EFTA01123162

Deutsche Bank Markets Research r4 United States Economics Date Rates 27 March 2015 Credit Dominic Konstam Research Anal t US Fixed Income Weekly Aleksander Kocic Research Anal • There are plenty of minefields out there but none are likely to dominate Joseph LaVorgna what we still think for now is a powerful rational that warrants the current Chief US Economist term structure. Long rates are well defined by low to negative term premium and a low terminal Funds rate. While we still see plenty of reasons why the Fed struggles to lift off making it as hard as it always has been to make money on shorting front rates to say a 3M forward horizon. Alex Lo • There are reasonable risk reward trades that we like including using bullish rate views to buy cheap risk on protection e.g. on SPX. We also for choice rather receive the market than pay it based on term premium staying very negative (Europe) but also the risk of some softer US data. This would favor curve caps and some relief steepening. Volatility should be higher in Stuart Sparks the front end relative to the back end. Research Analyst • The round out for 2014 GDP data was fascinating because like Rip Van Winkle after 5 years of would be accelerating recovery, we realize that there has been no acceleration - for five years! A rock solid dullness of sub Daniel Sand 4 percent nominal growth. And everyone is so afraid of inflation! More Research Analyst importantly it clearly justifies the low terminal funds rate that the market is pricing as it leaves as many questions unanswered in terms of productivity and profits especially. • We look at the potential for Japanese financial sector demand for overseas Steven Zeng, CFA securities to pick up in 2015 and conclude there is up to $200 billion to Ftneafflonth &naive. come based on dollar yen moving to 130 and recent sensitivities of asset allocation decisions as well as pre-announced pension asset reallocations. 'Actual, fitted, and projected wage acceleration Table of Content —Actual AXE acceleration US Overview Page 06 — Fitted AXE acceleration Treasuries Page 16 --- Projected ME acceention,no unemployment decline --- Projected ME acceention,rapid unemployment decline. LBO NAIRU Derivatives Page 22 --- Projected ME aceeention,rapid unemployment decline. FOMC NAIRU Agencies Page 26 LS LO US Credit Strategy Page 28 as Mortgages Page 32 AO Bond Market Strategy Page 41 Economics Page 44 Chart Pack Page 48 .10 ilta Ise 11 info non mil 1104 no! 1001 tile Moe Ical Dace 2431 acal 1001, axe 2011 1002 an4 100S 01 41 01 CO 41 01 01 QS 01 0) 01 OA CO 01 CO 01 41 Os 01 QS 01 4S &war 'OweManx salDeverch, Orme Deutsche Bank Securities Inc. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/0.4/2014. EFTA01123162 2015 Outlook Recommendations Trade Detail Rationale Risks Opened Entry Current P/L Overly aggressive Fed could produce a FVH5 Sell FVH5 puts versus buy like "tightening tantrum" which is negative for Spreads tighten in a Option +10.bp structured swaption for zero risk asset valuations, likely producing sell-off beyond the 12/19/14 Swaption premium hedging flows in swap spreads that push strikes +9bp spreads wider. The post-Fed sell-off has left the Option Buy 1x1, 1y1y receiver spreads Maximum total loss is spot/forward spread near multi-year post- 12/19/14 29c with strikes ATMF and ATMS the premium outlay crisis highs. This curve segment might be expected to steepen if, for example, higher inflation Swaps RV Pay 3y1y versus 2y1y produces greater pricing power, or if the Curve flattens 12/19/14 40 long-absent cyclical increase in productivity finally materializes. 1X2 receiver spreads: Buy Vulnerable to rally Option $100mn 3M10Y ATMF vs sell This a positive carry trade that captures the below the breakevens 12/19/14 $200mn 3M10Y 19bp OTM central path for the 10Y sector during 01. with potentially receivers at zero net cost unlimited downside. Sell 1X2 payer spreads at the Vulnerable to rally The repricing of Fed hikes could begin in Option short end: Sell $100mn 6M3Y below the breakevens, 02 with the short end rebounding sharply 12/19/14 ATMF vs. buy $200mn 34.5bp with potentially after initial rally. OTM payers at zero net cost unlimited downside. Sell $100mn 6M10Y straddles With expectations of Fed hikes, volatility Option vs. buy $300mn 6M3Y straddles should move to the front end of the curve, Unilateral spike in 12/19/14 backend vol. for a net premium of 175K while the back end movements remains Quiet flatteners: sell $1bn 6M Option 5s/l0s 9.5bp OTM curve cap vs. Potential for considerable bear flattening Curve steepens. 12/19/14 buy$lbn 6M 5s/10s atmf/9.5 should the market reprice the Fed hikes. curve floor spread at zero cost This captures the risk of bullish flattening Quiet bulls: Sell $100mn 1Y10Y of the curve where growth is unable to Option 50bp OTM payers vs. buy take off either due to fundamental Sell-off beyond 3.10%. 12/19/14 $100mn 1Y10Y ATMF/33 weakness or in response to a policy receiver spreads costless mistake of premature hikes. Option Buy $100mn 1Y30Y receivers, Loss equal to the Bull/flatteners at the back end. 12/19/14 struck at spot, at 1270c options premium This is a leveraged expression of a policy- 6M dual digital: 2s> F+10bn - & Loss equal to the Deutsche Bank Securities Inc Option mistake trade where premature hikes 12/19/14 10s c F-10bp offer 11.5% options premium cause a rally at the back end. Given the impressive run equities have had Equity/rates hybrids: Buy 19-Jan- on the back of both normalization of the Limited downside with Option 2015 SPX 100/90 put spreads markets as well as the accommodation. maximum loss equal to 12/19/14 subject to ss > Fwd+25bp, offer Fed exit is likely to be disruptive for their the options premium. short-term performance. Seurat. Lbutlab ILYA EFTA01123163 Deutsche Bank Securities Inc. 2015 Outlook Recommendations Trade Detail Rationale Risks Opened Entry Current P/L Further Treasury +5 bp Sell rich bond futures against The classic bond futures look rich in the outperformance of the 12/19/14 +21 bp (Closed on +1,249k RV cheap off-the-run bonds long end 6.25s of 5/2030 in the 2/25) long end Further decline in Inflation The 2yr2yr inflation appears attractive on a Buy 2yr2yr forward breakevens medium-term inflation 12/19/14 1.95% 2.03% +329k Swaps long-term history expectations The long end inflation market looks Inflation Buy long end inflation undervalued on a long-term perspective, Inflation markets 12119/14 1.92% 1.91% -1,305 with the 30-year TIPS breakevens trading further underperform. below 2.00%. Inflation Buy 5yr5yr forward breakevens The 5yr5yr forward breakevens have Decline in energy prices 12119/14 2.18% 2.06% -206k as a hedge to high rates dropped to their multi-year lows. and a stronger dollar With the Fed moving closer to its first rate hike in a low-inflation, moderate-growth Higher implied vol Agencies Buy 3nc1y and 5nc6m callables environment, there are few themes as sure cheapens callables 12119114 vs. matched-maturity bullets as the flattening of the curve, likely going relative to bullets beyond the forwards. On the bullet agency curve, spreads are relatively tight to the level of rates volatility, Increased GSE risk Agencies 2-year vs. 5-year agency spread and they risk widening 5-10bp from current widens intermediate 12/19/14 curve flattener levels on our model incorporating forward spreads vols and the projected level of outstanding debt. Widening of credit With CCC energy bonds trading at 60 cents spreads beyond the on the dollar, and oil just $10 away from breakeven point as well US Credit WHOYiMd:Sacovwed puts .matching - . the most severe percentage drop ---- - - in oil prices over 1asi-a, our sense is that as a rally in credit 12/19/14 on HY CDX beyond the breakeven, we may be reaching the latter stages of a with potentially pronounced move lower in a commodities- unlimited downside in driven decline in HY credit valuations either scenario Stamm Lboacts Ea * EFTA01123164 1,1 (Other Current Recommendations CO CO CD a Trade Detail Rationale Risks Opened Entry Current P/L Treasury Sell rich bond futures against Sell the rich classic bond futures versus Classic bond futures 11/26/14 +21 bp +12 bp +337k RV cheap off-the-run bonds off-the-run bonds in the 2026 to 2028 richen sector Treasury Short ultra long futures vs 30s Ultra long futures are rich Ultra continue to richen 6/12/14 +12 bp +6 bp +480k RV Inflation Short 1/2026 breakevens vs 5yr 10s look rich; sell the rich 1/2026s 10s richen further 1/23/15 +15 bp +0 bp +229k and 30yr breakevens Inflation Long 30yr TIPS breakevens 10s-30s breakeven curve appears too flat Long term inflation 11/26/14 +16 bp +6 bp +389k versus 10yr TIPS breakevens on a long term basis expectations decline Inflation Long 1/2029 breakevens vs 10yr 10yr TIPS to 1/2029 breakeven curve is too 1/2029 breakeven 10/3/14 +2 bp -2 bp +206k breakevens flat cheapen further The long end inflation market looks Long term inflation Inflation Long 30yr TIPS breakevens undervalued; 30yr TIPS breakevens near 12/12/2014 1.91% 1.91% -862k expectations decline multi-year lows We like being long 2yr2yr or 2yr3yr Inflation forward breakevens to take advantage of Medium term inflation Long 2yr2yr inflation swaps 12/12/2014 1.77% 2.04% +2,467k Swaps cheap 5s, while avoiding negative carry in expectations decline front end TIPS Reform bill stalls in Buy long-dated GSE debt: Legislative momentum of Johnson-Crapo Agencies Buy $100mm FNMA 6.625 on GSE reform is credit bullish for long- Congress or language 3/14/14 +40 bp +2,039k +48 by on government 11/30s vs. T 5.325 2/31s dated GSE debt. modified. Receive $100m 3y3y SIFMA Further ratio curve Muni Attractive roll down profile 4/25/13 78.2% 77.8% +590k at 78.2%. (Sorid) steepening Rally below the 1X2 1Y 5Y5Y ATMF/41 receiver Long-end rallies on premature or fast rate Option spreads costlass hikes (policy mistake) breakevens; unlimited 9/26/14 Os -87.85 -1,004k downside Buy $100mn 6M 2y1y 25bp OTM MC payers vs. Sell 100mn -0.65 -5k Option Curve flattens on a hawkish FOMC Curve bear steepens 9/12/14 Os 1Y 4Y1Y 45bp OTM MC payers at zero net cost Sell $100mn 6M5Y ATMF vs. Rates sell off half-way Option buy $200mn 6M5Y 30bp OTM Skew trades rich in a sell-off and stay there till the 9/12/14 0 bp 0.0 bp -2k payers at zero net cost expiry Buy $1bn 6M 5s./10s ATMF/15 Deutsche Bank Securities Inc Curve flattens beyond curve cap spread vs. sell Si bn Curve steepens as the market converges Option the floor strike; 9/5/14 6M 5s/10s 5bp OTM curve floor to Fed unlimited downside at zero net cost &yew Deur* &ink EFTA01123165 F Other Current Recommendations Trade Detail Rationale Risks Opened Entry Current P/L co co Option Buy $100mn 2Y2Y ATMF receivers vs. sell $22.7mn 2Y10Y ATMF Trend growth and low inflation limit the rise Recessionary mode with bull flattening of 10/3113 -6 bp -160 bp -1,538k receivers for the net takeout of $55K of long rates forwards Payer spreads:Sell n 2Y2Y F 92bp 01'M ptrierd Sell SS rs p va s buy 550mnnet V 00 laid niee ffeo reanov tial is frazte orearabelenifnogr itn raitdiaeting a Option 2Y30Y25bp "yersat zero The curve bear flattens 1/2/14 +2 by -10 by -127k eo cost curve payer: e mn 5Y5Y ATMF mid-curve payers vs buy 5Y5Y.has.a limited upside while IY2Y could Option $200mn 1Y2Y ATMF payers for the see significant repricing due to adjustments The curve bear steepens 3/14/14 -18e 0.00 +184k net takeout of 28c of monetary policy Swaps Receive $1,023.4mm 2yly rate Positive carry look at repricing Fed The curve bear steepens 5/20/14 +95 bp +78 bp +1,701k Rv versus pay $1,002.7mm lyly rate swaps Receive $1,023.4mm 2yly rate versus pay $431.2mm iyi y rate and Further rally via Fed delay benefits 2yly rate 2yly underperformance 5/20114 -10 bp -11 bp -179k Rv $597mm 3yly rate Swaps Foiward steePener: Receive fixed on Slope of 10s30s too fiat given level of lOy 11,1 41g1mmmmi W y0, pay fixed on Rate Curve flattens 3/28/14 +45 bp +34 bp -2,769k Rv Swaps cefiixvv edfiovi22 09n86 rr.t4r1 versus,51 vOryatft j arfo dnv is ahriya orZiagy Tait Oy°4v5ii:reiveirt:IsPreay y Further 10y5y 4/29/14 +22 bp +10 bp -781k nv mm 5y5y and $257.6 mm 15y5y 15ytoward outperformance Cross Buy S1Om each of SPNTAB 2.95% Bank credit +25 bp +9 bp 3/16; SPABOL 2.625% 5/16; DNBNOR Risk-on retightening of covered bonds in stable rates regime underperforms; Eurozone credit crunch; Widening 7/25n3 +37 bp +11 bp -567k Market 2.90% 3116 on ASW. (Sodd) in a rate sell-off +31 bp +11 bp US-Europe spread tightener: Receive Cross fixed in $244 mm USD 5y5y rate vs. US recovery disappoints Spread widens 1/24/14 +127 bp +178 bp -15k Market rate pay fixed on 5165.8mm EUR 5y5y P/L as of 03/26/2015 prices. We stoned &sarong the penbernance °four trade recommendettons on June 1$ 2010. This rabic shows ow current open tecommendattonv a rabic of our dosed posidons is in the bock or publication Both tables wig be a stout feature in the Weedy. PenO1171•7OCO numbers are based on trader end-a'day marks and do not include &Wolfer ;ores& or transaction costs. We consider the relevant benchmark for ow trades b be a rare position given the leveraged or omen* meeker neubal aspects &these trades Thstancal performs/me is no:asuman:ea °Maury performance Scene Deutstiv gent EFTA01123166 27 March 2015 US Fixed Income Weekly United States Rates Dommt Konstam Gov. Bonds & Swaps Research Analyst Rates Volatility 1+1) 212 250-9753 Aleksandar Kocic US Overview Research Analyst 1+1) 212 250.0376 e There are plenty of minefields out there but none are likely to dominate Alex Li what we still think for now is a powerful rational that warrants the current Research Analyst term structure. Long rates are well defined by low to negative term 1+1) 212 250.5483 premium and a low terminal Funds rate. While we still see plenty of reasons why the Fed struggles to lift off making it as hard as it always has been to make money on shorting front rates to say a 3 month forward Stuart Sparks horizon. Research Analyst e There are reasonable risk reward trades that we like including using bullish (+11212 250-0332 rate views to buy cheap risk on protection e.g. on SPX. We also for choice rather receive the market than pay it based on term premium staying very negative (Europe) but also the risk of some softer US data. This would Daniel Sond favor curve caps and some relief steepening. Volatility should be higher in Research Analyst the front end relative to the back end. (+1) 212 250-1407 e The round out for 2014 GDP data was fascinating because like Rip Van Winkle after 5 years of would be accelerating recovery, we realize that Steven Zeng. CM there has been no acceleration - for five years! A rock solid dullness of sub Research Analyst 4 percent nominal growth. And everyone is so afraid of inflation! More (+1) 212 250.9373 importantly it clearly justifies the low terminal funds rate that the market is pricing as it leaves as many questions unanswered in terms of productivity and profits especially. e We look at the potential for Japanese financial sector demand for overseas securities to pick up in 2015 and conclude there is up to $200 billion to come based on dollar yen moving to 130 and recent sensitivities of asset allocation decisions as well as pm-announced pension asset reallocations. e Historically, consistent bullish flattening of 1O53Os has increased the probability of falling CPI yly inflation over the subsequent six months. Bull flattening was pervasive enough to suggest an elevated risk of falling inflation following November, December, and January, and the indicator is hovering around "true" levels at present. e The median bond fund manager will likely finish the first quarter being close to flat to the benchmark. Our excess returns model and SMRA survey responses show that portfolio managers have reduced their exposure to corporate bonds and increased allocation into Treasuries. Still Play the Range Markets seem choppy without a lot of direction. Investors in general seem more occupied with long Eurostoxx, Nikkei and the still the dollar although since the Fed, the "handover" of dollar strength from Europe led to Fed led is undermining. In rates while everyone "wants" higher rates, we are of the view that the market isn't going anywhere and the range should continue to be traded. Our bias is still to buy dips rather than sell rallies. We also think investors should be more convinced not to short the front end. It didn't help you in the rally and it probably won't help you in a rangy market. This suggests carry trades and curve caps are more attractive now than before, relative to outright duration plays. Page 6 Deutsche Bank Securities Inc. EFTA01123167 27 March 2015 US Fixed Income Weekly There are some quiet bear trades that we continue to like. More volatility in the front end than back end; accumulator trades that put you into deferred payers conditional on short rates underperforming their forwards. We also still like cheap risk on protection trades that knock out if rates do breach their forwards. There are lots of issues that will likely roil markets. Greece is unresolved. The US jobs data has been so strong that it could lose a beat. The Fed is entering a decision zone that could rattle risk markets if too aggressive or the back end if too much of a "relent". With falling reserves and the end of bank HOLA purchases, investors are wondering who are the new buyers - especially as fx reserves are now falling, partly China but also petrodollars. Domestic insurance/pensions for now perhaps and maybe Japan again after their year end? While in Europe bonds are hard to come by and the ECB has only just begun! All said and done though 2 percent 1Os seem a very good mid point around which to trade with 5y5y around 2 1/2 percent. Daily realized volatility has been as high as 15 bps compared with more like 5 bps last year. So whatever the conviction, make it less so! Term Structure There has been just one day this year when being short the five year rate made money versus the 3 month forward. So for all the focus on "being in flatteners", it is important to appreciate that flatteners have worked to the extent that the long leg has rallied. Pushing the Fed up till now has been a fool's game. Over the past twelve months it is not much better with 5s beating the forward as around 10 percent of the time and that was concentrated in September before the Fed meeting. Note that the forward on March 6th was exceeded by 2.8 bps. It is hard not to take the moral of the story as not to push the Fed and that was before the latest FOMC meeting. Of course the curve is actually not flattening this year. 5s10s has been impressively stable around 45/50bps. If you can't make money from shorting the front end leg and the curve is stable, by definition this year is being defined by a range and performance is dictated by identifying the limits of that range. The range itself is anchored around a 2 I/2 percent 5y5y rate in our view which is consistent with our original outlook for 2015. If 5s gravitate towards their forwards (but not exceeding them!), 10s can budge a little higher to say 2 Vs percent for a 2 1/2 percent 5y5y rate. 5y5y has already traded close to 2'/4 and back up towards 3 percent as 10s came close to 1 /12 percent and traded in swaps over 2'/< percent. We think what we have seen so far this year remains a good template for trading through q2 and into the second half. Our view remains that we are likely to finish the year when 10s around current levels and 5s still no exceeding their forwards. Deutsche Bank Securities Inc. Page 7 EFTA01123168 27 March 2015 US Fixed Income Weekly l5y5y less 5y I 5Y realized vs. 3mth forward 5 yr rate 2.5 0.2 2 Sy+3mths less 0 1.5 0.1 - 0.2 - . 1 0.3 —5y5y less Sy OA 0.5 At 0 -0.6 3/27/2014 7/27/2014 11/27/2014 3/27/201S 6/27/2014 9/27/2014 12/27/2014 3/27/201S Sant BAN ham.LPond Detsischo Bea Samar Oka**,Mums LP•nd Amway Sant There are three themes that form this outlook and various risk factors that could force a reappraisal and need to be closely monitored. Two, the terminal Funds rate and term premium, relate directly to longer term rates, where we use the 5y5y as a proxy. One, the Fed, relates to the evolution of the front end in terms of the timing and speed of normalization. Terminal funds can be viewed as the sustainable terminal rate for the Fed in the sense that it is an equilibrium i.e. the Fed does not have to keep raising rates or reverse course. 5y5y has been a good proxy for the terminal rate in that it pretty much sits on top of Funds at the end of each cycle -- therefore represents an upper ceiling i.e. the fed would not have had to reverse course if funds never reached 5y5y ex ante. In the Fed's ACM term premium model 5y5y has averaged in 2015 2.59 percent. This is a little higher than the Treasury 5y5y and about 30 bps higher than the market pricing for 5y5y OIS, currently around 2.3 percent. Whichever way we look at it the market is clearly pricing for a terminal Funds rate somewhere around 2 1.6 percent if not a little below. For this rate to be higher we think there would need to be a sustained shock higher in sustainable growth expectations. With 2014 GDP now in, what is once again so impressive is that GDP has not failed to disappoint. Nominal growth finished the year a paltry 3.66 percent and the year averaged 3.88 percent. This is bang in line with the average of the last 5 years since 2009, of 3.85 percent. You could be forgiven for thinking that we actually were witnessing an accelerated economic recovery in reading the economic consensus. The fact is that this is nonsense. The economic growth has been incredibly stable at a sub 4 percent nominal pace for five years. No acceleration. Just the same. Will 2015 be any different. Best guess, "no". Note that this is why there is no productivity growth to speak of as the labor market recovery that has been impressive has cannibalized productivity. This raises core issues as to the sustainability of labor market strength, profitability and the ability of the economy to withstand any kind of accommodation removal. It also begs the question why have corporates relied so much on labor input to deliver the GDP rather than eking out productivity gains. Is it a technology/innovation constraint, an investment issue or simply using "cheap" labor while it is available. However while these issues are to be resolved, fair to say it is hard to argue that the fair value terminal rate needs to be very different from 2 /12 percent. Note that profits are now lower for 2014 than 2013, the first decline, since 2008. Page 8 Deutsche Bank Securities Inc. EFTA01123169 27 March 2015 US Fixed Income Weekly Term premium itself could also adjust even if the terminal funds rate outlook doesn't. In many ways this is probably a bigger risk especially if we link the term premium decline to foreign demand for US rates. We showed the other week the correlation between the decline in the term premium and noverinvestment" by foreign central banks into Treasuries. Note that the term premium enjoyed an accelerated decline in late 2014 but has since been more stable, in line with the collapse in euro yields. Clearly any shift in the Euro outlook could lead to a reversal in the drop in term premium in the US. However in this regard the Fed's own shift in their dot plot should be taken into consideration. The dots have both become less diverse and importantly the lower long term dot outlook - which we think has more to go - serves by definition to reduce market uncertainty around the Fed's normalization process. As such it is not at all clear that term premium should rebound 100 - 150 bps or so i.e. to mid 2014 levels or at least might be confined to a more moderate rise. This is especially likely once normalization begins in that in all the tightening cycles since the late 1980s term premium falls when the Fed tightens. !Funds vs. 5y5y term premium !Corporate Profits yoyo 20 7 60 18 —Fundc 50 6 16 . .hyby term premium - 5 40 14 30 12 4 20 10 3 10 8 2 0 6 • 1 10 4 0 20 2 30 0 -1 ;1 4 1 3 Vz MI IN Wt IN N N N N get IN get IDD on en io 0rn V' 40 IN CO CO D3 O1 al O1 O 13 CO 1.O LO LO N O O1 O1 O1 O1 O1 O1 O1 O1 O1 O1 O1 O1 O O O O S t0 N n tie O1 e[ll «) O1 co Cl mm 0 2 O2 Vi OO Swan &Wattla SNOW LP AndI:Mune-hit Bart* SOurt• IMF. ElbOinbiva FirstVE0 LP andOf•IfIthe &IS 15y5y term premium, fitted and neutral rate 'Nominal Private final demand vs. 5y5y risk neutral rate 5 20 5y5y RN rate 4 15 3 —nom private final demand yoy 2 10 1 5 0 5y5y fitted 1 purr.] rat. 0 *ii• 4 1' tit 440 sz, .4) N IN IN IN IN IN IN IN IN IN IN N to 0 to 0 0 0 en en en en on IN LII 03 L-I it N OM IN N tO O1 IN 1.11 CO L-I IN IN 8§ § N i-i 01 ot IP tE) 61. tab in 0 N r. r. CO 03 03 CO PI @ o 19% 19> 19% 46‘. 19 1, P . et at le 5 Smee. LW. Obarroog Anna LP on:taxman Bent &urry no. e,bambey AVM* LP en 04areme iba• Deutsche Bank Securities Inc. Page 9 EFTA01123170 27 March 2015 US Fixed Income Weekly The Front End The front end is all about the timing and speed of lift off. Speed will probably be more important than even timing in that the market twill easily absorb a one and done Fed. Speed can also backfire in that if risk assets behave poorly for any given speed, the Fe won't be making their terminal rate in one swoop. An intra tightening period of stable Funds would allow for a sharp re-rally in short rates at some stage (Note 5s typically converge to Funds at the end of a tightening cycle, so any sense that the fed would initiate a pause for several quarters would allow substantial spread convergence in our view). We remain of the view that this Fed does not want to commit the type 2 error and will be hard pressed to even begin raising rats in 2015. The bar is low for them to delay in that if the payroll report is all they have to go on, a soft patch in jobs could easily prompt ongoing delay. Using private final demand the long run output gap has barely improved since the crisis. One has to go the other extreme, to measure the gap from 2009 to argue that the gap has in fact closed. Either way the link with inflation has become tenuous. 'Output gap since 1960 'Output gap on trend since 2009 15 2.5 2.5 10 2 2 5 1.5 1.5 1 0 0.5 -5 e cvr yoy 1 0 10 —output gap since -0.5 0.5 15 1960 -1 ~ cdfe CPI yoy 0 - output aap since 200981 1.5 -20 N M 01 N § N tO tO N CO CO CO CO a, 8 01 01 01 01 01 01 01 01 01 01 01 0 0 0 el tnee et b9 , Ve rt b9 t e Smear IMF. Obambeng Sewn°,LP a. Daman &me Samar nwr. iffinninry FaeroeLI gniAntra.,Bork In terms of wage inflation below we update our wage model to incorporate the Fed's new NAIRU estimates. If unemployment does not continue to fall, there is still no wage acceleration. If it does then with the lower NAIRU estimates wage acceleration is still delayed until late 2015 - all consistent with a Fed struggling to raise rates. Unemployment Model In order to understand the relationship between wage acceleration and unemployment, we first project the year-over-year change in the growth rate of the average hourly earnings of production and nonsupervisory workers (AFIE) on two variables. The first is a dummy variable that equals one if the unemployment rate is less than the CBO's estimate of the NAIRU, and equals zero otherwise, and the second is the year-over-year change in the unemployment rate. The thought experiment is that wage inflation should be affected by whether there is slack in the labor market and by the trajectory of job growth. As shown in the chart below, the above-discussed variables are able to explain a fair amount of the variation in wage acceleration: the R- squared of the regression is 33%. Page 10 Deutsche Bank Securities Inc. EFTA01123171 27 March 2015 US Fixed Income Weekly We then project our model to assess the prospects for wage acceleration in the near future. If the unemployment rate remains stagnant at its present level, 5.5%, the NAIRU will not get breached and our model implies that wage inflation will not increase. By contrast, suppose that the unemployment rate continues its rapid decline. In particular, we consider the case in which payrolls grow at a steady pace of 225k per month through the end of (11 2016, and simulate the path of the unemployment rate using the Atlanta Fed's "Jobs Calculator", under the assumption of an unchanged labor force participation rate.1 Then our model suggests that wage inflation will pick up because the NAIRU will be breached. The timing of this event, however, depends crucially on the estimate of the NAIRU. In our projection, the unemployment rate will fall below the CBO's estimate of the NAIRU, which is slightly below 5.4%, in Q2 2015. But it will only fall below the FOMC's most recent estimate, 5.0%- 5.2%, in Q3 or Q4 2015.2 This highlights the importance of the FOMC's reduction of its NAIRU estimate at the March meeting from a range that was consistent with the CBO's estimate to the above-discussed range. All else being equal, the lower NAIRU estimate implies that the FOMC expects wage acceleration to be delayed by three-to-six months. The likely corollary is that the committee now expects to raise rates a quarter or two later. 'Actual, fitted, and projected wage acceleration — Actual ARE acce1eralon — Fitted ARE acteleraue' --- PrcietedAHE acceleraton, no unemployment decline - Preected t accelerator.. rapid unempOpilent clean*. CEO NAIRU Pre acted AHE accelerator.. rapid ureapIoyment dente, FOMC NAIRU IS • OS • 00 O5 .20 ISM MSS 1107 191$ 1990 1991 1993 1910 1996 1997 1999 MOO 1002 1003 MOS 1016 MOO 1009 1011 1012 1014 1015 41 43 41 43 41 43 CO 43 Al 43 41 43 Al 43 41 43 41 CO Co 43 01 03 Santa' MS Arleta. Itne• Anylotcs an Oansoka sine Japanese Potential Buyers? Treasury demand ebbs and flows between different investor classes. In 2014h2 foreign FX reserves managers became important but as much as a diversification trade away from Euros. Given the decision by the GPIF to increase their allocation to overseas bonds and equities, there is naturally a lot of interest in the potential for Japanese buying of Treasuries going forward. Here we try and quantify the potential in terms of three specific sectors: pensions; insurance and deposit taking institutions including the banks and post office. Note that we only have data for outward investment so this is not exclusively Treasuries but we can presume that the bulk of any outward investment adjustments will be made via Treasuries, given low Euro yields. I We also assume that the average monthly population growth rate and the average monthly CES/CPS employment ratio remain at their current levels. 2 - For austrative purposes, the chart uses the lower bound of the FOMC's estimate, 6.0%, which gets breached in O4 2015 in our projection. Deutsche Bank Securities Inc. Page 11 EFTA01123172 27 March 2015 US Fixed Income Weekly For pensions we simply adopt the GPIF asset allocation decision to raise foreign bond holdings by 4 percent. The allocation for all pensions is higher than GPIF at 23 percent but assuming the 4 percent is applied across all pension assets implies an increase in outward investment of about $51 billion. For depositories and insurers we are slightly more empirical and link changes in their allocation to the dollar yen 10 year forward rate. There tends to be a very strong correlation, especially for insurers and especially when JGB yields are very low as one would expect. The link via USJPY suggests that as long as the yen is viewed as been strong but likely to weaken, there is a greater drive for outward investment. This is consistent with a view hedge ratios likely run substantially lower than 100 percent. Based on the betas for each, we estimate that year on year allocations to outward investment can rise by as much as 3 percent for insurers and 0.7 percent for depositories, assuming dollar yen moves towards 130. Our outlook is to 2O16g1 which implies by this time outward investment would rise respectively to almost $700 billion and $940 billion for insurers and depositories. This represents an increase of almost $100 and $40 billion for each. In sum we think Japanese private investors could account for additional overseas (mainly bond and mainly Treasury) purchases of almost $200 billion. This is not quite as violent a shift as some of the FX reserve manager moves of 2014 but is an important additional source of demand that is likely to keep some downward pressure on yields, all else being equal. 'Outward investment stock by sector $ billion 'Allocation as % total assets total fin depositories nsurance pensions 20.0 5.0 10.0 5-0 -0' .."..."%ern.s.Ce . .,„.....a................wator 0.0 °I O,p .-I .-I .-I .-I .-I .-I .-I .-I .-I ... .4 o0, p ..... Owirimeol p gig§§§§r§§§ Soutar IMF, Oboe'Mince LP an Twat..Omit Swear (MM. &bombe, Fmtace to walkway 8,ne I 1 Insurance/depositories change in allocation vs. 10 yr Insurance change in allocation vs. JGBs usdjyp fwd 3 depositories 100 3 0.0 2.5 — insurance 2.5 95 lisurante ltisr e 83 2 - dollar yen 10yr fwd 05 90 2 1.5 85 1.5 1 1.0 1 80 0.5 0.5 75 1.5 0 0 70 0.5 2.0 65 1 60 1.5 2.5 20031 20081 20131 19981 20031 20081 20131 Stern AC &bombe°;mace Le rub:taxman Oat Sane NO. &bombe), Amerce LP es%Ocarche ibnot Page 12 Deutsche Bank Securities Inc. EFTA01123173 27 March 2015 US fixed Income Weekly A note on the cash curve and inflation Last autumn we noted historical evidence that 10s30s is forward looking with respect to inflation, and developed a simple indicator which illustrated that consistent bullish flattening (10s and 30s fall, 10s30s flattens) tends to presage a higher probability of declining inflation. The indicator is simple enough, we look at a rolling 20 trading day period and calculate the frequency of bullish flattening as a percentage of that 20 day period. Using Treasury data for 10s and 30s, and (month end) data from September 1994 until present, the unconditional probability of inflation declining over a 6m period was 53%. Conditioned upon a month-end bull flattening percentage of at least 60% (36 "events" during the historical period), the probability of CPI y/y falling over the subsequent 6m has historically been 75% (27 instances of falling inflation of the 36 events). 'Treasury 10s30s and bull-flattening "events" 120 1 100 80 Treasury 10s30s, by Indicator, 1 or 0 so 40 20 0 -20 0 f••• m m CO 8 8 8 8 8 ?..). .1 gt 0 e.• 01 6to 40 ct; g Ol Z —•LL 2 La. &war Often*.&ea To be fair there is a potential reason to view this result with more caution that usual, and that potential reason is the possibility that the long end slope could be flatter than might otherwise be the case due to capital inflows, particularly from Europe. Indeed, our colleagues in economics currently project that headline CPI y/y will rise to 0.6% in Q3. Additionally conditions in the Middle East are obviously fluid and a deterioration in the security environment could push oil and inflation higher. On the other hand, a more aggressive Fed could lead to further dollar strength and renewed downward pressure on traded goods generally and oil in particular. Portfolio managers flat in 01, reduce credit overweight It's so far been a rollercoaster year for real money investors. After lagging the benchmark for all of January, US bond fund managers reversed their underperformance and built a sizable lead over the benchmark in February through early March, only to see their excess retum steadily chipped away in the recent weeks. As it stands, the median bond fund manager will likely finish the first quarter being close to flat to the benchmark. The following charts show the cumulative excess returns from top 20 US bond funds in 2015 and the market performance of 10y yields and credit spreads. Deutsche Bank Securities Inc. Page 13 EFTA01123174 27 March 2015 US Fixed Income Weekly 'Top 20 bond funds vs. DB benchmark: 1/1/15 - 1/31/15 'Top 20 bond funds vs. DB benchmark: 2/1/15 - 3/6/15 0.50 2.50 Vilzasstos/stans 2/1/2015 to 3/6/2015 0.00 2.00 1.50 g -DSO too g o.so c _ _ LSO II .oso -2.00 -ISO .2.50 .narn goinsa .gr“00,0 nmq ..O..“00. g .INCOON,Dr-020.9..SNMON•01-.0,0.0. Performance ranting, sorted by returns Performance ranting, sorted by Sway Obcroborp hamar CPcn OowwMo Banc Seeker Obantov fnance!P sea Deuerchy Bane IUS bond fund excess returns and contributing factors 1.0 I10y Treasury yields and IG option-adjusted spreads 140 IG 045 lbe, left scale) 113re Yields (%, ribs scale) OA 139 2.30 0.6 136 2.20 0.4 134 132 2.10 0.2 0.0 130 2.00 (0.2) 121 1.90 126 (0.4) ISO 124 (0.6) 122 1.70 (0.) 120 1.60 (1.0) Jan.15 Feb-I5 Mar IS Ian-IS Feb 15 Mar-15 Saves Bluombal Minn LPend Attains Bank Sourer. elloombup FuLOOOLP end Dada?* line While the broad strategy for generating alpha has been for some time to overweight credit and underweight duration, money managers are showing signs of dialing back their overreliance on corporate debt and they seemed to have tiptoed back into Treasuries. The beta of daily excess returns from our credit index (80/20 IG/HY mix) regressed on bond fund excess returns has dropped to the lowest level of this year, and it's materially lower than the peak reading back in early 2014. The beta of daily Treasury total retums regressed on fund excess returns has decisively climbed higher over the last six months, now reaching the least negative level in more than a year. ( Credit and Treasury betas on the first component of bond funds excess return as —Credit beta — OundlOn beta Top 20 bond funds vs. DB benchmark: YTD 2015 2.0 IRO, based on /26/15 pikes 1.5 0.4 0.2 1.0 0.5 0.0 0000 0.0 .0.2 ..evM•INVO ne02g:: sou 2 -0.4 la013 120-14 Jan-15 Performance °miffing, sorted by return Sans &boobs" /Yard awwa Batt Sane &once Moen* LP end DautPdb> fine Page 14 Deutsche Bank Securities Inc. EFTA01123175 27 March 2015 US Fixed Income Weekly In the portfolio managers survey conducted by Stone McCarthy Research Associates, the systematic reduction in overexposure to credit is even more pronounced. As of last week, portfolio managers have a tactical allocation of 34.7% in corporate bonds versus the 23.7% in the Barclays US Aggregate Index. This 11% deviation from benchmark is the smallest in two years and nearly two percentage points lower compared to a year ago. The SMRA surveyed response of allocations to Treasuries also corroborates our excess returns model. Portfolio managers became very underweight in Treasuries in the second quarter of last year but gradually scaled back into this sector toward year end, and they closed the gap even more in January. Although, the SMRA survey showed a sharp drop in portfolio allocations to Treasuries in February that our model has yet to capture. SMR survey vs. Barclays US Aggregate Index: Portfolio Portfolio managers over-allocation in corporate bonds allocation to corporate bonds 40 Percent 35 30 25 -------------------------------------- 20 15 10 %IRA surveyed share: Corporates 5 --- Barcap Us AGG share: Corporates 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 Same' StompMcCarthy Ao AnomesMS< Parc*,Mice,and Ammer Bare Savoy Sent McOxtbrItrewca Measles ?USW Award radres one 0ftescia Are SMR survey vs. Barclays US Aggregate Index: Portfolio Portfolio managers under-allocation in Treasuries allocation to Treasuries 45 Percent (6) Percent 40 —Allocation vs. bendvnark: Treasuries ----------------------------------- (7) 35 30 (B) ....".''''",•••••••••••••••••••••••••••• 25 (91 20 IS (10) 10 — SMRA surveyed share: Treasuries Ill) S --- Baru, US Au share: Treasuries (12) s, 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 San Slone IlAcerniv Reseserh ASIOCONTSISURN OS,C6)6 110.m tedDestro.ibn. Source Scow Agerrtliy ftenetwoh Asseveles (SWAP. (AwSw mates on:f Camay art Deutsche Bank Securities Inc. Page 15 EFTA01123176 27 March 2015 US Fixed Income Weekly United States Rates Alex Li Gov. Bonds & Swaps Research Analyst (+1) 212 250.5483 Treasuries • Our 5s-10s UST model shows the curve is 60 bps (3.9 standard errors) too flat to Fed fund expectations and inflation outlook. We explore some factors that could drive this departure from the model fair value. • The difference between survey-based and market-based inflation measures could explain for about 35 bps of the deviation in our model. Higher term premium in the 5y sector could also account for another 15 bps. Taken together, it's reasonable to expect that 5s-10s is only 10 bps too flat. • We still like buying 5s on the curve. The 2s-5s-10s fly spread is 12 bps too high when regressed against the 2y1y rate. 5s-10s UST: a four-sigma event? (or something more prosaic) If the 5s-10s slope was completely determined by the level of short rates, Fed expectation and medium term inflation outlook, then the current excessively (and well-advertised) flatness of the curve is something of a massive anomaly that should have only 0.01% probability of occurrence. In modeling 5s-10s using observations going back the last 25 years, three variables - Fed funds, 2s-funds and the Michigan 5-10y inflation survey - have explained 88% of the variance in 5s-10s. It is puzzling then why the market has priced in such a flat 5s-10s that's 60 bps (or 3.9 standard errors) below the model's predicted value. I5s-10s UST, actual vs. fitted IModel residual (actual minus fitted) 1.60 Percent —Ss-les actual -Fated so 1.40 so 1.20 so 1.00 0.80 20 0.60 0 0.40 (20) 0.20 (40) (0.20) 1601 Predicted 0.097 4.207 • t ends- 0.09 . 2s-Funds f 0.39 . 6Y uMichlni (DA0) Sampe period: 411990. 1212014;R-square ES% (801 1990 1995 2000 2005 2010 2015 1990 1995 2000 2005 2010 2015 San Seoawerg twore [Pond Dowsolv Ant Sam" &wen hump LP andComte Bank One explanation is the divergence of market-based measures of inflation expectations from survey-based measures that's used in our model. While the median Michigan survey respondent expected 2.80% year-on-year inflation over the next 5-10 years, the 5Y5Y CPI swap has fallen to 2.20% from 2.80% six months ago. The Fed's 5-year forward breakeven inflation measure is even lower at 1.90%. The difference between survey and market inflation measures Page 16 Deutsche Bank Securities Inc. EFTA01123177 27 March 2015 US Fixed Income Weekly explains for about 35 bps of the excessive flatness using the Michigan beta in our model. If we plug in the lower of these two market-based measures, without recalibrating the model, 5s-10s looks 20 bps below fair value. Another explanation could be that there is some upward pressure on the 5y point of the curve. This could be the market pricing in a Fed that seems to be drifting apart rather than coming to consensus on the appropriate terminal Fed funds rate. In the March FOMC projections, the most hawkish and the most dovish members differed on their projection of the long run policy rate by 125 bps. Back in December their difference of opinion was 100 bps. One year ago, that difference was just 75 bps. Difference between highest and lowest projections of Fed ACM term premium and 2y-5y-10y term premium fly longer run policy rate 1.75 Percent 1.50 1.25 075 025- 000 illllllliillll G 4 G q N.Q v.0 1 4/ o# San MewsRees. endDeutsche ant tiA O 0 eft4 0 N.° 0 N.° s° by FOMC Projections Release Date 411( c#' -1 2008 2009 2010 2y term premium (%, left scale) —10y term premium (14, left sole) 2011 Sauter f cobra, Reserve zawl Onotadte Sant 2012 2011 2014 2015 Sy term premiurniii, left sc le) 2y-Sy-lOy fly (bp, right scale -20 The second chart on top shows the Fed's ACM Treasury term premium for the post-crisis period. Note that even though term premium on all parts of the curve have declined, only in recent months the 5-year term premium had begun trading on top of 10-year term premium. By the Fed's definition, this means investors are now more anxious about - and thus demanding more compensation for - the risk that short rates do not evolve as expected in 5 year's time than in 10 year's time. The 2y-5y-10y term premium fly also illustrates the point that required compensation for term risk is now the highest in the 5y sector relative to other parts of the curve. The fly residual suggests that this factor accounts for another 10-15 bps of excessive flatness in 5s-10s. All said, 5s-10s still may be too flat by 5-10 bps to fair value. But the misvaluation probably doesn't look as compelling as originally had seemed. We still like buying 5s on the curve. A regression of 2s5s10s fly versus 2yly swap rate shows the fly spread is cheap by 12 bps. With this week's surprisingly bad durable goods orders and the potential pressure on economists to take their Q1 GDP forecast lower, the Fed may be just one or two weak payroll reports away from being persuaded into waiting until next year to hike rates. If that happens, expect 5s to outperform and 5s-10s to resteepen. Auction recap: 2s, 5s, 7s, and 2-year FRNs Treasury sold $90 billion of notional securities through two-, five-, and seven- year note auctions this week. In addition, it also raised $13 billion cash in two- year floating rate notes (FRN). The two-year note and FRN auctions fared well with a solid customer demand and coverage ratios, whereas the other two auctions were comparatively weaker on both the measures. Deutsche Bank Securities Inc. Page 17 EFTA01123178 27 March 2015 US Fixed Income Weekly 2-year floating rate note (FRN) Indirect bidder participation rose by more than a half to a record high of 75.5% (42.9% average). In contrast, the indirect bidder participation fell to zero for the first time in the auctions held so far. The bid-to-cover ratio of the auction rose to a six-month high of 4.34, and compares with the prior-year average of 4.15. 12-year floating rate note (FRN) auction statistics Size ISbn) Primary Direct Indirect Cover Ratio Stop-out Dealers Bidders Bidders Yield 1yr Avg $ 13.7 52.3% 4.8% 42.9% 4.15 0.070 Mar-15 $13.0 24.5% 0.0% 75.5% 4.34 0.086 Feb-15 $13.0 49.9% 1.9% 48.2% 4.28 0.084 Jan-15 $15.0 46.0% 6.9% 47.1% 3.72 0.084 Dec-14 $13.0 70.1% 5.2% 24.7% 2.90 0.110 Nov-14 $13.0 42.8% 5.4% 51.8% 4.00 0.068 Oct-14 $15.0 50.1% 3.3% 46.6% 3.58 0.053 Sep-14 $13.0 41.0% 4.6% 54A% 4.45 0.041 Aug-14 $13.0 50.2% 3.3% 46.5% 4.38 0.055 Jul-14 $15.0 50.0% 3.3% 46.7% 4.09 0.070 Jun-14 $13.0 54.8% 5.1% 40.1% 4.43 0.069 May-14 $13.0 48.9% 9.4% 41.7% 4.69 0.063 Apr-14 $15.0 60.7% 4.8% 34.4% 4.64 0.069 Savor LS Masseyend Datinche Bank 2-year note Indirect bidder participation was solid for the third straight month in March; though their takedown of 45.7% was slightly lower in comparison with the five-year highs of +48% in the previous two months, but beat its prior-year average of 34.9% nonetheless. Direct bidder takedown rose past the average to 18.3% from 13.3% in February. Consequently, the combined buy-side participation of 64% was the highest since October 2012, and compares to its trailing-year average of 51.6%. The bid-to-cover ratio of the auction was in line to its average 3.4, and the auction stopped through by 0.1bp on its 1pm WI bid. 12-year note auction statistics Size Primary Direct Indirect Cover Stop-out 1PM WI BP Tail (Sbn) Dealers Bidders Bidders Ratio Yield Bid lyr Avg $29.0 48.4% 16.7% 34.9% 140 -0.2 Mar-15 $26.0 36.0% 18.3% 45.7% 3.46 0.598 0.599 -0.1 Feb-15 $26.0 38.5% 13.3% 48.2% 3.45 0.603 0.604 -0.1 Jan-15 $26.0 42.6% 8.8% 48.6% 3.74 0.540 0.541 -0.1 Dec-14 $27.0 49.8% 14.5% 35.7% 3.21 0.703 0.708 -0.5 Nov-14 $28.0 48.0% 16.2% 35.8% 3.71 0.542 0.550 -0.8 Oct-14 $29.0 47.2% 16.2% 36.7% 3.11 0.425 0.425 0.0 Sep-14 $ 29.0 43.0% 16.1% 40.9% 3.56 0.589 0.593 -0.4 Aug-14 $29.0 48.0% 12.1% 39.8% 3.48 0.530 0.530 0.0 Jul-14 $29.0 58.7% 14.3% 27.0% 3.22 0.544 0.542 0.2 Jun-14 $30.0 53.6% 23.3% 23.1% 3.23 0.511 0.513 -0.2 May-14 531.0 55.9% 25.2% 18.9% 3.52 0.392 0.391 0.1 Apr-14 532.0 57.7% 19.0% 23.4% 3.35 0.447 0.448 -0.1 Sant Le Musury end Ostesto Bank Page 18 Deutsche Bank Securities Inc. EFTA01123179 27 March 2015 US Fixed Income Weekly 5-year note Combined customer participation dipped below-average to a six-month low of 60.4% from 67.6% in February. Indirect bidder participation declined to 55.7% from 60.1% in February, though still above its prior-year average 53.7%. The trend of low direct bidder takedown continued in March as the participation fell to 4.7%, the lowest in the auctions since June 2013. The auction generated a soft bid-to-cover ratio of 2.35 in comparison to its prior-year average 2.68, and ended with a tail of 1.2bp. 15-year note auction statistics Size Primary Direct Indirect Cover Stop-out 1PM WI BP Tail ($bn) Dealers Bidders Bidders Ratio Yield Bid 1yr Avg $35.0 33.6% 12.6% 53.7% 2.68 0.1 Mar-15 $35.0 39.6% 4.7% 55.7% 2.35 1.387 1.375 1.2 Feb-15 $35.0 32.4% 7.5% 60.1% 2.54 1.480 t477 0.3 Jan-15 $35.0 27.4% 9.5% 63.1% 2.49 1.288 1.294 -0.6 Dec-14 $35.0 33.9% 7.3% 58.7% 2.39 1.739 1735 0.4 Nov-14 $35.0 25.1% 9.9% 65.0% 2.91 1.595 t611 -1.6 Oct-14 $35.0 41.7% 10.5% 47.8% 2.36 1.567 t550 1.7 Sep-14 $35.0 41.0% 8.8% 50.3% 2.56 1.800 1792 0.8 Aug-14 $35.0 36.4% 10.8% 52.7% 2.81 1.646 t644 0.2 Jul-14 $35.0 25.9% 25.9% 48.2% 2.81 1.720 1.729 -0.9 Jun-14 $35.0 38.2% 9.3% 52.5% 2.74 1.670 t668 0.2 May-14 $35.0 39.1% 10.5% 50.4% 2.73 1.513 t505 0.8 Apr-14 $35.0 36.5% 18.6% 44.9% 2.79 1.732 1723 0.9 Son US reenoyend Aroma* hat 7-year note The auction recorded a soft customer participation of 62.8% (vs. 64.7% average) for the second straight month. Indirect bidder takedown declined for the third consecutive month to 50.5% from 52.3% in February though was still above its prior-year average of 48.2%. Direct bidder participation increased to 12.3% from 10.5%, but remained below its average 16.5% for the seventh month in a row. The bid-to-cover ratio of the auction was also weak at 2.32, and compares with its 2.51 trailing-year average; consequently, the auction ended with a tail of 1.1bp. 17-year note auction statistics Size Primary Direct Indirect Cover Stopout 1PM WI BP Tail ($bn) Dealers Bidders Bidders Ratio Yield Bid 1yr Avg $ 29.0 35.3% 16.5% 48.2% 2.51 0.4 Mar-15 $29.0 37.2% 12.3% 50.5% 2.32 1.792 1.781 1.1 Feb-15 $29.0 37.1% 10.5% 52.3% 2.37 1.834 1.828 0.6 Jan-15 $29.0 29.0°k 14.9% 56.1% 2.50 1.590 1.584 0.6 Dec-14 $29.0 37.6% 5.9% 56.5% 2.39 2.125 2.118 0.7 Nov-14 $29.0 37.1% 12.8% 50.0% 2.63 1.960 1.957 0.3 Oct-14 $29.0 38.0% 15.4% 46.6% 2.42 2.018 2.009 0.9 Sep-14 $29.0 41.7°/3 10.0% 48.3% 2.48 2.235 2.225 1.0 Aug-14 $29.0 30.7% 20.4% 48.8% 2.57 2.045 2.047 -0.2 Jul-14 $29.0 37.4% 15.2% 47.4% 2.58 2.250 2.238 1.2 Jun-14 $29.0 42.7% 16.7% 40.6% 2.44 2.152 2.139 1.3 May-14 $29.0 35.6% 24.1% 40.4% 2.60 2.010 2.008 0.2 Apr-14 $29.0 31.0% 19.1% 49.9% 2.60 2.317 2.321 -0.4 son to Threswand Oniscne Ant Deutsche Bank Securities Inc. Page 19 EFTA01123180 27 March 2015 US Fixed Income Weekly Allotments update Treasury released the allotments data for the March three- and ten-year notes, and thirty-year bond auction last Monday. The investment funds were allotted 44.8% of the combined fixed coupon supply, the largest allocation since February 2006. Foreign and international investors were allotted 16.2% of the auction, down from 20% in February and below their average 18.4%. The combined share allotted to the two investor classes of 61% was strong for the fourth straight month averaging 59.1% vs. the one-year average of 54.7%. Three-year note The investment fund investor allotment share rose to a new record high of 44.5% since at least May 2003, bettering the previous month's record of 40.9%, and compares to the one-year average 28.8%. The allotment share to foreign and intemational investors of 12.2% remained below average 19.7% for the second straight month. Overall, the combined share allotted to the two investor classes of 56.7% was strong for the third straight month, averaging 56.0% over the period as compared to the one-year average 48.5%. Ten-year note The allotment share to investment funds investors rose past the average 38.2% to 41.7% in March from 36.1% in the previous month. Foreign and international investor share dropped to 24.7% from 33.3% in February, but remained solidly above its one-year average 19.8%. The combined share allotted to the two investor classes of 66.4% beat the average of 58.0% for the second straight month. 30-year bond Investment fund allotment share of 50.3% was close to the previous month allocation and in line with its one-year average 48.7%. Foreign and international investors were allotted 9.7% of the share, down from 11.9% in February, and also below their average share of 12.9% in the last year. The combined share allotted to the two investor classes of 60% compares with their average of 61.7%. Page 20 Deutsche Bank Securities Inc. EFTA01123181 27 March 2015 US Fixed Income Weekly 13-year note auction Total allotments Investment Foreign and Settle Date (less Fed) Federal Reserve Dealers and Brokers Funds International Other Sbn Sbn %' $bn % $bn Sbn Sbn %* Sbn 1 Yr Avg 27 0 0% 13.6 51% 7.5 28.8% 52 19.7% 0.2 0.6% 3/10/2015 24 0.0 0% 10.2 43% 10.7 44.5% 2.9 12.2% 0.1 0.6% 2/17/2015 24 0.0 0% 11.1 46% 9.8 40.9% 2.9 12.0% 0.2 1.0% 1/15/2015 24 0.0 0% 9.9 41% 8.1 33.7% 5.9 24.7% 0.1 0.4% 12/15/2014 25 0.0 0% 13.2 53% 7.1 28.6% 4.5 18.0% 0.2 0.8% 11/17/2014 26 0.0 0% 13.4 51% 6.6 25.5% 5.9 22.6% 0.1 0.4% 10/15/2014 27 0.0 0% 13.9 51% 6.6 24.6% 6.3 23.4% 0.1 0.5% 9/15/2014 27 0.0 0% 14.2 52% 6.0 22.1% 6.8 25.1% 0.1 0.4% 8/15/2014 27 0.0 0% 13.2 49% 6.9 25.4% 6.8 25.1% 0.2 0.7% 7/15/2014 27 0.0 0% 15.4 57% 6.6 24.4% 4.7 17.5% 0.3 1.1% 6/16/2014 28 0.0 0% 16.9 60% 6.2 22.0% 4.8 17.0% 0.2 0.7% 5/15/2014 29 0.0 0% 15.1 52% 7.7 26.7% 6.0 20.7% 0.2 0.6% 4/15/2014 30 0.0 0% 16.3 54% 8.1 27.0% 5.4 18.0% 0.2 0.6% • AA:wow as &ratans. FedSOW Saur US heastuy andDawes Bo* I10-year note auction Total allotments Investment Foreign and Settle Date (less Fed) Federal Reserve Dealers and Brokers Funds International Other Sbn Sbn %' $bn % $bn % Sbn % Sbn 1 Yr Avg 22 0 0% 9.1 42% £4 38.2% 4.4 19.8% 0.1 0.3% 3/161/2015 21 0.0 0% 7.0 34% 8.8 41.7% 5.2 24.7% 0.0 0.1% 2/17/2015 24 0.0 0% 7.3 30% 8.7 36.1% 8.0 33.3% 0.0 0.1% 1/15/2015 21 0.0 0% 9.1 43% 8.6 41.1% 3.2 15.4% 0.0 0.1% 12/15/2014 21 0.0 0% 8.9 42% 8.6 40.9% 3.5 16.7% 0.0 0.2% 11/17/2014 24 0.0 0% 10.8 45% 7.6 31.7% 5.5 22.9% 0.1 0.4% 10/15/2014 21 0.0 0% 111 53% 7.0 33.3% 2.6 12.5% 0.3 1.3% 9/15/2014 21 0.0 0% 7.8 37% 8.7 41.6% 4.4 20.9% 0.1 0.3% 8/15/2014 24 0.0 0% 10.1 42% 7.5 31.3% 6.3 26.3% 0.0 0.2% 7/15/2014 21 0.0 0% 10.5 50% 6.4 30.5% 4.0 19.2% 0.0 0.1% 6/16/2014 21 0.0 0% 10.1 48% 7.4 35.1% 3.4 16.2% 0.1 0.6% 5/15/2014 24 0.0 0% 7.7 32% 12.4 51.6% 3.9 16.3% 0.0 0.2% 4/15/2014 21 0.0 0% 9.1 43% 9.2 43.8% 2.7 12.7% 0.0 0.1% • Avow:swat &fatalass FadSOMA Scud* US Treasury end atursda SAtt p30-year bond auction Total allotments Investment Foreign and Settle Date (less Fed) Federal Reserve Dealers and Brokers Funds International Other Sbn Sbn */** $bn % $bn Sbn Sbn Vo• Sbn 1 Yr Avg 14 0 0% 5.4 38% 6.8 48.7% 1.8 12.9% 0.1 0.4% 3/16/2015 13 0.0 0% 5.1 39% 6.5 50.3% 1.3 9.7% 0.1 0.5% 2/17/2015 16 0.0 0% 6.1 38% 8.0 49.9% 1.9 11.9% 0.1 0.3% 1/15/2015 13 0.0 0% 5.1 39% 5.0 38.7% 2.8 21.6% 0.0 0.3% 12/15/2014 13 0.0 0% 3.6 28% 8.4 64.3% 1.0 7.7% 0.0 0.3% 11/17/2014 16 0.0 0% 7.3 46% 6.4 39.9% 2.3 14.1% 0.1 0.4% 10/15/2014 13 0.0 0% 4.5 35% 6.5 50.1% 1.9 14.8% 0.0 0.3% 9/15/2014 13 0.0 0% 4.6 35% 6.7 51.6% 1.6 12.7% 0.0 0.3% 8/15/2014 16 0.0 0% 5.1 32% 8.5 53.1% 2.4 14.8% 0.1 0.4% 7/15/2014 13 0.0 0% 5.0 39% 6.6 51.0% 1.3 9.7% 0.1 0.5% 6/16/2014 13 0.0 0% 3.6 28% 7.0 54.1% 2.3 17.8% 0.0 0.3% 5/15/2014 16 0.0 0% 8.7 54% 5.9 37.1% 1.3 8.1% 0.1 0.4% 4/15/2014 13 0.0 0% 5.6 43% 5.8 44.6% 1.6 12.3% 0.0 0.3% • Avonage a of fount*: FAISOMA Sant: US Scastav ergNowt* SA* Deutsche Bank Securities Inc. Page 21 EFTA01123182 27 March 2015 US Fixed Income Weekly United States Rates Aleksandar Kock Rates Volatility Gov. Research Analyst Bonds & Swaps 1+1) 212 250-0376 Derivatives ▪ No directional cues emerged after the last FOMC meeting. The net effect is essentially a distributional modification, a swelling of the tails - the probabilities of rates moving both higher and lower have increased, at the expense of the likelihood of staying within the range. The novelty of the Fed communication this time was the mechanism whereby Fed consensus is converted into the market dissensus. Fed language became a pure volatility effect. ▪ In this environment any residual overweight in assets for which valuation has been distorted by monetary policy so far is likely to come under scrutiny and possibly be corrected. That should free some maneuvering space for the Fed and make potential hikes less damaging and thus possibly more likely. As far as an attempt to return vol to the markets, this is mission accomplished. ▪ We are buyers of tail risk at the short end of the curve in the mid-run: • Sell $100mn 6M10Y 8bp wide strangles vs. buy $325mn 3M3Y straddles costless • Sell $100mn 6M3Y straddles vs. buy $200mn 60bp wide 6M3Y strangles costless a In our view, risk assets are at a bifurcation point - their future path depends on the way the economy and stimulus unwind interact with one other. We are buyers of hybrid S&P calls and puts conditioned on different rates responses to the Fed. We recommend: • 18-Dec-2015 SPX 95% put subject to 5s > ATMF + 25 , offer 1.15%, an 73% discount to vanilla at 4.30% • 18-Dec-2015 SPX 103% call subject to 10s < fwd-25bp at expiry, offer 1.00%, a 70% discount to vanilla at 3.37% From Fed consensus to market dissensus: Volatility could be here to stay The last FOMC could be seen as a template for what to expect in the near term. Two parts of the statement cause this. The combined statement reflects the divided subject of the future economic path and sets the terrain for a period of elevated volatility across various market sectors. Lowering of the NAIRU, the dovish side, means either we do not have the right model or, if we do, then we do not know how to calibrate it. It is not even clear that the U3 unemployment rate is the relevant statistic in this context. Either way, this means that there is relatively low confidence regarding the point at which the economy will turn around and the Fed would need to consider hikes seriously. The other side of the Fed's statement is the dots. Despite the dovish overtones conveyed by a lower median, the most relevant message is the emergence of a strong consensus, which is in sharp contrast with previous dot plots. As far as the end of 2015 is concerned, there is consensus that there should be two hikes by the end of the year (and four more in 2016). Page 22 Deutsche Bank Securities Inc. EFTA01123183 27 March 2015 US Fixed Income Weekly No directional cue emerged after the FOMC. It is effectively a distributional modification, a swelling of the tails. The probabilities of rates going both higher and lower have increased, at the expense of the likelihood of staying in the range. The novelty of the last FOMC meeting is the mechanism whereby Fed consensus is converted into market dissensus. Fed language became a pure volatility effect. With tails probability higher, confidence regarding a particular directional position is undermined — it is now subject to quick revisions at the slightest market move. Thus any residual overweight in assets for which valuation has been distorted by stimulus is likely to come under scrutiny and possibly be corrected. That should free some maneuvering space for the Fed and make potential hikes less damaging. As far as an attempt to retum vol to the markets, this is mission accomplished. Withdrawal of stimulus, if not carefully executed, has potential to expose the underlying negative convexity of the market created by the monetary policy itself. This can be seen from two complementary angles. Implicit belief in the Fed as a global market stabilizer has made both credit and equities behave like a positively convex asset. Whether the economy was improving or not, there was always stimulus as an alternative support in case economic data disappoints. As a consequence, both asset classes developed additional desirability due to embedded optionality. In that sense, unwind of stimulus is a withdrawal of "free" optimality of risk assets — and vice versa, delayed exit is an extension. Risk of stimulus unwind is all about the speed of events. The mechanics of this can be understood by visualizing its actual realization. In less liquid markets, like credit, this is especially easy to see. If unwind is too fast, the street would not have time to flatten its position in the interdealer market and therefore would be unable to extend liquidity further. This would cause additional spread widening with stop outs and likely panic selling, further undermining already-fragile liquidity. This is why volatility should not be allowed to increase too much too fast. Its return to the market prior to the final stage of Fed exit is essential, and that process has to be fine tuned. In the same way the long period of artificially low volatility led to positioning buildup in carry trade and risk assets, the longer volatility remains elevated the better chances would be for "bad positions" to clear. We are buyers of tail risk at the short end of the curve in the mid-run. In our view, risk assets are also at a bifurcation point - their future path depends on the way the economy and stimulus unwind cooperate with one other. We are buyers of hybrid S&P calls and puts conditioned on different rates responses to the Fed. Rates: Straddle/strangle switches Vol and tail risk are likely to be concentrated at the short end of the curve. To a large extent, vol surface is pricing this in through elevated volatility risk premia. Figs 1 & 2 show the history of realized and implied volatilities for 3Y and 10Y tenors. This rise in vol risk premia in the upper left corner is a relatively recent phenomenon that started in mid-2014. Fed communication at this stage of policy unwind is largely transmitted through the front end of the curve in the sense that most of the play defined by the dots and economic data concerns the timing and magnitude of rate hikes. At the same time, market flows and foreign central banks' actions are likely to constrain rate movements at the back end of the curve. Deutsche Bank Securities Inc. Page 23 EFTA01123184 27 March 2015 US Fixed Income Weekly Figure 1: Implied and (3M rolling) realized vol at the Figure 2: Implied and (3M rolling) realized vol at the short end back end 140 120 — 3MI OY 120 Realized 10Y 100 80 100 60 40 60 20 a0 0 20 10 11 12 13 14 15 10 11 12 13 14 15 Sawar Deutediseank Soutar Oroeseboank In the context of latest developments and further injection of uncertainty outlined after the FOMC meeting, we are buyers of tails at the front end of the curve, either outright or financed by selling back-end strangles. We capture this through two different variants of straddle/strangle switches. • Sell $100mn 8M10Y 8bp wide strangles vs. buy $325mn 3M3Y straddles costless The trade is vulnerable to bull flatteners and bear steepeners of the curve at this point with theoretically unlimited downside. We see these two modes as unlikely realization within 2015. Although a massive bull flatten could take place due to prolonged risk-off trade, it is unlikely that expectations of Fed hikes would remain unchanged under these conditions. Similarly, bear steepeners would be consistent with a rapid buildup of inflation and the Fed being caught behind the curve. At this point, there is no indication of the emergence of such a trend; on the contrary, it is difficult to envision the mechanism that could cause a rise in inflation despite seeming improvements in the labor market. Such an outcome is even more difficult to envision in the context of increased foreign demand for US duration. If anything, a rise in rates in the US would make the long-end UST even more attractive in comparison to other European bonds. An alternative view on the short end of the curve is a possible short-term response to the bimodal market - rates either descend lower to reflect delayed hikes or they align with the consensus reflected in the Fed dots. In this context we recommend 1X2 straddle/strangle switches: • Sell $100mn 8M3Y straddles vs. buy $200mn 60bp wide 8M3Y strangles costless The trade has limited downside with a maximum loss of 30bp running in case of limited rally or selloff, and would benefit from extreme repricing at both sides. Hybrid strangles Given the implicit convexity and exposure of risk assets to policy unwind, positioning in US stocks should be conditioned on expected Fed actions. It is conceivable that, if data support Fed hikes, the belly of the curve could sell off Page 24 Deutsche Bank Securities Inc. EFTA01123185 27 March 2015 US Fixed Income Weekly together with equities giving up some of the recent upside. We condition equity puts on a higher 5Y rate: • 18-Dec-2015 SPX 95% put subject to 5s > ATMF + 25 , offer 1.15%, an 73% discount to vanilla at 4.30% Alternatively, delayed hikes mean lower rates. However, unless the Fed abandons hikes in the foreseeable future, risk premia in the belly would remain elevated - 5s might not rally hard as the market remains in a standby position until further notice. In all likelihood, given the favorable rates differential between UST and European sovereign yields, this would be a "buy" signal for foreigners. In that sense, 10s could lead on the way down while risk assets rally. Thus, contingent S&P calls would be conditioned on the 10Y rate: • 18-Dec-2015 SPX 103% call subject to 10s < fwd-25bp at expiry, offer 1.00%, a 70% discount to vanilla at 3.37% When combined, these two trades describe effectively contingent equity strangles, with conditioning reflecting a particular Fed action. At inception, the put side is short S&P and long rates gamma, while the call side is long S&P and short rates gamma. Each leg reflects the doubling up as pressure on S&P is also bullish for gamma and delayed hikes are bullish for stocks and bearish for vol. This doubling up is the source of excess leverage. With both hybrid options at deep discounts in excess of 70%, buying the whole package (as a contingent strangle) is still cheaper than buying single vanilla options. Both trades have limited downside with max loss equal to the option price. Deutsche Bank Securities Inc. Page 25 EFTA01123186 27 March 2015 US Fixed Income Weekly United States Rates Steven Zeng• CM Gov. Bonds & Swaps Research Analyst Credit 1+1) 212 250-9373 Sovereigns Agencies • As volatility has recently declined, yield picks for callables have also fallen. We find the 5yr+ maturities relatively protected with the smallest decrease in picks compared to the recent average. e The additional yield for buying Berm vs. Euro call has increased. We like the 3NC3M Berm structure, which offers 10.7 bps over a 3NC3M Euro, the highest in a year. Relative value in callables Pick in yields for callable agencies over same-maturity bullets has fallen slightly over the past three months. For callable investors, we recommend extending out to 5yr maturities as the picks for various structures still look decent to their recent average. For example, a 5NC3M Berm has a new issue coupon of around t91%, a 3t4 bps pick over a par 5y agency. The pick is only about 2 bps lower than its 3m average, whereas for 2NC3M Berm and 3NC3M Berm, the picks are 4 bps and 5 bps lower, respectively. The best relative value play in callables seems to be in Euro vs. Berm switch. For a 3NC3M structure, buying the Berm vs. Euro offers the investor an additional 10.7 bps, the highest in a year. A 5NC6M structure also looks attractive on a lm Z metric. 'Yield picks for callables over same-maturity bullets 'Berms vs. Euro calls history so - — 3NC3M Berm vs Euro St4C31,4 —3NC3M —2NC3M 19 - 45 • - 514C6IN Berm vs Euro 17 40 - 15 35 - 13 30 25 - 11 2,3 9 IS I 10 5 1/1/16 2/1/15 3/1/15 3/25/14 6/25/14 9/25/10 12/25/10 3/25/15 Savor Owesale Bank I Santo &auto era The left table below shows new issue coupons, picks to bullet, and Berms vs. Euros, along with their respective 1m and 3m averages and z-scores. The table on the right shows the 3m z-score for the swaption implied volatility surface. The recent cheapening of vols was mostly concentrated in the upper left. Page 26 Deutsche Bank Securities Inc. EFTA01123187 27 March 2015 US Fixed Income Weekly Relative value in c“Ilable agencies Swap ion vol, 3m z-score rich/cheap • • 3NC1Y SNC3M • Tenor Cott • on 0.85 0.81 0.76 1.30 1.25 1.18 1.91 1.86 1.77 IV 2V 3V 4V SY 77 lOY 13 Last 17.9 14.0 9.1 28.7 23.4 16.5 31.4 25.6 16.8 10 0.32 4145 -067 -0.99 -1.07 -0.91 .0.53 0, .5 ;p 5 int avg 22.7 18.6 13.3 34.3 28_7 21.9 33.4 281 24.3 31.1 0.13 -0.82 .0.44 4.16 423 015 028 ao E 4 1mz-score L7 1.6 1.4 L 1.6 1.6 r GM oce -037 -028 4.02 0.04 046 0.57 g X 3m avg 22.3 18.0 13.0 33.8 28.3 21.8 33.2 28.9 25.8 0 LL 1`, -0.42 4.13 0.22 0.34 0.49 0.92 1.11 a. 3m 4-score L5 1.4 1.3 L4 L4 1.5 0.4 0.6 0.6 2Y 0.19 003 0.22 0.49 0.71 1.01 1.19 3Y 478 -0.81 -021 0.52 0.87 1.19 1.30 2NC3M 2NC 2NC1Y 3NC3M 3NC6M 3NC1Y SNC3M SNC6M SNC1Y 4Y 002 0.17 0.57 0.80 097 1.23 1.48 Last 2.9 1.0 0.0 10.7 6.3 2.4 24.3 17.1 10.3 SY -0.40 0.38 0.77 0.98 1.16 1.34 1.66 V .. know; 28 0.8 0.0 8.8 5.7 2.1 20.0 14.9 13.7 € o a lm 4-score 0.3 0.6 0.0 14 1.2 0.4 a 3m avg 28 0.8 0.0 A9 5.6 2.1 20.4 15.8 14.8 3m z-score 0.2 0.3 0.0 0.9 0.9 0.6 0.8 (OM Sato. Dwinalo &oat Soacee DIA4001013.,A Agency trading volume reported by TRACE is down 18% compared to the same period last year. Through 3/26, $294bn agency debt had traded, which includes S88bn FHLBs, $77bn FNMAs and S78bn FNMAs. March failed to see a pickup in volume as seen in the past two years. Agency trading volume by year 'Agency trading volume by month 3,000 250 1 2011 a —2012 — 2013 2C0 0 2013 •201.4 M2015 2.000 — 2014 —..92015 1, 150 • Esoo y 1c0 I 1.000 £ SOO I 5: II 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec &wet ONRA 7724LY endDamn. atra Soon .11144 TRACE antemne.ho BAS, MatchFauns ao throvon 3126 Deutsche Bank Securities Inc. Page 27 EFTA01123188 27 March 2015 US Fixed Income Weekly United States Credit Oleg Metentyer. C HY Strategy Strategist IG Strategy 1+1) 212 250.6779 Daniel Sorid US Credit Strategy Strategist 1+1) 212 250.1407 Taking Spread-per-Turn to Sector Level Seasonally-strong issuance period is about to take a break, but not retire Credit markets remained relatively stable over the past week, even as the equities and 10yr rates fully reversed their post-FOMC moves. HY spreads tightened 6 bps, with CCCs underperforming, and single-Bs showing a slight edge over the index. IG moved a basis point wider. Volatility remained high in FX, where EUR is now on its fourth round of retracing its very wide post-FOMC range of 1.06 to 1.11. Rates volatility, high to begin with, has jumped even further and now exceeds its recent peak level reached on Oct 15th, the day of a 7-sigma move in 10yr Treasuries. HY flows have stabilized in recent sessions, following wild swings between strong inflows in Feb and outflows in early March. Hidden behind this relative stability are continued outflows from HY open-ended funds (-$1.6bn in the last week), offset by intakes in ETFs. A $10 move higher in WTI oil since early-last week failed to produce a commensurate Figure 1: Seasonality in credit spread move tighter in energy spreads (they widened at first and retraced the move performance (averages since 1991) later, netting zero change over the full period). Beth between oil and energy zo 70 spreads has averaged $1 move in WTI = 10bps move in our DBHYSEN index, IS 60 as measured since last June. We highlighted what looked like tactical richness 10 se of 50.75bp in HY energy spreads going into last week and therefore view 40 absence of spread reaction to higher oil as a closing of that valuation gap. 0 10 Issuance has been going strong over the past couple of months, setting new -IC 10 YTD record in IG at $340bn, and matching a previous record of $85bn in HY -IS 20 (same as 2013). In interpreting and extrapolating from these numbers, our 10 In IF4b Ma Pp, 1.444 Jun hi Ny Sap Oct Now 024 0 readers should keep in mind that March happens to be the strongest month of t emerage5004S0.24.elhO aPa woods swot ,1151 issuance activity from seasonal standpoint in both IG and HY (measured on a pct of market size basis since 1998, so normalized for market growth). Naturally, one would expect to see some slowdown in a subsequent period, 00 and our historical data shows exactly that - April averaged the slowest 60 issuance pace of any month in the first half the year in IG, and 2nd-slowest in se HY (after February). This technical backdrop may help explain why April is also ▪ • e a l a • li a n a 40 one of the strongest months from seasonal spread-performance standpoint, I I 10 averaging a tightening of 17bps in HY and 4bp in IG (Figure 1). April also caps 20 20 the five-month stretch of seasonally strongest months for credit, with May 0 opening the door to a seasonally weak part of the year. 04. Feb Ma 424 On Poe hi 4.4 Sep On Noe Dee • 004440.3CaStlorn IN a Pad 7002412 bmi.omi Macro picture remains weakfish) as measured by real activity indicators, with the most recent sub-consensus readings coming in from durable goods, Sown Lanse-ho Banoi existing home sales, and Q4 GDP. These indicators continue to be contradicted by employment trends, such as jobless claims and payrolls, and thus it is becoming increasingly important to determine which side prevails here. We tend to think that real economic activity should hold a sway over employment trends in that such activity ultimately determines the need for labor, and not the other way around. For this reason, we continue to believe that as the US economy loses more momentum over the next few months, the Fed would likely find it difficult to remain on a sustainable rate-hiking path beyond the first few moves, if any at all. Thus we find macro picture to be on the side of credit investors, more so of those seeking safer yields, and not reaching all the way down to riskiest parts of the market. With IG spreads sitting in the middle of our expected range (120-140), and HY at its tight end (475-550), we keep a preference for IG over HY here. Page 28 Deutsche Bank Securities Inc. EFTA01123189 27 March 2015 US Fixed Income Weekly A HY portfolio allocation strategy we introduced last month has done well in its inaugural live performance period, registering a 1.1% outperformance of top-80th percentile over bottom-20th percentile names, as ranked by spread- per-tum (Figure 2). Another important attribute of this performance differential is that it is not a function of a simple high-beta outperformance, in that overall ex-energy HY index was down 0.3% for the month, and its CCC component was down by 0.7%. We will update our readers on the new composition of both baskets for April in the chartbook report to be published next week. Figure 2: Total return performance of top-80th vs bottom-20th percentile baskets, ranked by ex-ante spread-per-turn (backtested prior to March 2015) in — S.0 Marsh 201S 4.0 ... 3,0 11 t o• — —I I .!—Ill ll) e V !IL l i I .i ll ii 2,0 I ... -OA - 4.0 I a — 4.0 - 4.0 Jul 11 Dec 11 May 12 Oa 12 Mar 13 gun 13 lan 14 Jun 14 Nov It is Total Return, ToplOth w Bottom4Oth SPY Perangle Issuers —Alleginergy KY Saner &Janie an Taking this analysis a step further in this publication, we are introducing sector spread-per-turn readings, averaged on an issuer basis. As a reminder, selection criteria for this exercise includes min 10 names per sector (average count is 20), ex financials, real estate, and energy, max total leverage under 6x in BBs, 8x in Bs, and 10x in CCCs, max spreads under 600bp, 800bp, and 1,000bp in each rating category respectively. Figure 3 below presents the results. Figure 3: Average spread-per-turn in sectors and leve age buckets Aucennave Tranomrrunizaters Consigner Producis generals Food Raul Cacnal Gads Real huts Media Health Care corn eroat Strom Gamirt Houk L.. Tcanolhbr • 50 70 90 110 130 ISO CO 0.10 020 030 040 Annie Sasser Spasadaennwn Pain& 50 =ME 50 10 90 110 130 ISO 000 015 0.10 OAS 020 Anne* Levers Suds. Spreande.Turn Pa Ask SA AI DAnsan BMA Deutsche Bank Securities Inc. Page 29 EFTA01123190 27 March 2015 US Fixed Income Weekly The top portion on the graph reflects industry sectors, and bottom portion shows a breakout by leverage category. Left side displays current average spread-per-turn (SPT) in basis points, while the right-hand side shows percentile ranking score of current SPT vs history since Dec 2009. On a sector level, the interesting conclusions are: everything is trading to a certain degree of tightness, with an average percentile ranking score of 20%, which perhaps is not an eye opener for most experienced market participants. Specifically on sectors, autos and telecoms look relatively interesting here, while tech and gaming are the most overvalued based on this metric. We note that autos also came out as the most undervalued sector on our rooky- reaction-to-oil screen in January. Auto equities have outperformed S&P 500 by 5.5% since that publication date, and we continue to believe, reinforced by today's findings, that there is more to go in capturing autos outperformance in both equities and credit. The sector that came out most overvalued in equities in January - utilities - has proceeded to underperform S&P 500 by 12.5% since then. It did not make it to our HY SPT screen due to a low issuer count, but the original equity signal pointed towards a 30% overvaluation, so perhaps more to go there too. We excluded energy from the above SPT sector analysis for the obvious reason that the sector is too distressed at this point to be meaningfully judged against the rest of the market through the lenses of a single valuation framework. Here, we think a better approach would be to look at debt-to-enterprise-values as a factor for bond dollar prices. As a reminder, we have previously shown this indicator to have strong predictive power over future defaults (names trading over 65% D/EV have experienced a 1:3 subsequent default probability). Here, in Figure 4 we are showing US energy single-Bs and CCCs bond prices (average by ticker, y-axis), plotted against each issuer's total debt/EV. The scatter plot shows a nice and tight fit between the two (78% r-squared), and on Figure 5 we go on to highlight the largest divergences from regression line. Top portion here shows names that are too far below the regression line, i.e. bond dollar prices are too low given where the D/EV ratio stands; the bottom portion shows the opposite extremes. Figure 4: Energy single-Bs/CCCs Figure 5: Energy single-Bs/CCCs, largest gaps to D/EV Bond dollar prices (y-axis) vs Debt/EV (x-axis) 110 Bond Dollar Price • FANG • SIN Ticker Con Mty Rating Debt/EV Estimate Actual Est•Act • • WI • EPENEG 100 it---.. •-• • • DICE Largest Undervaluation Gaps in Bonds 051924104f5.8 GOP 8.875 2019 CCC2 80 66 45 +21 • ♦ .. .. SN 90 • NOG PVA US/127093AM NERO 10.25 2019 B3 95 43 30 +13 ICOS UNTUS ♦ ♦ P . UNE U52057684130 CRK 9.5 2020 B3 87 56 91 +14 so GP U57611694244 REN 8.5 2020 CCC2 94 43 30 +14 ♦ PPS • NM 70 U50492964C06 ARP 7.75 2021 CCCI. 69 80 67 +13 • ARP • HKUS U570101314Y70 PRO 7.5 2020 B1 59 89 82 +.8 60 KEG. • U592922PAC06 WTI 8.5 2019 B3 78 69 62 .7 XCO Average 80 66 51 +13 y .0.0136xt +0.795 89.284 VTG SO R'4 0.7781 • GOP • Largest Overvaluation Gaps in Bonds 40 U5654677A094 NKA 6.5 2019 CCC2 92 41 75 13 REN US6762534167 VTG 7.5 2019 B3 97 39 58 -18 30 • HERO U5707882AE64 PVA 8.5 2020 CCCI. 69 79 94 -15 20 LIS06846NAL83 BOG 7.625 2019 B3 67 82 95 -13 10 20 30 40 50 60 70 80 90 100 U59053704568 NINA 9.75 2020 CCC2 84 60 68 -8 U55360229155 UNE 6.25 2019 B2 72 75 81 -s U56655119854 NOG 8 2020 CCC 1 65 sa 90 -6 Average 78 69 80 -11 Scurce.Dassene Bare Savrortleurscaegana Page 30 Deutsche Bank Securities Inc. EFTA01123191 27 March 2015 US Fixed Income Weekly / We are dealing with mostly deeply distressed names here, with an average dollar price of 50-80pts in between the two baskets. Readers should realize that many of these names are unlikely to survive to pay off these bonds - and therefore this recommendation is not made under assumption of a credit continuing to perform to maturity. Rather, we suggest that divergences from fair value in these cases are too extreme and support a short-term tactical trading opportunity. Deutsche Bank Securities Inc. Page 31 EFTA01123192 27 March 2015 US Fixed Income Weekly United States Credit Steve Abrahams Securitization Research Analyst (+1) 212 250-3125 Mortgages Originally published on March 25 in The Outlook in MBS and Securithed Products. Slow motion housing The slow rebound in US housing since the 2008 crisis at some point has to put Steven Abrahams a limit on MBS supply. Although this year is still likely to put up more net Research Analyst supply than last, it all starts with housing where a lingering overhang of supply, (+1) 212 250-3125 weak demand and tight lending have made it hard to get things started. Christopher HeIwig Punching below its weight Research Analyst The contribution of housing to US GDP continues to run at some of the lowest (+112t2 250-3033 levels since the end of World War II (Figure 1). New construction of single- and multi-family homes, renovations, broker fees and the like still only make up a Jeans Curro bit more than 3% of current GDP, well below the post-war average of 43%. Research Analyst (+1) 212 250-0134 Not only has the level of lift from housing come in low, but it has bounced out of the last official recession slowly, too. Housing on average has contributed a Ian Carow half a percentage point to GDP a year after the end of every post-war US Research Analyst recession (Figure 2). This time around, housing added only 7 bp. And the (+1) 212 250-9370 contribution of housing in the second and third years after the recent recession also has fallen well below post-war averages. Jeff Ryu Research Analyst Housing supply hangover (+1) 212 250-3984 The slow motion in housing has to be due in part to supply. The last decade created a lot of owner-occupied units. US homeownership started the decade at 66.9%, peaked in 2004 at 69.2% and ended at 66.5%. It has since dropped to 64.0%. The exodus of owners initially threatened to leave a lot of extra houses behind and reduce the need to build new ones. But investors have come in to pick up the keys, and many houses have found a new home in the market for single-family rentals. This has helped reduce the supply of distressed homes, although it's still higher than the levels that prevailed in the early 1990s when homeownership last ranged around 64% (Figure 3). The supply hangover isn't done but should be in the next two or three years. And although multi-family housing is booming, it's clearly not enough per unit to replace the building of new single-family detached houses. The single-family market has to clear before housing overall gets back to normal. Page 32 Deutsche Bank Securities Inc. EFTA01123193 27 March 2015 US Fixed Income Weakly Figure 1: Housing's contribution to GDP still runs well Figure 2: Housing continues to rebound slowly from the below average crisis 8% o. 617 1 o 0.53% 0.49% f5\tyPiivit § 2 C 0.07% 0 '3.1 8 • 1YAftar Recession 2Y After Recession 3Y After Recession N , cc, w c• Ng, 88 $44 " z03 -)22 - tz03 -, 2 ■Average Post.AWl ■Currant Sated BEA Source BEd Figure 3: Distressed loans still put some supply pressure on housing 10 % of Outst MN Loans 8 6 4 0 8,72=18 888 0'2 qf, 4 `41 ri; 4 2 .2-0i1 ci t 8 2 —, 2 2 1i is ■ Serious DO % All Loans • FCL % All Loans Note: SCAOUS 00 includes 90-day or longer danquencies, FCI. and REO. Swear MBA we Obowerme ham.Le Housing demand drag Demand has likely played a part in slow housing, too, starting with owners that bought their homes in the last decade. Thanks to a 38% drop in home prices nationally from 2006 to 2012, according to Case-Shiller, a lot of those owners walked out the front door without any equity and without the ability to reenter the market as buyers. This has almost certainly contributed to the drop in rental unit vacancies from 10.6% in mid-2009 to 7.0% today. As for potential new owners, Americans, even before the crisis, started moving into their own place at a much slower pace than the long-term average of 1.2 million new households a year, that is, until recently (Figure 4). Demand from former and potential new owners has been soft, but that should slowly improve. Tight credit And then, after supply and demand, there's credit. Credit has clearly tightened since the crisis, but it's difficult to come up with a precise measure. Nonbank lending to almost any type of borrower outside the agency market has largely disappeared. Bank lending has tightened dramatically starting in 2007, according to the Fed's senior loan officer opinion survey, with only minor correction in the last year or so—although this measure captures the number Deutsche Bank Securities Inc. Page 33 EFTA01123194 27 March 2015 US Fixed Income Weekly 'Figure 4: Weak household formation, until recently 4,000 MY US HH formation (000s) 3,0130 2,000 1,000 0 -1,000 -2,000 -3,000 aR cie rv;) p. as e4 z in 0 N. 0 c.4 6 •C 2 4 2 2 2 4 7, :?Fit I 2 —9 8i4 ai4ilal2,18mgclam & Sans taConws Ours Sicentto. bosom LP 'Figure 5: Cumulatively tighter bank mortgage lending standards 80 600 Cumulative net % tightening Net % tightening mtg lending 60 500 40 400 20 300 0 200 -20 100 0 -40 0 CA VI •-• C•I 0) a, m re, m 8 0 8 71 I ln -33" 45 9 4 l it t, 8al 2 4 8 3 a' - < 2' ~ na Z 2) —+ Mato: data show standards for all loans to 1007 and prime bans altar. Sount.F•OWa) Room% Deuratho 'UM of surveyed banks tightening but not the precise magnitude (Figure 5). There's also the Qualified Mortgage and Ability to Repay standards introduced last year by the Consumer Financial Protection Bureau. Special questions in the Fed's loan officer survey last July showed that the QM and ATR rules had put a drag on all types of lending at all types of banks. And a review of bank lending released by the OCC in December showed that mortgage lending was the only area last year where more banks tightened than eased. And among banks that tightened in the OCC survey, the main reason was regulatory. Concern about put-backs from Fannie Mae and Freddie Mac and litigation from the FHA under the False Claims act has led banks to limit lending even to agency borrowers. Although the market seems to be clearing out the lingering housing supply and the economy and the labor market look likely to repair demand, the availability of credit could prove to be the lasting constraint. Today's lending standards reflect limits designed to keep the last decade's boom and bust from happening again. Borrowers today without the ability to repay will not get a loan. But it looks like some borrowers with the ability to repay —but with low FICO scores or with needs that keep them outside the agency or prime jumbo markets—will also not get a loan. The market is reducing risk today to avoid risk tomorrow. But it also is likely reducing housing growth today to avoid a downturn tomorrow. Who should make that tradeoff and how is an open question. Page 34 Deutsche Bank Securities Inc. EFTA01123195 27 March 2015 US Fixed Income Weekly The housing market looks likely to keep improving over the next two or three years while still punching below its historic weight in GDP. Reduction in supply and an increase in household formation look most likely to keep things on the mend. Credit looks less likely to change. And for investors in MBS, that means supply generally running below the pace that built the $5.4 trillion market outstanding today. • • • Ginnie Mae RV revisited Selling short TBA Ginnie Mae 30-year 4.0% and even 4.5% contracts against Fannie Mae's TBA still looks good more than two months after FHA surprised the market with a change in mortgage insurance premiums. That change reset fair value in Ginnie Mae MBS by scrambling the prepayment relationship to Fannie Mae. In "Adding up to fair value in G2/FN," Ian Carow and Jeana Curro build up the fair value of Ginnie Mae MBS step-by-step: the value of the longer Ginnie Mae delay, its poorer liquidity, its better credit and the new increase in its negative convexity. The result: fair value everywhere except in the 4.0%s and 4.5%s, where Ginnie Mae looks rich. • * • The view in rates Fed Chair Yellen last week opened the door to a rate hike this year while signaling yet again that a return to neutral policy would take a long time. The most notable change was the move down in the FOMC dots projecting fed funds through 2018 and beyond. The market has consistently made money since at least 2012 by positioning for rates below the ones expected by the Fed, and that still looks like the right trade; the market, in fact, continues to do that. Eurodollar contracts show rates well below the Fed dots through 2018 and beyond. Low growth, low inflation, even a lower NAIRU should keep yields below Fed dots. Against the market's forward rates, the curve looks broadly like fair value. Neutral on rates. The view in spread markets No material change in core positions, but the arc of MBS supply is worth some attention. Outstanding agency MBS looks like it is on track to finish the first quarter down $5 billion, well below Deutsche Bank's forecast of a $20 billion gain. Supply again is proving difficult to predict. Broad: • Neutral the MBS-Treasury basis • Long 30-year 4.0% MLB and 4.5% LLB, MLB or HLB pools • Overweight Fannie Mae 30-year 5.0%s or other up-in-coupon positions, underweight 30-year 3.5% and 4.0%s • Short Ginnie Mae 30-year 4.0% and 4.5% pass-throughs against long positions in Fannie Mae • Neutral 15-year against 30-year Narrow: • Short 15-year 4.0%/3.5% coupon swap to play the flatter curve and market technicals • Short FNCL 4.0°/os against a market value and duration neutral blend of low pay-up seasoned FNCL 3.5% pass-throughs and IOS 3.5%s of 2012 • Favor last cash flow PACs and Zs, and CMO floaters over open window structures to benefit from flatter curve and add convexity • Long 11O backed by MHA95 and MHA100 pools Deutsche Bank Securities Inc. Page 35 EFTA01123196 27 March 2015 US Fixed Income Weekly The view in mortgage credit Existing home sales skimmed under forecasts on Monday (+1.2% instead of +1.7%) while new home sales jumped that threshold Tuesday (+7.8% instead of -3.5%). The FHFA home price index came in Tuesday up YoY by 5.48%. Housing continued to deliver mixed signals, although generally showing modest growth and decelerating home price appreciation. Adding up to fair value in G2/FN With the first month of MIP-induced prepayments behind us and agency MBS Ian Carow prices showing some signs of stability post the March FOMC meeting, now Research Analyst presents a fine time to revisit relative value in agency pass-throughs. Sticking (+1) 212 250-9370 to our fair value formula (first detailed in our special report from January 27, 2015), we find that at current levels: Jeana Curro Research Analyst ▪ GN2/FN 4.5% looks quite rich and we recommend shorting, even though it (+1) 212 250-0134 is negative carry (-1/32 per month) ▪ GN2/FN 4.0% looks modestly rich, and being short is slight positive carry (<1/32 per month) 'Figure 6: Framework for evaluating fair value in Ginnie Mae II/Fannie Mae swaps Incremental value (discount) of Total Cpn FNCL Px OAS OAD Pay Delay Liquidity Credit Prepayment G2/FN FV G2/FN Act Act -FV Net Carry 2.50 98-314 17 6.78 0.007 -0.114 0.281 0.161 1-016 0.300 -0.03 6 0030 3.00 102.074 6 5.4 0.006 -0.062 0.232 0.086 0.264 0.234 -0.030 0015 3.50 104-305 -3 4.14 0.007 -0.056 0.165 -0.075 0.040 0.034 -0.004 O014 4.00 106.250 -6 2.68 0.006 -0.014 0.083 -1-015 -0-261 -0-150 0-111 - 0 - 005 4.50 108.185 27 3.37 0.007 -0.022 0.117 -2-034 - 1 - 25 1 -0.030 1-22 1 O012 5.00 111.010 10 2.95 0.007 -0.080 0.091 -1-160 - 1 - 140 -1-160 -0.020 O001 NO30..VtMyth Indallial eta COB 3/flea ANDlCsalagy dAkritrec bits. Corn(M.:iamb nodn eataa SO'S caries BIM Fair value framework To estimate fair value, we separate and price out the component risks (pay delay, liquidity, credit and prepayment) and then adjust the FN value to the corresponding GN2 fair value (Figure 6). We begin by running the FNCL at its market price in the DB prepay model to obtain an OAS. To calculate pay delay, we then alter the FNCL in the model to pay five days sooner, matching G2SF, and price at constant OAS. For the liquidity premium FNCL carries over G2SF, we assume current GD/FN swap prices. For value of full faith and credit premium, we tighten the initial FNCL OAS by the interpolated agency debenture spread over Treasuries and then re-price in the same model (Tight OAS Price - Mkt Price = Credit value). Finally, to calculate the prepayment differential, we price FNCL at even OAS but have the prepay model treat the FNCL as G2SF. Here the model assumes an FHANA split of 70/30% (based on historical percentage) and assigns corresponding upfront and annual MIPs to FNCL based on WALA. We can then sum the individual components to arrive at the fair value difference between G2 and FN, which we compare to actual GN2/FN swaps. The biggest discrepancies lie in the 4.0 and 4.5% coupon where GN2 appears overvalued by 11/32s and 1-22/32s, respectively. We note however that hedge adjusted carry for the G2/FN 4.5% short is slightly negative, but is marginally positive for the G2/FN 4.0% short. Page 36 Deutsche Bank Securities Inc. EFTA01123197 27 March 2015 US Fixed Income Weekly A final caveat One aspect that this framework does not control for (which may impact valuation slightly) is differences in the TBA collateral characteristics between Ginnie Mae II and Fannie Mae, such as WAC, WALA and geographic concentration. For example, the model loads FNCL 4.5%s at 4.85 GWAC, and G2SF 4.5%s at 4.96 GWAC. Fair value in spec pools In specified pools, a careful statistical analysis suggests that 4.5% coupons may be undervalued across loan balance stories, while CR pools may be Research Analyst overvalued across 3.0% through 4.5% coupons (Figure 7). Loan balance and f+11212 250-9370 CQ 4.0%s also look undervalued in our model —but not to such a significant extent that we can rule out model error. Hedge-adjusted carry over TBA also continues to improve in higher coupons, with 4.5% loan balance and high-LTV pools projecting 4/32s to 6132s of advantage, and loan balance 4.0%s around 1/32 to 2132s. The model fair value for high-LTV pools is the result of a new permutation of our model building on the previous work done on loan balance pay-ups. 'Figure 7: Modeling spec pay-ups suggests 4.5%s undervalued, CR overvalued Type Cpn Act Px Mdl Px Act - Mdl Z Score HAC 3.00 -0-060 -0-113 0-053 0.5 -0-004 3.50 0-280 0-176 0-102 1.2 -0-025 CQ 4.00 1-260 2-011 -0-071 -0.6 0-001 4.50 3-000 3-02 5 -0-02 5 -a2 0-051 3.00 -0-06 0 -0-28 3 0-22 3 2.3 -0-010 3.50 0-240 0-103 0-135 1.5 -0-036 CR 4.00 1-22 0 1-06 3 0-15 5 1.3 0-00 2 4.50 3-000 2-100 0-220 2.3 0-067 3.00 0-080 0-181 -0-101 -1.2 -0-010 3.50 1-040 1-03 7 0-001 0.0 -0-03 6 LLB 4.00 2-040 2-103 -0-063 -0.9 0-001 4.50 3-000 5-044 -2-044 -8.4 0-046 3.00 0-060 0-110 -0-050 -1.0 -0-005 3.50 0-300 0-286 0-012 0.2 -0-025 MLB 4.00 1-26 0 2-001 -0-061 -0.9 0-02 3 4.50 2-220 4-156 -1-256 -7.3 0-042 3.00 0-040 0-067 -0-027 -a8 -0-000 3.50 0-180 0-182 -0-002 -0.1 -0-02 4 HLB 4.00 1-100 1-152 -0-052 -0.9 0-013 4.50 2-000 3-03 2 -1-03 2 -5.1 0-04 6 N040: as of COB: 03/243/16, all levels indicative. MC based en Mar/Apr TBA dollar roll, spec pod carry calculated at prior 1M CPR, and hoop ratio based on model effective duration, with 'reality check' cap adjustments made for medal HRs greater than 160% of TM. &wee fieurrena Bad leaufinat Deutsche Bank Securities Inc. Page 37 EFTA01123198 27 March 2015 US Fixed Income Weekly Interpreting tradable implications and qualifications Our model is based on a regression of high-LTV and loan balance pay-ups on a small set of variables: • Refinance incentive: measured as the gross WAC on the TBA deliverable for a given period less the prevailing mortgage rate. This variable captures the price premium in the corresponding TBA, increased prepay risk in the TBA, and changes in the fair value of the dollar roll. As refi incentive increases, so too should pay-up value • Cumulative refinance incentive: Measures how long a given TBA cohort has been exposed to refi incentive. This variable captures borrower burnout and will interact with the impact of refi incentive. For higher levels of cumulative refi incentive, increases in refi incentive will have less of an impact on pay-up value as prepay sensitivity in the TBA is diminished • Month-over month change in primary rate: Measures the momentum and persistence of rate moves and can also change the impact of refi incentive. Pay-up values should change with a lag to sudden rate moves, as the new level will need to be sustained to translate into a real change in prepays. In addition to the core set of variables used in the loan balance model, we also found that a measure of national home price appreciation provided additional explanatory power for CO pools. For that measure we simply used the year- over-year percentage change in the S&P Case-Shiller 20-city home price index. Interestingly, that measure did not improve explanatory ability for CR pools, and is not included in that model. That difference seems reasonable given the minimum 105 LTV on CO pools versus the 125 LTV minimum on CR pools — home price appreciation is much less likely to spring CR borrowers from negative equity in the near term. The high-LTV model is a strong fit, explaining nearly 97% of observed variance, similar to the loan balance model. Using these models, loan balance 4.5%s look undervalued, while CR pools look overvalued. For instance, in LLB 4.5%s the difference between actual pay-up and model pay-up suggests that the story is undervalued by $2-04+. Of course, the model obviously does not fit perfectly —in fact, looking at the historical model predicted value versus actual shows a standard deviation of the error of $0.08. However, in the case of the LLB 4.5%s, the current difference of $2-04+ is 8.4 times the error standard deviation. Similarly, the actual pay-up on CR 4.5%s is $0.22 higher than the model value, which is 2.3 times the standard deviation of the error. Constructing a model of high-LTV pay-ups The most interesting aspect of this exercise is again that the relationship between refi incentive and pay-up is not linear in high-LTV pools, but instead is curved (Figure 8). Page 38 Deutsche Bank Securities Inc. EFTA01123199 27 March 2015 US Fixed Income Weekly IFigure 8: High-LTV pool pay-ups show curved relationship to refi incentive G.0 5.0 4.0 2i 3.0 2.0 a 1.0 0 0 0.S 1.0 1.5 2.0 Refi Incentive (%) —Smooth 0 Revue vs Refi Note: Refi incentive is measured as the gross WAC on the TM deliverable bar a given period less the prevaiin 30year primary mortgage rate. Sweetaemene awe IFigure 9: Model fit for CQ 3.5%s in and out of sample IFigure 10: Model fit for CQ 4.0%s in and out of sample 3.00 6.00 2.50 5.00 203 I» 4.00 100 4 3.00 050 0A0 2.00 •030 1.00 .140 0.00 .150 .240 •230 eV If 0, A A et V V V V V V V V 0 0 0 0 0 0 a a a z a aaa a a a aa IIIIIIIIIIIIIIIIiiiit —Ackul In Sample • Fitted In Sample Actual In Sample imed In Sample --- actual Out Samek e Fitted Out Sample m.= Muni Out Umple Fitted Out Sample Soureelleuneneeenk Sarno Dana* Salk Given this relationship we chose to use a non-parametric general additive model (GAM) to describe that function. Reassuringly, the core function relating refi incentive to pay-up continues to hold well in out-of-the-money high-LTV pools, which are non-deliverable and so can trade back of TBA. That model produced a fit with nearly a 97% R-squared, and each variable measured as highly significant, to 99.9% confidence. The model fit well on CQ and CR pools across multiple coupons, and appears to continue to track well when predicting out of sample. One final caveat to the accuracy of the model is our exclusion of any measure of dollar roll specialness. Within our theoretical framework, dollar roll specialness should have a significant inverse relationship with loan balance pay-ups. That is, a highly special dollar roll should reduce or eliminate the carry advantage of slower prepayments in the specified pool collateral. However, calculating a historical measure of roll specialness is inherently subjective, and our simple approach did not return a significant or logical relationship to pay- ups. One explanation may be that pay-ups may react more strongly when the roll is special in both the front and back months, indicating persistent specialness. However, determining back month roll specialness becomes even more complex and subjective than focusing on the front month alone. Deutsche Bank Securities Inc. Page 39 EFTA01123200 27 March 2015 US Fixed Income Weekly For this reason we excluded any such measure from the model. However, a model that did include a measure of specialness should theoretically be more robust. IFigure 11: Model fit for CR 3.5%s in and out of sample 'Figure 12: Model fit for CR 4.0%s in and out of sample 2.50 SOO 2.00 400 130 100 300 0.50 100 0.00 -0.50 100 -WO .I.50 .2.00 .2.50 ggg22g2gsgssgs......ssgsgssssgssg ---- 0000OOOO000000 oSSSSSSSS Actual M Sample —FOS MSomple — AnuO In Semple Filled In Sample Actual Clut Sample — Feted Out Sample --- mud Gut Sample Fitted Out Sample Smear easeceer 8../M Swear Demo* font Page 40 Deutsche Bank Securities Inc. EFTA01123201 27 March 2015 US Fixed Income Weekly Francis Yared nth: Strategist 1.441020 754-54017 Bond Market Strategy ▪ The improved growth momentum in Europe remains favourable for reflation trades and peripheral assets. However, the increase in the duration supply in the periphery could be material and is likely to increase market volatility ▪ We maintain long EUR5Y breakevens, the Bund ASW widener as a hedge, and shorts in the front-end of the eonia curve. We exit the long 30Y BTP and move instead to an optimised 7Y BTP - 30Y OAT cross market steepener. . ▪ The risk premium priced in the US rates market remains low, especially given the latest increase in oil prices and relative weakness of the USD. We maintain USD2s5s steepeners Supply Response The growth momentum in the euro-area continues to improve. The Eurozone Flash PMIs were above expectations and reached the highest level since May 2011. The details of the composite PMIs were also encouraging, with new orders, employment, input and output prices all up. The credit data is also improving, as the 3-month MFI loans to the private sector is at the highest since August 2011. If these levels of credit growth are maintained next month, the credit impulse should continue to improve. Moreover, as highlighted by Draghi in his recent speeches, the easy monetary policy is increasingly being transmitted to the real economy as the interest rate charged on loans to the private sector in Italy and Spain are converging towards the interest rate charged in core countries. In short, the hard data, business surveys and credit dynamics are all consistent with better growth momentum in the Eurozone in Q1. Credit dynamics suggest improving growth momentum Convergence of corporate lending interest rates (3M moving average) •0% BO% O.50 4.0% 40% 2316 20% 0216 OD% 40% 42% 4014 4.016 41014 40016 -5,314 -100% .100% 04 05 06 07 OS OD 10 11 I? 13 15 Sawed Daft:ft Bonk ECIE Hes Aflayeas Source Douses &Ink ECE1. item Mµ0.ro The improved economic outlook should be positive for reflation trades and peripheral bond markets, especially in the context of QE. However, the cash inflation linked and peripheral bond markets have underperformed on a relative basis. This underperformance is to some extent related to quarter-end Deutsche Bank Securities Inc. Page 41 EFTA01123202 27 March 2015 US Fixed Income Weekly dynamics, as investors and dealers reduce risk. More crucially it is likely to be related to the increased supply of duration from peripheral issuers. We had highlighted over the last few weeks that peripheral countries were likely to increase the duration of their new issuance to raise the average maturity of their outstanding debt back to pre-crisis levels. We expected the increase in duration to be a headwind to the spread tightening trend, but not to lead to a spread widening. On closer inspection, the duration supply could actually be quite meaningful. Indeed, Spain and Italy have increased the maturity of their issuance in 2015 by 2.5-3.0 years relative to 2014. If this increase in maturity is maintained for the duration of the QE programme, Spain and Italy would be issuing significant additional duration to the market relative to last year (see the table below and Euroland Strategy for more details). In fact, for Italy, the duration supply could be comparable to the duration taken out by the ECB. Of course, some maturity extension was likely to have been expected and already priced in by the market. Also, the maturity increase from Italy and Spain may be particularly high at the moment and may decelerate. Nonetheless, this simple calculation suggests that the magnitude of the duration supply could be material. IDuration supply in the periphery could be material II) (21 (31 =111 ' (21/ 10 Estimated Gross Maturity Increase Approximate Approximate ECB Supply Mar-15 2015 YID vs. Duration Suppty in OE in 10Y Sep-16 2014 (in years) 10Y Italy 427.5 3.0 135.5 124.1 Spain 142.0 2.4 34.1 66.7 France 345.2 -0.7 -21.1 130.1 Germany 254.9 -0.2 -6.6 146.2 Source Dweatho Boy LTA AM:in of PAPE*, Bbersbars NunnLP For core countries, there has been no supply response so far. Germany is unlikely to adapt its issuance to market conditions. However, France could prove to be more opportunistic. Net selling could come from non-domestic investors as these are the ones who have increased their ownership of core rates during the crisis. As we discussed last week, there are fewer incentives for Japanese investors to hold EGBs at these relative yield levels. For instance, the France-Japan 10Y spread has tightened from over 200bp in 2011 to less than 15bp today. Japanese investors may thus reduce their current holdings (which consists mostly of France) once the new fiscal year starts next week. Vol adjusted carry is more attractive in the belly of the Eonia is proving to be relatively sticky given the increase Italian curve liquidity 3M carry and roll down (LHS) 120% —to— 3M realised vol IAHSI y • 20966,rna1 • Joni° tO DOC-12 9.0 70.0 100% W.07619 8.0 2 • 60.0 • . Jan-13 awards 7.0 8• 00% •• i0 • 60.0 icc • • 6.0 • anent 5.0 40.0 -- 7. C0% 11 is maintenance e '4. Pane, Wan 13 4.0 ommt0/11 30.0 :3 40% '', A • 3.0 4 • • 20.0 20% • 44 •• t 2.0 10.0 • 4.0 - -A • A- A -A - -4 - 4- 40. 1.0 0% 0 100 200 300 400 500 600 700 603 0.0 0.0 Excess I0Jdav in ElAlbn SIPS 43/4 BTPS 1.05 SIPS 2.15 BTES 2 1/2 BTPS 4 3/4 05/01/17 12/01/19 12/16/21 12(01/24 0W01/44 Sauces 13Aeseno &ink 126PPOss Aiwa, w Sews* one SPA. ar4 aboinenPA.061LP Page 42 Deutsche Bank Securities Inc. EFTA01123203 27 March 2015 US Fixed Income Weekly From a trade recommendations perspective, we maintain our long 5Y breakevens as the macro backdrop is increasingly supportive for the trade. Moreover, we see upside risks to the consensus HICP print of next week. We also shift our short 2Y1Y eonia into a simple short 3y eonia as the curve up to December 16 is now fully pricing the increase in liquidity (forward eonias around -15bp). If anything, there is a risk that because of market frictions, eonia does not trade as low in the corridor. For instance, eonia is proving relatively sticky given the current level of excess liquidity. We exit the long 30Y BTP and move instead into an optimised cross-market steepener. We enter a long 7Y BTP to protect against the potential impact of the supply response on the long-end. Even if the most recent price action reverses, the volatility of the long-end of the curve makes this sector less compelling from a Sharpe ratio perspective. The 7 year point is the most attractive from a (volatility adjusted) carry and roll down perspective. At the same time, it is attractive to test a short in 30Y core rates given (a) the flatness of core curves, (b) the risk of unwind of Japanese portfolios and/or supply response from France and (c) the upside risks to the next inflation print. We therefore recommend a 7Y BTP - 30Y France cross-market steepener. Finally, we maintain the Bund ASW widener as a hedge against renewed tensions in Greece. Still looking for more risk premium in the US In the US, the hard data continues to disappoint leading tracking GDPs below 1%. On the more positive side, the jobless claims have remained resilient and some of the business surveys have improved. In any case, the Fed and the market have already adjusted for a weak Q1 GDP, and the inflation outlook remains the key driver. From this perspective, the relative weakness of the USD and rise in oil prices should be supportive of a greater risk premium in US rates. For instance, USD 10Y Breakevens are low relative to oil prices, metal prices and DXY (see graph below). From a trade recommendation perspective, we continue to favour USD2s5s steepeners as an attractive way of positioning for steeper money market curves. The trade remains at risk from a renewed USD strength and/or oil price weakness. However, given the flatness of the money market curve (around 50bp priced between dec-16 and dec-17), the downside risks to the trade are limited. The risk premium remains close to the historical lows And has room to increase given commodity prices and the USD 250.00 Ennui* of the risk peormurn (59105 dope ackustod for the level of 3.1 —USOBEI0Y roto41 200.<0 2.9 — hue& ((d, mesas, DM 'OE eternity 210.00 2.7 ‘. 190.00 2.5 170.00 2.3 15000 2.1 I9).00 110.00 1.9 90.00 1.7 70.00 1.5 50.00 1.3 88 50 909i 92 93 SI 95 90 97 9510 0001 02030105 00 07 05 01 10 II 12 a 14 Jan-10 Nov-10 Sep-11 Jul-12 May-13 Mar-14 Jan-15 &wee. Oftenne &at 96:07700.7 (wow LP SPAM Orono* Swot boonang Anima LP Deutsche Bank Securities Inc. Page 43 EFTA01123204 27 March 2015 US Fixed Income Weekly Economics US: Despite Q1 lull and dollar appreciation, trend growth will continue to improve • The economy is projected to grow 2.4% in Q1 2015, nearly the same pace as the previous quarter. The inability of the economy to sustain a 3%-plus growth rate in the first quarter is due to several transitory factors, which we expect to dissipate in Q2. Consequently, similar to last year, we expect economic activity to rebound over the next couple of quarters. The biggest risk to growth is from an appreciating dollar. However, we believe that most of the dollar strength will be offset by the fall in energy prices, which will significantly boost real income. At the same time, the outlook for interest rates is much more benign, as the timing and glide path of the fed funds rate has been significantly reduced. This, too, will help offset some of the projected weakness in net exports. Therefore, financial conditions have not tightened enough for us to mark down our full-year GDP forecast. Moreover, to the extent that monetary policymakers are projecting less tightening than before, recent dollar appreciation, which has been on a torrid path, is likely to moderate. • Given the lags between changes in the trade-weighted dollar and net exports, the economy has yet to meaningfully feel the impact of the appreciating dollar. If its current level is maintained or if the dollar appreciates further, net exports are poised to be a significant drag on economy activity. At the same time, the strong dollar will weigh further on import prices and hence consumer goods inflation. Based on the appreciation to date, we estimate the rise in the dollar is worth roughly 50 basis points of monetary tightening. However, overall economic activity may not be meaningfully compromised because a stronger dollar will keep interest rates lower than would otherwise be the case, which should help housing-related spending. Additionally, to the extent that the rising dollar has helped dampen inflation both through lower energy prices and eventually even lower goods prices, real wage growth will be lifted. This is a meaningful tailwind for consumers, who dominate US aggregate demand. Ultimately, the appreciating dollar may simply alter the composition of real GDP growth and not the trajectory of growth. This is why we have not changed our longer-run forecasts for the economy. • The economy has generated 3.3 million jobs over the past 12 months, the strongest pace since March 2000, when interest rates were much higher. In 2000, the fed funds rate was 6.0% and inflation-adjusted fed funds, using the headline personal consumption expenditures deflator, was 3.13% at that time. Even with a strengthening dollar and the expectation of a rising fed funds rate, monetary policy will remain highly accommodative for the foreseeable future. 'Figure 1: Macro-economic activity & inflation forecasts: US Economic Activity 2014 2015 2014 2015F 2019P 4% clog, Arent 01 02 03 04 OIF 02F 03F 04F % yoy % vOII %Vol/ GDP 4.8 5.0 2.2 2.4 4.0 3.2 3.1 2.4 3.3 3.1 Private conaumptIon 1.2 2.5 3.2 4.4 3.9 3.4 3.3 3.3 2.6 3.8 3.1 Investment rata. inventories) 19.1 7.2 3.7 10.2 0.1 8.3 5.8 4.8 7.7 Gov't consumption 1.7 4.4 -1.9 2.0 2.8 2.8 3.0 2.9 Exports 11.0 4.8 4.5 1.0 0.0 3.2 1.8 Imports 2.2 11.3 -0.9 10.4 3.0 4.0 4.0 4.0 3.5 4.8 Contribution (pp): Stocks 1.3 0.7 0.2 0.0 0.0 0.0 0.0 Nat trade 0.7 0.3 -0.9 Industrial production = = 4.1 4.5 3.9 Unemployrnent rate, % 8.8 8.2 8.1 5.7 5.5 5.2 4.9 4.7 8.2 5.1 4.5 P... as. 8.. wagur..0,..Y.Y1 CPI 1.4 2.1 1.8 1.2 0.5 0.1 0.5 1.4 1.0 0.8 2.8 Cora CPI 1.8 1.9 1.8 1.7 1.8 1.8 1.8 2.0 1.7 1.7 2.5 Producer prices 1.8 2.8 2.4 0.7 -lb 1.3 1.9 3.8 Compensation per amp.. 3.1 1.8 2.4 2.5 1.8 2.7 2.9 3.4 2.5 2.7 4.2 Productivity 0.8 1.1 1.2 1.5 1.1 0.5 1.3 0.7 1.1 1.3 SAD./ tr:WArnbautheraIA LIP•001.illeegthliaad. Page 44 Deutsche Bank Securities Inc. EFTA01123205 27 March 2015 US Fixed Income Weekly Where are we at the moment? The economy is projected to grow 2.4% in Q1 Figure 2: Underlying economic 2015, nearly the same pace as the previous quarter. The inability of the growth is poised to accelerate economy to sustain a 3%-plus growth rate in the first quarter is due to several factors. One, the economy faced an unusually brutal winter for the second consecutive year. Temperatures across much of the country were unseasonably low and activity was hampered by numerous winter storms. This likely depressed discretionary purchases and hurt construction activity. Two, a slowdown in West Coast port activity, a function of labor strife, may meaningfully dent O1 exports. This will likely reverse next quarter as the labor issues have been resolved. Three, the seasonal factors might not be 40 adequately capturing the currently prevailing seasonal pattern. If our quarterly 2015 GDP profile is correct, this would mark the eighth time in the last 13 years in which Q1 turned out to be the weakest quarter of the year. Finally, the 400 200/ 1009 2010 2011 2013 201 2015 collapse in energy prices is causing a sharp pullback in energy-related capital Scow: 8EA HoterilnoWca Amara,. ay* Rosecach spending at the moment. However, if oil prices stabilize, the drag from diminished oil and gas capital expenditures (capex) should dissipate toward yearend. Based on DB's forecast for West Texas Intermediate oil prices, Figure 3: February was extremely energy-related capex should show an increase by Q4 of this year. cold, thereby depressing economic activity Baby, it's cold outside. We can measure weather by looking at the number of Popaoilon vanoole0 hoodoo egos den Oov16000 heating degree-days relative to the average. When the figure is positive, it 200 Irom nornadt US 200 awe means that households had to heat their homes more than normal, and vice 100 100 versa. As we can see in the accompanying chart, there was a large jump in February 2015 heating degree-days. Indeed, it was the largest positive reading 0 since December 2000, and it was one of the coldest Februarys on record. There is little doubt this had a negative impact on discretionary purchases such .100 • 100 as motor vehicles. In fact, various reports among dealerships across the .200 .200 country highlighted the unusually harsh weather as a factor depressing sales. The story has been the same for housing. In February, housing starts fell a 1098 2000 2002 2004 2020 2006 2010 2012 2014 .300 whopping 17% to 0.897 million annualized, the lowest reading since January 539/90 NOLS. Mkt .4/3.134/99 139/0010 Hoeg lbsoirca 2014. However, housing permits increased 3.0% in the month to 1.092 million annualized. Why does this matter? For a start to be counted, ground needs to be broken. But if the ground is frozen, the start is not captured. This is not the Figure 4: The trade-weighted dollar case with a permit. With the spread between starts and permits the widest has appreciated at a rapid pace since January 2007, expect the former to snap back toward the latter as the tiommal Said indonmorsed exch./999190.a weather normalizes. 40 USO 140 Me/ Inclem 120 nO History repeats itself yet another weak O1 performance. Over the past several 00 100 years, we have noticed a tendency for Q1 real GDP to be significantly weak, at least relative to the rest of the year. While this is hardly a large sample, it is 90 00 possible the seasonal factors are not properly accounting for the currently 00 00 prevailing seasonal pattern in production and spending. Shifting weather e!, 40 patterns only further complicate the ability of the government to seasonally adjust the data. Of course, the seasonal adjustments net out to zero over the 20 20 1975 IMO 1905 1990 1995 2000 MG 2010 2015 full calendar year. S:tims ma Ha MaerAtogeor. Demo* Avg Rennet Lower oil prices mean less energy capex. The roughly 60% decline in crude oil prices from last July's high points to significantly less spending within the capital-intensive energy sector. Historically, changes in oil prices lead changes in energy spending by roughly two quarters. Not surprisingly, energy-related capex is poised to decline sharply this quarter, which is another factor weighing on measured economic output. However, when energy prices stabilize and eventually trend higher as oil and gas supply goes offline, the reduction in capex will eventually come to a halt. Given Deutsche Bank's outlook for oil prices, we should see a sequential gain in energy-related spending by Q4 2015. It is also worth highlighting that energy-related capex accounts for only about 10% of total capital outlays or just 1% of GDP. Therefore, we do not believe that economy-wide capital spending will be meaningfully impaired by the decline in energy prices. Deutsche Bank Securities Inc. Page 45 EFTA01123206 27 March 2015 US Fixed Income Weekly Whither the dollar? The bigger issue for the economy and the financial markets Figure 5: Dollar strength will weigh is the dollar. To be sure, the Fed is worried about its recent appreciation, which has been the fifth fastest on record. It has been eclipsed only by the moves in on net exports for the foreseeable 1981-1982, 1984-1985, 1997 and 2008.2009. In the case of the two 1980s future episodes, high real interest rates, which were induced by tight monetary policy, %. awned axis -2 were the root cause of dollar appreciation. In 1997, the surge was due to the 201610,0cent —>" abandonment of fixed currencies in the Asian bloc. The most recent previous period of dollar strength occurred during the global financial crisis, which .9 resulted in a massive flight to safety into US Treasury securities. The current period is different: The US economy is arguably the healthiest of the major .5 industrialized economies, and the Fed is still expected to raise interest rates this year. Other central banks such as the BOJ and ECB are at different stages awolodon a 063 -10 of the business cycle and are both pursuing expansionary monetary policies designed to weaken their exchange rates. -16 2 1975 1980 1985 1990 1996 2000 2005 2010 2015 — kW Wad wievw10/4.0 wxMn0e *Woe o11.15011w1 In order to gauge the implications of the strengthening dollar for monetary — Combww, of ow won, weed 504112w ba 0v1 policy, we simulated a one-time, 14% shock to the trade-weighted dollar (the Son: FM BEA. Crnitsate 8.7557.57(ch current move from last summer) in the Federal Reserve Board's macroeconomic model of the US economy, often just referred to as FRB/US. All else being equal, the simulated shock causes real GDP growth to decrease Figure 6: The collapse in oil prices by about -0.5 percentage points (or 50 basis points) and -0.8 percentage points, respectively, one and two years after the shock occurs. This is also broadly points to a sharp pullback in energy consistent with what we found when we estimated the impact of the change capex in the dollar on the contribution of net exports in the GDP accounts. As we 100 51. yoy %WY 50 illustrate in the accompanying chart, changes in the trade-weighted dollar tend to impact net exports with a lag of approximately two years. When the dollar 00 25 strengthens, net exports tend to weaken as US manufacturers' prices become 0 less competitive in the global marketplace and imported goods become 0 relatively cheaper. In the process, domestic production and employment 20 suffers. The opposite is the case when the dollar weakens. Hence, a stronger -60 dollar can effectively act as a monetary tightening. This is partly why the Fed recently "shallowed out" its trajectory for interest rates over the next few .100 2003 2003 2006 2007 2000 2011 2013 years; the other reason being the Fed's lower estimate of the NAIRU. - 1.V11crud* 61(701020.11w1 — Petokum nalwe gas u'wlwtc end v(540men1Mel At the same time, the strengthening dollar will weigh on US inflation: Source. £141W54 BEA Nast Anakkt 13557550 &hitt afratidi Domestic producers will be forced to keep their prices as internationally competitive as possible as the cost of imported goods declines. We can see in the nearby chart that when the dollar rises, import prices decline, and when Figure 7: Import prices are likely to import prices fall, consumer goods prices tend to weaken. According to our weaken further in the months ahead FRB/US simulations, the recent dollar appreciation could subtract a tenth or 226 %toy more off of core consumer prices over the next couple of years. This may not seem like much, but core inflation has been running significantly below the leo Fed's 2% target for the past three years. For inflation to rise toward that level, 75 either dollar strength will have to reverse, or services prices will have to rise 00 further, thereby offsetting the former. Given our expectation of a further significant decline in the unemployment rate, services prices, which are dominated by the cost of labor, should increase further, effectively negating 450 dollar strength. Services prices account for roughly 75% of core CPI inflation 0:neiama • -OW -225 compared to just 25% for goods. 2001 20:111 2001 2010 2012 2053 - MOTS/ brOad InIck.w•nr Lam..'Sue DI USD 12m — Won Oct init. a iewom Don't forget oil prices. An important caveat to the above analysis is that the Swot Ma Oa Hew An7.7055Oouncho Bunt brert75 I appreciation of the dollar has been accompanied by a collapse in oil prices to below $50 per barrel, which has been a significant stimulant to US households and non-energy related businesses. We estimate that the decline in energy prices has lifted US household cash flow by approximately $140 billion. Another way to see this positive effect is to look at real earnings: Over the past 12 months, real earnings are up 2.4%, the largest increase since October 2009. Last quarter, inflation-adjusted consumer spending rose at a robust 4.2% annualize rate — matching its best quarter of the business cycle — and while recent nominal spending figures for the current quarter have been disappointing, we believe this is mainly due more to weather and the seasonal Page 46 Deutsche Bank Securities Inc. EFTA01123207 27 March 2015 US Fixed Income Weekly issues discussed earlier. Consequently, even though the stronger dollar will Figure 8: Goods prices will continue weigh on net exports and help dampen inflation pressures, the drop in energy will ultimately be a boon to consumers. Regarding the negative impact on to fall but this should be offset by energy-related spending and hiring, it is worth noting that employment within services the transportation sector, arguably the industry best positioned to benefit from 5 % Cue,CP1 lower fuel costs, is more than three times larger than the energy sector as a percentage of total employment (4.6% vs. 1.4%). The reason we have not lowered our GDP forecast for 2015 or beyond is that we believe that dollar appreciation will be offset by the stimulus from lower oil prices. Hence, we are maintaining our top-down forecast from last December, but the mix of underlying output growth has changed —we have factored in a larger drag from intemational trade, but this is largely offset by stronger domestic spending .3 If the economy is able grow 3% this year, the unemployment rate is likely to 2001 2003 2005 2007 2009 2011 2013 2015 . .Seexces —Coos continue declining at its current pace, which is roughly one percentage point per year. Our forecast assumes the unemployment rate will fall to 43% by SOtarok BLS Mist AitaStia, Dertetheame/Ruoute yearend, which is well below the Fed's central tendency of 5.0% to 5.2%. This further expected tightening in the labor market, which will be accompanied by Figure 9: A rising hiring rate points rising hiring and quit rates, should exert upward pressure on labor costs. In tum, this should add to policymakers' confidence that inflation will trend back to an acceleration in wage costs toward their 2% target, thus allowing the Fed to begin the process of monetary 4,5 %we 13 policy normalization at the September 16-17 FOMC meeting. As always, there are risks to the economic and financial outlook. 3.8 12 3.0 11 9 With respect to output growth, there is a risk that recent dollar appreciation exerts a larger-than-anticipated drag on the US economy than 2.3 10 what we have assumed in our forecast. This would also put further downward pressure on goods inflation and likely stay the commencement l.5 9 Coned...bon = 0.88 of interest rate normalization a bit longer. 0.8 - 2001 2003 2005 2007 2009 2011 2013 9 Another downside risk is that the second-order effects of lower energy — Employment Coal Index 20 lag ORR prices on capital spending and energy-related employment are larger than — JOLTS hiciw rate Hell what we currently anticipate. At the same time, the boost to domestic Source. BLS Host Asayals, AnAwhe 8.9nA Abaft" spending from lower energy prices may not fully come to fruition if households and businesses chose to save a meaningfully greater portion of the energy tax cut. 9 In terms of the upside risks to growth, the rapid appreciation of the dollar may already be reflective of divergent central bank policies. In tum, the pace of dollar appreciation may slow significantly over the coming 9 quarters, and could even reverse, resulting in less drag on net exports and domestic production than we currently assume. Another upside risk is the labor market. As the job market continues to I Figure 10: External balances & financial forecasts 2013 20141 20151 29141 strengthen and the unemployment rate declines meaningfully further, Ravi balance. % el GC, Trade bateau,. USD ton .076 .29 472 -213 .0103 wage and income growth may rise faster than expected, thus providing Trade belancR %el GOP -29 41 -93 4.1 account. Usual -463 407 481 households with even more spending power than we envision. Curran mutant GDP -24 .29 -21 flev.ncal Cuiranl 02.2015 04 2015 01.201E 9 The final upside risk pertains to inflation. The aforementioned potential for 016081 012 013 Oen Ck00 31.1 rate 026 020 0.26 1.10 faster wage gains, combined with a more dramatic recovery in energy USO pet EUR 1.09 101 1.00 0.96 19994, USO 119 121 l25 129 prices relative to our projection — possibly the result of less dollar USO per GOP 1.09 167 1.36 1.33 appreciation, stronger overseas growth and substantially less oil production — may push headline inflation more quickly back toward the Slwer.. &beau'aultrotrt &tante &Ink Remora eat Mart 30 Fed's 2% target. With respect to all of the aforementioned risks, this is perhaps the one that financial markets are least prepared for. Joseph A. LaVorgna, (1) 212 250 7329 Brett Ryan, (1) 212 250 6294 Aditya Bhave, (1) 212 250 0584 Deutsche Bank Securities 111C. Page 47 EFTA01123208 27 March 2015 US Fixed Income Weekly Chart Pack [DB Treasury Yield Forecasts 12-3-5 butterfly, 50/50 weight, long bullet 2Y 5Y 10Y 30Y 20 2015 O1 0.50 1.35 1.85 2.40 0 2015 O2 0.95 1.95 2.50 3.05 2015 Q4 130 2.35 2.65 3.10 -20 Swear Ofteche Sva May rowanSect maraca lc+awl-eternal. -40 -60 -80 03 04 05 06 07 08 09 10 11 12 13 14 12-5-10 butterfly, 50/50 weight, long bullet 12-10-30 butterfly, 50/50 weight, long bullet 40 120 —Butterny2,10-30 —Butterfly2-5-10 30 100 20 80 10 60 0 40 -10 20 -20 0 -30 -40 20 02 03 04 05 06 07 08 09 10 11 12 13 14 02 03 04 05 06 07 08 09 10 11 12 13 14 Some:&vas° e Soak 15-10 30 butterfly, 50/50 weight, long bullet 15-7-10 butterfly, 50/50 weight, long bullet 55 10 — Butterfly 5.7-10 — Butterfly 5-10-30 8 45 6 35 4 2 25 0 -2 15 -4 5 -6 -8 -5 -10 -15 12 02 03 04 05 06 07 08 09 10 11 12 13 14 Ma -12 Seµ12 Mar-13 Seµ13 Mar-14 Seµ14 Mar-15 Same:Davao*Dint Same:Demo* **At Page 48 Deutsche Bank Securities Inc. EFTA01123209 27 March 2015 US Fixed Income Weekly 2-5-10 butterfly (PCA 57.40% and 42.60% risk on the 5-10-30 butterfly (PCA 41.38% and 58.62% risk on the wings) wings) 40 0 - Butterfly 5.10.30 — Butterfly 2.5.10 30 20 10 0 -10 -28 -20 • 32 Ma -13 Sep-13 Mar-14 Sep-14 Mar-15 Ma -13 Sep-13 Mar-14 Sap-14 Mar-I5 Scveca:OntsoWdront Senn eera-roaarrrna 2-10-30 butterfly (PCA 28.20% and 71.80% risk on the wings) 10 —Butterfly 2 .12 20 0 -10 - -20 - -30 - 4' -40 -50 Mar-13 Sep -13 Mar-14 Sep -14 Mar-15 San Oawune awe Deutsche Bank Securities Inc. Page 49 EFTA01123210 27 March 2015 US Fixed Income Weekly 130Y Treasury yield seasonals (Change since Jan-1) 10Y Treasury yield seasonals (Change since Jan-1) 22 2005-2014 —1997 2014 2015 22 2005-2014 —1997 2014 2015 12 12 2 2 -8 -8 -18 -18 -28 -28 -38 -39 -48 -48 J n Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Stink Dotsfato Bak sawn.~wt. Smk 5Y Treasury yield seasonals (Change since Jan-1) 12Y Treasury yield seasonals (Change since Jan-1) 25 2005-2014 -1997 2014 . .2015 20 . 2C05-2014 —1997 2014 2015 15 10 5 -5 -10 -15 -25 -35 -45 -40 J n Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sane:Deena,efOnt ~co:[toots°, itrnt I2Y/5Y slope seasonals (Change since Jan-1) 12Y/10Y slope seasonals (Change since Jan-1) 2005-2014 -1997 2014 2015 14 2005-201.1 1997-2014 2015 9 4 -1 -e -11 -16 -21 26 J n Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Apr May Jun Jul Aug Sep Oct Nov Dec Stun». Dots Molly* Sane:Deena,efOnt Page 50 Deutsche Bank Securities Inc. EFTA01123211 27 March 2015 US Fixed Income Weekly 12Y/30Y slope seasonals (Change since Jan-1) 15Y/10Y slope seasonals (Change since Jan-1) 24 2035-2014 -1997 2014 2015 9 2035-2014 —1997 2014 2015 19 7 14 5 9 4 3 -1 1 -6 -1 -11 -3 -16 -21 -5 -26 7 J n Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sweat:Data. &DM 15Y/30Y slope seasonals (Change since Jan-1) 110Y/30Y slope seasonals (Change since Jan-1) 20 , 2005-2014 —1997 2014 . ,2015 • ,2005-2014 -1997 2014 2015 15 • 10 0 -5 2 J n Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec I &woe. lja~ Bont 130Y swap spread seasonals (Change since Jan-1) 110Y swap spread seasonals (Change since Jan-1) — 2035-2014 -1997 2014 2015 —2005 2014 1997 2014 2015 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -a -10 -10 -12 -14 -12 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sweet. ~who Bunk Sweat. ~ads Sénk Deutsche Bank Securities Inc. Page 51 EFTA01123212 27 March 2015 US Fixed Income Weekly I5Y swap spread seasonals (Change since Jan-1) 12Y swap spread seasonals (Change since Jan-1) 8 2005-2014 — 1997 2014 2015 . 2005-2014-1997 2014 2015 6 4 2 0 -2 -4 -4 -6 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Semen: DOMICM 3041 Sault*: DaseMbe &Mk S&P Index seasonals (Change since Dec-31) I3M1OY Implied vol seasonals (Change since Dec-31) . 2005-2014 —1997 2014 •-2015 25 2005-2014 , 1997-2014 . 2015 8% 20 6% 15 4% 10 5 2% 0 0% -5 -10 -2% -15 -4% J n Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Spumy:~be SAM sown. 00~A) IRMA I5Y10Y Implied vol seasonals (Change since Dec-31) -•200r2014 — 1997 2014 2015 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec SOuire. Dauthet. Sat* Page 52 Deutsche Bank Securities Inc. EFTA01123213 27 March 2015 US Fixed Income Weekly I30Y Treasury roll business days from auction N OY Treasury roll business days from auction 1.5 •- •2.500% 02/45 -3.000% 11/44 3.125% 08/44 -3.375%05/44 3.8 —2.000%02/25 - 2.375%08/24 —2.250%11/24 -2.500%05/24 3.3 1.0 2.8 2.3 0.5 1.8 1.3 0.0 0.8 0.3 -0.5 -0.2 -0.7 -1.0 1.2 O 20 40 60 80 100 120 0 20 40 60 80 100 120 Business days horn the auction date Business days from the suction date Sweat Deana.an Same:Divas°W Sant I7Y Treasury roll business days from auction I5Y Treasury roll business days from auction _1 76096 03/22 —1 7509602/22 - 1.375% 03/20 - 1.375% 02/20 - 1.5009601/22 - 2.12596 12/21 2.5 - - 1.250%01/20 -1 625%12/19 2.5 2.0 2.0 - 1.5 1.5 - 1.0 0.5 1.0 - 0.0 0.5 -0.5 0.0 - -1.0 1.5 -0.5 O 10 20 30 40 50 60 0 10 20 30 40 50 60 Business days horn the auction date Business days from the auction date SwearDash' Salk I 3Y Treasury roll business days from auction I2Y Treasury roll business days from auction -1 000%03118 - 1 000%02/18 - 0.500% 03/17 - 0.500%02/17 - 0.875% 01/18 — 1.000% 12/17 6.0 - 0 500% 01/17 - 0 62596 12/16 5.0 4.0 3.0 2.0 1.0 0 10 20 30 40 50 60 0 10 20 30 40 50 Business days from the &action date Business days from the suction date S:wire 0rixxist (ex Deutsche Bank Securities Inc. Page 53 EFTA01123214 27 March 2015 US Fixed Income Weekly ITop 15 USD Flatteners Top 15 USD Steepeners Rank Trade Percentile Men 25th Median 75th Max ly Carry I'm Vol Rata Rank Trade ly CM,' i-Tp Vol Ratio Percentile Min 25th Median 75th Max ESEVEZIIKM ELMKENMEMCHM NOMEEn OEM= MEENIEMEN=:::= IEEICREMEMCI In 3M IY3Y -OA 398 0.0 18 EEICMNMLEIEt1 2 6M 2•20Y 49.4 605 0.8 79 Minn Min MEEDOMIINM CM KEN=I= EEILEIKEEMEal ME EOMKIM KENMI= MilIMEll CUM EN 3M IVEY Eirrnzzonnenrgrunrn 4 cairns+. ran ta et MEE CI EMU nraisnran Mr] EHEli 1:11En Sir aim m0 MilLEIKEE CEREI Ea CI EilIEEMEKENWC=EWENKEEIII CB MECA CI EOMKENWI= En EaMEMIEN 7 3M IY1CIY -24.8 81.9 lain -1.9 0.3 0.1 04 42 7 6142Y101. 388 m oh 85 -2A ICEMBMin EA MEEELMCI MEMEa CI KEEM Ell o1IEEZEIMEEE22ECMWI= IEEICEICIECUM NM 1V IY2Y Om EMI=!= EREl EtaEMU 9 marry tirin 08 86 lal Ell CMMEM Ell 111=ZEEMIE EMIEl= Erl IMIEll CI CEI EalELMOCM WEEKEN=::= KUM KEECUM ETEEl= MEMMEMCI MZ= EULEWINlal BEI EIEBEMCM WEEKEEM2MCI OilWEILEIMEI 12 6M20 -2.0 4.9 -0.4 55 -1.6 -0.7 -OS -0.1 0.7 12 1Y 2Y7Y 332 423 08 78 - -03 0.1 0.7 1.3 EEIE7E5IEZEEMIE ®' O MEICI KENlal En En CI MDSTO WEEMEMEll MI:= lal CI KENCUM ME= MITEErrnrinenni Ell ENITI 14 n Ell7EErnWM Erl DI ETUITIIn WMauL.!iiMEMESEMKENfl agLEIEli CI 1:13 EITC WEEEINEKEEMI= MCI EXE111ElE1 54.4.42 osula10SaM sa.yoe. owners oath Top 15 EUR Flatteners ITop 15 EUR Steepeners k Trade 1y Carry la p. Vol Ratio Percentile Alin 25th Median 75th Max 1 6M 2Y3Y 3.8 6.1 0.5 65 1.7 -0.3 0.2 07 2_4 1 6M15Y25Y 0.2 13.6 02 15 0.0 0.3 0.5 0.7 IA 2 1Y 2Y3Y 3.1 7.1 0.0 70 .12 .0.3 0.2 0.5 1.5 2 lY 15Y20Y 21 89 02 12 0.0 0.3 0.5 DA 09 3 3/A 2Y3Y 62 98 04 82 -2.0 .0.3 0.2 0.7 3.7 3 611115Y20Y 21 9.1 02 18 0.0 0.3 0.5 DA IA 4 3/A 2Y5Y 7.7 19.5 OA 68 -1.8 -0A 0.1 0.6 3.0 4 lY 10Y25Y 63 27.7 02 14 -01 0.3 0.5 0.7 IS 5 6M2Y5Y 7.0 187 04 67 -1.5 -0.3 0.1 03 I.8 5 1Y 10Y20Y 52 23.1 02 19 -CO 0.3 0.5 0.8 1.1 6 1Y 2Y5Y 5.6 174 0.3 68 -1.1 -OA 0.1 OA E3 6 lY 10Y30Y 7.0 30.9 02 14 -01 0.3 0.5 0.7 1.0 7 3M 3Y5Y 3.5 114 0.3 68 -13 -OA 0.0 OA E4 7 lY 15Y25Y 3.2 14.1 02 11 0.0 0.3 0.5 OA 08 8 61A 3Y5Y 3.2 112 0.3 68 -12 -0.3 0.0 OA 12 8 81115Y30Y 3.8 17.3 02 17 0.0 0.3 OA DA 1.0 9 3IA WY 8.5 301 0.3 65 -1.8 -0A 0.1 0.5 29 9 81110Y25Y 62 28.7 02 17 0.0 0.3 0.5 0.7 12 10 6/A WY 7.7 29.5 03 68 -1.0 -04 0.1 OA IS 10 CM 10Y30Y 6.9 318 02 17 -CO 0.3 0.5 D.7 1.1 11 3/A 1Y5Y 121 512 02 55 -2.6 -as 0.2 0.7 3.9 11 lY 15Y30Y 3.8 178 02 12 0.0 0.3 OA OA 09 12 1Y3Y5Y 2.5 11.1 02 71 -1.0 -04 0.0 0.3 1.0 12 lY 10Y15Y 3.2 14.9 02 21 -02 0.2 0.5 08 IA 13 3/A 1Y7Y 129 57.7 02 57 -2A -as 0.1 08 4.0 13 1Y 7Y30Y 9.0 43.1 02 25 -02 0.2 0.5 D.7 1.0 14 1Y 2Y7Y 5.8 29.8 02 68 -1.0 .0.0 0.1 0.3 I.1 14 6I1110Y20Y 5.1 24.7 02 18 0.0 0.3 0.5 08 12 15 3/A 3Y7Y 43 22.1 02 67 -1A .0.0 0.0 02 E4 15 1Y 7Y25Y 8.4 40.7 02 25 -02 0.2 0.5 08 1.0 .Sao-m.004.4460- &WM &Warne 8444 ITop 15 JPY Flatteners Top 15 JPY Steepeners Rank Trade ly Carry Iwo Vol Ratio Percent- El Min 25th Median 75th Max Rank Trade ly Carry Inc, Vol Ratio • Mt/ 1 1Y 2N3Y 20 5.0 0.0 42 -1.0 0.1 0.5 0.6 1.0 1 1Y 15Y20Y 23 112 02 1 .0.3 0.5 0.7 0.9 1.6 2 1Y 21e5Y 0.8 123 OA 41 -18 0.1 OS 0.6 12 2 C11115/20Y 23 120 02 4 .1.3 0.5 0.7 DA 18 3 6/A MY 3.0 Al 0.0 41 -1.5 0.1 OA 0.6 1.8 3 3I1115Y20Y 21 11.9 02 8 -3.8 0.4 0.7 DA 2.4 4 6IA 2Y5Y 49 13.8 OA 35 -18 0.1 OS 0.7 1.8 4 1Y 10Y20Y 1.3 232 0.1 1 -0.3 0.3 0.7 08 1.5 5 tY 3Y5Y 28 83 0.3 41 -1.0 0.0 OA 0.6 12 5 81115Y30Y 5.3 99.6 0.1 1 -0.5 0.1 0.3 08 1.7 6 3/A 3Y5Y 3.1 9.5 0.3 38 -1.5 0.0 OA 0.6 3.0 6 lY 15Y30Y Sd 116.5 0.0 1 -0.3 0.1 0.3 0.8 12 7 l Y 2Y7Y 6.1 19.7 0.3 39 -18 0.1 OA 08 1.1 7 38115Y30Y 52 119.0 0.0 2 .1.3 0.1 0.2 08 2.4 8 6/A 2Y3Y IA SA 02 32 -1.7 02 OS 0.7 1.7 8 611110Y20Y 1.1 25.5 0.0 2 -0.6 0.3 0.8 DA IS 9 6/A WY 6.4 21.6 0.3 34 -1.8 0.1 OA 0.6 15 9 C11110Y30Y 0.1 1109 0.0 1 -0.6 0.1 OA 08 1.7 10 61A 1Y5Y 5.9 202 0.3 27 -2A 0.3 0.6 0.7 E9 10 lY 10Y30Y 0.4 1282 0.0 1 -04 0.1 0.3 08 12 11 1111Y5Y 6.1 212 0.3 25 -1.8 0.3 OS 0.7 IA 11 3I1110Y20Y 09 25.6 0.0 it -12 0.3 0.8 0.8 2.7 12 3M 2Y5Y 08 16.6 0.3 32 -1.5 0.1 OS 0.7 24 12 611120Y30Y 3.1 904 0.0 3 -0.5 0.1 0.2 0.7 1.4 13 6M 1Y7Y 7A 272 0.3 28 -2A 0.3 OS 0.7 I.8 13 91110Y30Y 3.9 129.7 0.0 2 -0.9 0.1 0.3 08 2A 14 1Y VIOY 7.3 28.9 0.3 47 -1.6 0.0 0.3 03 1.0 14 lY 20Y30Y 3.0 107.8 0.0 2 -03 0.1 0.2 0.7 1.3 15 6M 3Y7Y 46 16.7 0.3 38 -1.7 0.0 OA 0.6 1.8 15 3I1120Y30Y 3.1 1102 0.0 3 -24 0.0 0.1 0.7 21 ThA .. °nanny front Carry is calculated for nen 3 months and shown in annualized form. Volatility is calculated as 1m realized for CAD and swatted from swaptions prices for other currencies. Percentile statistics are calculated from a 10 year history. Page 54 Deutsche Bank Securities Inc. EFTA01123215 27 March 2015 US Fixed Income Weekly Top 15 CAD Flatteners Top 15 CAD Steepeners Wiese Hly Catty Riad. Vol Ratio Percentile Min 25th !Artisan 75th Max MaEilliMINM MEMZENMEMCEILEIKENLEIEn I 11A 1Y2Y 20.0 152 1 18.5 IY WV nWIENEIMMTMCIEIEINTICE1111 2 1Y 1DY20Y 10.9 172 0.6 St -0.5 0.3 0.6 0.8 1.5 EINZIE01MEEMMEENCMM".:2=CI LEIMEUSER 3 11. H. 10.1 17.7 0.6 41 -2.1 0.3 0.8 1.0 2.3 ENIZIK81Eat CM ZEEMZ:=C23CI KINBEICI d 32,115Y20Y 4.4 7.8 0.6 54 -0.5 0.3 0.5 0.8 0.1 5 I Y 1Y7Y 28.6 58.2 DS es -2.2 0.1 02 1.6 5 1Y 1DY15Y 6.6 11.7 0.6 60 -1.0 0.3 0.5 0.7 1.3 MMIZEZIEEMMENCSEallEEICIEESEEICI 6 4.11. H. 10.3 18.7 0.6 40 -1.0 0.3 0.8 0.9 1.7 WE 6.11Y5Y IlairrErirINIIMETINTICEIIIM 7 1Y 1520Y 4.4 8.0 0.5 55 DA 0.3 0.5 0.7 1.4 EROEMMEMCMCMIINIMMESIEaKIMmm 8 lYTYZEI 12.0 211 15 50 -02 0.2 0.5 DA 1.7 Ma Mat EENEXEMTEMEaICEIKINCIE3 9 1Y10Y259 12.6 242 15 46 -0.0 0.3 0.8 DA 1.3 0 I Y IY1OY 27.4 65.6 0.. 87 -1.9 0.0 0.2 1.1 10 3M 10Y25T 12.0 244 0.5 40 -1.7 0.3 0.8 0.8 2.1 KM MEENEEENEXEMTMETIICEIMEMMIEEI 11 3M 10YI SY 5.7 12.3 0.5 44 -3.7 0.2 0.5 0.8 3.1 Eli SkI I VIEW INSTMEMEMIMMTIMISTIETIMMITIIMI 12 6M 10Y25T 12.1 25.9 0.5 37 -0.8 0.3 0.8 0.8 1.5 EEO 6M WY IKEEME:EMMINM:MIETICEICENIMIIII 13 lY TY25Y 13.7 29.6 0.5 45 -02 0.3 0.5 0.8 1.4 ErnOEMMELEEMEMZEN=::::=lElilCI KENm® 14 1Y 1DY30Y 13.9 312 0.4 43 -0.3 0.3 0.5 0.7 1.1 15 3M 2Y5Y 140 Mb D2 76 -26 0.1 D2 1.3 064.1.10.00 Bath Sa.ym. pounds Roth Top 15 AUD Flatteners !Top 15 AUD Steepeners Rank Trade ly Carry Imp. Vol Ratio Percent Min 25th Median 75th Max Rank Trade ly Carry Imp. Vol Ratio Percent Min 25th lAedian 75th Max 1 3M 2Y5Y 589 79.7 D.7 89 -12 -D.0 0.3 0.5 1.4 19 7Y10Y 38 21.6 D.2 58 -0.1 0.1 0.2 Di 0.5 2 Al 1Y5Y 78.2 118.8 17 71 -1.3 -02 0.5 17 1.4 MEMEZIMMEMantEMMEMMEEININEEKEI 3 61.42Y3Y 228 372 DA 68 -1.0 0.2 0.5 D.7 1.6 ENITMITINTErtilMEINITIETIETIITI 4 3M I WY 77.2 144.7 0.5 67 -12 -02 0.4 DA 1.3 fl 3M 7Y1DY ErEEMEMEINOIMEEICENEEICEI 5 31.12`1711 57.8 109.7 0.5 90 -0.9 -0.3 0.1 DA 1.0 tal=i1M:ES CM MNM:= EMILEICMCEIEEI 6 31.I I `CY 41.5 BEd 0.5 81 -1.0 0.1 0.4 0.6 1.6 8 1Y 5Y7Y 2.7 37.1 Di 13 -0.1 0.1 0.2 02 OA 7 3.12Y3V 22.2 49.3 0.5 87 -0.9 0.1 0.3 0.5 1.3 nalMECLIKEMEMEIMMMEEMIKINII11:13 8 6M 1Y5Y 51.0 115.8 DA 65 -1.1 -02 0.3 0.5 1.0 EMITEICLIMMEMIKEN=r1.13:1EEICE1133 9 I Y 1Y3Y 28.4 66.5 DA 71 -0.9 0.0 0.3 0.5 1.0 MI 3M MY MEECM CMMrM IM LEICM111103 10 31.13Y5Y 36.6 86.1 0.4 74 -1.0 -0.7 SI 0.5 1.8 ECIEMZIMEMMUMMIN=12=CHM MIER EMI 11 31.I IYIDY 70.0 1674 0. 65 -1.1 -02 0.3 0.5 1.1 NM IY Teri MinnwrinEnnuninrn 12 61.12Y5Y 362 88.0 0.4 CO -1.1 -02 0.2 DA 09 MEIBYEMIMEMWEECMMli= CI 131KIMCMIII 13 EN I Y3Y 37.6 92.9 0.4 58 -1.0 0.0 0.0 0.5 1.2 EFII7MICEZETInstranurrainn II I Y 2Y3Y 17.8 44.7 0.4 50 -1.3 0.1 04 DA 1.1 MI I Y 2Y1ElY CONEENZEIMMEEIEEMMEEKEI 15 3k12YIDY 50.8 1364 DA 68 -0.7 -0.3 0.1 D2 OS EEICEMIZEME[2:1EIMMEMEEICIEEME:1111 Swett Orme.* dront Sane:Omer..Sint Top 15 GBP Flatteners Top 15 GBP Steepeners Rank Trade ly Catty Imp. Vol Ratio Obeesessi win PEThrileellan Ighillax nil• NM zwillitmvit 1 Ai I Y2Y12.1 23.6 DS 51 .0.7 0.2 0.5 1.1 9.8 1 6M 3Y2DY 20.2 03.3 0.6 63 S6 0.0 0.3 0.9 3.7 2 MA I Y2Y 9.0 242 DA 60 -0.9 0.1 0.3 DA 3.4 2 6M 3YI5Y 21.5 385 0.6 65 -0.6 0.0 0.2 0.9 3.7 3 31.I I Y3Y 11.3 39.3 D2 35 -08 0.2 0.5 DA 40 3 lY 2Y20Y 286 516 0.5 62 -0.5 0.0 0.3 CO 2.0 4 MA I Y3Y 7.0 358 D2 39 -1.1 0.0 0.3 DA 3.4 4 lY 3Y20Y 25.0 07.1 0.5 60 -0.4 0.0 0.3 CO 2.0 5 I Y 1Y2Y 2.2 158 DI 43 -12 -0.1 0.2 0.5 2.5 5 lY 2Y15Y 218 090 0.5 63 -0.5 0.0 0.3 DA 2.1 6 31.I I Y5Y 5.0 58.3 D.1 32 -1.1 0.0 0.3 17 3.4 6 6/113`,25Y 25.9 09.3 0.5 62 -0.6 0.0 0.2 CO16 7 6\11Y5Y -0.1 49.4 DA 37 -1.3 -02 0.2 DA 2.9 7 6%159711 5.5 10.5 0.5 72 -0.6 -0.1 0.2 0.6 3.3 8 am VT' -0.4 62.7 DA 32 -1.3 -0.1 0.3 DA 2.9 8 6/.13Y30Y 26.9 514 0.5 62 -0.5 0.0 0.2 0.9 3.6 9 31A 2Y3Y -OS 18.0 DA 49 -52 -15 0.0 0.5 2.0 9 I Y 3Y7Y 115 25.8 0.5 87 .0.7 .D.1 0.2 0.7 2.1 10 I Y 1Y3Y -1.4 24.6 -0.1 37 -12 -02 0.2 0.5 2.0 10 lY 3Y15Y 22.3 426 0.5 81 .0a 0.0 0.3 0.9 2.0 11 En125Y30Y -1.1 15.0 -0.1 59 -1.6 -02 SI DA 0.2 11 6812Y20Y 262 50.1 0.5 63 S.8 .0.1 0.3 0.9 3.8 12 3\11YI OY -as 65.4 -0.1 33 -1.4 -02 0.2 0.5 2.6 12 6/13YIDY 17.3 33.4 0.5 87 -0.6 -0.1 0.2 0.7 3.7 13 EM I Y7Y -16 53.5 -0.1 35 -1.3 -0.3 0.1 0.5 2.5 13 lY 2Y25Y 30.2 586 0.5 81 -0.5 0.0 0.3 0.9 2.1 14 6/.120Y2ST -Is 15.1 -CU 63 -2.3 -DA -0.3 DA 0.2 14 lY 3Y10Y 182 35.4 0.5 65 -0.5 0.0 0.2 18 2.0 16 MA 2Y3Y -1.9 118 -0.1 47 -3.9 -0.5 0.0 0.5 1.5 15 6M5Y15Y 11.3 275 0.5 62 -0.4 0.1 0.3 DA 13 Source. °saw%)Rot! da.vat DAMMAM Sat* Carty is calculated for next 3 months and shown in annualized form. Volatility is calculated as In, realized for CAD and extracted from swaptions prices for other cunencies. Percentile statistics are calculated from a 10 year history. Deutsche Bank Securities Inc. Page 55 EFTA01123216 27 March 2015 US Fixed Income Weekly Top 15 CHF Flatteners Top 15 CHF Steepeners Rank Tradr 1y Can) Rep Vol Ratio Percent Min 25rh Mecion 75th Max flunk Trndr 1y Ciro Imp. Vol Ratio Percent Min 25th Median 75th Max ME MEN MEM KEN MMS CI EMI Era MID IBUTAI EZEN WEE CM E3 CI CI MiEM LEI in MI 3M WM KIM CM Waal Ilaa IIM ran in L. dIrIMINEMIIMMESIMTMUM OM MTN CO EU min 3M2Y5Y WEE MICE KEN MIN EU CEEI WEI CHU [EMI MACE m' 0 KB EU tri L® EN MEM MEIM WEE CEO CI Ell Mia Ell MEI El= KM MEN MB M:E= MIMI CI MID Ea 3M3Y5Y EMMET. DA 56 Minn Erin Ea= Era minim Ira MEI EMEIESOI a:MENEMCEO CHM NMI Ell ICI CI37:152ME M=sS CM MS CR EINEENEE1110 MR FIEEMIWES MEM CM MZM EH CU KEE al EU L__ICEMIMEM MOM MIN fl EICIEU MIN 1:13in 8 IV2YSY 1.7 17A 0.1 51 -0.8 -0.1 0.1 0.5 1.1 I 61.17YMY 1.9 184 0.3 20 Inn 0.6 0.9 1.0 Ea MEEMCM KIM =1::= Ell MI Ma al IZI _ ' I WES WEEMINMI= EEEIrEIMMEI3111 Eril 6143Y5Y .7. WM EM In 03 BM CM III Ill IlaMIEIMWICEMMWMEIrlrurtmrrun EN 31A MCP? MEM MEME CM 1=2:2M MEI EU CM LEI MEI __i_dinEMIMEENEENMIN a 193 ICEMEN in MEI Ma EIZEMINM MEM a O CC CM EU Eli _7111MIMEMMENEEMMEMIMEEIE11103111 13 1Y2Y7Y -2.2 25A -0.1 44 -0.9 -05 0.0 OA 1.0 - 1 1Y2Y10Y 7.2 33.1 Er. 58 IrEl Ira 0.1 0.6 1.0 aa Raga MEE MEER MN MEM CI lal CM EU MI lEDENEZIMEMMENNIMaIllrEIMMEIMI Ell CDS= MEM MEEEMEIMEM Mg IMI CM III Ma CM WEE MIEN KEN Ma MEI M KEN En EU sxmv Desire Sank Same. Oeutecire ant I Top 15 SEK Flatteners Top 15 SEK Steepeners Flank Trade 1y Carry Imp. Vol RaMoYi PerOMIC Min 25th /Indian 75th Max 1 1Y 1}3Y 146.1 63.3 2.3 Si .4.9 4.1 2. r' 3A 1?BY 725.1 951.9 0.8 9 3.8 2.3 5.1 9.1 14.6 2 3M 7Y1C11. 46.0 20.8 2.2 103 -3.8 -1.8 -1.2 -06 24 2 al 1Y7Y 688.3 931.4 D.7 8 -0.5 2.4 5.0 8.8 14.9 3 I Y 1Y5Y 185.5 93.8 2.0 51 -4.3 -1.3 1.8 &I 76 3 31,A IYIDY 6422 925.1 0.7 8 -0.3 2.8 5.0 9.0 15.0 4 I Y1Y7Y 202.3 110.3 1.8 54 -42 -1.6 1.5 3.6 68 4 30.1 1VT/ 752.8 1105.7 D.7 13 -13 2.1 5.7 9.9 21.1 5 I Y IYIOY 215.6 1186 1.8 58 -4.5 .1.8 1.2 32 6.3 5 6M1Y3V 2433 325.3 DA 8 -1.0 1.4 2.2 3.9 8.1 6 66.1NI CPI 18.4 12.8 1.4 103 -4.3 -1.9 -1.3 -0.6 1.6 8 6M1Y5V 230.6 463.4 0.5 11 -0.5 1.1 1.7 32 69 7 3,ol 5YI CPI 832 612 1.4 103 -3.4 -2.1 -1.1 -02 1.4 7 EMIY7Y 214.9 4615 DA 9 -0.5 1.1 1.7 32 66 8 1Y7/10Y 13.4 11.0 12 103 -4.6 .1.8 -1.2 -04 1.3 8 64.1 IYIDY 196.5 489.7 DA 7 -0A 1.2 1.9 32 63 9 1Y5V10Y 30.1 312 1.0 103 -42 .1.8 -1.0 0.0 1.0 9 3A 3NSY -27.4 242.5 -0.1 42 -2.6 -DA 0.2 12 3.2 10 3/A 5Yre 37.1 42.5 0.9 103 -3.1 .1.8 -OA 0.0 1.0 10 GM 3Y5Y -17.7 152.7 -0.1 44 -2.9 -0.7 0.2 1.3 2.8 11 I Y 5Y7Y 16.7 21.4 0.8 96 -3.5 -1.5 -OA 0.3 1.0 11 GM 3Y7Y -33.5 184.1 -02 35 - -OA 0.5 IA 3.6 12 66.1 5Y1CIY 342 44.5 05 103 -4.0 -2.1 -1.1 -0.3 08 12 31...13Y7Y -64.5 2625 -02 31 -2.1 -DA 0.8 1.7 3.6 13 I Y 3Y10Y 695 107.5 06 88 .4,7 .1.8 35 0.9 2.0 13 6M 3YIDY -51.8 194,9 -0.3 24 -1.9 -02 0.8 IS 3.9 14 I Y 3Y7Y 562 962 06 60 -43 -13 -02 12 25 14 31.43YIDY -110.6 303.3 -0.4 22 -1.5 -0.1 0.8 20 3.4 15 I Y 3Y5Y 39.4 78.1 0.5 54 -4.1 .1.1 0.2 1.7 32 15 GA 5Y7Y -15.8 33.1 -0.5 8 -1.0 0.0 OA 1.7 3.9 Satin*. Daum*.En Spread of Swap Spreads Trades Values as of Mar 26th 2015 Current Current Trade Percentile Min 25th Median 75th Tenor Repo Spot Swap Spread 1M Fwd. Swap Spread Carry Level 2Y3Y -1.92 3.0 11 -4.9 -20 -1.2 -0.5 2 15.00 23.5 26.2 2Y5Y -1.78 -10.2 3 -11.7 -6.9 -3.9 0.3 3 16.00 20.5 21.3 2YN -2.25 -16.8 4 -18.5 -11.8 -6.1 1.3 2Y10Y -2.72 -14.6 2 -15.9 -8.1 -3.2 -0.4 5 7.50 13.3 14.2 2Y30Y -3.02 -39.2 1 -41.4 -23.6 -19.4 -14.8 7 9.50 6.7 7.2 3Y5Y 0.14 -7.2 4 -8.2 -5.0 -2.6 0.8 10 2.50 8.8 8.8 3Y7Y -0.33 -13.8 3 -15.3 -10.0 -4.5 2.0 3Y10Y -0.80 -11.6 2 -12.7 -62 -1.9 0.3 30 I 11.50 -15.7 -16.0 3V30V -1.10 -36.2 1 38.2 -223 -18.3 -13.8 Sane: Deutsche Oink 5Y7Y -0.48 -6.6 8 -7.7 -4.4 -2.0 0.7 5Y10Y -0.94 -4.5 4 -6.2 -2.1 -0.6 1.0 5Y30Y -1.24 -29.0 3 -31.0 -20.3 -16.2 -11.2 N10Y -0.47 2.1 49 -7.5 -1.4 2.2 3.8 N30Y -0.77 -22.4 16 -33.8 -183 -12.4 -9.2 10Y30Y -0.30 -24.5 6 -30.7 -20.2 -14.8 -12.7 Page 56 Deutsche Bank Securities Inc. EFTA01123217 27 March 2015 US Fixed Income Weekly IDGX and DVX across different market regimes 'Term structure of 2Y vol 220 160 135 - 26 Mar-15 DGX ! I 200 ---r. • a • 26 Mar-13 140 115 26-far-10 180 I 160 ------ 120 95 140 120 100 55 I 80 35 60 40 40 15 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 0 5 10 15 20 SwearDemo* Art 'Ratios of 2Y to 10Y tenors (quartiles, 5-year history) 'Term structure of 10Y vol 125 1.4 2Y Tenors/10Y Tenors • Mean 0 Last •26-Mar-13 115 1.2 26-Mar-10 105 95 0.8 85 0.6 75 0.4 65 0.2 55 1m 3m 6m 1y 2y 5y 7y 10y 0 5 10 15 20 Swear Sa+mmM Sank Same:Dwes° Sint 'Ratios of 30Y to 10Y tenors (quartiles, 5-year history) 'Term structure of 30Y vol 2.4 30'1Tenors/IV Tenors • Wan 0 Lest 2.2 I 0.8 0.6 1m 3m 6m 1y 2y 5y 7y 10y 0 5 10 15 20 Save.. Alaimo Sink Deutsche Bank Securities Inc. Page 57 EFTA01123218 27 March 2015 US Fixed Income Weekly I3M carry across different expiries lATMF receivers) IBreakdown of 3M carry for 6M expiries (% premium) 6mly 6rrey 6rr6y 6m7y 6m10y 6m15y 6m20y 6m30y Tenor Sower Cleesre Halt IUS surprise index: WY Treasury yield ITrade weighted dollar surprise index 110 55 110 100 OS a 33 3 25 2 —10yr TreasuryPato 30 1 44a 41 lisuOi Mira lat40 Meal ManCell far* 11.21 Warn Warn Wall Mien Swear Oeuedre Sy* Saute:Dawes° Holt 'Combined put/call ratio in Treasury futures 2.25 2.00 , Put/call ratio —Average - 1.75 LSO - 1.25 - 1.00 0.75 050 - WA Y 0.25 2/1/07 2/1/09 2/1/11 2/1/13 2/1/15 Souses Deutsche Beth andLW &OW Page 58 Deutsche Bank Securities Inc. EFTA01123219 27 March 2015 US Fixed Income Weekly I US Treasury Coupon Auction Calendar Ticker/Coupon/Maturity Date Tap/New Issue Size I US Economics & Events Calendar Event DB Forecast Personal Income Income +0.4% Consump. +0.2% Mon, Mar 30 2015 Core PCE +0.1% Pending Home Sales Index +1.0% Fed Vice Chair Fisher gives keynote address at Atlanta FRB conference Chicago PMi 50.0 Tue, Mar 31 2015 Consumer Confidence 95.0 ADP Employment Report +215k ISM Index 52.7 Construction Spending +0.7 Wed, Apr 01 2015 Unit motor vehicle sales 5.6M Cars 8.2M Trucks 16.6M Total -S41.08 Intemational Trade Balance +0A% Factory Orders 5248 3 Yr Note Announcement Thu, Apr 02 2015 5218 10 Yr Note announcement 5138 30 Yr Bond Announcement glees opening remarks at Fed conference on Fed Chair Yellen economic mobility Employment Payrolls +225k Private +215k Fri, Apr 03 2015 UnRate 5.5% Hrly Erngs +0.2 Weary* 34.6hrs Deutsche Bank Securities Inc. Page 59 EFTA01123220 27 March 2015 US Fixed Income Weekly I European Economics & Events Calendar Date Economic Releases Political Events Bond Redemption/Supply Mar 30 Spain: CPI EU Harmonized YoY Italy to Sell Up to EUR2 Bln 1.05% 2019 Bonds Portugal: Industrial Production YoY Italy to Sell Up to EUR2.5 Bln 1.5%2025 Bonds Germany: CPI VoY Italy to Sell Up to EUR3 Bln 2022 Bonds France: PPI YoY Italy: Business Confidence Eurozone: Consumer Confidence Mar 31 Spain: Retail Sales YoY Germany: Unemployment Rate Italy: CPI EU Harmonized VoY Greece: Retail Sales YoY Eurozone: CPI Estimate YoY Apr 01 Spain: Markit Spain Manufacturing PMI Germany to Sell EOM BM 0% 2020 Bonds Germany: MarkitA3ME Germany Manufacturing PMI (DE0001141711) France: Markit France Manufacturing PMI Ireland: Unemployment Rate Italy: MarkiVADACI Italy Manufacturing PMI Greece: Markit Greece Manufacturing PMI Eurozone: Markit Eurozone Manufacturing PMI Apr 02 France to Sell Bonds Apr 03 Ireland: Investec Composite PMI Ireland Page 60 Deutsche Bank Securities Inc. EFTA01123221 27 March 2015 US Fixed Income Weekly 'Total/excess return forecasts in HY, IG, leveraged loans HY 16 Syr Trsy 10yr Trsy Loans 2yr Trsy Spreads/Yields Spreads/Yields Current 476 129 147 201 Current 515 55 Target 510 130 195 250 Target 500 155 Change 34 1 48 49 Predicted Change -15 100 Now Rate Duration 1.0 Duration 4.6 6.5 4.8 8.5 Spread Duration 2.7 Change in Yield 82 49 48 49 Avg Par Coupon 440 Change in Price -377 -319 -230 -417 Ubor/Tsy Change 100 Current Yield 737 421 Total Change in Yield 85 Current Price 100.4 109.2 Repricings -50 Default Rate 3.5 0.0 Capital Gain •110 Recovery 40 Credit Loss -211 0 Current Yield 440 Default Rate 3.5 Price Return -5.9 -2.9 Price 99.9 Total Return 1.5 1.3 Credit Loss 87 Excess Return 2.3 2.7 Total Return 2.4 Sanaa CwYo[M 84.1 Deutsche Bank Securities Inc. Page 61 EFTA01123222 Closed Trade Recommendations Trade Detail Rationale Risks Opened Entry Closed Exit P/L Being long 2019 BEs versus 2016 BEs 2019 breakevens drop Inflation Long 2019 TIPS breakevens versus has positive carry, and is less more than 2016 11/26/14 +41 bp 2/25/15 +22 bp +4,014k 2016 TIPS breakevens correlated with energy prices than 1yr breakevens BEs Inflation Long 30yr TIPS breakevens Bond TIPS look cheap on a relative Inflation expectations 2.08% 12/9/14 1.97% -1,171k 10/17/14 value basis decline Inflation Long 5yr TIPS 5yr TIPS look cheap Inflation declines further 9/12/2014 -6 bp 10/28/14 -11bp +81k Inflation Long 10yr TIPS breakevens vs 5yr and 10yr breakevens look cheap ahead of 10yr breakevens -120k 5/16/14 +6 bp 9/25/14 +6 bp 30yr TIPS breakevens supply underperform Inflation Long 30yr TIPS breakevens vs 10yr 10yr breakevens +8 bp 7/23/14 +12 bp +171k 10s-30s breakeven curve is too flat 6/12/14 TIPS breakevens outperform We favor short-dated TIPS for near- Decline in energy prices +200bp 9/16/14 +182 bp -1,240k Inflation Long 5yr TIPS breakevens term carry. cheap and 6/12/14 orinflation expectations liquid 0.125s of 4/2019. Inflation Long 2y2y inflation swap 2y2y inflation looks attractive on Forward inflation falls 10/3/14 2.1% 12/9/14 2.0% -309k Swaps historical basis - rho spread between 5yr5yr inflation Inflation swaps and 5yr5yr TIPS breakevens is 5yr5yr inflation swaps Sell the 5yr5yr inflation swaps wide. Selling the 5yr5yr inflation rise 11/7/14 2.58% 12/18/14 2.43% +1,361k Swaps swaps looks attractive. Treasury Long 5s vs 2s and lOs 5s appear attractive 5s cheapen further 9/5/2014 +41 bp 10/28/14 +34bp 4418k RV Treasury Classic bond futures close to 1.5 Continuing Sell classic bond futures CTD (6.125 a sta ndnd war: deviations rich versus lOs o bu otpdefrfotrma uresnce of classic 10/7/13 +13bp 8/12/14 +7 bp -404k RV Aug29s) against Aug22s and Aug42s s Treasury Take profits on the 2026-2029 bonds. 2026-2029 bonds have outperformed 2026-2029 bonds 9/17/13 +11 bp 8/12/14 +7 by -226k RV (U) recently and look rich to lOs and 30s continue to cheapen Treasury Long lOs vs 5s and 30s lOs look cheap on the curve lOs continue to cheapen 9/12/13 +26 bp 7/7/14 +14 bp +384k RV Conditional bull steepeners: Sell $32.8mn 3M10Y ATMF receivers vs. Front-end gets re-priced in a delayed Curve bull flattens; -1 bp 12/30/14 0 bp +19k Option 9/26/14 buy $100mn 3M3Y ATMF receivers at Fed hike unlimited downside net takeout lc Rally below the Buy 1X2 3M3Y ATMF/13.5bp receiver Deutsche Bank Securities Inc Option Short-term risk off and short covering breakevens; unlimited 9/26/14 0 bp 12/30/14 0 bp +28k spreads for zero net cost downside EFTA01123223 Deutsche Bank Securities Inc Closed Trade Recommendations Trade Detail Rationale Risks Opened Entry Closed Exit P/L Carty pays for option, repriced Buy $1,000mm 6m single reset cap on Curve flattening, max loss Option fed suggests 5y 5/20/14 +9 bp 11/20/14 0 bp -875k CMS10-CMS5 strike 89bp for 9.75c premium outperformance Sell $100mn 3M5Y straddles vs. buy Option $100mn 3M5Y 22bp OTM payers for No big changes in vol near term Rates rally 9/19/14 -100 bp 12(30/14 0 bp +1,028k net takeout of 100c. Buy 2y10y 25/75/115 payer ladder at Positive carry bearish rates Higher gamma: rates rally 4/5/13 0 bp 10)9/14 +92 bp +991k Option zero net cost. positioning Buy 5342m 18m3y ATMF+25bp payer Curve steepens and rates Option and sell $113m 18m10y ATMF+57.5bp Fed tapers in 2013 rise 5/16/13 +147 bp 10)9/14 +127 bp +539k payer. (Kocic) Option Buy $207mm 3m5y receiver ATMF - 25 High payout ratio for exposure Market sell off, max loss net 5/20/14 +17 by 8/19/14 +0 by -339k bp, sell 207mm 3m5y receiver ATMF - to delayed Fed premium 50 bp at 16.75 bp premium Sell $100mn 1Y2Y ATMF receivers vs. 5s lead the way in a rally as rate Option buy $40mn 1Y5Y 22bp OTM receivers Bull steepening in 2s/5s 10/3/13 0 bp 10/3/14 0 bp +7k hikes are taken out at zero net cost The risk of weak data and/or Buy $880mn 1Y 5s/30s ATMF curve more aggressive forward caps vs. sell $100mn 6m10Y 11bp guidance becomes a 5s/30s 3/14/14 +2441k Option Short term flattening sell off 9/13/13 0 bp +229 bp OTM payers at net zero cost. steepener, while slowdown of (Kocic) growth puts an upper limit on the 10Y sector Receive $208.2mm 6m5y rate versus par Swaps RV pay $292.9mm 10y5y rate to reppar Fled WIT pyoesgva Curve flattenening 5/20/14 +219 bp 11/19/14 +320 bp -7,274k carry Cross Receive 158m 1y5y EUR and pay 773m ECB cuts the depo rate further Forward curve steepens 5/16/13 +84 bp 5/16/14 +55 bp +2,963 Market 1y1y EU. (Sparks) Cross Receive 3y1y JPY and pay lyly JPY Recent sell-off in Japan US rate outperforms 5/16/13 +44 bp 4/22/14 +8 bp +4,575k Market (Sparks) Swn o nttl C'e . nume4nlive on owls. wee* not rota im<J..0er soma or venom* cow 1W convect theMort lienennek Ict anindivto 0ea aropostvon. own Me levenget1or emcee& mon, ce "NEW /was a the,e enctrs. Moroni's( orfannor a MOO ours*.oquevrecogownce • EFTA01123224 2014 Outlook Closed Trades Trade Detail Rationale Risks Opened Entry Closed Exit P/L Treasury 10s have underperformed on +5 bp Further sell-off in Treasuries, Buy 10y Treasuries vs 5s and 30s the curve since May, and curve 12/6113 +17 bp 6/25/14 (Closed on +1,123k RV led by a steeper 5s/10s appear cheap on fly 6/25) 1y 3s10s conditional bearish flattener The curve should bear flatten as Option for zero premium: Buy 1y3y + 25 bp soon the Fed tapers and front Curve steepens as rates rise 12/6/13 +212.5 bp 12/19/14 +17 bp 0k payer, sell DV01 weighted 1y10y +41.5 end sells off by payer for zero premium. Curve slope is near its historic Swaps RV Receive 3y1y/2y1y rate spread at 108 levels; curve is likely to flatten Curve steepens 12/6/13 +108 bp 12/19/14 +80bp +222k hP in both sell-off or rally Curve flattens beyond the Dual digital option on 5s and 10s: Buy Either of the two conditions current forwards; adding Option a 6m dual digital that pays out if 5s > shorting is not true at expiration; additional leverage by 12/6/13 12/19/14 2% & 10s< 3.50%, offer 1m (6:1 maximum loss is premium the correlation between 5y and leverage) outlay 10y rates Contingent curve cape Buy 6M 5s10s Option ATMF cum caps subject to 10s < Front-end of the curve remains Curve flattens 12/6/13 12/19/14 3.50%, 5.25c offer, a 40% discount to anchored, limited sell off in 10s vanilla at 9c Option Receiver spreads: 0 Buy S100mm 2y2y Macro data disappoints, curve Rates rise as recovery ■ 12/6/13 +28 by 12/19/14 +29 by +19k ATMF/25 bp receiver spreads at 28 bp bull flattens strengthens Contingent payerst3 Buy 1y30y ATMF Rate hikes unbundled from Option payers subject to 55c ATMF+50 bp at taper, long end sells off while Curve flattens 12/6/13 12/19/14 259 bp, a 57% discount to vanilla 5y remains anchored Option Curve caps: Buy 1y single reset, ATMF Economic recovery disappoints Curve flattens 12/6/13 +21.5 bp 12/19/14 0 bp -197k 5s30s curve cap at 21.5 bp and curve remains steep Long-end US real rates vs long-dated Long dated real rates in the US +50 by Inflation Europe real rates: Buy 2041 US TIPS vs appear cheap to those in Further selloff in long dated 12/6/13 +40 bp 9/25/14 (Closed on +3,382k US rates relative to Europe sell 2040 OATei Europe, especially France 9/25) The intermediate sector in Further cheapening of the Inflation Buy 2023 TIPS vs. 712019 and 1/2025 inflation markets is cheap belly in inflation markets 12/6/13 +38 bp 12/19/14 +8 bp +2,263k TIPS on ASW relative to the wings relative to the wings US Credit Underweight high-yield into Taper W spreads should widen upon Tapers gets delayed 12/6/13 12/19/14 the onset of the taper SourcrOmmIMAnk PernwmmynumbornmAmclonewbronOAliwmflieWdammomou*ActtArsproaMorramsemncosuftommWdromiNemNwNweefocwvaintoboommpostiongmmerelwmgWorsimagymetemeoftwersemementMMmWx*menmemis rymwmdMVenWoontmC Deutsche Bank Securities Inc EFTA01123225 27 March 2015 US Fixed Income Weekly Appendix 1 Important Disclosures Additional information available upon request For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Dominic Konstam/Aleksandar Kocic/Joseph LaVorgna/Alex Li/Stuart Sparks/Daniel Sorid/Steven Zeng The authors of this report wish to acknowledge the contribution made by Shailendra Singh, Ignacio Quintana, Catherine Montecinos, employees of Evalueserve, a third-party provider to Deutsche Bank of offshore research support services. Deutsche Bank Securities Inc. Page 65 EFTA01123226 27 March 2015 US Fixed Income Weekly Regulatory Disclosures 1. Important Additional Conflict Disclosures Aside from within this report, important conflict disclosures can also be found at under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing. 2. Short-Term Trade Ideas Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at 3. Country-Specific Disclosures Australia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively. Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) and its(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is indirectly affected by revenues deriving from the business and financial transactions of Deutsche Bank. 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We may charge commissions and fees for certain categories of investment advice, products and services. Recommended investment strategies, products and services carry the risk of losses to principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value. Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this report are not registered credit rating agencies in Japan unless "Japan" or "Nippon" is specifically designated in the name of the entity. Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may from time to time offer those securities for purchase or may have an interest to purchase such securities. 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Related financial products or services are only available to Professional Clients, as defined by the Dubai Financial Services Authority. Page 66 Deutsche Bank Securities Inc. EFTA01123227 27 March 2015 US Fixed Income Weekly Risks to Fixed Income Positions Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates - these are common in emerging markets. It is important to note that the index fixings may — by construction — lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to the risks related to rates movements. Deutsche Bank Securities Inc. Page 67 EFTA01123228 David Folkerts-Landau Group Chief Economist Member of the Group Executive Committee Raj Hindocha Marcel Cassard Richard Smith and Steve Pollard Global Chief Operating Officer Global Head Co-Global Heads Research FICC Research & Global Macro Economics Equity Research Michael Spencer Ralf Hoffmann Andreas Neubauer Stove Pollard Regional Head Regional Head Regional Head Regional Head Asia Pacific Research Deutsche Bank Research, Germany Equity Research, Germany Americas Research International Locations Deutsche Bank AG Deutsche Bank AG Deutsche Bank AG Deutsche Securities Inc. Deutsche Bank Place GroBe Gallusstralle 10-14 Filiale Hongkong 2-11-1 Nagatacho Level 16 60272 Frankfurt am Main International Commerce Centre. Sanno Park Tower Corner of Hunter & Phillip Streets Germany 1 Austin Road West.Koveloon, Chiyoda-ku, Tokyo 100.6171 Sydney. NSW 2000 Tel: (49) 69 910 00 Hong Kong Japan Australia Tel: (852) 2203 8888 Tel: (81) 3 5156 6770 Tel: (61) 2 8258 1234 Deutsche Bank AG London Deutsche Bank Securities Inc 1 Great Winchester Street 60 Well Street London EC2N 2EG New York, NY 10005 United Kingdom United States of America Tel 04) 20 7545 8000 Tel: 111212 250 2500 Global Disclaimer The inlomation era °Whore ri ma report were prepaedtre Dotage. Park AGO, one Of ens athlete, 1001ec5w4y teutsCha Barlel TN into:wrath. hereunto Leland lobe notable and has been obtained from pubic hang°, Waved to be Wade Deutsche Bank makes nOwareawalon as to se Wcurnacy or ecergietenass of suCh inhumation. Ceutercla Bank may (Nage in seeuntes itensagens. on a peoproWy Lass or othervaso in a nurase .,consistent with the New Wien in Ma tbeablttli wad. In addilen others with. 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This wool is diarb.003 an gang Kong be Deutsche Peak AC. gaw Kong BeanCh. in Korea by Ceutsehe Secodus Korea Co This Nan is claributed n Sncpapone by Dadata Park AZ. Singer:me Branch of DeulsChe Secures Asia Limited. Singapore Dearth Mee Raffles Quer CUSCO South Tower Snowom 048583. 465 6423 E0011. and mcpants in Sngapore 01 the sepal ae 10 contact Ceutsche Park hO. Swepapone °tenth of Deutsche &if singes AN Lands.; Sin gh:ore Borsch in %cool Many matters arising firs. or a conecheri *MN iho tspal. Voltam iho ((eels issued of peonargaled in Sngrapore to a paces oho a eh a, ateceedilod opal Omaha Cr wailutionalswestet Ns delined in the applcablo Singapore lass and mediaeval, Deutsche Bank AG. Sowareee Branch Cr Dentsittat &Oman Asa Limited. Sngepone Branch of ants Legal nepleobloly to such person foe se centants of this report In Japan iho opal w approval anchor deaf toad by Mutate Swoones. Inc TN alornalion Contained in this report doe rat oassobluie Be proosion 01 inotarnail adoce. In Ave:rata. Natal Mardi shosid °bins 4 copy Of a Product Coselosuee Statement IFONNIaling to Wes renasiel pcf4aci tacos.] to in Ma sepal and [Oros:tat the PDS before maim° any decision about whether to orains We pt.: Deutsche Bank hO Johannesbugos noorpowad in the Federal Repute of Cr'gnarly Ukiah Regina, Number n South Attica. IX.60803flifel01. Additeral aloonnalion seethe leacetate& other financial prodatto of isseodocuoam Wis topal is inviable upon request This agog nay not be reproduced. diaributal Or peUelral to any Noon loe env "nose Mao' Deutsche Bank's wet wean Consent. Plana ore rouge Wan quoting. Copyright t 2015 Dentate Bank AG GRCM2015PROD033776 EFTA01123229