Hayman Global Outlook Texas Investor Summit February 14, 2014

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Table of Contents
U.S. Fed Tapering & Improving Trade Balance Japan Abenomics & Quantitative Easing Emerging Markets Slowing Growth & Signs of Stress

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United States Fed Tapering & Improving Trade Balance

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U.S. Federal Reserve is Tapering Asset Purchases

On December 18, 2013, the Federal Reserve announced it would taper its monthly asset purchases by $10bn to only $75bn a month; subsequently, on January 29, 2014, the Federal Reserve announced it would taper another $10bn to $65bn a month. A continuation of the policy would see additional asset purchases cease by end of 2014 and stabilize the size of the Federal Reserves balance sheet.
Total Federal Reserve Assets (in millions)
$5,400,000

$4,900,000

$4,400,000

$3,900,000

$3,400,000

$2,900,000

Fed Balance Sheet

Source: Bloomberg.

No Taper

Dec Taper Trajectory

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Revolution of Hydrocarbons in U.S.

As U.S. crude oil production has increased dramatically led by the shale oil revolution while U.S. consumption of petroleum and other liquid fuels has reduced off its peak in 2005, U.S. net imports have declined dramatically, a trend likely to continue.
Total U.S. Crude Oil Production
9,500 9,000 8,500 8,000 7,500 7,000 6,500 6,000 5,500 5,000 4,500 4,000 3,500 2002 2004 2006 2008 2010 2012 1984 1986 1988 1990 1992 1994 1996 1998 2000 2014 5000 4500 (bpd in thousands) 4000 3500 3000 2500 2000 1500 1000 500 0 2007A 2008A 2009A 2010A 2011A 2012A 2013E 2014E 2015E

Total U.S. Shale Oil Production

(bpd in thousands)

U.S. Petroleum & Other Liquid Fuels Consumption vs. Supply

25 (bpd in millions) 20 15 10 5 1997 1999 2001 2003 2005 2007 2009 2011 2013 1981 1983 1985 1987 1989 1991 1993 1995 2015 60% 27% (bpd in thousands)

U.S. Net Imports of Crude & Petro Products (bpd in 000s)

16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

U.S. Supply

U.S. Consumption

Source: Bloomberg, US Energy Information Administration, Bank of America ML Research.

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Unconventional Hydrocarbons Are Changing U.S. Trade

The revolution in unconventional oil and gas projects that has emerged via fracking of shale have radically increased the hydrocarbon production occurring within the U.S. U.S. crude oil production has returned to levels not seen since the late 1980s. It is one of a series of factors that has narrowed the U.S. current account deficit to the lowest point since the late 1990s. That period coincided with the largest USD rally since Paul Volcker slayed the inflation dragon in the 1980s.
Total U.S. Crude Oil Production (bdp in thousands)
9,500 (bpd in thousands) 8,500 7,500 6,500 5,500 4,500 3,500 2002 2004 2006 2008 2010 2012 1984 1986 1988 1990 1992 1994 1996 1998 2000 2014

U.S. Current Account Balance (as % of GDP)

(%) (1) (2) (3) (4) (5) (6) (7)

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: Bloomberg.

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2013

Japan Abenomics & Quantitative Easing

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Japanese Current Account Structural Deficit

The deterioration in the Japanese balance of trade combined with changes in the level of domestic savings and investment have driven the Japanese Current Account into structural deficit.
Japanese Current Account Balance (as % of GDP)
5.50

4.50

3.50

2.50

1.50

0.50

(0.50)

(1.50) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Quarterly Annualized
Source: Bloomberg.

Trailing 12 Months

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Bank of Japan QE Twice as Aggressive as U.S. Policy

The Bank of Japan (BOJ) announced plans in April 2013 to double the monetary base through JGB purchases of 60-70 trillion per year, which represents approximately 70% of the amounts purchased by the Fed in absolute terms for an economy 1/3 the size of the U.S., or more than twice as aggressive as U.S. policy.

Japanese Aggregate Debt Monetization Bank of Japan Total Assets (JPY Trillions)
190 180 170 160 150 140 130 120 110 100 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 120 100 Mar-13 Q2 Q3 Q4 Dec-13 Increase Increase Increase (Apr-Jun) (Jul-Sep) (Oct-Dec) 200 180 164 160 140 21 23 240 220 9-month increase: 36% 224 16

60 trillion

Source: Bloomberg.

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Real Yield Divergence U.S. vs. Japan

Japanese CPI has picked up while nominal yields remain close to all time lows forcing Japanese real yields into negative territory, part of the Bank of Japans attempt to force a reallocation of capital from JGBs further out on the risk curve. At the same time, US inflation remains anchored while growth and the Federal Reserves tapering of its QE program has led to nominal yields creeping upwards; this has created a long term rising trend of US real yields. The real yield differential has a strong correlation to the value of USD/Yen over time. Hayman expects the current divergence to continue and to force further Yen weakening.
10-yr Real Yields U.S. vs. Japan
3.0 2.0 1.0 (1.0) (2.0) (3.0)
Dec-10 Dec-11 US 10yr Real Yield Dec-12 Japan 10yr real Yield Dec-13

10-yr Real Yield Differential (U.S. vs. Japan) vs. JPY/USD

3.0 2.0 1.0 (1.0) (2.0) (3.0) (4.0) 110 105 100 95 90 85 80 75 70 65

Jun-11

Jun-12

Dec-10

Dec-11

Dec-12

Jun-13

Mar-11

Mar-12

Mar-13

Differential

Yen

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Dec-13

Sep-11

Sep-12

Sep-13

Emerging Markets Slowing Growth & Signs of Stress

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Chinese GDP Growth Rate Under Threat

Chinese GDP growth has been robust over the last 10 years but has been fueled by massive increases in credit. Total Social Financing (which includes bank asset growth as well as the shadow banking system) continues to expand at unprecedented levels. However, the utility of TSF is slowing which suggests the Chinese GDP growth rate has entered structural decline. Resource commodity based countries with strong trade links to China are likely to be negatively impacted by the slowing rate of growth.
Dramatic Growth in Total Social Financing (RMB in Billions)
20,000 16,000 12,000 8,000 4,000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Declining Marginal Return on Credit Growth

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 RMB of Growth for Each RMB of TSF 3-Yr Average

Source: Bloomberg.

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Turkish Lira Currency Devaluation

Emerging markets have come under renewed pressure recently, hurt by concerns about China's economy and the impact of tapering by the U.S. Federal Reserve, especially on those countries with twin deficits (fiscal deficit and current account deficit), including Turkey. As confidence waned amid political instability, the Turkish Lira experienced a significant and rapid devaluation, reaching record low levels, and foreign reserves were depleted by 12% in a one-month period. The Turkish central bank raised its overnight lending rate to 12% from 7.75% percent and the overnight borrowing rate to 8% from 3.5% in late January to defend the Lira. The Lira has begun to stabilize, but the recent devaluation and the aggressive action taken by the Turkish central bank highlight the sensitive state of emerging markets.
Source: Bloomberg.

Turkish Lira vs. USD

2.4 2.3 2.2 2.1 2.0 1.9 1.8 1.7

Turkey Overnight Lending Rate

13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0%

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Brazilian Inflation and Interest Rates

Brazil has undertaken a 275 basis point hiking cycle to contain inflation. The SELIC rate has risen from a trough of 7.75% to 10.5% with the most recent hike of 50bps coming on January 15, 2014. The forward rates market in Brazil is pricing in about 65bps of hikes between now and January 2015 and 201bps before January 2017. Forward expectations of IPCA Y-o-Y inflation have peaked (high in October 2013 of 6.2% to 5.59% now) as well as M-oM trends (12-month average high in June 2013 of 0.54% to 0.48% in January 2014 official target is 4.5%). Growth in Brazil is cratering, with GDP contracting in Q3 2013 for the first time since 2009. President Dilmas approval ratings have tanked to the low 30s with an election due October 5, 2014; a boost to growth will need to start now to have any impact before the election. The inflation trajectory is contained, and with growth stalling and global commodity prices unlikely to significantly increase in the near term, it seems likely the hiking cycle is finished or close to being finished.
Source: Bloomberg.

Brazil Y-o-Y CPI (IPCA)

7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% Dec-07 Dec-08 Dec-09 Y-o-Y Dec-10 Dec-11 Dec-12 Dec-13

12-mth Avg

Brazilian Rates Jan 17 Forward vs. Overnight Rate (%)

13 12 11 10 9 8 7 6 Dec-10 Dec-11 January 17 Forward Dec-12 Overnight Deposit Rate Dec-13

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Argentina vs. Historical European Problem Children

Population GREECE GDP Debt / GDP Current Yield

11mm 5mm 11mm

$249bn $210bn $213bn

157% 118% 124% 38%

7.5% 3.3% 5.0% 13.5%

ARGENTINA PORTUGAL IRELAND

41mm

$477bn
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Source: Bloomberg, Moodys; Note: Current yield is based on 10-yr government bonds (as of 2/12/14).

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Argentina Significant Developments

The 2nd Circuit Court of Appeals upheld the lower courts ruling regarding the litigation; however, it declined to lift the stay on Judge Griesas injunction in order to prevent a prejudicial outcome prior to the possible hearing of an appeal by the Supreme Court of the United States (SCOTUS). Argentinas appeal to be heard en banc by the entire Court of Appeal was denied in late 2013, giving them until mid February 2014 to file a petition for certiorari in the Supreme Court. Argentina has retained a former Solicitor General, Paul Clement, to act as specialist SCOTUS counsel, a step Hayman considers to be a very positive sign for both the likelihood that the appeal will be heard but also for the fortunes of Argentinas case. Following a cabinet reshuffle in the second half of 2013, Kirchners government placed renewed emphasis on the resolution of outstanding creditor complaints. In October 2013, Argentina began settling outstanding cases at the International Court for the Settlement of Investment Disputes (ICSID). Former Economy Minister Lorenzino was appointed the head of a specialist debt restructuring unit tasked with resolving outstanding issues with the Paris Club as well as ongoing litigation.

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Argentina What Kirchner Should Do

Following the Second Circuit Court of Appeals ruling, Kirchner announced plans to re-open a debt swap offer to holdout creditors on the same terms as those offered in 2005 and 2010. Kirchner is attempting to show Argentinas willingness to negotiate with holdouts and to pay its debts; however, the holdout creditors are not expected to accept the new swap offer given the significant haircut it represents. Kirchner should engage the hold-outs and try to come to a settlement. This will be a complete departure from her current stance of not wanting to pay them one penny more than the previous exchange offers of 2005 and 2010. In fact, she did not even want to re-open these offers but did so to placate the US courts. Settlements ordered by the US Courts are not likely to trip the MFN agreements given to those who have already exchanged bonds in one of the other two offers (93% have exchanged and 7% are holding out). Kirchner should get creative in her settlement talks by offering new par bonds with extended terms (i.e. 20+ years to maturity) and low coupon (i.e. 2%). By doing so, she should be able to satisfy the judgments in the NY courts and save face that she did not burn through significant FX reserves to do so. NML/Singer is not likely to fall for a bond with an NPV of 30c but will likely negotiate for more; he is fully aware of the fact that any settlement with holdouts will likely cause a massive yield compression in all bonds. Any settlement with holdouts will likely allow Argentina access to international capital markets (which they have been shutout from since 2001). This will be extremely beneficial to the 41 million people living in Argentina as well as to the Argentine government. Kirchner should also continue to engage in a more rapid or aggressive devaluation of the official exchange rate (7.8) versus the offshore rate (12.0) which has just recently accelerated. They had allowed a basic linear devaluation from 3.2 in 2008 to 6.5 at the end of 2013 before the rapid devaluation to 7.8 currently in 2014. Argentina has engaged in severe limitations on imports as well as capital controls to avert additional capital flight and continued widening of the current account balance.

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Argentina Embracing a Needed Devaluation

Argentina has been allowing a controlled devaluation of the Peso (ARS) throughout the last few years but significantly increased the rate of depreciation into the end of 2013. On January 23, 2014, Argentina stopped intervening and allowed a 12% devaluation. The unofficial blue dollar rate is closer to 12 ARS to the USD. The devaluation will limit imports and encourage delayed exports which will help to reduce the depletion of FX reserves and encourage economic growth.
Official Exchange Rate Argentine Peso vs. U.S. Dollar
8.50 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 Jul-13

Aug-13

Sep-13

Oct-13

Nov-13

Dec-13

Jan-14

Feb-14

Source: Bloomberg.

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Argentina Impact on Foreign Law FX Bonds

Following the significant devaluation, foreign law FX bonds traded off recent highs in the low 70s.
Argentina Euro Denominated 7.82% Discount Bond Price

75

70

65

60

55

50

45 Jan-13

Feb-13

Mar-13

Apr-13

May-13

Jun-13

Jul-13

Aug-13

Sep-13

Oct-13

Nov-13

Dec-13

Jan-14

Source: Bloomberg.

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