Copyright 2014 Arbor Research & Trading, Inc. All rights reserved.

This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in
any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

TIPS Breakevens Potential for Narrowing

SUMMARY
AQAs model uses three indicators: gasoline prices,
gold/silver exchange rate, and a financial stress index
to estimate 100-day changes in TIPS breakevens.
These three indicators look overdue for a correction,
which implies narrower TIPS breakevens going into
July.
Those looking for better levels for executing widening
positions may soon find them.


AQA reviewed a series of variables in attempt to explain 100-day changes in TIPS breakevens. Some of the markets
indlcuded on this list stemmed from discussions in a Federal Reserve Bank of New Yorks paper titled Decomposing Real
and Nomial Yield Curves. This list was whittled down to three key variables:
Daily National Average Gasoline Prices Regular Unleaded
Gold/Silver Spot Exchange Rate
Bank of Americas Financial Stress Index
Breakevens (see scatterplots below) are positively correlated to gasoline prices and negatively correlated to the
gold/silver exchange rate and financial stress index.

100-Day Changes Variables vs 5 Yr TIPS Breakevens Since 2010



6/26/2014
Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in
any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

AQA generated a linear regression of 100-day changes for TIPS breakevens as explained by 100-day changes in gasoline
prices, gold/silver exchange rate, and the financial stress index. Data since 2008 indicates these variables explain 84% of 5
Yr and 10 Yr breakevens 100-day changes. See below for out-of-sample 5 Yr breakevens as estimated by a regression
model updated at the end of each year.
5 Yr Breakevens 100-Day Changes (Bps) Regression vs Actual


5 Yr breakevens 100-day change is rising and catching up to the models estimation after running narrower than
expected since early May 2014.
We are concerned the models estimate is due to fall as gasoline prices, gold/silver exchange rate, and financial stress
index appear overdue for a correction. Corrections by these markets and index from recent trends would
reduce the models estimation and imply lower breakevens going into July.
Gasoline prices and the gold/silver exchange rate are coming off two standard deviations from their 30-day averages.
Gasoline prices are pushed up against highs formed during the summer of 2013 and spring of 2014.
The financial stress index is at its lowest (-0.46) since November 2006, which is unlikely to go much lower with its all-time
low at -0.66.

Copyright 2014 Arbor Research & Trading, Inc. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in
any form without the prior consent of Arbor. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

5 Yr Breakevens are poised to signal a significant widening shift by breaking Mthly Resistance 202.3/204.6 bps for the
first time in 16 months. Nonetheless, its overbought nature appears due for a narrowing correction. Buyers should look
to forming support for July at 197 bps.

10 Yr Breakevens are challenging a MAJOR Mthly/Qtrly Resistance overlap at 225.4/227.2 bps going into month-end.
Its overbought condition appears due for a narrowing correction. Buyers should look to forming support for July at 218
bps.

TECHNICAL OUTLOOK