Global Macro Commentary

Shakedown Street
Monday, August 04, 2014
Guy Haselmann
(212) 225-6686
Director, Capital Markets Strategy

John Zawada
Director, US Rate Sales



Shakedown Street
After two weeks out of the office, I return and take notice that the back end of the Treasury
curve has performed well, while the front end has bounced around before settling nearly at the
same level. Credit spreads widened, particularly high yield (aka junk). The 10 year Bund yield
fell 8 bps to near its all-time low of 1.11%. Spanish bonds rallied 28 bps, which was
directionally representative of the rest of the European periphery.
Portugal spent 4.9 billion (2.4% of 2013 GDP) to rescue its biggest bank (BES) in an attempt to
prevent further contagion. J ust weeks ago, the Bank of Portugal said BES had enough capital to
withstand shocks coming from its parent. At least, the bailout was conducted properly with
depositors and senior bondholders spared, while subordinated creditors and shareholders will be
wiped-out.
Momentum to undermine the US dollar grew as well. The BRICS countries agreed to launch a
Shanghai-based BRICS bank, freshly named the New Development Bank (NDB). China is set to
establishment (in 2015) a $100 billion Asian International Infrastructure Bank (AIIB). The
rotating presidency will initially be led by India. The intent is to challenge the West-centric IMF
and World Bank. The FT reported that France has gained support of Berlin, London and Rome
to confront the US about US regulatory over-reach at the G-20 meeting being held in Australia
later this year. These issues combine to form the biggest challenge to the world monetary system
since the creation of the Bretton Woods system in 1944.
During this two week period, the VIX rose 34%. The SPX fell over 2%. This is not a typo:
despite continued Fed promises, the S&P actually declined. In fact, the loss last week in the
S&P 500 was its biggest weekly decline in more than two years. Small caps underperformed
large caps. Defensive sectors like utilities and consumer staples (bond-like sectors)
outperformed high P/E and high beta stocks. Warning signs are on the horizon.
In addition, geo-political tensions ratcheted higher. Events in Gaza dominated the news, yet it
was not the only noteworthy story. Syrian fighting has spilled into Lebanon. Libya disintegrated
into violent multi-militia fighting, causing evacuations and embassy closings. ISIS advanced,
capturing Iraqs biggest damn and a Kurdish town. Argentina defaulted, triggering CDS
payments. Additional and more significant Russian sanctions were announced; and Moscow
responded with retaliatory measures. Incidents of Chinese social unrest and random attacks are
growing in frequency and boldness. 60 Minutes news program re-broadcasted the story about
the extent of Chinas credit and housing bubbles (http://www.cbsnews.com/news/china-real-
estate-bubble-lesley-stahl-60-minutes/).
On the domestic front, Obama bluntly admitted that we tortured some folks after 9/11. It was
also revealed that CIA spies improperly accessed Senate computers; most likely a violation of
the constitutional separation of powers. The over-reach experiments of the NSA, IRS, FOMC
and (now) CIA have increased cries of Washington bureaucracy veering out of control.
In addition, in an interview with The Economist, the President accused corporate leaders of being
insincere and disingenuous, stating that there is a gap between their professed values and how
their lobbyists operate. A man who is possibly carrying the Ebola virus is being quarantined in a
NY hospital. Hopefully, the CDCs recent mishandling of Small Pox and Anthrax samples is not
representative of the governments overall competencies.
Markets recently have had a perverse reaction to economic data. Equity markets seem to fall
on strong data and rally on weak data. In such, it seems fair to conclude that Fed
accommodation continues to trump economic fundamentals. Therefore, it may be fair to
conclude that a tepidly growing economy is likely best for risk assets. At the moment, this
might be consistent with the Feds forecasts of modest improvement that will allow the FOMC to
withdraw accommodation gradually and methodically. However, the odds of such a convenient
outcome are small.
Market volatility is highly likely to rise, because the FOMCs future path will likely deviate
from current forward pricing. There is a wide range of economic projections amongst market
participants who will be forced to reassess and shift positions as data unfolds. Fortunately for the
Fed, after QE ends in October, the FOMC will have greater flexibility.
However, the Fed will have difficulties controlling market gyrations and its potential loss of
credibility from troubles that are likely to arise from its exit strategy. If the economy strengthens,
markets will be forced to price in a more aggressive Fed as consensus builds that it is behind the
curve. If data weakens, the market will worry that the Fed has no ammunition; and regardless,
markets would question QEs effectiveness. Neither outcome is good for equities or credit, but
long-dated Treasury Bonds would benefit. I maintain my prediction of a sub 3% 30 year by year
end.
Long distance runner, what you holdin out for? Grateful Dead
FOMC Speeches





Key Events
RBA Aug 5
ECB Aug 7
BOE Aug 7
BoJ Aug 8
J ackson Hole Aug 29
FOMC Sep 17

www.gbm.scotiabank.com

TM
Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with "Global Banking and
Markets", is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova
Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc.


Disclaimer

This publication has been prepared for Major U.S. Institutional Investors by Fixed Income Strategists of the Bank of Nova Scotia, New York
Agency. (BNS/NYA). BNS/NYA Fixed Income Strategists are employees of Scotiabanks Fixed Income Credit Sales & Trading Desk and
support the trading desk through the preparation of market commentary, including specific trading ideas, and other materials, both written and
verbal, which may or may not be made publicly available, and which may or may not be made publicly available at the same time it is made
available to the Fixed Income Credit Sales & Trading Desk. Fixed Income Strategists are not research analysts, and this report was not reviewed
by the Research Departments of Scotiabank. Fixed Income Strategist publications are not research reports and the views expressed by Fixed
Income Strategists in this and other reports may differ fromthe views expressed by other departments, including the Research Department, of
Scotiabank. The securities laws and regulations, and the policies of Scotiabank that are applicable to Research Analysts may not be applicable to
Fixed Income Strategists.

This publication is provided to you for informational purposes only. Prices shown in this publication are indicative and Scotiabank is not offering
to buy or sell, or soliciting offers to buy or sell any financial instrument. Scotiabank may engage in transactions in a manner inconsistent with the
views discussed herein. Scotiabank may have positions, or be in the process of acquiring or disposing of positions, referred to in this publication.
Other than the disclosures related to Scotiabank, the information contained in this publication has been obtained fromsources that Scotiabank
knows to be reliable, however we do not represent or warrant that such information is accurate and complete. The views expressed herein are the
views of the Fixed Income Strategists of Scotiabank and are subject to change, and Scotiabank has no obligation to update its opinions or
information in this publication. Scotiabank and any of its officers, directors and employees, including any persons involved in the preparation or
issuance of this document, may fromtime to time act as managers, co-managers or underwriters of a public offering or act as principals or agents,
deal in, own or act as market-makers or advisors, brokers or commercial and/or investment bankers in relation to the securities or related
derivatives which are the subject of this publication.

Neither Scotiabank nor any of its officers, directors, partners, or employees accepts any liability for any direct or consequential loss arising from
this publication or its contents. The securities discussed in this publication may not be suitable for all investors. Scotiabank recommends that
investors independently evaluate each issuer and security discussed in this publication, and consult with any advisors they deemnecessary prior
to making any investment.