa 17 J J J J J J J

Home price indexes have weakened over the past year, although they had risen in the prior year and net changes since mid-2009 have generally been modest. Prices may be starting to stabilize.
index, June 2006 = 100 105

14 11 8 5 2

Jun

17 14
94 83 72 61 06 07 08 09 10 11 FHFA house price index (purchase only, sa) S&P/Case Shiller index (composite 20, sa) CoreLogic home price index (nsa) Radar Logic house price index (nsa) Apr/May*

Jun 25 Jul 2

11 8 5 2

Jan-08 Aug-08 Mar-09 Oct-09 May-10 Dec-10 Jul-11 Regular continuing claims Regular + emergency/federal extended continuing claims Total unemployed in employment report
Note: extended claims are seasonally adjusted using seasonal factors for regular continuing claims. Source: Department of Labor and MF Global

*FHFA and S&P/Case Shiller through April; Radar Logic through mid-May; CoreLogic through May. Source: CoreLogic, Federal Housing Finance Agency, Standard & Poor's, Fiserv, MacroMarkets LLC, and Radar Logic

FHFA HOUSE PRICE INDEX (THU, JUL 21, 10:00)

MAY EST FEB PURCHASE-ONLY INDEX %m/m, sa %m/m, nsa %y/y -1.5 -1.0 -5.6 -0.4 -0.3 -6.2 0.8 1.8 -5.7 0.1 0.0 0.5 -6.1 MAR APR CONS MF

The weakening in home prices recently has been concentrated in distressed-sale homes.
index, January 2000=100, nsa 210 190 170 150 130 05 06 07 08 09 10 11 12 CoreLogic home price index: total CoreLogic home price index: excluding distressed sales
Source: CoreLogic

Source: Federal Housing Finance Agency, Bloomberg, and MF Global

Home price indexes may be starting to stabilize after several months of declines.

May

11

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

LEADING INDICATORS (THU, JUL 21, 10:00)

JUN EST MAR APR -0.4 4.8 0.1 2.0 MAY 0.8 5.2 0.1 1.8 CONS 0.2 MF 0.3 5.7 0.1 1.7

FED BALANCE SHEET (THU, JUL 21, 16:30)

billions of dollars unless noted, nsa TOTAL FED ASSETS %y/y SECURITIES HELD OUTRIGHT US TREASURIES FEDERAL AGENCY MORTGAGE-BACKED OTHER LOANS JUN 29 2869 22.9 2643 1617 117 909 13 0 13 61 0 153 2629 31.9 JUL 6 2874 23.1 2648 1625 115 909 13 0 12 60 0 153 2694 34.8 JUL 13 2882 22.9 2654 1630 115 909 13 0 12 60 0 155 2694 34.8 JUL 20

LEADING INDEX (%m/m, sa) %y/y COINCIDENT INDEX (%m/m, sa) %y/y

0.7 5.2 0.2 2.4

Source: Conference Board, Bloomberg, and MF Global

The index of leading indicators appears to have risen modestly in June, with boosts from the yield curve and money supply more than offsetting drags from the stock market, housing permits, and consumer expectations components.
PHILADELPHIA FED MANUFACTURING SURVEY (THU, JUL 21, 10:00)
JUL EST indexes, sa CURRENT ACTIVITY NEW ORDERS EMPLOYMENT PRICES PAID PRICES RECEIVED 6-MONTH OUTLOOK 6-MONTH CAPEX PLANS APR 18.5 18.8 12.3 57.1 27.5 33.6 20.0 MAY 3.9 5.4 22.1 48.3 16.8 16.6 23.1 JUN -7.7 -7.6 4.1 26.8 4.4 2.5 12.9 CONS 2.0 MF 2.0

PRIMARY CREDIT TALF MAIDEN LANE LLC (I*, II**, & III***) CENTRAL BANK LIQY SWAPS OTHER ASSETS
MONETARY BASE (2-wk avg)

% y/y

* Bear Stearns assets. ** AIG CDO assets. *** RMBS assets. Source: Federal Reserve Board

Fed officials have been assuming that every $200 billion increase in total Fed assets provides stimulus equivalent to 25 bps on the funds rate. Based on that arithmetic, the $2 trillion increase since 2008 has provided stimulus equivalent to around 250 bps on the funds rate. (See our Taylor Rule analysis in the June 24, 2011 issue.)
MONETARY AGGREGATES (THU, JUL 21, 16:30)

Source: Federal Reserve Bank of Philadelphia, Bloomberg, and MF Global

The national ISM index showed improvement in June, in contrast to the sharp weakening in the New York and Philadelphia Fed surveys. To some extent, the contrast may have reflected momentum turning from negative to positive during the month since the sample cutoff point came later in the ISM survey than in the New York and Philadelphia Fed surveys. Meanwhile, the New York survey showed only a slight fading of weakness in early July, with the current activity index rising to -3.7 from -7.8 in June. We expect the Philadelphia Fed report to show a bit more improvement, with more help from a rebound in auto production than in the New York Fed survey.

JUN 20 M1 (billions of $, saar) %ch from 13 weeks ago, saar %y/y M2 (billions of $, saar) %ch from 13 weeks ago, saar %y/y Source: Federal Reserve Board 1940 10.9 12.4 9088 8.0 5.7

JUN 27 1949 10.3 12.3 9165 11.7 6.3

JUL 4 1998 21.8 15.9 9253 14.8 7.9

JUL 11

At 7.9%, the y/y change in M2 is up sharply from 4.3% in Q1 and 2.3% in all of 2010. The recent acceleration has reflected renewed inflows into money market funds and a pickup in inflows into demand and savings deposits. To some extent, the pattern likely reflects increased risk aversion.

12

Economic Analysis | US 7/15/2011 | MACRO FOR MARKETS

July 11Aug 5
MONDAY TUESDAY WEDNESDAY THURSDAY FRIDAY

11
(11:00) Fed purchase op (11:00) 4-wk Bill Announcement (11:30) 3- & 6-mth Bill Auction

12
(07:30) Jun NFIB (07:45/08:55) Store Sales (08:30) May Foreign Trade (10:00) Jul IBD/TIPP (10:00) May JOLTS (11:30) 4-wk Bill Auction (13:00) 3-yr Note Auction (14:00) FOMC Minutes

13
(07:00) Mortgage Apps (08:30) Jun Imp Prices (09:10) Boston Feds Rosengren (10:00) Fed Chairman Bernanke to deliver semiannual monetary policy report testimony to the House Financial Services Committee (13:00) 10-yr (r) Note Auction (13:20) Dallas Feds Fisher (14:00) Jun Budget (14:00) Month-ahead Treasury purchase op schedule from NY Fed

14
(08:30) Initial Claims (08:30) Jun Retail Sales (08:30) Jun PPI (10:00) May Inventories (10:00) Fed Chairman Bernanke to deliver semiannual monetary policy report testimony to the Senate Banking Committee (11:00) 3- & 6-mth Bill and 10yr TIPS Announcement (13:00) 30-yr (r) Bond Auction

15
(08:30) Jun CPI (08:30) Jul NY Fed (09:15) Jun Indust Prod (09:55) Jul prelim Michigan (11:00) Fed purchase op

18
(09:00) May TICS (10:00) Jul NAHB HMI 14e (11:00) 4-wk Bill Announcement (11:30) 3- & 6-mth Bill Auction

19
(07:45/08:55) Store Sales (08:30) Jun Starts/Permits Starts 560Ke Permits 575Ke (11:00) Fed purchase op (11:30) 4-wk Bill Auction (14:00) Discount Rate Minutes (19:30) KC Feds Hoenig

20
(07:00) Mortgage Apps (10:00) Jun Exist Home Sales 4810Ke/0.0%m/m

21
(08:30) Initial Claims 405Ke (08:30) Chicago Feds Evans (10:00) May FHFA 0.0%e (10:00) Jun Lead Ind 0.3%e (10:00) Jul Phil Fed 2.0e (10:00) Fed Chairman Bernanke testifies on Enhanced Oversight after the Financial Crisis (11:00) 3- & 6-mth, & 1-yr Bill, and 2-yr, 5-yr, & 7-yr Note Announcement (13:00) 10-yr TIPS Auction

22
(11:00) Fed purchase op

25
(10:30) Jul Texas Mfg. (11:00) 4-wk Bill Announcement (11:30) 3- & 6-mth Bill Auction

26
(07:45/08:55) Store Sales (09:00) May S&P/CS (10:00) Jul Cons. Cof. (10:00) Jul Richmond Fed (10:00) Jun New Home Sales (11:00) Fed purchase op (11:30) 4-wk and 1-yr Bill Auction (13:00) 2-yr Note Auction

27
(07:00) Mortgage Apps (08:30) Jun Durables (13:00) 5-yr Note Auction (14:00) Beige Book

28
(08:30) Initial Claims (10:00) Jun PHSI (11:00) Jul KC Fed (11:00) 3- & 6-mth Bill Announcement (13:00) 7-yr Note Auction (12:45) Richmond Feds Lacker (14:30) SF Feds Williams

29
(08:30) Q2 GDP (1st est), including annual revision (08:30) Q2 ECI (09:45) Jul Chicago PMI (09:55) Jul Michigan (10:00) Jul Milwaukee PMI (10:00) Q2 Housing Vacancies (11:00) Fed purchase op (15:15) Atlanta Feds Lockhart and St. Louis Feds Bullard

1
(10:00) Jun Construction (10:00) Jul Mfg ISM (10:00) Jul Help Wanted (11:00) 4-wk Bill Announcement (11:30) 3- & 6-mth Bill Auction

2
(07:45/08:55) Store Sales (08:30) Jun Personal Income, including annual revision (11:30) 4-wk Bill Auction Jul Lt Vehicle Sales

3
(07:00) Mortgage Apps (08:15) Jul ADP (08:30) Jul NonMfg ISM (10:00) Jun Factory Orders

4
(08:30) Initial Claims (11:00) Fed purchase op (11:00) 3- & 6-mth Bill Announcement Jul Chain Store Sales

5
(08:30) Jul Employment (15:00) Jun Consumer Credit

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