EFTA01459048.pdf

The terminal rate will be lower than in the past but very likely higher than current market expectations The neutral rate has fallen since the crisis — but the rate implied by market pricing is consistent with a very pessimistic scenario Neutral rate estimates 4.50% • How high the Fed's policy rate eventually rises (i.e., 3-3.25% the terminal rate) is closely tied to the neutral rate 2.00% - A higher neutral rate means the Fed has to raise rates more to tighten financial conditions Market pricing DB Fed Pre-crisis* ■ Estimates suggest the neutral rate is currently very Neutral rate estimates are consistent with: low due to growth headwinds (e.g., fiscal drag, tight Potential growth 0.6% 1.75-2% 2-2.25% 3% credit, slow global growth), lower potential growth Productive 0% 1.25% 1.5% 2% ■ Neutral rate should rise as these headwinds fade -ty growth and potential growth improves... Source: C60. Laubach and Williams (2004 POMO. Deutsche Bank Research No (1Avg. 1995-2005 • ...But estimates suggest that the long-run neutral Several of the reasons for a lower terminal rate have faded rate will remain lower than in the past Reducing Rationale terminal rate? - Prior to the crisis the neutral rate was near 4.5% • Fiscal policy has shifted from a significant - Fed's estimate is currently 3.25-3.50%; we think Fiscal policy • drag to neutral it is somewhat lower (i.e., 3-3.25%) Private • Deleveraging slowed significantly: credit deleveraging • growth picking up • The market pricing of a terminal rate around 2% is Mortgage cre- • Still tight but showing some signs of consistent with a very pessimistic economic dit conditions • loosening scenario, assuming no rebound in potential growth Subdued • Global growth, giving less external impulse • As the market reprices the pace of hikes, it will also global growth O to US growth have to raise its view on the terminal rate Low potential • Still low but should rise modestly as growth O productivity picks up Deutsche Bank 12 Research Kiattetrihre.,="olt Note (e): FOMC committee's leadership (Yellen. Fischer and Dudley) kke1f expect only 3-4 hikes CONFIDENTIAL - PURSUANT TO FED. R. GRIM. P. 6(e) DB-SDNY-0119259 CONFIDENTIAL SDNY_GM_00265443 EFTA01459048