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Investment ResearchGeneral Market Conditions

Contrary to market speculation, we do not expect any changes to policy measures or

the balance sheet management at todays FOMC meeting.

The recent deterioration in data should warrant a softer tone in the statement. The

growth section is likely to be downgraded, but with no material changes to the

outlook.

The extended period language should be retained and the forward-looking section is

likely to see a dovish twist indicating a softening in the policy stance.

While the statement will fundamentally support the current low level of yields, themarket might be a bit disappointed when the Fed fail to announce further easing.

Hence, the risk-reward is for higher yields going into the meeting.

Activity

Economic data has weakened over the past couple of months and is now highlighting the

risk of a hard landing in H2. The combination of declining leading indicators, a

significant setback in housing data, soft consumer spending growth and a moderate

recovery in the labour market is likely to increase the concerns on the outlook at the

committee. On a positive note, improving financial conditions and robust household

incomes support the H2 outlook. The statement should acknowledge the recent

weakening in data and reflect a less upbeat growth picture with increased downside risks.

We believe that the Fed will stick to its medium-term outlook for a moderate expansion.

Inflation

Core inflation has fallen below the Feds comfort zone and remains on a downward trend,

reinforced by the huge slack in the economy. 5y5y B/E inflation has declined recently but

other measures of inflation expectations remain stable. The risk of a change in the

inflation language is limited. The FOMC is likely to reiterate that inflation will remain

subdued for some time, but could skip the note about declining commodity prices.

Bias and policy outlook

There have not been any big changes in communication from the central Fed members.

However, among the local Fed presidents the hawks have softened along with the

deterioration in data. Market speculation of further easing has intensified followingreports in the news media that the Fed would be re-investing its proceeds from the MBS

portfolio to avoid tightening the balance sheet. We believe that such an announcement

would be premature but believe the Fed will indicate that the door is open should the

outlook deteriorate further. The extended period language is likely to be retained at this

meeting and a dovish twist could be added to the forward-looking section. Furthermore,

we believe it unlikely that Hoenig will repeat his dissent, therefore adding to the

likelihood of a dovish shift in the bias.

Market pricing

Themarket has postponed the initial Fed hike to November 2011. We believe that the

market could initially be disappointed should the Fed fail to announce further easing.

However, the statement is not expected to change the fundamental outlook for low rates,which is currently in the Feds interest. E

10 August 2010

Senior Analyst

Signe Roed-Frederiksen

+45 45 12 82 29

[email protected]

Senior Analyst

Peter Possing Andersen

+45 45 13 70 19

[email protected]

Fed funds rate and expectations

Source: Bloomberg and Danske Markets

Probabilities for August 11 meeting


Fed funds expectations


Flash CommentFOMC: Preview

08 09 10 110.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5% %

Danske

Futures prisning

Fed funds

Probabilities for August meeting

DB Market*

Unchanged

(0-0.25%) 100% 100%

Hike to 0.50% 0% 0%

* Based on optio nsprices as of settlement August 6

DB Market*

Unchanged 100% 100%

Hike to 0.50% 0% 0%

* Based on optio nsprices as of settlement June 21


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2 | 10 August 2010www.danskeresearch.com

Flash Comment

FOMC chart book

Fed to keep ZIRP in place but will the balance sheet be allowed to shrink?

90 92 94 96 98 00 02 04 06 08 10

0

1

2

3

4

5

6

7

8

9

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50% Thousand bn

Size of Fed balance sheet >>

>


3/7


Flash Comment

Business confidence has peaked and will move lower during H2

90 92 94 96 98 00 02 04 06 08 10

30

35

40

45

50

55

60

65

30

35

40

45

50

55

60

65Index Index

ISM non-manufacturing

Neutral zone

ISM manufacturing

04 05 06 07 08 09 10

30

35

40

45

50

55

60

65

30

35

40

45

50

55

60

65Index Index

ISM manufacturing

Neutral zone

ISM non-manufacturing

Source: EcoWin and Danske Bank

Note: Dark (light) shading indicates periods of tightening (easing)Source: EcoWin and Danske Bank)

Job gains has been accelerated by Census hiring but underlying labour indicators are improving

90 92 94 96 98 00 02 04 06 08 10

-1000

-750

-500

-250

0

250

500

-1000

-750

-500

-250

0

250

5001000 persons, m/m 1000 persons, m/m

Private non-farm payrolls

07 08 09 10

-800

-600

-400

-200

0

200

400

-800

-600

-400

-200

0

200

4001000 persons, m/m 1000 persons, m/m

3 mth. avg.

Private non-farm payrolls


Note: Dark (light) shading indicates periods of tightening (easing)Source: EcoWin and Danske Bank

Consumer spending has recovered at a moderate pace and we expect some improvement in Q2

92 94 96 98 00 02 04 06 08 10

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0 % y/y % y/y

Real personal spending

Retail sales, CPI deflated

07 08 09 10

-25

-20

-15

-10

-5

0

5

10

15

-25

-20

-15

-10

-5

0

5

10

15 3 mth chg, % AR

Real personal spending

Retail sales (CPI deflated)

3 mth chg, % AR


Note: Dark (light) shading indicates periods of tightening (easing)Source: EcoWin and Danske Bank


4/7


Flash Comment

Sharp setback in housing indicators as the first-time homebuyer tax credit expires

75 80 85 90 95 00 05 10

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5Millions % y/y

Real house prices (FHFA) >>

Source: EcoWin and Danske Bank Source: EcoWin and Danske Bank

Mortgage and corporate funding costs close to record low... ...and money market spreads have narrowed again

90 92 94 96 98 00 02 04 06 08 10

0

2

4

6

8

10

12

0

2

4

6

8

10

12% %

FRM 30-year mortgage lending rate

Fed funds

Moody's Baa corporate yield

10-year Treasuries

03 04 05 06 07 08 09 10

0

2

4

6

8

0

2

4

6

8% %

90-day non-financial corporatepaper, A2/P2 rated

Fed funds

3 mth LIBOR

Source: EcoWin and Danske Bank Source: EcoWin and Danske Bank

FOMC key statements

Bernanke (neutral, voter) July 21, 2010 to the Congress: One factor underlying the

Committee's somewhat weaker outlook is that financial conditions--though much

improved since the depth of the financial crisis--have become less supportive of economic

growth in recent months. Notably, concerns about the ability of Greece and a number of

other euro-area countries to manage their sizable budget deficits and high levels of public

debt spurred a broad-based withdrawal from risk-taking in global financial markets in the

spring, resulting in lower stock prices and wider risk spreads in the United States

As I noted earlier, the FOMC continues to anticipate that economic conditions are likely

to warrant exceptionally low levels of the federal funds rate for an extended period.

Of course, even as the Federal Reserve continues prudent planning for the ultimate

withdrawal of extraordinary monetary policy accommodation, we also recognize that the

economic outlook remains unusually uncertain. We will continue to carefully assess

ongoing financial and economic developments, and we remain prepared to take further

policy actions as needed to foster a return to full utilization of our nation's productive

potential in a context of price stability


5/7


Flash Comment

Extracts from FOMC minutes, June 22-23 meeting

In their discussion of the economic situation and outlook, meeting participants generally

saw the incoming data and information received from business contacts as consistent with

a continued, moderate recovery in economic activity (...) financial markets were generallyseen as recently having become less supportive of economic growth, largely reflecting

international spillovers from European fiscal strains. In part as a result of the change in

financial conditions, most participants revised down slightly their outlook for economic

growth, and about one-half of the participants judged the balance of risks to growth as

having moved to the downside.

On balance, meeting participants revised down modestly their outlook for inflation over

the next couple of years; they generally expected inflation to be quite low in the near term

and to trend slightly higher over time (...) A few participants cited some risk of deflation.

Other participants, however, thought that inflation was unlikely to fall appreciably further

given the stability of inflation expectations in recent years and very accommodative

monetary policy

The economic outlook had softened somewhat and a number of members saw the risks

to the outlook as having shifted to the downside. Nonetheless, all saw the economic

expansion as likely to be strong enough to continue raising resource utilization, albeit

more slowly than they had previously anticipated. In addition, they saw inflation as likely

to stabilize near recent low readings in coming quarters and then gradually rise toward

more desirable levels. In sum, the changes to the outlook were viewed as relatively

modest and as not warranting poliiy accommodation beyond that already in place.

However, members noted that in addition to continuing to develop and test instruments to

exit from the period of unusually accommodative monetary policy, the Committee would

need to consider whether further policy stimulus might become appropriate if the outlookwere to worsen appreciably.

SeeFlash Comment - FOMC minutes: more downbeat but the bar is set high for further

QE

Statement from June 22-23 meeting

Information received since the Federal Open Market Committee met in April suggests

that the economic recovery is proceeding and that the labor market is improving

gradually. Household spending is increasing but remains constrained by high

unemployment, modest income growth, lower housing wealth, and tight credit. Business

spending on equipment and software has risen significantly; however, investment in

nonresidential structures continues to be weak and employers remain reluctant to add topayrolls. Housing starts remain at a depressed level. Financial conditions have become

less supportive of economic growth on balance, largely reflecting developments abroad.

Bank lending has continued to contract in recent months. Nonetheless, the Committee

anticipates a gradual return to higher levels of resource utilization in a context of price

stability, although the pace of economic recovery is likely to be moderate for a time.

Prices of energy and other commodities have declined somewhat in recent months, and

underlying inflation has trended lower. With substantial resource slack continuing to

restrain cost pressures and longer-term inflation expectations stable, inflation is likely to

be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percentand continues to anticipate that economic conditions, including low rates of resource

utilization, subdued inflation trends, and stable inflation expectations, are likely to

warrant exceptionally low levels of the federal funds rate for an extended period.
http://danskeanalyse.danskebank.dk/link/FlashCommentFOMCminutes14072010/$file/FlashComment_FOMCminutes_14072010.pdfhttp://danskeanalyse.danskebank.dk/link/FlashCommentFOMCminutes14072010/$file/FlashComment_FOMCminutes_14072010.pdfhttp://danskeanalyse.danskebank.dk/link/FlashCommentFOMCminutes14072010/$file/FlashComment_FOMCminutes_14072010.pdfhttp://danskeanalyse.danskebank.dk/link/FlashCommentFOMCminutes14072010/$file/FlashComment_FOMCminutes_14072010.pdfhttp://danskeanalyse.danskebank.dk/link/FlashCommentFOMCminutes14072010/$file/FlashComment_FOMCminutes_14072010.pdfhttp://danskeanalyse.danskebank.dk/link/FlashCommentFOMCminutes14072010/$file/FlashComment_FOMCminutes_14072010.pdf


6/7


Flash Comment

The Committee will continue to monitor the economic outlook and financial

developments and will employ its policy tools as necessary to promote economic

recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William

C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; SandraPianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the

policy action was Thomas M. Hoenig, who believed that continuing to express the

expectation of exceptionally low levels of the federal funds rate for an extended period

was no longer warranted because it could lead to a build-up of future imbalances and

increase risks to longer-run macroeconomic and financial stability, while limiting the

Committees flexibility to begin raising rates modestly.

SeeFlash Comment - FOMC: no Midsummer surprises

FOMC ornithology

Lacker Richmond Non-voter

Plosser Philadelphia Non-voter

Hoenig Kansas City Voter

Fisher Dallas Non-voter

Kocherlakota Minneapolis Non-voter

Duke Board member Voter

Pianalto Cleveland Voter

Evans Chicago Fed Non-voter

Warsh Board member Voter

Tarullo Board member Voter

Lockhart Atlanta Non-voter

Bernanke Chairman Voter

Bullard St. Louis Voter

Kohn Board member Voter

Dudley New York Voter

Yellen San Francisco Non-voter

Rosengren Boston Voter

HAWKISH

NEUTRAL

DOVISH
http://danskeanalyse.danskebank.dk/abo/FlashCommentFOMC230610/$file/FlashComment_FOMC_230610.pdfhttp://danskeanalyse.danskebank.dk/abo/FlashCommentFOMC230610/$file/FlashComment_FOMC_230610.pdfhttp://danskeanalyse.danskebank.dk/abo/FlashCommentFOMC230610/$file/FlashComment_FOMC_230610.pdfhttp://danskeanalyse.danskebank.dk/abo/FlashCommentFOMC230610/$file/FlashComment_FOMC_230610.pdf


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7 | 10 August 2010d k h

Flash Comment

DisclosureThis research report has been prepared by Danske Research, which is part of Danske Markets, a division of

Danske Bank. Danske Bank is under supervision by the Danish Financial Supervisory Authority. The authors of

this research report are Signe Roed-Frederiksen, Senior Analyst and Peter Possing Andersen, Senior Analyst.

Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high

quality research based on research objectivity and independence. These procedures are documented in the Danske

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Danske Bank research reports are prepared in accordance with the Danish Society of Investment Professionals

Ethical rules and the Recommendations of the Danish Securities Dealers Association.

Financial models and/or methodology used in this research report

Calculations and presentations in this research report are based on standard econometric tools and methodology

as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be

obtained from the authors upon request.

Risk warning

Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis

of relevant assumptions, are stated throughout the text.

First date of publication

Please see the front page of this research report for the first date of publication. Price-related data is calculated

using the closing price from the day before publication.

DisclaimerThis publication has been prepared by Danske Markets for information purposes only. It has been prepared

independently, solely from publicly available information and does not take into account the views of Danske

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