Macro Rate Markets Outlook - Europa

Goldman Sachs Global Investment Research 1

Macro Rate Markets Outlook

Francesco Garzarelli Co-Head of Global Macro-Markets Research

and of European Economics

Goldman Sachs International

Frankfurt, 7th April 2016

Investors should consider this research as only a single factor in making investment decisions. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to

www.gs.com/research/hedge.html.

The Goldman Sachs Group, Inc.

Goldman Sachs Research


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18 Mar-19 Sep-19

FOMC Dec Dots

FOMC March Dots

USD OIS 1m

%

Longer Run

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

-3.0

-2.0

-1.0

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1.0

2.0

3.0

4.0

5.0

6.0

Jan-04 Jul-05 Jan-07 Jul-08 Jan-10 Jul-11 Jan-13 Jul-14 Jan-16

Headline CPI (LHS)

Services Inflation Trend(RHS)

%

Oil Shock

%

100.0

100.2

100.4

100.6

100.8

101.0

101.2

101.4

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16

GS US MAP (LHS)

US FCI (Inverted, RHS)

IndexIndex Easier Financial Conditions, Better Growth

Source: Bloomberg, Haver Analytics, Goldman Sachs Global Investment Research

Real Rates Driving the Rally in Nominals

Core Inflation Trending Higher US Data Surprising Positively as FCI Eases

FOMC Converging to Market Expectations

GS US MAP Score and GS US FCI

FOMC March and December FOMC ‘Dots’ and US$ OIS

US Headline CPI Inflation and Trend in US Service Inflation

Decomposition of Change in US Treasury Yields Since Dec FOMC

United States

Resilient Growth and a More Dovish Fed

-150

-100

-50

0

50

100

150

2yr 5yr 10yr 30yr

Inflation Compensation

Real Rate

Nominal

Change in:bp


0

0.5

1

1.5

2

2.5

3

-1.0

0.0

1.0

2.0

3.0

4.0


Headline CPI (LHS)

Services Inflation Trend(RHS)

% %

95.5

96.0

96.5

97.0

97.5-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5


GS EA MAP

EA FCI (Inverted, RHS)

IndexIndex

Easier Financial Conditions, Better

Growth


Steep Term Structure of Periphery Spreads

Inflation Dynamics Remain Subdued Activity Data Improving from Lows

Market is No Longer Expecting Further Rate Cuts

GS Euro Area MAP Score and GS Euro Area FCI

EONIA Curve Pre and Post ECB March Meeting

Euro Area Headline Inflation and Trend in Service Inflation

Euro Area Core Periphery Spread and Germany 10 Year Yield

Euro Area

ECB Still the Marginal Price Setter for Euro Rates

-50

-45

-40

-35

-30

-25

-20

Spot 1m 2m 3m 4m 5m 6m 9m 10m 1y 1y1y 2y1y

9th March 2016 (Pre ECB)

10th March 2016 (Post ECB)

31st March 2016

bp

ECB Deposit Rate

70

80

90

100

110

120

130

140

150

0

0.1

0.2

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0.6

0.7

0.8

0.9

1

Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16

Germany 10-year Yield (LHS)

Euro Area Periphery Core 10-Year Spread * (RHS)

% bp

* Germany and France constitute core; Italy and Spain make up periphery


-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16

1m JPY OIS

JPY 10 Year Yield

%

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0


Headline CPI (LHS)

Services Inflation Trend (RHS)

% %92.5

93.0

93.5

94.0

94.5-2.0

-1.5

-1.0

-0.5

0.0

0.5


GS JPY MAP (LHS)

JPY FCI (Inverted, RHS)

IndexIndex

Easier Financial Conditions, Better Growth


...And Led to an Increase in Market Volatility

Activity Data Still Weak

NIRP has Dragged JGBs Lower..

GS Japan MAP Score and GS Japan FCI

JPY OIS 1m and 10-Year JGB

Japan Headline Inflation and Trend in Service Inflation

JPY Swaption Implied Volatility and Realized

Japan

Negative Rates Result in Tighter Financial Conditions

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16

JPY Swaption 1y10y Implied vol (LHS)

Implied to Realised JPY 1y10y vol ratio (RHS)

bp/day

Core Inflation Is Stabilizing



Yields in G-4 Have Co-Moved

Since the Start of Year

10-yr nominal bond yields in G-4 countries

JGBs have Been in the Driving Seat

Since Last November

Idiosyncratic ‘shocks’ originating in each market, estimated

through a methodology based on Rigobon (2003)

Japan in the ‘Driving Seat’ of Global Rate Rally

-0.1

0.1

0.3

0.5

0.7

1.2

1.4

1.6

1.8

2.0

2.2

2.4

Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16

UK

US

Japan (RHS)

Germany (RHS)

% %

-12

-10

-8

-6

-4

-2

0

2

4

6

Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16

US

UK

Japan

Germany

Cumulative 'Shocks'Standardised

Bullish Shocks


Source: Bloomberg, Goldman Sachs Global Investment Research

...Both in the US and the Euro area In Spite of Lower Yields, Investors Fear a

Further Rally More than a Selloff...

Investors Fear Further Bond Rally More than Selloff

EUR 30y swap plotted against 1y30y 100bp out-of-the-money low recv.

vol less1y30y 100 bp out-of-the-money high payer vol

-1.5

-1.3

-1.1

-0.9

-0.7

-0.5

-0.3

-0.1

0.1

0.3

0.5

1

2

3

4

5

6

7

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

US 30y Swap (LHS)

US$ 1y30y 100bp low recv vol less 100bphigh payer vol (RHS)

% bp per day

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

EUR 30y Swap (LHS)

EUR 1y30y 100bp low recv vol less 100bphigh payer vol (RHS)

bp per day%

US$ 30y swap plotted against 1y30y 100bp out-of-the-money low recv. vol

less1y30y 100 bp out-of-the-money high payer vol


0%

20%

40%

60%

80%

100%

2010 2011 2012 2013 2014 2015 2016

Probability low inflation

Probability medium inflation

Probability high inflation


...But Sees Very High Chance of Persistent

Low-flation in the Euro area

Market Still Assigns High Probability

to Moderate Inflation in the US…

Option-implied probability distribution of 5-year inflation by strike

‘clusters’: low inflation (≤1%), medium, and high (≥3%)

Option-implied probability distribution of 5-year inflation by strike

‘clusters’: low inflation (≤1%), medium, and high (≥3%)

0%

20%

40%

60%

80%

100%

2010 2011 2012 2013 2014 2015 2016

Probability low inflation

Probability medium inflation

Probability high inflation

The Market Prices Persistent Low-flation



From ‘End of Austerity’ (2014-15) to

Synchronous Modest Fiscal Expansion

Government Debt Moves

onto Official Sector Balance Sheet

Central Bank Ownership of Government Debt

as % of Stock Outstanding

Central Bank Bond Purchases Create ‘Fiscal Space’

Estimates of contribution of fiscal policy

annual real GDP growth in selected countries

0

5

10

15

20

25

30

35

40

45

50

Japan UK Euro Area US

% of outstanding stock of governmentdebt directly held by central bank (est.

end-2017)

%

Median

0

20

40

60

80

100

120

140

USA Euro Area Japan China

2015

2016

bp


Source: IEA, EIA, JODI, China NBS, Datastream, Haver Analytics, Goldman Sachs Global Investment Research

Oil Market Imbalances to

Narrow from H2-16 Onwards

Global Oil Market Imbalances, WTI Price

and GS WTI Forecast

Global Risk Sentiment Sensitive to Oil Prices

0

20

40

60

80

100

120

140

-2500

-2000

-1500

-1000

-500

0

500

1000

1500

2000

2500

3000

00 01 03 04 06 07 09 10 12 13 15 16

Global Oil Imbalance

WTI Price (RHS)

kbd $/bbl

Broader Asset Classes Increasingly

Correlated to Oil

3m Rolling Absolute Correlation of Weekly Returns to WTI

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0.0

0.1

0.2

0.3

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0.7

0.8

0.9

US

D H

Y

ST

OX

XE

uro

pe 6

00

S&

P 5

00

MS

CI E

M

MS

CI A

sia

ex J

apan

US

10-y

ear

bre

akeven

US

10-y

ear

yie

ld

TO

PIX

US

D T

WI

US

D IG

EU

R IG

EM

FX

JP

Y/U

S$

US

5y5y B

E

Germ

an

10-y

ear yie

ld

EU

R/U

S$

Japan

10-y

ear yie

ld

Current

Percentile since 1990


Source: Haver Analytics, Goldman Sachs Global Investment Research

The Inclusion of Corporates Should

Mitigate ‘Scarcity’ Issues

Breakdown of Pool of Corporate Credit

Eligible for ECB Purchase

ECB is Absorbing a Large Share

of Gross Government Issuance

Estimated ECB purchases under PSPP for 2016

as percentage of gross bond issuance

The ECB Is Gluing EMU Bond Markets Together

0

20

40

60

80

100

120

Electric Utilities Auto Mfg Telecoms Oil & Gas

Germany

Spain

France

Italy

Other countries

Bn Euro

0

20

40

60

80

100

120

140

Germany France Italy Spain

ECB Purchases in 2016/Gross Government BondIssuance in 2016

%


90

92

94

96

98

100

102

104

Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16

FTSE 250

UK domestic (GSSTUKDE)

UK domestic + Investment-sensitive screen

EU referendum

date set

Index

Source: DataStream, Bloomberg, Haver Analytics, Goldman Sachs Global Investment Research

UK Equities Are Pricing Brexit Risk ..& Driven Cross-Currency Basis Lower

Brexit Concerns have Increased GBP Vols Polls Still Too-Close-To-Call

GBP USD plotted with GBP USD 1y1y Implied Vol 30 Day Average of Brexit Polls Source: ORB, YouGov, BMG Research, ICM, ComRes, Survation, Ipsos Mori, The Times, TNS, Panelbase,

GQRR, Pew, Opinium, TNS-BMRB

GBP USD plotted with 1y1y Cross Currency Basis UK Equity Performance After EU Referendum Announcement

‘Brexit’ Risk For Now Mostly Limited to UK Assets

6

7

8

9

10

11

12

13

1.3

1.35

1.4

1.45

1.5

1.55

1.6

1.65

1.7

1.75

Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16

GBPUSD Spot (LHS)

GBPUSD 1y ImpliedVol (RHS, Inverted)

2015 UK ParliamentElections

UK ReferendumAnnouncement

-20

-15

-10

-5

0

5

1.3

1.35

1.4

1.45

1.5

1.55

1.6

1.65

1.7

1.75

Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16

GBPUSD Spot (LHS)

GBP 1y1y CrossCurrency Basis (RHS)

2015 UK ParliamentElections

UK ReferendumAnnouncement

0%

10%

20%

30%

40%

50%

60%

70%

Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16

Remain

Leave

Undecided


European Government Bond Liquidity

A Case Study of BTPs on ECB Meeting Day

Source: MTS Market Data


European Government Bond Liquidity

A Case Study of BTPs on ECB Meeting Day

Source: MTS Market Data


Disclaimer

I, Francesco Garzarelli, hereby certify that all of the views expressed in this report accurately reflect my personal view, which have not been influenced by considerations of

the firm’s business or client relationships.

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Macro Rate Markets Outlook - Europa