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Quarterly Economic ReportInside views on economic and market factorsaffecting global markets and business healthQ3 2018

0718-0177DMEXP063019SVB Asset Management | Quarterly Economic Report Q3 2018 2

Economic Report: Q3 2018

3 Thoughts From the Desk

4 Domestic Economy

11 Global Economy

17 Central Banks

23 Markets and Performance

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Thoughts From the Desk

SVB Asset Management | Quarterly Economic Report Q3 2018 3

Volatility in the U.S. bond market retreated in the second quarter while the U.S. Treasury curve flattened 15 basis points as a result of additional Fed tightening and increased geopolitical uncertainty. With strong economic fundamentals, labor market tightness and inflationary readings arriving at the Fed’s preferred target — after a long and slow march, the Fed delivered another 25 basis points in June and a hawkish tone that was more than markets had anticipated. Policy makers’ new economic assessment now sets the stage for two additional rate hikes by the end of the year. The Fed also implied, through its dot plot, it expects to raise rates three times in 2019. Although strong economic performance garnered headlines during the quarter, it was largely upstaged by increasing political tensions abroad.

From tariffs on imported European steel and aluminum to an escalating tit-for-tat trade war between the U.S. and China, the prospects of a full-fledged trade war will bring downside risk to future growth. The tariff tiffs were initially seen as limited in size and reach, but when temporary exemptions were eliminated, retaliatory tariffs followed from the EU, Mexico and Canada. More headlines came when additional tariffs were announced against products imported from China. Early estimates indicate these tariffs could deduct one full percentage point from U.S. GDP with even more severe impact to other advanced and emerging economies. Additionally, these potentially non-growth induced inflationary factors could force the Fed’s hand and accelerate the removal of monetary accommodations, which in turn would slow the economic engine.

The slope of the yield curve was a closely monitored indicator during the quarter as the spread between the yields on the two-year and 10-year U.S. Treasury notes compressed to 33 basis points to close the quarter. Thus far, the flattening of the yield curve can largely be attributed to rate increases by the Fed. As the curve flattened during the quarter, total return was mostly positive across all fixed income sectors except for corporate credit. In the quarter, total return of the broad investment grade (IG) corporate credit underperformed U.S. Treasuries as the spread widened as a result of increased M&A-induced supply in the industrial sector. Despite higher corporate yields, the additional credit income over Treasuries was not enough to overcompensate the headline risk of M&A rumors.

On balance, growth rebounded after a slow start to the year with three to four percent U.S. GDP growth anticipated in Q2. On the other hand, the synchronized global growth story is showing signs of fatigue just as Central Banks such as the ECB and the Bank of England committed to ending their asset purchase programs and rate hikes to follow in the near horizon.

The uncertainties around the impact of tax reform at the corporate and individual levels and mounting concerns around a global trade war support our strategy to favor high-quality credits. As central banks remove monetary accommodations, we will selectively add duration but with the overarching goal of staying duration defensive to help minimize portfolio volatility.

4

Domestic Economy

SVB Asset Management | Quarterly Economic Report Q3 2018

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Overview


The U.S. economy grew by 2.0 percent in Q1 2018, the strongest first quarter reading in three years. Growth was driven by nonresidential investment. The economy continues to benefit from reduced taxes and steady wages propelled by a tight labor market. However, the recent trade conflicts have the potential to hamper future growth.

The unemployment rate touched an 18-year low of 3.8 percent in Q2. However it closed the quarter at 4.0 percent as more participants entered the workforce. The United States continues to add jobs, with an average of over 200,000 jobs per month added in the first half of the year.

The U.S. housing market continues on stable footing; existing home supply has improved from earlier in the year and, despite rising mortgage rates, total home sales are steady.

As the second half of the year kicks off, all inflation measures are finally at or above 2.0 percent. The acceleration in inflation further supports the Fed’s stance towards monetary policy normalization and the shift towards a total of four interest rate hikes in 2018.

Domestic economy

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-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018

Perc

enta

ge ch

ange

Personal consumption Gross private domestic investment Net exports Government GDP

The U.S. economy grew by 2.0 percent in Q1 2018, the strongest first quarter reading in three years. Growth was driven by nonresidential investment. The economy continues to benefit from reduced taxes and steady wages propelled by a tight labor market. However, the recent trade conflicts have the potential to hamper future growth.


GDP: Strong start to the year

GDP and Components

Source: Bureau of Economic Analysis, Congressional Budget Office and SVB Asset Management. Data as of 7/3/2018. GDP values shown in legend are percent change vs. prior quarter, on an annualized basis.


Consumption: Temporary pauseThe consumer retreated in Q1; however, as the economy moves into the second half of the year expectations are for the consumer to pick up again. Recent retail sales numbers show that sales have accelerated and should drive growth as theyear progresses.

Consumption Overview

Source: Bloomberg and SVB Asset Management. Data as of 7/3/2018.

Retail and Food Service Sales

5.0 7.0 9.0 11.0 13.0 15.0 17.0 19.0 21.0 23.0 25.0

250.0

300.0

350.0

400.0

450.0

500.0

550.0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Vehi

cle

sale

s ($

mill

ions

)

Reta

il an

d fo

od se

rvic

es sa

les (

$ bi

llion

s)

Retail and food services sales Vehicle sales

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20.0

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60.0

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140.0

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2.0

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2010 2011 2012 2013 2014 2015 2016 2017 2018

Perc

ent

Perc

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Personal consumption Household debt to disposable income ratio

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78

79

80

81

82

83

84

85

60

62

64

66

68

70

2001 2003 2004 2005 2006 2007 2008 2010 2011 2012 2013 2014 2015 2017 2018

Perc

ent

Perc

ent

Labor force participation rate Labor force participation rate 25 to 54-year-olds

-5.0

-2.0

1.0

4.0

7.0

10.0

-300.0

-100.0

100.0

300.0

500.0

700.0

2010 2011 2012 2013 2014 2015 2016 2017 2018

Perc

ent

Thou

sand

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Non-farm payroll Unemployment rate


Employment: Healthy balanceThe unemployment rate touched an 18-year low of 3.8 percent in Q2. However it closed the quarter at 4.0 percent as more participants entered the workforce. The United States continues to add jobs at a heathy pace, with an average of over 200,000 jobs per month added in the first half of the year. Furthermore, the labor force participation rate for 25 to 54-year-olds shows a strong pace of growth the last few years.

Employment Landscape

Labor Force Participation

Source: U.S. Bureau of Labor and Statistics, Bloomberg and SVB Asset Management.Data as of 7/6/2018.


U.S. Housing: Stable footingThe U.S. housing market continues on stable footing; existing home supply has improved from earlier in the year and, despite rising mortgage rates, total home sales are steady.

Home Sales and Supply


Home Prices — Indexed to 100

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2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Thou

sand

s ($)

Median home price FHFA purchase Case-Schiller 20 city

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

3.0

4.0

5.0

6.0

7.0

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9.0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Hom

e su

pply

(mon

ths)

Hom

e sa

les (

$ m

illio

ns)

Total sales (new and existing) Existing home supply

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0.00.51.01.52.02.53.03.54.04.55.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Perc

ent c

hang

e fro

m p

rior y

ear

Core PCE Fed core PCE target Average hourly earnings


Inflation: Bulls eyeAs the second half of the year kicks off, all inflation measures are finally at or above 2.0 percent. The acceleration in inflation further supports the Fed’s stance toward monetary policy normalization and the shift toward a total of four interest rate hikes in 2018.

Core PCE Below the Fed’s Target While Wage Pressure Could Pick Up


Oil Prices

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1.0

2.0

3.0

4.0

5.0

0.0

20.0

40.0

60.0

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100.0

120.0

140.0

160.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Pric

e pe

r gal

lon

($)

Pric

e pe

r bar

rel (

$)

Crude oil Daily national average of gasoline prices

11

Global Economy


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Overview


Global economyEconomies across developed and emerging markets are experiencing positive growth, with few exceptions. This synchronized expansion is particularly supportive for large multinational corporations who have broad geographic reach.

Mild inflation provides scope for easy monetary conditions to be normalized, though some emerging economies are facing challenges with a stronger U.S. dollar.

In the eurozone, all economies are in growth mode, though the pace of expansion is slower among the three largest countries.

The U.S. dollar experienced broad strength over the past few months, as the Fed’s tightening actions contrast with no significant near-term monetary policy changes in other developed countries, including in the U.K. and the eurozone.

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-1

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1

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Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18

Perc

ent c

hang

e ye

ar-o

ver-y

ear

Real GDP, adjusted Core inflation


Europe: Glass is half fullThe eurozone remains firmly in growth mode, with all member countries posting multiple consecutive quarters of positive year-over-year growth. The economic expansion has been slow and steady, leading to a low rate of inflation and allowing the European Central Bank (ECB) scope to continue a loose monetary policy. Growth rates within the eurozone's three largest economies are expanding below 2.0 percent recently. Spain, aided by strong exports, and Ireland, where consumer spending and construction activity are both thriving, have been outperforming. Smaller Eastern European countries remain robust contributors to the eurozone expansion.

Slow and Steady Growth With Low Inflation

Source: Eurostat. Data as of 6/28/2018.

Eurozone Growth: Some Faster, Some Slower

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%

Italy Belgium Portugal France Germany Greece Finland Netherlands Spain Austria Lithuania Slovakia Cyprus Estonia Malta Slovenia Latvia Ireland*

Perc

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hang

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ar-o

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, adj

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Domestic Q1 2018 GDP Eurozone Q1 2018 GDP

*Data for Q4 2017

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10152025303540

Other Energy supply Pensions Taxes Inflation The environment EU worldinfluence

Crime Climate change Unemployment Public finances Economy Terrorism Immigration

Perc

enta

ge o

f res

pons

es

What do you think are the two most important issues facing the EU at the moment?


Europe: Subpar demand and politics are drags Domestic demand has been at under capacity, reflected partially by imports consistently below exports, which has contributed to a persistent current account surplus. This surplus has been a barrier to significant euro currency weakness despite years of near zero interest rates. The relative strength of the euro has helped to keep a lid on inflation, which in turn has kept ECB policies dovish. The eurozone has also experienced political developments that have created uncertainty for financial markets, driven by concerns over immigration and terrorism.

Persistent Current Account Surplus Reflects Subpar Demand

Survey Says: Immigration and Terrorism Top Concerns For EU

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10

20

30

40

50

Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Apr-18

Billi

ons (

euro

), ad

just

ed

Trade balance Net current account

Source: European Central Bank, Eurostat and European Commission(Standard Eurobarometer 88). Data as of 6/28/2018.


Greenback Outperforms Despite HeadwindThe USD index outperformed in Q2 as solid momentum in the U.S. economy allowed the Fed to become more hawkish and lifted expectations for higher interest rates until 2020, coupled with various global regions' diverging economic growth at differing rates. The rise in trade tensions and geopolitical risks also provided support for the USD as a safe haven alternative. With heightened sensitivity to policy uncertainties, markets tend to overreact by factoring in extreme tail risk scenarios. The focus is back on the probable tit-for-tat retaliations that could transpire into an all out trade war with the potential for some countries to take extreme measures by devaluing their currencies or selling foreign assets.

U.S. Dollar Index (DXY)

Source: Bloomberg, Silicon Valley Bank and SVB Asset Management. Data as of 6/29/2018.

U.S. Trade Policy Uncertainty

88

89

90

91

92

93

94

95

96

Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18

USD

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Jul-98 Apr-99 Jan-00 Oct-00 Jul-01 Apr-02 Jan-03 Oct-03 Jul-04 Apr-05 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10 Apr-11 Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Oct-15 Jul-16 Apr-17 Jan-18

Polic

y Un

cert

aint

y In

dex


Euro and Pound: Geopolitical risks aheadEUR/USD has retraced lower in Q2 due to USD strength and slowing growth outlook in recent months. On June 14, the ECB announced that they would end asset purchases in December but at the same time lowered growth and inflation forecasts. Interest rates are not expected to rise until at least mid 2019, which caught the market by surprise as it was a unanimous vote. Meanwhile, uncertainties over migration policies in Europe, Brexit and politics in Germany and Italy have elevated tail risks for the common currency.

U.S. Dollar Per One Euro (EUR)

Source: Bloomberg, Silicon Valley Bank and SVB Asset Management. Data as of 6/29/2018.

U.S. Dollar Per One British Pound (GBP)

In the U.K., the reversal in GBP/USD has been just as devastating, with cable reaching a seven-month low. USD strength, softer U.K. growth and inflation plus the lack of confidence over Bank of England’s ability to raise rates with ongoing Brexit negotiations have leveled the pound. With only nine months left until the end of the EU transitional period and with a divided U.K. cabinet, it has become a gargantuan task to make any meaningful progress on Brexit.

1.14

1.19

1.24

1.29

Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18

USD

1 EUR to USD

1.3

1.32

1.34

1.36

1.38

1.4

1.42

1.44

Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18

USD

1 GBP to USD

17

Central Banks


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Overview


Hawkish sentiment continues to build across the global monetary policy landscape. Recent projections from the Federal Reserve imply two additional rate hikes of 25 basis points in 2018, for a total of four hikes, with three more hikes penciled in for 2019. Front-end Treasury yields continue to rise as a result.

A synchronized global recovery and improving growth outlooks have tempered versus the start of the year as trade tensions bubble up and monetary policy accommodation has surpassed an inflection point. At its June meeting, the European Central Bank announced a tapering of its asset purchase program, beginning in September and concluding by December 2018. At the same time, with a dovish tilt, Mario Draghi, president of the ECB, announced that the deposit rate would remain unchanged through the summer of 2019.

Uncertainties still remain, such as the ultimate impact of corporate and individual tax reform, timing and uses of repatriated corporate cash, further policy changes such as healthcare reform and infrastructure spending and how the Fed progresses on its path of policy tightening. The Fed is well underway on its tightening cycle, and its unprecedented balance sheet reduction is smoothly progressing.

Central banks

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Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18

Perc

ent

2-year Treasury note 1-year Treasury yield Fed funds midpoint

Historical Interest Rates


Fed policy normalization and the resultant policy rate hikes have elevated yields in the front end of the U.S. fixed income market.

3Q17: Treasuries broke out of their recent trading range as hawkish comments reverberated across central banks. Projections from the Federal Reserve implied one additional rate hike of 25 basis points in 2017 with three more to follow in 2018.

1Q18: As expected, the FOMC raised rates at their March meeting and communicated their belief that growth and inflation will accelerate in the U.S. economy. Median committee projections showed three rate hikes in 2018 at that point.

4Q17: Treasury yields continued their ascent as the FOMC raised rates at their December roundtable and again communicated median committee projections for three hikes in 2018

Fed rate hike


2Q18: Treasury yields marched higher,as the FOMC met expectations by raising rates at their June meeting. In contrastto March, median FOMC member projections increased to four totalrate hikes in 2018.

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Central Bank Economic Projections


Global growth and employment remain strong and synchronous, while inflation remains relatively subdued.

Source: Federal Reserve, European Central Bank, National People’s Congress of China, Bank of Japanand Bank of England. Data as of 6/29/2018. Forecasts are not available for all periods.

Economic projections 2017 2018 2019

United States

Change in real GDP 2.3% 2.8% 2.4%

Unemployment rate 4.4% 3.6% 3.5%

Core PCE inflation 1.5% 2.0% 2.1%

United Kingdom


CPI inflation 2.7% 2.2% 2.1%


Eurozone


CPI inflation 1.5% 1.7% 1.7%


China

Change in real GDP 6.9% 6.5%

CPI inflation 1.6% 3.0%

Unemployment rate 3.9% 4.5%

Japan


Core CPI inflation 0.8% 1.3% 2.3%

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0.0

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202020192018 Longer Term

Dec-17 Mar-18 Jun-18

Recent FOMC meetings have indicated a steeper path of interest rate hikes, with current projections implying four rate hikes this year and anotherthree in 2019.

The FOMC Dot PlotCurrent and historical Fed projections for the federal funds rate (median rate)

Federal Reserve Rate Projections

21

Committee members’ projections for the path of the federal funds rate.

SVB Asset Management | Quarterly Economic Report Q3 2018Source: Bloomberg and Federal Reserve. Data as of 6/29/2018. Median rate references forecasted rate at the end of each period.

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Central Banks: No traffic on the offramp


Solid employment gains, positive economic growth and mild inflation allow central banks to maintain a gradual approach to normalization. The measured pace of change provides for accommodative financial conditions to absorb road bumps, including ambiguity arising from political developments.

Source: Federal Reserve, European Central Bank, Bank of England, The People’s Bank of China,Bank of Japan, Bloomberg and SVB Asset Management. Data as of 7/2/2018.

Analysis

JAPAN: Inflation inching up but well below target, even as unemployment is at a 25-year low. No change to easing policy.

EU: ECB will end asset purchase program by year-end. Committed to not raising rates beforeSeptember 2019.

CHINA: Conditionally cut reserve requirements by 50basis points. Chinese financial conditions have weakened recently, while small business activity has slowed.

UK: Domestic demand is firm, helped by a strong labor market. Inching toward a rate hike by September. Committed to keeping monetary conditions loose.

US: Strong employment conditions increase odds of interest rate hikes in September and December.

-0.07%

0.00%

4.35%

0.50%

2.00%

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1.40%

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0.50%0.70%

2.00% 1.80%2.40%

2.80%2.20%

7.00%

3.86%4.20%

3.80%

-1.00

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Benchmark interest rate Consumer spending – MoM change Growth rate – QoQ change Inflation – YoY change Unemployment rate

23

Markets and Performance


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Overview


Markets and performanceThe U.S. economy continues to post solid data as positive domestic growth persists, labor markets remain strong and inflation is gaining momentum. This has led the Fed to continue its policy tightening translating to higher interest rates across the yield curve, particularly on the front-end.

The underperformance in long duration credit was technically driven by heavy bond issuance and increased risks from M&A activity, both of which add to supply, impair credit metrics and raise liquidity concerns. However, short duration assets continue to perform well due to strong demand caused by expectations for higher interest rates.

The Dodd-Frank Act rollback effort has gained traction with the enactment of the Economic Growth, Regulatory Relief and Consumer Protection Act, which provides regulatory relief for thousands of small and medium-sized banks with minimal impact to large global banks.

The legislation preserves the Dodd-Frank Act requirement for systemically important banks with over $250 billion in assets, which will continue to be subject to enhanced prudential standards. The Fed would retain the discretionary authority to apply enhanced prudential standards for banks with $100 billion-$250 billion in assets.

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Broad Market Performance

25

All returns above are on a total return basis. 2018 YTD returns are on an aggregate basis up to 6/29/2018. U.S. Aggregate refers to Bloomberg Barclays Aggregate Bond Index; U.S. High Yield refers to Bloomberg Barclays U.S. High Yield Index; Gold refers to S&P GSCI Gold Spot; Crude Oil refers to Spot West Texas Intermediate Crude Oil; Wilshire refers to Wilshire 5000 Total Market Index; REIT refers to MSCI US REIT Index; S&P 500 refers to S&P 500 Index.

Asse

t cla

ss re

turn

s

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD

Crude Oil78.00%

Gold29.67%

Gold10.23%

REIT 16.47%

Wilshire 33.06%

REIT 28.24%

S&P 500 1.40%

Crude Oil 44.80%

S&P 500 21.80%

Crude Oil 22.6%

U.S. High Yield58.21%

REIT26.97%

Crude Oil8.15%

Wilshire16.05%

S&P 500 32.39%

S&P 500 13.69%

REIT 1.30%


Wilshire 21.00%

Wilshire 3.00%

Wilshire 28.29%

Wilshire 17.18%

U.S. Aggregate7.84%

S&P 500 16.00%


Wilshire12.70%

Wilshire0.70%

Wilshire13.40%

Gold13.70%

S&P 500 2.60%

S&P 500 26.46%


REIT 7.48%


Crude Oil7.32%

U.S. Aggregate5.97%

U.S. Aggregate0.55%

S&P 500 12.00%

Crude Oil 12.50%

REIT 0.50%

REIT 26.27%

Crude Oil 15.10%


Gold 6.96%

REIT 1.26%


U.S. High Yield-4.47%

Gold8.60%



Gold 23.96%

S&P 500 15.06%

S&P 500 2.11%

U.S. Aggregate4.21%

U.S. Aggregate-2.02%

Gold -1.51%

Gold -10.50%

REIT 7.10%

REIT 3.70%

U.S. Aggregate-1.62%

U.S. Aggregate5.93%

U.S. Aggregate6.54%

Wilshire 0.98%

Crude Oil -7.08%

Gold -28.26%

Crude Oil -45.76%

Crude Oil -30.50%

U.S. Aggregate2.65%

U.S. Aggregate3.54%

Gold-4.20%

SVB Asset Management | Quarterly Economic Report Q3 2018Source: Thomson Reuters and Bloomberg Barclays indices.Past index performance is no guarantee of future results.

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Current duration

Currentyield

Non-annualized periodic total return (percent)

Q218 Q118 Q417 Q317 Q217 Q117 Q416 Q316

U.S. Aggregate Index

U.S. Treasuries 6.10 2.71 0.10 -1.18 0.05 0.38 1.19 0.67 -3.84 -0.28

U.S. Agencies 3.82 2.78 0.00 -0.53 0.06 0.82 0.93 1.13 -2.10 0.25

Corporates 7.26 4.02 -0.98 -2.32 1.17 1.34 2.54 1.22 -2.83 1.41

U.S. MBS 5.10 3.41 0.24 -1.19 0.15 0.96 0.87 0.47 -1.97 0.60

U.S. ABS 2.11 3.01 0.42 -0.39 -0.01 0.42 0.60 0.54 -0.70 0.20

U.S. CMBS 5.31 3.48 -0.06 -1.32 0.35 0.79 1.31 0.86 -3.03 0.59

U.S. Short Duration

1-3 yr U.S. Treasuries 1.93 2.53 0.21 -0.16 -0.28 0.24 0.19 0.27 -0.46 -0.11

1-3 yr U.S. Agencies 1.72 2.58 0.25 -0.04 -0.21 0.27 0.28 0.35 -0.39 0.00

1-3 yr corporates 1.96 3.20 0.47 -0.38 -0.04 0.59 0.59 0.69 -0.18 0.32

AAA Credit Card ABS 2.22 2.97 0.36 -0.48 -0.08 0.41 0.67 0.56 -1.04 0.15

AAA Auto ABS 1.85 3.04 0.43 -0.25 -0.02 0.37 0.46 0.41 -0.31 0.15

Fixed Income Returns: Volatility returns

26

Short duration sectors have outperformed, generating positive returns as investors position for additional rate hikes. Meanwhile, long duration assets underperformed their short end counterparts, led by corporates that have substantially lagged other riskassets in the aggregate index. Heavy credit issuance and the possibility of increased M&A activity have been the technical drivers to why credit spreads widened in Q2.

SVB Asset Management | Quarterly Economic Report Q3 2018Source: Bloomberg Barclays Indices. Data as of 6/29/2018. Heatmap colors based on periodicreturn percentage for time period shown. Past performance is not a guarantee of future results.

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Prudential standard

• <$100 billion: Relax enhanced supervision and ease regulations• $100 billion-$250 billion: Fed has discretionary authority to apply the prudential standards• >$250 billion: No change

Stress test • <$250 billion: End company runs of stress tests entirely • $100 billion-$250 billion: Allow regulators to design tailored supervisory stress tests and the Federal

Reserve Bank is required to conduct “periodic” stress tests• >$250 billion: No change

Supplementary leverage ratio

• Exclude funds of a custody bank deposited with a central bank from the supplementary leverage ratio calculation, which would allow for increased leverage

Liquidity coverage ratio

• Direct regulators to classify investment grade, liquid, readily marketable municipal securities as level 2B liquid assets, which may incentivize banks to hold these assets

Volcker Rule • Exempt banks with <$10 billion in assets from Volcker Rule restrictions

Community bank capital

• Simplify capital calculations for banks with < $10 billion in assets

Examination cycles • Raise the asset threshold for banks to qualify for an 18-month exam cycle as opposed to 12-month to $3 billion from $1 billion


Regulatory Relief for Small andMedium-Sized BanksOn May 24, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act was signed into law to simplify Dodd-Frank regulatory requirements for thousands of small and medium-sized banks with minimal impact to large global banks. A key component of this bill increases the asset threshold for systemically important financial institutions (SIFI) to $250 billion from $50 billion. Key provisions are highlighted below.

Source: Congress.gov

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2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

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ad b

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Yield spread of the 10-year and 2-year Treasury notes

Flat Yield Curve

28

2s10s Treasury Curve

From 2004 to 2006, the FOMC raised the federal funds rate 17 straight times.

During the financial crisis, the FOMC cut rates to a low range of 0 to 0.25 percentstarting in 2009.

The FOMC raised the federal funds rate three times in 2017 and so far twice in 2018. At the June FOMC meeting,the Fed increased its forecast of total 2018 rate hikes from threeto four.

The 2s10s curve closed at +32 in the second quarter of 2018, which is the flattest in over a decade. Comparing the currentrate-hiking cycle to the one from 2004 to 2006, the curve has room to flatten further. Contributing to the continued flatness is larger front-end Treasury issuance relative to the long end along with the Fed continuing to signal its plan to gradually increase interest rates.


In 2015, the FOMC signaled they would be increasing the federal funds rate. The first increase occurred at the December FOMC meeting with a new range of 0.25 to 0.50 percent

Source: SVB Asset Management and Bloomberg. Data as of 6/30/2018. Past performance is nota guarantee of future results. The above is not to be construed as a recommendation for yourparticular portfolio.

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Relative Value: Attractive credit yields


Front-end Yields

In the first quarter of 2018, the yield pickup of credit over comparable Treasuries widened to approximately 50 basis points due to market volatility and less credit buying as a result of repatriated cash from the passage of the tax reform.

The second quarter witnessed corporate bond spreads tightening relative to the rise in Treasury yields as a result of solid economic data and corporate earnings. The spread pickup averaged 30 basis points for 3 month to 2 years while 2.5 to 3 years averaged 50 basis points.

Credit historically offers an attractive yield pickup over comparable Treasuries. In a rising rate environment, credit helps mitigate the impact from negative bond prices due to higher income.

Source: SVB Asset Management and Bloomberg. Data as of 6/27/2018. Past performance is nota guarantee of future results. The above is not to be construed as a recommendation for yourparticular portfolio.

1.90%2.00%

2.17%

2.30%2.42%

2.49%2.55% 2.59%

2.12%

2.36%

2.49%2.61%

2.74%

2.88%3.00%

3.09%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

3 Month 6 Month 9 Month 1 Year 1.5 Year 2 Year 2.5 Year 3 Year

Treasuries Credit (AA to A-)


Our Team and Report Authors

Lauri MossPresident, SVB Asset [email protected]

Eric SouzaSenior Portfolio [email protected]

Hiroshi IkemotoFixed Income [email protected]

Daeyoung Choi, CFACredit Risk [email protected]

Ninh ChungHead of Investment Strategy and Portfolio [email protected]

Jose SevillaSenior Portfolio [email protected]

Jason GraveleyFixed Income [email protected]

Tim Lee, CFACredit Risk & Research [email protected]

Melina Hadiwono, CFAHead of Credit [email protected]

Paula SolanesSenior Portfolio [email protected]

Renuka Kumar, CFADirector, Portfolio [email protected]

Steve JohnsonSenior Portfolio [email protected]

Guest contributor

Peter NgSenior FX [email protected]

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Are not insured by the FDIC or any other federal government agency

Are not deposits of orguaranteed by a bank May lose value


This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. This information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction.

None of this material, nor its content nor any copy of it, may be altered in any way, transmitted or distributed to any other party without the prior express written permission of SVB Asset Management. SVB Asset Management is a registered investment advisor and nonbank affiliate of Silicon Valley Bank, and member of SVBFinancial Group.

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©2018 SVB Financial Group. All rights reserved. SVB, SVB FINANCIAL GROUP, SILICON VALLEY BANK, MAKE NEXT HAPPEN NOW and the chevron device are trademarks of SVB Financial Group, used under license. Silicon Valley Bank is a member of the FDIC and the Federal Reserve System. Silicon Valley Bank is the California bank subsidiary of SVB Financial Group (Nasdaq: SIVB). Rev 07-25-18.

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