2015 06 AVM Rates Review

1 AVM RATES REVIEW June 2015 MARKET REVIEW UNITED STATES Sincelate2014,economicreleaseshave,inaggregate,surprisedtothedownside.Economic Surprise Indices quantify the difference between Economic releases and the markets consensus expectations.The history of the Bloomberg Economic SurpriseIndex is shown in Chart 1. As thisshows,thefirst-halfof2015hasseensome ofthemost negativeeconomicsurprisesseen overthepastfiveyears.Thesurprisesreachedalowinmid-Aprilbuthavelessenedinrecent months. Alongside the overall index, the surprises in the Bloomberg index are broken down into sectors. ThisisshowninChart2.Asthechartshows,inmid-April(shownbythedottedlines),data across a wide range of sectors were surprising to the downside.In contrast, the breakdown in the current data shows significantly positive surprises in Housing and Real estate but economic data from both the Retail/Wholesale sector and Business cycle indicators continue to show significant downside surprises. CHART 1CHART 2 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP Inaconfirmationoftherecoveryineconomicdata,therecentquarterhasseenarecoveryin GDPgrowth,whichhasreturnedtolevelsseeninmid-to-late2014.Anumberofeconomic commentators have suggested that the weakness in growth seen in Q1-2015 was due to weather related effects with the very cold winter negatively impacting economic growth. In the statement followingitsAprilFederalOpenMarketsCommittee(FOMC) meeting,theFederalReserve noted that: Economic growth slowed during the winter months, in part reflecting transitory factors. Bylinkingthegrowthslowdowntothewintermonths,theFederalReserveimplicitlysignaled that it believed that growth would recover in Q2 as: a)the negative effects of the severe winter weather on consumer spending waned 2 b)theexportdragfromacombinationoftheWestCoastportslowdownandthestrong dollar dissipated. The data in Chart 3 confirms the Feds intuition and shows Q2 2015 growth having recovered to 2.4% with consumption growth picking up to 2% and the drag in growth from investments and net exports being offset by a pickup in government spending. CHART 3CHART 4 Source: AVM, L.P., FRB AtlantaSource: AVM, L.P., FRB Atlanta WhatisinterestingisthepicturethatemergeswhentheGDPgrowthisbrokendownintoits components.ThebreakdownofGDPintocomponentsisshowninChart4.Itisbasedonthe CGIX framework implied from the Atlanta Feds now-casting model.As this shows, the fallin GDPgrowthfromQ42014toQ12015wasduetothecombinedeffectsofweaknessinthree components of growth (consumption, investment and exports). Let us look at some of the drivers of these components: 1. Consumption growthIt has been shown that the consumption component of growth is well supported by growth in real personal incomes. CHART 5CHART 6

Source: AVM, L.P., Bloomberg LP Source: AVM, L.P., Bloomberg LP 3 Inlate-2014,thedramaticfallinthepriceofgasolineprovidedsignificantaccelerationinreal personal income growth (see Chart 5). This in turn supported consumption growth (see Chart 6) in late-2014.However, sincelate-2014 and in-spite-of continuing high levels of growth in real personal income, consumption growth has weakened from its high of 3% at the start of 2015 to its current level of 1.8%. It should be noted that the growth in aggregate incomes is a function of the growth in three factors: (i)the total employed pool of labor;(ii)average hourly earnings; and (iii)total hours worked While the growth in both average hourly earnings and total hours worked is close to unchanged over the past year, the total pool of employed has increased steadily.As a result, much of the growth in aggregate income has come from the growth in the total pool of employees which has supported aggregaterealincome growth at close to 4%. Given the elevatedlevels ofgrowth of real income, consumption growth may revert to higher levels in coming months. 2. Investment and Export Growth Up untillate-2014, investment growth had contributed positively to GDP growth (See Chart 7). However, this turned into a dragin early 2015.The dramatic shiftininvestments from being a growth contributor to being a drag on growth appears to be correlated tolagged changes in the oil price with the drop in oil price leading to a pullback in oil-related investments. According to researchersatGoldmanSachs,theenergysectoraccountsforapproximatelyone-thirdofthe totalcapexofS&P500companies,andmuchhasbeenmadeofcapexbeingoneofthecore driversofgrowthincomingyears.InQ22015,investmentgrowthstabilizedatclosetozero.However, with oil prices remaining below $60/bbl (below the breakeven price level for much of theshaleproductionintheUS),itisunlikelythatoil-relatedinvestmentgrowthwillbea significantcontributortooverallgrowthincomingmonths.Thus,weneedtoseeabroader pickupinvestmentgrowthfromothersectorsoftheeconomyforinvestmentstobecomea positive contributor to growth. CHART 7CHART 8

Source: AVM, L.P., Bloomberg LP Source: AVM, L.P., Bloomberg LP 4 3. Export growth The other component of the drag on growth in Q1 was exports which slowed from contributing +0.5% to GDP in Q4 2014 to -1.0%in Q1 2015.The growth in this sector appears to be driven bychangesinthetradeweightedUS$(seeChart8).ThestabilizationoftheUS$inQ22015 helped reduce the growth drag in this sector. However, as the Federal Reserve begins to tighten ratesinthecomingquarter,growthinexportsislikelytobechallengedbyafurther strengthening of the US$. Looking ahead, it remains to be seen which components will lead growth given that: a)the US$ is expected to re-strengthen as the Fed moves to normalize rate policy and with globalgrowthcontinuingtolanguish,growthinnetexportsisunlikelytoaccelerate significantly from current levels; and b)investmentgrowthisunlikelytocontributesignificantlyunlessoilpricespush significantly higher Withthisoutlook,andwithgovernmentspendingunlikelytoexpandincomingquarters,this leaves consumption spending as the likely driver of growth. As Chart9 shows, consumption is stronglycorrelatedwiththe4-qtr%changeinaggregateincome.Since1985,Personal ConsumptionExpendituregrowthhashadacorrelationof85%withthegrowthinaggregate personal incomes. CHART 9CHART 10 Source: Goldman Sachs Source: AVM, L.P., Bloomberg LP In recent years, much of the growth in aggregate income has come from the growth in the total poolofemployees.However,withboththeU-3andthebroaderU-6unemploymentrates progressivelyfallingtowardslevelswherewagepressuresarelikelytoincrease(seeChart11 andChart12),aggregatepersonalincomemaypick-upinthecomingquartersduetothe combinedeffectsofbothanincreaseintotalemploymentandaccelerationinaveragehourly earnings.This should be supportive of the consumption and of overall levels of growth. Change (% yoy) 5 CHART 11CHART 12 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP Implications of monetary policy on yield curves Sincethestartof2014,themarket-impliedmonthstofirst25bpriseintheshort-termrate (derivedasthepointwheretheovernightFedFundsraterisesby25bp)hasbeenstrongly correlatedwiththefallintheU-3unemploymentrate(see Chart13).Asthechartshows,the unemploymentgap(i.e.,thedifferencebetweenthecurrentunemploymentrateandthenon-acceleratinginflationrateofunemployment(NAIRU)consideredbymarketconsensus to be 5% for the U-3 unemployment rate is likely to fall to zero at the end of 2015. This time period is consistent with market pricing of the point of first 25bp increase in the Fed Funds rate. CHART 13CHART 14 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP The fallin the months to first tightening has also been accompanied by a flattening of the yield curve.As Chart 14 shows, the spot [30Y-5Y] yield curve spread has decreased steadily from its high of near 200bps in March 2014 to a low of 70bps in March 2015.In March 2015, the market waspricedforthestartofthetighteninginshortratestobegininJuly-Sep2015.However, giventhegrowthslowdowninQ1,theFederalReserveattheMarchFOMCshowedaspilt between members calling for a near-term tightening and others wanting to hold back until 2016. 6 others anticipated that the effects of energy price declines and the dollars appreciation would continuetoweighoninflationinthenearterm, suggestingthatconditionslikelywouldnot be appropriatetobeginraisingratesuntillaterintheyear,andacoupleofparticipantssuggested that the economic outlook likely would not call for liftoff until 2016. ThelackofconsensusforaneartermtighteningwithintheFederalReserveledmarket participants to conclude that they were unlikely to tighten rates at their June meeting. This led to the recent re-steepening of the yield curve (see Chart 14). However,thisre-steepeningislikelyovergiventheproximityofthetighteninginthesecond half of 2015.The term structure of the curve is shown in Chart 15. As the chart shows, rates at the back end of the curve are higher relative to the start of the year. As we begin to price for the tightening, the front end of the yield curve is likely to shift higher and drive a re-flattening of the yield curve. CHART 15CHART 16 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP Implications of monetary policy on volatility Anotherinterestingfactoristheincreaseinvolatilityinforwardrates.AsChart17shows, realized volatility in front-end forward rates has risen considerably from its 2012-2013lows. In late-2014, realizedvolatility in front end forwards was elevated but realized volatilityin longer dated forwards was close to its 2012-2013 lows. However,withtheFederalReserveshiftingtoadatadependentstance,weexpectedvolatility levelsalongtheentiretermstructuretopickup.Thisappearstobehappeningoverthepast quarterwithelevatedlevelsofrealizedvolatilityinboththefrontendandthe backendofthe yield curve. We expect volatility levelsin the front end of the yield curve to shift higher as we start the tightening cycle. The critical element for this is how the Federal Reserve approaches the normalization of its short rate policy. If the Federal Reserve tightens by 25bp and then goes on hold for an extended period oftimethenvolatilitylevelsmayremainatcurrentlevels.However,ifthefirsttighteningisa pre-cursor to a series of tightenings at subsequent meetings which push short rates by +100bp to 7 +150bp over the next year then volatility levels along the entire term structure are likely to rise further as asset managers restructure their fixed income portfolios. In such a scenario, volatility is likely to be compounded by the liquidity constraints placed on dealer portfolios. CHART 17 Source: AVM, L.P., Bloomberg LP Summary Insummary,weexpecttheFederalReservetoimplementatighteningofitsratepolicyinthe second-half of 2015.This will likely lead to higher rates and a flattening of the yield curve and continued elevated levels of volatility. 8 MARKET REVIEW - EUROPE From mid-2014 to Jun-2015, spot inflation in both core- and peripheral-Eurozone countries has fallen(seeChart18)withinflationdeterioratingsuchthatanumberofcountriesarecloseto outrightdeflation.Withhighlevelsofunemploymentandmulti-yearfiscalausterityprograms across the Eurozone, output gaps remain wide. As a result, disinflationary and deflationary forces broadenedwithinflationacrossasignificantfractionoftheinflationbasketfallingbelow1% (seeChart19).Thedistributionofinflationacrossthebasket(showninChart20)clearly highlightsthebroad-basednatureofdisinflationwithveryfewsectorsoftheinflationbasket above the ECBs 2% target. HICP LEVEL (YoY, %)CHANGE IN YOY (%) CHART 18Jun14Jun15Jun14-Jun15 Eurozone+0.5%+0.2%-0.3% Germany+1.0%+0.1%-0.9% France +0.6%+0.3%-0.3% Italy+0.2%+0.2%0.0% Spain+0.0%0.0%0.0% Source: III Capital Management, Bloomberg LP CHART 19CHART 20 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP With regards to the inflation basket, the shift from disinflation in mid-2014 to outright deflation in early-2015 occurred in areas such as transportation, which shifted from inflating at +1% yoy inmid-2014to-4.2%inearly2015.Oneofthesignificantdriversofthedeflationin transportationcamefromtheweakeningofcommoditypricesinthesecond-halfof2014.The price of oil in EUR terms fell by 35% between September and December. This impacted not only spotinflationbutalsolongterminflationexpectations.AsChart22shows,medium-term inflationexpectations,asmeasuredbythe2yforward2Yinflationbreakeven,fellby approximately50bpinthesecondhalfof2014.Thedynamicsofmedium-terminflation expectations have been well correlated with the dynamics of oil prices. Throughout 2013-2014, members of the ECB have consistently voiced the view that they cannot 9 allow structural deflationary forces to take hold.Structural forces are characterized by being: a)broad based (i.e., across a broad range of prices); b)entrenched in expectations; andc)persistent (lasting a year or more). With a negative output gap keeping disinflationary forces in play, the first two components were alreadyevidentatthestartof2014.Sincethen,asspotinflationmovedlower,therewas increasing pressure on the ECB to increase the level of monetary stimulus and engage in a Large Scale Asset Purchase (LSAP) program to arrest the broadening disinflationary forces. CHART 21CHART 22 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP Until late 2014, the ECB had consistently resisted the pressure to undertake such a program and argued that, unlike the US, an increase in monetary accommodation would do little to benefit the Eurozonesbank-centriceconomy.TheECBhadarguedthatitmayactuallybe counterproductive by exposing the ECBs balance sheet to sovereign credit risk. Impact of ECBs LSAP on inflation and economic outlook By late 2014, with the deposit rate already negative and little risk premium in the term structure ofEuropeanforwardrates(thepointoffirsttighteninghasbeenpushedouttolate2018,see Chart 26), the ECB concluded that there is little that additional easing of short-rate policy could do to increase monetary accommodation.As a result, the ECB reversed its stance and started its firstassetpurchaseprogramwiththegoalofexpandingitsbalancesheetby1.14tn(12%of GDP) at the rate of 60bn per month.This, together with a 20% appreciation of oil prices, has helpedstabilizespotinflationatclosetozero.Alongsidethis,aseconomicgrowthstabilized, forward inflation expectations have increased strongly (see Chart 22). The expectation of an expansion of the ECBs balance sheet had led to a weakening of the trade-weighted EUR (see Chart 23) by approximately 10% in the second-half of 2014. The weakening of the currency helped to normalize inflation by increasing imported inflation and was supportive ofgrowththroughimprovedexportperformance.Thistailwindhasledtoaseriesofpositive economicsurprisesinearly2015.However,sincereachingmulti-yearlowsmid-March,the 10 trade-weighted EUR has stabilized and economic numbers are no longer surprising to the upside. CHART 23CHART 24 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP Impact of ECBs LSAP program on term structure of rates One of the effects of the implementation of the LSAP program has been the rally to lower rates across the term structure of the European yield curve. Chart24 shows the term structure of the German sovereign bond (Bunds) curve. From the start of the year, as the ECB pressed ahead withitsLSAPprogram,theGermansovereigncurveralliedtolowerratesandflattened significantly.German30Yearbondratesfelltotheirall-timelowyieldinmid-April,witha significantportionofthetermstructuretradingatnegativeyields.Alongsidethemoveinthe German curve, the term structure of the Euro swap curve also flattened significantly (see Chart 25) such that, by mid-April, the date of first 25bp tightening implied from the overnight-indexed swapsmarketwaspricedforJanuary2020(seeChart26)i.e.,thatmonetarypolicywould remain on hold for nearly five years. WhiletheECBhasgivenguidancetothemarketthatitintendstocontinuebalancesheet expansionuntilSeptember2016,theextrapolationbythemarketthatmonetarypolicywould remain on hold for over three years thereafter seemed to be at the limits of expectations. Also, with the ECBs deposit rateat -20bp, theoretically sovereign bond yields in secondary markets could rally until they reached -20bp.One of the fundamental problems faced by investors is that bonds purchased at negative yields, if held to maturity, will generate capital losses. With positive economic surprises, improving inflation expectations and with long-term sovereign bondyieldsatclosetonegativelevels,investorslostconfidenceinholdingGermansovereign bonds at close to negative yields.These concerns resulted in a 100bp increase in long term rates andareturn ofriskpremiumthroughare-steepeningofbothcoreandperiphery yieldcurves. This so-called value-at-risk (VAR) shock, characterized by a rapid shift higherin yield which increases the VAR risks associated with bonds, creates a vicious cycle whereby investors have to liquidate their holdings of sovereign securities to maintain their holdings within risk guidelines. Long-term Bund rates have pushed higher towards the levels seen in early October (prior to the announcement of the ECBs LSAP program, see Chart 24).Also, the term structure of the front 11 end of the swap curve is now atlevelslast seenin October (see Chart 25) and implies the first tighteningtobeinJuly2017(i.e.,approximately12monthsaftertheECBendsitsLSAP program).CHART 25CHART 26 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP Impact of ECBs LSAP program on risk assets Fromthestartoftheyear,theimplementationoftheLSAPprogrambytheECBimproved valuations of European assets such that by mid-April- a) peripheral bond spreads relative to Germany fell to multi-year lows (see Chart 27); b) the European Stoxx50 had risen by 27% for the year (see Chart 28);c)the5Yand5y5Yinterestratesforbothcore-andperipheral-sovereignsfelltotheirall-time lows (see Chart 29 to Chart 33) CHART 27CHART 28

Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP However, since mid-April, even with the ECB continuing to purchase assets at the rate of 60bb per month, longer dated interest rates (such as the 5y forward 5Y rate) pushed higher in both the core- and the periphery markets and the Stoxx50 moved lower by -5%. Alongside this, fears of Greeces exit from the Eurozone resulted in- 12 a)awideningofthebondspreadbetweenSpanish/Italian5Ybondyieldsrelativeto German 5Y bond yields (see Chart 27); b)asignificantunderperformanceofequitiesrelativetothepathimpliedby balancesheet expansion (see Chart 28). With the recent resolution of the Greek issue, risk asset valuations have stabilized. With the ECB continuing to purchase assets at the rate of 60bb per month, we expect riskassets richen with further compression of peripheral bond spreads and additional appreciation of the Stoxx50. Loan growth and the transmission of monetary policy Oneofthekeygoals oftheECBsLSAP programistoimprovethetransmissionof monetary policy across the Eurozone.With the ECB continuing to purchase sovereign bonds through its asset purchase programs, investors looking for yield may be forced to shift to lower tiers of the capital structure. This may result in a fall in loan rates and a tightening of bond spreads. CHART 29CHART 30 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP CHART 31CHART 32 Source: AVM, L.P., Bloomberg LPSource: AVM, L.P., Bloomberg LP 13 Over the past few months, loan rates in both core and peripheral countries have started to move lower(seeCharts29-33).Therecentselloffinlongerterm5yforward5Yyieldsispartlya normalization of the term structure of bonds and may be also the result of an increasein credit premiumassociatedwithGreecesexitfromtheEurozone.Ifso,thentherecentagreement between Greece and her creditors should help alleviate some of the widening pressure and result in a fall in longer term sovereign yields and with it a further fall in loan rates. One area that has consistently been highlighted as a limitation for the transmission mechanism in Europe is the critical role played by European banks in lending to NFCs.Traditionally European NFCshavereliedheavilyonbanksforaccesstoloans. However,inthecurrentenvironment, regulatoryconstraintsandimpairedbankloan portfolioshavemadeitharderforNFCstogain accesstofunding.Inthisenvironment,Europeanbusinesses,andhouseholdshaveavoided borrowing in recent years.After growing at an average annual pace of 8% in the pre-crisis years, household borrowing has been near flat in the past few years (see Chart 33 and Chart 34).This hasalsohelddowncoreconsumerspendingwhichhastrackedthesluggishpaceofcredit growth. CHART 33CHART 34 Source: AVM, L.P., Bloomberg LP Source: AVM, L.P., Bloomberg LP As Chart 33 shows, Credit growth is showing some signs of revival as the purchase of Sovereign bonds by the ECB leads investors to shift lowerin the capital structure and purchase high-yield loansandbondstogainyield.TheECBslargescaleassetpurchaseprogramishelpingto improveboththepriceandtheavailabilityofcredit.Webelievethatone possibleworkaround for credit growth in Europe would be to dis-intermediate the banks and restart the securitization market. FollowingtheUSsub-primecrisis,securitizationmarketvolumesfellsignificantlyacross EuropeastheEuropeanUnion(EU)implementedanumberofskin-in-the-gamerules.Thesedirectivesforcedoriginatorstoretainapartoftheloanriskandrequiredbanksand insurerstosetasidemorecapitalagainstsuchinstruments. Whilethereisnointentiontorelax thecore oftherules,LordHill,theEUsFinancialServicescommissioner,laidoutaseriesof options that would lead to a softening of capitaland risk retention requirements and revive the blocs moribund securitization market. 14 Summary As the ECB implements its LSAP program, we expect rates in Europe to remain low. Given the negativenetissuancepictureinEurope,weexpect boutsofidiosyncraticvolatilityastheECB buyback struggles to source the appropriate level of bonds. In addition, the divergence in growth and monetary policy paths between Europe and the US may weaken EUR FX against the USD. 15 MARKET REVIEW JAPAN Inpursuitofits2%inflationtarget,theBankofJapan(theBoJ)introducedqualitativeand quantitativeeasing (QQE) in April 2013 with net purchases of JGBs at therate of 50-60trn per year.QQE was expanded in October 2014 to increase net purchases to 80trn per year and to extend the average maturity of its assets to 7-10 years. As Chart 35 shows, the BoJs balance sheet is currently more than 60% of GDP, and if the BoJ continues with the current rate of purchases, then by year-end 2015, the balance sheet is likely to expand to 80% of GDP.This is similar in magnitude to the levels reached by the Swiss National Bank (SNB) before it abandoned the EUR currency peg in January 2015. CHART 35 Source: Bank of America The current pace of purchases (80trn per year)is basically accounting for the total annual net issuance of JGBs.This creates a dilemma for the banks: while they are obliged to cooperate with the BoJ and sell their holdings of JGBs, if they do so then they are penalized in two ways: a)Risk asset regulation results in an increase in capital charges should banks sell JGBs and buy equity or REITs; and b)Seasoned JGBs pay a palatable coupon while a shift into excess reserves would result in banksreceivinginterestonexcessreserves(IOER).Withloandemandtepidat best, this would have a negative impact on their net interest margin securities (NIMs). As a result of these limitations, the Presidents of Mizuho and Sumitomo Mitsui Financial Group have commented that each of their respective approximate 15trn holdings of medium and long-term bonds are at an appropriate level given their need for collateral.Thus, the BoJ may find that even if it wants to buy, it may struggle to do so. Insuchascenario,shouldtheBoJopttoreducepurchasesintheabsenceofadditional 16 mechanismstoincreasethemonetarybase,itwouldbeseenasaneffectivetighteningof monetary policy and inconsistent with BoJ Governor Kurodas aim of doing whatever it takes to hit its inflation target. In early 2013, with the new Abe administrationin place, the BoJ adopted ultra-loose monetary policies with the view that 2% core inflation could be attained by early 2015.One of the results of the loosening of monetary policy and the expansion of the BoJs balance sheet was the broad-basedweakeningofthetrade-weightedyen.Thisweakeningofthecurrencycreatedvery significant levels of inflation in imported goods which, as Chart 36 shows below, passed through to core CPI with a lag. CHART 36 Source: AVM, L.P., CSFB, Bloomberg LP However,withtheyenhavingstabilizedinearly2014,importpriceinflationsloweddown considerably;andwiththeweakeningofcommodity pricesinlate2014,Japanhasreturnedto outright deflation.As a result, market forecasters expect that import price deflation willlead to continuingslowdownincoreCPIthroughout2015withanexpectedreturnto deflationinQ3 2015 (see Chart 37). Incontrasttothe marketforecasts,inflationprojectionsfromtheBoJs Januaryboard meeting implyaturnaroundintheslowdownininflationfrommid-2015,andforinflationtoreachthe centralbankstargetof2%bytheendoffiscalyear2015,asshowninChart37.TheBoJs 17 turnaround in inflation is based on the view that the output gap in Japan isvery small and that wage rises are likely to lead to a structural increase in inflation. CHART 37 Source: AVM, L.P., CSFB, Bloomberg LP Throughoutthelasttwoyears,theBoJhastargetedtheexpansionofthemonetarybaseasa mechanism to increase inflation.As inflation slowed down in the second-half of 2014, the BoJ increased the rate of expansion of the monetary base.However,inflation has continued to fall since October, and it isincreasingly clear that the BoJs QQE framework has very little chance of achieving the stated goal of achieving 2% inflation within two years. It is likely that, should the path of inflation follow the expectations of market participants and not theexpectationsoftheBoJ,thecentralbankmayrespondwithadditionalmonetarystimulus laterthisyear.However,itisalsopossiblethat,giventheslowdownininflationandthe expectedreturntoneardeflationarylevelslaterthisyear,theefficacyoftheBoJsgoalof expanding the monetary base to generate inflation may come into question. The increasing technical limitations faced by the BoJ in expanding excess reserves may result in the BoJ being forced to slow down or even abandon its current approach and to possibly shift to an entirely new monetary framework.If the BoJ is reluctant to acknowledge that QQE has been a failure, then one possible additional step may be to adopt a zero or even negativelending rate 18 forloanstoprivatesectorbanks.Itispossible,althoughwebelieveunlikely,thattheBoJ acknowledgesthefailureofitsmonetarybaseexpansionprogramingeneratinginflationand shifts to an entirely new monetary framework.Such a move would have significant implications for global rate, FX and equity markets and, in our view, would likely result in a very significant increase in volatility. 19 Important Disclaimer ThismaterialisnotanofferorasolicitationforanymanagedaccountorfundproductofIIICapital Management(III). Suchanofferorsolicitationcanonlybemadepursuanttotheapplicableoffering document and otherwise in accordance with applicable futures and securities laws. Thismaterialis intendedtoreport solely ontheinvestmentstrategies andopportunitiesidentifiedbyIII. Additional information is available upon request. Information herein is believed to be reliable, but III does notwarrantitscompletenessoraccuracy.Opinionsandestimatesconstituteourjudgmentandare subject to change without notice. Past performance is not indicative of future results.The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. III, its employees, its affiliates and/or its affiliates advisory clients (including the III funds and other clients ofIIICapitalManagement)mayholdapositioninanyofthesecuritiesandfinancialinstruments discussed herein, or in other securities or instruments of any issuer discussed herein. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investmentrecommendations.Changesinratesofexchangemayhaveanadverseeffectonthe value, priceorincomeofinvestments.Certaininvestments,includingthoseinvolvingstructuredproducts, futures, options and other derivatives, are complex, may entail substantial risk and are not suitable for all investors.Thepriceandvalueof, andincomeproducedby,securities andotherfinancialproductsmay fluctuateandmaybeadverselyimpactedbyexchangerates,interestratesorotherfactors.Priorto effecting any transaction in options or options-related products, investors should read and understand the currentOptionsClearingCorporationDisclosureDocument,acopyofwhichmaybeobtainedupon request from III. Allcasestudiesareshownforillustrativepurposesonlyandshouldnotberelieduponasadviceor interpreted as a recommendation. Results shown are not meant to be representative of actual investment results. Any securities mentioned throughout the presentation are shown for illustrative purposes only and should not be interpreted as recommendations to buy or sell. ThiscommunicationisissuedbyIII,whichisregulatedintheUnitedStatesbytheSecuritiesand ExchangeCommissionandtheCommodityFuturesTradingCommission.Accordingly,thisdocument shouldnotbecirculatedorpresentedtopersonsotherthantoprofessionalorinstitutionalinvestorsas defined in the relevant local regulations. III Capital Management 777 Yamato Road | Suite 300 | Boca Raton, FL 33431 2015 III Capital Management FOR INSTITUTIONAL USE ONLY | NOT FOR PUBLIC DISTRIBUTION