1

Fixed Income Macro Outlook

Boston FMS Meeting

March, 24th 2015

Jim DeMasi, CFA

Managing Director, Stifel Fixed Income Research and Strategy Group

This research report is intended for institutional investors only . Refer to the last page of this report for Stifel Fixed Income Capital Markets disclosures and analyst

certifications.

Stifel, Nicolaus & Company, Incorporated Member NYSE / SIPC.

2

The Recovery from the Great Recession Remains a Work in Progress

7,000

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

16,000

17,000

Dec-

86Ap

r-88

Aug-

89De

c-90

Apr-

92Au

g-93

Dec-

94Ap

r-96

Aug-

97De

c-98

Apr-

00Au

g-01

Dec-

02Ap

r-04

Aug-

05De

c-06

Apr-

08Au

g-09

Dec-

10Ap

r-12

Aug-

13De

c-14

*Source: Bloomberg L.P. as of 12/31/2014

($ in Billions)Actual vs. Potential Real GDP

20-Year Pre-recession GDP Trendline(Potential GDP)

Actual Real GDP

GDP Output Gap

-3.00

-2.00

-1.00

0.00

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6.00

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-10

Jul-1

0

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10

Mar

-11

Jul-1

1

Nov-

11

Mar

-12

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Nov-

12

Mar

-13

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3

Nov-

13

Mar

-14

Jul-1

4

Nov-

14

U.S. GDP Growth

GDP QoQ GDP YoY*Source: Bloomberg L.P. as of 12/31/14.

(%)

GDP Avg. of 2.3% (3Q'09-4Q'14) GDP Avg. of 3.5% (1947-2007)

3

While falling energy prices and a strengthening job market have boosted consumer spending, the economy is still not firing on all cylinders.

International Trade

Consumer Spending Business Investment

Residential Construction

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep-

14

Nov

-14

Jan-

15

Exports

*Source: U.S. Census Bureau as of 01/31/2015

YoY(%∆)

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1.0

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6.0

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-12

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-12

Jul-1

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-12

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-13

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-13

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-13

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14

Mar

-14

May

-14

Jul-1

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Sep-

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Nov

-14

Jan-

15

New Orders and Inventories

New Orders ex Transportation Inventories*Source: U.S. Census Bureau as of 01/31/2015

YoY(%∆)

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

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13

Mar

-13

May

-13

Jul-1

3

Sep-

13

Nov

-13

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14

Mar

-14

May

-14

Jul-1

4

Sep-

14

Nov

-14

Jan-

15New Housing Starts And Building

Permits

New Housing Starts Building Permits*Source: Bloomberg L.P. as of 02/28/2015

YoY(%∆)

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep-

14

Nov

-14

Jan-

15

Core Retail Sales

*Source: U.S. Census Bureau as of 02/28/2015**Core retail sales excludes autos & gas stations

YoY(%∆)

4

Auto/Durable Goods Replacement Cycle

Housing Pent-Up Demand

Improving Household Balance Sheets

Disposable Income Growth

Job/Wage Growth in Professional Services, Technology, Education, and Health Care Sectors

Revival in State and Local Government Spending

Positive Forces Supporting Continued Moderate Growth

5

Pro-Growth Fiscal Policies and a Balanced Regulatory Regime

Stronger Global Economic Growth

Vibrant Labor Market Conditions

Normalized Housing Turnover Rates

Stable Financial Market Conditions

Pass-Through from the Financial Markets to the Real Economy

Missing Links to a More Robust Recovery

6

Labor Market Struggling to Regain Pre-Recession Dynamics

'03-'07 Most Recent Difference from Pre-Crisis Avg.Unemployment Rate 5.2% 5.5% + 0.3 percentage points U6 Unemployment Rate 9.0% 11.0% + 2.0 percentage pointsAnnual Worker Wage Growth 2.9% 2.0% - 0.9 percentage pointsLong-Term Unemployed (Millions) 1.54 2.709 + 75.91%Part-Time Seeking Full-Time Jobs (Millions) 4.44 6.63 + 49.32%Average Monthly Job Openings (Millions) 3.96 4.998 + 26.21People Quitting Jobs, Monthly Avg. (Millions) 2.75 2.799 + 1.78%

*Source: Federal Reserve Board; Bureau of Labor Statistics; Bloomberg L.P. as of 03/ 16/ 2015.

Labor Market Dashboard

7

Housing Turnover Remains Well Below Historical Levels

200

400

600

800

1,000

1,200

1,400

Dec-

86Ju

l-88

Feb-

90Se

p-91

Apr-9

3No

v-94

Jun-

96Ja

n-98

Aug-

99M

ar-0

1Oc

t-02

May

-04

Dec-

05Ju

l-07

Feb-

09Se

p-10

Apr-1

2No

v-13

New Home Sales

New Home Sales 20-Yr Pre-Recession Avg. Post-Recession Avg.

(000's)

*Source: US Department of Commerce as of 01/31/2015.

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

Dec-

86Ju

n-88

Dec-

89Ju

n-91

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92Ju

n-94

Dec-

95Ju

n-97

Dec-

98Ju

n-00

Dec-

01Ju

n-03

Dec-

04Ju

n-06

Dec-

07Ju

n-09

Dec-

10Ju

n-12

Dec-

13

Housing Starts

Housing Starts 20-Yr Pre-Recession Avg. Post-Recession Avg.

(000's)

*Source: US Department of Commerce as of 02/28/15

8

Financial Conditions Still Favorable But Volatility Increasing

1000110012001300140015001600170018001900200021002200

Jan-

10

Apr

-10

Jul-1

0

Oct

-10

Jan-

11

Apr

-11

Jul-1

1

Oct

-11

Jan-

12

Apr

-12

Jul-1

2

Oct

-12

Jan-

13

Apr

-13

Jul-1

3

Oct

-13

Jan-

14

Apr

-14

Jul-1

4

Oct

-14

Jan-

15

S&P 500 Index All-time high of 2,117set on 03/02/15

*Source: Bloomberg Finance L.P. as of 03/19/15

101520253035404550

405060708090

100110120

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c-1

0

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r-1

1

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-11

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Financial Market Volatility

BofA MOVE Index (L-axis) VIX Index (R-axis)*Source: Bloomberg L.P as of 03/19/2015

9

GDP Growth Outlook

Positive Forces: Disposable income growth Stronger household balance sheets Acceleration in consumer spending Revitalization of housing market

Economic Challenges: Stronger U. S. Dollar Slower growth abroad Negative consequences of lower oil and natural gas prices on U. S. energy

industry Heightened financial market volatility

GDP Contributions by Sector 2010-2013 2014 2015Household Consumption 1.6 1.9 2.2Business Investment* 0.7 0.8 0.7Residential Investment 0.2 0.1 0.2Net Exports 0.0 -0.6 -0.5Government Expenditures -0.4 0.2 0.2 Real Final Sales 2.0 2.3 2.8Inventories 0.3 0.1 -0.3Total (Average Annualized GDP Growth) 2.3 2.4 2.5Source: Bureau of Economic Analysis. 2015 is a Stifel projection. *Business investment includes structures, equipment, and intellectual property.

U.S. Real GDP Growth (%)

10

While we envision a slight improvement in GDP growth this year, our forecast is 0.5% below the Bloomberg consensus estimate.

Lower energy costs, weak global growth, and moderate wage gains should keep core inflation well below the Fed’s 2.0% target level through the end of 2015.

While unemployment should continue to fall, the rate of decline will likely slow as previously discouraged workers return to the labor market.

The balance of risks to our forecast is tilted to the downside: European deflation/contagion Geo-political turmoil Negative market reaction to Fed tightening

Comparative Economic Forecasts

U. S. Economic Projections2014 2015 2014 2015 2014 2015

Stifel FI Strategy Group Forecast 2.4% 2.5% 1.4% 1.4% 5.6% 5.3%Bloomberg Economists' Survey 2.4% 3.0% 1.4% 1.3% 5.6% 5.2%Fed Forecast - Central Tendency Mid-Point 2.4% 2.5% 1.6% 1.4% 5.6% 5.1%Updated as of 03/20/15.

GDP Core PCE Price Index Unemployment Rate (YE)

11

The vast majority the 1.0%+ decline in long-term Treasury yields since the beginning of 2014 can be attributed to the sharp drop in inflation expectations .

Inflation expectations have rolled over primarily due to the plunge in oil prices. Other contributing factors to the flatter Treasury curve include:

Low sovereign bond yields in other safe-haven countries. Appreciation in the U. S. Dollar Downward revisions to global GDP estimates Heightened geopolitical risks

As oil prices have tentatively stabilized over the past few weeks, Treasury yields have leveled off.

Interest Rate Outlook

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3m 6m 12m 2y 3y 5y 7y 10y 30y

Treasury Yield Curve

US Treasury Active Curve as of 03/19/2015

US Treasury Active Curve as of 12/31/2013*Source: The Yield Book as of 03/19/2015

(%)

40

50

60

70

80

90

100

110

1.51.61.71.81.92.02.12.22.32.4

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-13

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14

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10-Yr B/E vs. Crude Oil Price

10-Year Break-Even Rate (L-axis) Crude Oil (R-axis)

(%) ($)

*Source: Bloomberg L.P. as of 03/19/2015

12

Treasury yields are unlikely to increase significantly until the Fed raises rates or inflation accelerates.

Over the past 20 years, the five-year Treasury yield has increased by 100 bps or more over a 24-month period on three separate occasions. In all three cases, the Fed was lifting short-term interest rates during these periods of rising Treasury yields. In every other instance, the Treasury rate spikes were temporary.

Moderate wage growth should gradually pull the Core PCE Price Index toward the Fed’s 2.0% target rate over the next 12 to 24 months. Long-term Treasury yields will likely remain relatively stable as long as inflation is well-contained.

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% C

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Inflation vs. Wage Growth

Core PCE (L-axis) US Avg. Hourly Earnings (R-axis)

(%)

*Source: Bureau of Labor Statistics through February 2015.

(%)

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-93

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7Au

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g-04

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ov-0

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15

Fed Policy vs. 5-Year Treasury Yield

5-Year Treasury Fed Funds Target Rate

(%)

*Source: Bloomberg L.P. as of 03/19/2015.

13

Interest Rate Forecast

As disinflation works its way through the economy, we expect the Fed to delay its initial tightening move until the fourth quarter of 2015.

Projected Fed Timeline: First Rate Hike: 4Q15 Terminal Funds Rate: 2.0% 4Q17

Our projected path for the fed funds rate closely resembles the forward curve but sits well below the Fed’s “dot plot” forecast in 2016 and 2017. We expect the Fed’s path to be downwardly revised again at the June FOMC meeting.

Fed funds should finish 2015 no higher than 0.50%, compared to consensus expectations for a 0.75% year-end policy rate.

We expect the yield curve to continue to flatten throughout 2015, as short-term yields increase relative to long-term rates.

Long-term rates should remain well anchored, even as shorter-term yields move higher. Relative to the consensus projection of 2.58%, we expect the 10-year Treasury yield to close 2015 at 2.25%.

1Q15 2Q15 3Q15 4Q15Fed Funds 0.25% 0.25% 0.25% 0.50%2-year 0.60% 0.80% 0.95% 1.15%5-year 1.50% 1.55% 1.60% 1.70%10-year 2.00% 2.10% 2.20% 2.25%30-year 2.55% 2.65% 2.75% 2.80%2s to 10s +140 bps +130 bps +125 bps +110 bps*Updated March 10th, 2015

Source: Stifel Fixed Income Research and Strategy Group.

All projections are as of the end of the respective quarters.

Yield Curve Projections

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Fed Funds Projections

Fed Funds Forward Rates Derived from Eurodollar FuturesStifel Fed Funds ProjectionsFed Dot Plot Median

(%)

*Source: Bloomberg L.P. as of 03/19/15

14

Heightened interest rate and spread volatility

Increased importance of individual security selection

Barbell strategy outperformance as curve flattens

Fixed Income Strategy Themes for 2015

15

Barbell strategies with a 3-year average duration remain our preferred approach to position portfolios for further yield curve flattening.

The long-term component of the barbell (10-years+) provides income protection and capital appreciation potential if rates move sideways or decline further. Well-structured, call-protected securities such as Treasuries, Municipals, Corporates, and CMBS are attractive candidates for the long-end of the barbell.

The short-term component of the barbell provides cash flow for reinvestment once short-term yields eventually rise and helps to maintain overall portfolio duration and price sensitivity at reasonable levels. MBS, Agencies, ABS and CLOs work well for the front-end of the barbell.

Our back-testing results in the table above show that a 3-year duration barbell would have produced a positive quarterly total return 90% of the time over the past 25 years.

1.) Source: BAML Index Data, Stifel Calculations2.) The barbell is a 3.2 average duration combination of the 7 – 12 year Municipals Index and the 1-3 year Tsy/Agcy Index

Barbell Strategy Historical Total Returns

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(1.00)

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May

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ar-0

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ov-0

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ct-0

4Se

p-05

Aug-

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l-07

Jun-

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ay-0

9Ap

r-10

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-11

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n-13

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-14

5-Ye

ar T

reas

ury

Yiel

d

Qua

rter

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otal

Ret

urn

Barbell Quarterly Total Return 5 Year Treasury Yield

Bond Portfolio Strategies

16

Depository Balance Sheet Strategies

Assets Liabilities

Supplement organic loan demand with loan purchases and participations.

Evaluate non-core, credit-sensitive sectors in the securities portfolio to enhance returns.

Utilize a barbell structure for portfolio composition.

Manage extension risk and price volatility via bond swap opportunities.

Employ a variety of coupon rates, collateral types, and cash flow structures.

Utilize interest rate derivatives such as swaps and caps to manage IRR profile and funding cost.

“Blend & Extend” existing FHLB borrowings to lower rate and extend duration.

Utilize term borrowings vs. overnight.

Issue fixed rate debt and brokered CDs.

Pay up for longer time deposits.

Mitigate income-reducing transactions with duration-matched leverage strategies.

With 2015 potentially representing a turning point for interest rates and the economy, regulatory focus is likely to shift from Capital and Asset Quality to Interest Rate Risk (IRR).

As an example, the Winter 2014 edition of the FDIC’s Supervisory Insights focused almost exclusively on IRR.

While supervisors have pledged not to criticize institutions for “temporary adverse consequences to earnings” coming from a IRR-driven repositioning, maintaining profitability is a key management focus.

Careful planning and consideration on both sides of the Balance Sheet should allow institutions to effectively manage IRR without sacrificing profitability objectives.

17

Bond Market Total Returns by Sector

In contrast to last year’s robust performance, we expect the major investment-grade sectors to produce low single-digit total returns in 2015.

Credit spreads have retraced approximately 50% of their October – January widening.

The municipal sector has the potential to repeat its top excess return ranking in 2015 .

Description2014

Total Return (%)2014

Excess Return (%)2015 YTD Total

Return (%)2015 YTD Excess

Return (%)

US Broad Market Index 6.27 0.31 1.33 -0.03 US Treasury 6.02 0.05 1.43 -0.01 US Agency 4.06 0.64 1.02 0.09 Foreign Govt/Supra 5.41 0.67 1.04 -0.12 Taxable Munis 18.79 2.88 2.56 0.01 Corporates 7.51 -0.04 1.87 0.25 Financials 6.13 0.87 1.66 0.40 Industrials 7.73 -0.56 1.86 0.13 Utilities 11.60 0.44 2.79 0.71 Mortgages 6.07 0.74 0.71 -0.40 ABS 1.63 0.55 0.56 0.15 CMBS 4.33 1.57 1.32 0.47 Covered Bonds 2.31 0.75 0.77 0.18High Yield Index 2.50 -1.29 1.98 0.87Municipal Bond Index 9.78 3.56 1.12 -0.02Source: Bank of America Merrill Lynch as of 03/19/2015.

18

Muni-to-Treasury Ratios

Source: Stifel, Bond Buyer

10-Yr ‘AAA’ Municipal as a % of 10-Yr UST

10 Yr Average = 97%

30-Yr ‘AAA’ Municipal as a % of 30-Yr UST

M-14 J-14 S-14 D-14 M-1520%

40%

60%

80%

100%

120%

Max = 108%Min = 55%Current = 79%

2-Yr ‘AAA’ Municipal as a % of 2-Yr UST 5-Yr ‘AAA’ Municipal as a % of 5-Yr UST

10-Yr ‘AAA’ Municipal as a % of 10-Yr UST

M-14 J-14 S-14 D-14 M-1520%

40%

60%

80%

100%10 Yr Average = 87%

Max = 92%Min = 64%Current = 82%

M-14 J-14 S-14 D-14 M-1560%

70%

80%

90%

100%

110%

10 Yr Average = 93%

Max = 106%Min = 83%Current = 100%

Source: Stifel, MMD; as of 3/19/15

30-Yr ‘AAA’ Municipal as a % of 30-Yr UST

M-14 J-14 S-14 D-14 M-1580%

90%

100%

110%

120%

Max = 114%Min = 95%Current = 109%

10 Yr Average = 102%

19

Forecast Overview

Economy: The U. S. economy should continue to expand at a moderate pace in 2015,

with GDP growth of 2.7%. Consensus expectations for 2015 appear too optimistic and are vulnerable to

downward revisions.

Monetary Policy: Monetary policy should remain highly accommodative for the next several

years. The first rate hike will likely be delayed until the fourth quarter of 2015 and could be pushed into 2016.

QE has ended in the U. S., but the Fed’s $4+ trillion balance sheet and the ECB’s QE program will likely suppress long-term bond yields for some time to come.

Treasury Yields: Interest rates should fluctuate in well-defined trading ranges through at least

the middle of 2015. During the second half of next year, the bond market will likely begin to

anticipate Fed rate hikes, which could trigger a more pronounced bear flattening trend.

Portfolio Strategies: Achieving a reasonable balance between current income and future interest

rate risk remains the key to out-performance in this highly challenging low-yield environment.

20

Disclosures

 

Disclosures and DisclaimersFor distribution to institutional clients only

The Fixed Income Capital Markets trading area of Stifel, Nicolaus & Company, Incorporated may own debt securities of the borrower or borrowers mentioned in this report and may make a market in the aforementioned securities as of the date of issuance of this research report.

Please visit the Research Page at www.stifel.com for the current research disclosures applicable to the companies mentioned in this publication that are within Stifel’s coverage universe.

The information contained herein has been prepared from sources believed reliable but is not guaranteed by Stifel and is not a complete summary or statement of all available data, nor is it to be construed as an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of investors. Employees of Stifel or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinions expressed within. No investments or services mentioned are available to “private customers” in the European Economic Area or to anyone in Canada other than a “Designated Institution”. The employees involved in the preparation or the issuance of this communication may have positions in the securities or options of the issuer/s discussed or recommended herein.Stifel is a multi-disciplined financial services firm that regularly seeks investment banking assignments and compensation from issuers for services including, but not limited to, acting as an underwriter in an offering or financial advisor in a merger or acquisition, or serving as a placement agent in private transactions. Moreover, Stifel and its affiliates and their respective shareholders, directors, officers and/or employees, may from time to time have long or short positions in such securities or in options or other derivative instruments based thereon.Stifel Fixed Income Capital Markets research and strategy analysts (“FICM Analysts”) are not compensated directly or indirectly based on specific investment banking services transactions with the borrower or borrowers mentioned in this report or on FICM Analyst specific recommendations or views (whether or not contained in this or any other Stifel report), nor are FICM Analysts supervised by Stifel investment banking personnel; FICM Analysts receive compensation, however, based on the profitability of both Stifel (which includes investment banking) and Stifel FICM. The views, if any, expressed by FICM Analysts herein accurately reflect their personal professional views about subject securities and borrowers. For additional information on investment risks (including, but not limited to, market risks, credit ratings and specific securities provisions), contact your Stifel financial advisor or salesperson.

Our investment rating system is three‐tiered, defined as follows:Outperform ‐ For credit specific recommendations we expect the identified credit to outperform its sectorspecific peers over the next six months.Marketperform ‐ For credit specific recommendations we expect the identified credit to perform approximatelyin line with its sector specific peers over the next six months.Underperform ‐ For credit specific recommendations we expect the identified credit to underperform its sectorspecific peers over the next six months.

Additional Information Is Available Upon Request

We, Jim DeMasi, CFA, Will Fisher, Kyle Cooke, and Marie Autphenne certify that the views expressed in this research report accurately reflect our personal views about the subject securities or issuers; and we certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report.

© 2015 Stifel, Nicolaus & Company, Incorporated, One South Street, Baltimore, MD 21202. All rights reserved.

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