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This monitor reflects the best interpretation of financial market developments and views of the staff of the Office of Financial Research (OFR). It does not necessarily reflect a consensus of market participants or official positions or policy of the OFR or the U.S. Department of the Treasury. Contributors: Viktoria Baklanova, Ted Berg, and Daniel Stemp.

Fourth Quarter 2016 (data as of December 31)

A review of financial market themes and developments

U.S. Long-Term Interest Rates Rise, But Remain Low U.S. long-term interest rates have risen from all-time lows in July, driven by stronger global economic data, higher inflation expectations, and growing expectations of a U.S. shift from monetary to fiscal policy stimulus. However, U.S. long-term rates and volatility remain low by historical standards (see Figure 1). Although an improving economic backdrop tempers financial stability concerns, as discussed in the OFR’s 2016 Financial Stability Report and 2016 Annual Report to Congress, the combination of persistently low long-term interest rates, the high level and continued growth of U.S. nonfinancial business debt, high valuations in U.S. equity and U.S. commercial real estate markets, and challenges to major financial institutions’ business models and profitability creates risks to U.S. financial stability.

Key developments in the fourth quarter of 2016 • U.S. long-term interest rates rose sharply in the past few months, especially since the U.S. election. The 10-year

Treasury yield has increased more than 100 basis points since July, when it and other global long-term rates fell to all-time lows (see Figure 1). The U.S. dollar appreciated to its strongest level in more than 10 years.

• The Federal Open Market Committee (FOMC) raised short-term interest rates 25 basis points in December as

expected. Committee members projected a faster pace of tightening in 2017.

• Major U.S. stock indexes set new record highs amid a general rally in U.S. risky assets. A number of metrics show U.S. stock valuations are elevated.

• China’s capital outflows accelerated, adding to an unprecedented reduction in official reserves since 2014.

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Figure 1. Ten-year Treasury bond yield (percent) U.S. long-term interest rates have risen from all-time lows

Source: Bloomberg L.P.

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Figure 1. 10-year Treasury bond yield (percent) U.S. long-term interest rates have risen from historic lows

Source: Bloomberg L.P.

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U.K. referendum

OFR MARKETS MONITOR Fourth Quarter 2016 | 2

Several factors pushed long-term interest rates higher. U.S. long-term interest rates have recently risen faster than at any time since the “taper tantrum” of 2013, although rates remain near the bottom of their historical range (see Figure 1). The yield on the benchmark 10-year Treasury bond has increased 108 basis points from its all-time low set in July, weeks after financial markets were rattled by the United Kingdom (U.K.) vote to leave the European Union. The rise in U.S. long-term interest rates was initially gradual and driven by stronger inflation and economic activity data in the United States and Europe. Rates jumped after the U.S. presidential election, in part reflecting expectations of a shift in the U.S. fiscal-monetary policy mix (see Figure 2). It is unclear what policies will be enacted under the new administration. With all else equal, however, a shift to fiscal stimulus, for example, through increased government spending on infrastructure and lower corporate tax rates, likely would spur economic growth, inflation, and expected future budget deficits, all of which could put upward pressure on long-term interest rates. About a third of the total increase in U.S. 10-year Treasury note yields since the election can be attributed to higher “breakeven” rates, which capture bond market inflation compensation. Such rates are imperfect measures of inflation expectations; technical factors in bond markets also influence them. The observed U.S. inflation rate has risen from 2015 lows as oil prices have stabilized, while inflation forecasts remain anchored in a healthy range (see Figure 3).

Major foreign interest rates also moved somewhat higher. Long-term interest rates also rose in other major economies during the fourth quarter (see Figure 4). The spike in Treasury yields and higher U.S. growth expectations were factors lifting global interest rates. Other factors were an improved economic outlook and reduced expectations for monetary policy easing in some countries. In the U.K., for example, the Bank of England refrained from additional monetary stimulus as economic data continued to be surprisingly strong in the months after the U.K. vote.

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Figure 2. Changes in 10-year Treasury bond yields (basis points)Treasury yields rose faster after the U.S. election

Note: The breakeven rate is the difference between the nominal yield of a Treasury bond and the real yield of a Treasury inflation-protected security of similar maturity.Source: Bloomberg L.P.

Nominal YieldReal RateBreakeven Rate

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Figure 3: U.S. inflation and expectations (year-over-year percent change) Inflation is expected to rise but remain in a healthy range

U.S. CPI inflation

International Monetary Fund

Organization for EconomicCo-operation and Development

Forecasts

Survey of Professional Forecasters

Note: CPI stands for Consumer Price Index, which measures the weighted average of prices of a basket of consumer goods and services. Sources: Organisation for Economic Co-operation and Development, Federal Reserve Bank of Philadelphia, International Monetary Fund, OFR analysis

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Figure 4: 10-year sovereign bond yields (percent)Key long-term rates rose notably in the fourth quarter

U.S.

U.K.

Source: Bloomberg L.P.

Japan

Germany

China

OFR MARKETS MONITOR Fourth Quarter 2016 | 3

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Figure 5: Overnight interest rates (percent) Effective federal funds rate traded within new target range

Source: Bloomberg L.P.

Figure 6: Assets under management in money market funds ($ trillions) Investors shifted from prime to government funds

Interest on Excess ReservesFederal Funds Effective RateReverse Repo Facility Rate

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Government

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Figure 7: 3-month LIBOR-OIS spread (basis points) LIBOR-OIS spread has narrowed after money market reform

Source: Bloomberg L.P.

Oct. 14 deadline for reform compliance

Markets reacted by pushing yields on 10-year U.K. government bonds up to pre-referendum levels. In the eurozone, rates increased more modestly. Japanese rates were little changed as the Bank of Japan reiterated its intention to target 10-year yields at zero percent.

The Federal Reserve raised rates for the second time since the financial crisis. In December, the Federal Reserve’s FOMC voted to raise its target for short-term interest rates by 25 basis points. This rate hike is the first since last year’s “liftoff ” from rates near zero percent (see the February 2016 Financial Markets Monitor). The move was widely anticipated, and trading was orderly. The effective federal funds rate quickly adjusted to trade within its new target range of 0.50 percent to 0.75 percent (see Figure 5). Rates for excess reserves and the Federal Reserve’s reverse repo facility provide the bounds of the policy rate range. The median FOMC participant now projects 75 basis points of hikes in 2017, versus 50 basis points in previous projections. The market adjustment to U.S. money market fund reform was orderly. On Oct. 14, the Securities and Exchange Commission implemented a major reform of U.S. money market funds (see our September blog). Since the reform was announced in July 2014, approximately $1.1 trillion has shifted out of prime funds and into government funds, reducing the volume of prime funds by 67 percent. Data from the OFR’s U.S. Money Market Fund Monitor show that this shift slowed after the reform (see Figure 6). Before the reform, fund flows also caused an increase in private short-term borrowing costs, as discussed in the previous Financial Markets Monitor. The LIBOR-OIS spread, an important gauge of the relative cost of banks to borrow, stopped increasing when the reform was implemented and has since receded somewhat (see Figure 7). LIBOR stands for London Interbank Offered Rate. OIS stands for Overnight Indexed Swap. LIBOR-OIS is the difference between the three-month LIBOR and OIS rates. OIS rates indicate what the market expects for future central bank interest rates.

OFR MARKETS MONITOR Fourth Quarter 2016 | 4

The U.S. dollar rose against other major currencies. The U.S. Dollar Index surged by 7 percent in the fourth quarter, reaching its highest level in more than a decade (see Figure 8). The recent climb in U.S. yields and the rate hike by the Federal Reserve have accentuated interest rate differentials and fueled the U.S. dollar’s strength. The yield spread between 10-year Treasuries and German government bonds of similar maturity is now more than 2.2 percent, the widest since 1989. Changes in foreign exchange rates showed little correlation to economic conditions in those countries, implying that the U.S. dollar’s strength is due to attractive U.S. yields rather than negative factors in foreign countries. The rising U.S. dollar has not curbed investors’ appetites for U.S. assets, although it is a drag on U.S. economic activity.

An agreement to cut oil supply drove oil prices higher. The Organization of Petroleum Exporting Countries agreed at its November meeting to cut production for the first time since the financial crisis. The announcement sent the U.S. benchmark for crude oil to a new high for the year at $54 a barrel (see Figure 9). Russia and Mexico, two other major oil producers, also agreed to reduce output. In all, these actions, scheduled for implementation in January, could reduce supply by about 1.7 percent of estimated global production. The cuts are forecasted to bring supply and demand in the global oil market into balance for the first time since 2014, when prices were more than $100 a barrel.

U.S. corporate earnings improved, driven by energy firms. The third quarter of 2016 marked an end to the “earnings recession” in the United States. For the first time since the third quarter of 2014, quarterly operating earnings per share increased year-over-year. Earnings for S&P 500 companies exceeded analysts’ expectations. For example, adjusted earnings per share increased 4 percent year-over-year, versus analyst expectations for slightly negative growth.

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Figure 8: Major global currencies (Index 100 = Sept. 30, 2016)Interest rate divergence drives the U.S. dollar higher

dollar

yuan

yen

Note: dollar = The U.S. Dollar Index is an average of exchange rates between the dollar and major world currencies.Source: Bloomberg L.P.

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pound

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Figure 9: Oil futures price per barrel ($) Promised production cut propels oil prices to higher range

BrentWTI

Source: Bloomberg L.P.

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Figure 10: Quarterly S&P 500 operating earnings (percent change year-over-year) Corporate earnings rebound

Sources: Haver Analytics, OFR analysis

Excluding energy sectorIncluding energy sector

OFR MARKETS MONITOR Fourth Quarter 2016 | 5

The turnaround was largely driven by a return to profitability for the U.S. energy sector as oil prices rose after having collapsed from mid-2014 to early 2016. The energy sector had previously been a major drag on S&P 500 corporate profits, responsible for most of the negative earnings growth during the last two years (see Figure 10). U.S. stock valuations are stretched. Major U.S. equity indices achieved all-time highs during the fourth quarter as prices rallied after the U.S. election. During the quarter, the U.S. benchmark equity index, S&P 500, rose 3.3 percent. The Russell 2000, which reflects the value of smaller companies, increased 8.4 percent. Financial sector stocks appreciated by almost 21 percent, more than any other sector (see Figure 11). The benchmark equity indexes in Europe, Japan, and China were also higher for the quarter. After the rally, U.S. stock valuations were even more elevated (see Figure 12). Currently, the market’s forward price-to-earnings (P/E) ratio and the Q-ratio exceed the 80th percentile of historical valuations. The Buffett Indicator (the ratio of corporate market value to gross national product) is at the 90th percentile. The cyclically adjusted P/E ratio, or CAPE, is at the 96th percentile (see Figure 13). A sharp decline in U.S. equity prices could affect U.S. financial stability if the assets are widely held by entities that use short-term funding and have high levels of leverage. A sharp decline could also amplify the financial stability risks from a severe corporate default cycle (see the OFR 2016 Financial Stability Report).

Corporate bond spreads tightened after the U.S. election. U.S. corporate bond spreads, for both investment grade and high yield, continued to decline in the fourth quarter, capping a rally since early 2016 (see Figure 14). The energy and materials sectors benefited from the rebound in oil and commodity prices. Investors are optimistic that corporate earnings growth can improve meaningfully over the next year, outweighing the risks associated with elevated corporate leverage. The OFR views the level and growth rate of U.S. nonfinancial corporate debt

Figure 12: U.S. stock valuations Key valuation metrics are high relative to history

Metric Current Historical percentile

Cyclically adjusted P/E 27.9x 96%

Q-ratio 97% 85%

Buffett Indicator 130% 90%

Forward P/E 17.6x 81%

Trailing P/E 21.0x 85%

Price-to-book 2.9x 68%

Note: P/E stands for price-to-earnings ratio. Historical ranges start in 1881, 1951, 1970, 1990, 1954, and 1990, respectively. Sources: Bloomberg, Haver, OFR analysis

Figure 13: Cyclically adjusted price-to-earnings ratio (CAPE)

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Figure 11: S&P 500 sector returns (Index 100 = Sept. 30, 2016)U.S. stocks rallied, led by the financial and energy sectors

Source: Bloomberg, OFR analysis

FinancialsEnergyS&P 500

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1881 1897 1914 1931 1947 1964 1981 1997 2014

The CAPE ratio is eleveated

Average

Note: CAPE is the ratio of the monthly S&P 500 price level to trailing 10-year average earnings (inflation adjusted).Sources: Robert Shiller, OFR analysis

Dec '99: 44x

Sep '29: 33x

Mar '09: 13x

Jul '82: 7xJun '32: 6x

May '07: 27x

Dec '16: 28x

OFR MARKETS MONITOR Fourth Quarter 2016 | 6

as a key potential threat to financial stability (see the OFR 2016 Financial Stability Report).

China and other emerging markets had sizable capital outflows. Emerging market assets sold off sharply in the days after the U.S. election. Capital outflows from funds that invest in emerging market debt were the heaviest since at least 2004. Emerging market currencies depreciated by more than 4 percent during the election week. China had especially sharp capital outflows in the fourth quarter, and its currency depreciated more than 4 percent against the U.S. dollar. Capital outflows have reduced China’s official foreign reserves by 25 percent since 2014 (see Figure 15). Also in China, tighter monetary conditions caused investors to pull cash from wealth management products, a type of off-balance-sheet investment vehicle used by Chinese financial institutions. A rout ensued in the $8 trillion domestic bond market in which wealth management products are heavily invested. Since August, when the People’s Bank of China signaled its desire to rein in credit growth, the yield on 10-year Chinese government bonds has climbed 40 basis points. China and other large emerging markets face considerable challenges to financial stability amid lower growth, capital outflows, and a large overhang of private sector debt. In a severely adverse scenario, financial instability in these large emerging markets could spill over to the United States (see the OFR 2015 Financial Stability Report).

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Figure 14: U.S. corporate bond option-adjusted spreads (basis points) Corporate bond spreads continued to decline

Investment grade (left axis)High yield (right axis)

Source: Haver Analytics

Figure 15: Chinese foreign exchange reserves ($ billions) Renewed reserve declines in the fourth quarter

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China's FX Reserves (left axis)Monthly Change (right axis)

OFR MARKETS MONITOR Fourth Quarter 2016 | 7

LEVEL (12/31/2016)

1Q CHANGE (bps or %)

1Q CHANGE (standard

deviations)*

YTD CHANGE (bps or %)

12-MONTH RANGE**

EQUITIESS&P 500 2239 3.3% 0.2 10 –––––––––––––––––|––––––––O–––U.S. KBW Bank Index 92 29.6% 2.2 26 –––––––––––|–––––––––––––––O––Russell 2000 1357 8.4% 0.6 19 ––––––––––––––|–––––––––––O–––Nasdaq 5383 1.3% -0.1 8 –––––––––––––––––|––––––––O–––Euro Stoxx 50 3291 9.6% 0.8 1 –––––––––––––––|––––––––––––O–Shanghai Composite 3104 3.3% 0.0 -12 –––––––––––|––O–––––––––––––––Nikkei 225 19114 16.2% 1.4 0 ––––––––––––|–––––––––––––O–––Hang Seng 22001 -5.6% -0.6 0 –––––––––––––––|––O–––––––––––FTSE All World 279 1.0% -0.1 6 ––––––––––––––––––|–––––––O–––

RATESU.S. 2-Year Yield 1.19% 43 0.9 14 –––––––––––|–––––––––––––O––––U.S. 2-Year Swap Rate 1.45% 44 0.8 27 ––––––––––|–––––––––––––––O–––U.S. 10-Year Yield 2.44% 85 1.7 17 –––––––––––|–––––––––––––O––––U.S. 10-Year Swap Rate 2.34% 88 1.7 15 ––––––––––|–––––––––––––O–––––U.S. 30-Year Yield 3.07% 75 1.7 5 –––––––––––––|–––––––––––O––––U.S. 2y10y Spread 125 42 1.3 3 ––––––––––––|––––––––––O––––––U.S. 5Y5Y Inflation Breakeven 2.05% 27 0.6 24 ––––––––––––|–––––––––––O–––––U.S. 5Y5Y Forward Rate 3.05% 94 1.8 17 ––––––––––––|––––––––––––O––––Germany 10-Year Yield 0.21% 33 1.0 -42 –––––––––––|––O–––––––––––––––Japan 10-Year Yield 0.05% 14 0.6 -22 ––––––––––––|––––O––––––––––––U.K. 10-Year Yield 1.24% 49 1.2 -72 ––––––––––––––O|––––––––––––––JPM EMU Periphery Yield 1.68% 49 1.3 1 –––––––––––––|––––––O–––––––––Euro area 5Y5Y Inflation Breakeven 1.74% 39 2.5 6 –––––––––––|––––––––––––––––O–

FUNDING1M T-Bill Yield 0.42% 23 0.7 29 –––––––––––|––––––––––––O–––––DTCC GCF Treasury Repo 0.47% -80 -3.8 -17 ––––––O|––––––––––––––––––––––3M Libor 1.00% 14 0.3 39 ––––––––––|–––––––––––––––––O–Libor-OIS Spread 33 -8 -0.3 10 –––––––––––––|–––O––––––––––––EURUSD 3M CCY Basis Swap -55 0.2 0.0 -37 –––––––––––O–––––––––|––––––––

U.S. MBSFNMA Current Coupon 3.13% 77 1.7 13 –––––––––|–––––––––––––O––––––FHLMC Primary Rate 4.32% 90 2.2 31 ––––––––|–––––––––––––––––––O–

CREDITCDX Investment Grade 5-Year CDS Spread 67 -8 -0.4 -21 –O––––––|–––––––––––––––––––––CDX High Yield 5-Year CDS Spread 356 -45 -0.2 -117 O––––––––––|––––––––––––––––––CDX Itraxx Euro 5-Year CDS Spread 72 0 0.0 -5 –––O–––|––––––––––––––––––––––

IMPLIED VOLATILITYVIX Index 14 6% 0.0 -23 –––––O–––|––––––––––––––––––––V2X Index 18 -8% -0.4 -18 ––––O––––––|––––––––––––––––––VDAX Index 18 -5% -0.3 -21 ––––O––––––|––––––––––––––––––MOVE Index 72 18% 0.8 6 ––––––––––O|––––––––––––––––––3M2Y Swaption Volatility 55 11% 0.3 -2 ––––––––––O––|––––––––––––––––3M10Y Swaption Volatility 84 20% 1.0 14 –––––––––––|––––O–––––––––––––DB G10 FX Volatility Index 11 14% 0.7 17 –––––––––––|–––O––––––––––––––JPM EMFX Volatility Index 11 8% 0.2 -1 –––––––––––|––O–––––––––––––––

FOREIGN EXCHANGE & COMMODITIESU.S. Dollar Index*** 102 7.1% 1.7 4 –––––––––––|–––––––––––––O––––EUR/USD 1.05 -6.4% -1.3 -3 –––O––––––––––––––|–––––––––––USD/JPY 117 15.4% 2.4 -3 ––––––––––––|–––––––––O–––––––GBP/USD 1.23 -4.9% -1.1 -16 ––O–––––––––––––|–––––––––––––USD/CHF 1.02 4.9% 1.0 2 ––––––––––––|–––––––––––O–––––Brent Crude 57 15.8% 0.7 52 –––––––––––––––––|––––––––––O–Gold 1148 -12.8% -2.1 8 ––––––––O–––––––––|–––––––––––S&P GSCI Commodities Index 398 9.3% 0.6 28 –––––––––––––––––|––––––––––O–

EMERGING MARKETSJPM EMFX Index 66 -3.6% -0.7 1 –––––––––––––O––––|–––––––––––MSCI Emerging Market Equity Index 862 -4.6% -0.5 9 –––––––––––––––––|––O–––––––––CDX EM 5-Year CDS Spread 242 4.9 0.0 -117 ––O–––––––|–––––––––––––––––––

* Standard deviations based on quarterly data from January 1994 or earliest available thereafter.** Trailing 12-month range. Latest (O); Mean ( | ).*** Dollar index from Bloomberg (ticker: DXY); averages the exchange rates between the U.S. dollar and major world currencies.Sources: Bloomberg L.P., OFR analysis

Selected Global Asset Price Developments

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Select U.S. Interest Rates

U.S. T reasury yields and yield curve

S ource: Bloomberg L.P .

percent basis po intsTwo-year (Left Axis)Ten-year (Left Axis)Ten-year - Two-year spread (Right Axis)

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U.S. T reasury t erm premium (basis point s)

Note : Adrian, Crump, & Moe nch mode lS ource: Bloomberg L.P .

Ten-year Two-year

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U.S. swap spreads (basis point s)

S ource: Bloomberg L.P .

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Short -t erm market rat es (percent )1-month Treasury bill 3-month LIBORGCF Treasury Repo

S ource: Bloomberg L.P .

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T hree-mont h Eurodollar fut ures (percent )

Note s: T he high and low points of the De c FOMC proje ctions are the maximumand minimum fore casts. T he re ctangle re pre se nts the me dian.S ource: Bloomberg L.P .

4-Jan-17 5-Dec-16 4-Nov-16FOMC pro jections from Dec 2016

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Money market and policy int erest rat es (percent )

S ource: Bloomberg L.P .

GCF Treasury repoFed funds effectiveInterest on excess reservesReverse repo facility

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U.S. Corporate Debt Markets

U.S. corporat e bond opt ion-adjust ed spreads(basis point s)

S ource: Haver Analytics

Investment grade (Left Axis) High yield (Right Axis)

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U.S. corporat e CDS indexes (basis point s)

Note : Five -ye ar maturity CDS Inde xS ource: Bloomberg L.P .

Investment grade (Left Axis) High yield (Right Axis)

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U.S. corporat e credit gross issuance ($ billions)

S ources: S ecurities Industry and Financial Markets Association, S tandard &Poor's Leveraged Commentary & Data

Investment Grade High Yield Leveraged Loans

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U.S. corporat e credit fund flows ($ billions)

Note : Flows data are re le ase d with one -month lag.S ource: Haver Analytics

High yield Leveraged loans

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Leveraged loan issuance by use of proceeds (percent )

Note : Data for 2016 are ye ar-to-date as of De ce mbe r.S ources: S tandard & Poor's Leveraged Commentary & Data, OFR analysis

M&A/LBO Dividend/Buyback RefinancingOther

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Leveraged loan price act ivit y

Note s: S&P Le ve rage d Loan Inde x. Inde x 100=January 01, 2012.S ource: Bloomberg L.P .

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Primary and Secondary Mortgage Markets

Primary mort gage rat es (percent )

S ource: Bloomberg L.P .

Five-year/one-year adjustable rate Thirty-year fixed

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MBS yield and opt ion-adjust ed spread t o U.S. T reasurysecurit ies

S ource: Bloomberg L.P .

percent basis po ints

Current coupon (Left Axis) Spread (Right Axis)

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30-year home mort gage fixed and jumbo rat es and spread

S ource: Bloomberg L.P .

percent basis po intsThirty-year fixed (Left Axis)Thirty-year jumbo (Left Axis)Thirty-year jumbo-conforming spread (Right Axis)

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Agency MBS holdings by invest or

Note : Data for 2016 is as of third quarte r 2016.S ource: Inside Mortgage Finance

Other Agencies (GSEs) Foreign InvestorsMutual Funds Commercial Banks Federal Reserve

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Refinance and purchase loan applicat ions

Note : Inde x 100 = January 01, 2016.S ource: Bloomberg L.P .

percent

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Convent ional mort gage severe delinquencies(percent , 90+ days lat e, seasonally adjust ed)

S ource Haver Analytics

Prime Subprime

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Equity Markets

Global equit y indices

Note : Inde x = January 01, 2016.S ource: Bloomberg L.P .

S&P 500 MSCI EM Nikkei 225Shanghai Euro Stoxx 50

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U.S. equit y indexes

Note : Inde x 100 = Jan 01, 2000.S ource; Bloomberg L.P .

S&P 500 NASDAQ Russell 3000

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S&P 500 sect or performance

Note : Inde x 100 = January 01, 2016.S ource: Bloomberg L. P .

S&P 500 Financials Consumer staplesEnergy

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90

100

110

120

130

S&P 500 price-t o-earnings and price-t o-book rat ios(mult iple)

S ource: Bloomberg L.P .

Price-to -earnings (Left Axis) Price-to -book (Right Axis)

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

14

16

18

20

22

2.3

2.5

2.7

2.9

3.1

Price-to-book 10-year Avg

Price-to-earnings 10-year Avg

S&P 500 cyclically adjust ed price-t o-earnings (CAPE) rat io

Note : CAPE is the ratio of the monthly S&P 500 price le ve l to trailing te n-ye arave rage e arnings (inflation adjuste d).S ources: Haver Analytics, OFR analysis

1920 1930 1940 1950 1960 1970 1980 1990 2000 20100

10

20

30

40

50

S&P 500 implied volat ilit y and opt ion skew(percent )

Note s: Option ske w is the diffe re nce be twe e n thre e -month implie d volatility ofout of the mone y puts and calls with strike s e qual distance from the spot price(+/- 20 pe rce nt). Highe r value s re fle ct gre ate r de mand for downside riskprote ction.S ource: Bloomberg L.P .

VIX 80% - 120% Skew

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

5

15

25

35

45

5

Volatility

Implied volat ilit y by asset class (Z-score)

Note s: Z-score re pre se nts the distance from the ave rage , e xpre sse d instandard de viations. Standardization use s data going back to January 01, 1993.S ource: Bloomberg L.P .

U.S. equities (VIX) Global currencies (JPMVXYGL)U.S. Treasuries (MOVE) Average

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-2

-1

0

1

2

3

Realized volat ilit y by asset class (Z-score)

Note s: T hirty-day re alize d volatility. Equitie s base d on S&P 500 inde x, inte re strate s base d on we ighte d ave rage of T re asury yie ld curve , FX base d on we ightsfrom JPMVXY inde x. Standardization use s data going back to January 01, 1993.S ources: Bloomberg L.P ., OFR analysis

Global FX U.S. interest rates U.S. equitiesAverage

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-2

-1

0

1

2

3

Volat ilit y risk premium by asset class (percent )

Note s: One -month option-implie d volatility minus one -month mode l-pre dicte dvolatility. T he latte r is compute d base d on re alize d volatility, using a he te ro-autore gre ssive mode l with 1, 5, and 22 day lags. U.S. Inte re st Rate s re pre se ntsthe ave rage volatility risk pre mium of two- and te n-ye ar swap rate s. Equitie sbase d on S&P 500 inde x. Curre ncie s base d on we ights from JPMVXYGL Inde x.S ources: Bloomberg L.P ., OFR analysis

U.S. Equities U.S. Interest RatesGlobal Currencies

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-15

0

15

30

Slopes of implied volat ilit y curves(basis point s)

Note s: Se ve n-day moving ave rage . Slope re pre se nts diffe re nce be twe e n one -ye ar and one -month maturitie s. G10 FX base d on we ights from De utsche Bank'sCVIX inde x.S ources: Bloomberg L.P ., OFR analysis

G10 FX (Left Axis) S&P 500 (Left Axis)Two-year USD Swaption Rate (Right Axis)Ten-year USD Swaption Rate (Right Axis)

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-1000

-800

-600

-400

-200

0

200

400

600

800

-50

-40

-30

-20

-10

0

10

20

30

40

Opt ion skew by asset class (z-score)

Note s: Option ske w is the diffe re nce be twe e n thre e -month implie d volatility ofout of the mone y puts and calls with strike s e qual distance from the spot price(+/- 10 pe rce nt). Highe r value s re fle ct gre ate r de mand for downside riskprote ction. Equitie s re pre se nts S&P500 inde x. Inte re st rate s re pre se ntwe ighte d ave rage ske w of T re asury future s curve . Curre ncie s re pre se nt dollarske w against major curre ncie s base d on JPMVXY inde x we ights. Z-scorestandardization use s data going back to January 01, 2006.S ources: Bloomberg L.P ., OFR analysis

U.S. equities U.S. interest ratesGlobal currencies Average

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-3

-2

-1

0

1

2

3

Volat ilit y of equit y volat ilit y

Note : VVIX Inde x me asure s the e xpe cte d volatility of the 30-day forward priceof the CBOE VIX Inde x.S ource: Bloomberg L.P .

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

60

80

100

120

140

160

180

6

Advanced Economies

T wo-year sovereign bond yields (percent )

S ource: Bloomberg L.P .

U.S. Germany U.K. Japan

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

T en-year sovereign bond yields (percent )

S ource: Bloomberg L.P .

U.S. Germany U.K. Japan

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Breakeven inflat ion (percent )

S ource: Bloomberg L. P .

U.S. ten-year Germany ten-year U.K. ten-yearJapan ten-year

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

0

1

2

3

4

10-year euro area periphery government bond spreadsover German bunds (basis point s)

S ource: Bloomberg L.P .

Italian govt (Left Axis) Spanish govt (Left Axis)Portuguese govt (Left Axis) Greek govt (Right Axis)

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

80

120

160

200

240

280

320

360

400

0

400

800

1200

1600

2000

Major currency indexes

Note s: Fore ign curre ncy incre ase s re pre se nt gre ate r stre ngth ve rsus the U.S.dollar. DXY incre ase s re pre se nt gre ate r stre ngth of the U.S. dollar ve rsus abaske t of major world curre ncie s. Inde x 100 = January 01, 2016.S ource: Bloomberg L.P .

DXY (U.S. do llar) euro British poundJapanese yen Swiss franc

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

70

80

90

100

110

120

130

U.S. dollar long posit ioning vs. major currencies(net speculat ive posit ions, t housands of cont ract s)

Note s: Positive value s re pre se nt ne t U.S. dollar long positions. T he DollarInde x (DXY) is a future s contract base d on the U.S. dollar's value against abaske t of major world curre ncie s. T o e xpre ss a U.S. dollar long position in anon-U.S. dollar contract, the contract must be shorte d.S ource: Bloomberg L.P .

DXY (U.S. do llar) euro British poundJapanese yen Total

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

-100

0

100

200

300

400

7

Emerging Markets

Emerging market currencies(U.S. dollars per foreign currency unit )

Note s: Incre asing value s indicate stre ngthe ning ve rsus the U.S. dollar. Inde x100=January 01, 2016.S ource: Bloomberg L.P .

RussiaChina o ffshoreBrazilEM currency Index

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

80

90

100

110

120

130

Spreads t o T reasuries (basis point s)

Note s: EM gove rnme nt and corporate hard curre ncy spre ads-to-worst are fromthe dollar-de nominate d J.P. Morgan Eme rging Marke ts Bond Inde x Global andthe J.P. Morgan Corporate Eme rging Marke ts Bond Inde x. Gove rnme nt localcurre ncy spre ads are the nominal yie ld diffe re nce be twe e n the J.P. MorganGove rnme nt Bond Inde x – Eme rging Marke ts and the 5-ye ar U.S. T re asury note .S ource: Bloomberg L.P .

EM govt hard currencyEM corporates hard currencyEM govt local currency

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

300

400

500

600

700

Equit y price indexes

Note s: T he US e quity inde x is the S&P 500 Inde x. T he Chine se e quity inde x isthe Shanghai Composite Inde x. T he De ve lope d Economie s inde x is the MSCIWorld Inde x and the Eme rging Marke ts inde x is the MSCI EM Inde x (both are inlocal te rms). Inde x 100 = January 01, 2016.S ource: Bloomberg L.P .

U.S. China Developed economiesEmerging markets

Jan2016

Apr2016

Jul2016

Oct2016

Jan2017

80

90

100

110

120

130

One-mont h realized emerging market s volat ilit y (percent )

Note s: Re alize d volatility is the annualize d standard de viation. Hard curre ncysove re ign de bt base d on the J.P. Morgan Eme rging Bonds - Global Price Inde xand curre ncie s base d on a we ighte d ave rage of EM curre ncy re turns against thedollar using we ights from J.P. Morgan VXY-EM curre ncy volatility inde x.S ources: Bloomberg L.P ., OFR analysis

EM sovereign hard currency debt EM currencies

2010 2011 2012 2013 2014 2015 2016 20170

10

20

IIF port folio f lows t o emerging market s ($ billion)

Note s: Data re pre se nt the Institute of Inte rnational Finance 's monthly e stimate sof non-re side nt flows into thirty EM countrie s. Data for late st obse rvations arede rive d from IIF's e mpirical e stimate s using data from a smalle r subse t ofcountrie s, ne t issuance , and othe r financial marke t indicators.S ource: Bloomberg

Debt flows Equity flows

2010 2011 2012 2013 2014 2015 2016 2017-30

-20

-10

0

10

20

30

40

50

China's Foreign Exchange Reserves ($ t rillion)

S ource: Bloomberg

FX Reserves

Jan2006

Jan2007

Jan2008

Jan2009

Jan2010

Jan2011

Jan2012

Jan2013

Jan2014

Jan2015

Jan2016

$0.5

$1

$1.5

$2

$2.5

$3

$3.5

$4

$4.5

8

Commodit ies

Major commodit ies prices

Note s: Inde x 100 = January 01, 2010S ource: Bloomberg L.P .

Bloomberg commodities indexCrude o il front month (Brent) Gold front month

2010 2011 2012 2013 2014 2015 2016 20170

50

100

150

200

Crude oil

Note : WT I and Bre nt are front-month contracts.S ource: Bloomberg L.P .

$/Barrel Million BarrelsWTI (Left Axis)Brent (Left Axis)U.S. inventories (Right Axis)

2011 2012 2013 2014 2015 2016 201720

50

80

110

140

300

350

400

450

500

550

Oil and nat ural gas fut ures curves

Note : Data as of January 05, 2017.S ources: Bloomberg L.P ., OFR analysis

$/barrel $/mmbtu

Brent (Left Axis) Natural gas (Right Axis)

2M 6M 12M 24M 60M45

50

55

60

2.5

3.0

3.5

4.0

Oil supply and demand fact ors

Note : Global production and consumption are e stimate s by the Inte rnationalEne rgy Age ncy.S ource: Bloomberg L.P .

Million barrels per day

Global production (Left Axis)Global consumption (Left Axis)U.S. rig count (Right Axis)

2010 2011 2012 2013 2014 2015 2016 201785

90

95

100

200

400

600

800

1000

1200

1400

1600

1800

Speculat ive fut ures posit ioning(t housands of cont ract s)

Note s: Positive value s re pre se nt ne t long positions. Ne gative value s re pre se ntne t short positions.S ource; Bloomberg L.P .

Brent (Left Axis) Gold (Left Axis)Copper (Left Axis) Steel (Right Axis)

Jul2015

Jan2016

Jul2016

Jan2017

-140

-70

0

70

140

210

280

350

-20

-10

0

10

20

30

40

50

Met als spot price indexes

Note : Inde x 100 = January 01, 2010.S ource: Bloomberg L.P .

Copper Steel Precious metals

2010 2011 2012 2013 2014 2015 2016 20170

50

100

150

200