GLOBAL MARKETS CHART BOOK

High-grade bond yields plunge to record lows

The 10-year US Treasury yield fell by more than 35bp in May, hitting a record low of less than 1.6% as investors sought refuge in high-grade government bonds. The main trigger for the rally was a renewed flare up in the euro-zone crisis after the first round of Greeces general election produced no clear winner. This raised the prospect of the countrys early exit from EMU and ignited fears about the risks of currency redenomination in the euro-zone more generally. Concerns grew about the prospects for larger, troubled countries in the region with fragile banking sectors at risk of depositor flight, especially Spain. 10-year government bond yields in Germany and the UK dropped even more sharply than in the US. Money markets saw a suggestion from the latest US FOMC meeting that a third round of quantitative easing is not completely off the agenda. (Page 2.) Government bonds in the 10-year sector in the US, Germany and the UK all plummeted to record lows. (Page 3.) Swap spreads increased in the US as implied volatility in the stock market picked up and the yield curve flattened further. (Page 4.) Credit markets saw spreads for US BBB-rated bonds in the 7-10 year sector increase substantially, but yields barely rose. (Page 5.) Equities performed poorly in Japan in particular as the yen remained strong. (Page 6.) Emerging markets came under more pressure as investors appetite for risk waned. The EMBI+ bond spread over Treasuries rose above 4% for the first time this year. (Page 7.) Currency markets saw the dollar gain ground against sterling and the euro in particular, but not against the yen. (Page 8.) Volatility in the US dollar/euro exchange rate increased. (Page 9.) Correlation between US government bonds and yen/dollar turned significantly more positive. (Page 10.) Asset returns. The price of oil fell sharply again. (Page 11.) Our forecasts have been updated and are detailed at the end of this publication. (Page 12.)
John Higgins Senior Markets Economist Direct Line: +44 (0)20 7811 3912 Switchboard: +44 (0)20 7823 5000 Fax: +44 (0)20 7823 6666 john.higgins @capitaleconomics.com

1 Jun. 2012
Global Markets Chart Book 1

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Money Markets
The Fed continued its Operation Twist in May (1). The minutes of Mays FOMC meeting suggested that one or
two more voting members were open to the idea of additional monetary easing, at least if the US recovery faded.

One key message from the ECBs press conference was that it was not obviously prepared to sanction additional
support measures for the euro-zone economy, despite signs of weakness in the business survey data. However, the tone of the minutes of the MPCs meeting in May suggested that the door to more quantitative easing in the UK is still open. Elsewhere, the Bank of Japan announced no further increase in the size of its Asset Purchase Program in May. Overall, investors remained confident that interest rates will still be very low in a couple of years time (2).

The ECBs LTRO operations have reduced tensions in the interbank market (3) and lowered the cost of dollar
funding (4), but investors remain concerned by the build-up of imbalances in the TARGET2 settlement system that reflects the reticence of banks in strong economies to lend directly to those in weaker economies. The linkages between the health of countries banking systems and their sovereign borrowing costs remain very strong (5 & 6).
1. US Federal Reserve Banks US Treasuries Held Outright By Remaining Time To Maturity ($bn)
1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 >10yr 5yr<>10yr 1yr><5yr <1yr 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 2.0 1.5 1.0 0.5 0.0 -0.5 Jan-10 3 day moving average Jul-10 Jan-11 Jul-11 Jan-12

2. Expected Overnight Interest Rates In 2 Years Time (%) (Derived From Overnight Indexed Swap Markets)
3.0 2.5 US Euro-zone UK Japan 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5

3. 3m Libor-OIS Spreads* (bp)

125 100 75 50 25 0 Jan-10 US Euro-zone UK Japan *3-day moving average 125 100 75 -100 50 25 0 Jul-10 Jan-11 Jul-11 Jan-12 -150 0

4. 3-Month Currency Basis Swap Euros vs. US Dollars (bp)

0

-50

-50

-100

-150

-200 Jan-10

-200 Jul-10 Jan-11 Jul-11 Jan-12

5. Selected Current Euro-zone Sov. 10-year Govt. Bond Yields & Est. Eurosystem TARGET2 Balances At End-March (%)
10-Year Government Bond Yield 12 10 8 6 4 2 0 -60 -40 -20 0 ES PT 10-Year Government Bond Yield 14 y = -0.1082x + 3.8615 R = 0.6894 14 12 10 8 IT BE AT FR GE 20 40 60 NL FN 6 4 2 0 400 350 300 250 200 150 100 50

6. 5-Year Credit Default Swaps (Euro-zone) (bp)

Sovereign* Banking Sector *Euro-zone-10 (ex Greece), Q1 GDP-weighted 800 700 600 500 400 300 200 100 0 Jul-10 Jan-11 Jul-11 Jan-12

Estimated "Target 2" Balance As A Share Of Domestic GDP

0 Jan-10

Sources Thomson Datastream, Bloomberg, Capital Economics

Global Markets Chart Book 2

Government Bonds
The 10-year US Treasury yield fell by more than 35bp in May, hitting a record low of less than 1.6% (1). The
trigger for the rally was a renewed flare up in the euro-zone crisis after the first round of Greeces general election produced no clear winner. Concerns also grew about the prospects for larger, troubled countries in the region with fragile banking sectors at risk of depositor flight, especially Spain. The expectation of continued ultra-loose monetary policy provided support to Treasuries (2), with the Fed hinting that more quantitative easing was not completely off the agenda. The drop in the 10-year nominal Treasury yield was driven both by a decline in the real yield and in the breakeven rate of inflation (3).

The 10-year Bund yield dropped even more sharply to a record low of around 1.2%. Although the 5-year
sovereign credit default swap premium in Germany has risen since the end of March, the country has benefited from its perceived status as a sounder credit than most of its regional peers (4). Reflecting growing fears that Spain and Italy are now being sucked deeper into the crisis, the yield spread of 10-year government bonds in these countries over Bunds rose (5). Finally, the 10-year nominal JGB yield dropped to around 0.8% (6).
1. 10-Year Government Bond Nominal Yields (%)
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 US Germany UK 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 1.0 0.0 Jan-10 May-10 Sep-10 *3-day moving average Jan-11 May-11 Sep-11 Jan-12 May-12 1.0 0.0 3.0 2.0 3.0 2.0 5.0 4.0

2. US 10-Year Treasury Yield, US 10-Year OIS Rate & US Implied Overnight Rate In 2 Years Time (%)
10yr US Treasury Yield 10yr US Overnight Indexed Swap Rate US Implied Overnight Rate, In 2 Years' Time* 5.0 4.0

3. Decomposition Of 10-Year US Treasury Yield (%)

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 Jan-10 Nominal Yield Real yield - TIPS Break-even Inflation Rate 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 Jul-10 Jan-11 Jul-11 Jan-12

4. Selected Euro-zone Sov. 5-Year CDS Premiums & 10-year Government Bond Yields, Change Since End Mar-2012 (bp)
150 125 100 75 50 25 0 -25 -50 -75 5-Year Sovereign CDS Premium 10-year government bond yield 150 125 100 75 50 25 0 -25 -50 -75

5. Selected Euro-zone 10-Year Government Bond Spreads Over 10-Year German Bunds (bp)
1,500 1,250 1,000 750 500 250 0 Jan-10 Italy Spain Portugal *3 day moving averages 1,500 1,250 1,000 750 500 250 0 Jul-10 Jan-11 Jul-11 Jan-12 4.5 4.0 3.5 3.0 2.5 2.0

6. 10-Year Government Bond Nominal Yields (%)

1.7 US (LHS) Japan (RHS) 1.5 1.3 1.1 0.9 0.7 0.5 Jan-11 May-11 Sep-11 Jan-12 May-12

1.5 Jan-10 May-10 Sep-10

Sources Thomson Datastream, Bloomberg, Capital Economics

Global Markets Chart Book 3

Swap Spreads
The spread of US dollar interest rate swaps over US Treasuries of an equivalent maturity rose further in May in
both the 10-year (1) and, to a greater extent, the 2-year sectors (2).

A pick-up in implied volatility in the US stock market may have been one factor behind the increase in the 10year swap spread (3).

An additional flattening of the US yield curve may have also played a role (4). A flatter curve provides corporate
borrowers with less incentive to refinance long-dated debt with shorter-dated debt. This usually tends to result in a decrease in long-dated fixed rate receiving in the swap market.

Meanwhile, the poor state of the US public finances probably continued to provide an explanation for the
relatively low level of the swap spread by historical standards (5).

Finally, the US 5-year CDS/asset swap basis increased significantly further in May (6).
1. 10-Year US Treasury Swap Spread (bp)
30 25 20 15 10 5 0 -5 -10 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 30 25 20 15 10 5 0 -5 -10 10 0 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 10 0 40 30 20 40 30 20 60 50

2. 2-Year US Treasury Swap Spread (bp)

60 50

3. 10-Year US Treasury Swap Spread & VIX

160 140 120 100 80 60 40 20 0 -20 1990 1993 1996 1999 2002 2005 2008 2011 10 0 50 40 30 20 10-Year US Treasury Swap Spread, (bp, LHS) VIX, % (RHS) 70 60

4. 10-Year US Treasury Swap Spread & US Treasury Yield Curve Slope

160 140 120 100 80 60 40 20 0 -20 1990 1993 1996 1999 2002 2005 2008 2011 10-Year US Treasury Swap Spread (bp, LHS) 2 minus 10-Year US Treasury Yield (bp, RHS) 150 100 50 0 -50 -100 -150 -200 -250 -300

5. 10-Year US Treasury Swap Spread & US Budget Balance

10-Year US Treasury Swap Spread, (bp, LHS) US Budget Balance*, (% of GDP, RHS)

6. US 5-Year Credit Default Swap Premium & US 5-Year Swap Spread (bp)
70 70 CDS Premium 60 50 40 30 20 10 0 Jan-10 Swap Spread 60 50 40 30 20 10 0 Jul-10 Jan-11 Jul-11 Jan-12

160 140 120 100 80 60 40 20 0 -20 1990 1993

4 2 0 -2 -4 -6 -8

*12m rolling inc. CE interpolations 1996 1999 2002 2005 2008 2011

-10 -12

Sources Thomson Datastream, Bloomberg, Capital Economics

Global Markets Chart Book 4

Credit Markets
7-10 year corporate bond spreads in the West increased further in May as the euro-zone crisis flared up (1). For BBB-rated US corporate borrowers, spreads rose by about 35bp, to nearly 3% (2). Assuming a 40% recovery rate, the estimated implied probability of default within the next five years was around 22% at the end of the month (3). Although credit spreads tend to fluctuate with the economic cycle (4), we do not expect the US economic recovery to be especially strong. Accordingly, we do not expect spreads to contract much from here, especially while the euro-zone crisis continues to brew. That being said, US corporate bonds should continue to benefit from ultra-loose monetary policy via its favourable impact on Treasuries. Corporate bond yields are therefore unlikely to rise by much indeed, they barely rose in the BBB-rated, 7-10 year sector in May. They could even grind lower as they did during much of the 1940s (5). Firms also appear to be in a fairly healthy financial state. The liquid assets held by US non-financial companies at the end of last year were at their highest level as a share of short-term liabilities in more than half a century (6).
1. 7-10 Year Average Corporate Bond Spread (bp)
600 500 400 300 200 100 0 Jan-10 US Euro-zone UK Japan 600 500 400 300 200 100 0 Jul-10 Jan-11 Jul-11 Jan-12

2. US 7-10 Year, BBB-Rated Corporate Bond Spread (bp)

800 700 600 500 400 300 200 100 0 2000 2002 2004 2006 2008 2010 2012 Dotted line is average since 2000 800 700 600 500 400 300 200 100 0

3. US 7-10 Year BBB-Rated Corporate Bond Spread & Implied Probability Of Default
800 700 600 500 400 300 200 100 0 2000 2002 2004 2006 2008 2010 2012 10 0 *40% assumed recovery rate BBB-Rated 7-10 Year US Corporate Bond Spread vs. Treasuries (bp) (LHS) Implied Probability* Of Default Within 5 Years (%) (RHS) 60 50 40 30 300 20 200 100 700 600 500 400

4. US Industrial Production & Corporate Bond Spread

US Baa Corporate Bond Spread (bp) (LHS) US Industrial Production (%, y/y) (Inv.) (RHS) -20 -15 -10 -5 0 5 10 15 20 1970 1980 1990 2000 2010

0 1960

5. US 10-Year Treasury Yield & Moodys Seasoned Baa Corporate Bond Yield (%)
12 Jun-1932 10 8 6 4 2 Apr-1938 Corp. Bond Yield (1925-1950) Corp. Bond Yield (2002-) Treasury Yield (2002-) Treasury Yield (1925-1950) 12 10 8 6 4 2 10 9 8 7 6 5 4 3

6. Liquid Assets Of US Non-Farm, Non-Financial Companies

As A Percentage Of Total Assets (LHS) As A Percentage Of Short-Term Liabilities (RHS) 70 60 50 40 30 20 10 1962 1972 1982 1992 2002 2012

0 0 1925/2002 1930/2007 1935/2012 1940/2017 1945/2022 1950/2027

2 1952

Sources Thomson Datastream, Federal Reserve, Capital Economics

Global Markets Chart Book 5

Equities
Stock markets fell sharply in May as investors appetite for risk cooled. The S&P 500 fell about 6%, but this decline
was trumped by both the German DAX (-7%) and the UK FTSE 100 (-7%). However, Japans Topix recorded the worst performance down nearly 11% (1).

Japanese equities were once again undermined by the persistent strength in the yen (2). Meanwhile, the relative
performance of euro-zone and US equities continued to be closely tied to movements in the dollar/euro exchange rate (3).

Euro-zone equity markets appeared to remain attractively valued from a historical perspective (4), unlike US
equities (5). At the end of May, the 10-year cyclically-adjusted price/earnings ratio for the non-financial sector was nearly ten points lower in the euro-zone as a whole than in the US the biggest gap in a decade (6).
1. Equity Indices (Rebased, 1 Jan 2010=100)
150 140 130 120 110 100 90 80 70 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 US (S&P 500) Euro-zone (German DAX) UK (FTSE 100) Japan (Topix) 150 140 130 120 110 100 90 80 70 75 70 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 70 60 90 85 80 100 95
st

2. Japan vs. US Non-Financial Equity Markets & Yen/Dollar

Yen/Dollar (LHS) Ratio of Japanese to US Non-Financial Equity Markets (Jan-08=100) (RHS) 120 110 100 90 80

3. Euro-zone vs. US Non-Financial Equity Markets & Dollars/Euro

1.70 1.60 1.50 1.40 1.30 1.20 1.10 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Dollars/Euro (LHS) Ratio of Euro-zone to US Non-Financial Equity Markets (Jan-08=100) (RHS) 110 100 90 80 70 60 50 18 16 14 12 10 8 6 4 2 0

4. Cyclically-Adjusted Price/Earnings Ratios (Selected Euro-zone Countries)

Non-Financial Sector Financial Sector Total Market 18 16 14 12 10 8 6 4 2 0

5. 10-Year Cyclically-Adjusted Real P/E Ratio (S&P 500) & Tobins Equity Q (US Non-Financial Corporate Sector)
2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1900 Dotted lines are est. geometric annual averages (1900-2011) 1920 1940 1960 1980 2000 10 0 20 Tobin's Equity Q For The Non-Farm, NonFinancial Corporate Sector (LHS) S&P 500 Price/10-Year Average Earnings Ratio (Real) (RHS) (Includes CE estimates through 29-May-2012) 50 40 30 60 50 40 30 20 10 0 -10 -20 1985

6. Cyclically-Adjusted Price/Earnings Ratios US vs. Euro-zone (Non-Financial Sector)

US Less Euro-zone US Euro-zone 60 50 40 30 20 10 0 -10 -20 1990 1995 2000 2005 2010

Sources Thomson Datastream, Bloomberg, Wright, Shiller, CE

Global Markets Chart Book 6

Emerging Markets
The spread of the JP Morgan EMBI+ Global Index over Treasuries rose by more than 90bp in May to well above
400bp for the first time this year (1). Contributions to the substantial increase in the overall EMBI+ spread during the month were broad-based. The biggest contribution came from Venezuela, where there is considerable uncertainty about the political outlook and whose economy is heavily reliant on crude oil, the price of which dropped sharply during the month (2).

Equities in emerging markets generally fared less well than those in developed markets. Emerging Europe fared
worst in this regard among the main emerging market regions given its close ties to the euro-zone, while Asia ex Japan performed least badly (3). That being said, the stock market in India fell sharply in dollar terms as foreign investors withdrew capital (4).

The dollar strengthened nearly 4% against the currencies of the USs other important trading partners (5). Among
the BRICs, the Russian rouble fell by about 12% against the greenback as the price of oil retreated (6).
1. EMBI Spread vs. US Corporate Bond Spread vs. CE Estimate Of S&P 500 Equity Risk Premium (bp)
600 500 400 300 200 100 0 Jan-10 US 7-10 Year, BBB-Rated Corp. Bond Spread S&P 500 CE Equity Risk Premium EMBI+ Spread 600 500 400 300 200 100 0 Jul-10 Jan-11 Jul-11 Jan-12

2. Approximate Contributions To Change In EMBI+ Stripped Spread (bp) (30-Apr-12 to 31-May-12)

30 25 20 15 10 5 0 -5 EMBI % weights at 1-May-2012 shown in brackets 30 25 20 15 10 5 0 -5

3. Developed & Regional Emerging Equity Market Indices ($ Basis, Rebased at Jan-09 = 100)
250 230 210 190 170 150 130 110 90 70 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Developed Markets Emerging Europe Asia ex Japan LATAM 250 230 210 190 170 150 130 110 90 70

4. Foreign Flows Into Indian Stock Market vs. Sensex

25,000 22,500 20,000 17,500 15,000 12,500 10,000 7,500 2007 Indian Stock Market (Sensex, LHS) Net Foreign Flows Into Indian Stock Market ($bn, 12m rolling, RHS) 50 40 30 20 10 0 -10 -20 2008 2009 2010 2011 2012

5. US Dollar Trade-Weighted Indices (Rebased at Jan-07=100)

120 115 110 105 100 95 90 85 80 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Broad Major Other Imp. Trading Partners (EM Proxy) 120 115 110 105 100 95 90 85 80

6. Selected Emerging Market Currencies vs. US Dollar (Rebased at Jan-07=100)

150 140 130 120 110 100 90 80 70 60 Jan-07 Russian Ruble Brazilian Real Chinese Renminbi Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 150 140 130 120 110 100 90 80 70 60

Sources Thomson Datastream, Bloomberg, Capital Economics

Global Markets Chart Book 7

Currencies
The euro fell sharply against the US dollar during May. The trigger was the escalation of the euro-zone crisis, which
prompted an increase in investors perceptions of sovereign credit risk in the euro-zone relative to in the US (1). The gap between the expected level of interest rates in the euro-zone and the US in a years time also remained very small, thereby underpinning the greenback (2). Investors increased aversion to risk, which was reflected in the poor performance of equities, also fuelled save haven demand for the US currency (3). Otherwise, speculative positioning in favour of the US currency against the euro increased sharply to a new record level (4).

Sterling also lost ground against the dollar, but strengthened against the euro. The latter was again probably due to a
shift in investors perceptions of relative sovereign credit risk in the UK and the euro-zone (5).

By contrast, the dollar weakened slightly against the yen amid the hunt for safety. The yen also remains supported by a
small US/Japan short-term interest rate differential (6) and a relatively conservative policy stance from the BoJ.
1. US Dollar/Euro & 5-Year Euro-zone vs US Sovereign Credit Default Swap Premiums
300 250 200 150 100 50 0 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Euro-zone* Minus US 5yr Sovereign CDS Spread (bp) (LHS) Dollars/Euro (Inv.) (RHS) *10 countries (ex Greece), Q4 2011 GDP-weighted 1.00 1.10 1.20 1.30 1.40 1.50 1.60

2. US Dollar/Euro & Expected Interest Rate Differentials

300 250 200 150 100 50 0 -50 -100 Jan-10 May-10 Sep-10 *3 day moving average Jan-11 May-11 Sep-11 Jan-12 May-12 EUR less US O/N rate, 12m Forward (bp) (LHS)* Dollars/Euro (RHS) 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15

3. US Dollar/Euro & US S&P 500

1.70 1.60 1.50 1.40 1.30 1.20 1.10 Jan-08 Dollars/Euro (LHS) US S&P 500 (RHS) 1800 1600 1400 1200 1000 800 600 Jan-09 Jan-10 Jan-11 Jan-12

4. US Dollar/Euro & CFTC Net Non-Commercial Positioning

1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 *Non-commercial Net Speculative* Longs: Euro vs. Dollar (000s) (RHS) Dollars/Euro (LHS) 200 150 100 50 0 -50 -100 -150 -200 -250 Jan-12

N.B. Difference in timing of weekly data 1.00 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

5. Euro/UK Pound Sterling & 5-Year Euro-zone vs. UK Sovereign Credit Default Swap Premiums
300 250 200 150 100 50 0 -50 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 *10 countries (ex Greece), Q4 2011 GDP-weighted Euro-zone* Minus UK 5yr Sov. CDS (bp) (LHS) Euro/Sterling (RHS) 1.35 1.30 1.25 1.20 1.15 100 1.10 1.05 1.00 0 500 400 300 200

6. Yen/US Dollar & US-Japan Yield Differential

US minus Japan 2-Year Government Bond Yield (Basis Points, LHS) Yen/Dollar (RHS) 130 120 110 100 US yield lower relative to Japan yield, yen stronger 2007 2008 2009 2010 2011 2012 90 80 70

-100 2006

Sources Thomson Datastream, Bloomberg

Global Markets Chart Book 8

Volatility
Volatility in the US Treasury market declined slightly in May (1). US equity market volatility also fell a little (2), but did implied volatility increased sharply (3). The volatility of the dollar against the euro increased (4), but not as much as implied volatility for the pair (5). The volatility of oil and gold prices both rose, but remained at low levels compared to recent years (6).

1. 10-Year Government Bond Yield Volatility (30-day historical, annualised)

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 US Euro-zone (Germany) UK Japan 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-07

2. Stock Market Price Volatility (30-day historical, annualised)

US (S&P 500) Euro-zone (DJ Stoxx) UK (FTSE 100) Japan (Topix) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

3. S&P 500 Volatility (Annualised)

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Actual (30-Day Historical) Implied (1 Month) 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 40% 35% 30% 25% 20% 15% 10% 5% 0% Jan-07

4. Currency Volatility (30-day historical, annualised)

40% Dollar/Euro Dollar/Sterling Dollar/Yen Euro/Sterling 35% 30% 25% 20% 15% 10% 5% 0% Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

5. Currency Volatility (1-month, implied)

40% 35% 30% 25% 20% 15% 10% 5% 0% Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Dollar/Euro Dollar/Sterling Dollar/Yen Euro/Sterling 40% 35% 30% 25% 20% 15% 10% 5% 0% 110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-07

6. Commodity Price Volatility (30-day historical, annualised)

110% Brent Crude Oil Gold 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Sources Thomson Datastream, Bloomberg, Capital Economics

Global Markets Chart Book 9

Correlation
The correlation between US government bonds and US equities became slightly less negative in May (1). The positive correlation between euro-zone equities and dollar/euro declined (2). The positive correlation between emerging market equities and emerging market bonds increased (3). The correlation between US government bonds and yen/dollar turned significantly more positive (4). The positive correlation between US equities and gold decreased (5). The positive correlation between dollar/euro and oil fell (6).

1. Equities & 7-10 Year Government Bonds (Correlation of Daily Returns During Past 6m)
0.40 0.20 0.00 -0.20 -0.40 -0.60 -0.80 -1.00 Jan-10 US Equities & US Bonds German Equities & German Bonds UK Equities & UK Bonds Japanese Equities & Japanese Bonds 0.40 0.20 0.00 -0.20 -0.40 -0.60 -0.80 -1.00 Jul-10 Jan-11 Jul-11 Jan-12 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60

2. Equities & Currencies (Correlation of Daily Returns During Past 6m)

US Equities & Dollar/Yen Eurozone Equities & Dollar/Euro UK Equities & Dollar/Sterling Japanese Equities & Dollar/Yen 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 -0.80 Jul-10 Jan-11 Jul-11 Jan-12

-0.80 Jan-10

3. Emerging Market Equities & Various Assets (Correlation of Daily Returns During Past 6m)
1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 EM Equities & Dollar/Yen EM Equities & EM Bonds EM Equities & US Equities EM Equities & US Bonds 1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60

4. 7-10 Year Government Bonds & Currencies (Correlation of Daily Returns During Past 6m)
US Bonds & Dollar/Yen German Bonds & Dollar/Euro UK Bonds & Dollar/Sterling Japanese Bonds & Dollar/Yen 1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 -0.80 Jul-10 Jan-11 Jul-11 Jan-12

-0.80 Jan-10

5. US Equities & Commodities (Correlation of Daily Returns During Past 6m)

1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 US Equities & Gold US Equities & Brent Crude (Dated) US Equities & Base Metals 1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 -0.60 0.20 0.00 0.60 0.40 1.00 0.80

6. Commodities & Currencies (Correlation of Daily Returns During Past 6m)

Brent Crude (Dated) & Gold Dollar/Euro & Gold Dollar/Euro & Brent Crude (Dated) 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 Jul-10 Jan-11 Jul-11 Jan-12

-0.20 Jan-10

Sources Thomson Datastream, Bloomberg, Capital Economics

Global Markets Chart Book 10

Asset Performance
Equities came under heavy selling pressure. High-grade government bonds performed very strongly. The euro plummeted against the dollar. The price of oil fell sharply again. ASSET RETURNS & VOLATILITY 1m Equities3 US Euro-zone UK Japan Emerging Market Bonds4 US Euro-zone UK Japan Emerging Market Currencies5 Euro Sterling Yen Commodities6 Brent Crude Oil Gold Base Metals 3m Returns1 (%) 6m 12m 3yr 5yr 30d Volatility2 (%) 90d 180d 360d

-6.1 -6.2 -6.6 -10.6 -6.7

-3.7 -11.3 -8.0 -13.4 -8.5

6.3 -3.2 -1.3 0.0 2.8

-0.6 -20.0 -7.4 -13.4 -10.0

48.4 2.4 31.6 -17.0 23.6

-4.1 -39.9 -4.2 -56.4 8.6

12.9 21.5 18.5 16.4 12.4

12.2 20.2 15.8 16.1 11.4

19.1 26.2 18.9 17.3 15.3

20.9 25.6 19.8 20.9 15.8

2.8 1.0 4.0 0.6 -2.9

3.7 1.2 4.6 1.5 -1.2

5.5 10.5 7.3 2.9 4.3

15.0 8.1 17.8 4.6 8.4

30.8 13.5 32.3 12.8 42.2

58.9 29.4 64.1 20.6 48.0

4.1 4.5 5.2 1.9 4.5

5.5 4.3 6.0 1.9 3.9

6.5 6.5 6.7 1.9 5.5

7.1 5.9 6.3 2.2 4.8

-6.9 -5.8 2.5

-7.4 -4.2 3.8

-8.4 -2.6 -0.6

-14.0 -6.4 3.6

-13.0 -7.0 23.6

-8.4 -22.9 56.3

6.7 5.6 7.4

7.9 6.7 8.9

10.4 7.7 8.1

10.9 8.0 8.5

-15.6 -6.6 -9.5

-20.7 -9.6 -13.6

-8.3 -11.0 -0.1

-11.9 0.9 -22.0

50.7 59.3 44.0

45.5 131.3 -25.1

18.5 14.8 14.2

19.1 16.5 17.4

22.7 18.8 22.9

27.3 19.3 23.1

Data to 31st May 2012 or 1st June 2012. 1. Total returns in local currency for equities and bonds (except emerging market bonds, which is in US dollar terms). Total returns in US dollar terms for commodities. 2. Annualised percentage standard deviation, based on daily movements in each period. 3. MSCI indices. 4. EFFAS indices (7-10 year maturity), except Emerging Market, which is JP Morgan EMBI+ Sovereign Index. 5. A positive figure represents a rise in these currencies against the US dollar. Note that these are un-hedged returns: they show purely the currency movements and do not include the effect of interest rates differentials. 6. Spot market returns.

Sources Thomson Datastream, Bloomberg, Capital Economics

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Forecast Summary
Latest (1st Jun.) Official Interest Rates US Euro-zone Japan UK Currencies $/ /$ $/ / / Bonds (10 year unless stated) US Germany Japan UK EM (JP Morgan EMBI+ Spread, bp) Stock markets US (S&P 500) Germany (DAX 30) Japan (Nikkei 225) UK (FTSE 100) EM (MSCI $ Index) Commodities Brent Crude Oil ($pb) Gold ($/oz.) 101 1552 100 1800 95 2000 95 2000 90 2000 95 2000 85 2000 End Q312 End Q412 End Q113 End Q213 End 2012 End 2013

0-0.25 1.00 0-0.10 0.50 1.23 78 1.53 0.81 119 1.54 1.16 0.82 1.50 419 1310 6138 8440 5294 906

0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 1.00 1.00 1.00 1.00 1.00 1.00 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0.50 0.50 0.50 0.50 0.50 0.50 1.15 75 1.50 0.77 113 1.50 1.25 0.75 1.50 450 1350 6000 8250 5150 900 1.10 70 1.45 0.76 102 1.50 1.50 0.75 1.50 475 1350 5750 8000 5000 900 1.10 70 1.45 0.76 102 1.50 1.75 0.75 1.50 450 1350 5750 8000 5000 950 1.10 70 1.45 0.76 102 1.50 2.00 0.75 1.50 450 1350 5750 8000 5000 950 1.10 70 1.45 0.76 102 1.50 1.50 0.75 1.50 475 1350 5750 8000 5000 900 1.10 70 1.45 0.76 102 1.50 2.50 0.75 1.50 400 1350 5750 9000 5000 1000

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