GSAM Powerpoint

23/07/2014
GLOBAL
SOVEREIGN
ASSET
MANAGEMENT
Sebastien Galy (212) 278 7644

sebastien.galy@sgcib.com
Important Notice: The circumstances in which this publication has been produced are such that it is not appropriate to characterise it as independent
investment research as referred to in MiFID and that it should be treated as a marketing communication even if it contains a research recommendation. This
publication is also not subject to any prohibition on dealing ahead of the dissemination of investment research. However, SG is required to have policies to
manage the conflicts which may arise in the production of its research, including preventing dealing ahead of investment research.
This document is being provided for the exclusive use of SEBASTIEN GALY (SGCIB)
ONE GLOBAL RATE SET BY THE FED
1. Japanification light is spreading

The adjustment in global imbalances is happening mainly via domestic prices and particularly mature and overly
expensive sectors vs more dynamic ones (e.g. conceptually Ketchup vs Ipad). This has political consequences
down the road.
Reserve managers extend Fed policy along the UST curve, EU sovrereign curve and increasingly into Asia and
commodity currencies.
The easy part of EM growth is behind us.
Fed policy impacts a broad USD world with side effects on the EUR et al via reserve diversification.
2. Longer Deposits (liquidity portfolios)

Mostly deposits with commercial banks (USD1.2trn) as well as Treasuries. Very heavy concentration with a few
very safe names creates unique risks. Extend duration to better match bank needs and diversify across
counterparties.
3. Longer Duration (Asset management portfolios)

Duration 2.6 years going for 3 years, likely more in the EU than US.
Buy and Hold accounting matters is sensical, but doesnt fit with IMF statistical requirements.
4. Diversification is spreading
Heavily into EUR. The pressure differs between commodity producers (commodity/equities..), other EM reserves
and advanced economies.
Diversification across assets as supply of high quality assets is limited.
23/07/2014 2
1. JAPANIFICATION OF A CLOSED SYSTEM
ADJUSTMENT VIA INTERNAL PRICES IN A CLOSED SYSTEM
Eurozone commodities
A
U
S
S
I
A
A
Quasi Fixed FX
23/07/2014 4
GDP AS A FUNCTION OF CAPITAL AND LABOUR IN A STATIC WORLD
GDP
level
Developed market
style lower growth
potential
EM style
rapid growth
Capital or Labour
for a constant level of
technology and
demography
23/07/2014 5
SOUND EM COUNTRIES SEE ABOUT TWO TO THREE DECADES OF EXPLOSIVE
GROWTH
12%
2%
10%
8%
6%
1%
4%
2%
0% 0%
1960 1970 1980 1990 2000 2010 2020
China vs World GDP in USD lhs

Korea vs World GDP in USD (16 years ago) rhs
Singapore vs World GDP in USD (16 years ago x5.52) rhs
23/07/2014 6
G10 Fixed Income Custodial and Client Lending, Repo,
10-30years Asset Mgt/Deposit Collateral mgt
Asset
7-years US Credit 1-3Y
Mgt EM Fixed Income Gold Domestic
5-7years Assets
Duration
3-5years 3-5years
Equities
1-3years 1-3years 1-3years
USD EUR Externally CNY KRW FX

managed
Interventions,
rebalancing,
Liquidity USD: Treasuries, Bank and CB EUR: Treasuries, Bank and CB TAA, dividends,
employee pay,
Portfolio depots, CP depots, CP FX execution
for gvt,
Nostros: Nostros: commodity
FX Commodity Principal, Rebalancing for FX baskets post Principal, producer, repo,
interventions Cash Flows Coupons USD interventions (RUB, SDR) Coupons gold lending,
collateral mgt..
Cost of running
Liabilities Domestic Liabilities: Sterilization Domestic Liabilities:
operation and
Forecasting of expected FX interventions
pension fund Domestic policy
23/07/2014 7
Asset
Mgt EM Fixed Income Gold Dome
5-7years Asse
Duration
3-5years 3-5years
Equities
USD
2. EUR
LONGER
ExternallyDEPOSITS
CNY KRW FX
managed
Intervention
rebalancing,
Liquidity USD: Treasuries, Bank and CB EUR: Treasuries, Bank and CB TAA, dividen
employee p
Portfolio depots, CP depots, CP FX execut
for g
Nostros: Nostros: commodity
FX Commodity Principal, Rebalancing for FX baskets post Principal, producer, re
interventions Cash Flows Coupons USD interventions (RUB, SDR) Coupons gold lendi
collateral mg
Cost of running
Liabilities Domestic Liabilities: Sterilization Domestic Liabilities:
operation and
Forecasting of expected FX interventions
pension fund Domestic policy
LIQUIDITY PORTFOLIO GROWS TO COVER FOR RISING IMPORTS IN USDTRN
0
1983 1986 1989 1992 1995 1998 2000 2003 2006 2009 2012
Liabilities of banks and BIS to officials trn USD
Global Allocated Reserves trn USD (rhs) ex Japan, SAFE
Global Exports trn USD (rhs)
23/07/2014 9
LIQUIDITY PORTFOLIO (USD BN)
Liquidity Portfolio, bn USD 1,992

As % of total EM reserves 25%
1. Commercial Deposits (BIS banking), bn USD 1,150
2. Others 842
UST Bills (official UST number) bn USD 364
via auctions (auction history for foreigners) 250
via intermediaries 114
As % of all outstanding US Treasuries 26%
Bonds maturing from Buy and Hold AM reserves, bn USD 341
Duration of EM AM reserves 2.60
Other G10 et al Treasuries, bn USD 136
23/07/2014 10
RESERVE DEPOSITS WITH BANKS ARE USD1.2TRN
180% 1.80
1.60
1.40
1.20
1.00
120%
0.80
0.60
0.40
0.20
60% -
1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2006 2008 2010 2012
Ratio of Deposits/Global Exports
Deposits of central banks with commercial banks (trn USD)
23/07/2014 11
DURATION OF THE BIS MONEY MARKET LIABILITIES
100% 7.0
6.0
75%
5.0
50%
4.0
25%
3.0
0% 2.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Treasuries (FIXBIS 1w to 1Y) Fixed Term Deposits 3M to 1Y
Dual Currency Deposits up to 1Y Sight deposits (up to 3d)
Duration MM portfolio in months (rhs)
23/07/2014 12
FOREIGN AND INTERNATIONAL HOLDER OUTSTANDING AMOUNTS FROM BILL
AUCTIONS DURATION INCREASES
400 7.40
350 7.20
300
7.00
250
6.80
200
6.60
150
6.40
100
50 6.20
- 6.00
01/2010 07/2010 01/2011 07/2011 01/2012 07/2012 01/2013 07/2013 01/2014
4-Week Bill 13-Week Bill 26-Week Bill
52-Week Bill Duration in Months (rhs)
23/07/2014 13
3. LONGER DURATION

Asset
Mgt EM Fixed Income Gold Dome
5-7years Asse
Duration
3-5years 3-5years
Equities
USD EUR Externally CNY KRW FX

managed
Intervention
rebalancing
Liquidity USD: Treasuries, Bank and CB EUR: Treasuries, Bank and CB
TAA, dividen
TOTAL ALLOCATED FOREIGN RESERVES IN USDTRN
0
1999 2001 2003 2005 2007 2009 2011 2013
Unexplained (interventions, SAA, error)
FX Effect
IR Valuation Effect
IR Accrual
23/07/2014 15
MAIN CONSIDERATIONS IN DETERMINING THE TARGET DURATION FOR THE
RESERVES PORTFOLIO
23/07/2014 16
CENTRAL BANK DURATION HAS BEEN STEADILY INCREASING BASED ON BIS
LIABILITIES
100% 4.00
75% 3.50
50% 3.00
25% 2.50
0% 2.00
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Bonds (MTI 1 to 10Y) Callable Bonds (CMTI - 1 to 10Y)
FRIBIS (1Y and above) Treasuries (FIXBIS 1w to 1Y)
Fixed Term Deposits 3M to 1Y Dual Currency Deposits up to 1Y
Sight deposits (up to 3d) Duration (rhs in years)
23/07/2014 17
SPLIT OF USD INVESTMENTS BY INSTRUMENT
USDbn
Total Foreign Reserves (bn USD) 7,448
including SWF 9,154
Split Maximum Minimum
Supranationals and Agencies (Reserves) 3,118 1,242
1. US Agencies 2,721 447
Agencies in Fed custody 292 292
Agencies ex Fed custody 2,429 155
in % of outstanding US agencies 66% 11%
2. Supranationals and Agencies ex US 397 795
in % of outstanding Supras . 50% 100%
TIPS 75 299
in % of outstanding TIPS 8% 32%
USD Sovereigns ex USA 9 91
UST holdings (Reserves) 5,961 7,613
UST holdings of Foreigners (Treasury) 5,961 5,961
in Fed custody 2,975 2,975
ex Fed custody 2,986 4,638
Unexplained reallocated 2,429 155
Note: Holdings of UST by US funds 1,195
Note: Holdings of UST by Banks 457
Note: Fed/Soma holdings of Agencies 44
Note: Fed/Soma holdings of AMBS 1,664
Supranational/Agency Debt ex US in USD 795
Sovereign issuance in USD ex USA, A- and above 91
US Agencies USDbn
Total Agencies 4,116
- Agencies held by the Fed/SOMA 1,708
Agencies available to the market 2,409
23/07/2014 18
1. DIVERSIFICATION IS SPREADING
INVESCO SURVEY OF RESERVE MANAGERS, SWF AND SOES
23/07/2014 20
EM / COMMODITY PRODUCER DIVERSIFICATION
NZD CNY
AUD 2% 1%
12%
CAD
2%
GBP
5%
JPY
11%
EUR
67%
23/07/2014 21
FX ALLOCATION STRATEGY
Chart 1. Month-end impact of central bank diversification
111 100
90
109
80
70
107
60
105 50
40
103
30
20
101
10
99 -
1/3/2000 1/3/2002 1/3/2004 1/3/2006 1/3/2008 1/3/2010 1/3/2012 1/3/2014
Veurostox (rhs) Index of rebalancing (lhs)
Source: SG Cross Asset Research Note: At the end of the month, reserves need to be rebalanced in FX and Fixed Income. Based on this simple
trading rule we assumed that the basket would be rebalanced as long as the Eurostoxx VIX was below 20, i.e. in a normal regime of risk. As has
been emphasized by key risk managers, diversification and risk management are the key questions for risk management. Going forward, net EUR
demand is likely to shrink significantly given negative interest rates.
23/07/2014 22
CUMULATIVE FX INTERVENTIONS IN USDTRN, ALLOCATED RESERVES
2.50
2.00
1.50
1.00
0.50
-
1999 2003 2007 2011
(0.50)
USD EUR GBP JPY CHF Others
23/07/2014 23
ANNEX
ARBITRAGE BETWEEN ON AND OFFSHORE
Chart 21. Chinese Firm exporting Chart 22. Exporters cash profit cheaply finances the reserves
PBOC/SAFE
Liabilities
Asset Sterilization debt Interest
Foreign Reserves Required
Reserves
3.1(1-20%)bn Bank
PBoC intervenes in USD/CNY
Asset
Liabilities
Loan
Bank RRR
3.1bn Interest
Asset Liabilities Reserve
6.2bn CNY Interest
Deposit
Exports 1mn IPADS
PBOC/SAFE
Receives 1bnUSD
1bn x6.2USD/CNY Reserve
Asset Requirement
20%3.1bn
1bnUSD
Bank Bank
Source: SG Cross Asset Research/Forex
23/07/2014 25
Foreign Reserves USD EUR JPY GBP CAD AUD NZD CHF NOK SEK DKK CNY KRW MYR THB SGD BRL MXN CLP COP INR IDR ZAR RUB SDR OthersTotal
Com m odity 13.3% 4.7% 0.6% 0.8% 0.3% 0.2% 0.0% 0.0% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 20%
im plied USD diversification 70.1% 8.6% 11.2% 4.7% 2.6% 0.1% 0.4% 0.8% 0.2% 0.3% 0.1% 0.0% 0.1% 0.1% 0.3% 0.5%
in bn USD 1,585 566 69.2 90.8 37.7 21.1 0.7 3.0 6.6 1.7 2.2 0.9 0.2 0.5 0.9 2.2 3.7 2,392
Algeria 53% 37% 10% 100%
Botswana 30% 37% 9% 11% 12% 100%
Brazil 77% 5% 2% 3% 6% 3% 2% 0% 99%
Chile 48% 22% 3% 2% 9% 6% 2% 2% 2% 2% 1% 100%
Colom bia 85% 12% 3% 100%
Mexico 80% 20% 100%
Nigeria 85% 6% 2% 2% 5% 100%
Norway 35% 31% 10% 7% 4% 4% 1% 0% 0% 7% 100%
Russia (Basket) 46% 40% 9% 1% 3% 1% 100%
Brunei (SGD peg) 60% 20% 5% 5% 2% 1% 2% 5% 100%
Libya (SDR peg) 42% 37% 9% 11% 100%
Angola (USD quasi peg) 80% 20% 0% 0% 100%
Bahrain (USD quasi peg) 60% 40% 100%
Kuwait (USD quasi peg) 75% 25% 100%
Om an (USD quasi peg) 80% 20% 100%
Qatar (USD quasi peg) 79% 20% 1% 100%
Saudi Arabia (USD quasi peg) 75% 20% 5% 100%
Venezuela (USD jum ping peg) 90% 10% 100%
Pegs or quasi pegs USD 5.4% 1.4% 0.1% 0.2% 0.1% 0.5% 0.1% 7.8%
im plied USD diversification 59.9% 4.9% 6.4% 4.5% 20.3% 4.1%
in bn USD 647 172 14 18 13 58 12 935
Azerbaijan 100% 100%
Baham as 100% 100%
Bolivia 100% 100%
Costa Rica 80% 20% 100%
Egypt 85% 10% 5% 100%
Ecuador 90% 10% 100%
Guatem ala 94% 6% 100%
Ghana 90% 10% 100%
Hong Kong 67% 20% 4% 4% 4% 5% 4% 107%
Jam aica 100% 100%
Jordan (SDR peg) 42% 37% 9% 11% 100%
Myanm ar 100% 100%
Taiwan 70% 20% 10% 100%
Tajikistan 90% 10% 100%
UAE 75% 20% 5% 100%
Ukraine 90% 10% 100%
Vietnam 90% 5% 5% 100%
Floating 12.9% 5.1% 0.8% 1.2% 0.3% 0.4% 0.1% 0.0% 0.0% 0.1% 0.0% 21.1%
in bn USD 1,536 606 98 146 42 45 14 5 5 17 5 2,518
Australia 55% 35% 5% 5% 100%
Bulgaria 10% 90% 100%
Canada 67% 33% 1% 100%
Czech 27% 66% 3% 4% 5% 105%
Japan 87% 7% 5% 1% 100%
New Zealand 25% 25% 25% 15% 10% 100%
Sweden 8% 51% 10% 7% 11% 13% 100%
Switzerland 27% 48% 9% 7% 4% 1% 1% 1% 1% 1% 100%
UK 40% 40% 20% 100%
USA 55% 45% 100%
Poland 36% 32% 15% 10% 7% 100%
Rom ania 25% 75% 100%
Hungary 25% 75% 100%
EU - Austria 55% 20% 10% 15% 100%
EU - Belgium 55% 20% 10% 15% 100%
EU - Cyrpus 55% 20% 10% 15% 100%
EU - ECB 82% 18% 100%
EU - Estonia 55% 20% 10% 15% 100%
EU - Finland 91% 5% 4% 100%
EU - France 55% 20% 10% 15% 100%
EU - Germ any 91% 5% 4% 100%
EU - Greece 82% 18% 100%
EU - Ireland 55% 20% 10% 15% 100%
EU - Italy 55% 20% 10% 15% 100%
EU - Latvia 55% 20% 10% 15% 100%
EU - Luxem bourg 55% 20% 10% 15% 100%
EU - Malta 55% 20% 10% 15% 100%
EU - Netherlands 55% 20% 10% 15% 100%
EU - Slovakia 55% 20% 10% 15% 100%
EU - Slovenia 55% 20% 10% 15% 100%
EU - Spain 55% 20% 10% 15% 100%
EU - Portugal 55% 20% 10% 15% 100%
Pegs or quasi pegs EUR 0.1% 1.0% 0.0% 0.0% 0.0% 1.2%
im plied EUR diversification 5.8% 3.0% 3.0% 3.0%
in bn USD 8 123 4 4 4 143
BEAC - Cam eroon 100% 100%
BEAC - Central Africa 100% 100%
BCEAO - Benin 100% 100%
BCEAO - Burkina Faso 100% 100%
BCEAO - Senegal 100% 100%
BCEAO - Niger 100% 100%
BCEAO - Ivory Coast 100% 100%
Burundi 100% 100%
Croatia 100% 100%
Denm ark 5% 80% 5% 5% 5% 100%
Lithuania 100% 100%
Serbia 25% 75% 100%
Managed Currency 31.1% 11.7% 2.2% 0.5% 2.3% 0.7% 0.0% 0.0% 48.4%
im plied USD diversification 67.4% 12.4% 2.9% 13.2% 3.8% 0.0% 0.2%
in bn USD 3,711 1,396 257 61 273 79 0 3 5,780
Argentina 90% 10% 100%
Belarus (RUB peg) 42% 37% 9% 11% 100%
China 64% 24% 5% 5% 2% 100%
Georgia 100% 100%
Honduras 90% 10% 100%
Iceland 25% 75% 1% 101%
India
Indonesia
60%
75%
20%
20%
5%
5%
10% 5% 23/07/2014 100%
100%
26
Israel 75% 20% 5% 100%
Kazakhstan
Kenya
100%
75%
25%
100%
100%
SWF
Country Reserves SWF Total SWF bn USD SWF bn USD SWF bn USD SWF bn USD SWF bn USD
Nat Social Security China Africa Dev
China 1,000 2,948 3,948 CIC 575 SAFE (incl ICPRC) 425 Fund 161 Fund 5
Saudi Arabia 730 13 743 SAMA 738 Public Invst Fund 5
Reserve Fund, of which the IMF share is Russia Direct
Russia 383 87 470 8.8bn. 87 FX reserves 383 Investment Fund 13
Brazil 357 5 362 SWF 5
South Korea 341 57 398 KIC 57
HK 317 327 643 HKMA Invest Portfolio 327
Singapore 270 444 714 GIC 435 Temasek 173 MAS is the CB 270
National Investment Fund
(Fonds national
Algeria 193 95 289 Fund for the Regulation of Receipts 77 d'investissement) 18
Mexico 177 6 183 Oil revenues stab fund 6
Malaysia 127 47 174 Khazana Nasional 47
Libya 112 65 177 Libya Investment Authority 65
Peru 62 7 70 Fiscal stab fund 7 Muvadala
International Development Emirates
Investment Corporation of Petroleum Investment Company (Abu Investment
UAE 67 828 895 ADIA 627 Dubai 70 Company (Abu Dhabi) 65.3 Dhabi) 55.5 Authority 10
Canada 64 16 80 Alberta Heritage Fund 16
Norway 59 818 877 NGIM 818
Australia 47 89 136 Australian Future Fund 89
Chile 39 22 61 Social and Economic stab fund 15 Chile pension fund 7
Qatar 39 170 209 QIA 170
Angola 32 5 37 Fundo soberano de Angola 5
Italy 36 6 42 Italian Strategic Fund 6
Kuwait 33 386 419 KIA 386
France 30 26 56 Strategic Investment Fund 26
Botswana 8 7 15 Pula Fund 7
Fondo de Invesion para la Esabilisacion
Venezuela 6 16 22 Macroeconomica 16
Ireland 0 19 19 National Pensions Reserve Fund 19
Brunei 3 90 93 Brunei Investment Agency 90
Iraq 62 18 80 Development Fund for Iraq 18
Bahrain 5 7 12 Mumtalakat holding company 7
Naational Investment
Kazakhstan 22 166 188 Samruk-Kazyana JSC 78 Kazhakhstan National Fund 69 Corporation 20
New Zealand 16 19 36 NZ Superannuation Fund 19
Oman 18 14 32 State General Reserve Fund 8 Oman Investment Fund 6
Azerbaijan 16 34 50 State Oil Fund 34
TOTAL 4,673 6,857 11,531
TOTAL accord SWF inst 5780
23/07/2014 27
IMF DATA STANDARDS
23/07/2014 28
23/07/2014
SOVEREIGN DEMAND
AND US RATES
Bruno Braizinha (212) 278 5296

bruno.braizhinha@sgcib.com
Important Notice: The circumstances in which this publication has been produced are such that it is not appropriate to characterise it as independent
investment research as referred to in MiFID and that it should be treated as a marketing communication even if it contains a research recommendation. This
publication is also not subject to any prohibition on dealing ahead of the dissemination of investment research. However, SG is required to have policies to
manage the conflicts which may arise in the production of its research, including preventing dealing ahead of investment research.
CORE VIEWS
The Federal reserve was still the largest marginal buyer of Treasuries in Q1
2014, and the second largest holder of Treasury securities outright after
foreign holders.
With QE expected to end in October, we expect supply and demand to
progressively play a more significant role in the US rates dynamic in H2
Generally higher yields are expected to come incremental marginal
demand, and regulation is also playing a role.
Whether the expected pick-up in demand is enough to fill the role of the Fed
and avoid supply and demand imbalances, the answer is not clear at this
point
and it is strongly contingent on sovereign demand
foreign official accounts diversification efforts should offset at least partially the
trend increase in foreign reserves
We are biased towards...probably not, and that is reflected in our bearish
view for rates
23/07/2014 30
HOLDERS OF TREASURIES
Total debt held by different investor groups

The total public debt of the U.S.
Mutual funds, US banks & Insurance cos, Broker/dealers, government in June 2014 was $17.6
close-end and credit unions, 2% 1% trillion (103.5 % of GDP), of which $12.6
ETFs, 6% 3%
trillion (74.1% of GDP) was held by the
Money market public and $5.1 trillion by the
mutual funds,
4%
government, such as the social security
State and local
trust fund
govts, 5% http://www.treasurydirect.gov/govt/reports/pd/mspd/2014/opds062014.pdf
Almost 50% of the public debt is held by

Households, 7%
Rest of the
the Rest of the world ($6.0 trillion),
world, 48% most of it in the hands of Foreign
Private & govt Official institutions ($4.1 trillion).
pension funds, http://www.treasury.gov/ticdata/Publish/mfh.txt
6%
Fed, 19% The Fed holds $2.4 trillion of US
treasury securities, which together with
foreign official institutions makes up for
more than 50% of the total held by
official accounts.
http://www.federalreserve.gov/releases/h41/current/
23/07/2014 31
HOLDERS OF TREASURIES
Non-utilitarian investors Foreign Investors
Other Rest of
the World,
15%
China, Mainland,
Foreign
OTHER, 19% 19%
Official, 33%
Ireland, 2%
Other, 33% Russia, 2%
Luxembourg, 2%
Fed, 19% Japan, 19%
Hong Kong, 2%
Switzerland, 3%
Taiwan, 3%
United Kingdom,
3%
Brazil, 4%
Oil Exporters, 4% Belgium, 6%
Carib Bkg Ctrs,
5%
23/07/2014 32
TREASURY SUPPLY
Budget deficits (% of GDP)
The last couple of years have been
marked by a significant shrinkage of
budget deficits, from 7% of GDP in
2012 to 4% in 2013 and just below 3%
projected for 2014.
When putting the expected reduction
of net supply into the context of the
tapering process, we find that there is
an expected contraction of supply
Treasury issuance net of Fed buying net of Fed purchases in fiscal year
2014 versus fiscal year 2013, but this
is followed by an expansion in
subsequent years
23/07/2014 33
TREASURY DEMAND
14,000
Broker/dealers Insurance cos
US banks & credit unions Mutual funds, close-end and ETFs
Money market mutual funds State and local govts 12,000
Private & govt pension funds Households
Federal Reserve Rest of the world
10,000
8,000
6,000
4,000
2,000
0
Q1-09
Q2-09
Q3-09
Q4-09
Q1-10
Q2-10
Q3-10
Q4-10
Q1-11
Q2-11
Q3-11
Q4-11
Q1-12
Q2-12
Q3-12
Q4-12
Q1-13
Q2-13
Q3-13
Q4-13
Q1-14
The Federal Reserve is the second-largest holder of Treasury securities outright
after foreign holders, and was still the largest marginal buyer in Q1 2014
http://www.federalreserve.gov/releases/z1/current/z1.pdf
23/07/2014 34
TREASURY DEMAND
2,500
10yT yield ~ 3.5%
2,000
1,500
1,000
500
-500
Broker/dealers Insurance cos -1,000

US banks & credit unions Mutual funds, close-end and ETFs
Money market mutual funds State and local govts -1,500
Private & govt pension funds Households
Federal Reserve Rest of the world
-2,000
Q1-09
Q2-09
Q3-09
Q4-09
Q1-10
Q2-10
Q3-10
Q4-10
Q1-11
Q2-11
Q3-11
Q4-11
Q1-12
Q2-12
Q3-12
Q4-12
Q1-13
Q2-13
Q3-13
Q4-13
Q1-14
The rest of the world was both the largest holder and the largest marginal buyer of
Treasuries prior to the Feds massive LSAP interventions.
23/07/2014 35
AFTER QE3...
The asset purchase program is expected to terminate in October

Although, beyond October, the Fed will continue to reinvest SOMA matured
proceeds (not interest payments) to maintain balance sheet neutrality up until at
least the timing
the total for re-investment in 2015 is rather insignificant (of the order of a few
billion) as the short maturity bucket was mostly disposed off during twist.
Maturing bonds in the SOMA portfolio pick up beyond 2016, but by that time the
Fed is expected to start fading the reinvestments to effectively reduce balance
sheet
So. Who will be the new marginal buyers of Treasuries?
23/07/2014 36
AFTER QE3...
Pension funds
The recent rally in equities has resulted in the highest level of funded liabilities since
2008, and this may result in a rotation from equities into bonds, to better match liabilities
and reduce the risk of deficits.
Also, the Budget Act of 2013 increased the incentive to de-risk by increasing the fixed
and variable portions of the PBGC premium for plan years beginning in 2015.
The purchases in this investor group are expected to be concentrated in the back end of
the curve, and to provide some price support there.
We saw little evidence of a step-up in marginal buying in Q1, with purchases below
average.
US banks
As tighter regulation most notably the liquidity coverage ratio (LCR) pushed these
institutions to increase their holdings of so-called HQLA by up to $200bn by 2017.
Recently released data show that these institutions increased their holdings of Treasuries
by 23% during Q1, the largest expansion since the financial crisis, with their ownership of
Treasuries at the highest level since 1997.
This purchases are expected to be concentrated in the front-end of the curve to avoid
taking duration risk in a regulatory buffer, and should not contribute significantly to price
support at the back end of the curve
23/07/2014 37
AFTER QE3...
Generally
Higher yields are expected to contribute to some incremental marginal demand for
Treasuries from households, mutual funds (we see that clearly in Q1 data), and most of the
other investor groups that have reached for yields in other asset classes
However, this demand is likely to be slow to return and it may take yields on the 10yT
above 3.5% before these investors get lured from other asset classes
Also, with US yields significantly higher than those for core EU countries, Switzerland
and Japan, it is not surprising that we continue to find interest in Treasuries
And then there is the Rest of the World
We have at least $40 billions / month of Fed purchases that new to find to find a new
investor group
The rest of the word (particularly official accounts) are a strong candidate for a significant
portion of this reallocation
say 50%, or roughly $240 billion per year, of the order of 5% of the foreign official
holdings
to put this into context the Rest of the World holdings increased 4.2% last year, with the
last 5 years averaging an annual increase of roughly 11% (albeit in a Fed trade
environment)
However, this happens in a context of diversification of reserves
23/07/2014 38
AFTER QE3... RESERVES AND DIVERSIFICATION
Roughly $13 trillion of reserves, Foreign Exchange Reserves

with a further $6 trillion in SWF
Top holders are China and Japan
Roughly $6 trillion in reserves are
unallocated (mostly China and
Taiwan)
OTHER, 24%
If currency composition for People's Republic of
allocated and unallocated reserves China , 31%
is similar, we expect the USD Thailand , 1%
allocation to be roughly 60-65% Mexico , 1%
(the remaining is expected to be Algeria , 1%
mostly in EUR), this corresponds to Germany , 2%
roughly $8 trillion in USD reserves Singapore , 2%
Japan , 10%
or $11 trillion when we include SWF India , 2%
If 70% if dollar reserves are held in Hong Kong , 2%
treasuries, and 40% for SWFs, we Republic of Korea ,
obtain total Treasury holdings of $7 3% Brazil , 3%
Saudi Arabia , 6%
trillion Taiwan , 3%
Russia , 4% Switzerland , 4%
23/07/2014 39
AFTER QE3... RESERVES AND DIVERSIFICATION
Changing the currency composition to 55-60% USD implies a change in

Treasury holdings of roughly $600 billion
We dont expect this to happen instantaneously, but lets say this happens over
a period of a couple of years. In this case this would correspond to a reduction
of up to $25 billion / month in treasury demand
However, even if this happens, it is expected to happen in a context of
increasing foreign reserves which have averaged 6% annual increase over
the last 3 years. Assuming the same rate that corresponds to a pickup of $30
billion / month
Overall, the increase of reserves at the recent pace should offset the
diversification effect
23/07/2014 40
RECENT OBSERVATIONS
May TIC data shows strong demand for treasuries from foreign investors
Custodian bias affects the reading of the data, overestimating the holdings of
large financial centers at the expense of the actual investors
This may partly explain why we see a recent decline in coupon Treasuries from
China while in the same period its foreign reserves have grown significantly
Evidence from recent auction statistics also point to increase in duration of
foreign purchases
23/07/2014 41
CORE VIEWS
The Federal reserve was still the largest marginal buyer of Treasuries in Q1
2014, and the second largest holder of Treasury securities outright after
foreign holders.
With QE expected to end in October, we expect supply and demand to
progressively play a more significant role in the US rates dynamic in H2
Generally higher yields are expected to come incremental marginal
demand, and regulation is also playing a role.
Whether the expected pick-up in demand is enough to fill the role of the Fed
and avoid supply and demand imbalances, the answer is not clear at this
point
and it is strongly contingent on sovereign demand
foreign official accounts diversification efforts should offset at least partially the
trend increase in foreign reserves
We are biased towards...probably not, and that is reflected in our bearish
view for rates
23/07/2014 42
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SG LEADER IN GLOBAL CROSS ASSET RESEARCH
Macro & Strategy Fixed Income
2013 2013
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* Euromoney - Primary Debt Poll

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23/07/2014

Sebastien Galy (212) 278 7644

1. Japanification light is spreading

2. Longer Deposits (liquidity portfolios)

3. Longer Duration (Asset management portfolios)

China vs World GDP in USD lhs

USD EUR Externally CNY KRW FX

Liquidity Portfolio, bn USD 1,992

G10 Fixed Income Custodial and Client Lending, Repo,

USD EUR Externally CNY KRW FX

Chart 1. Month-end impact of central bank diversification

Veurostox (rhs) Index of rebalancing (lhs)

Source: SG Cross Asset Research/Forex

Bruno Braizinha (212) 278 5296

Total debt held by different investor groups

Almost 50% of the public debt is held by

Non-utilitarian investors Foreign Investors

Broker/dealers Insurance cos -1,000

The asset purchase program is expected to terminate in October

So. Who will be the new marginal buyers of Treasuries?

Roughly $13 trillion of reserves, Foreign Exchange Reserves

Changing the currency composition to 55-60% USD implies a change in

Macro & Strategy Fixed Income

* Euromoney - Primary Debt Poll

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