ICAP Futures LLC

ICAP Global Macro Monitor

Nicolas Lenoir, Chief Market Strategist
April 20 2010
Global Macro Monitor

Growth Outlook 3

Private vs. Public GDP 4

Restart Private Credit? 5

Expand Public Spending? 6

Between a Rock & a Hard Place 7

Deflationary Case & Aging Population 8

Consequences on Investing 12

FAQ & Appendices 14

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Growth Outlook: Just a Blip?
Highlights Nominal US GDP
• Was the 2008 crisis just a blip?

• Factoring the inventory rebound coming down

the pipeline nominal GDP will reach new highs
by Q3 2010

• Nasdaq is only 13% from the 2007 highs

• Commodity prices have recovered to their 2007

levels as well for the most part

• Banks are reporting record profits

Nasdaq
• Central banks around the world are starting to
remove accommodative policies

• On April 15 2010, the daily momentum on the

Nasdaq measured using the 21-day RSI was at
its highest since December 1999

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Private vs. Public: 2 Different Stories
Highlights US GDP Vs. US PRIVATE SECTOR GDP
• Subtracting government spending from GDP, we 16000 10000

find that the private sector GDP is barely flat YoY 14000
9000

• Around the world governments have taken over 12000

8000

for the private sector, China’s stimulus package 10000

7000

for 2008 was 14% of GDP 6000

8000
5000

• The US Federal Reserve’s balance sheet 6000 "US GDP"

4000
"US PRIVATE SECTOR GDP"
expanded by $1.4Tr to compensate for credit
4000 3000
contraction

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• But consumer credit outstanding is still shrinking Total Outstanding Consumer Credit in the US
and the deleveraging process is in its early
stages

• The Federal Reserve’s balance sheet is

expected to shrink slowly as asset purchase
programs have expired

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Restart Private Credit?
Highlights Consumer Credit Report
• A strong February reading was cancelled out by
March, April will be crucial to tell if the consumer
is back spending money she/he does not have

• Small businesses are still reporting difficulty

accessing credit

• Lending standards have been tightened and it is

Total Debt Picture
preferable to stay away from what caused our
downfall in the first place, GSEs now represent
90% of the MBS market

• Total US debt as a percentage of GDP is

skyrocketing

• The last 30 years of growth have been fuelled by

an expansion from 160% to 380% of the debt to
GDP ratio: we simply cannot keep carrying on

• The savings rate after briefly flirting with 7% is

now back to 3% and headed lower; it is dramatic

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Expand Public Spending?
Highlights Some Pictures Are Worth 1,000 Words
• Since 1970 federal spending has increased 7X
as much as the median income

• Since 1980 the 5th percentile for household

income has grown at 3 times the annual pace of
the average household income

• Total Public Debt Outstanding grew by $4Tr since

the end of 2006

• Many worry that excessive issuance will lead to

failed auctions resulting in a dangerous bear
market for US Treasuries

• Japan went down the path before us; 20 years

later all they have is a 200% public debt to GDP
ratio to show for it along with a soon-to-be
negative savings rate

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Between a Rock & a Hard Place

• Consumer credit has not restarted meaningfully yet, and public debt is reaching worrying levels so the
government cannot keep acting as the engine of growth much longer

• Q2 numbers will impress because of inventory rebuilding but once that momentum abates the scrutiny
on federal spending as the only engine of growth will intensify

• Two possible scenarios:

Private sector lending rises again holding growth between 2.5% and 3.5% until the inventory cycle
peaks, then closer to 2% once the government progressively pulls out stimulus and the cycle peaks

The federal government is forced to step up again as private sector growth falters again

• Two scenarios for the economy yet three scenarios for the bond market:

The economy grows enough for the federal government to pull back spending and the Federal
Reserve to normalize rates in 2011 avoiding a financing crisis: 10% probability

The economy slows and government spending keeps expanding to maintain growth in a slump that
carries on for several years: 70% probability

The US faces a refinancing crisis after other countries default due to the same problem: 20%
probability
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The Deflationary Case
Highlights US Demographics
• Demographics are going to play a fundamental
role in the next 20 years and it starts now

• Using a distribution of the average salary as a

function of age, the aging of the baby boom
generation has been a major boost to GDP since
the 70s contributing as much as 2% and 1.5% on
average

• For the next 30 years demographics will only

contribute 0.65% on average

• The 65-year old or older population is going to

grow between 1.7% and 2.5% over the next 30
years against 1.15% on average over the last 20
years

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We Are not Alone
Highlights China’s Demographics
• Aging in China will be exponentially worse due to
the one child policy

• Also add in the fact that there are 58% men

when the “natural” observed population split is
48% men and 52% women

• Currently the percentage of the Chinese

population which is outside of the workforce is
43%. Starting in 2012 this number is going to
move up to reach 60% in 2060

• It will reach 50% before 2020

• In the US this number is currently 35% according

to the official BLS releases; it has moved up from
33% in the last 10 years

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 Aging & Demand for US Treasuries

• There is a lot of talk about excess supply of US Treasuries, but very little comprehensive work is done
regarding demand

• People are concerned about foreign demand for US Treasuries, but the USD remains the world reserve
currency, and the US Treasury market is the biggest and most liquid: what is the alternative?

• Aging usually implies a more conservative portfolio allocation. Rule of thumb for investing states that
your fixed income allocation should grow by 1% every year

• People over 50 own over 80% of the assets in circulation

• American people own $41Tr of assets, a change of +1% in their asset allocation towards fixed income
represents $410Bn of additional demand

• If the baby boomers own 80% or more of the assets, they could represent an additional $328Bn of
additional demand every year

• A system which is overleveraged cannot afford high rates without triggering a jump in defaults, lower
equity prices, and in turn a higher demand for Treasury bonds

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Impact of Age on Yield
Highlights 30Y Treasury Yield
• Consequences of an aging population and
excessive liquidity held by the older generations
means slower growth and low yields

• 30Y Treasury yields moved down from 14% to

4.7% over the last 30 years

• IG credit spreads have recovered over 80% of

the widening due to the 2008 crisis

• In 2007 you were only paid 33bps a year to own

IG credit risk IG 5Y CDS

• It will all end in tears with skyrocketing interest

rates but until then we are stuck in a low yield
environment that can last for some time if we
believe modern Japanese history

• How to invest in such a binary environment?

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 Consequences on Investing

• Buy and hold made increasingly harder as yields are decreasing and make the benefits of holding less
attractive relative to the dangers in the case of a crisis

• Electronic trading, retail brokers, and faster circulation of information, have accelerated the speed at
which capital moves across asset classes

• It is becoming increasingly important to allocate a greater share of a investment portfolios to tactical

strategies capable of thriving in any environment, relying on liquid markets which allow rapid liquidation
if necessary, and benefitting from market volatility

• Financial Futures are the ideal product for tactical allocations:

Abundant liquidity

Transparency

Scalability

No credit risk

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Benefit of US Treasury Futures

• US Treasury futures allow you to build a strategy set-up to outperform other fixed income vehicles
irrespectively of market conditions

• Enhance return when rates are static by capitalizing on the option premium embedded in the US
Treasury futures

• Benefit from lower rates by buying US Treasury futures thereby selling the embedded option which
loses value as rates move down

• Benefit from higher interest rates by selling US Treasury futures thereby owning the imbedded option
which increases in value as rates move up

• Lower transaction costs mean less dilution of performance

• No issue with illiquid bonds in the case of market disruption

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 FAQ & Appendices
Contact Details

•ICAP Futures Sales & Trading www.icap.com

212-815-6802
•Dean Aldrich Vice President dean.aldrich@us.icap.com
•Michael Lawrence Vice President michael.lawrence@us.icap.com
•Nicolas Lenoir S. V. P. nicolas.lenoir@us.icap.com
Chief Market Strategist

Disclaimer: There are risks inherent in trading, including the risk of loss greater than the original investment. The opportunity for profit creates a corresponding
risk of loss. Anyone wishing to invest in any of the products mentioned should seek their own financial or professional advice.

ICAP Futures LLC is a member of the National Futures Association and registered as an FCM (NFA ID # 293651)

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