NET ISSUANCE EXPECTED TO DECREASE

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1 NET ISSUANCE EXPECTED TO DECREASE Summary of Bill, Coupon, and TIPS Issuance by Treasury 2008:Q1-2012:Q2E $ Billions CMBs 13-week Bills 52-week Bills 3-year Notes 7-year Notes 30-year Notes 4-week Bills 26-week Bills 2-year Notes 5-year Notes 10-year Notes TIPS 0 1Q'08 3Q'08 1Q'09 3Q'09 1Q'10 3Q'10 1Q'11 3Q'11 1Q'12 Source: U.S. Treasury, 2Q'12 SIFMA Government Forecast Survey TOTAL ISSUANCE OUTLOOK The SIFMA Quarterly Issuance Survey 1 forecasts total net Treasury bill, note, and bond issuance to be $194.5 billion in the second quarter of 2012, 51.5 percent below the net $401.2 billion issued in the first quarter (actuals include cash management balances) 2. The survey participants expect the Treasury issuance to be almost in line with the Treasury s January borrowing estimate of $200 billion. 3 The 5-year and 7-year notes issuance is expected to increase by 44 percent in 2Q 12 from the results in 1Q 12, while 4-week bills are projected to decrease by 25.4 percent. Overall, the net issuance of bills is expected to decrease significantly from $153.9 billion in 1Q 12 to redemption of $57.5 billion in 2Q 12 while issuance of coupons is expected to increase by 1.9 percent to $252.0 billion in 2Q 12. Excluding cash management bills (CMBs), total net issuance stood at $361.2 billion in 1Q 12, a 20.4 percent increase from $300.0 billion in the prior quarter. CMBs issuance quadrupled in 1Q 12 to $40.0 billion from the post-crisis low of $10.0 billion in 4Q 11. The total first quarter net issuance of $401.2 billion was 29.4 percent higher than $310.0 billion issued in the previous quarter and 9.6 percent below the Treasury s January borrowing estimate of $444 billion for the first quarter of After a very unstable second half of 2011, the US economy showed small signs of improvement in 1Q 12. The unemployment rate fell to 8.2 percent in March to a three-year low, inflation rate declined to 2.7 percent, consumer spending increased, and the Conference Board s index stayed relatively flat in March. On March 13, 2012 the Federal Reserve indicated that the economic activity was expanding moderately. The Fed agreed to keep the target Fed Funds rate at percent at least through late 2014, continue the program of extending the average maturity of its securities holdings, as well as reinvesting principal payments from its MBS holdings to support conditions in the mortgage market. Also, under the terms of the Budget Control Act passed in August 2011, the statutory debt limit was increased by $1.2 trillion to $ trillion on January The survey was conducted beginning on April 9, 2012 and ending on April 20, Survey results are medians and the dates and numbering of quarters are based on calendar year rather than fiscal year, unless otherwise noted. A description of the participants is provided on page 6. Previous survey reports may be found at (Research Reports). 2 SIFMA s 1Q 12 Government Forecast Survey results can be found here. 3 Treasury s January borrowing estimates can be found here. 1

2 Projected 2-Year, 5-Year, and 10-Year Treasury Yield Movement Sept Sept. 2012E % Yield 10-year 5-year 2-year Sept Dec Mar Jun Sept Dec Mar Jun. 2012E Sept. 2012E Source: U.S. Treasury, 2Q'12 SIFMA Government Forecast Survey TREASURY COUPON ISSUANCE The median forecast for net issuance of Treasury coupon securities (notes and bonds) is $252.0 billion for the second quarter, 1.9 percent higher than 1Q 12 s net issuance of $247.3 billion. 4 Gross coupon issuance is expected to total approximately $536 billion, 4.8 percent below the $563.2 billion issued in the prior quarter. The gross issuance of notes and bonds is expected to decrease across all maturities with largest declines expected in 3-year, 10- year, and 30-year note, which are forecasted to decrease by 8.0 percent, 8.2 percent, and 8.2 percent, respectively. All other maturities (2-, 5-, and 7-year) are expected to fall by about 2.0 percent in 2Q 12. Survey respondents also expect Treasury to finish 2Q 12 with $85 billion in cash 5, slightly below the $90 billion mark Treasury estimated in January for an end-june cash balance. As Treasury has transitioned from bill to coupon financing, the percentage of nominal coupons in the Treasury s portfolio has been gradually increasing and the average maturity of the portfolio continues to extend. The Treasury Borrowing Advisory Committee has consistently advised Treasury to extend the average maturity of the debt portfolio in order to minimize borrowing costs over time and reduce the portfolio s rollover risk. During the last Treasury Borrowing Advisory Committee meeting, Treasury discussed the viability of using Floating Rate Notes (FRNs) as a way to minimize borrowing costs, better managing its liability profile, enhancing market liquidity, and expanding investor base. The committee unanimously favored FRNs issuance but noted that more work remains to be done to explore various structural considerations. T-BILL ISSUANCE Survey participants expect to see net bill redemption of $57.5 billion in the second quarter, much different result than the $153.9 billion issued in the first quarter of Compared to the previous quarter forecast, there was a smaller, however still wide, variance in responses 6 showing no consensus in expectations for net bill issuance. As Treasury continues to extend average maturity of its portfolio, the percentage of bills in the portfolio keeps falling (currently at about 15 percent). The Supplementary Financing Program (SFP) remains suspended. In the report to the Secretary, the Treasury Borrowing Advisory Committee stated that as the future debt limit increases remain uncertain the reintroduction of the SFP was not possible for the foreseeable future. TIPS Survey respondents forecast that Treasury will issue $26.0 billion of Treasury Inflation- Protected Securities (TIPS) in the second quarter of 2012, slightly below the $37.4 billion issued in 1Q 12. Treasury mentioned in February Quarterly Refunding Statement 7 that it has taken a number of steps over the past two years to improve liquidity in the TIPS market as they are an important part of Treasury s overall debt management strategy. Treasury remains pleased with the demand for inflation protection and expects to continue to gradually increase gross issuance of TIPS planning to issue $150 billion in TIPS in U.S. TREASURY YIELD OUTLOOK The survey forecasts benchmark 2-year Treasury yields to decrease slightly in 2Q 12 and than staying flat at 0.30 percent through the third quarter of The yields of 5-year and 10-year Treasuries are expected to increase slightly in the second quarter and then decline in 3Q 12. After the period of significant yield increases until March 2011, the yields have been declining mostly due to the sluggish US recovery and continued financial crisis in Europe reaching their lows at the end of In the first quarter of 2012, Treasury yields rebounded slightly for all maturities. Two-year rates increased from 0.25 at the end of 2011 to 0.33 percent at the end of 1Q 12, five-year yields increased from 0.84 percent in 4Q 11 to 1.04 percent in 1Q 12 and 10-year rates rose from 1.87 percent to 2.22 percent during the same period. 4 Net coupon issuance projections for the second quarter of 2012 ranged from $231 billion to $275 billion. 5 Net cash position projections for the end of the second quarter of 2012 ranged from $60 billion to $100 billion. 6 Net bill issuance projections for the second quarter of 2012 ranged from a net redemption of $7 billion to $121 billion. 7 See US Treasury s February 2012 Quarterly Refunding Statement. 2

3 Treasury Yield Projections and Ranges 2 year Treasury Note ( ) ( ) 5 year Treasury Note ( ) ( ) 10 year Treasury Note ( ) ( ) 30 year Treasury Bond ( ) ( ) 3 Month LIBOR Source: 2Q'12 SIFMA Government Forecast Survey Mar. 31, 2012 Jun. 30, 2012 E Sept. 30, 2012 E Going forward, through September of 2012, survey respondents forecast the rates to slightly increase and then decrease for the intermediateand long-term maturities. On the front end of the curve, the respondents expect the rates to slightly decrease in 2Q12 and then stay flat through September 2012 (forecast summarized in the table on the left side). UPSIDE AND DOWNSIDE RISKS TO RATES The survey asked participants about risks to their forecasts or events that could cause interest rates to move higher or lower than forecasted (summarized below in the table). The main risks to the forecast identified on the upside (higher-thanexpected yields) remained: better than expected economic data, improvement of the US labor market, strong position of the Fed on no QE3, and improvement of the situation in Europe. In contrary, the main risks noted on the downside (lower-than-expected yields) were: worsening of the US economy, escalation of European crisis, lower than expected inflation, and another quantitative easing program. Summary of Risks to Rate Forecast #1 #2 #3 #4 #5 #6 #7 Risks to Upside Risks to Downside US economic data much stronger than expected, Escalating crisis in Europe, weaker than expected increased concerns on US sovereign risk US economic data Lack of further bad news from Europe, better US Return of the European debt talk, announcement of economic data more easing policy from the Fed Stronger than expected US economic data, risk asset Weakening US economy, lower than expected rally inflation, European contagion Fed communicating that there will be little/no Further deterioration of the European situation with chance of QE3 or any other quantitative easing a possible worsening of the situation in Spain program following the Maturity Extension Program Stronger economic growth Disorderly markets in Europe leads to financial crisis Labor market improvement; removal of end-2014 More rapid deterioration of US economy, european language by fomc, clear resolution of european crisis enters more intense stage, full-blown QE3 sovereign crisis Relatively aggressive Fed, signs of some agreement on avoiding the fiscal cliff Weaker than expected economic data and worsening of European financial conditions Source: 2Q'12 SIFMA Government Forecast Survey AGENCIES COUPON ISSUANCE In 1Q 12 the total issuance by the four largest Federal agencies stood at $181.9 billion, a 3.5 percent decline from $188.4 billion in 4Q Survey participants forecast total gross coupon issuance by the four largest Federal agencies to increase to $195 billion in the second quarter. The projections reflect 7.2 percent increase from 4Q 11, with much of the forecasted increase coming from Freddie Mac, which is expected to issue $50.0 billion in coupons in 2Q 12, 61.6 percent above its 1Q 12 issuance of $30.9 billion. Fannie Mae and Federal Farm Credit Banks are expected to increase their issuance in 2Q 12 by 8.7 percent and 8.4 percent, respectively, while Federal Home Loan Banks issuance is forecasted to drop by 13.2 percent to $75.0 billion from $86.4 billion in 1Q 12. Survey respondents indicated that almost 40 percent of 2Q 12 s issuance volume is expected to come from the Federal Home Loan Banks (FHLBs), about 25 percent each from Freddie Mac and Fannie Mae, and the remaining 11 percent from the Farm Credit System Banks. 8 Includes Fannie Mae, Freddie Mac, the Federal Home Loan Banks (FHLBs), and the Federal Farm Credit Banks Funding Corporation. 3

4 Projected 2-Year, 5-Year, and 10-Year Spreads to Treasury Sept Sept. 2012E Bsp Sept Dec Mar Jun Sept Dec Mar Jun. 2012E Sept. 2012E Source: U.S. Treasury, 2Q'12 SIFMA Government Forecast Survey Distribution of Duration Weightings 2-year Agency 5-year Agency 10-year Agency Strong Over Over Neutral Under Strong Under 0-3 years 0% 14% 71% 0% 14% 3-7 years 0% 0% 71% 0% 29% 7-10 years 0% 0% 71% 14% 14% years 0% 0% 14% 71% 14% Source: 2Q'12 SIFMA Government Forecast Survey SPREADS OUTLOOK Respondents expect agency-to-treasury yield spreads to increase slightly in 2Q 12 for the short- and long-term securities and stay flat for intermediate-term securities and then stay flat for the intermediate- and longterm securities in the third quarter of 2012 while continuing to slightly increase for short-term maturities. The swap spreads for all maturities are predicted to increase in 2Q 12 and then stay flat through September The 3-month LIBOR rate is expected to increase to 0.50 percent by end-june from 0.47 at the end of 1Q 12 and stay flat through the 3Q 12. PORTFOLIO ALLOCATION RECOMMENDATIONS The survey asked for model portfolio allocation recommendations, compared to the current portfolio weighting, across the maturity spectrum of the U.S. Treasury yield curve. The results showed that the consensus among the participants regarding the weighting is neutral to strong underweighting. No respondents recommended strongly overweighting any of the maturities and only one recommended overweighting the short maturities. Most recommendations remained neutral for short- and intermediate-term maturities and underweight for year maturities. Compared to the results from the last survey, which showed no consensus regarding the portfolio weightings, the participants are leaning towards more neutral and underweight position for all securities for 2Q 12. 4

5 SIFMA S GOVERNMENT SECURITIES ISSUANCE AND RATES FORECASTS SIFMA's Government Securities Issuance and Rates Forecast Forecast numbers appear in bold Issuance Projections (in $Billions) U.S. Treasury Borrowing 1 1Q'11 2Q'12E Net Coupon Issuance Gross Coupon Issuance Gross Coupon Redemptions Net Bill Issuance (57.5) Gross Bill Issuance 1, ,251.0 Gross Bill Redemptions 1, ,317.0 Quarter end cash balance (expected) 85.0 U.S. Treasury Quarterly Gross New Issuance 4 week Bill week Bill week Bill week Bill year Treasury Note year Treasury Note year Treasury Note year Treasury Note year Treasury Note year Treasury Bond Treasury Inflation-Indexed Securities Federal Agency: Projected Total Gross Coupon Debt Issuance 2 Fannie Mae Freddie Mac Federal Home Loan Bank System - Office of Finance Federal Farm Credit Banks Funding Corporation FY estimates Federal Budget Deficit Estimate - FY2012 1,100.0 Federal Budget Deficit Estimate - FY Rates & Spreads Outlook 3/31/12 6/30/12E 9/30/12E Interest Rates (End of Quarter in %Yield) 2 year Treasury Note year Treasury Note year Treasury Note year Treasury Bond Month LIBOR Spreads to Treasury (End of Quarter in Basis Points) 2 year Agency Benchmark/Reference Notes year Agency Benchmark/Reference Notes year Agency Benchmark/Reference Notes Year SWAP Spreads Year SWAP Spreads Year SWAP Spreads Excluding Federal Reserve's purchase 2 Including all callable coupon issuance and excluding all discount notes 3 Agency spreads to Treasury yield are in basis points. 5

6 SURVEY PARTICIPANTS Primary Dealers Committee Richard C. Volpe (Co-Chair) RBS Securities Inc. Paul Murphy (Co-Chair) Bank of America Merrill Lynch Government Securities Research and Strategist Committee The Securities Industry and Financial Markets Association s Quarterly Government Securities Issuance and Rates Forecast reflects the responses to a survey of members of the Association s Primary Dealers Committee and Government Securities Research and Strategist Committee. The Committee is composed of trading strategists and research analysts at Association member firms who specialize in the U.S. government and agency securities markets. The survey is intended to provide market participants with the current consensus expectations and median forecasts of many of the Primary Dealers and other firms active in the U.S. government and agency securities markets. 6

7 CAPITAL MARKETS Robert Toomey Managing Director and Associate General Counsel, Rates Division SIFMA RESEARCH Charles Bartlett Vice President and Director of Statistics Justyna Podziemska Research Analyst The Securities Industry and Financial Markets Association (SIFMA) prepared this material for informational purposes only. SIFMA obtained this information from multiple sources believed to be reliable as of the date of publication; SIFMA, however, makes no representations as to the accuracy or completeness of such third party information. SIFMA has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete. The Securities Industry and Financial Markets Association (SIFMA) brings together the shared interests of hundreds of securities firms, banks and asset managers. SIFMA's mission is to support a strong financial industry, investor opportunity, capital formation, job creation and economic growth, while building trust and confidence in the financial markets. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA). For more information, visit 7