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2011 SECURITIES LENDING OUTLOOK

February 8, 2011
Host Paul Wilson International Head of Client Management and Sales, Financing and Markets Products, J.P. Morgan Featured Guest Speaker David Mackie Head of Western European Economic Research, J.P. Morgan Speakers John Shellard Global Head Equities Lending, J.P. Morgan Robert Taub U.S. Fixed Income Desk Manager, J.P. Morgan Matthew Sarson Trading Manager, Securities Lending Investment Desk, J.P. Morgan

THE OUTLOOK FOR THE GLOBAL ECONOMY

David Mackie Head of Western European Economic Research

Overview of global economy in 2011

2011 should be a solid year for global growth, with good performance everywhere except the Euro area periphery.

Divergent inflation pressure at the core level: upward in EM, steady to down in G3. Divergent central banks: modest tightening in EM, no tightening in the G3.

THE OUTLOOK FOR THE GLOBAL ECONOMY

In the first year of recovery, in terms of growth the world was divided into:

Those that have baggage (the need to repair household, bank and public sector balance sheets): U.S., U.K., Euro area periphery.

Those that dont have baggage: EM, Germany, Scandinavia, Switzerland, Japan

GDP growth 2Q09 3Q10


%q/q, saar U.S.
THE OUTLOOK FOR THE GLOBAL ECONOMY

2.9 1.9 0.0 7.3 3.7 5.4 3.0 3.7

U.K. Spain EM Germany Sweden Switzerland Japan

Key themes for global growth in 2011


Ongoing strength in those economies without baggage. A change in the household deleveraging process eases the drag in economies with baggage.

Non-financial corporates provide the engine for growth even in economies with baggage: boosting demand directly and generating income for households.

Monetary policy easy everywhere and the traction builds over time; mild fiscal tightening in Western Europe; US policymakers go all in.

THE OUTLOOK FOR THE GLOBAL ECONOMY

Ongoing growth in economies without baggage


Euro area domestic final sales
101

100

99

Germany
98

97
THE OUTLOOK FOR THE GLOBAL ECONOMY

96

Euro area ex. Germany

95 2008 2009 2010

*1Q08 = 100

The household deleveraging process: the flow adjustment is complete, the stock adjustment is ongoing
U.S. household saving and the stock of debt outstanding
8

% of GDP

% of GDP

100

Financial position

Debt
90

80

70

0
THE OUTLOOK FOR THE GLOBAL ECONOMY

60

-2

50

-4 80 85 90 95 00 05 10

40

In general, nonfinancial corporates do not have any baggage: not only is corporate spending at a low level, but cashflow is very elevated
U.K. business investment share in GDP
16

U.K. private non financial corporations net lending


6 5 4

14

3 2 1

12

0 -1 -2

THE OUTLOOK FOR THE GLOBAL ECONOMY

10

-3 -4 -5

*8
65 70 75 80 85 90 95 00 05 10

* -6
87 92 97 02 07

* Nominal share, %

* % of GDP, positive indicates net lending

Divergent resource utilization drives divergent core inflation outlook


Resource utilization
3

Global core inflation


6

EM
5

EM

DM excl US
1 4

-1

2
THE OUTLOOK FOR THE GLOBAL ECONOMY

Global
-3 1

DM

US * -5
91 93 95 97 99 01 03 05 07 09 11

*0
04 05 06 07 08 09 10 11

* Standard deviations from long-term average

* %oya

To exit the current crisis, the region either needs sovereign debt restructuring or a long period of liquidity support at very low interest rates

Gross debt under alternative interest rate subsidies relative to German borrowing rates
% of GDP 2015 Scenario 1 Esp Grc Ire Prt
THE OUTLOOK FOR THE GLOBAL ECONOMY

2020 Scenario 3 79 142 121 89 Scenario 1 89 184 155 95 Scenario 2 87 153 136 95 Scenario 3 78 125 113 80

Scenario 2 83 151 129 95

84 161 135 95

Note: Scenario 1 assumes borrowing rates are capped at 6% through 2012 but then move to market rates thereafter. Scenario 2 assumes market rates are capped at 350bp above the German borrowing cost from now through 2020. Scenario 3 assumes market rates are capped at 100bp above the German borrowing cost from now through 2020. See "A way out of the EMU fiscal crisis," Global Issues, December 16, 2010.

2011 SECURITIES LENDING OUTLOOK


Speakers John Shellard Global Head Equities Lending, J.P. Morgan Robert Taub U.S. Fixed Income Desk Manager, J.P. Morgan Matthew Sarson Trading Manager, Securities Lending Investment Desk, J.P. Morgan

Securities Lending Equities Q4 Market Environment

Another volatile quarter for equity markets. Uncertain environment contributed to risk aversion amongst investors. Hedge funds still lacking direction and conviction, having taken risk off the table. Year finished with a strong equity market rally in December, especially in the U.S.

Securities lending balances came down in the run up to year end. Demand continued to come from directional and capital raising trades. Sectors in demand included financial, consumer and industrial.

O U T L O O K

Active quarter for yield enhancement trading. Main revenue generating markets were France and Italy, with activity also in Netherlands and Spain.

In general hedge funds had a good year, returning 7-9% on average. However wide variance between strategies and individual funds.

L E N D I N G

2 0 1 1

S E C U R I T I E S

Heavy lobbying from industry on the European Commission short selling regulatory proposals.

Securities Lending Outlook for Equities Q1 2011

Optimistic that 2011 will see an increase in hedge fund activity as they look to put money to work and generate returns for investors. Expect continued strong investment inflows into hedge funds.

Increased M&A activity as cash rich companies look to grow through acquisitions. Expect continued strength in equity markets as EU works towards a more robust solution to the Euro Sovereign debt crisis, and continued improvement in the global economy.

O U T L O O K

However, balances likely to struggle in Q1. Strong equity markets resulting in greater long bias from hedge funds and lack of appetite to go short.

Initial yield enhancement indications are mixed. Tax changes and lower than expected demand, offset by higher dividend payments.

L E N D I N G

Continued discussions with regulators and Governments on the regulatory environment. Continued focus on collateral, both by clients and borrowers.

2 0 1 1

S E C U R I T I E S

The Change to Treasury Supply and the Impact on Treasury Repo Rates

Treasury Issuance

As the budget deficit narrowed, net issuance declined from its 2009 peak. J.P. Morgan is expecting the treasury to issue additional $1.1 trillion Treasuries in CY 2011 as opposed to $1.5trillion in CY2010.

The Debt Ceiling

On 1/27th Treasury announced their plan to decrease the issuance of US treasury bills in the Supplementary Funding Program from $200bn to $5bn. The decrease may lead to

O U T L O O K

downward pressure on repo rates temporarily and lower yields on UST bills and discount notes.

L E N D I N G

The Federal Reserve Banks Large Scale Asset Purchase (LSAP) program, also known as quantitative easing (QE2)

S E C U R I T I E S

At the last FOMC meeting, The Fed announced their commitment to continue to buy back $600bn in treasuries from the market by June 2011.

2 0 1 1

FDIC changes to fee calculations

The Storm Has Passed, But Headwinds Prevail

Challenges remain on the Distribution side of the Securities Lending business


Balance sheet constraints Treasury supply

Short-end Investor demand continues to exceed available supply

Favorable market conditions for issuers


Collateralized Commercial Paper/non-traditional repo balances

Concerns remain around the Euro-zone

Spain/Italy

O U T L O O K

Regulatory impact current market environment


Strong Floater demand Step-up putable structures Collateralized CP

2 0 1 1

S E C U R I T I E S

L E N D I N G

The Storm Has Passed, But Headwinds Prevail

Early rumblings of the Fed Exit plan


Market generally believes no Fed action for 2011 Beginnings of differences in opinion J.P. Morgan believes no Fed move until Q1 2013

Short-end participant behavior-recap

2 0 1 1

S E C U R I T I E S

L E N D I N G

O U T L O O K

THE OUTLOOK FOR THE GLOBAL ECONOMY

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