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Operating revenues rose 3% y-o-y to $173bn in 1Q16, its highest 1Q on record, ... of low energy prices on the banking in
StreetStuff Daily June 2, 2016

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… Fig.1: Global IP vs. manufacturing confidence

1 June 2016

April construction spending report trims US Q2 GDP tracking estimate to 2.2% …Revisions to prior months’ data suggest modest upward revisions to Q1 private nonresidential structures and government investment and a small downward revision to Q1 residential investment. On net, our Q1 GDP tracking estimate rose one-tenth, to 0.9%. Broadly weaker-than-expected construction spending in April trimmed our tracking estimate of residential, nonresidential, and state and local government investment. On net, our Q2 GDP tracking estimate fell four-tenths, to 2.2%. 1 June 2016

Global Global manufacturing confidence little changed in May Our final reading of the Barclays global manufacturing confidence was little changed at -0.46 in May vs April’s print of -0.43. PMI prints in the US continue to point toward stabilization in the manufacturing sector. In China, PMI reports were mixed: While the official NBS PMI was unchanged, the Caixin PMI declined, suggesting that some uncertainty remains. In the UK, manufacturing PMI surprised positively in May, moving back into the expansion zone (above 50) following the sharp decline in April. However, sentiment is likely to deteriorate as the EU referendum date draws nearer. In the euro area, manufacturing sentiment waned over the month amid weakening confidence in the peripheries. In sum, we continue to expect that any improvement in the near-term global manufacturing confidence would be aided primarily by the US and China. In terms of subcomponents, our global new orders gauge remained unchanged at -0.39 in May. Global new export orders fell to -0.41, from -0.26 in April, a reflection of weak global demand conditions. Meanwhile, our forward-looking measure of new orders less finished goods inventories worsened to -0.26 (vs. -0.05 in April), although the three-month moving average retained its positive momentum.

2 June 2016

U.S. Large-Cap Banks

Quarterly Bank Chartbook Summary This is a quarterly installment of our FDICChartbook, eyeing the past 32¼ years. ROA above historical average, ROTCE modestly below. In 1Q16, FDIC insured institutions reported net income of $39.1bn. Net income declined 2% y-o-y (1st y-o-y decline since 4Q14) and was 4% below 4Q15. PPNR was little changed sequentially, while the loan loss provision increased. The industry's ROA was 0.97%. While below its pre-crisis average (1995-2006) of 1.22%, it is above its long-term average (32 years) of 0.82%. ROTCE was 10.8%, modestly below its longterm average of 11.7%. While pre-crisis it was over 17%, equity has increased nearly 50% since. Record revenues for a 1Q, costs controlled. Operating revenues rose 3% y-o-y to $173bn in 1Q16, its highest 1Q on record, though slipped 1% from 4Q15. Net interest income rose 1% from the prior quarter. Loans increased 7.0% y-o-y (fastest growth rate since mid-2008) and gained 1.1% from 4Q15. Unused credit lines rose 2% (+$122bn) sequentially. The net interest margin declined 3bps from 4Q15 to 3.10%, though ex. BAC's FAS 91 adjustment we believe it was closer to unchanged. Deposits rose 2% to an all-time high. Fee income declined 4%, driven by lower servicing fees. Expenses were little changed, up 1% y-o-y and down 1% sequentially. The industry posted y-o-y positive operating leverage for the 5th straight quarter. The efficiency ratio remained in the 61% area for the 3rd straight quarter, though was 58% pre-crisis. Stress in the energy sector weighed on credit quality. The noncurrent loan ratio rose 2bps to

1.58%. This marks its first increase since 1Q10. Noncurrent loans to C&I borrowers jumped $9.3bn (largest quarterly increase since 1Q87; +65%), primarily as a result of weakness in loans to the energy sector (have increased in 5 straight quarters). The NCO ratio declined 3bps to 0.46%, less than half its long-term average. Dollar NCOs increased $1.1bn, though was unchanged ex. C&I. The loan loss provision jumped 50% y-o-y and gained 3% from 4Q15. Provisions have increased on a y-o-y basis for 7 straight quarters. Banks increased loan loss reserves by $2.1bn, its 1st increase in 6 years. Banks with assets over $1bn, which itemize their reserves, reported a $3.3bn increase in C&I reserves (all other $1.2bn). Still, the FDIC commented that the full impact of low energy prices on the banking industry remains to be seen, particularly for consumer and business loans in energy-producing regions of the country. Still, the industry is quite healthy. In 1Q16, only 5% of banks were unprofitable (lowest level since 1Q98). The number of banks on the FDIC's Problem List fell from 183 to 165, the smallest number banks in more than 7 years and down dramatically from a peak of 888 in 1Q11. Assets of problem banks fell from $46.8bn to $30.9bn (lowest level since 1Q08). Only 1 bank failed during 1Q16. The DIF increased from $72.6bn at 4Q15 to $75.1bn. The DIF reserve ratio rose from 1.11% to 1.13%. Still, the DIF must achieve a minimum reserve ratio of 1.35% by 3Q20. We expect special assessments to add $0.5bn to our coverage's quarterly expenses beginning in 3Q16.







2 June 2016

Global Equity Strategy Pricing US election uncertainty After a "relatively" calm second term for President Obama, the 2016 election will likely see a rise in uncertainty around policy. Historically, the S&P 500 has fallen 2-4% going into an election when a president is leaving office after serving more than one term. Although the business cycle can explain much of the two-term anomaly, the headwind for equities in this election could be considerable as the odds of Trump winning increase, based on the fall in S&P futures after he won key primaries. Overall, we believe that the US election in November introduces another layer of uncertainty as the economy and markets grapple with mid-to-late cycle developments, including mediocre growth, potential for Fed hikes, above average equity valuations and China slowing. History and markets suggest that the downside for US equities could be notable, though other factors will determine the path for equities, with growth the key. • Equities have sold off 2-4% from July to November going into elections following a two-term president (ex 2008), as the equity risk premium increased in all but one case. On the other hand, the S&P 500 has rallied an average of 7% through 2H in the

other election years. The business cycle and Fed tightening explain much of the anomaly, but the potential for policy changes likely has an impact on equity risk premiums as well. This election of two unpopular candidates comes seven years since the last recession and as the Fed is tightening, adding to existing uncertainty. Our economists and policy strategists see a number of areas that could be impacted if Clinton or Trump were elected (US elections: It's the economy), which supports the notion of an election-related risk premium. Donald Trump is perceived as the more uncertain candidate based on his comments made throughout the primaries – on trade, immigration, large tax cuts, debt, currency manipulators and Fed (to name a few). The GOP convention July 18-21 will be key in assessing the direction of the Trump campaign, and how much markets overlook some of his previous rhetoric. The risk premium ascribed to a Trump presidency could be notable. According to the Financial Times and Barron's, business and investor surveys seem to show a clear preference for Clinton. Additionally, although it is difficult to assess the market impact of Trump, we analyze the moves in S&P futures after Republican primaries. The declines in S&P futures after the Indiana, Nevada and New Hampshire primaries as Trump's election odds rose suggests that an increase in his chances could be a considerable headwind for equities. History shows that government spending has picked up after elections when one party controls the White House, Senate and House. A potential fiscal boost could be an important offset to a market-implied Trump discount, although the joint probability of Republicans winning the presidency and Congress is currently low.

1 June 2016

BMO Morning Note | Payroll Misses Figure 2: Payroll Precision



Over time, NFP forecasts have improved. Taking the absolute value of all misses/beats since 2000, the trailing one year rolling average has fallen



from a peak of 117K to levels closer to 40K. But on this basis, the consensus precision has limits: it hasn’t done better than getting within 30K of the actual print. Of the 196 NFP prints since 2000, 112 have missed consensus and 83 have beat it (and one was exactly right), making the odds of missing slightly better than a fair coin toss at 57%. When NFP misses expectations, it misses by an average of 68K jobs, and when it beats, it beats by an average of 50K jobs. The standard deviation is 78K jobs. However, over the past year, the average miss has been much lower at 34K jobs while the beat has been the same as the long term average at 50K jobs. With consensus for Friday at 160K, the market should not be surprised by 126K to 210K

01 Jun 2016

US Macro Credit and XAsset Relative Value Core views* 



Global Daily Macro Monitor | 2 June 2016 •



Eurozone: The ECB will focus on implementing existing measures at its June meeting. Comments on the economic outlook and the staff projections should reflect waning risks. US: We expect ADP employment growth to slow in May due to the effects of the Verizon strike and a slowdown in hiring in the services sector.



01 Jun 2016



US: May ISM mfg - headline head fake, details weak



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The manufacturing ISM index increased to 51.3 in May, above our and market expectations, following a 50.8 print the previous month. The supplier deliveries index drove the improvement in the headline, rising by 5 index points to 54.1 (last: 49.1). All other sub-components (new orders, production, employment, and inventories) worsened or were unchanged. 12 of 18 industries reported expansion in May compared to April, when 11 of 18 industries reported growth. The improvement in the national ISM manufacturing index stands in contrast to regional manufacturing surveys for May which were generally weak.

Macro Overview: Central bank easing and their continued dovishness have brought US credit and equity markets to levels close to last April’s highs (from the lows of midFebruary this year). Two other macro factors that were weighing on global markets earlier this year (i.e. China’s devaluation concerns, and the decline in Oil and Commodity prices) look stable in the short term. However, we believe that concerns regarding China’s devaluation, as well as the decline in commodities prices might come in play again later this year. In the near term, the major risks to markets are the Fed’s potential hawkishness, as well as other Europe-related risks, which keeps us short-biased in the near term. However, we expect US credit markets to perform if the Europe-related risks do not materialize later this month. Credit-Equity: We remain bearish on the longcredit/short-equity trade, as we expect oil prices to go sideways from here (or lower if the dollar rallies due to the Fed’s hawkishness), as well as the potential risks posed by Europe later this month. US Credit Volatility: We expect credit vols to increase in the short term (as the expectations of the Fed’s rate hikes increase, as well as when the Europe-related risks increase). The skew has moved to the lower end of the range, implying a low probability of tail risks being priced in the credit vol markets. CDX-Cash Basis: We are neutral to bearish on basis at current levels, and expect basis to remain range bound (or move wider) if the Fed becomes more hawkish than expected. we are bearish on the CDX HY-HYG basis in the short term. Compression/Decompression: We expect CDX HY26/IG26 to trade range-bound relationship in the short term, driven mostly by technicals, as opposed to being driven by the single name CDS spreads. Credit Index Skew: In our opinion, it is attractive to own the IG26 skew package at current levels, as we do not expect skew to move more negative (as has happened in January this year). We expect skew to be less negative in risk-off scenarios, as the index has higher liquidity than the single name constituents.

Change in Treasuries US Bancorp, State Street and TD increased Treasuries while Citi, BoA and Wells decreased them.

US Rates at the Bell June 1st, 2016 Ed Acton & Bill O’Donnell

Recap & Discussion:

More strategically, with US rates continuing to ride within ranges (see the attached VWAP Chart of TY and FV futures), building up a significant base of volumeweighted price within a slowly constricting band, we continue to ponder what the ‘resolution’ of this current consolidation may look like. As far as catalysts, the headline events of NFP, Yellen’s 6/6 speech, as well as next week’s UK polling outcomes stick out, there similarly remains several cross-asset influences that look to be on a knife’s edge as well. …

2 June 2016

Global Political Flash Alert: Leaning Leave – Time to Revisit Brexit Risk? •



6/1/2016

US Banks Security Portfolio Changes – Q1, 2016 Corporates Up / RMBS Down • • •

Security portfolios declined by $5.5 billion in Q1, 2016 at the 18 largest US banks Banks bought credit and reduced exposure to RMBS over the quarter. Most banks reduced exposure to agency CMO’s while adding to CMBS holdings.



Leave Taking the Lead in UK EU Referendum? The 4 polls released this week showed a swing in 1 favour of Leave , rattling markets that had grown complacent about the long-standing, if slight advantage, for Remain. Remain probabilities according to betting markets also dropped markedly 2 in the past week, from 83% to 74%. These moves may partly reflect numbers released by the ONS on immigration, showing net migration to the UK at 333,000 in 2015, the second highest level on record. 3 These data were covered prominently in the media. Polling Trend Little Changed in Past Month, but Variations Highlight Concerns This week, our 10-poll average still reflects a modest 3.3-point lead for Remain, at 45.2% and 41.9% for Leave – a 4.8-point decline in the Remain-Leave margin compared to the previous week when Remain had an 8.1-point lead. This is within the 3pp margin of error. Remain had a roughly 3-point lead since February up until a fortnight ago. Too Close for Comfort We continue to maintain a 30-40% probability of Brexit, but are increasingly concerned about the implications of continued closeness in the polls, 4 erratic polling results , and growing rancor within the Conservative Party for post-Referendum domestic political stability. We also note a contagion effect, at least in rhetorical terms, beyond the UK to other EU member states, as Eurosceptic populism continues to expand its brand across the Continent, with further instances of campaigns for reform and referendum likely to clog EU decision-making even if the UK votes to stay.

1 June 2016

FX Strategist: CNY: More depreciation We have raised our three month forecast for USDCNY from 6.59 to 6.65 and have pushed our 12 month forecast from 6.75 to 6.85. With this, we raise our 3 and 12 month forecasts for USDCNH to 6.67 and 6.88 respectively. Chinese FX policy is responding to broad USD strength with higher levels for USDCNY. We think that underlying this is a government willingness to allow ongoing balance of payments outflows to clear at least partially through trend CNY depreciation rather than just FX reserve losses. Recent fixes suggest the government is likely to continue to test the market’s willingness to accept gradual depreciation, in our view. We think a significant reversal lower in USDG10, not just dollar drift, would be necessary to stop the grind higher in USDCNY.

In this issue of the FX Compass, we take a critical look at vol markets and EM FX in light of the somewhat benign response of risky assets to the repricing of Fed tightening expectations. We find that while the EM FX aggregate implied vol curve has steepened, likely limiting the impact of a stronger USD on EM assets, the steepening has been concentrated in selected currencies, namely CNY and CNH. Other corners of the EM FX universe, in particular MXN and INR, appear less braced for an extension of USD strength. We also focus on the upcoming Antipodean currencies. Concerns over entrenched disinflationary expectations and a stubbornly strong NZD TWI pose asymmetric risks toward an out-of-consensus RBNZ cut. The market is pricing in a 20% chance of a cut at the RBNZ’s June meeting. We think this is underpriced, and there is scope for the NZD to fall further on a rate cut or in response to dovish forward guidance. In contrast, the 5% chance of a June RBA cut appears fair to us, while we anticipate a follow-up cut in August.

Deutsche Bank

A strong USD-G10 rally remains the main risk to our USDCNY forecasts.

2 June 2016

FX Compass: On Third Thoughts Figure 1: Subdued EURUSD overnight vol and risk reversals indicate modest risk in spot

Japan's PM Abe has decided to postpone a second sales tax hike for a second time, this time by 2.5 years. Some see in this a sign that the Japanese economy is in a crisis mode which will force the BOJ to ease again in the summer. Together with hopes for a Fed hike around the same time, they argue that the divergence trade is coming back and that USDJPY should move higher. Instead we believe that the further tilt towards fiscal policy as a growth driver in Japan reduces the likelihood of the BOJ easing, especially ahead of the July 10 Upper House elections. With a Fed hike over the summer now more than 50% priced, we see room for divergence trade disappointment. We continue to target USDJPY 105 in 3m. As for this week, the ECB meeting, OPEC's latest gathering and US payrolls data top the list of potential market movers. But we do not expect any of these potential catalysts to deliver much to change the underlying picture.

1 June May 2016

US Daily Economic Notes April construction highlights the uneven nature of the housing recovery Total construction spending in April (-1.8%) fell by the most since January 2011 (-4.1%) but this was much less concerning in light of a cumulative 160 basis points of upward revisions to the prior two months. Over the last three months, construction spending increased at a 4.3% annualized rate. However, private residential construction is up a much stronger 18.5%, consistent with further improvement in the housing sector. Despite this outsized increase—the year-over-year growth rate remains at a trend-like 8%—we continue to view the housing sector as providing only modest support to the overall economy. Recall that nominal single-family construction spending remains nearly 50% below its 2006 peak while multi-family spending is a little less than 10% above its 2006 apex.

2 June May 2016

FX Daily - Update on EUR/USD (and JPY) …On the real rates side, the recent Fed repricing has helped push near-term "fair value" back down below 1.10, and it is our belief in the continuation of a Fed hiking cycle – however shallow – that is crucial for this rate spread to continue to widen. On this front the ECB

meeting today is likely to be less impactful given Draghi's shift away from rate policy earlier in the year. However we see downside risks to the crucial staff 201718 core CPI forecasts that are likely to build market confidence that QE is likely to be extended well into next year.



somewhat weaker than average in presidential election years. This pattern becomes clearer once we control for the effect on confidence of other economic variables, suggesting that the political cycle does play a role. So far in 2016, we find little evidence that the presidential election has weighed on consumer confidence. That said, political uncertainty seems likely to rise more than usual this year, and the candidates have lower favorability ratings than the candidates in the last few presidential contests did. These factors may keep confidence from rising as much as it typically does later in presidential election years.

1 June 2016

1 June 2016

USA: Beige Book Reports Modest Growth Across Most Districts BOTTOM LINE: The Fed’s Beige Book reported modest growth in economic activity across most of the country in late April and May, a slight downgrade to the language characterizing growth in the April Beige Book. Consumer spending rose modestly in the majority of Districts, while the description of manufacturing activity was downgraded slightly. Labor market conditions continued to strengthen, and most districts reported tight labor markets. Retail prices increased modestly across most districts, but were held back in part by increased competition from online retailers. 1 June 2016

US Daily: Consumer Confidence and the Presidential Election (Phillips) 

Consumer confidence is higher on average in presidential election years, driven mainly by greater optimism in the expectations-related components of the surveys. By contrast, perceptions of the present situation are

USA: ISM Manufacturing Index Signals Continued Expansion; Construction Spending Edges Lower BOTTOM LINE: The ISM manufacturing index rose in May, contrasting with the recent weakness in several regional manufacturing surveys. However, the underlying details of the report were less upbeat. Construction spending was below consensus expectations, although prior months were revised up. We revised down our Q2 GDP tracking estimate by two tenths to +2.8% (qoq ar).

JUNE 1, 2016

Global Interest Rate Strategy Brief Bull Steepeners to Hedge the Fed Market sentiment has turned, yet we look at ways to position for a potential bull rate scenario. We like low-cost bull steepeners that don't lose unless the front-end inverts and benefit from rolldown and vol RV.

After an uptick in economic data and Fed-speak pointing to a higher propensity to hike this summer, the market is now pricing in a material probability of a hike by July. However, for investors who want to position to benefit in a rally scenario, we like positioning in front-end bull steepeners, which benefit from the slow pace of hikes still priced in. Investors can pay 0.5bp to enter a December expiry Dec16/Dec17 bull steepener that doesn't lose money at expiry unless the curve inverts.

JUNE 1, 2016

Enter front-end bull steepeners given attractive breakevens, rolldown, and vol RV

now see Q2 GDP growth tracking at 2.0% instead of 2.4%. We see residential investment

Trade idea: EDZ6/EDZ7 Bull Steepeners Trade idea: EDZ6/EDZ8 Bull Steepeners Ted Wieseman

JUNE 1, 2016

U.S. Treasuries Daily Commentary …At 3:00, benchmark nominal Treasury yields were flat to 3 bp higher and the curve back to the post-recession low for 2’s-10’s and near the low end of the range since early 2015 after the launch of ECB QE for 5’s-30’s. The 2-year yield rose 3 bp to 0.90%, 3-year 3 bp to 1.05%, 5year 2.5 bp to 1.38%, 7-year 2 bp to 1.67%, and 10-year 1 bp to 1.85%, while the 30-year yield was little changed at 2.63%. There were some scattered moves into flattening trades noted, but our desk’s flows overall weren’t consistent with the curve move, with better buying into weakness in the belly of the curve seen and some asset manager selling in the long end. Speculation that OPEC might announce a production ceiling after Thursday’s meeting left June WTI oil little changed on the day near $49 after it fell as low as $47.75 in the morning. That provided some support to front-end TIPS, but more real yield selling in the longer end hit long-end breakevens significantly, flattening the breakeven curve notably. The 5-year TIP yield rose 3 bp to -0.10%, 10year 2.5 bp to 0.28%, and 30-year 2 bp to 0.91%, with resulting declines in inflation breakevens of 0.5 bp, 1.5 bp, and 3 bp, respectively. Calculated from the Fed’s constant maturity yield figures, the 30-year breakeven has fallen to 1.72% after rising from 1.62% ahead of the March FOMC meeting to a high of 1.84% at the end of April.

U.S. Economics Construction Spending … With the sharper than expected correction in April of that weather-boosted upside in Q1, we

slowing to 5.3% from 16.4%, with the homebuilding component decelerating to 0.4% from 14.2%. We estimate an 11.9% drop in business investment in structures in Q2, including a 70% drop in drilling and 4% decline ex mining and drilling, after an 8.1% decline in Q1, including an 88% decline in drilling and 18% rise ex mining. We see state and local government spending reversing to a 0.5% decline in Q2 after a revised 3.1% gain in Q1, with construction investment swinging to -13.7% from +16.9%.

JUNE 2, 2016

Global FX Strategy FX Morning UK events - US rates: Rate hikeexpectations at thevery frontend of the market haveeased,allowing surplus currencies to regain somestrength. AXJ FX has rebounded overnight, with thelower USDCNY fixing helping somewhat and Korea GDP slightly beating expectations, but this is wherethe good news ends this morning.Seeing US rateexpectations easing dueto markets repricing Brexit probabilities is nota good sign for risk appetiteand has the potential to push equity prices lower. An ICM phone poll for The Guardian, published Tuesday, has seen a sharp swing in recent weeks,as a 10pp lead for the Remain camp has turned into a 4pp edgefor Leavein just 14 days. An online poll,also by ICM for The Guardian, showed Leave with a lead of 47% vs. 43%, unchanged from thefinding in midMay.Welike being long EURGBP, supported further by theECB likely being a non-event today. Draghi is unlikely to rock the boatat times of high uncertainty.

Exhibit 1: EIA oil inventories haverisen whilefreight rates haveremained depressed

JUNE 2, 2016

Muni Monthly Dashboard May: Lemonade

JUNE 1, 2016

U.S. Economics ISM •





Surprising uptick in the ISM composite to 51.3 from 50.8 after a run of weak regional surveys and sluggish global reports overnight, but we'd discount this as a sign of improvement in manufacturing activity since all of the upside came from a 5‐point spike in the supplier deliveries gauge (54.1 v. 49.1). Growth in orders (55.7 v. 55.8) was solid but marginally slower, production growth (52.6 v. 54.2) slowed, employment (49.2 v. 49.2) contracted for a sixth straight month, and the inventory correction (45.0 v. 45.5) continued. 12 of 18 industries reported growth in May, similar to 11 in April and 12 in March after recovering from 9 in February, 8 in January, 6 in December, 5 in November, and 7 in October and September. Highlighted comments from survey respondents were modestly upbeat overall.

Consistent with views in our spring playbook, macro conditions helped make lemonade (0.3% MoM, 2.7% YTD returns) from lemons: a hawkish Fed, Puerto Rico default, and mixed credit spread performance on late-cycle-style fiscal challenges. Some insights from May, with inspiration from one pop icon.

…Cross-asset value 'Deja Vu' - Relative value unchanged to slightly worse MMD/UST ratios were unchanged to slightly tighter on the month' while long-end ratios fell slightly (Exhibit 5 and Exhibit 6). Value versus corporates was unchanged to worse on the month (Exhibit 7 and Exhibit 8) as risk premiums in both markets moved only modestly. Exhibit 7: After major rally, IG corporates widen slightly versus IG munis

A positive sign for now amid recent signs of renewed slowing in global growth was the export orders index holding steady at 52.5, high since late 2014 after rebounding from a post‐recession low of 46.5 in February. That may not last,

though, judging from Korea's real exports holding unchanged in May at a low level after a steep drop in April (Korea Trade Tracker: What Does May Data Say about Korea and Global Trade? (01 Jun 2016)).

Technicals '03 Bonnie & Clyde' - Strong demand meets positive net supply

JUNE 1, 2016

Global Macro Briefing

Global Trade about to Recover? After contracting sharply in 1Q, global trade has likely picked up tentatively in the course of 2Q, according to our new proprietary indicator, MSGTLI, thus supporting expectations for a recovery. Despite structural shifts in global trade dynamics since the global financial crisis, global trade still captures the heartbeat of the global business cycle. On our estimates, swings in global trade can explain nearly 60% of the quarterly swings in global GDP growth. The advantage of tracking global trade is that trade data are usually comparable across countries and that national data are available on a timely basis. The Morgan Stanley Global Trade Leading Indicator (MSGTLI) allows us to forecast global trade dynamics with a one-month lead. Based on a fresh set of high-frequency indicators for the month of May, MSGTLI points to a tentative recovery in global trade growth in late 2Q. In this context, we will keep an eye on whether an earlier expected end to the mini-upcycle in China could create new headwinds for a global trade recovery. Exhibit 1: Are Global Trade Dynamics about to Turn Around?

JUNE 1, 2016

Global Banks Should investors still care about energy risks with oil at ~$50?

What’s the level of global bank exposure to the energy complex? Adding Asia to our global estimates, we believe that bank exposure amounts to ~$870bn (~$510bn O&G, ~$360bn commodities). O&G exposure equates to 2-5% of total loan books across US/Europe/Asia (10-50% of TBV) with Commodities amounting to a further 2-3% (1035% of TBV).

Should investors still care given the rally in energy/commodity prices? We think ‘yes’. The recovery in energy prices has driven strong improvement in prospective FCF generation for the oil majors; however, significant cost/capex retrenchment is feeding continued weak oil services activity, whilst we believe a number of E&P players need oil at ~$60bbl for their models to work. As such we continue to see risks in these areas. Access to capital markets is materially improved for commodity names, though sustained higher prices remain key to B/S repair. In a number of Asian countries (excl Japan, Singapore, Australia) the oil industry is state owned hence risks are low. For many Asian banks, we see greater risks from commodity exposures.

Do higher US provisioning levels signal risks to come for Europe/Asia in energy? US bank energy reserve ratios sit at an average ~6% 1Q16 with the worst of the build behind us vs. Europe ~2%. Part of the explanation reflects the difference in seniority (I-grade) and type of exposure (majors, E&P, etc), and part the differing regulatory and accounting regimes. We expect an eventual narrowing, with Europe seeing a ~75% increase 1Q16-4Q16 vs US 40% and another European step-up in 2017. Although this still leaves European reserves at around half the US levels by 2017 (4.3% vs 8.8%) when expressed as a % of “higher risk” E&P/Oil services exposures, this implies both US/Europe at 15-16% by 2017. As such we think European estimates bake in a realistic increase in coverage despite optics suggesting otherwise – we note that European banks often disclose exposure at default vs US on-B/S exposure. We estimate Europeans’ on-B/S exposure at ~50% of EaD, which also helps to explain the gap in reserving levels often assumed.

Top investment ideas: Our forensic review increases our confidence that risks for European banks with exposure are adequately captured in estimates. Among energy sensitive names we prefer ABN, BNP in Europe, BoA and Zions in the US; we remain cautious on a number of Asian names, such as UOB, SBI, STAN, in part on asset quality risks.

SECULAR OUTLOOK

The Global Outlook: Stable But Not Secure BY ANDREW BALLS, RICHARD CLARIDA, DANIEL J IVASCYN

Regarding helicopter money, we thought it very unlikely to happen in the U.S. over our secular horizon. By contrast, in Japan, there already appears to be a rather high degree of coordination between monetary and fiscal policy, and there are real prospects for even closer ties between the Ministry of Finance and the Bank of Japan in which the existing quantitative and qualitative monetary easing (QQE) program evolves into a Japanese government bond price-pegging program. The uncertainty surrounding the impact of helicopter money scenarios is especially radical. …

Turning to more traditional fiscal policy options, the world’s three major economies – the U.S., Germany and China – all have space to run more expansionary fiscal policies, and in a right tail scenario they do so and with a focus on infrastructure and the supply side. … In sum, our secular thesis is that with risks to global economic stability rising, investors should be compensated up front for the growing and heightened uncertainty and potential consequences of monetary policy exhaustion they face. Under a left tail scenario in which this stable disequilibrium unravels sometime and in some fashion during our secular horizon, no one has a crystal ball to determine what it would look like. The timing and precise dynamics of the eventual endgame following such a scenario are uncertain, the plausible paths are many and complex, path dependence would be the rule and not the exception, and much would depend on the timeliness and boldness of the policy –

including fiscal policy – response. But while there are myriad uncertainties, there is no doubt that a global disruption of our baseline scenario would have serious repercussions for growth, inflation and financial markets. The risks are uncertain, but they are real, and active investors can aim to put a price on them.

… Investment implications Stay on dry land and preserve capital …Guard against negative yields and guard against the asymmetric risk of rising yields Markets now price in the New Neutral outlook for central banks and for market rates, which has been a central theme of our secular outlook for the past two years. Over the coming secular horizon, we will guard against negative yields in Japan and the eurozone, looking for more attractive global alternatives. Overall in our baseline outlook we expect government bond market yields to be fairly range-bound, but there is a clear asymmetric risk toward higher yields than those priced into forward curves.

JUNE 2, 2016

FIXED INCOME DAILY The trend is not your friend Market Update The trend is not your friend. Trend-following CTAs have had a particularly poor run over the past three months. More generally, they have been struggling for more than a year, after a brilliant run in the year to April 2015. Policy then supported clear and sustained trends, e.g. a sharp and sustained dollar and global bond rally. The recent struggle may well reflect both policy exhaustion and a lack of direction at stretched valuation levels. We will discuss the topic in more depth, with the help of our quant analysts, in our 2016 H2 Fixed Income Outlook, due by the end of the week. Our message about future financial returns may be dispiriting, but it makes tactical positions, relative value analysis and conditional (optional) trades ever more

important in a successful investment process. Watch this space.

… The front end of the Treasury curve remained under moderate pressure (with 2y yields rising by 2bp) as the market debates the merits of a rate hike in June versus July. We are likely to get some clarity on this topic later this week, when we get the change in nonfarm payrolls for the month of May. Consensus estimates are for an increase of160k jobs (SG 140k), which is lower than recent prints, owing to a couple of special factors, such as the Verizon strike and the large increase in the “management, technical consulting” sector in the previous month, which is likely to reverse. Ultimately the market will have to wait until Fed Chair Janet Yellen’s speech on Monday in Philadelphia to gain insights into the committee’s thought process and timing of the next rate hike.  The market is currently pricing in a 50% probability of a rate hike in July, and there is still more room for frontend yields to rise as Yellen keeps the door wide open to a summer hike. A fully priced July hike would see 2yT yield rise to 95-100bp and the 10yT yield to 1.95-2.00%. We believe the hurdle for a June rate hike is still high ahead of the UK referendum on 23 June, especially now since the polls continue to be evenly divided. Kit Juckes

JUNE 2, 2016

FX DAILY DODGING BULLETS 

USD/JPY and real yields as ‘Abenomics 2.0 is born

 With markets overall in wait and see mood, the yen

was the winner in FX again overnight. The consumption tax increase has finally been postponed, and another significant round of fiscal easing is coming. See here for our thoughts on fiscal policy. The shift in emphasis away from easy money and towards easier fiscal policy marks a turning-point in Abenomics. Of course, easier fiscal policy is possible largely because so much of the public sector’s debt is now in the hands of the BOJ, but even so, if we now get decreased talk of further BOJ action and upgraded growth forecasts, that doesn’t point

towards dramatic yen weakness. However, I’m not ready to embrace a strong yen yet. Firstly, I’d be more convinced if the Nikkei wasn’t greeting the latest developments by blowing raspberries at them. A positive equity market reaction to easier fiscal policy would help get growth back to a sustainable path. And secondly, the collapse in relative US/Japanese real bond yields that drove USD/JPY down, is still being corrected. As long as real yields are supportive of USD/JPY, the temptation is to fade yen strength (after tomorrow’s NFP).

JUNE 1, 2016

GLOBAL EQUITY MARKET ARITHMETIC IT’S ALL ABOUT US DOLLAR STRENGTH … AGAIN Courtesy of a good final week, the MSCI World index finished the month of May up 0.2% and remains slightly (0.7%) in the black for 2016. However the US was the only region to make USD denominated gains during the month (the NASDAQ particularly strong with a rise of 3.6%) while elsewhere, most notably Japan strong (+4.0%), rises disappeared when translated back into US dollars. The Yen had its weakest month versus the dollar since May last year, although it remains almost 12% of its lows of 125. Investors had been debating the reasons for the sharp rebound in equities from the February low. Was it the oil price, emerging market risk, US interest rate direction? Well it looks like we have the answer - it was the weakness in the US dollar. For while equity markets have been okay but not incredible in recent weeks, a whole string of USD related trades feature amongst the leaders and laggards. Emerging Markets for one, which had been enjoying some welcome relief from a weakening USD but then fell by 3.9% in May and this despite oil prices rising significantly during the month. And Mining, still the best performing global sector this year, slumped almost 13%. Meanwhile Technology stocks were the clear leaders. US dollar strength was the key performance driver in May (Global Technology vs Mining performance and the US dollar index)

2 June 2016

Macro Keys 1 June 2016

Market Musings USDJPY: The Fact was Sold—Look to Buy The Dip •









As expected, Japanese PM Abe announced a delay in the sales tax increase. This is part of a broader shift from monetary policy levers towards fiscal policy tools, both in Japan and more broadly. USDJPY had rallied in the days ahead of the announcement as this move was widely anticipated. In a classic case of “sell the fact”, spot has fallen sharply since. Given the likely causes of this pullback, however, we believe it will prove temporary. Indeed we have been looking for such a correction and think it will present an opportunity to enter strategic longs from better levels. We believe that this correction has a bit further to run, but we have turned strategically bullish on USDJPY. We also think the 107.50/108.05 zone should contain weakness from here. Investors should look to enter long strategic positions in this range, or slightly above, for a move toward our year-end target of 115. We continue to see some upside risks to that forecast.

US corporate default wave: Rogue wave, or the start of a tsunami? The key debate is around ex-commodity defaults. We expect a material increase driven by solvency concerns. And risks are biased up due to structural shifts. The key questions In this piece we address several pivotal questions around the US default outlook. First, is the recent default wave breaking with the recent recovery in commodity prices? Second, should it be viewed as a proverbial rogue wave – a one-off, extreme event – or could this be the start of a tsunami – a series of successive, larger defaults? Third, what will be the key determinants of defaults in this cycle? And how will changes in market structure impact the outlook? Fourth, what's priced in by market expectations? And finally, how should investors position portfolios? Commodity defaults to remain elevated well into 2017 In brief, we expect commodity sector defaults will remain elevated for the rest of 2016 and into 2017. And we project excommodity industry defaults to rise with the deterioration in corporate profits, lending standards and funding costs. In particular, investors should focus on the media/entertainment, consumer/service, retail and industrial sectors. In this cycle, our belief is that structural impairment will be the key drivers of defaults. Market participants should focus more on the narrow cushion between the market value of assets and debt as well as weak cash flow generation at lower quality firms, and less on bond maturities and covenants as triggers of default. Non-commodity defaults to climb above consensus forecasts Our year-ahead forecast for US speculative grade defaults is 5 – 5.5% by Q2 '17, comprised of 15% and 3.5% default rates in commodity and ex-commodity sectors, respectively. We believe our projection for non-commodity defaults is largely out of consensus, with most participants expecting only an incremental increase in non-commodity defaults from current levels near 1.5%. In our view, the bias to our forecasts is to the upside. Part of our rationale is driven by structural changes in credit markets which could worsen the cycle, including greater macroprudential regulation, a higher concentration of holdings in 'frail' hands, a much riskier leveraged loan market, and less relief from rates at the zero bound.

Recommend positioning in high grade credit, large cap equities We recommend corporate credit investors maintain an up-inquality bias, preferring US high grade over high yield. We actually prefer expressing this view in equities, favoring large caps over small caps. Fundamental credit deterioration is causing a more pronounced rise in leverage and decline in interest coverage for small caps. In addition, small cap benchmarks such as the Russell 2K have an elevated concentration in financials. We believe tighter credit conditions, not only in C&I but also CRE, will increasingly weigh on small capitalized financials, the majority of which are regional banks and REITS, relative to their large cap peers

Economics Group Forecast Revision Incorporating this week’s information including the ISM manufacturing index and the BLS’ worker strike impact, we have revised our forecast for May nonfarm payrolls to 135,000 from 125,000. Note, our forecast for the May unemployment rate remains the same at 4.9%. June 01, 2016

Economics Group Special Commentary June 01, 2016

Economics Group Interest Rate Weekly Three dimensional checkers: Part II Observing the interplay of interest rates, exchange rates and capital flows creates a fascinating challenge for forecasters. The importance of appreciating this interplay commands investors’ attention. … Nominal Yields Since the recession in 2008-2009, two-year interest rates in Japan, South Korea and Singapore have all declined (until the more recent rise in twoyear rates for Singapore since 2014). This reflects the global slide in interest rates over that same period. However, since early 2014, South Korean yields have fallen sharply while Japanese yields have dropped below zero. In fact, Japan is now one of several countries including Germany, Sweden, Denmark and Switzerland that exhibits negative interest rates. For some of these countries, the move to negative yields has reflected an attempt to offset capital flows and exchange rate appreciation… June 01, 2016

Housing Chartbook: June 2016

Beginning to Believe

All year we have been making the case that 2016 would be a break-out year for homebuilding, and, finally the data are beginning to support our argument. The April reports on new home sales, pending home sales and new home construction all came in well ahead of market expectations and data for previous months were also revised higher. The leading indicators of housing demand also improved, including buying plans, mortgage applications and homebuilder sentiment. The string of better reports has reversed the news flow at the most critical time of the year for the housing market and has led forecasters to boost their estimates for home sales and new home construction this year, even though interest rates now appear set to move modestly higher. Our forecast remains essentially unchanged, with new home sales expected to climb 11.8 percent this year and housing starts projected to rise 9.7 percent to a 1.22 million-unit pace (Figure 2). Home prices are likely to moderate slightly, as more supply comes on line While we certainly welcome the better news, we continue to stress caution in interpreting the recent data. Seasonal adjustment has likely amplified recent gains. This past winter was one of the mildest on record and allowed for more sales and home construction during the winter months. Moreover, Easter came exceptionally early this year, falling on the last weekend in March, marking the earliest Easter since 2008. This meant that April essentially had one more weekend available to sell homes than most other years. Easter will not fall this early again until 2035 We suspect the impact of the early Easter was greatest on new home sales and pending home sales, both of which measure sales contracts. New home sales surged 16.6 percent in April, nearly seven times consensus’

expectations for a 2.4 percent rise. Pending home sales soared 5.1 percent in April, also more than seven times the consensus forecast of a 0.7 percent increase. Existing home sales, which measure closings, were less impacted by the timing of the holiday.