Economic ScenarioSeptember 11, 2008

September 2008

*Economic Scenario A multi-year adjustment processCentral scenario (70%) A multi-year adjustment processA multi-year adjustment process The drop in oil prices is good newsas is the conservatorship for Freddie Mac and Fannie MaeFixing the US housing market will take time growth below trend in 2008, 2009 and 2010Credit supply to remain impaired as financial sector balance sheets are trimmedNegative wealth effects from falling asset prices (housing and equity)Additional fiscal stimulus could be in the pipeline (notably in the US and UK)Still dynamic emerging economies will help keep global recession risks at bay

Monetary policy dilemmas have easedThe Fed is back in risk management mode no rate hikes before 2009The ECB is changing tack a rate cut is due in 2009

Risk scenario (30%) Global recession Risks have eased thanks to the sharp drop in oil prices and the GSE conservatorshipTriggers for a global recession; (1) credit crunch, (2) geopolitics, (3) new surge in food & oil prices

Keystone variables: Credit supply indicators

September 2008

Main changes to the central scenario

September 2008

*G4 Growth Profile US double dips, but prolonged recession is averted

September 2008

*Market Outlook

September 2008

*US The central scenario

2008-09: Double dip but no deep recessionThe GSEs crisis exacerbates the risk of a deep credit crunchThe housing downturn is far from over. Unemployment will rise and the saving rate will trend higher.Buffers: Firm global growth, healthy corporate balance sheets, fairly valued equity markets, a weak dollarGDP growth accelerated in Q2, But the rebound will prove temporary. Headline inflation may temporarily exceed 5.0% but core inflation remains under controlThe peak in inflation is past. Declining commodity prices and slower growth in aggregate demand will limit the pricing power and with strong productivity, unit labour costs will remain under control.No deep recession thanks to a very reactive policy-mixThe fiscal authorities have room for manoeuvre. A new stimulus package will possibly be adopted if things get worseMonetary normalisation will happen once the macro financial risks recede. A risk management approach has resurfaced. First rate hike in Q2..09 Fiscal deficit will worsenSlowdown in tax receipts in 2008 on the back of weaker profits. Higher expenses probably in the pipelineCurrent account deficitA positive contribution of net exports to growth (weaker dollar, global growth still solid).

September 2008

*Central scenario Eurozone A technical recession in Q2 and Q3. 2008 but economic growth will (slightly) rebound in 2009Business and consumer confidence have hit new lows this summerConsumer confidence on a downside trend as oil price rise has made a dent in consumers purchasing powerInvestment, the last growth engine, is fadingBusiness orders are depleting and business confidence is down as export growth is slowingReal estate sector : housing prices are plunging (Spain, Ireland) or start falling, dragging down households investmentRecent positive signs need to get confirmedOil price is receding : consumer confidence is going to improve as CPI is softeningInflation expectations levelled off.Euro FX is depreciating against USD

ECB monetary policy easing in early 2009 ECB : a new rate hike is implicitly dismissedThe ECB is likely to stay on hold until end-2008. Inflation deceleration and slackness in economic activity will prompt rate cut(s) in H1.09.

Growth will remain below trend in 2009

September 2008

*Central scenario UK - Downside risks are materializingA technical recession is on the cardsTight monetary conditions, high inflation and a deteriorating labour market will continue to weigh on consumptionResidential investment set to shrug off 0.5pp to GDP in 2008Tight credit conditionsCorporate balance sheets remain healthyNet exports set to have a strong positive contributionMonetary policy Rate cuts back on the agendaDespite a bleak economic environment, rate cuts will not be due before end-2008:Above 4% inflationHigh inflation expectationsCurrency depreciationBut medium-term, well-below trend growth will help ease inflationary pressuresFiscal policy A mini-fiscal package for a startHousing market measures of 0.06% GDPNew measures for low-income earners are set to be announced

September 2008

*Central scenario Japan to stagnate until year endGrowth stagnate until end of the yearRecession faresbut buffers are in placeConsumer pain ease as CPI declinesNo major inventory overhangStill fair external demand prospectsFiscal stimulus boost Politics/Fiscal policyThe government irons out an 11.7 trillion worth economic package. BOJ Normalization to resume mid-09 GDP gap on the back of outflow of domestic income to overseas caused by terms of trade deterioration will prevent the monetary authorities from tightening policy.The BoJ show a harmonized view with the government which announced a pump-priming measures.

September 2008

*Central scenario BRIC Domestic demand decouplesBrazilGDP growth set to ease in 2009 but infrastructure investment will limit the slowdownInflation risks remained tilted to the upsideFurther rate hikes in the pipelineTowards a marked deterioration in external balanceRussiaFundamentals remain strong thanks to high oil price and public spendingInflationary pressure remained elevatedTowards a move from FX targeting to inflation targeting?The Russian/Georgian conflict has led to huge capital outflows.IndiaConsumption set to continue to support growthBut downside risks are high (inflation, twin deficit, )Political tensions have easedRBI set to tighten by 50bps before end of calendar yearChinaNo trade decoupling, pockets of domestic consumption and investment decoupling(s).Inflation has peaked and growth remains the main riskRMB appreciation to moderate, fully priced in by markets participants. A depreciation scenario against USD is unlikely.Huge FX reserves would help weather any downside risk to growth

September 2008

*Presentation OutlineKey ThemesOnly step one to fixing US housingNo repair yet to money marketsBelow trend growth to continue in the USEurope and Japan hit recession territoryEmerging slowdown, but still sustained growthNon-Financial Corporate Balance Sheets Ride the StormIn Focus - What next for oil?

1. Only Step One to Fixing US Housing

September 2008

*More Weekend Action from the US AdministrationSeptember 7, 2008 Freddie and Fannie Mae placed into conservatorship by the FHFA

Three additional steps from the Treasury Securing capitalA senior preferred stock purchase agreement with an indefinite duration and a capacity of $100bn each. A liquidity backstop for the GSEsA new secured lending credit facility which will be available to Fannie Mae, Freddie Mac, and the FHL Banks. This facility is intended to serve as an ultimate liquidity backstop and will be available until Dec. 2009. A temporary program to purchase GSE MBSThis will expire with the Treasury's temporary authorities in Dec. 2009.

September 2008

*Bad news for the equity ownersgreat news for the bond holders

September 2008

*and Home Purchasers

September 2008

*Just About Everyone Owns GSE Backed Securities !

September 2008

*US Housing Market Remains Depressed

September 2008

* but Prices are No Longer Falling Off a Cliff

September 2008

*Delinquency Rates Continue to Climb

September 2008

*Putting Public Finances in Danger?Cost of Paulson Plan, CBO estimate from July 22, 2008$25bn (or 0.2% of GDP) over fiscal years 2009 and 2010 with a 50% chance of no cost at all and a 5% chance that the cost could reach $100bn. According to the CBO, the bulk of the costs relate to the purchase of GSE equity and debt. Cost of new measuresWe estimate the worst case scenario for the taxpayer at $200-300bn (or 1.4% to 2.1% of GDP).

Note, the tax payer could even end up making money from the spreads between GSE MBS and US Treasuries.

2. No Repair Yet on Money Markets

September 2008

*Tension on Money Markets Remains High

September 2008

*More Mysteries in the Money Market

September 2008

*Trimming Bank Balance Sheets is Proving a Lengthy Exercise

September 2008

*Repairing Credit Supply Will Take Time

September 2008

*and a Cyclical Increase in Default Rates is on the Cards

September 2008

*A turning point for credit markets ?

September 2008

*Banks - Continued Tension, but with Greater Dispersion

3. Below Trend Growth to Continue in the US

September 2008

*Q2 GDP Defies the Leading Indicators

September 2008

*Thanks to Exports

September 2008

*Export Prospects Are Set to Weaken

September 2008

*and the Income Side Tells a Different Story

September 2008

*US Employment Conditions Continue to Weaken

September 2008

*A Welcome Relief !

September 2008

*A Multi-year Period of Below Trend Growth

4. Europe and Japan hit recession territory

September 2008

*Eurozone Activity is weakening sharply as confidence is deteriorating fast and deep

September 2008

*Eurozone A technical recession, but not a prolonged recession. Below potential growth.

September 2008

*Eurozone Declining housing prices drag down households investment and consumption

September 2008

*Eurozone PMI survey points to lower job creation, but not a sharp downturn

September 2008

*Eurozone Easing of inflation will sustain consumption in quarters ahead

September 2008

*Eurozone And consumer sentiment should benefit gasoline price decline

September 2008

*Eurozone - Faltering foreign demand but the euro has been recently declining restoring somewhat competitivity

September 2008

*Eurozone Productive investment : not a free fall, as profits remain elevated and many Capex decisions are driven by long term trendsManufacturing and cyclical industries are in a bad moodIn many industries, Capex decisions are driven by long term demand trends: infrastructure, transport, oil and gas, utilities

September 2008

*UK - The Worst Crisis Since in 60 Years ?

September 2008

*UK - An Unprecedented Housing Bust A 1bn (0.06%GDP) Homeowners Support Package A 1-year tax emption for around 50% of all house purchasesCreation of a new mortgage rescue schemeBringing forward public spending to deliver up to 5,500 new social rented homesPublic funds available to buy unsold property from house buildersFurther measures are likely notably to help the low-income earners

September 2008

*UK - Financing gap back to zero but corporate profit ratio remains close to historical high

September 2008

*UK - A weaker Sterling will help exports to recover

September 2008

*UK - Short-term, high inflation and inflation expectations combined with external price pressures are limiting the BoE room to manoeuvre

September 2008

* but longer-term, the economic slowdown points to an aggressive easing cycle

September 2008

*Japan - Business confidence plummeted to the level of the past recession from Oct. 2000 to Jan. 2002

September 2008

*Japan - But the absence of inventory pressure indicates this economic downturn will be short and shallow

September 2008

*Japan - Sharp rise in price, coupled with economic deceleration seriously damages real purchasing power of consumers

September 2008

*BOJ will be forced to stay sidelines as deteriorating nations terms of trade considerably spoils domestic purchasing powerTrade loss amounts to 5% of GDP

5. Emerging slowdown, but still sustained growth

September 2008

*Emerging Asia - Growth is the Risk Now, not Inflation

September 2008

*China Resilient, but Slowing

September 2008

*China Equities Look More Reasonable Prices

September 2008

*Eastern Europe The credit crunch has taken its toll on the Baltic and Hungarian credit binge but not yet in Poland

September 2008

*Eastern Europe Risks remain high, especially in the Baltics and in the South-Eastern Countries

September 2008

* especially in the event of a currency shock Source: National bank of HungaryHungary

6. Non-Financial Corporate Balance Sheets Ride the Storm

September 2008

*US - Cash flows companies remain high

September 2008

*US - Debt ratios are far from their 1999 level

September 2008

*US - But a strong increase of the corporate bond as a source of financing

September 2008

*US - And a preference for bonds issues and decrease capital

September 2008

*How Long Will it Take for Market Confidence to Return?

In Focus: Whats next for oil?

September 2008

*Oil prices up and down - the same list of suspectHigher oil pricesThe weak US dollar and low US interest ratesSpeculators and index tradersTight fundamentalsLow inventoriesRefineries bottleneckRising costsGeopolitics: Iran

What did trigger lower prices? A stronger US dollarSpeculators and index tradersHedge funds deleveragingBetter fundamentalsDemand destructionIncreased output (notably from Saudi Arabia)Geopolitics: IranA calm hurricane season

September 2008

*Oil prices peaked in July and are now below 100$/b: whats next?

September 2008

*Oil The impressive link to the dollar

September 2008

*Open interest surge between 2001 and Summer 2008but are now decreasingCommodity investors might have sold $40 bn since early July

September 2008

*Oil Price-induced demand reduction resultedUs demand dropped by 1mb/d y/y in August

September 2008

*Oil Global demand is slowing and not just in the OECD countries

September 2008

*OPEC in the spotlight, trying to take the lead

OPEC produces 40% of world oil and its role will be more dominant in the long-term

September 2008

*OPEC decided to adhere to old production quotas:A gradual cut in output and a Saudi Arabia affairOPEC Production is 2 mb/d higher than a year ago

Production is recovering in Irak (no quota)OPEC 11 official targets are not revised

Saudi Arabia is the swing producer

Some countries are unable to produce to quota and Iran supplies above capacity

September 2008

*Supply higher than demand But OECD stock cover has not increased since the beginning of the year Days of forward demand are based on average demand over the next three monthsSource : IEAOECD End of Month Oil Stocks (Industry)

September 2008

*Geopolitics: Another front. Producers in Azerbaijan have few alternative export routes

September 2008

*Long term fair value Real price approach

September 2008

*Long term fair value Substitute approachThe surge in oil prices had not been reflected in other substitutes (gas, coal)

September 2008

*Long term fair value Long term marginal costRising costs - Exploration licences, labour, royalties, taxes, material , energy, Lesser gains in access to reserves (resource nationalism)Lesser progress on drilling and exploration technologies

September 2008

*Long term fair value Energy supply responds in the long-term

September 2008

*Oil prices is dropping. Reasons not to cheer to quicklyFlowsThe pace of dollar appreciation will fadeInvestors come back when price levels are supportingFundamentalsFair oil price is around 80$/b-100$/bSupply is now bigger than global demand butInventories remain low in OECD countriesGrowth remain robust in emerging countriesOPEC could cut production if price dropped too quicklyClimate: The hurricane season is not over (end October): Gustav, IkeThe impact on downstream production would be more meaningful than on upstream production The last two winters were mild. Will it be the case for the next one?

Geopolitics: A potential flare-up with IranNew uncertainties around Russia

***** UK curve missing on the chart.***NB! The EMU4 slide is missing*******F:\Eco\Borowski\US\GSEs\GSE Spread.xls*GUG6**GTQ2*GS September 3, 2008*****GUG6**GU2A*Based on GU15 (Profits shown as year-on-year)*F:\ECO\Marcussen\mini_models\excel_models\us\Crisis Chronologie.xls***GSFY*GTQL**GUFK*****GPJ3*F:\ECO\Investment Strategy\New Notation\Eurozone forecast and contributions.xls***GQNM actualiser

*GUGH*gugi*gug9*GQNH*GQ04**GUG7*********GTHV******GUG5

*GUGC*GUGD*GoieMais les entreprises ont fait davantage appel aux financement par les obligations et ont plutt rachet leurs actions.****GTYE*GU8m, GUA4 **F:\ECO\Commodities\oil\bloom\oilconsumption.xlsgudk

**GUBY*GUBW*