JP Conklin 704-887-9880 office jp.conklin@pensfordfinancial.com www.pensfordfinancial.

com Leveling the Playing Field October 24, 2011 _______________________________________________________________________ The passing of one of longest tenured dictators has many celebrating, but not me. I am one of those fortunate souls that can run a sub-4.30 40 yard dash, and with no more Al Davis, who will draft me? Oh, whats that? You thought I was talking about Gaddafi? No, Im glad hes gone. Rates are under some upward pressure lately, in part to Europe refusing to collapse. Nothing dramatic, but rates moved slightly higher on the week. Take a look at the section below on Melt Up and it may help explain why we think rates are headed higher through year end.

Fed Speak Although recent data has been generally better than expected and suggest moderate growth, Fed speakers have reinforced that unemployment remains at unacceptably high levels. We expect a more formal policy framework to be unveiled at the November FOMC meeting with specific inflation and unemployment thresholds. Fed Vice Chairman Yellen reiterated Chicago Fed President Evans earlier statement that the Fed will keep rates at 0% until the Unemployment Rate falls below 7% or outlook for inflation. She also noted that additional securities purchases might become appropriate if her forecast for a modest pickup fails to materialize. Additionally, Evans/Rosengren/Tarullo have all signaled they would support additional quantitative easing. Tarullo said there is need, and ample room, for additional measures to increase aggregate demand in the near to medium term. He also called the current labor market a crisis just like those fans of a certain South Bend team might be experiencing. But what happened to the Feds plan (mainly Bernanke) of leaning on Washington to enact fiscal policies to help with the economy? Tarullo said this is still ideal but the absence of such policies cannot be an excuse for the Federal Reserve to ignore its own statutory mandate. For these reasons, we believe QE3 will be rolled out at the December or January FOMC meeting.

On Tuesday, Tim Geithner said the US cannot overhaul tax code in two months. If the past is any indicator, we should have a brand new tax code by year end. Now if I could just get Timmy to say The Eagles will NEVER make the playoffs just like he assured us the US would never lose its AAA rating. From the Department of WTF, Merkel canceled her EFSF statement on Thursday and markets didnt seem to care. So, the only country strong enough to bail out the entire Eurozone continues to send mixed signals about its desire to provide a bailout and markets react nonchalantly? Maybe people are just tired of being negative? And then on Friday the German Parliament limited the countrys bailout commitments and rejected any deal that would effectively transform the EFSF into a commercial bank. And what was the result? US equities were up 2%. WTF? Moodys announced it is set to review French triple-A rating, and like weve been saying all along, we expect a downgrade at some point. Moodys also said there is no way for Greece not to default. Meanwhile the Misery Index is up to 13.0, the highest reading since 1983.

Melt Up I learned a new phrase this week from TBTIEK (The Best Trader Ive Ever Known). I heard PIMCO had sold equities and bought fixed income in insane size from one of my contacts. When I contacted TBTIEK to ask what he thought, he said he wished he was big enough to take the other side and save PIMCO the transaction costs. When I asked him to explain why he felt this way, he responded: I'm pretty agnostic here believe it or notI still think there's a significant non-zero chance that we have a risk melt-up into year-end as everyone is negative and no-one is positioned for a bouncecould see 1350-1400 S&Pbeen buying some out of the $ calls and I'm short the euro against the swiss franc as i think the markets going to test the SNB's resolve around defending the 1.20 level. Rates are a super boring trade to me herethe Fed's buying coupled with dealer's risk aversion is going to keep the market contained on the downside (as dealer's aren't going to aggressive trade until 2012), but I still can't see owning fixed income at negative real rates as an investmentclearly pensions/ins companies/fed have buying mandate but anyone that doesn't have to own fixed income is better off not owning treasuries in my view. When I asked him to explain (because Im slow) what he meant by melt-up he suggested that everyone still remembers the lessons from three years ago. We tend to forget what happened a decade ago, but not just three years ago. So the European crisis has everyone on edge and short the markets. As Europe continues to avoid implosion, short positions get squeezed out and markets actually move higher. Hence, a melt up.

Hes up 29% since he started his own fund a few months ago, so I listen to what he says. I should have him draft my fantasy football team, which has one win and is a 41 point dawg this weekend. Year End Trade Idea If you need to free up some cash flow heading into year end, you may want to consider modifying an existing swap to drop the rate lower for the next two months and pay a higher rate at a later date. For example, lets assume you have a $10mm swap at 5.00% and could use some short term cash flow relief. If we can negotiate a temporary 2.00% reduction for two months, that would save $33,000 in November and December. Now, you have to add this back in at some later point in the swap, but the point is we can defer interest to help with cashflow for 2011. And if youre one of the lucky companies out there that would actually like to reduce net income this year, you can do the exact opposite. You could increase the rate over the next two months and in exchange lower the rate at some other point of the swap. Please give us a call to discuss these cash flow ideas.

LIBOR Outlook Our projection is for 3m Libor to rise as high as 45 bp by late October, and push above 55 bp by year-end.- BNP Research 10.17.11 From the same report: In periods of little market stress, the distribution of the quotes tends to be skewed upwards - meaning the difference between the highest quote and the setting is greater than the difference between the lowest quote and the setting. As funding pressures have escalated, the quotes now have a pronounced downward skew - the lowest quotes are much farther below the setting than the highest quotes are above it. Since funding stress re-emergerd in mid-July, the dispersion of 3m Libor quotes has also become quite "gappy," and the rank order of the bank quotes has shifted considerably. The contrarian signal to the steadily rising 3mL setting is coming from HSBC, which has recently been lowering is quoted borrowing rate. Shorter-term unsecured rates such as 1mL are under less pressure, and the spread between 1mL and 3mL is likely to continue to widen. The recent Euro sovereign downgrades will likely put additional pressure on the ratings, credit spreads and financing conditions for Euro-area financials, particularly those banks in the affected countries or with considerable exposure to them.

Although we almost never recommend one year swaps, it may make sense to swap a portion of your debt through December 2012 at approximately 0.50% to protect yourself in the event of a LIBOR run up.

Fixed Rate Outlook Were at the top end of the range over the last two months, but keep in mind what TBTIEK said about a risk melt up heading into year end. If hes right, that means rates can move higher from here. As people pull money out of Treasurys to chase risk assets, rates move higher. A 10yr Treasury at 2.50% seems entirely reasonable by year end. Operation Twist is doing an effective job of flattening the yield curve. Check out what has happened to the spread twixt 10T and 30T in the graph below. Thursday and Friday are bringing about a reversal and the curve may steepen in the near term, but Im wary about fighting the Fed and would expect the spread to compress over the long term.

This Week Very full week of data ahead, most notably the advance release of GDP for Q3, which should come in around 2.3%. Durable Goods should see a boost from Boeing orders and hopefully Consumer Confidence will rebound from historically low levels and reflect the recent uptick in data strength. Unfortunately, there are also a several data points on housing which will likely remain very weak. Biggest speech of the week is on Monday when NY Fed President Dudley gives his views on the economy, policy, and Eurozone issues. Treasury auctions beginning Tuesday.

Wells Fargo mixed up about 4,000 monthly statements between customers and then blamed it on a faulty printer, which has since been decommissioned according to the bank. That surprises me, because WFC tends to decommission the good printers and promote the broken ones

ECONOMIC CALENDAR
Economic Data Day Monday Tuesday Time 8:30AM 10:00AM 10:00AM 10:00AM Wednesday 7:00AM 8:30AM 8:30AM 10:00AM 10:00AM Thursday 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 10:00AM 10:00AM 11:00AM Friday 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 9:55AM Report Chicago Fed Nat Activity Index Consumer Confidence House Price Index MoM Richmond Fed Manufacturing Index MBA Mortgage Applications Durable Goods Orders Durables Ex Transportation New Home Sales New Home Sales MoM GDP QoQ (Annualized) Personal Consumption GDP Price Index Core PCE QoQ Initial Jobless Claims Continuing Claims Pending Home Sales MoM Pending Home Sales YoY Kansas City Fed Manufacturing Activity Personal Income Personal Spending PCE Deflator (YoY) PCE Core (MoM) PCE Core (YoY) U. of Michigan Confidence 0.2% 1.7% 58.0 0.3% 0.6% -0.1% 0.2% 2.9% 0.1% 1.6% 57.5 0.3% -0.7% 0.5% 300k 1.7% 2.3% 1.9% 2.4% 2.2% 46.0 Forecast Previous -0.43 45.4 0.8% -6 -14.9% -0.1% -0.1% 295k -2.3% 1.3% 0.7% 2.5% 2.3% 403k 3719k -1.2% 13.1%

Speeches and Events Day Monday Time 8:45AM 9:00AM 1:00PM Wednesday 5:15PM Report Fed's Dudley speaks on the Economy in the Bronx Fed's Fisher speaks in Toronto on U.S. Economy Fed's Dudley speaks to Bronx Chamber of Commerce Bank of Canada Governor Carney speaks Place Bronx, NY Toronto, Canada Bronx, NY New York, NY

Treasury Issuance Day Tuesday Wednesday Thursday Closing 1:00PM 1:00PM 1:00PM 2 year Treasury 5 year Treasury 7 year Treasury Issues Size $35B $35B $29B

BLOOMBERG SURVEY RESULTS Fed Funds

3.50%
3.00% 2.50% 2.00%
Median Average High Forecast Low Forecast

1.50% 1.00%
0.50% 0.00% 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013 2Q 2013

10 Year Treasury
6.00% 5.50% 5.00% 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013 2Q 2013

Median Average High Forecast Low Forecast

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