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Investment Management Division
This material represents the views of the Investment Strategy Group (ISG) in the Investment Management Division of Goldman Sachs. It is not a p roduct of Goldman Sachs Asset Management (GSAM) or
Goldman Sachs Global Investment Research. The views and opinions expressed herein may differ from those expressed by other groups of Goldman Sachs.
Investment Strategy Group
The Federal Reserve: Dont Let It Be Misunderstood
June 26, 2013
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Investment
Management
DivisionTodays Call
2
Recent Financial Markets Performance
Interpreting the Federal Reserves Commentary
Implications for Financial Markets
China: A Confluence of Events Fueling the Fire
Key Takeaways
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Investment
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DivisionGreat Market MomentumUntil Recently
3
1. Asset Class Returns: Dec. 31, 2012 S&P 500 Peak Close (May 21, 2013) 2. Asset Class Returns: S&P 500 Peak Close (May 21, 2013) June 25, 2013
Source: Investment Strategy Group, Datastream
(1) Indices used: Barclays US Corporate High Yield for US Corp High Yield, Barclays High Yield Munis for HY Muni, Barclays US High Yield Loans for HY Bank Loans, MSCI Indices for
EM and Chinese equities, JP Morgan GBI-EM Global Diversified Index for EMLD and Gold Bullion LBM for Gold.
-1.0%
-4.7% -4.8%
-6.7%
-8.3%
-9.5% -9.7%
-11.6%
-15.3%
-18%
-16%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
HY BankLoans
S&P 500 US CorpHigh Yield
Gold HY Muni EuroStoxx 50
EMLD EMEquities
ChineseEquities
18.0%
10.0%
5.4%3.9% 3.4%
2.1%1.2%
-1.2%
-17.8%-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
S&P 500 EuroStoxx 50
US CorpHigh Yield
HY Muni HY BankLoans
EMEquities
EMLD Chines eEquities
Gold
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Investment
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DivisionKey Driver of Markets Recently: Taper Timetable
4
US 10-Year Treasury Yields Around Major Events in 2013 (Through June 25, 2013)
Source: Investment Strategy Group, Datastream
April EmploymentReport (May 3)
FOMC MeetingMinutes Releasedand CongressionalTestimony "Taper"
(May 22)
FOMC Statementand Bernanke Press
Conference(June 19)
2.55
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
2.5
2.6
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13
Recent FOMC commentary introducing the possibility of tapering later this year pushed yields above their
YTD range.
The 10-year Treasury is now down 5.5% YTD on a total return basis, down 3.2% since June 19 and a total
drawdown of 7.6% since early May.
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Investment
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DivisionFederal Reserve Commentary Reverberations
5(1) This is a proxy measure for the 5-year Treasury yield based on the swap market.
Source: Investment Strategy Group, Datastream
1. ForwardImplied Short Rate Curve (3 Month Rate)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
13 14 15 16 17 18
As of May 21st (Day Prior to FOMC Minutes and Testimony)
As of Jun 25th
The market now expects the FOMC to raise interest rates earlier.
Moreover, 5-year interest rates are expected to normalize faster than previously thought.
2. US 5-Year Treasury Yield 5 Years Forward1 (Through June 25, 2013)
2.88
4.14
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
2010 2011 2012 2013
Percen
tagePoints
+126
bps
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Investment
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DivisionUS Equity Volatility has not Matched the Increase in Rates
6Source: Investment Strategy Group, Federal Reserve.
VIX (S&P 500 Implied Volatility) Through June 25, 2013
18.5
24.7
15.0
15.0
0
10
20
30
40
50
60
70
80
90
2008 2009 2010 2011 2012 2013
VIX Average 50-Day Moving Average 200-Day Moving Average
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Division
Interpreting the Federal Reserves Commentary:
Congressional Testimony and FOMC Minutes (May 22)
7(1) Represents the views of the Investment Strategy Group.
Source: Investment Strategy Group, Reuters, Federal Reserve, C-SPAN.
Chairman Ben Bernanke's Testimony
Dovish1
Hawkish1
A prem ature tightening of monetary
policy could lead interest rates to rise
temporarily but would als o carry a
substantial risk of slowing or ending
the economic recovery and causing
inflation to fall further. To this point oursense is that major asset prices like
stock prices and corporate bond
prices are not inconsistent with the
fundamentals.
If we see continued im provement and
we have confidence that that's going to
be sus tained then we could in the next
few meetings ... take a step down in
our pace of purchases.
Minutes from April/May FOMC Meeting
Dovish1 Hawkish1
However, economic data releases over
the intermeeting period were mixed,
raising s ome concern that the recovery
might be slowing after a solid start
earlier this year, thereby repeating the
pattern observed in recent years.
continued progress, more
confidence in the outlook, or
diminished downside risks would be
required before slowing the pace of
purchases would become appropriate.
A number of participants expressed
willingness to adjust the flow of
purchases downward as early as the
June meeting
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Interpreting the Federal Reserves Commentary:
Chairman Bernankes Press Conference (June 19)
8(1) Represents the views of the Investment Strategy Group.
Source: Investment Strategy Group, Federal Reserve, C-SPAN.
Chairman Ben Bernanke
Dovish1
Hawkish1
The Comm ittee expects a
considerable interval of time to pass
between when the Comm ittee will
cease adding accommodation through
asset purchases and the time when
the Comm ittee will begin to reduceaccomm odation by moving the federal
funds rate target toward more normal
levels.
If the incoming data are broadly
consis tent with this forecas t, the
Comm ittee currently anticipates that it
would be appropriate to moderate the
monthly pace of purchases later this
year.
However, any need to cons ider
applying the brakes by raising short-
term rates is still far in the future.
And if the subsequent data remain
broadly aligned with our current
expectations for the econom y, we
would continue to reduce the pace of
purchases in m easured steps through
the first ha lf of next year, ending
purchases around midyear.
When as set purchases ultimately
come to an end, the unemployment
rate would likely be in the vicinity of 7
percent.
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Investment
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DivisionCommentary From Other Fed Officials (June 24)
9
Source: Investment Strategy Group, Bloomberg, The Wall Street Journal, The Financial Times, Global Post, Federal Reserve Bank of Minneapolis.
(1) Excerpts from his speech at a conference at the Official Monetary and Financial Institutions Forum on June 24, 2013.(2) Excerpts from Statement: Recent FOMC Communications as a Part of Appropriate Monetary Policy, published by the Minneapolis Fed June 24, 2013.
(3) Represents the views of the Investment Strategy Group..
Richard Fisher
(President of the Federal Reserve Bank of Dallas,
Non-Voting Member of the FOMC)1
Narayana Kocherlakota
(President of the Federal Reserve Bank of Minneapolis,
Non-Voting Member of the FOMC)2
Dovish3 Hawkish3 Dovish3 Hawkish3
I'm not in favour of going from Wild
Turkey to cold turkey over night
It would be appropriate for us to dia l
back the monetary stimulus.
The Committee shou ld continue to buy
assets at least until the unemployment
rate has fallen below 7 percent
"The Committee may choose to stop
using this tool [QE] before the econom y
has fully normalized."
Even if we reach a s ituation this year
where we dial back (stimulus ), we will
still be running an accommodative
policy.
The housing market is very robust. The
question is when do you get market
forces to take that on. For me the
answer is now.
"It may be appropriate for the
Comm ittee to buy additional assets
even after the unem ployment rate falls
below 7 percent."
An exit is still way out in the future.I agree fully with the chairman that we
should dial back on the stimulus.
"The Committee shou ld keep its target
range for the fed funds rate at its
current extraordinarily low level at least
until the unemployment rate has fallen
below 5.5 percent"
On Thursday, June 27, New York Fed President and FOMC Vice-Chairman Bill Dudley is scheduled to give a speech
in which he may comment on monetary policy.
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DivisionThe FOMC Has Upgraded Their Outlook
10Source: Investment Strategy Group, Datastream, Federal Reserve, GIR.
1. FOMC & GIR Unemployment Rate Projections (As of June 25, 2013) 2. FOMC & GIR Core PCE Inflation Projections (As of June 25, 2013)
The FOMC has revised its unemployment rate projections down since the end of 2012. In contrast, projections for
core inflation have been also revised lower.
The FOMC appears to have focused on changes in the labor market outlook more than on changes in the inflation
outlook.
7.6
7.5
6.9
6.3
7.6
7.1
6.3
7.3
6.7
6.0
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10 11 12 13 14 15
Perce
ntage
Years
Unemployment Rate June GS Projection
Dec. 12 FOMC Projection June 13 FOMC Projection
1.1
1.81.8
1.9
1.81.8
1.9
1.3
1.71.9
0.0
0.5
1.0
1.5
2.0
2.5
3.0
10 11 12 13 14 15
YoY-
Percent
Years
Core PCE Inflation (YoY) June GS Projection
Dec. 12 FOMC Projection June 13 FOMC Projection
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Investment
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DivisionSlight Shift in Communication Seems Inconsistent with Data
11Source: Investment Strategy Group, Datastream
1. US Real GDP Growth Through Q1 2013 2. Non-Farm Payroll Growth Through May 2013
The economy has been growing at a moderate pace, and private demand had been resilient in spite of higher taxes
and sequestration.
Employment has continued to grow at a moderate but steady pace.
Nonfarm payroll growth has averaged 155 thousand in the last 3 months as compared to 221 thousand in the prior
5 months.
7
171
-3
-300
-200
-100
0
100
200
300
400
500
600
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Thousands
Private ex Construction Construction Public sector
155QE3: 135
QE2: 49
3.5%
1.8%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
06 07 08 09 10 11 12 13
%QoQAnn.
Years
Real GDP Ex. Government Consumption and Investment Real GDP
QE1
QE2
(3.3%) QE3
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Investment
Management
Division
99.0
99.2
99.4
99.6
99.8
100.0
100.2
100.4
100.6
10 11 12 13
USFinancialC
onditionsIndex
Financial Conditions Tighter
QE2
QE3
US GDP Growth is Expected to Accelerate
12
1. GS GIR US Real GDP Growth Forecasts (QoQ Ann. %) As of June 25, 2013
Source: Investment Strategy Group, Goldman Sachs Global Investment Research
2. GS US Financial Conditions Index Through June 25, 2013
2.4
1.8
2.0
2.5
3.0
3.5 3.5 3.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014
QoQ
Ann.%
Forecast
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Investment
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DivisionIs a Repeat of 1994 Likely?
13
1. Path of US 10-Year Treasury Yields
Source: Investment Strategy Group, Datastream
2. Drawdowns and Annual Returns Across Fixed Income and S&P 500 in 1994
5.5%
6.0%
6.5%
7.0%
7.5%
8.0%
8.5%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
0 714
21
28
35
42
49
56
63
70
77
84
91
98
105
112
119
126
133
140
147
154
161
168
175
182
189
196
203
210
217
224
5/1/13 Left Axis
1/28/94 Right Axis
Number of Days Since 10-Year Yield Trough
The rise in interest rates since early May has drawn comparisons to1994:
10-year Treasury yields have risen by a similar magnitude to the initial increase in 1994.
This increase in rates has also been accompanied by declines in both bond and equity prices.
-16%
-10%
-8%
-7%
-5%
-12%
-8%
1%
-3%
-1%
-13%
-8%
-6%
-4%
-5%
-18%
-16%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
30-Year Treasury 10-Year Treasury S&P 500 Barclays USAggregate Index
US Corp High Yield
Drawdown During 1994
Total Return in 1994
Current Drawdown
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Investment
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DivisionChina: A Confluence of Events
15Source: Investment Strategy Group, Bloomberg, Datastream
1. China: Real GDP Growth Bloomberg Consensus Expectations (%YoY) 2. China: 7-Day Shanghai Interbank Offered Rate (%)
11.0
7.2
0%
2%
4%
6%
8%
10%
12%
Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13
7-DayS
HIBOR
Chinas growth expectations have fallen as new leadership has signaled a desire for quality growth at the
expense of faster growth.
Interbank rates spiked last week, with the overnight repo rate reaching an intraday high of >30%. This raised
concerns about a banking crisis in response to central bank efforts to slow rising off balance sheet lending.
The Peoples Bank of China has asked larger banks to play an active role in stabilizing the market. It also
provided liquidity to some financial institutions this week.
7.70
7.65
7.4%
7.6%
7.8%
8.0%
8.2%
8.4%
8.6%
Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13
ChinaConsensusRea
lGDPGrowth(%YoY)
2013 2014
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Investment
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DivisionKey Takeaways
16
Clients should use the recent downdraft to build toward their strategic allocation to equities.
While we think that interest rates will gradually rise over the next several years and lead to low
Investment Grade Fixed Income returns, a repeat of 1994 is highly unlikely.
We recommend tactically underweighting Investment Grade Fixed Income in favor of the following
areas where the risk-return opportunities are much more attractive:
High Yield Bonds
US Bank loans
Emerging Market Local Debt
Euro Stoxx 50 (currency hedged)
US Bank Equities
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Investment
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DivisionImportant Information
17
Investment Strategy Group. The Investment Strategy Group (ISG) is focused on asset allocation strategy formation and market analysis for Private Wealth Management. Any information thatreferences ISG, including their model portfolios, represents the views of ISG, is not research and is not a product of Global Investment Research or Goldman Sachs Asset Management, L.P
(GSAM). The views and opinions expressed may differ from those expressed by other groups of Goldman Sachs. If shown, ISG Model Portfolios are provided for illustrative purposes only. Your
asset allocation, tactical tilts and portfolio performance may look significantly different based on your particular circumstances and risk tolerance. Your actual asset allocation, tactical tilts and
portfolio performance may look significantly different based on your particular circumstances and risk tolerance. The model performance calculation assumes that (1) each asset class was owned
in accordance with the recommended weight; (2) all tactical tilts were implemented at the time the recommendation was made; and (3) the portfolio was rebalanced every time a tactical tilt change
was made and at the end of every quarter (unless a tactical tilt was made within a month of quarter-end). Performance is calculated using the daily returns (actual or interpolated) of indices that
ISG believes are representative of the asset classes included in the model. Results shown reflect the total return but generally do not take into account any investment management fees,
commissions or other transaction expenses, which would reduce returns. The results shown reflect the reinvestment of dividends and other earnings. All returns are pre-tax and are not adjusted
for inflation. Additional information about the model portfolio performance calculation, including asset class benchmarks used for modeling performance and a history of tactical tilts, is available
upon request.
Forecasts. Economic and market forecasts presented herein reflect our judgment as of the date of this material and are subject to change without notice. These forecasts are estimated, based
on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes tothese forecasts. Case studies and examples are for illustrative purposes only.
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are licensed for use for certain purposes by the Issuer. These securities, based on such index, have not been passed on by MSCI as to their legality or suitability, and are not issued,
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Investment
Management
Division
2013 Goldman Sachs. All rights reserved.18
Important Information
18
Indices. Any references to indices, benchmarks or other measure of relative market performance over a specified period of time are provided for your information only.
Certain Investments / Strategies.
Alternat ive Investments . Private investment funds and hedge funds are subject to less regulation than other types of pooled vehicles. Alternative investments may involve a substantial degree of
risk, including the risk of total loss of an investors capital and the use of leverage, and therefore may not be appropriate for all investors. Please keep in mind that liquidity may be limited. Investors
should review the Offering Memorandum, the Subscription Agreement and any other applicable disclosures for risks and potential conflicts of interest.
Commodi t ies. Commodity investments may be less liquid and more volatile than other investments. The risk of loss in trading commodities can be substantial due, but not limited to, volatile political,
market and economic conditions. An investors returns may change radically at any time since commodities are subject, by nature, to abrupt changes in price. Commodity prices are volatile because
they respond to many unpredictable factors including weather, labor strikes, inflation, foreign exchange rates, etc. In an individual account, because your position is leveraged, a small move against
your position may result in a large loss. Losses may be larger than your initial deposit. Investors should carefully consider the inherent risk of such an investment in light of their experience, objectives,
financial resources and other circumstances. No representation is made regarding the suitability of commodity investments.
Emerging Markets Securit ies. Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and
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Tactical Tilts. Tactical tilts may involve a high degree of risk. No assurance can be made that profits will be achieved or that substantial losses will not be incurred.
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