subprime crisis and global economic outlook april 18, 2008 see the disclosure appendix for the...
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Subprime Crisis and Global Economic Outlook
April 18, 2008
See the Disclosure Appendix for the AnalystCertification and Other Disclosures
Cheng-Mount Cheng
Vice President
Taiwan Chief Economist
Asia Pacific Economic & Market Analysis
886-2-2777-7070
2
An Evolving View: Key IssuesAn Evolving View: Key Issues
• Real factors -- housing and energy--are combining with financial stress to slow the U.S. economy sharply.
–The U.S. is probably in a recession.
– Financial stress remains intense.
– Looking ahead the critical issues are: The dynamics of the housing adjustment; The depth of the financial sector problems;
How aggressive will the Fed be in trying to contain the impact of financial turbulence.
• Other industrial countries are facing different versions of the same problems.– The U.K. is experiencing a housing-led slowdown.
– Europe may be vulnerable, but later.
• We expect only a modest slowdown for most emerging markets.
– But the EM countries are more vulnerable to downside scenarios.
3
US Subprime WoesUS Subprime Woes
4
Subprime Money TrailSubprime Money Trail
How subprime mortgage can end up in your investmentsHow subprime mortgage can end up in your investments
Home buyers
Mortgage brokers
Big banksSubprime lenders
Securitization manufacture of
CDOs
WALL ST
Investors
LOAN DEBTS
CDO
Securities /CDOs
MBS
MORTGAGE
LOANS
AAAAA-BBB
Rating
Ratingcompanies
Source: Bloomberg Markets, July 2007
5
Financial AlchemyFinancial Alchemy
1.The CDO
A CDO is a company typically incorporated offshore that buys collateral such as bonds, mortgage-backed securities and loans and sells debt securities with varying degrees of risk
2.Multiply CDOs
A CDO with collateral consisting of pieces of other CDOs is called a CDO squared. When a CDO is built of CDO squareds, it’s called a CDO cubed.
Unrated equity(toxic waste)
AA- BBB
AAA
$
Interest payment
Potential losses
Bonds
Mortgage-backed
securities
Other asset-Backed
securities
$SECURITIESCOLLATERAL
CDOCDO
CDOCDO
CDO squareds
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDO cubeds
Wall Street has a way to transform risky debt into CDOs rated AAA or Wall Street has a way to transform risky debt into CDOs rated AAA or Aaa.Aaa.
Source: Bloomberg Markets, July 2007
6
Rapid Growth of Alternative Mortgage Products and Structured Rapid Growth of Alternative Mortgage Products and Structured CreditCredit
Origintions of Sub-Prime Mortgages, Issuance of Sub-Prime Mortgage-Backed Securities and Issunce of CDO's of Assets-Backed Securities
(U.S.$, billions, annual rates)
0
100
200
300
400
500
600
700
2000 2001 2002 2003 2004 2005 2006 20070
100
200
300
400
500
600
700
Sub-Prime OriginationsSub-Prime RMBSCDO of ABS
Sources: Inside Mortgage Finance, and Creditflux.
7
Deterioration of Sub-Prime Mortgage PerformanceDeterioration of Sub-Prime Mortgage Performance
Cumulative Deliquencies* for Sub-Prime Mortgages Issued 2000-2007
(percent)
0
5
10
15
20
25
30
35
0 6 12 18 24 30 36Months Since Issuance
0
5
10
15
20
25
30
35
40
2007
2006
2005
* More than 60 Days. Source Citi
Range for loans issued 2000-2004
2000 2002 2004 2005 2006
FICO<600 59 48 38 34 34
Debt Service/ Income >45% 34 35 37 40 45
Coincident Second Lein 2 4 20 28 32
Low Docu-mentation 25 32 40 44 46
Source: Citi
Percent of Sub-Mortgages Securitized in:
Underwriting Charateristics for Sub-Pirme Mortgages By Vintage
8
Evolution of Prices of Sub-Prime SecuritiesEvolution of Prices of Sub-Prime Securities
Prices of Sub-Prime ABS (06-02, Percent)
0
25
50
75
100
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08
0
25
50
75
100
AAA
AA
A
BBB
Source: Citi
Bear Stearns Problems First
Reported
Discount Rate Cut Sept.
FOMCDec.
FOMC
Inter-Meeting
CutBear
StearnsRescue
9
The additional problems with complicated structuresThe additional problems with complicated structures
Source: Citi.
Typical Mezzanine CDO of ABS
Potential loss 75%
CDO of ABSUnderlying
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Super senior
AAA
Equity
A
AA
AAA
AA
Unrated
BBB
A
BBB-
AAAAAAAA
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBCDO
Typical RMBSUnderlying
loans
Potential loss 10%
10
Sub-prime Woes as a Trigger of Credit Market DisruptionsSub-prime Woes as a Trigger of Credit Market Disruptions
• Sub-prime & Alter-A mortgages at end ’06
more than US$1 trillion outstanding
roughly one-third of total US mortgages
10% of bank assets
sub-prime delinquency ratio up to 13.8% in 1Q07 and 14.8% in 2Q07
US sub-prime related credit loss at around US$50-100 billion (Fed estimate)
• But sub-prime mortgages triggered confidence crisis & liquidity crunch
investors can’t assess the fair value of complicated and illiquid structured credit securities backed by sub-prime mortgages
hedge funds dump leveraged buy-out (LBO) and corporate notes after losing heavily in mortgage-backed securities and credit default swaps
confidence crisis spread to corporate note and inter-bank markets
11
Major Fund/Corporate Losses Leading up to ABCP Market CrisisMajor Fund/Corporate Losses Leading up to ABCP Market Crisis
• Jun 20: Merrill Lynch seized assets from two Bear Stearns hedge funds that were backed by sub-prime loans. Bear Steams froze withdrawals from a third fund on Aug 1.
• Jul 10: S&P put on Watch negative 622 sub-prime deals worth US$12.1 billion, with loss expectations rising to 10-14%. (S&P subsequently downgraded 582 out the 622 deals for a total of US$6.38 billion)
• Aug 6: American Home Mortgage Investment Corporation filed Chapter 11 bankruptcy
• Aug 10: BNP Paribas stopped valuing three of its funds and suspended all withdrawals by investors
• Aug 14: Countrywide Financial, the largest mortgage lender in the US, said foreclosures and mortgage delinquencies had risen to their highest levels since early 2002, raising fears that the company could face bankruptcy.
• Sep 13: UK’s 5th largest mortgage lender Northern Rock asked the Bank of England for emergency lending due to a "liquidity squeeze.“ Concerned customers produced an estimated GBP2bn withdrawn in just three days.
12
A Mild Improvement of CA Mild Improvement of Credit redit MMarketarket Strain Following Fed 50bp Strain Following Fed 50bp Rate Cut; TRate Cut; Tightening in ightening in CCredit redit MMarketarket U Unlikely to nlikely to FFully ully RReverseeverse
• Contraction in commercial papers (CP) shows borrowers’ failure to roll over debts
• CP issuers draw down credit lines, reducing bank liquidity
• Corporate issuers face higher interest rates and shorter maturity
Commercial Paper Outstanding(US$, bil.)
400
500
600
700
800
900
1,000
1,100
1,200
2001 2002 2003 2004 2005 2006 2007100
150
200
250
300
350
Asset-Backed (left)
Financial (left)
Non-financial (right)
Sourece: Federal ReserveSource: US Federal Reserve Board, Hover Analytics, Bloomberg, Reuters
13
Corporate Credit Spreads Have WidenedCorporate Credit Spreads Have Widened
Spreads: Invest.Grade Corp. Bonds (basis points)
50
100
150
200
250
300
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
50
100
150
200
250
300
25th Percentile
Median
75th Percentile
Change in Spreads: I.G. Corp. Bonds (Basis Points)
-60
-40
-20
0
20
40
60
1988 1989 1992 1993 1996 1997 2000 2001 2004 2005
-60
-40
-20
0
20
40
60
+2StDev-2StDev
Change in Spreads: H.Y. Corp. Bonds (Basis Points)
-250
-200
-150
-100
-500
50
100
150
200
250
1994 1996 1998 2000 2002 2004 2006
-250
-200
-150
-100
-500
50
100
150
200
250
+2StDev-2StDev
Spreads: High Yield Copr. Bonds (basis points)
0
200
400
600
800
1000
1200
1990 1992 1994 1996 1998 2000 2002 2004 2006
0
200
400
600
800
1000
1200
25th Percentile
Median
75th Percentile
Source: Citi
14
Other Spreads Have Widened as WellOther Spreads Have Widened as Well
Spreads: Interest Rate Swaps (basis points)
20
30
40
50
60
70
80
90
100
110
120
1990 1992 1994 1996 1998 2000 2002 2004 2006
20
40
60
80
100
120
25th Percentile
Median
75th Percentile
Change in Spreads: I.R. Swaps (Basis Points)
-20
-10
0
10
20
30
1994 1996 1998 2000 2002 2004 2006
-20
-10
0
10
20
30+2StDev
-2StDev
Spreads: Emerging Market Bonds (basis points)
0
200
400
600
800
1000
1200
1400
1600
1800
1990 1992 1994 1996 1998 2000 2002 2004 2006
0
200
400
600
800
1000
120025th PercentileMedian75th Percentile
Change in Spreads: Emerging Market Bonds (Basis Points)
-400
-200
0
200
400
600
800
1000
1994 1996 1998 2000 2002 2004 2006
-400
-200
0
200
400
600
800
1000
+2StDev-2StDev
Source: Citi
15
International markets have entered a difficult periodInternational markets have entered a difficult period
16
Losses across the mortgage supply chain – who holds the risk?Losses across the mortgage supply chain – who holds the risk?
17
Estimates of nonprime mortgage lossesEstimates of nonprime mortgage losses
18
There has been a parallel weakening of credit discipline in the corporate There has been a parallel weakening of credit discipline in the corporate segmentsegment
19
U.S. Financial StressU.S. Financial Stress
20
Financial Stress RemainsFinancial Stress Remains
Spread Between 3-mon. LIBOR and OIS Rates,3 Months Forward (Basis Points)
-20
0
20
40
60
80
100
120
Apr-07 Jul-07 Oct-07 Jan-08-20
0
20
40
60
80
100
120
USD
EUR
GBP
Source: Bloomberg and Citi
CDS Spreads for Major Banks andBroker-Dealers (Basis Points)
0
50
100
150
200
250
300
350
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-080
50
100
150
200
250
300
350
BanksBrokers
Source: Citi
21
Credit Tightening Across Loan CategoriesCredit Tightening Across Loan Categories
-40
-20
0
20
40
60
80
100
1990 1993 1996 1999 2002 2005 2008-40
-20
0
20
40
60
80
100
Other Consumer
Commercial Real Estate
C & I Loans
-40
-20
0
20
40
60
80
100
-40
-20
0
20
40
60
80
100
1990 1993 1996 1999 2002 2005 2008
Mortgages toIndividuals
Prime
Non-traditional
Subprime
Credit Tightening at Banks for Select Lending Categories, 1990-1Q 08 (Percent)
Source: Federal Reserve
22
Larger Haircuts and margins reduces leverageLarger Haircuts and margins reduces leverage
Source: Citi. Source: Citi.* May be difficult to find** May be even more difficult to find.
Product Mar07 Mar08
AA corp bond 0-3 8-12
BB lev loan 15-20 25-35 BB HY bond 5 10-15 25-40
Equities 15 20
IG CDS / derivs 1 5
Product Mar07 Mar08
AAA CDO of ABS 4 n/a
AAA CLO 4 10-20**
AAA RMBS 2 10-20*
Typical Haircut / Initial Margin Levels by Asset Class(Percent, Approximate Estimates)
Synth super snr 1 2
23
Deleveraging is still having a deep impact on credit marketsDeleveraging is still having a deep impact on credit markets
Average Normalized Spreads(St. Dev.)
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3
1991 1993 1995 1997 1999 2001 2003 2005 2007
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
3
Note: Average of normalized spreads for nvestment grade and high yield corporate bonds, conventional mortgage and asset-backed securities, agencies and swaps. Sources: Citi
31-May 31-Mar
Corporate Bonds
Inestment Grade 90 270(30) (100)
High Yield 244 813(10) (94)
Swaps 49 84(58) (93)
57 115(57) (100)
22 61(27) (96)
56 91(51) (86)
139 289(0) (17)
Source: Citi
Emerging Market Sov. Bonds.
Credit Spreads(basis points, figures in
parenthesises are percentiles)
Conventional Mortgage-Backed Sec.
Agency
Asset-Backed Sec.
24
U.S. OutlookU.S. Outlook
25
The Economy Now Shows the Effects of Earlier TightenginThe Economy Now Shows the Effects of Earlier Tightengin
-3
-2
-1
0
1
2
3
4
97 99 01 03 05 07
-1
0
1
2
3
4
5
6
FCI (Left) Same-Store Sales (Right)
%
Citi Financial Conditions Index and Year-to-Year Percent Change in Same Store Sales (13-Week Average), 1997-05 Apr 08
Note: Shaded region denotes recession.Sources: Redbook Research and Citi.
26
Forecast DetailsForecast Details
2007 2008F 2009F 2Q 3Q 4Q 2QF 3QF 4QFGDP SAAR 3.8% 4.9% 0.6% -1.3% 0.1% -0.6%
YoY 2.2% 0.8% 0.9% 1.9 2.8 2.5 1.2 0.0 -0.3Consumption SAAR 1.4 2.8 1.9 -0.8 1.3 -1.2
YoY 2.9 0.9 0.4 2.9 3.0 2.5 1.1 0.7 0.0Business Investment SAAR 11 9.3 6.9 -4.1 -4.7 -5
YoY 4.8 1.5 -2.6 4.1 5.1 7.3 3.1 -0.4 -3.3Housing Investment SAAR -11.8 -20.5 -25.2 -20.5 -13.9 -7.0
YoY -17.0 -20.3 -4.9 -16.5 -16.5 -18.6 -22.6 -21.0 -16.6Government SAAR 4.1 3.8 2.2 -0.2 1.1 1.2
YoY 2.0 1.4 1.2 1.9 2.7 2.4 1.6 0.9 0.7Exports SAAR 7.5 19.1 4.8 4.0 4.2 4.2
YoY 8.0 5.9 4.6 7.1 10.3 7.9 7.6 4.0 3.9Imports SAAR -2.7 4.4 -1.9 -2.1 0.3 -3.3
YoY 1.9 -0.5 -1.0 2.0 1.7 0.9 0.1 -0.9 -1.2CPI YoY 2.9 3.7 1.9 2.6 2.4 4 3.8 3.7 2.9Core CPI YoY 2.3 2.4 1.9 2.3 2.1 2.3 2.4 2.4 2.3Unemployment Rate % 4.6 5.5 6.7 4.5 4.7 4.8 5.3 5.7 6.1Govt Balance (Fiscal Year) % of GDP -1.1 -3.0 -3.0 — — — — — —
Assumed WTI Spot Price US$ 72.3 104.8 102.3 65 75.5 90.9 109.2 106.1 104.7
Current Account US$bn -747 -734 -622 -756 -714 -732 -749 -735 -694
% of GDP -5.4 -5.2 -4.3 -5.5 -5.1 -5.2 -5.3 -5.1 -4.8
S&P 500 Profits (US$ PerShare)
YoY -1.7 -0.6 5 9.4 -5.7 -19.2 -11.5 1.8 22.4-9.7
—
99.3
-760
-5.4
0.04.22.4
5
2.73.18.50.2
6.9-24
-20.50.6
2.50.61.70.8
2007 20081QF
0.5%
Notes: F Citi forecast. YoY Year-to-year percent change. SAAR Seasonally adjusted annual rate. Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, I/B/E/S, Treasury Department, Wall Street Journal, and Citi.
27
Small Business Sector Retreats SharplySmall Business Sector Retreats Sharply
-35
-30
-25
-20
-15
-10
-5
0 %
0
1
2
3
4
5
6
7
8
9
86 88 90 92 94 96 98 00 02 04 06 08
%
Higher Current Earnings (Left) Nominal GDP (Right)
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
88 90 92 94 96 98 00 02 04 06 08
0
5
10
15
20
25
Unemployment Rate (Left) Manpower (Right) NFIB Employment (Right)
% %
Percent of Small Businesses Reporting Higher Earnings this Quarter vs. Year-to-
Year Percent Change in Nominal GDP, 1986-Mar 08
Manpower Employment Current Quarter Outlook (Inverted), Unemployment Rate and Percent of
Small Businesses Planning to Increase Employment (Inverted), 1988-Mar 08
Sources: National Federation of Independent Businesses and Bureau of Economic Analysis
Notes: Manpower results are plotted in the quarter the survey was taken. Shaded regions denote recession. Sources: National Federation of Independent Businesses, Manpower Inc., and Bureau of Labor Statistics.
28
Housing Markets Reveal Only Tentative Signs of Reviving Investor Housing Markets Reveal Only Tentative Signs of Reviving Investor ConfidenceConfidence
10
20
30
40
50
60
70
80
90
92 94 96 98 00 02 04 06 08
110
120
130
140
150
160
170
180
190
HMI (Left) Buying Conditions (Right)
NAHB Housing Market Index and Michigan Consumer Assessments on Current Conditions for Buying Houses, 1992-Apr 08
Sources: National Association of Home Builders and University of Michigan.
29
Home Prices Most Vulnerable In Nonprime/Nonconforming Properties Home Prices Most Vulnerable In Nonprime/Nonconforming Properties
The Ratios of House Prices to Disposable Income Per Household(Percent)
80
90
100
110
120
130
140
1975 1980 1985 1990 1995 2000 2005 201080
90
100
110
120
130
140
OFHEO
Census Constant-Quality
S&P/Case-Shiller
Sources: Office of Federal Housing Enterprise Oversight and BLS.
30
Rate/Price Balance Needed to Maintain Housing AdjustmentRate/Price Balance Needed to Maintain Housing Adjustment
Ratio of Standard Mortgage Payment to Household Incomeand Mortgage Rate
4
6
8
10
12
14
1985 1990 1995 2000 2005
Percent
12
13
14
15
16
17
18
19
20
21
22Percent
Mortgage Rate (left)
Mortgage Payment/Income (right)
Note: Standard interest payment based on 80% loan to value ratio. Sources: OFHEO, BEA, National Association of Realtors, and Citi.
31
Commercial Starts, moderate downside risk.Commercial Starts, moderate downside risk.
Commercial Construction Starts(2006=100)
60
80
100
120
140
160
180
1997 1999 2001 2003 2005 200760
80
100
120
140
160
180
AggregateOfficeIndustrial
Source: Census Bureau, McGraw-Hill, and Citi.
32
Corporate Spreads Have Over-shot FundamentalsCorporate Spreads Have Over-shot Fundamentals
Normalized Spreads and Corporate Default Rates
-1.5
-0.5
0.5
1.5
2.5
3.5
4.5
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
St.Dev.
0
2
4
6
8
10
12
14Percent
Investment Grade Spreads (left)
High Yield (left)
S&P Default Rate (right)
Sources: S&P and Citi
Forecast
33
Softening Demand Should Moderate Price PressuresSoftening Demand Should Moderate Price Pressures
Nominal Final Domestic Demand (y/y Percent Change, Four-Quarter Lag) and Chg. in Two-Year
Annualized Core CPI (Percent)
1
2
3
4
5
6
7
8
9
1990 1993 1996 1999 2002 2005 2008-1.2
-0.8
-0.4
0.0
0.4
0.8
1.2
Final Demand (Left)
Core CPI (Right)
Source: BEA, BLS, and Citi
f
Alterantive Measures of Long-term Inflation Expectations
1.5
1.7
1.9
2.1
2.3
2.5
2.7
2.9
3.1
3.3
3.5
1999 2000 2003 2004 2007
Percent
1.5
1.7
1.9
2.1
2.3
2.5
2.7
2.9
3.1
3.3
3.5Percent
5yr5ry Forwards (from TIPS)
Forecasters (10 years, median)
Consumer (5-10 years, median)
Sources: Federal Reserve, University of Michigan, Federal Reserve Bank of Philadelphia, and Haver.
34
The Fed is still trying to stabilize financial conditionsThe Fed is still trying to stabilize financial conditions
Movement of Citi Financial Conditions Index in Fed Easing Cycles(Standard Devations)
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
-12 -8 -4 0 4 8 12 16Months from Start of Easing
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
Current Cycle
Extreme Average
Mild Average
Source: Citi
35
Financial Conditions Have Not Responded Normally to Policy Financial Conditions Have Not Responded Normally to Policy ActionAction
-5-4
-3
-2
-1
0
1
2
3
4
5 -3
-2
-1
0
1
2
3
88 90 92 94 96 98 00 02 04 06 08
Fed Funds Target (Left, Inverted) FCI (Right)
-5% 3
Twelve-Month Change in Fed Target Rate and Citigroup Financial Conditions Index, 1988-Mar 08
Note: Shaded regions denote recession.Sources: Federal Reserve Board and Citi.
36
Outlook For PolicyOutlook For Policy
Economic Surprises: United States and G-10 (St.Dev.)
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
United StatesG-10
Source: Citi
Federal Funds Rate: Effective, FOMC Target, Expectations and Citi Forecast (Percent)
0
1
2
3
4
5
6
Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-080
1
2
3
4
5
6
Federal Funds EffectiveTargetForecast
Market Expectations as of: March 28, 2008
Source: Citi
37
Outlook For Euro and YenOutlook For Euro and Yen
Economic Surprises: Eure Area, and G-10 (St.Dev.)
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
Euro Area
G-10
Source: Citi
Economic Surprises: Japan, and G-10 (St.Dev.)
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
Japan
G-10
Source: Citi
USD/EUR
1.2
1.3
1.4
1.5
1.6
1.7
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-091.2
1.3
1.4
1.5
1.6
1.7
SpotForwardsForecast
Sources: Bloomberg and Citi
JPY/USD
90
100
110
120
130
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-0990
100
110
120
130
SpotForwardsForecast
Sources: Bloomberg and Citi
38
Global Economic OutlookGlobal Economic Outlook
39
A Global SlowdownA Global Slowdown
Contributions to Global Growth(Percentage Points)
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
2000 2002 2004 2006 2008
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
Emerging Markets Industrial Countries
F
Source: IMF and Citi
2008 2009 2008 2009 2008 2009 2008 2009
Industrial Countries
United States 0.8% 0.9% 3.7% 1.9% -0.8% -1.2% 0.1% -0.1%
Euro Area 1.3 1.1 2.5 1.7 -0.4 -0.7 0.2 -0.1
J apan 1.7 1.0 0.7 0.2 -0.2 -0.7 0.0 -0.1
United Kingdom 1.4 1.3 2.8 2.7 -0.3 -0.6 0.3 0.7
Canada 1.2 1.4 1.4 2.0 0.2 -0.1 0.0 0.0
Australia 2.6 3.4 3.4 2.6 -0.1 0.0 0.1 0.0
Emerging Markets
Brazil 4.6% 3.5% 4.7% 4.4% 0.2% -0.5% 0.0% -0.1%Russia 6.6 6.5 12.8 9.4 0.0 0.0 -0.1 0.5
India 7.7 8.3 4.3 4.0 -0.6 -0.2 0.0 0.0
China 9.8 9.3 5.8 3.0 -0.7 -0.7 0.8 -1.0
March 2008 GEOS Forecasts Change from February 2008 GEOS
GDP Growth Inflation GDP Growth Inflation
Global — Forecasts for Growth and Inflation, Changes Since February 2008 GEOS
Sources: Citi.
40
Spillovers from U.S. slowdown should increaseSpillovers from U.S. slowdown should increase
Deviations of U.S. Non-Oil Imports from Trend (Percent of R.O.W. GDP)
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1970 1975 1980 1985 1990 1995 2000 2005-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
Sources: BEA, IMF, and Citi calculations.
Change in Imports (y/y, percent) and the Average of ISM New Orders and Imports (6-mon. lag)
-15
-10
-5
0
5
10
15
20
25
40
45
50
55
60
65
70
1996 1998 2000 2002 2004 2006
Growth of Imports (Left)
Imports&Orders (Right)
Sources: Bureau of Economic Analysis and ISM
41
Re-Distribution of Economic Activity in Favor of GermanyRe-Distribution of Economic Activity in Favor of Germany
Euro Area — Manufacturing PMI (Diffusion Index), 2004-Mar 08
Sources: NTC Economics Limited.
Euro Area — Real Exports of Goods and Services (Index 1Q 1999 = 100), 1999-4Q 07
Sources: Eurostat
42
Business Confidence Among Large Manufacturers Fell More Than Business Confidence Among Large Manufacturers Fell More Than ExpectedExpected
Japan — Proportion of Companies Reporting Business Conditions Are “Unfavorable” (Large Manufacturing), 1980-March 2008 (Percent)
Note: There is a break in the data at the end of 2003.
Sources: NTC Economics Limited.
Japan — Business Investment Plans (Including Software Investment but Excluding Land
Purchases), FY2007-2008 (Yr-Yr-CHg, Percent)
Sources: Bank of Japan, Nikko Citigroup.
43
The Central Bank ResponseThe Central Bank Response
Source: Central banks and Citi.
2Q2008
3Q2008
4Q2008
1Q2009
2Q2008
3Q2008
4Q2008
1Q2009
Policy RatesUnited States 1.5% 1.0% 1.0% 1.0% -0.5% -1.0% -1.0% -1.0%Euro Area 3.75 3.5 3.25 3.0 – – -0.25 -0.5J apan 0.5 0.5 0.5 0.5 – – -0.25 -0.25United Kingdom 4.75 4.5 4.25 4 – – – -0.25Canada 3.0 3.0 3.0 3.0 – – – –Australia 7.5 7.5 7.5 7.5 – – – –China 7.75 7.75 7.75 7.5 – – – -0.25Foreign ExchangeYen/USD 98 95 95 98 -7 -14 -17 -14USD/Euro 1.60 1.65 1.60 1.55 0.07 0.14 0.12 0.1USD/GBP 1.96 1.98 1.92 1.93 – – – –
March 2008 GEOS Forecasts Change from February 2008GEOS
Global — Forecasts for Key Policy Rates and FX Rates (End-Quarter), Changes Since GEOS of February 2008
44
The Details of VulnerabilityThe Details of Vulnerability
The index is a ranking of internal and external cyclical and structural measures: inflation, fiscal balances, public debt-to-GDP ratios, current account balances, net international reserves to short term debt, trade as a share of GDP and foreign direct investment as a share of GDP. For each indicator we split the range between the minimum and maximum into ten levels, assigning numbers from -5 to +5, with the negative number associated with more international exposure or a greater vulnerability. The numbers are summed to give the overall vulnerability index. Source: Citi
Vulnerability Indicators: 1998 and Current
-20
-10
0
10
20
30
Current 1998 Current 1998 Current 1998 Current 1998 Current 1998 Current 1998 Current 1998 Current 1998
Russia Korea China Brazil Mexico South Africa Poland Turkey
-20
-10
0
10
20
30
CPI Public Debt Fiscal Balance Current Account Reserves/S.T.Debt FDI (Exp.+Imp)/GDP
45
Monetary Tightening Likely Will Continue on Strong Growth Monetary Tightening Likely Will Continue on Strong Growth and Rising Inflationand Rising Inflation
China -- 1Q GDP Growth Slows
China – Uneven Squeeze: Industrial Profit Growth by Type of Enterprise
Source: National Statistics Bureau and Citi.
Actual Previous1Q GDP Growth (% yoy) 10.6% 11.2%March CPI (% yoy) 8.3 8.7March Retail Sales (% yoy) 21.5 19.1March Fixed Asset Investment (YTD, % yoy) 25.9 24.3March Industrial Production (% yoy) 17.8 15.4
Source: Citi.
China – Summary of Production Cost Distributions
Source: National Statistics Bureau and Citi.
46
The Gov’t Regards Current Inflation as Structural Price IncreasesThe Gov’t Regards Current Inflation as Structural Price Increases
Source: CEIC Data Company and Citi.
China’s Inflation – Headline, Food and Non-Food CPI, January 2001 – March 2008 (%)
-5
0
5
10
15
20
25
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
CPI Headline CPI Food CPI Non-Food
-2
-1
0
1
2
3
4
5
6
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0
5
10
15
20
25
30
35
40CPI (LHS)
Exports (RHS)
China’s Export Growth and Headline CPI Inflation, 1997-2007 (%)
Source: CEIC Data Company and Citi.
47
Source: Chicago Board of Trade and Citi .
Cautious Outlook for RMBCautious Outlook for RMB
China -- Annualized Monthly Appreciation Rate of RMB Against US Dollar, November 2005 – March 2008 (%)
China -- RMB/USD Exchange Rate: Actual, Forward Markets and Citi Forecast, May 2007-April 2008
-5
0
5
10
15
20
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08
6.0
6.5
7.0
7.5
8.0
May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09
Actual Forward Citi
Source: CEIC Data Company and Citi.
48
Strong demand, limited excess capacity, and Geopolitical riskStrong demand, limited excess capacity, and Geopolitical risk
OPEC Excess Capacity and Ratio of Inventoriesto Consumption
0
2
4
6
8
10
12
14
16
18
85 87 89 91 93 95 97 99 01 03 05 07
Percent
7.6
7.8
8.0
8.2
8.4
8.6
8.8Percent
Excess Capacity as % of Supply (Left)
Inventory/Consumption (Right)
Sources: Oil and Gas Journal, Department of Energy.
Change in Supply and Demand for Petroleum Products
(y/y, million barrels per day)
-0.5
0
0.5
1
1.5
2005 2006 2007
-0.5
0
0.5
1
1.5
World Demand Non-OPEC Supply
OPEC Capacity OPEC Supply
Sources: Department of Energy, Haver, Bloomberg
49
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