GS Fixed Income Monthly May 2011

Fixed Income Monthly
May, 2011
Goldman Sachs Global Economics, Commodities and Strategy Research at https://360.gs.com
The Greek Conundrum

Francesco U. Garzarelli
francesco.garzarelli@gs.com
+44 (0)20 7774 5078 Constantin Burgi constantin.burgi@gs.com +44 (0)20 7051 4009
Government bond yields have rallied further over the past month, mirroring the ongoing downgrade to consensus (and our own) growth forecasts across the major economic regions. Our models suggest that higher inflation expectations represent a significant offset to the lower outlook for real activity in determining the current fair value of bond yields. On valuation grounds, we think 2.8% should represent an important resistance level for the UST 10-yr. We expect a decision on the disbursement of further financial aid to Greece to be made in the coming weeks. This month, we discuss the different options policymakers could be exploring. Our central case is that agreement will be reached on the extension of the program, involving a top-up of public funds and, in 2012, a re-profiling of the maturity structure of official bonds and those held by the private sector. More broadly, we continue to believe that the larger high-yielding sovereigns (Italy, Spain, Belgium) offer value relative to their AAA-rated EMU peers. In the year to date, these countries have significantly outperformed the core; notably, Italy has outperformed on a volatility-adjusted basis.
6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0
Bonds Priced Consistently with Negative Fed Funds

Taylor-type Rule Yield Curve -/+ 1 std.dev. Current Yield Curve
Fed Funds Target
2-yr
5-yr
10-yr
30-yr
Source: Bloomberg, GS Global ECS Research
100 90 80 70 60 50 40 30 20 10 0
Cumulative Unconditional Probability of Greek Default Implied by CDS*
End 2011
2-yr
5-yr
10-yr
*Assuming 45c recovery Source: GS Global ECS Research
Important disclosures appear at the back of this document
Goldman Sachs Global Economics, Commodities and Strategy Research
Bond Rally Capped

Government bond yields have rallied further, mirroring the ongoing downgrade to consensus (and our own) growth forecasts across the main economic regions. Our models suggest that higher inflation expectations represent a significant offset to the lower outlook for real activity in determining the current fair value of bond yields. On valuation grounds, we think 2.8% should represent an important resistance level for the UST 10-yr (currently 3.05%). In Europe, we expect a decision on the disbursement of further financial aid to Greece to be made in the coming weeks. We continue to believe that the larger high-yielding sovereigns (Italy, Spain, Belgium) offer value relative to their AAA-rated EMU peers. In the year-to-date, these countries have significantly outperformed the core ones; notably, Italy has outperformed on a volatility-adjusted basis.
Slower Growth Priced In

Since the April issue of our Fixed Income Monthly, fixedincome markets have rallied further, with US Treasury yields now setting fresh lows for the year. Year-to-date total returns in local currency on 7-10-yr US T-notes are now around 3.9%, comfortably outperforming the European markets and Japan. Australian bondsour top pick in previous issues of this publicationhave posted the highest period returns among the majors (4.0% ytd). Over the past weeks, bond yields have mirrored the ongoing downgrade to consensus growth expectations and the relative decline in cyclical stocks in evidence since March. Over this period, the relationship between our Wavefront US Growth equity basket (which pits cyclicals vs. defensives in the S&P500) and the 2-10-yr slope of the US curve has been relatively tight. Our aggregate GDP growth forecast for 2011 in the advanced economies has come down by 30bp since last December. The biggest downward revisions have been in the UK and Asia. Consensus forecasts have increased by 10bp for the advanced economies over the same period, mainly due to an upgrade to the Euro-zone numbers. Importantly, our forecasts for inflation this year have risen by 110bp since the start of the year, and those of consensus have risen by 90bp. Controlling for the lower mean, the volatility of headline inflation is now as high as it was in the 1970.
%yoy
These shifts in the macro outlook beg the question of whether changes to our bond forecasts are also warranted. To remind readers, using 10-yr Treasuries as a gauge, at the start of the year our forecasts for the end of 2011 were 25bp below the forwards; they are currently 45bp above the forwards. While the uncertainty around our near-term projections is admittedly high, our strategic view remains that global bond yields will rise in the second half of this year, for the following reasons: Treasury yields are not too high in relation to contemporaneous measures of the output gap and consumer inflation, according to our Taylor rule-type estimates across US benchmark maturities, first introduced in the November issue of this publication. Even with the Fed Funds rate at negative 3.5%, our estimates suggest that 10-yr T-notes should currently trade at 2.9%. Taking our 1-year-ahead projections for growth and inflation, we calculate that the term structure should flatten from the 2-yr sector, with 10-yr rates trading at 3.6% at that horizon. Given the ongoing deterioration in the growth-inflation tradeoff, we consider these estimates conservative. The current fair value for US Treasuries is 3.4%, and the corresponding figures for Bunds and JGBs are 3.2% and 1.3%all are above the current market yields. According to our Sudoku bond valuation model, which feeds off our 1-year-ahead domestic and
%yoy
5.0 4.0 3.0 2.0 1.0 0.0
Rolling 1- year-ahead Inflation Expectations Continue to Rise...

US Euroland UK Japan
3.5
...While GDP Growth Forecasts Are Being Pushed Down
3.0 US Euroland UK Japan
2.5
2.0
1.5 -1.0 -2.0 Jan-10 1.0 Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Source: Consensus Economics, GS Global ECS Research
Source: Consenus Economics, GS Global ECS Research
May 2011
Index 110
US Bonds Track Underperformance of Cyclical Stocks
% 3.0
% 4
Global Bond Premium Remains Below Average
Global Bond Premium 105 2.8 2 Period average
2.6 100 2.4 95 2.2 90 GS Wavefront US Growth Basket (LHS) 2s-10s UST slope (RHS) 85 Aug-09 Feb-10 Aug-10 Source: GS Global ECS Research Feb-11
-2
-4
2.0
-6
1.8
-8
00 02 04 06 Source: GS Global ECS Research
08
10
international expectations for short rates, GDP growth and inflation, the shifts in the two macro factors described earlierlower growth and higher inflation broadly cancel each other out in the determination of equilibrium bond yields. Our measure of the bond risk premium remains depressed. This could be related to the sovereign uncertainties in Euroland, as well as to the actions by the Federal Reserve, which we calculate could have shaved as much as 40bp off 10-yr bonds (see our April issue of the Monthly). Admittedly, the premium may take some time to reverse, but it is unlikely to decline further from here. Over longer horizons, we have found that our measure of the premium is tied to 5-10yr-ahead inflation expectations. These have been more volatile lately, reflecting the rise in commodity prices. In conclusion, the slowdown in activity growth appears to us already largely priced into the bond market, and rising core inflation should prevent a decline in nominal rates. That said, the risk to our forecasts stems from a more meaningful downward revision in growth prospects in 2012-13, stemming, for example, from a fiscal
%
contraction in the US and Europe. This applies particularly to our projections for the end of 2012, but the available information does not allow us to reach strong conclusions either way. Using 5-yr and 10-yr USTs as a gauge, on current macro information, the valuation argument starts become compelling at yield levels of around 1.5% and 2.8%, respectively.
End Game for Greece Approaching

On the first anniversary of the Greek financial rescue and the eve of a fourth disbursement of quarterly funding, intense pressures on the sovereign have resurfaced. Based on CDS and bond pricing, and assuming a recovery rate of around 45c, the market is assigning a 20-30% probability of a default occurring in the coming six months, and a much higher cumulative probability of a credit event over the next five years. As we discuss in the next section, a number of policy options are still being discussed, and more clarity should be reached. Our baseline view is that Greece will be given additional time, and funding, to smooth out its adjustment towards a sustainable primary surplus. Additional
% 1.8 1.6 1.4 1.2 1.0 0.8
Taylor Type Model Projections Forward Rates
6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0
Bonds Priced Consistent with Negative Fed Funds

Taylor-type Rule Yield Curve -/+ 1 std.dev. Current Yield Curve
Smaller Output Gap by End-2012 Means Higher Rates Than Forwards Discount
0.6 0.4 0.2
Fed Funds Target
2-yr
5-yr
10-yr
30-yr
0.0
2-yr 5-yr 10-yr Source: Bloomberg, GS Global ECS Research
30-yr
May 2011
bp
1000 900 800 700 600 500 400 300 200 100 0 Mar-09
Greater Segmentation Across Non-Core EMU Bonds

Program Countries (Avg. of Greece, Ireland, Portugal) Italy, Spain and Belgium (avg.)
%, yoy
4 3 2 1 0 -1 -2 -3
Non-Core Contribution to CPI Inflation Expected to Remain High
Contribution of food and energy to headline inflation
Euroland Japan UK US 05 06 07 08 09 10 11
GS F'cast 12
Sep-09
Mar-10
Sep-10
Mar-11
Source: GS Global ECS Research
austerity measures and an accelerated privatisation plan are currently being discussed, although the negotiations will probably remain tense for some more weeks. We also hold the view that the existing debt stock is in all likelihood too high for Greece to shoulder and that some form of restructuring can be expected. Developments in Greece understandably continue to command a lot of attention, as decisions taken there will set an important precedent for the Euro-zones policymaking (conditionality, seniority of claims, etc). On a broader basis, a number of important developments have occurred over the past year. All three program countries (Greece, Portugal and Ireland) have been largely quarantined from a flow of funds standpoint. The public sector is almost entirely funded by official channels (which will represent up to 50% of the total debt stock by 2013), while banks rely extensively on the ECB. The distribution of losses on existing liabilities remains politically charged, but manageable (the government debt stock represents around 7% of the Euro-zones) particularly if piloted by the official sector. Secondary market purchases of outstanding Greek bonds by the EFSF, currently not allowed, would be a cost-efficient way of moving forwards, in our view. At the end of March, EMU member states agreed to a deeper integration of the areas economic governance. Moreover, common joint rescue mechanisms have been established. In light of these developments, our strategy template continues to highlight the divergence between the three program countries and the larger high-yielding economies. Yield spreads relative to Germany in Italy, Spain and Belgium incorporate, in our view, a high risk premium. Italy and Spain have been among the best performers since the start of the year, even controlling for volatility.
InflationUpward Pressures Continue

Our Commodity Strategy team has recently revised upwards their forecasts for Brent crude (from US$106.5/bbl to US$126.5/bbl in 12 months), Gasoline (from US$2.78/gal to US$3.36/gal), and Wheat to 8.35$/bu. On the back of these new projections, we now estimate that the contribution of food and energy prices to overall inflation in the US and Euroland will peak later (probably between August and September) and at a higher level (150bp in the Euro area and around 250bp in the US). Meanwhile, core inflation appears to have turned upwards since the end of last year. Our focus is on the more persistent components, particularly services excluding energy and rents. According to our i-Swap metrics, 5-year inflation swaps are now more than 1 standard deviation below fair value in the Euro-zone, US and the UK. We continue to recommend long 5-year JPY inflation swaps. Francesco U. Garzarelli and Constantin Burgi London, May 27, 2011
May 2011
The Greek Conundrum

Greece and its official-sector creditors face important decisions in the coming weeks. The background to their discussions will be the quarterly adjustment program review by the IMF, planned ahead of a fourth disbursement of financial aid.
By Way of Background
Policymakers now acknowledge that Greeces adjustment program, laid out in May of last year, contains a number of design shortfalls. The timeline set for turning around the structural fiscal dynamics is very front-loaded (calling for a swing of 7% of GDP in the primary budget balance between 2010 and 2013) and, until recently, official funding carried punitive rates. The program also assumes that Greece would be able to refinance itself in markets as early as 2012one and a half years after losing market access, only just after achieving a primary surplus and well before the mid-2013 expected overhaul of EMU government bond clauses. The Greek government lowered the deficit by around 5% of GDP last year to 10.5%, and agreed to reduce it by another three percentage points this year. However, further fiscal effortswhich have now entered the politically-charged phase of structural reforms and privatizationswill have to be implemented in the context of a weaker economy. The combination of budgetary restraint, a stronger exchange rate and higher energy prices has led to a contraction in nominal GDP of a further 4.1% between Q2:10 and Q1:11, bringing the cumulative decline since end-2008 to 6.5%.
granting Greece more aid, the resources could be subject to more binding clauses and be collateralized by privatization receipts (an option that should not trigger CDS, according to the prevailing legal interpretation). Outside the IMF (which enjoys preferred creditor status), aid from Eurozone countries ranks pari passu with existing bondholders. Of note, after 2013, if the ESM (the permanent successor to the EFSF) provides new funding, this would be senior to private creditors (although this could be modified) and junior to the IMF. Whether at that time new private creditors would also demand seniority is open to debate. 2. Buy time through a voluntary re-profiling of public debt maturities Last March, Euro-zone officials decided to extend the maximum maturity of the loans provided to Greece from 3 years to 7.5 years. The IMF is considering taking similar action, switching the assistance status for Greece from a Stand-by Agreement to an Extended Fund Facility, with the repayment profile stretching up to ten years. Official-sector creditors could be subject to comparability of treatment from at least a subset of private creditors (e.g., commercial banks), probably without a discount of principal. Extending the maturity of a good portion of the bonds coming due in, say, 2012-15 would release resources from the existing program, and these could then be allocated to other usesfor example, boosting the capital base of Greek banks in the event of a credit event down the line (see below, for more on the recapitalization needs). Considering that around 40% of Greek public bonds are held by financial institutions in Greece and other Euro-zone countries, an extension of maturities for the period 2012-13 alone could release something in the region of EUR30bn. The challenge is making such a re-profiling take place voluntarily, i.e., without triggering a default (although rating agencies would nonetheless label such move as SD, selective default) . This involves an appropriate mix of incentives
Breakdown of Greek Public Debt by Holder
as of Q1:2011 Greek Banks Other Greek Residents Total Greek Private Sector Bank of Greece ECB Bilateral Loans + IMF Total Official Sector Eurozone Banks Other Holders Outside Greece Total Non Greek Private Sector
Source: Bank of Greece, IMF, GS estimates
Choose From One of the Following Options

There are several routes policymakers can take from here, but they can be grouped into three broad options: 1. Modify the adjustment plan and provide Greece with a top-up of public funds This remains the option advocated by the ECB, provided the Greek government shows strong commitment to adhere to fiscal adjustment and speeds up privatizations. It would involve acknowledging that, partly due to factors outside of Greeces control (e.g., a stronger EUR and higher oil prices), the country will need more time to achieve a primary fiscal surplus, and hence that commercial funding is unlikely to be in place until mid-2013. Under such circumstances, Greece would need an additional EUR60bn to make up for bond redemptions, and at least another EUR10-15bn to fill the funding gap, assuming privatization proceeds yield around EUR20bn over the next two years, or two and a half times the amount currently budgeted by the IMF. Additional funds would presumably come mostly from EMU peers (who have already committed EUR80bn, of which EUR37.9bn have been disbursed to date) and probably be raised through the EFSFa more cost-effective option than bilateral loans, but requiring a broader political consensus. Under this scenario, official-sector lending could represent more than half of Greeces sovereign debt by end-2013. In order to appease public opinion across Europe on the merits of
5
% of total 17.9 6.9 24.8 5.9 17.6 18.5 42.0 17.1 16.2 33.3
May 2011
EUR bn
Maturity Profile of Greek Public Debt

Official loans
60 50 40 30 20 10 0 Interest Payments Bond Principal
Source: Bank of Greece, IMF, GS Global ECS Research estimates
(the type of securities used to replace maturing ones) and penalties for not participating in the exchange (usually, the threat of default does the trick, but in Europe that threat is less credible than in emerging economies). Potential violations of inter-creditor equity and the need for coordination among different jurisdictions are among the issues that need to be taken into account, if this option is pursued, as is the possibility of contagion. The response of Ireland and Portugal, for example, would also need to be considered. 3. Declare that debt dynamics are unsustainable and manage a restructuring According to Eurostat, Greek public debt stood at 142.8% of GDP last year, and is currently officially projected to peak at about 160% in 2013. The argument is frequently put forward that such a high level of debt is too onerous for Greece, particularly given that threequarters of its creditors are residents of other EMU countries. Some commentators go as far as to argue that restructuring the debt now could clear the air, allowing the country to return to markets sooner. As early as in May 2010, the IMF admitted that medium-term sustainability was subject to significant uncertainties. But, at the time, the Fund argued that aid was nonetheless justified given a high risk of international systemic spillover effects. In its third review, published at the end of February, an update to the debt sustainability analysis (DSA) continued to emphasize the risks surrounding the baseline case, and contained conservative assumptions on privatization receipts (a total of EUR6bn in 2012-13). A new DSA will be made public in the coming weeks with the fourth review. In the (unlikely, in our view) event that debt dynamics are considered to be unsustainable, the Fund would not be able to disburse any further funds. This helps explain the recent emphasis on speeding up privatizations, as they would compensate for the deterioration in the underlying fiscal dynamics (and help unlock a funding top up by other EMU members). As to the potential impact of a haircut on sovereign debt, opinions vary significantly. In a narrow sense, at least, a
Greek default would appear manageable according to estimates run by our European bank research team. Assuming a 60% haircut (which is roughly what the market is currently discounting), the impact on European commercial banks would amount to around EUR41bn (broken down as around EUR25bn in Greece, EUR3.8bn in France, EUR7.5bn in Germany and the remainder in other countries). This would correspond at most to a 36bp hit to aggregate European Tier 1 capital ratios (52bp in Germany and 23bp in France) and thus would not represent a threat to the stability of the financial system.1 Based on such a large haircut assumption, the hit on Greek banks would instead be commensurately big, wiping out 80% of Tier 1 capital, equivalent to around 170% of current market cap. Thus, recapitalizing the Greek institutions with some EUR30-40bn of funding would seem a necessary precondition ahead of a restructuring. As to the possibility of contagion, the hit to European banks should Portugal and Ireland also both decide to apply a 60% haircut appears small (an additional 30bp hit to aggregate European Tier 1 ratios). Importantly, the market is currently treating the fortunes of Greece and the other two program countries (Ireland and Portugal) as broadly separate from those of other non-core markets, such as Italy, Spain and Belgium. But whether this pattern will hold also in the event of a Greek default is hard to say. Other known unknowns include where short Greek sovereign CDS risk is ultimately warehoused, and what could be the net impact of a sovereign default on pension funds and insurance companies, where data on holdings is less accessible.
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
The Greek Conundrum

Where policymakers will place themselves along this spectrum of options (and combinations thereof) is the subject of intense debate among investors. There are a few points that we think should be taken into account in the discussions. Both Greece and its EMU peers share an interest in the country reaching a primary budget surplus (i.e., put
% of par 110 100 90 80 70 60 19-Oct-09 50 40 07-May-10 26-May-11 2-year 5-year Source: GS Global ECS Research 10-year 30-year
Greece: Benchmark Bond Yields
1. Includes only banks that participated in the European stress test. See European bank exposure to Greece revisited, April 20, 2011. 6
May 2011
Recovery Rates on Defaulted Sovereign Bond Issuers

Year of Default 1998 1999 1999 2000 2000 2001 2002 2003 2004 2005 2006 2008 2008 Defaulting Country Russia Pakistan Ecuador Ukraine Ivory Coast* Argentina Moldova Uruguay Grenada* Dominican Republic Belize Seychelles* Ecuador Average Trading Price** (% of par) 18 52 44 69 18 27 60 66 65 95 76 29 26 50 31 PV*** Ratio of Cash Flows (ratio in %) 50 65 60 60 NA 30 95 85 NA 95 NA NA NA 68 38
Issuer-Weighted Recovery Rates Value-Weighted Recovery Rates

* Not rated by Moodys at the time of default. ** 30-day post-default price or pre-distressed exchange trading price.
*** Ratio of the present value of cash flow s received as a result of the distressed exchange versus those initially promised, discounted using yield to maturity immediately prior to default (Source: Bank of England (2005)). Source: Moody's, Sovereign Default and Recovery Rates, 1983-2008 (March 2009)
Greece Inc. on a sustainable cash flow positive trajectory) in an orderly fashion. This is a necessary condition for the sovereign to eventually return to market, and for its public-sector sponsors to be reassured they are not feeding unsustainable dynamics. In the absence of an offset to fiscal tightening from easier financial conditions (the ECB is not easing rates in response to the weakness in Greek domestic demand; oil prices and the EUR continue to work in the wrong direction), a more lenient fiscal approach is probably opportune. Buying Greece more time to reach a primary surplus requires more money. Topping up the size of the program or keeping the existing bondholders tied to the credit for longer, so that existing resources can be diverted to bridge the cash flow shortfall rather than paying redemptions, is ultimately a question of political choice. As European Parliaments may be hostile to committing more funds, keeping existing creditors involved has its advantages (an option that has several historical precedents, as we have highlighted for several months in our research, and which we think has merits). Not all investors can be brought into a debt exchange, other than through retroactive legislation forcing them to agree, and this may create transfers of wealth across investors (which may have already whetted some appetites, judging from the buying in 2-5-yr maturities). The question of the sustainability of the existing debt stock is a different one, involving the distribution of potential losses among creditors, the current generation of taxpayers and future ones. We continue
7
to believe that going for a haircut now, with Greece still running a cash flow deficit, carries more costs than benefits. Even in this event, funding in 2012-13 will most likely still need to be provided by the official sector, and the backlash on growth and on the commitment to deliver deep-seated adjustments may be negative. The issue of contagion cannot be easily dismissed, in our view, although the cross-section of prices would currently suggest differently. The CDS market prices a 20% chance of a credit event by the end of this year (assuming a 45cent recovery, roughly the cash price of the Greek 30-yr bond), and a much higher probability of a default over the next 5-years (the cumulative
%
100 90 80 70 60 50 40 30 20 10 0
Cumulative Unconditional Probability of Greek Default Implied by CDS*
End 2011
2-yr
5-yr
10-yr
*Assuming 45c recovery Source: GS Global ECS Research
May 2011
probability is close to 90% over the next 5-years). And yet indicators of systemic risk in the Euro-zone are much healthier today than a year ago. In our view, there is only a small probability that the shockwaves from a Greek restructuring will materially affect bigger countries, such as Spain, which are busy fixing problems in their own banking sector. But if Spain were indeed to face pressures, the current endowment of rescue funds would most likely be insufficient to take on market forces, and a round of asset purchases by the ECB would probably be the only credible fire-breaker. Policy risk management should account for this timing issue. On most plausible macro scenarios, the Greek stock of public debt will have to be restructured eventually, as it is difficult to see Greece being able (or wanting) to sustain the bond rollover schedule it used to have before the crisis. The level at which Greek GDP growth and the fiscal position stabilize in the next few years will allow policymakers and investors to form a better judgment on the countrys debt capacity. A managed deleveraging could be facilitated by the transfer of bonds into the official sector, which has already started. The process could receive a boost from secondary market bulk purchases of Greek bondsat a discount, but at the risk of pushing market prices higherby the other Euro-zone governments, either in exchange for cash or other securities. The EFSF is currently authorized only to conduct primary market interventions, but this could change. In the process, the ECB could be relieved of its intervention portfolio at average cost. The official entity that has purchased the securities would then have a range of options at its disposal, including extending maturities and sitting on the bonds while benefiting from a positive carry, arranging a reduction of principal orour preferred solution accepting subordination to new funding. Francesco U. Garzarelli London, May 27, 2011
May 2011
Goldman Sachs Global ECS Research
Interest Rate Forecasts

Interest Rate Forecasts: Policy, Interbank, 10-yr Gov't and 10-yr Swap Rates
Date
27-May-11 Jun-11
Policy rate
0.3 0.2 0.2 0.2 0.2 0.2 0.2 1.3 1.3 1.5 1.8 1.8 2.0 2.5 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.5 0.5 0.5 0.8 1.0 1.3 2.0 1.0 1.0 1.0 1.3 1.8 2.3 2.5
3-mth rates
Forecasts 0.3 0.4 0.4 0.5 0.5 0.5 0.8 1.4 1.3 1.6 1.9 2.0 2.3 2.8 0.2 0.4 0.4 0.4 0.4 0.4 0.4 0.8 0.8 0.9 1.1 1.3 1.6 2.3 1.2 1.3 1.4 1.8 2.3 2.6 2.6 Forward 0.3 0.3 0.4 0.5 0.7 1.1 1.5 1.7 1.8 1.9 2.0 2.3 0.3 0.3 0.3 0.3 0.3 0.4 0.8 0.9 1.0 1.2 1.4 1.8 1.3 1.3 1.5 1.7 1.8 2.2
10-yr rates
Gov't Rate Swap Rate 3.1 3.5 3.8 3.8 4.0 4.0 4.3 3.0 3.3 3.3 3.5 3.5 3.5 4.0 1.1 1.3 1.4 1.6 1.7 1.8 1.9 3.3 3.5 3.8 4.0 4.3 4.5 4.8 3.0 3.8 3.8 4.0 4.0 4.3 4.5 3.2 3.8 4.1 4.1 4.4 4.4 4.6 3.3 3.6 3.6 3.7 3.8 3.8 4.3 1.2 1.4 1.5 1.8 1.9 2.0 2.1 3.5 3.7 4.0 4.2 4.5 4.8 5.0 3.3 4.0 4.0 4.2 4.3 4.6 4.8 Swap rate (Forward) 3.2 3.3 3.4 3.6 3.8 4.0 3.3 3.4 3.5 3.5 3.7 3.8 1.2 1.2 1.3 1.3 1.4 1.6 3.5 3.6 3.7 3.8 3.9 4.1 3.4 3.4 3.5 3.6 3.8 4.0
USA
Sep-11 Dec-11 Mar-12 Jun-12 Dec-12 27-May-11 Jun-11
Germany
Japan
UK
Canada
Sep-11 Dec-11 Mar-12 Jun-12 Dec-12
May 2011
Interest Rate Forecasts: Policy, Interbank, 10-yr Gov't and 10-yr Swap Rates
Date
27-May-11 Jun-11
Policy rate
4.8 4.8 4.8 5.0 5.3 5.3 5.3 0.3 0.3 0.5 0.8 1.3 1.8 2.8 1.8 1.8 2.3 2.8 3.0 3.3 3.8 2.5 2.5 2.5 2.5 3.0 3.5 3.8 2.3 2.3 2.5 2.8 3.0 3.3 3.8
3-mth rates
Forecasts 5.0 5.0 5.1 5.3 5.5 5.5 5.5 0.2 0.3 0.3 0.5 0.8 1.3 2.3 2.5 2.5 2.9 3.3 3.5 3.8 4.2 2.8 2.7 2.7 2.7 3.4 3.9 4.1 2.8 2.8 3.0 3.2 3.5 3.7 4.2 Forward 5.0 5.1 5.1 5.1 5.2 5.3 0.2 0.2 0.3 0.5 0.6 1.0 2.4 2.7 2.9 3.0 3.1 3.2 2.6 2.7 2.9 3.2 3.5 4.1 2.8 3.0 3.1 3.3 3.4 3.8
10-yr rates
Gov't Rate Swap Rate 5.2 5.6 5.8 5.8 6.0 6.0 6.3 1.8 2.0 2.3 2.5 2.5 2.8 3.3 2.9 3.5 3.8 3.8 4.0 4.0 4.3 5.1 5.8 5.8 6.0 6.2 6.3 6.5 3.4 4.0 4.0 4.3 4.3 4.5 4.8 5.8 6.1 6.3 6.3 6.5 6.5 6.8 2.2 2.4 2.7 2.9 2.9 3.2 3.7 3.5 3.9 4.2 4.2 4.5 4.5 4.8 5.2 5.9 5.9 6.2 6.4 6.5 6.7 4.4 4.7 4.7 5.1 5.1 5.3 5.6 Swap rate (Forward) 5.7 5.8 5.8 5.8 5.9 6.0 2.2 2.3 2.3 2.4 2.5 2.7 3.6 3.6 3.6 3.6 3.7 3.7 5.2 5.3 5.4 5.5 5.6 5.8 4.4 4.4 4.5 4.5 4.6 4.7
Australia
Switzerland
Sweden
Sep-11 Dec-11 Mar-12 Jun-12 Dec-12 27-May-11
New Zealand
Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Dec-12 27-May-11 Jun-11
Norway
Sep-11 Dec-11 Mar-12 Jun-12 Dec-12
10
May 2011
GS Sudoku Valuation Model Output
10-yr Bond Yields: Market vs GS Sudoku Model*, Spot and 3 Months into the Future Misvaluation against fair value***, standard Actual** (%) deviations CE USA Germany Japan UK Canada Australia Switzerland Sweden 3.07 3.00 1.13 3.33 3.04 5.23 1.83 2.87 -0.6 -0.3 -0.4 -0.4 -0.7 0.0 -0.2 0.2 GS -0.4 -0.2 -0.2 -0.2 -0.6 0.1 0.0 0.2 Fair value change (due to change in fundamentals), t + 3mth GS 0.05 0.08 0.00 0.09 0.09 -0.05 0.13 0.12
Fair value***, % CE 3.40 3.18 1.29 3.63 3.70 5.26 1.91 2.64 GS 3.31 3.14 1.22 3.53 3.60 5.15 1.82 2.52
* Details in Chapter 12 of The Foreign Exchange Market (2006), Global Viewpoint 07/24 and Global Viewpoint 08/04. **Last close. ***CE stands for Consensus Economics inputs of macroeconomic fundamentals (latest available month), GS stands for GS Economic Research inputs (current month). Source: GS Global ECS Research
St.Dev.
2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0
Degree of 10-yr Bond Misvaluation According to Sudoku (I)*

USA Japan Germany UK
St.Dev. 2.5 2.0 1.5 1.0 0.5 0.0
Degree of 10-yr Bond Misvaluation According to Sudoku (II)*
Canada Switzerland
Australia Sweden
-0.5 -1.0
1S
-1 St.Dev.
-1.5 -2.0
-1 St.Dev.
-2.5 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Source: GS Global ECS Research * Latest data point used is last close.
-2 St.Dev.
-2.5
-2 St.Dev.
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Source: GS Global ECS Research * Latest data point used is last close.
11
May 2011
USA, 10-yr Bond Yield
Germany, 10-yr Bond Yield
7.0 6.0 5.0 4.0 3.0 2.0 1.0

% Actual Fundamental
7.0 +/- 2 St.Dev. 6.0 5.0 4.0 3.0 2.0 1.0

+/- 2 St.Dev.
00 01 02 03 04 05 06 07 08 09 10 11
00
01
02
03
04
05
06
07
08
10
11
Japan, 10-yr Bond Yield
UK, 10-yr Bond Yield
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

8.0 7.0 +/- 2 St.Dev. 6.0 5.0 4.0 3.0 2.0 1.0
+/- 2 St.Dev.
00 01 02 03 04 05 06 07 08 09 10 11
00 01 02 03 04 05 06 07 08 09 10 11
Canada, 10-yr Bond Yield
Australia, 10-yr Bond Yield
9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0

8.0 +/- 2 St.Dev. 7.0 6.0 5.0 4.0 3.0 2.0 1.0
+/- 2 St.Dev.
00 01 02 03 04 05 06 07 08 09 10 11
00 01 02 03 04 05 06 07 08 09 10 11
Switzerland, 10-yr Bond Yield
Sweden, 10-yr Bond Yield
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
Actual Fundamental
9.0 8.0 7.0 +/- 2 St.Dev. 6.0 5.0 4.0 3.0 2.0 1.0 0.0
Actual Fundamental
+/- 2 St.Dev.
00 01 02 03 04 05 06 07 08 09 10 11
00 01 02 03 04 05 06 07 08 09 10 11
Source: Datastream, Goldman Sachs. 12

May 2011
Policy Rates Outlook: GS Forecast vs. Market

%
US: Federal Funds Rate

GS Forecast Implied by OIS
Euro-area: ECB Main Refinancing Rate

GS Forecast
1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12
Source: Bloomberg, GS Global ECS Research %
3.0
2.5
Implied by OIS
2.0
1.5
1.0
0.5 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

Japan: Overnight Call Rate
UK: Bank of England Repo Rate

GS Forecast
0.3 GS Forecast Implied by OIS 0.2
2.5
2.0
Implied by OIS
1.5
1.0 0.1 0.5


Canada: Overnight Interest Rate Target
Australia: RBA Cash Rate
2.6 2.4 2.2 2.0 1.8 GS Forecast Implied by OIS
5.50
5.25
5.00 1.6 1.4 1.2 1.0 0.8 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12
Source: Bloomberg, S Global ECS Research %
4.75
GS Forecast Implied by OIS

Switzerland: 3-mth LIBOR Middle Target

GS Forecast
Sweden: Riksbank Repo Rate
3.0 3.5 2.5 2.0 1.5 1.0 0.5 0.0 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12
Implied by OIS 3.0
2.5
2.0
1.5
GS Forecast
Implied by OIS 1.0 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12
13
May 2011
GS Curve Valuation Model Output: US and Germany

%
USD Yield Curve Dynamics

Actual (27/5/2011) Actual, month before (27/4/2011) Actual, quarter before (26/2/2011)
USD Yield Curve: Actual vs GS Curve*

Actual (27/5/2011) Fitted Fair (Fundamental) Fair (Dynamic)
5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 3m
5.20 4.70 4.20 3.70 3.20 2.70 2.20 1.70 1.20 0.70 0.20 -0.30 -0.80
10y 20y 30y
* GS Curve output using May 2011 data.
6m
1y
2y
3y
5y
7y
3m 6m
1y
2y
3y
5y
7y 10y 20y 30y
Source: Goldman Sachs.
USD Yield Spreads: Market vs GS Curve* bp 2-5y 2-10y
5-10y
10-30y
2-5-10y** 2-10-30y**
Actual (27/5/2011) 125 258 133 116 -4 71 Fitted 132 263 131 116 0 74 Fair (Fundamental) 158 273 115 93 22 90 Fair (Dynamic) 147 272 125 107 11 83 * Details in Chapter 11 of The FX Mark et (2007) and Global Viewpoint 08/16. Fundamental fair value is based on economic variables only. Dynamic fair value also accounts for the past dynamics of yields. ** A-B-Cy 'butterflies' are calculated as B-(0.5A+0.5C). Source: Goldman Sachs.
%
DEM Yield Curve Dynamics

DEM Yield Curve: Actual vs GS Curve*

6.00 5.00 4.00
5.00 4.00 3.00
3.00
2.00
2.00 1.00 0.00

1.00 0.00 * GS Curve output using May 2011 data. 3m 1y 3y 5y 7y 9y 20y
3m
1y
3y
5y
7y
9y
20y
DEM Yield Spreads: Market vs GS Curve* bp 2-5y 2-10y
5-10y
10-30y
2-5-10y** 2-10-30y**
Actual (27/5/2011) 67 139 72 53 -3 43 Fitted 81 148 67 56 7 46 Fair (Fundamental) 76 155 78 70 -1 42 Fair (Dynamic) 88 150 62 50 13 50 * Details in Chapter 11 of The FX Mark et (2007) and Global Viewpoint 08/16. Fundamental fair value is based on economic variables only. Dynamic fair value also accounts for the past dynamics of yields. ** A-B-Cy 'butterflies' are calculated as B-(0.5A+0.5C). Source: Goldman Sachs.
14
May 2011
GS Curve Valuation Model Output: Japan and UK

%
JPY Yield Curve Dynamics

JPY Yield Curve: Actual vs GS Curve*

2.50 2.00 1.50 1.00 0.50 0.00
2.20 1.70 1.20 0.70 0.20 -0.30
3m
1y
3y
5y
7y
9y
15y
30y
3m
1y
3y
5y
7y
9y
15y
30y
JPY Yield Spreads: Market vs GS Curve* bp 2-5y 2-10y
5-10y
10-30y
2-5-10y** 2-10-30y**
Actual (27/5/2011) 24 95 72 89 -24 3 Fitted 53 124 72 67 -9 29 Fair (Fundamental) 63 132 69 62 -3 35 Fair (Dynamic) 62 138 76 69 -7 34 * Details in Chapter 11 of The FX Mark et (2007) and Global Viewpoint 08/16. Fundamental fair value is based on economic variables only. Dynamic fair value also accounts for the past dynamics of yields. ** A-B-Cy 'butterflies' are calculated as B-(0.5A+0.5C). Source: Goldman Sachs.
%
GBP Yield Curve Dynamics

GBP Yield Curve: Actual vs GS Curve*

7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 3m 1y
7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00
2y
3y
4y
5y
7y
10y 15y 20y 30y
3m 1y
2y
3y
4y
5y
7y 10y 15y 20y 30y
GBP Yield Spreads: Market vs GS Curve* bp 2-5y 2-10y
5-10y
10-30y
2-5-10y** 2-10-30y**
Actual (27/5/2011) 120 212 92 142 14 35 Fitted 109 233 124 112 -7 60 Fair (Fundamental) 131 214 83 64 24 75 Fair (Dynamic) 124 226 101 85 12 70 * Details in Chapter 11 of The FX Mark et (2007) and Global Viewpoint 08/16. Fundamental fair value is based on economic variables only. Dynamic fair value also accounts for the past dynamics of yields. ** A-B-Cy 'butterflies' are calculated as B-(0.5A+0.5C). Source: Goldman Sachs.
15
May 2011
GS iSwap Valuation Model Output

%
USD Inflation Swap Curve, Fair & Actual

Fair
US 5-yr Fair and Actual*
3.3 Current
3.5 3.0 2.5 2.0 1.5
2.8
2.3
1.8
1.0 0.5
1.3
0.0
0.8
-0.5
1yr 2yr 5yr 10yr 15yr 20yr
Actual Fair (based on our iSwap model) 04 05 06 07 08 09 10 11
Source: GS Global ECS Research *Last Close

%
EUR Inflation Swap Curve, Fair & Actual

Fair Current
Euroland 5-yr Fair and Actual*
2.7 2.5 2.3 2.1 1.9 1.7 1.5
2.9 2.7 2.5 2.3 2.1 1.9 1.7 1.5 1.3 1.1 Actual Fair (based on our iSwap model) 04 05 06 07 08 09 10 11
1yr
2yr
5yr
10yr
15yr
20yr
0.9

%
JPY Inflation Swap Curve, Fair & Actual

Fair
Japan 5-yr Fair and Actual*
1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 1yr 2yr 5yr 10yr 15yr 20yr Current
1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 04 Actual Fair (based on our iSwap model) 05 06 07 08 09 10 11
Source: GS Global ECS Research %

%
GBP Inflation Swap Curve, Fair & Actual
UK 5-yr Fair and Actual*
4.5 4.0
4.5
3.5 3.0
2.5 2.0 1.5
3.5 Fair Current 2.5 1yr 2yr 5yr 10yr 15yr 20yr
1.0 0.5 0.0 04 Actual Fair (based on our iSwap model) 05 06 07 08 09 10 11
16
May 2011
Contribution of Food to Headline

1.5% 1.5% 1.0% 0.5% 0.5% 0.0% 0.0% Japan US Euroland UK 05 06 07 08 09 10 11 -0.5% -1.0% -1.5%
Contribution of Core Goods to Headline

Japan US Euroland UK
1.0%
-0.5%
-1.0%
05
06
07
08
09
10
11
Source: GS calculations.
Contribution of Rents and OER to Headline

0.20% 0.15% 0.10% 0.05% 0.00% -0.05% -0.10% 1.4% 1.2% 1.0% Japan Euroland UK US (RHS) 0.8% 0.6% 0.4% 0.2% 0.0%
Contribution of ex-housing Services to Headline

2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0%
Japan Euroland US UK
05
06
07
08
09
10
11
-0.2%
05
06
07
08
09
10
11
Contribution of Energy to Headline

4.0%
G4 Inflation Breakdown*
Food Energy Core goods -0.2% 0.7% 1.0% 1.9% 0.20 0.21 0.29 0.31 -0.04% 0.16% 0.30% 0.61% Services exhousing 0.5% 2.1% 2.0% 4.6% 0.34 0.34 0.36 0.40 0.17% 0.73% 0.70% 1.83% Housing
3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% 05

Japan US Euroland UK
06
07
08
09
10
11
yoy Japan -0.8% US 3.9% Euroland 2.1% UK 7.4% weights Japan 0.20 US 0.08 Euroland 0.15 UK 0.11 = contribution Japan -0.16% US 0.31% Euroland 0.32% UK 0.80%
6.8% 18.2% 12.6% 9.7% 0.07 0.09 0.10 0.09 0.51% 1.56% 1.21% 0.85%
-0.4% 1.0% 1.4% 2.3% 0.18 0.30 0.06 0.05 -0.07% 0.28% 0.08% 0.12%
* Reclassified by GS so as to make the sub-components fully comparable across economies (see Global View point No: 07/14)
17
May 2011
Main Economic Forecasts

GDP Forecast: % change yoy
2009 2010 2011 2012 USA Euroland Japan UK Canada Australia Switzerland Sweden New Zealand Norway Brazil Russia India China G7 G10 G20 Advanced Economies BRICs Asia Asia ex Japan Central and Eastern Europe Latin America Emerging Markets World -2.6 -4.1 -6.3 -4.9 -2.5 1.3 -1.9 -5.3 -1.7 -1.6 -0.6 -7.9 7.7 9.2 -3.7 -3.5 -0.5 -3.3 5.6 4.1 6.4 -1.0 -1.9 3.3 -0.6 2.9 1.7 4.0 1.3 3.1 2.7 2.6 5.3 1.5 0.3 7.5 4.0 8.5 10.3 2.8 3.0 5.0 3.0 8.8 8.3 9.2 3.0 6.2 7.9 5.1 2.6 2.0 -0.8 1.9 3.0 2.5 2.2 4.6 1.5 1.6 4.5 5.3 7.5 9.4 2.0 2.1 4.3 2.2 7.9 6.4 7.8 3.6 4.9 7.1 4.3 3.2 1.7 3.0 2.6 3.3 3.7 2.3 3.1 3.9 2.7 4.0 5.6 7.8 9.2 2.8 3.0 4.7 2.9 7.9 7.1 7.9 3.9 4.3 7.0 4.7 USA Euroland Japan UK Canada Australia Switzerland Sweden New Zealand Norway Brazil Russia India China G7 G10 G20 Advanced Economies BRICs Asia Asia ex Japan Central and Eastern Europe Latin America Emerging Markets World
CPI Forecast: % change yoy

2009 2010 2011 2012 -0.3 0.3 -1.3 2.2 0.3 1.8 -0.5 -0.3 2.1 2.2 4.9 11.7 3.8 -0.7 -0.1 -0.1 1.3 0.2 2.5 0.6 1.1 3.0 6.2 3.9 1.7 1.7 1.6 -0.7 3.3 1.8 2.8 0.7 1.3 2.3 2.4 5.2 6.8 9.6 3.3 1.4 1.4 3.1 1.6 5.4 3.7 4.7 2.7 6.2 5.8 3.4 3.1 2.8 0.7 4.2 2.5 3.4 0.8 3.2 4.4 1.5 6.6 8.4 8.1 4.7 2.7 2.7 4.1 2.9 6.1 4.6 5.4 3.7 6.7 6.4 4.4 2.1 2.1 0.3 2.2 2.0 2.8 1.6 3.1 2.7 2.1 6.5 6.2 5.1 3.0 1.8 1.9 3.1 2.0 4.2 3.2 3.8 3.0 6.5 5.0 3.4
For India we use WPI not CPI. Asia consists of China, Hong Kong, India, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand.
Central Bank Policies

Current Situation UNITED STATES: FOMC JAPAN: BoJ Monetary Policy Board EUROLAND: ECB Governing Council UK: BoE Monetary Policy Committee The Fed cut the funds rate to a range of 0%-0.25% on December 16, 2008. The BoJ cut the overnight call rate to a range of 0%-0.1 on October 5, The ECB hiked rates by 25bp to 1.25% on April 7, 2011. The BoE cut rates by 50bp to 0.5% on March 5, 2009. Next Meetings Jun-22 Aug-09 Jun-14 Jul-12 Jun-09 Jul-07 Jun-09 Jul-07 Expectation We expect the Fed to keep the funds rate near 0% through the end of 2012. We expect the BoJ to keep the policy rate near 0% through the end of 2012. We expect the ECB to continue hiking to 1.75% by end-2011. We expect the BoE to keep the policy rate on hold until a 25bp hike in Q4 2011.
For our latest Currency and GSDEER forecasts (https://portal.gs.com/gs/portal/research/econ/econmarkets/).
please
refer
to
the
Goldman
Sachs
institutional
portal
18
May 2011
Trading recommendations
RATE TRADES IN 2011 Date TOP TEN 1. Stay long 5-yr JPY Inflation Swaps TACTICAL 1. Stay long 30-yr Greece (4.6% Sep 2040) 2. Close short 5-yr EONIA 3. Close Paying 3m2yr ILS rates vs USD 4. Stay long 10-yr Spain vs Italy 5. Pay 5-yr Swiss swap rates vs Euroland 6. Stay Short 5-yr UST 7. Pay 5-yr Korean swaps 8. Pay 2-yr GBP rates vs EUR
*including carry. Source: GS Global ECS Research
OPENED At
TARGET LAST CLOSE At
STOP
CLOSED Date At
POTENTIAL PROFIT
16-Feb-11
-13 bp
40 bp
8 bp
n/a
n/a
n/a
21.0 bp
03-Sep-10 13-Jan-11 18-Feb-11 25-Feb-11 04-Mar-11 18-Mar-11 18-Mar-11 29-Mar-11
54 c 2.08 % 288 bp 54 bp -137 bp 1.94 % 4.04 % -48 bp
n/a n/a n/a n/a -100 bp n/a 4.40 % n/a
n/a n/a n/a n/a -130.9 bp n/a 3.96 % n/a
n/a n/a n/a n/a below -152 bp n/a below 3.80 % n/a
28-Apr-11 03-Feb-11 14-Mar-11 20-May-11 n/a 03-May-11 n/a 12-Apr-11
49.1 c 2.44 % 327 bp 82 bp n/a 1.98 % n/a -66 bp
-4.9 c 38 bp 39* bp -28 bp 6.1 bp 0* % -0.08 % -18* bp
19
May 2011
Goldman Sachs Global Markets Research

Global Markets Research Dominic Wilson~ 1(212)902-5924 Francesco Garzarelli~ 44(20)7774-5078 Global Macro Research Kamakshya Trivedi* Stacy Carlson^ FX Research Thomas Stolper~ Robin Brooks* Themistoklis Fiotakis* Fiona Lake* Fixed Income Research Francesco Garzarelli~ Constantin Burgi^ Macro Equity Research Noah Weisberger~ Alexander Kazan* Aleksandar Timcenko* Kamakshya Trivedi* 44(20)7774-5078 44(20)7051-4009
44(20)7051-4005 1(212)855-0684
1(212)357-6261 1(917)343-4543 1(212)357-7628 44(20)7051-4005
44(20)7774-5183 1(212)357-8763 44(20)7552-2901 852()2978-6088
~MD
* VP/ED
#Associate
^Research Assistant/Analyst
Email: firstname.surname@gs.com
We, Francesco U. Garzarelli and Constantin Burgi, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firms business or client relationships.
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20
May 2011

GS Fixed Income Monthly May 2011

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Fixed Income Monthly

The Greek Conundrum

6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0

Bonds Priced Consistently with Negative Fed Funds

Fed Funds Target

Source: Bloomberg, GS Global ECS Research

Cumulative Unconditional Probability of Greek Default Implied by CDS*

*Assuming 45c recovery Source: GS Global ECS Research

Important disclosures appear at the back of this document

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

Bond Rally Capped

Slower Growth Priced In

5.0 4.0 3.0 2.0 1.0 0.0

Rolling 1- year-ahead Inflation Expectations Continue to Rise...

...While GDP Growth Forecasts Are Being Pushed Down

3.0 US Euroland UK Japan

1.5 -1.0 -2.0 Jan-10 1.0 Jan-10

Source: Consensus Economics, GS Global ECS Research

Source: Consenus Economics, GS Global ECS Research

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

US Bonds Track Underperformance of Cyclical Stocks

Global Bond Premium Remains Below Average

Global Bond Premium 105 2.8 2 Period average

00 02 04 06 Source: GS Global ECS Research

End Game for Greece Approaching

6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0

Bonds Priced Consistent with Negative Fed Funds

0.6 0.4 0.2

Fed Funds Target

Source: Bloomberg, GS Global ECS Research

2-yr 5-yr 10-yr Source: Bloomberg, GS Global ECS Research

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

Greater Segmentation Across Non-Core EMU Bonds

Non-Core Contribution to CPI Inflation Expected to Remain High

Contribution of food and energy to headline inflation

Source: GS Global ECS Research

Source: GS Global ECS Research

InflationUpward Pressures Continue

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

The Greek Conundrum

Choose From One of the Following Options

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

Maturity Profile of Greek Public Debt

60 50 40 30 20 10 0 Interest Payments Bond Principal

Source: Bank of Greece, IMF, GS Global ECS Research estimates

The Greek Conundrum

Greece: Benchmark Bond Yields

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

Recovery Rates on Defaulted Sovereign Bond Issuers

Issuer-Weighted Recovery Rates Value-Weighted Recovery Rates

Cumulative Unconditional Probability of Greek Default Implied by CDS*

*Assuming 45c recovery Source: GS Global ECS Research

Goldman Sachs Global Economics, Commodities and Strategy Research

Fixed Income Monthly

Goldman Sachs Global ECS Research

Fixed Income Monthly

Interest Rate Forecasts