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and GC repo rates – a proxy for “balance sheet” cost – has narrowed by 10bp ... deposit funding Instead, it just
StreetStuff Daily September 29, 2017

Thu 9/28/2017 9:26 AM

Thursday 8:30 Data Stephen Stanley Chief Economist

Three releases this morning, none of which were huge game changers, but there were certainly implications for the GDP outlook. The final revision to Q2 GDP was even more trivial than usual. The top line figure was nudged from 3.0% to 3.1%, and practically every major category was not significantly different from before. We close the book on the first half of the year with average GDP growth of 2.15% annualized, dragged down to a degree by inventory liquidation. Real final domestic demand (i.e. GDP minus inventories and trade) posted a 2.55% annualized gain. Looking ahead to Q3, we received advance data this morning on trade and inventories for August. Both point to higher GDP for the quarter.

… Wholesale and retail inventories were both higher in

August than I had penciled in. Thus, I bumped up my estimate for Q3 inventories. The inventory figures will be distorted to a degree by the hurricanes. It’s a little early to have a firm handle on the inventory situation, but my guess is that storm-related supply chain problems could be a mixed bag, raising stocks for some and lowering them for others. In any case, I have long counted on a significant acceleration in inventories in the second half of the year after stocks were essentially flat in Q1 and Q2. The data so far for Q3 point to a substantial boost to GDP from inventories, possibly close to a full percentage point. On the back of these two reports, I have raised my Q3 tracking estimate for real GDP growth to 3.0%, up from 2.6%. I expect others to boost their projections as well.

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… As an aside, industry sources are surprisingly calling for a huge pop in auto sales in September. The assumption had been that sales would be depressed again in September and recover in October, but it now looks like dealers are seeing a nice acceleration this month already. While this may not have a big impact on Q3 GDP (any new vehicles available for sale in September are going to show up in Q3 output regardless, either as sales or inventories), but it is a positive sign that the economy is working through the hurricane distortions quickly and will see no lasting impact on growth…

Thu 9/28/2017 3:48 PM

What Did We Learn from the Fed Over the Last Week? Stephen Stanley Chief Economist

The extremely heavy slate of Fed speakers is essentially complete for the week (Philadelphia Fed President Harker speaks tomorrow but the topic is FinTech). We have heard from 13 different Fed speakers (out of a total of 16 FOMC participants) since last Friday. What have we learned?

4) … Chair Yellen’s views. Chair Yellen took a considerable

amount of flak last week for essentially throwing her hands up in the air and suggesting that the low inflation figures were a “mystery.” It is pretty clear that several members of the FOMC felt that they needed to push back against that notion. Yellen clarified her views on inflation with an extended speech Tuesday. While her fleshed out position was not entirely inconsistent with her comments at the press conference last week, she explained much more decisively why she believes inflation will move back up. She gets to that conclusion from several different angles. First, true to her Phillips Curve instincts, she relies heavily on the fact that the labor market no longer has slack. Second, she breaks down recent inflation data with a model and finds that most of the decline this year reflects “idiosyncratic shifts in the prices of some items.” She makes a point that I have noted as well, that the trimmed mean measure of inflation has fallen less than the core, which demonstrates that the deceleration in core inflation is relatively narrowly focused. She then goes on to lay out and shoot down some of the objections to this view. Some might argue that, contrary to popular belief, there is still considerable slack in the labor market (this is one of Kashkari’s far-out-of-consensus economic arguments). Yellen proceeds to invoke virtually every labor market indicator under the sun to bolster the case that the labor

market is in fact tight and that wage pressures are likely to pick up going forward. The next objection is that inflation expectations may have declined, putting in jeopardy the credibility of the Fed’s 2% target. She cites relatively steady survey-based inflation expectations. She dismisses out of hand TIPS breakevens as a reliable proxy for inflation expectations, which provides stark confirmation that the Fed’s thinking about the relevance/importance of TIPS breakevens has evolved substantially over the years and that officials no longer pay much attention to them. In the end, Yellen acknowledges that while she thinks inflation will accelerate back toward 2%, there is more uncertainty than usual. In such a circumstance, she says the case for gradual adjustments in policy is even more compelling. If she had left it there, we could still have concluded that the tone was not much different from last week’s press conference. But she felt it necessary to add the following punch line:

“But we should also be wary of moving too gradually. Job gains continue to run well ahead of the longer-run pace we estimate would be sufficient, on average, to provide jobs for new entrants to the labor force. Thus, without further modest increases in the federal funds rate over time, there is a risk that the labor market could eventually become overheated, potentially creating an inflationary problem down the road that might be difficult to overcome without triggering a recession. Persistently easy monetary policy might also eventually lead to increased leverage and other developments, with adverse implications for financial stability. For these reasons, and given that monetary policy affects economic activity and inflation with a substantial lag, it would be imprudent to keep monetary policy on hold until inflation is back to 2 percent.” That passage lands Yellen clearly in the hawk camp and strongly confirms that the FOMC is likely to hike in December – and to keep going in 2018. The financial markets are buying in to the December rate hike story but remain skeptical about 2018. I suspect that it will take a few more firm inflation readings to push market participants’ expectations for 2018 closer to the dots, but Fed rhetoric is certainly providing ample backing for the “continued gradual” hikes signified in the dot projections.

28 September 2017

US nominal goods trade balance improves in August; Q3 GDP tracker up one-tenth at 2.2% …Regarding the effect on our Q3 GDP tracking estimate, the lower-than-expected trade deficit implies a positive contribution to GDP from the net exports subcomponent. In addition, today’s strong inventories data also boosted our GDP tracking. However, weaker core goods imports led us to lower our equipment investment tracking estimate for Q3, partly offsetting the boost to GDP from other components. Taken together, the trade and inventory data pushed our tracking estimate of Q3 GDP higher by onetenth, to 2.2%. 28 September 2017

US Q2 GDP revised higher to 3.1% on stronger inventories contribution …Altogether, the third estimate of Q2 GDP paints a solid picture of the economy. While growth in Q1 slowed significantly, it rebounded strongly in the following quarter suggesting likely temporary factors drove the weakness at the start of the year. We expect growth to slow again in Q3 to 1.5% q/q saar following the disruptions from the hurricane season, but reconstruction of the affected areas should boost Q4 GDP (we expect 3.0% growth for the final quarter). October 2017

Money Markets Monthly Update This month we take a closer look at the recent behavior of repo markets with a focus on large dealer balance sheet capacity. Tri-party repo volumes have increased sharply since 2015 – rising 44% since August 2015. At the same time, the spread between the overnight GCF and GC repo rates – a proxy for “balance sheet” cost – has narrowed by 10bp to 8bp. Treasury collateral has become more available outside the Fed’s RRP program

– from both new providers as well as traditional market participants which have sharply increased their repo borrowing. But while money fund reform (and the sharp increase in the demand for Treasury repo) has loosened up balance sheet constraints at larger dealers, it hasn’t flowed through to other types of collateral. Instead, trading volumes in the equity and MBS repo markets are largely flat since 2015. Separately, we review the behavior of the secured overnight funding rate (SOFR) – the rate that has been chosen to replace Libor. And we take a look at cleared repo activity. Next we consider the path for 3m LOIS in the near- and longer term. The lack of unsecured bank issuance has meant that a large portion of the daily submissions are based on data from related markets such as repo and the cross-currency basis. Outside last fall, there has historically been little connection between the size of the Treasury’s cash balance, bill supply, or, more generally, the level of bank reserves and unsecured bank funding spreads. That said, positioning in the cross-currency and repo markets could cause LOIS to overshoot this fall.

We follow up by examining the Fed’s balance sheet normalization and its potential connection to LOIS as banks finance their replacement HQLA.

…Defining normalization •



The Fed’s definition of its balance sheet normalization is still somewhat vague o The Fed appears to favor maintaining an operating system in which bank reserves are plentiful1/ And the IOER and RRP rates act as floors under the fed funds policy rate o Bank reserves provide some financial market insulation And are used by banks to satisfy their demand for Level 1 HQLA under the LCR But how abundant?

US bank HQLA



LOIS: Financing the replacement HQLA • • • • • •

Financing the purchase of replacement HQLA will depend on the institution US banks are likely to boost their retail deposit rates But this doesn’t increase the supply of deposit funding Instead, it just shifts it from small to large banks Non-US banks will turn to wholesale markets And this will determine how wide LOIS gets Along with the steepness of the term Libor curve

29 September 2017

Spain

Catalonia Referendum: What to expect Tensions between the central and regional government have escalated in the run-up to the independence referendum, scheduled for 1 October. The central government and prosecutor have shifted gear, deploying resources to prevent the illegal referendum taking place. These include measures of financial control (in particular with the central government taking over the funding of the main public services), seizing of voting materials, as well as arresting and questioning regional officials allegedly involved in the vote organisation. The Spanish state prosecutor has also instructed the police to take control of the polling stations. Overall, the latest developments are in line with the most likely scenarios we identified in Euro themes: Spain: The Catalonia issue, 14 September 2017. We also discussed in that

note why the market impact is likely to be limited, even if it is a complex issue without a straightforward resolution.

earnings are the most positive in nearly five years. On the face of it, the outlook appears serene

28 September 2017

FIGURE 2 Global equity valuations are now in-line with historic norms

Global Outlook Too early to play defense …Economic Outlook And the beat goes on The global recovery continues, synchronized across regions and broadening into investment. US growth remains decent if unexciting, while Europe and Japan have further surprised on the upside; China has peaked, but other EMs are catching up.

What worries us is the mix

Interest Rates Outlook An uncertain reaction function We are neutral on duration, but expect the 2s10s curve to continue flattening in the US. We expect a 1y1y-2y1y EONIA steepening and recommend selling high-strike payers in the UK. We maintain a US/EUR rate and vol convergence trade and our 10y US swap spread widening view.

US Treasuries: Holding the line We continue to recommend 2s10s curve flatteners. We think the normalization of short rates is likely to occur at a faster pace than is priced in. The moderate economic backdrop argues against a large rise in long-term rates. The Fed shrinking its balance sheet is unlikely to put undue upward pressure on term premia. The key risk to our view is a major easing of fiscal policy, geared towards lower/middle income households.

Credit Market Outlook Still going strong With a supportive economic and fundamental backdrop, we remain constructive on credit over the next 3-6 months, although tight valuations should limit the room for further compression. We continue to favour US HY over European HY, but see IG RV as more balanced.

Equity Market Outlook Uncomfortably bullish The current bull run in global equities is near the strongest in history. Yet global valuations are only near the trough levels of 2003. Moreover, prospects for

While in aggregate, inexpensive global valuations, coupled with a forecast for strong earnings growth, suggest positive stock market returns, what worries us is the mix. The biggest stock market region in the world, the US, is outright expensive on most valuation metrics. Most other regions, including Europe, look cheap. As we highlighted in European Equity Strategy: Uncomfortably Bullish, 15 September 2017, the expensiveness of the US persists on most valuation metrics, calculated on both a cap-weighted and an equalweighted basis. Of the several measures, perhaps the Shiller PE presents the harshest perspective on US valuations. Going back to 1881, US stock markets have been more expensive only twice: during the later stages of the Tech Bubble and during the late cycle surge that preceded the Great Depression in 1929. European stocks on a Shiller PE of 17x and emerging market stocks on 15x, on the other hand, look cheap. FIGURE 4 Since 1881, US stock markets have been more expensive only twice

Market Commentary Byron Wien

Low Volatility Is Here to Stay October 2017

In my conversations with institutional investors I find a surprising lack of optimism about the outlook for equities. The capitalization-weighted Standard & Poor’s 500 was up over 11% year-todate, excluding dividends, on September 18. Some would argue that only a few stocks are accounting for the rise, but the equal-weighted S&P 500 was up over 8% year-to-date as well. Everyone is aware that the economic expansion and the bull market have continued for a long time. Equities bottomed in March of 2009 and the economy began to strengthen in June of that year, so we have been in a favorable period for investing for more than eight years. Cycles usually do not last this long. We all know it can’t go on forever, but I believe we could continue on a positive course for both the economy and the market for several more years. The principal reason for this conclusion is that the usual factors that warn of a bear market or recession are not evident. What would really worry me would be an inverted yield curve, but there is now almost an eighty basis point spread between the two-year Treasury and the ten-year. I would also be concerned if retail investors were euphoric about equites as they were in 1999 or 2007. They are generally optimistic, but not excessively so, although earlier this year sentiment did rise to a worrisome level. Investors large and small are also leaning toward the defensive. Hedge fund net exposure clearly shows a mood of caution: it is just under 50% now; it was mostly 55%– 60% in the 2000–2008 period. Individuals are still buying bond funds even at these low yields because of their lack of confidence in the stock market. Institutions, in their desperate search for yield, have bid up the price of lower-quality bonds to the point where their spread with Treasurys is historically low. Warnings of trouble ahead, however, would usually be associated with high spreads. Maybe investors are too complacent, but not this may not be the case if the economy continues to grow.

We know that the Federal Reserve was considering an additional increase in the federal funds rate in September, but was discouraged from taking any action by hurricanes Harvey and Irma. The planned shrinkage of the Federal Reserve balance sheet was probably also delayed for the same reason. The S&P 500 has also shown a tendency to peak after each rate increase by the Federal Reserve and we have only begun the tightening cycle now. The hurricanes are likely to reduce third-quarter real GDP growth by at least one-half of one percent, but demand driven by rebuilding should be reflected positively in the fourth quarter and the first quarter of 2018. Another important warning signal is the Leading Indicator Index, which has been climbing steadily since 2016. Recent data shows the possibility of a growth slowdown but a continuation of the expansion. The slowdown, if it comes, may trigger a correction in the equity market, but the present steep slope of this indicator suggests nothing more serious than that. Based on this data, even when the Index tops out, we would still have as long as two years for the market to work its way higher before the downturn begins. Corporate earnings are still increasing and there has never been a recession while that is happening… … The Bank Credit Analyst (BCA) has identified some other indicators that could provide an early warning on inflation. They include personal consumption expenditures, the producer price index for finished goods, the Institute for Supply Management Manufacturing Prices Paid and the Corporate Prices Paid deflator. Only the finished goods indicator looks troubling now. In that connection, BCA also has found money velocity a useful indicator of future inflation, and this looks like it could be signaling a problem at some point in the near future.

Thu 9/28/2017 3:17 PM

Lyngen/Kohli BMO Closing: Plucky Sevens We were encouraged by the Treasury market’s ability to pull back from the overnight lows, but with 10-year yields still above 2.30% it’s difficult to call the move a reversal. We remain skeptical that massive tax reforms are an inevitability and based on what others are saying on the topic, we’re not alone in that opinion. That observation isn’t offered by way of a justification for our initial read that the tax deal is far from done, but rather we highlight the convergence of views as evidence that there is more afoot than rewriting the tax code. Domestic equities certainly benefited from the news on Wednesday, but there was very little follow-through as the details (or rather lack of details) were scrutinized.

to get to that point. All that being said, if the Fed steps back from recasting the data as acceptable within a ‘new paradigm’ than 5s will retain the position as the go-to policy spot on the curve – terminal funds rate assumption and all. …More immediately germane to the Treasury market will be the process of defining a new trading range after 10-year yields have backed off the 2.016% low marks for the year. Momentum has once again edged in favor of a bounce and stochastics point toward lower yields. The 200-day moving-average at 2.325% has held on a closing basis, although Thursday’s intraday challenge didn’t go unnoticed. The most recent Stone McCarthy investor survey showed positions closer to neutral with the duration-weighted measure at 99.8% of target, suggesting that it may prove more difficult to breakout in either direction than in recent episodes.

Core-PCE vs. Core-PCE ex-Housing Recessions Shaded

…Supply is now behind us and the 7-year auction concluded the process on a strong note. The 1.2 bp stop-through was an impressive showing for the sector, particularly for an auction that doesn’t tend to do well in the month of September. The combination of month-end demand and some early dip-buying led to one of the largest non-dealer awards on record at nearly 90% -- in fact, it was the second largest buyside award ever. It’s not a leap to suggest that we’ll be watching for overnight followthrough of foreign buyers for further evidence that the tax-triggered selloff has lost its initial urgency. …… Tactical Bias: …It is way too early for this shift, but we suspect there is a point at which softer data, inflation or otherwise, triggers a more significant response further out the curve (i.e. 10s and 30s) as it’s taken as a reflection of the disconnect between the Fed and investors’ read on the real economy. We recognize this would represent a marked departure from the traditional response of the belly leading the curve, but it speaks more to the notion that the sector of the curve anchored to Fed policy may be creeping out the maturity spectrum. Admittedly, we’re not there yet and we suspect it will take a couple more hikes in the face of benign inflation and uninspired growth

28 Sep 2017

Global Rates Plus - Optimism 2.0 Trump bump rebound? The optimism regarding the economic outlook which arose in the wake of the US election has taken a hammering since Q1. Since the post-election peak in March, there have been strong reversals in US policy rate expectations, the dollar and in world bond yields. President Trump’s fiscal plans were put in doubt by legislative deadlock, and inflation failed to revive despite falling unemployment.

However, an uptick in US inflation and recent statements on the monetary and fiscal policy

outlook by, respectively, Fed Chair Yellen and President Trump, have revived US rate hike expectations and bond yields (see chart). What’s more, the effect is being spread around the world by the recovery of the US dollar, which allows non-US central banks to be more hawkish. The post-election 'Trump bump' is reviving

in the shape of the curve has changed carry along the curve; since 1 June, 1-year US carry on the US 2-year has risen by 4bp, whereas the carry on 5- and 10-years has marginally declined (lower chart). The positive carry is only 1bp/3m, but effectively means the investor gets paid to be long convexity. If the money-market curve returns to post-election levels, 2s5s10s should return to around 13bp (upper chart). The Fed’s balance sheet unwind should also help this trade by increasing term premia along the curve.

US 2s5s10s lagging the money-market curve steepening

New opportunities: Not all markets have expressed this change in outlook to the same extent, however, which creates opportunities for investors. For example, the US 10-year yield has reversed 53% of its peak-totrough fall; but US 2s5s10s and 2s10s have recovered just 26% and 17% respectively of their peak-to-trough move (table below). Also in this week's Global Rates Plus Global: Optimism 2.0 Eurozone: Prepare for new seasonal bearish pattern on Bunds Eurozone spreads: Potential S&P upgrade of Spain priced in Eurozone spreads: Buy 7s BTP vs 3s and 10s UK: Switch into GBP 2s5s 1y forward steepeners US: Fiscal talk and a hawkish Yellen MBS: Why GN2/FN swaps are so cheap Australia: Time to outperform Eurozone: September index duration extension

Changed curve shape means changed carry US 2s5s10s: One of the opportunities presented by the rebound in economic optimism is that US 2s5s10s has lagged the steepening of the money-market curve. As a result, it now looks about 6bp too cheap (top chart). What’s more, there is currently positive carry in being long the 2s+10s barbell against selling the 5y bullet. This unusual state of affairs is due to the way that the change

•Pay 6m forward US 2s5s10s at -5bp.Target: +13bp. Stop: -10bp. 6-month +carry roll: +3.1bp. Carry shifts not limited to US: Quickly-shifting rate expectations are changing carry and curve dynamics around the world. Most striking is the transformation of expectations in the UK, which has raised 1-year carry on 2-year rates by 21bp since 1 June, and changed the UK’s carry curve from looking less like Europe’s and more like the US’s (lower chart). Thus we now add to our USD 1y forward 2s5s steepener recommendation a GBP 1y forward 2s5s steepener at 22bp which carries +1.2bp/3m (see UK section). Finally, on peripherals, there is also a significant carry and roll on long 7s BTPs vs 3s and 10s. Laurence Mutkin BNP Paribas London branch

US: Fiscal talk and a hawkish Yellen US rates have bear steepened on fiscal talk and a hawkish Fed Chair. US President Trump’s plan for the “largest tax cut in our country’s history” includes: Corporate reform: There could be a reduction in the tax rate to 20% (from 35%), partial limitations on interest deductions and a one-time tax for accumulated offshore profits (paid over several years).

Changes for individuals: Three tax brackets – 12%, 25%, and 35%, versus the existing seven rates, and increased standard deductions. While uncertainty remains over how Congress would offset revenue loss from tax cuts, the House Freedom Caucus has agreed to support the House budget resolution – an important step on the path towards achieving reform. Yellen warns that the Fed should be “wary of moving too gradually”:  The Fe d is unlike ly to ke e p m one ta ry polic y on hold until reaching the 2% inflation target, even if 2017’s inflation shortfall is still a mystery.  Ye lle n re ite ra te s tha t the Fe d will continue to focus on incoming economic data (but is likely to look through hurricane-related noise).  S ince the F e d s ta rte d tighte ning, ra te hike expectations (1y and 1y1y OIS) have become more sensitive to the y/y inflation rates (top chart). BNPP forecasts find the greatest rise in inflation occurs in Q2 and Q3 2018 – we keep our short EDH8/U8/H9 fly recommendation. We keep our structural recommendations: (i) 5y5y atmf payer swaption, (ii) 1y10y payer spread and (iii) 2y fwd, 2s5s steepeners. We expect bear steepening in US rates to continue with low (but increasing) expectations of tax cuts. Interest rate forwards and vol are lower than in January, when fiscal stimulus was more priced, and vol skew implies that the cost of protection against rate moves (via options) has not changed (lower chart). Shahid Ladha, Timothy High, BNP Paribas Securities Corp

2y TIPS (Apr-19) vs 10y TIPS (Jul-27) breakeven flattener at 32bp. Target: 10bp. Carry: +8, +32, +4bp at 1, 2, 3 months. Stop: 50bp. Rationale: Carry on 2y TIPS over the next three months does not look fully priced (top chart). 2y breakevens could reprice higher (and then fall to offset the positive carry ahead) or they may not move (but the positive carry is then earned over a holding period). Either way, we expect long 2y breakevens to perform well in Q4 (given our oil/inflation assumptions). We find the 2s10s US real curve very flat versus the nominal curve, especially on a (carry-implied) 3m forward basis. Longer-dated maturities experience much lower bp carry than short-dated TIPS. Resulting 2s10s breakeven curve looks extremely steep at 2m and 3m forwards – levels which have not been seen for two years. For re a l yie ld inve s tors or inve s tors wa nting to pos ition for a steeper curve (with Fed balance sheet unwind), 2s10s TIPS real curve steepener offers good potential and very positive carry (lower chart). Shahid Ladha, Timothy High BNP Paribas Securities Corp

28 Sep 2017

Global FX Plus - Tax Focus To Support The USD

US: 2y TIPS to outperform in real and inflation curves

Weekly FX key themes: Prepare for higher volatility in October

After five consecutive months of weakness, August saw the first upside inflation surprise for six months with core printing +0.249%, 1.8% y/y.



Inflation dynamics: Upside risks from hurricanes, but trend is weak From Ma rch through J uly, ne a rly e ve ry m a jor ca te gory within core CPI has underperformed its 2y average run rate. S om e we a kne s s is idios yncra tic (unlim ite d da ta bundles), but some effects are structural, as NY Fed President Dudley acknowledged. G a s oline future s a re a t YTD highs – up more than 25% from June. BNPP inflation forecasts imply 2y TIPS breakevens would earn +51bp of carry in Q4 thanks to positive seasonals and the rise in energy prices.





Rising expectations of fiscal reform should support the USD. However, data over the weeks ahead are likely to be disturbed by the recent hurricanes. Expect vol to rise. Uncertainty around the Japanese election is likely to rise over the next three weeks if the opposition gains support.

Fed Chair Yellen’s speech this week added to the increasingly hawkish tone seen at the recent FOMC press conference. She warned of the risks of tightening too gradually and emphasised that temporary factors appear to be holding down inflation. A 70% probability of a rate hike in December is now priced into interest rate markets which, coupled with rising expectations of US fiscal reform has seen the first monthly gain in the USD since February. However, whether or not a rate hike is delivered depends on the upcoming data flow, and data in the coming months are likely to be tricky for the

market to interpret due to disruption from Hurricanes Harvey and Irma.

Chart 1: The USD has tracked relative performance of tax-sensitive stocks

Next week’s data releases should provide the first detailed view of the impact of the storms on the economy. Already, the most recent release – the weekly initial jobless claims data – showed a rise since the start of the month. Furthermore, the volatility of economic data surprises appears to have picked up in a very similar pattern to the volatility of data following Hurricane Katrina in 2005. This volatility could therefore increase markedly in the next month, and we expect this to lead to higher volatility in markets.

The recent hurricanes are causing volatility of economic data surprises to rise. Expect further increases ahead

Macro Matters 28 September 2017 BIG PICTURE: Boiling the frog of risk Low inflation, decent growth and patient central banks have been a recipe for rich asset valuations. But with the mood music of central banks changing and some valuation measures looking heady, is a correction on its way?

US tax reform: Supporting the USD in Q4   



Momentum is rising for meaningful tax legislation as we move into Q4. We expect the USD to benefit from rising expectations for tax changes through a number of channels: Growth & the Fed, capital markets and repatriation. We favour long USD exposure via options. In particular, we recommend long USDCHF via a seagull structure

… Market pricing for successful tax reform appears to be rising for the first time since the immediate aftermath of the election, with our EQD Strategy team’s basket tracking tax reform-sensitive companies beginning to close the gap with the S&P 500 (Chart 1). As Chart 2 highlights, fading tax reform hopes have coincided with USD weakness so far this year, and a rebound in tax pricing is a key element of our expectation that the USD will trade well into year-end.

THEMES OF THE WEEK Spain: Some pain, still gain Despite tensions over Catalonia’s independence bid, we think Spain’s bond market should remain insulated from political risk events by solid economic fundamentals, an improved outlook and continued ECB asset purchases. Germany: Slow start to coalition talks Talks on forming the next government coalition look unlikely to start before mid-October. We expect significant policy differences between the likely coalition partners to require tough and perhaps lengthy negotiations.

US FOMC: Just keep swimming… The FOMC’s and Yellen’s statements suggest an intention to raise rates if inflation does not surprise on the downside again. We are nervous about our December call. Japanese politics: Hope over experience? Polls suggest the snap election will deliver the ruling coalition a majority of seats in the lower house. However, its prospects look much less certain now that it faces a direct challenge by the governor of Tokyo.

US Rates at the Bell September 28th, 2017

Trader’s Tab  Stops, Blocks, and Holding the Range: While legislative momentum and opaque-ier hawkish policy shifts have dominated the ‘narrative’ behind the recent selloff, the recent volume and block activity has had all the ear-marks of trendfollower (CTA) positioning indigestion. Looking at both BBG/SG Macro Fund and CTA indices and comparing 2-week rolling R-squared’s to TY futures, recent strategy underperformance looks to go hand-in-hand with the recent selloff, which may suggest today’s auction strength may lead to a period of consolidation absent a fundamental catalyst.

we show in (figs. 5-6), the 2-week rolling correlations between TY futures and these strategies peaked in mid-September when the UST rally was at its crescendo, which begs the question whether the latest block activity and overnight “algo-spikes” have been partially the product of stop-outs from these cohorts as we’ve taken out technical barriers on the way to higher yields (50dma at 2.21, 100dma at 2.23, 200dma at 2.32). Net-net, with cleaner positioning (FV 1m put/calls back to ‘puts over’ today), this may suggest today’s auction strength may lead to a period of consolidation absent a fundamental catalyst.

…Recap & Discussion:

… Data and policy-wise, there was little nuance, as

George echoed Yellen and Rosengren in a characteristically hawkish speech, while Fischer kept it pretty close the vest on his farewell tour. GDP was stale too (but still best quarter since Q1 2015), while the modest bump in claims seems inconsequential given the hurricane-implied noise of late. The one notable data point was manufacturing and trade inventories, which came in better-than-expected, a solid sign for the third-quarter GDP figures (with some sell-side upward revisions on deck, no doubt). Outside of the D.C. tax debate, the markets were left to their own designs into the afternoon, with a modest rotation towards risk-off as we gravitate towards quarter-end rebalancing flows (SPX +3.5%, 10yr UST -0.4% for Q3). Flow-wise, this was personified by re-emergent real$ buying in the longend. In addition, one potential explanatory variable around the outsized moves this week may be CTA activity. And while the topic (that only comes up when people are “looking for a reason”) does come with the usual eye-roll, it actually does appear that the recent selloff in futures has been in lockstep with macro fund/CTA underperformance for the last two weeks. As

28 Sep 2017 12:42:48 ET

Global Macro Strategy Weekly Views and Trade Ideas – Tax Cuts and Inflation Targets 





Monetary policy expectations are turning more restrictive as Central Banks ignore low inflation and the GOP (and new German government) promise tax cuts. Short term, this implies still higher yields with the 5y point the likely underperformer – we pay vs. 10s and in a 2s5s10s fly. We also stay short Dec 18 Fed. Medium term, curves may flatten more as lower long run inflation expectations are locked in and EUR real yields may rise more than USD ones on tapering. The $ bounce is logical given easy fiscal/ tighter money, positioning and possible repatriation with JPY likely vulnerable. Medium term, we are still $ bears, adding to long EUR/$ at 1.1555-1.1680.

 

EM outperformed in 2005 when the US curve flattened, $/G10 FX rallied and the Fed was hiking. We think it can continue to perform now. Equities need earnings and predictable tightening. Long NKY is the US tax cut hedge.

..Rates, Central Banks and Trump We have been running USD curve flattening trades for some time4, a trend we see as a major beneficiary of Central Banks reducing the importance of inflation targets but actual core inflation remaining subdued (our core view). We added an outright short front end rates (EDZ8) on 17 August when we felt market pricing had moved too far to price out any Fed action on rates until 2019. As we write, front end pricing is for 17bp/25 at the December 17 meeting which still feels low to us. Then by end-2018, just fewer than two hikes are priced (Figure 4, LHS). This feels very low to us given the Fed’s revealed preference to downplay low inflation and especially give the tax reform “news”. We are therefore remaining short EDZ8. What about the curve trades? 4. Fed and Trump Could See 5y Underperformance

We think it makes sense to take profits on our 2s10s flattening trade here given the immediate upwards pressure on 10y yields5 from the current tax reform related squeeze. But we enter a 6mf 2s5s10s fly to add to our existing 5s10s flattener. Trade: Exit 2s10s flattener trade to 01Dec2017. 2y to 01Dec at 1.78%. 10y to 01Dec at 2.31%. 2s10s to 01Dec at 53bp. Profit of 4bps. Spot reference 86bp. Pricing as of 16:05 GMT 28/09/2017 Trade: Enter into paid 6m Fwd 2s 5s 10s USD Swap Fly. 6m2y USD Swap at 1.85%, 6m5y USD Swap at 2.06%, 6m10y USD Swap at 2.33%. 6m Fwd 2s 5s 10s USD Swap Fly at 7bps. Spot reference on fly -3bps. Pricing as of 16:17 GMT 28/09/2017

Separately, we also note the view of our global head of rates strategy Harvinder Sian that real yields may rise more in Europe than in the US as Central Bank support is withdrawn both sides of the Atlantic. Current low yields relative to nominal neutral yields and a relatively more impressive cyclical pick up in Europe are drivers here. See Figure 5 and European Rates Weekly: Mandate creep. The GOP tax plan may modify this view but so may potential tax cuts in German post the Election results Sunday. 5. Citi Rates Strategy: Real Yield Upside More in Europe

The curve ball here is tax reform and the potential budget deficit increase implied in the GOP plan. This could create further bear steepening as seen over the past two days but more noticeably around the Election last year. Most probably, short 5y is the sweet spot in this scenario – see how rich 5y look on the 2s5s10s fly and how this changed late last year (Figure 4, RHS). Recently, 2s5s has been steepening and 5s10s flattening leaving 5s to underperform on both legs.

28 Sep 2017 16:56:16 ET

European Rates Weekly Markets underestimating German election implications German fiscal loosening risk joins the Trump trade, adding to bearish pressure. Low-for-long ECB rates are inconsistent with fiscal dynamics and the German establishment’s reckoning that 50% of the rise of AfD owes to ECB policies. The exit from negative rates will be swifter. Periphery inference from the election is bearish but only medium term. We continue to like steepeners. € long end forward levels and proximity to USD are not a barrier. …The market is rightly focused on the bearish implications of the US tax plan and reflation trades. We take a look at market positioning and see scope for long liquidation. What is missing in the conversation is Sunday’s German election result which has weakened Chancellor Merkel’s position and has some important implications which are yet to be digested by markets. Firstly, there is now a higher probability of a more sizeable fiscal stimulus from Germany. Our economists were already looking at 0.5%/GDP stimulus in 2018 given commonalities in the policy platforms of major parties. The fact that only a ‘Jamaica’ coalition looks feasible brings the risk of more sizeable tax cuts (FDP) and spending (Greens) with the result that a stimulus nearer 1% would not damage the balanced budget rule. That level of stimulus is close to the most optimistic outcome of the Trump reform impact in 2018. Second, there are implications for the ECB outlook. In a famous comment, the outgoing Finance Minister Wolfgang Schäuble, following regional election victories for the right-wing AfD in 2016, told Mr Draghi that his policies were responsible

for 50% of the AfD gains. The CDU/CSU diagnosis of the election losses is that too much space has been left on the right-wing, including sentiment on monetary policy. Critical ECB voices are about to get louder. That leaves less scope for the ECB to toy with the capital key and more pressure to cease QE. The timing of hikes is pulled forward because of the implications of negative rates for a large tail of small (unprofitable) German banks. Third, the harder moral-hazard rhetoric of the FDP on bailouts and ECB policy chimes with many in Markel’s CDU/CSU, but the inference for periphery is medium term. After all there needs to a catalyst for the periphery to need some form of backstop. The first test could well be a new Greek debt//bailout deal in H1-18. …How does a potential new Trump reflation trade compare with the original? Post the 2016 US presidential election, yields moved 80bps higher as the market priced in the Trump reflation into year-end. Is positioning similar now? The short answer is No - current positioning is very different the previous episode. To illustrate this point we have plotted the evolution of positioning and PnL in 10y USTs in Figure 6 and Figure 7. …The take-away 



The positioning summary shows that in contrast to the original Trump trade markets currently have a long bias which is getting increasingly off-side and risks further long liquidation. The vulnerable positions are especially interesting in US 10y and 30y. In Europe, the positioning is most interesting in Bund 10y and Green Euribor.

28 Sep 2017 10:19:11 ET

RPM Daily New Shorts Ahead of US Tax Proposal 

Summary: Long cash (+1.4) / neutral futures (-0.1): One-sided long UST positions are concentrated in the long-end and are largely caught offside. In Australia, ACGBs remain a one-side short which holds modest profit.



In North America – Long-end Longs: Futures (2.5) / cash (1.8): $5.9m new shorts added across the curve as yields climbed ahead of Trump’s tax proposal. Still the long bias remains at least in the long-end (average 2.2 normalised), but given the recent rise in yields these positions are slightly underwater (-0.1).

28 Sep 2017 17:58:14 ET

North America Municipals Strategy Focus Elimination of State and Local Tax (SALT) deduction is NOT bullish for municipals •



The unveiling of President Trump’s tax plan has caused a flutter in the municipal markets and the long end of the municipal curve has sold off more, with 30YR ratios trading above 100%. While the tax plan did not really have any surprises as far as municipals are concerned, we are surprised by some of the conjectures floated by market experts regarding the impact on the municipal bonds. We discuss.

…Lower

top individual marginal tax rates: The framework aims to consolidate the current seven tax brackets into three brackets of 12%, 25% and 35%. Some investors are worried that a lower top marginal tax-rate (from the current level of 39.6%) can reduce the attractiveness of municipals for retail buyers as it reduces the benefit of taxexemption. After analyzing historical trends, we are strongly of the opinion that, it will not. Between 1980 and now, the top marginal tax-rate for municipals has fluctuated in the range of 28 – 70%. The top marginal tax-rate was 70% in 1980, 69.1% in 1981 and then 50% from 1982 – 1986. It dropped to 38.5% in 1987 and was as low as 28% in 1988 – 1990 which was mostly during President George H.W. Bush’s regime. Yet, we find no correlation between municipal yields and the top marginal tax rate. As we can see (Figure 3 and Figure 4), long term municipal rates have trended down with Treasury rates over the last 15 years even as the top marginal rate has moved in the band of 31 – 39.6%. For instance, President George W. Bush’s tax cuts of 2001 and 2003 had no discernible impact on municipal rates

In our estimate, this is likely because the average tax-rate for municipal holders is much lower than the top marginal tax rate (likely around 23 - 28%) and that has not changed much over the years

(Figure 5 and Figure 6). Thus, as we have often mentioned, we believe it is a misconception that tax-exemption for municipals is a “loophole” used mainly by the rich and curtailing the benefit of tax-exemption will have a more profound effect on mom and pop type investors and retirees rather than wealthy investors. And, whether the top marginal tax rate stays at 39.6% or drops down to 35% should really not impact municipal yields. 28 Sep 2017 19:18:19 ET

Global Inflation Strategy Monthly

Breakevens on the rise US TIPS Yellen’s comments underscore the increasing inflation uncertainty at the Fed, which should keep the Fed on the defensive with regard to raising rates and is positive at the margin for breakevens. …While Yellen has repeatedly referenced the

FOMC’s projections of inflation touching 2% in the next couple of years (note however that the median projection dropped to 1.9% in the Sep SEP), there seems to be far less confidence in Yellen’s talk on Tuesday of inflation exceeding the 2% goal than undershooting the target. Stitching these threads together, our conclusion is that a Fed driven by Yellen at the helm would be cautious in raising short rates and this in turn is positive for inflation risk premiums, and therefore positive for breakevens. Yellen’s discomfort about inflation thus adds to our comfort in our long position in 5y breakevens that we initiated earlier this month (see Alert: North America Rates Trade Idea - Buy 5y TIPS breakevens[1.80% as of 9/28/17 4:30PM]). The risk is if Yellen is replaced after her term ends next year by a more hawkish Chair. This would be particularly bad for longer end breakevens, and our choice of the 5y mitigates this risk, although it doesn’t eliminate it.

…Commodities

Crude oil rallies to YTD highs while US allfood CPI and world food price inflation outlook remains tempered Global Economics We expect that headline CPI inflation in AEs is bottoming out, while it continues to moderate in EMs.

US Economics

UK

Unchanged outlook, slightly more confident

The UK DMO will issue £2.75bn of the 0.75% Treasury gilt 2023 next Thursday. There are no gilt cash flows eligible for reinvestment next week.

28 Sep 2017 11:28:44 ET

Global Economics View US Protectionism Round-Up: Canada planes, NAFTA, China 





While USTR Lighthizer highlighted some progress during the third round of NAFTA negotiations, Secretary Ross pointed out that rules of origin need to be fixed to shift the trade imbalance(mostly in autos and auto parts) with Mexico and Canada. We continue to expect NAFTA to be renegotiated successfully over the next 3-5 months. However, a stricter trade enforcement by the US (e.g. on Canadian planes) and the discussion of more contentious items could delay or derail the talks. During his visit to China, Secretary Ross reiterated the need for concrete deliverables to address concerns of US businesses. We do not expect a trade war with China, yet. However, we note that Chinese officials suggested that any unilateral action from the US would be followed by retaliation. Coming next — KORUS Joint Committee (Oct 4), NAFTA talks fourth round (Oct 11-15), report on trade abuses and FTA violations (by Oct 26).

28 Sep 2017 10:37:10 ET

Weekly Supply Monitor Euro, US and UK Supply Outlook Europe EGB supply next week is scheduled from Germany (€3bn) and France (estimated €8bn) and Spain (estimated €4.6bn). There are no coupons/redemptions eligible for reinvestment next week.

US There is no UST supply or cash flows next week.

US net cash requirement (NCR) over the next 4 weeks On a settlement date basis, $88bn of gross supply next week will be supported by $5.7bn of coupons and $80bn of redemptions settling over this period (Figure 20). 20. US weekly cash flow profile for next four weeks, USD billions

28 September 2017

Global Economics Quarterly: Ballad of a thin tail Having improved in 2016, global growth has run remarkably steadily, and modestly above trend, since the start of this year. In the continued absence of significant macroeconomic, financial, sectoral or policy shocks, we expect this to be sustained: global GDP should grow at 3.1% in 2018 after 3.0% this year; with both developed and emerging economies sustaining current momentum. In the US, trade and housing should offset a slightly weaker consumer. Chinese growth should only moderate slightly after next month’s political transition. The vigorous euro area expansion seems underwritten by solid fundamentals. Japanese growth is supported by buoyant consumption and strong construction. And the rest of Asia should see a local cyclical peak later this year. Meanwhile, Latin America and Russia continue to emerge from recent weakness. Central bank policy should move in a tighter direction. In particular, we look for the Fed to continue raising rates this year and into 2018, as well as reducing its balance sheet. We expect the ECB to announce it will bring its asset purchase programme to an end next year. A decade of expanding central bank balance sheets expansion is coming to a close. These policy changes are well telegraphed. So, alongside our growth forecasts, this is a macroeconomic environment low in volatility and consistent with an orderly rise in core government bond yields. Risk assets should steadily outperform. But risks are building. They are hard, perhaps impossible, to quantify. And they are not at all priced. The political economy is changing and presents volatility. Parties, candidates and causes that challenge long established orthodoxy on trade, monetary and fiscal policy continue to gather support and occasionally win elections. As we discuss in our lead essay, those orthodoxies have delivered two decades of unprecedentedly low, stable inflation that is seemingly unresponsive to anything other than major cyclical shocks. We can no longer be sure that those orthodoxies will endure. For example, at the time of writing, US trade policy is unknown; the style and character of Fed leadership is unknown; and the stance of short- and medium-term fiscal policy is unknown.

So, although our forecasts show steady inflation over the coming year or so, we are concerned that politics could precipitate a shift to a more volatile inflation regime.

Tail risks are fatter than they look. Or are priced.

uncertainties about all of the above should give us pause in thinking about the path of inflation several years out. Forecasting error bands may be universally too narrow in these circumstances. Longer-term upside inflation risks seem to be much higher than many investors are willing to consider. And our current, insipid inflation forecasts for the next 18 months should not distract our readers from thinking about a long time horizon.

Inflation regime change – the biggest risk to markets

…US:

“Because something is happening here but you don’t know what it is.” Bob Dylan, 1965

Core inflation has been soft so far this year, but we anticipate a modest improvement going forward. Part of the weakness was due to unusual one-off shocks – especially to mobile phone service prices. However, beyond these idiosyncratic factors, there is also some persistent underlying weakness. Importantly, shelter prices have stopped accelerating and health care inflation is likely to remain contained. We expect core inflation to remain below the Fed’s 2.0% target in the medium term.

…Back to the Future Here is our bottom line: thinking about a shift in the inflation regime (that is, the trend in inflation, the volatility of inflation, and the correlation between inflation and other macro indicators) is fundamentally different from forecasting inflation within the recent, well defined regime. Even a cursory glance at inflation history reveals many clear regime shifts. The problem is, in an economy and financial system that are always in flux and structurally changing, expecting a single variable (such as money growth or fiscal policy) to be a consistent trigger for inflation regime changes seems unlikely. We just do not have a large enough sample size of inflation regime changes to describe with precision the variables behind regime shifts. And simple models either mask the economy’s complexity or (worse) hide behind complex equations that only appear to have the big questions covered. What we believe history shows clearly is that inflation volatility has tended to follow periods of political upheaval, including but not limited to times of war.

Figure 2: Annual US CPI inflation since 1914

High policy uncertainty despite solid growth



28 September 2017

US Economics: The Week Ahead Next Week's Highlights The Employment Report and ISM manufacturing are the key data next week. The September payrolls release is likely to be impacted by recent natural disasters. We have reduced our expectations for job gains this month by around 150K due to hurricane disruptions and we forecast jobs growth of just 30K. However, the uncertainty around this estimate is extraordinarily high – we would not be surprised by triple digit job losses or by a fairly ordinary month of low-100s job gains. We expect the unemployment rate to tick up slightly to 4.5%. However, we forecast that unemployment will begin to decline again towards the end of the year. Average hourly earnings are likely to rise 0.3% MoM, lifting the YoY figure to 2.6% from 2.5%. We expect headline ISM manufacturing to remain strong in September at 58.5. A reading in line with our forecast would support our view that global growth is likely to remain above trend in the medium term.

…Humility is a good idea when thinking about long-term inflation, a topic which befuddled Isaac Newton. Alan Meltzler’s three volume History of the Federal Reserve, which covered minor and major Fed events since 1913, reminded us that in nearly every era of Fed history, there was an orthodoxy about how inflation, money, credit, and policy were working, and it was wrong. Now is no time for a secure consensus. We are hesitant to venture specific guesses on longer-term policy or geopolitical variables from here. But the profound

Forecast Update: we revised our Q3 GDP forecast to 2.5% (QoQ annualized) from 1.9% due to strong investment, trade, and inventory data.

29 September 2017

29 September 2017

Japan Economics: Quick Take: August industrial production was stronger than expected, growing +2.1% mom

Japan Economics: Quarterly Update: Low inflation-steady growth continuing (29 Sep 2017)













Industrial production rebounded meaningfully by +2.1% mom in August after -0.8% in July (Figure 2), coming in stronger than expectations (BBG: +1.8%, CS: +1.2%, METI forecast survey: +1.5%). Productions for general machinery, transport equipment, and ICT equipment were especially strong, which were basically in line with the latest recoveries in exports of such goods to China and other Asia regions. The average level during July and August was +0.4% higher than the Apr-Jun quarter. The index of inventory-to-shipment ratio fell by -4.3% mom in August after +2.6% in July, average level of which for July to August underrunning Apr-Jun average by -1.5%. This means the pressure of inventory adjustment is not high. METI’s manufacturing production forecast survey this month, however, predicted a pullback of -1.4% mom for September. Meanwhile, capital goods shipments (ex. transport equipment), which are used for estimating real capex in the GDP statistics, rebounded significantly by +9.4% mom after -4.3% in July. That said, the average level during July and was just +0.3% higher than the AprJune quarter (Figure 3). The nationwide core CPI (excluding fresh food) inflation rate rose 0.2%pt to +0.7% yoy in August (Figure 5), and the index was increased +0.1% mom from July on a seasonally adjusted basis. But this can be attributed to a one-off increase in out-of-pocket medical treatment fees for the high-income elderly. At the same time, the core-core CPI inflation rate (all items less foods and energy) came in at +0.0% yoy, while the BOJ-favored measure of underlying inflation (all items less fresh foods and energy) rose 0.1%pt to +0.2% yoy. Meanwhile, the Tokyo core CPI inflation rate for September rose 0.1%pt to +0.5% yoy in August (Figure 6), as the contributions from energy expanded mainly due to an easy comparison to the last year. The unemployment rate was flat at 2.8% in August (Figure 8). While the number of employed rose by 200K mom (after +140K in Jul), the labor force also increased by +150K mom (after +150K mom) in seasonally adjusted terms. The number of corporate employees (excluding self-employed) rose by +40K mom (after +200K mom). The labor market has steadily expanded, mainly driven by hiring in retail and service sectors. Meanwhile, the job offer-to-applicant ratio stayed flat at 1.52 times in August. Both effective job offers (+0.5% mom) and job seekers (+0.5%) increased somewhat.











Real GDP growth rate forecast: We are projecting +1.2% for CY2017 and +0.6% for CY2018, foreseeing slowdown in qoq growth between 3Q 2017 and 2Q 2018. Decelerating upward momentum for private consumption with a statistical anomaly affecting the GDP-basis data, peaking of machinery investment and slowing growth of public investment are the main backgrounds. Still, the projected numbers suggest continued improvement in the output gap. Inflation rate (yoy change in core CPI) forecast: We look for +0.4% for both CY2017 and CY2018. Mild moderation of the inflation rate is expected after 3Q 2017, unless a major import inflation shock takes place. We maintain our view that the inflation rate is rather insensitive to fluctuation in the output gap. Wage inflation pressures appear to remain contained. Corporate sector developments: The MoF corporate survey for 2Q17 showed improved profitability but a remaining cautious attitude of firms towards expenditures on capital equipment and labor. Both the capex-to-cash flow ratio and the labor share dropped. Household behavior: Stabilizing retail prices and unchanged job market tightness seem to have backed consumer confidence, having invited a downward pressure on the savings rate. Comparatively young (20 to 39) and the elderly (above 60) consumers have contributed to recent strength of consumption. Focus of the quarter: Based upon our latest analysis of corporate data, the construction industry has successfully boosted labor productivity, probably through labor-substituting investment backed by technology innovation. What’s more, the industry has enjoyed a declining labor share and improving profitability as real wage growth has been contained lower than productivity growth. It appears as if a virtuous circle is now starting in the construction sector as improved profitability boosts financial capacity of construction firms for labor-substituting investment, which should lead to further gains in productivity of the industry.

28 September 2017

Special Report - How good is the market at forecasting inflation?

Deutsche Bank 29 September 2017

Early Morning Reid Macro Strategy … So welcome to the last day of September and the quarter. There’s always a slight randomness to month and quarter end trading as investors adjust portfolios! The penultimate day of the month initially saw the sudden global bond rout continue after the more optimistic take on tax reform continued before a slight miss on German inflation seems to reverse the decline. 10 year Bund and Treasuries yields saw an intra-day peak of 0.516% and 2.357% respectively, before closing +1.1bp and -0.2bp at 0.475% and 2.309% (+0.7bp this morning in Asia). The yield lows this month were 0.302% and 2.04%.

… The DB house view on 10 years bonds is for YE yields of 2.75% (USTs) and 0.65% (Bunds) but as DB's Francis Yared suggested yesterday the scale of the move over the last 36 hours has been a surprise as he believes the tax plan is just an opening bid and likely to be pared down. So a long way to go although at least we've moved away from pricing no probability of a tax plan passing.

One event that has slipped a bit under the radar is the independence referendum in Catalonia on Sunday. It's been deemed illegal and therefore it’s all a bit confusing as to what will happen on Sunday, whether it will indeed go ahead and what happens next. Remember 3 years ago a non-binding ballot saw 80% support independence albeit on a 30% turnout. DB's Marc de-Muizon recently published an article (The Catalan independence puzzle), see the note for more details.

Recent better news about inflation has increased market-implied inflation expectations, with 1y swaps currently trading at 2.1%. Is this a good measure of future inflation or do the potential liquidity and risk premiums and other caveats make simple backwardlooking measures of inflation a more accurate forecast? Looking at the forecasting power of swaps versus the latest available CPI or the average of the latest available CPI prints, swaps have on average outperformed these backward-looking measures of inflation over the last 10 years (Figure 1). This is expected though given that, for example, 1y swaps at the beginning of September 2017, which signal expectations about the y/y inflation rate in June 2018, have an information advantage over the latest CPI print that was available at that time, July’s CPI. In particular, in this case swaps incorporate about two additional months of information on energy prices. This conclusion though seems to hinge on looking at headline inflation. Here, we look at ex-energy inflation by first estimating the ex-energy swap rate, which we obtain by assuming the market uses gasoline futures to forecast future energy prices. We find that using exenergy swaps to forecast ex-energy inflation results in higher forecast errors than simply using the latest available ex-energy CPI (Figure 2). These results suggest swaps are adding little information beyond the content provided by the latest available ex-energy CPI print and gasoline futures. At the beginning of September, swaps were trading at about 1.83%, signaling y/y headline CPI would be below 2% in June 2018. Using gasoline futures, we estimate that the ex-energy swap rate at that time was about 1.57%. Based on the results above, at the beginning of September one would have done a better job at forecasting ex-energy inflation in June 2018 by looking at July ex-energy CPI rather than the swap. However, this time around, swaps were very close and only slightly below the latest available ex-energy CPI print, which was 1.60%. Swaps have significantly increased since then though, especially after the release of the August CPI report, which showed a strong rebound from recent weakness. This has brought swaps closer to our forecast, which assumed the recent low prints were due to temporary factors.

28 September 2017

Asset Allocation

Figure 2: The big cycle in 10y yields during 1966-1995 reflected the Great Inflation

Are We In A Low Return World?  





A legacy of the financial crisis has been the narrative of a secular decline in rates of return. But have rates of return declined? This is patently the case in fixed income where government bond yields are near all-time lows and credit spreads at mid- to late cycle tights. The US 10y yield has historically been a good predictor of subsequent total returns, so prospective returns look unambiguously low. A longer history suggests bond yields are low but not unusually so. Yields were in a 2-5% range for 65 years from 1900-1965; broke out above during the Great Inflation of 1966-1995; then reverted back into the “old normal” range. Do bond yields near the bottom of the “old normal” range simply reflect a government (monetary) policy decision or do they reflect a wider decline in underlying rates of return available in the economy and in other asset classes? Outside fixed income, three broad measures of rates of return have remained well within their norms of historical variation over the business cycle. Not only is there no hint of a secular decline, two have been at the upper end of their historical ranges for the last 4-5 years: 





The economic return on physical capital (real after tax) has fluctuated over this cycle well within its historical range (2.7-6.0%). It has been at the upper end of it for the last 5 years; The financial return on corporate equity (ROE) for the S&P 500 is presently (13.3%) slightly above its historical average (12.6%). This is despite the well-known declines for the Financials and recently Energy, outside which (82% of market cap) the ROE has been running at very robust all-time highs (18%) for the last 4 years; The market return on equities in this cycle of 14% (average total return on the S&P 500 since 2010) has been somewhat higher than the average return historically (11%) since 1900.

Figure 1: Since 1996 the US 10y yield has been back in its prior 2-5% range

Figure 3: The 10y yield has historically been a good predictor of subsequent total returns

29 September 2017

Japan FX Insights Japanese stocks and USD/JPY Japanese stocks typically rise during periods of yen weakness. Firstly, higher stock prices and a weaker yen are apt to occur simultaneously in risk-on phases driven by a favorable economy. Secondly, yen weakness typically acts as a tailwind for rising stocks as it dramatically boosts Japanese firms' exports and overseas business earnings. Thirdly, yen weakness forces overseas index investors to buy Japanese assets to the extent that their dollar-based value has fallen. Foreigners have for many years been the main buyers of Japanese equities, despite the increased presence of Japanese pension funds and the BoJ since 2014. We still receive quite a number of questions about whether from a flow perspective, foreigners buying yen in order to purchase Japanese equities will result in a stronger yen. However, as the three factors above imply, there is a relatively strong sense in which yen weakness leads to Japanese equity buying. If foreigners' purchases of yen to buy Japanese stocks resulted in yen appreciation, that would in turn blunt their inclination to buy Japanese stocks… … If the strong US economy and a succession of Fed hikes drive USD/JPY to 115 in the medium term, TOPIX should see a commensurate rise. The GPIF and BoJ are unlikely to purchase Japanese stocks in a rising market

given their relentless focus on buying on dips. In contrast, foreigners may increase buying given their scope to raise portfolio weightings for Japanese stocks. The fundamentals are again boosting risk-on sentiment. Our impression is that both TOPIX and USD/JPY are building up steam for an upward move amid downward pressure from the North Korea issue.



disproportionately laid off and higher in expansions when they are hired back. While composition effects alone cannot explain the wage puzzle, slower growth of average labor quality is just one part of a broader slowdown in productivity growth. While wage growth looks unimpressive compared to prior expansions, accounting for the impact of this decline in overall productivity growth suggests that even at its current low level, it is less of an outlier among the wide range of labor market data that indicate a return to full employment.

28 September 2017 | 10:31AM EDT

28 September 2017 | 2:04PM EDT

USA: Q2 GDP Revised Up to 3.1%; August Trade and Inventory Data Better than Expected; Hurricane Irma Boosts Jobless Claims

Housing and Mortgage Monitor: US house prices remain 15% below their 2006 peak in real terms

BOTTOM LINE: Real GDP growth was revised up one tenth in the second quarter, reflecting revisions to inventory investment. Revisions to inflation data were negligible. The advanced goods trade balance narrowed more than expected in August, and wholesale inventory growth was firmer than expected, though the hurricane may have affected these data. Initial jobless claims rebounded last week, in line with consensus expectations, while continuing claims fell more than expected in the prior week. On net, we increased our tracking estimate of Q3 GDP growth by two tenths to +1.7% (qoq ar).

28 September 2017 | 9:04AM EDT

US Daily: Wages, Composition Effects, and Productivity: Making Sense of the Wage Growth Numbers (Mericle) 



While most labor market indicators now signal a return to full employment, soft wage growth appears to be an outlier. But one complication in interpreting the wage numbers is that composition effects can distort the signal they provide about labor market tightness Estimates of demographic composition effects suggest that changes in the characteristics of the employed workforce are contributing about ¼pp less than average to wage growth. This is not abnormal for a period when the unemployment rate is falling: composition effects on wage growth tend to be higher in recessions when lower-paid workers are

House prices are growing but remain below 2006 peak in real terms The Case-Shiller house price index for July surprised to the upside and is now up 6% year over year. Prices still appear to be growing fastest in the lower price tier market segments: for example, in Miami, prices in the lowest tier (bottom third of the market) have grown 13% over the past year vs. just 3% in the highest tier (top third of the market). The strong growth in prices in the low price tier appears to be related to a scarcity of inventory of homes available for sale at the lower price points. Despite the strong growth of US home prices in recent years, prices on average still remain 15% below 2006 peak levels in real (inflationadjusted) terms. In Miami and Las Vegas, real house prices are 35% and 45% below their peaks. Our models suggest that nominal prices are, overall, close to fair value levels as determined by fundamentals such as household incomes and interest rates. We look for US nominal house price appreciation to decelerate to 3.4% and 2.5% in 2018 and 2019 as rising mortgage rates begin to provide a headwind to growth. Agency MBS spreads have tightened since the announcement of balance sheet normalization

As had been expected, the FOMC announced the start of its balance sheet normalization program at the September meeting. Runoff of the portfolio will begin in October; the passive runoff will be slow, with an initial cap of $4bn in non-reinvested paydowns per month. Our US Economics team expects the Federal Reserve to maintain a large steady-state terminal MBS and Treasuries portfolio. Under this assumption, runoff would be terminated in 2021, at which point the Fed would still hold over $1tn in MBS. Mortgage OAS

and mortgage basis have tightened 3bp since the FOMC meeting, suggesting the market is, so far, not alarmed by the imminent prospects of declining Fed portfolio balances. We remain neutral on the agency MBS sector overall, as we expect spread widening to be modest but manageable going forward. We would be overweight in conventional 4s and GN 3s vs. conventional 3% coupon MBS.

28 September 2017 | 5:55PM EDT

US Daily: GSAI: September Slippage (Thakkar) 



The Goldman Sachs Analyst Index edged down 0.6pt to 56.6 in September, following a 2.0pt gain in August. Month-on-month declines in the sales and shipments, inventories, and input prices components might be suggestive of some impact from the recent hurricanes, though it is difficult to isolate storm-related effects. Analyst commentary remains constructive on the growth outlook, but many respondents noted the potential for near-term disruptions from the recent hurricanes. In response to special questions on the expected impact of the hurricanes on key areas of their industries, analysts reported that the impact of the hurricanes is likely to be concentrated in the near-term

Exhibit 1: GSAI Moderates in September

September 27, 2017

Stocks for the Long Run? Not Now Based on today’s relatively rich valuations, U.S. equity investors are likely to be disappointed after the next 10 years.

Introduction Valuation is a poor timing tool. After all, markets that are overvalued and become even more overvalued are called bull markets. Over a relatively long time horizon, however, valuation has been an excellent predictor of future performance. Our analysis shows that based on current valuations, U.S. equity investors are likely to be disappointed after the next 10 years. While the equity market could continue to perform in the short run, over the long run better relative value will likely be found in fixed income and nonU.S. equities.

Elevated U.S. Equity Valuations Point to Low Future Returns U.S. stocks are not cheap. Total U.S. stock market capitalization as a percentage of gross domestic product (market cap to GDP) currently stands at 142 percent. This level is near all-time highs, greater than the 2006–2007 peak and surpassed only by the internet bubble period of 1999–2000. This reading is no outlier: It is consistent with other broad measures of U.S. equity valuation, including Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE), Tobin’s Q (the ratio of market value to net worth), and the S&P 500 price to sales ratio.

U.S. Equity Valuation Is Approaching Historic Highs

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the time, a record high for all Treasury coupon auctions, dating back to May 2003. On the other side of the coin, Dealers took down 10.4% of the auction, the second smallest since the 8.8% record-low takedown in April. Directs took down 19%, which is their largest takedown since December 2016. The market couldn’t hold the stopout level following the 8.8% Dealer takedown and 2.2 bps short stop in April. However, the stats for this auction aren’t quite as extreme and the market looks to have squared up following the sell-off this morning, so the WI is probably in a stable position.

September 28, 2017

September 28, 2017

JEF Economics

Primary Dealer Positions: Dealers Dump Treasuries Ahead of FOMC In the week ended September 20th, Primary Dealer positions fell $20.6 bln to a net long of $219.9 bln from $240.5 bln. The majority of the change was concentrated in Treasury positions, which fell $15.9 bln. Note that the reporting date for this week’s data coincides with the most recent FOMC meeting. Elsewhere, agency debt positions fell $5.7 bln while other asset classes were relatively little changed.

September 28, 2017

Auction Results 7-Year Note Auction -

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The 7-year note auction stopped 1.1 bps above where the WI was bid at 1:00PM at 2.131%. This was a very strong auction. Indirects took down 70.6% of the auction, which is their largest takedown since the record 81.7% takedown in April that was, as

JEF Economics

Q2 GDP Revised Up to 3.1 %, Up 2.2% YoY The 3rd estimate of Q2 2017 GDP reflected an upward revision to 3.1% from the 3.0% growth rate of the second estimate of growth. The economy grew at a 1.8% rate in Q4 2016 and appears to be on track to grow at roughly 2.2% in Q3 of 2017. The 3rd estimate of GDP growth was close to expectations, as the consensus call was for no change from the second estimate of 3.0%. GDP growth on a yoy basis was unrevised at 2.2% in the second revision. The yoy rise in GDP was 1.2% in Q1 and 1.8% in Q4 2016. Q2 real final sales – which strip out inventories – rose 2.9%, compared with 3.0% in the second estimate…

… The Bottom Line: Not Robust, but Enduring Growth during this cycle has tended to be both moderate and erratic, but also fairly relentless.

The downside of moderate growth is the absence of the sense of “booming” conditions and the associated accoutrements of spiraling home prices, rising inflation robust income growth, consumer spending, consumer leverage and corporate imbalances that eventually have led to a bust in prior cycles.

GDP tracking

The upside of moderate growth is the extension of the cycle due to the absence of the sense of “booming” conditions and the associated excesses that eventually lead to a bust.

There has been a clear deceleration in growth in recent cycles.

After incorporating incoming data on wholesale and retail inventories as well as the third release of 2Q GDP, we raised our 3Q GDP tracking to 2.9%, from 2.1% previously.

September 29, 2017

US Economics: GDP: Parsing Second Half Growth With 2Q GDP data in the bag, we make further adjustments to incorporate new data and hurricane effects into the near-term outlook. Effects look likely to cause a see-saw effect in domestic growth, keeping 2017 GDP growth on track for 2.2% 4Q/4Q.

September 28, 2017

US Economics & Rates Strategy: Treasury Market Commentary, September 28 Treasury yields ended slightly lower on Thursday. An overnight rise in yields - a muted continuation of the rise on Wednesday - was eventually faded in New York hours as investors assessed the tax plan details more closely, and month-end index extension came in focus. 10y yields ended at 2.31%. …One of the key issue for JGBs in regards to the elections is the pricing of a consumption tax hike in Japan - expected to take place in October 2019 - a part of Abe's economic agenda but likely to be opposed by Koike. Such a tax hike could lead to material repricing of breakevens and JGB bond yields, as well as potentially for Japan's credit rating. Additionally, the Democratic Party has been known not to favor negative rates, and has advocated a more flexible approach to monetary policy vis-à-vis QE. JGB yields rose in the Tokyo session, dragging Treasury yields higher by 3bp.

The final release of 2Q GDP came in largely as expected, continuing to point to a solid rebound in growth after a soft first quarter. While Thursday's 2Q GDP data release itself had limited implications for the near-term growth outlook, concurrently-released data made for more impactful shifts. Notably, data on August inventories boosted our 3Q GDP growth estimate by a whopping 0.8 percentage points to 2.9%. Upside was driven by both wholesale inventories—which surged 1.0% for a cumulative 3-month gain of 2.8%, the highest since April 2014—and retail inventories, which grew 0.7% in August. Headline GDP was revised up by one tenth to a 3.1% annualized Q/Q rate in Q2 (compared with 1.2% in 1Q), driven by a pick-up in consumption (3.3% vs. 1.9%) and continued support from business investment (6.7% vs. 7.1%) and net exports (8.5% vs. 8.9%). Residential investment contributed the biggest downside after a surge in 1Q (-7.3% vs. 11.1%) and government spending remained soft (-0.2% vs. -0.6%). With 2Q GDP data in the bag, we've also adjusted the assumptions underlying our near-term growth estimates to further incorporate effects of hurricanes Harvey and Irma. The effects are most likely to be reflected in consumer spending and housing, which we estimate will be depressed in 3Q before rebounding in 4Q.

Assumptions underlying our near-term growth forecasts: • Consumer spending: pending the release of our US Retail Sales Tracker, we assume below-trend retail control in September, reflecting slower spending in the South and the squeeze of higher gas prices across the country. Offsetting some of the weakness will be the replacement of thousands of motor vehicles that suffered flood damage from Harvey. According to the Greater Houston Partnership, the Houston area may have lost approximately 300,000 vehicles with a total value of $2.4 billion (see Houston and Hurricane Harvey: What You Need to Know, September 22, 2017). Industry estimates show auto sales are tracking a ~17.5mn unit annual pace through late September, a 10% jump from August. We see additional upside in October as post-Irma replacement sales materialize, followed by a reversal back to trend in November and December. • Housing: We estimate a dip in single-family housing starts in September on the order of 3-4%, followed by a catch-up to an above-trend pace between October and December. The pace of home building and home improvement following the hurricanes will be highly uncertain and determined by the availability of labor and supplies in an already constrained industry. • Oil & gas structures investment: The rig count hasn't been affected meaningfully through September 22, but has come off modestly to an average of 940 vs. 954 in early August (with the decline having started before the hurricanes). Still, we could see an impact going forward given that rigs in Texas account for roughly half of the total. As such, we pencil in the month-to-date average for the rest of the quarter, followed by a pick-up in the fourth quarter. The Bureau of Economic Analysis (BEA) uses the rig count as a direct input when estimating energy infrastructure spending in the US. • Prices: Retail gasoline prices have averaged $2.62 per gallon so far in September, 11% above the August average. We estimate that this translates into almost 30 basis points of upside in headline PCE in September. As gas prices come off elevated levels, headline PCE should see payback in October and to a lesser extent in November and December. Prices are used to deflate nominal values in GDP accounting, and our changes lower real GDP growth in 3Q and provide a slight boost in 4Q. On net, these assumptions imply a meaningful boost to final private domestic demand in 4Q on the back of depressed growth in 3Q (Exhibit 1).Final private domestic demand refers to the sum of consumption, business investment and residential investment, i.e. GDP stripped of inventories, trade and the government sector. Strong headline GDP in 3Q is somewhat misleading, as it includes an outsized rise in inventories that we calculate likely contributed 1.4 percentage points to growth. Excluding this boost, and further excluding net

exports and the government sector, final private domestic demand is tracking just 1.4%—driven largely by softer growth in PCE (1.8% vs. 3.3% in 2Q) and business investment (1.3% vs. 6.7%). We see final private domestic demand rebounding by one percentage point to 2.4% in 4Q, more in-line with the most recent four-quarter trend of 2.9%. Overall, headline GDP is likely to decelerate to 1.6% in 4Q from our current 3Q tracking estimate of 2.9%. … Looking more broadly suggests that the economy remains on track for solid, above-trend growth in 2017 as a whole. Our adjustments imply that growth is tracking 2.2% 4Q/4Q in 2017, in line with the forecasts in our mid-year outlook but slightly below the 2.4% median forecast in the Federal Reserve's most recent Summary of Economic Projections.

September 27, 2017

Global Macro Briefing: Lessons on US Monetary Policy from the Last Two Cycles Drawing on lessons from the past, we expect that sustained capex growth, a move of inflation in the right direction and a stronger focus on financial stability risks will keep the Fed on a tightening path. In the US, the backdrop of low inflation despite better growth and an improving labour market has led to a renewed debate around the pace of monetary policy tightening: Some Fed members argue that more caution about tightening further may be warranted in order to reach the 2%Y inflation target. However, the 'core' of the FOMC believes that a gradual pace will be just enough to head off risks, while remaining accommodative enough to prolong the cycle. To address this debate, we turn to monetary policy tightening cycles during the 2000s and 1990s to glean lessons from these experiences. We find three: i) Stronger investment and productivity growth should provide room for real rates to rise further; ii) The risk of an inflation overshoot should remain moderate due to structural factors; and iii) Financial stability risks will likely be in greater focus. As private sector risk attitudes and capex growth are improving, and we expect inflation to rise gradually and financial stability risks to move increasingly into focus, we think that further rate hikes as in our base case

are justified. In particular, we think that the Fed will continue to lift real rates and lean against easy financial conditions to contain financial stability risks, drawing on the lessons from the past. While we think that rising real rates will increase the risk of more corporate defaults, it is our base case assessment that the US economy will be able to weather this gradual pace of monetary policy tightening over 2017-18. Core PCE has not deviated visibly from 2%Y, even during periods of very low unemployment

the currency union, and the rise of the EUR itself, could increase the EUR allocation but that process hasn’t occurred yet. According to SWIFT, 32% of global payments are made in the EUR today, therefore it is currently underrepresented in reserves. In today’s COFER release, the USD’s proportion may remain unchanged around 65-66% as there appear to be two factors at play. The 3% weaker trade weighted USD would reduce the proportion but we know from the Fed’s weekly custody holdings data that holdings have increased slightly faster than reserves. For the FX markets we will continue to monitor the size of the whole reserve pool as that supplement to global liquidity is supportive for risk appetite.

Global FX Reserves Have Risen but Currency Composition Unchanged

September 29, 2017

FX Morning Daily Commentary, 09/29 Watching the DXY trend-channel. Over the past few days the momentum in the USD’s appreciation has accelerated, suggesting we could see a bit more of a rally vs G10 currencies. The DXY Index has reached the top end of its downward sloping channel and stayed above the 50-day moving average at 92.88. In yesterday’s FX Pulse we adjusted our portfolio accordingly, opting to close the long EURUSD position (for now) but still keep long EURCHF. The USD could rise further as the market prices in a higher probability of rate hikes from the Fed and increases the very small probability of tax reform in the US. The market was long the EUR and short the USD at the end of last week. The extreme bearish sentiment on the USD has reduced and higher US treasury yields have affected yield sensitive currencies like the AUD and NZD. We add a short AUDUSD position to reflect an over-pricing of RBA rate hikes in 2018. Today’s market focus will be on the release of August US PCE. What’s the currency composition of FX reserves? Global reserves were over USD11trn at the end of the second quarter and have been rising since December. Today the IMF releases the currency composition of these reserves (COFER) and there is a market discussion developing over whether the EUR will form a larger proportion, signifying a reallocation of other currencies into the EUR. In 1Q, 19% of the reported reserves were in EUR assets. Using just FX valuation changes, we could see a small rise to 21% but this wouldn’t signify a portfolio shift. Over time, we think the reduction in the tail risk that there could be a breakup of

September 28, 2017

FX Pulse: G10 USD Bull Reinvigorated The rise in US bond yields has driven the USD higher vs currencies which saw heavy long positioning, such as the CAD and the EUR. Current market momentum and the fact that the Fed rate path is underpriced suggest there could be a bit more upside for the USD vs G10 currencies. We opt to close our long EURUSD position but stay long EURCHF. We are not suggesting this is negative for risk. DM equity markets have continued to perform well even as yields have risen. The market appears to be in position adjustment mode rather than rethinking global economic stories. Oil prices have rallied further as metals

underperform, indicating that demand is strong but that China is reducing steel production ahead of winter, affecting metals prices. Market rate pricing reconsidered. The AUD and GBP rate curves appear to be overpriced for next year or have reached limits, without a significant pick-up in economic data. Both these currencies are added to our sell list. The CAD curve sees 3 more hikes by the end of 2018 but with market positioning long the currency and the central bank sounding cautious, we think the riskreward is now skewed towards a higher USDCAD. EM return expectations still look attractive but the currencies have been reacting to USD strength this week. We see no reason to panic as fundamental and valuation justifications remain intact. We are recommend selling USDINR on rallies, around 67 where technicals look stretched, and remain long RUB, PLN and MYR. The RUB has some of the highest yields in EM and should continue to be supported by a cautious policy approach from the CBR.

…USD positioning becoming vulnerable. The market has started to reprice expectations around the timing of the next Fed hike (72% for Dec) and moved up from the tiny probability of any tax reform in the US. We think that the USD's recent rally has further legs vs G10 currencies so change some of our currency stances today. The story of generally strong global growth hasn't changed and for now, US inflation expectations have remained contained (even as oil prices have risen) and our US policy analysts believe that tax reform should make slow progress towards passing in 2018. The risk for currency markets is that USD positioning is short and markets are now seeing volatility pick up in US yields, which has an impact on the USD. Exhibit 2 and Exhibit 3 show which currencies are sensitive to US yields. … No reason to panic: Most frameworks for thinking about asset prices involve the three pillars of fundamentals, valuations and technicals. The fundamental and valuation justifications for EM exposure remain intact., as we'll explain below. It is just the technical/positioning angle that looks a bit suspect at the moment. As the charts below show, there have been a substantial quantity of inflows over the past year into local currency bonds and thus investors are more likely to be sensitive to factors that might reverse the USD's trend on a sustained basis. But so far we see little evidence that currency performance is related to the level of bond inflows. For example, MXN is the second worst performing EM currency since the broad selloff started on September 15th despite not seeing

any change in the value of foreign holdings of bonds this year. Russia remains the best performer in EM over this period, despite seeing a 25% increase in foreign bond holdings this year. Macro vulnerabilities and politics/policy uncertainty are probably the bigger drivers of positioning at the moment, and its no surprise that TRY and ZAR are among the worst performers either. … Global growth has exceeded expectations. Global growth remains strong, supporting our "Goldilocks" thesis. Indeed, for the first time since the financial crisis we are seeing growth synchronized across both DM and EM (Exhibit 22). An important source of strength for the global economy remains trade. Global trade has exceeded expectations and the MS Global Trade Leading Indicator shows that trade growth will likely remain strong (Exhibit 23). Exhibit 23: Global trade continues to firm

September 28, 2017

US Economics: Capex Plans Index: Solid Spending Ahead Our composite Capex Plans Index fell by 0.6 points to 24.8 in September—continuing to soften from multi-year highs and slipping below its year-to-date average. At current levels, our index suggests the upturn in equipment spending will continue into 4Q17.

September 28, 2017

September 29, 2017

China Economics:

Japan Economics: August Econ Data (IP, Consumption, Employment): Sharp Increase in Capital Goods Shipments

Three Questions on Recent Developments This guide addresses key debates and questions regarding our constructive view on China's economic growth, policy, and inflation. We see slower but more self-sustaining growth in 2H17-2018 amid continued deleveraging and efforts to cut capacity following the Party Congress. Question #1: Has growth recovery ended? We expect a policy-induced growth moderation in 2H17-2018 amid closures of capacity for environmental reasons (which we think could drag down industrial production growth by 1-1.5ppt in 2H17); tighter control on local government financing and SOE leverage; and slower housing activity. That said, adjustments in industrial capacity and housing destocking in recent years mean limited room for slowdown. We remain structurally constructive on the medium-term outlook – growth is turning more selfsustaining with support from robust export, private consumption, and investment. GDP growth is tracking at 6.6-6.7% YoY in 2H17 (vs. 6.9% in 1H17) and could slow to 6.4% in 2018. Question #2: What will policy trajectory be following the Party Congress in October? Policy direction is likely to remain largely unchanged, and efforts in deleveraging and cutting capacity made to date should continue after the Party Congress. We expect policy implementation on financial regulatory tightening, local government financing, and SOE leverage to be at a calibrated pace. Meanwhile, we believe CNY moves will be largely a function of trade-weighted US dollar, and capital controls will remain in place in the next 1-2 years. Question #3: Would upstream supply-side controls squeeze mid- to downstream profitability? We believe the higher commodity prices amid supply-side capacity and production control would have a manageable impact on mid- to downstream profitability. A robust job market, strong consumption demand, and the multiyear capacity consolidation have boosted downstream corporate pricing power and ensured a smooth price transmission A Slower But More Self-sustaining Growth Expected

Production showed a solid recovery in August, consistent with strong export data. A sharp increase in shipments of capital goods came as positive news. On the other hand, personal consumption appears to have temporarily stalled.

September 29, 2017

Japan Economics: CPI and Koike’s Monetary Policy View While energy items are having a large impact on the recent price trend, upturn in Japan-style core CPI might boost requests from labor unions in spring labor negotiations. We also briefly review our impression of Koike’s monetary policy view at this point.

September 27, 2017

Government Month-End Index Extensions: September Index Extensions Eurogovies extend by 0.06y, lower than average September, USTs extend 0.06y, in line with average September, Gilts extend by 0.086y, lower than average September. Higher than monthly average extension in Euro, higher than September average in TIPS, contraction in UKTis … USTs: We expect an extension of about 0.06y, in line with an average September (0.06y) but lower than an average month (0.085y).

… United States We expect the 1y+ UST index to extend by ~0.06y, in line with an average September (0.06y) but lower than an average month (0.085y) - see Exhibit 7. A total of $144bn of supply will affect the extension, and $117bn of bonds will fall out of the index. The monthly issuance of 2y, 3y, 5y, 7y, 10y and 30y will affect the respective maturity-wise indices and the extensions will also be affected by bonds changing indices. Exhibit 7: US index extension: Lower than September average

to be some minor buzz about the possible return of the “Trump trade” as the White House and Congress made the long-awaited shift towards tax reform and away from healthcare. Then it seems like everyone went home, started to look through the details of the plan in depth, and started to ask questions. This shift in tone from “FINALLY, TAX REFORM!” to “but what about…” was readily apparent in the media coverage from yesterday afternoon to today. Admittedly, my take on this might be somewhat clouded by confirmation bias as our strategy desk was immediately skeptical about the lack of details or decisions on a number of key issues that will still need to be hashed out. There were also a few more technical developments likely helping to prop up Treasuries during today’s session. One was some probable support at the 200-day moving average in 10s. 10s seemed to break through this level (2.33%) fairly cleanly overnight, trading as high as 2.35%, but fell back below as the domestic session got underway. Anecdotally, we also think that there are some real money accounts who had been eying the 2.35-2.40% range as a level at which they were ready to dip their toes in. Lastly, the positive results from today’s 7-year auction likely added some fuel to that fire, and may have convinced some dipbuyers who have been waiting for signs of a bottom, that support was starting to materialize. We had been looking for a back-up to 2.35% in 10s (with a possible test of 2.40%) and now that we are at that level, the risk/reward of trying to chase the sell off any further has largely evaporated. This leaves us very cautious on outright duration and looking primarily to the curve for exposure.

10s cash temporarily break above 200-day moving average US Markets Closing Notes, September 28th, 2017 Recap and Comments: The 2-day selloff in rates hit a bit of a snag during today’s session, as the front-end and belly more than made up for overnight losses with yields falling by as many as 2bps in the 2-year point. The long-end traded a bit heavier today with 30-year yields closing slightly higher. This divergence allowed the correction in 5s30s steepener to continue, even as the directional move in rates reversed course. Meanwhile equities drifted very slightly higher, oil fell modestly, and the dollar was broadly weaker, falling by around 0.3% to 0.4% against the pound, yen, and euro. Overall, there didn’t seem to be a clear directional risksentiment across major asset classes today. With regards to the move in Treasuries, we think there were a couple of factors supporting today’s grind higher. First, it feels like a bit of the sugar high from yesterday’s tax announcement wore off overnight. Yesterday there seemed

72,000 but jumped to 369,000 in November 2012 following Hurricane Sandy. Sandy also resulted in an increase in those working fewer hours, which averaged about 375,000 in November but soared in November 2012 to 1.075 million.

SEPTEMBER 28, 2017

ON OUR MINDS: US PAYROLLS AND THE HURRICANE EFFECT Summary: Hurricane Harvey may have led to a decline in nonfarm payrolls in September, which would mark the first negative reading in seven years. Quantifying the hurricane's impact on job growth is fraught with uncertainty, but we suspect that Harvey's impact was similar to the drag on payrolls seen in the wake of Hurricane Katrina in 2005. Harvey to reduce payrolls After seven straight years of positive payroll prints, the September jobs report could show a 25,000 decline in nonfarm payrolls due to the impact of Hurricane Harvey. To be sure, quantifying the hurricane's impact on jobs is difficult, and there is some early evidence that perhaps the drag on employment may not be as bad as feared. Still, we are more cautious given the sheer number of people impacted by the storm, and the fact that the affected areas account for just over 2.0% of total national employment. Weather effects on the data Before getting into the details, it is important to remember how the BLS accounts for the impact of weather on the employment statistics. With respect to the headline jobs figure, a person is counted as employed as long as he received pay for any part of the survey period (the week that includes the 12th of the month), even if it is for one hour of work. Thus, headcount would be reduced only if a person missed work for the entire survey period and did not receive any pay. Meanwhile, the average weekly hours series will sometimes, although not always, show a drop due to the impact of severe weather. The BLS also publishes an employment figure from the household survey. In that survey, a person is counted as employed even if he missed the entire week's work without pay for a weather-related reason. The household survey also provides data on the number of people who were not able to attend work due to bad weather, as well as a series on people who usually work full-time (35 hours or more) but had to work fewer hours due to bad weather. For context, the chart below shows that the number of people unable to work due to bad weather in the month of September averaged about 46,000 from 1977-2016, but it spiked to 210,000 in September 2005 following Katrina. Similarly, in the month of November, this series averaged

SEPTEMBER 28, 2017

FI WEEKLY EMBRACING OPTIMISM Central bankers are feeling good about normalising, with the economy in a sweet spot. Politicians feel good about pump priming in the US. Some budget constraints look set to be lifted in Italy and even Germany. Plus, supply is picking up, and we expect chunky offers next week.

… United States

Further scope for steepening Rates have traded with a bearish bias since early September. With the market reluctant to price more than one hike at a time, we expect the frontend to re-anchor and the curve dynamic to be dominated by bear-steepening/bull-flattening moves near-term. We see the risks skewed towards a bearsteepening bias into end-2017 on some fading of geopolitical risk, support from the data front, an ECB announcement in Q4 of tapering of its asset purchase programme (likely at its 26 October meeting), and even some repricing of the US administration pro-growth agenda (a case in point is the recent steepening on the roll out of the administration tax plan). We see roughly 10bp upside on 2s10s steepeners from current levels, and favour expressing our steepening bias in forward space or through conditional bear steepeners.

Recommendations Hold or add 3m 5s10s curve caps, single look (outright or financed through 3m2y receivers). Hold or add costless 6m fwd 5s30s bear steepeners. Hold or add costless 2y fwd 2s10s bear flatteners.

Further scope for steepening Rates have traded with a bearish bias since early September, with a parallel move on the US curve for the most part (see Graph 1). At the frontend of the curve, this move reflects a more hawkish repricing of the Fed, with a December hike now priced in with close to 70% probability (see Graph 2). This is in line with our expectations. We saw the pricing of the Fed in mid-August and early-September as excessively dovish, even in the context of a significant pickup in geopolitical risk. We recommended investors switch to a tactical short bias in the 2y

sector of the curve in our FI Weekly from 17 August (see here), and the position has served us well.

Graph 5. Fair value model for 10yT

At the current levels however, there is little upside for frontend shorts. The market is increasingly reluctant to price in more than one hike at a time (see Graph 3), and this has been reflected by tightening of the 2yT spread to IOER from 20-25bp on average in 2016, to the 5- 10bp we have seen recently. Indeed, we expect this to continue to be the case going forward, and project 2yT spreads to IOER to stay in the 5-10bp range over our forecast horizon (3Q18 – see Graph 4). In this context, the current 2yT yield level provide only roughly 10bp upside for shorts in a December hike scenario, which are partially offset by a 6.5bp negative carry and rolldown on a 3m horizon (see here). We therefore expect the frontend to re-anchor near-term, with a much more gradual move expected going into the December FOMC meeting.

… Given the partisan nature of the tax plan, we don’t expect smooth sailing in Congress, and we may well see an unravelling of the optimism soon enough. The steepener however will likely stay with us for a while longer. The recent hawkish turn in Fed communication has been supportive for the dollar, and the fading of the headwinds from the currency-led tightening of eurozone financial conditions allows more room for the ECB to start tapering its asset purchases programme in October. The pricing in of a process of global recoupling of monetary policy has the potential to be a more significant and persistent driver of the steepening bias near-term through its logical implication of the normalization of global yields and a counter-cyclical build up of term premiums.

How much steepening? We see 10yT fair value consistent with current US fundamentals at 3.2%. However, as we noted in How rich are Treasuries - a guide for the perplexed these macro models break down in periods of significant noneconomic buying of Treasuries - like the 04/06 conundrum, the periods of QE after the crisis, or more recently due to the significant levels of overseas demand on a grab for yield in the context of the low global yield environment. We include the first principal components of global yields in our model to account for the later, and note that fair value adjusted for this effect drops to 2.5% presently (see Graph 5). In our rates projections (see here), we expect a 10yT yield convergence towards the 2.5% adjusted fair value by end-2017, with the main catalyst for this convergence coming from the ECB tapering expected in 4Q17 and its implications for a monetary policy recoupling process.

We continue to find it difficult for Treasuries to trade on the cheap side of fair value near term, however, and expect significant resistance around the 2.5-2.6% range. An argument that we have used to support this view is related to the demand dynamic of asset managers and large bond portfolios as the cycle matures. If one assumes that: 1) these investors are buyers of duration at yields they expect to prevail at the peak of the cycle; 2) the curve inverts at the peak of the cycle; and 3) there are roughly five hikes left in this cycle, in line with economist consensus for the a 2.5% neutral rate, then it follows from this set of assumptions that one could expect a significant level of demand around the 2.5-2.6% range. This, we believe, explains the significant level of decoupling between positioning for speculators and asset managers earlier in the year. In our view, breaking out of this rate likely requires: 1) expectations of a significant improvement of US fundamentals, and a re-set of potential growth from the current 1.7% into the two-handle range; and/or 2) expectations of significant Treasury supply/demand imbalances; and/or 3) a process of normalization of global yields. As we argued above, the tax package being rolled out may have contributed to a modest pickup of the first two (justifying the recent bearsteepening move), but we expect the latter to be a more significant and persistent effect. SEPTEMBER 28, 2017

FX WEEKLY DOLLAR RALLY BRINGS OPPORTUNITY A savage rebound in bond yields, led by the US, has delivered a strong bounce for the dollar. We like buying the USD and CAD versus the JPY. Otherwise, though we're not inclined to chase it, we will be looking for opportunities to buy EUR/USD and sell GBP/CAD as current trends slow.

We think we'll be at EUR/USD 1.25 by next September. Although sterling is undervalued, there is no fundamental catalyst for us to expect an appreciation trend from here. On the contrary, UK growth momentum is slowing and we are doubtful that the two rate hikes priced in by end-2018 will be realised.  The yen has long been seen as the global risk proxy par excellence, yet it has failed to weaken in the face of buoyant risk sentiment and rising equity markets in recent quarters. It is clear that the yen is not trading primarily as a funding currency anymore. One important development that might explain this is the persistent and sizeable yen-dollar negative cross-currency basis spread since mid-2015. The deeply negative basis spread makes it unprofitable for a yen-based investor to buy US Treasury securities despite the apparent yield pickup on offer because of the cost of hedging dollars. USD/JPY and real yields — eyeing 115, dreaming of 120

SEPTEMBER 29, 2017

HEDGE FUND WATCH THE IMPLICIT RISKS OF EXTREME POSITIONING Low volatility leads to a false sense of security For a wide range of assets, current volatility levels have reached near historical lows (see chart p. 2). In normal times, volatility is one of the most fundamental risk indicators that helps make a useful comparison between different asset classes. Current levels are so low though that they give falsely reassuring messages. Consequently, assets with vastly different risk profiles get treated basically in the same way, caught in the relentless hunt for the last remaining sources of yield as the only focus. Hence the title of our latest MAP: beware complacency. Reduce risk ( link ). Particularly short VIX A fitting example of extreme positioning is the unusually strong level of net short positions on implied equity volatility (VIX), more than three standard deviations below the longterm average. Despite very low levels (spot VIX at 9.87 on 27 September) hedge funds continue to expect this very low volatility environment to continue. If it does, the strong skew in volatility futures results in attractive returns. Compare that with dancing on the rim of a volcano. If there is a sudden eruption (of volatility) you get badly burned.

EUR/USD = 1.397 + 0.1437 * 10y Bunds-Tsy

28 September 2017

Market Musings XCCY Basis Widens– A Perfect Storm 

Cross currency basis have sharply widened across currencies, though the move has been more pronounced for 3m EUR and JPY basis (QE currencies). We think that impending quarter end was a catalyst for the move, but the market may



have been spooked by the apparent divergence in central bank communication, less USD issuance by non US issuers, political risk and potential repatriation flows. We think that this perfect storm of factors is responsible for the move but it has become a little overdone and could retrace as we head to the October ECB meeting. We enter a 25k DV01 of 3m EUR/USD basis tightener at - 39.8bp targeting – 22bp with a stop of –50bp. This is more of a tactical trade (we target a holding period of only a month) and we think that the basis could very well widen out into the year end turn.

… Repatriation of USDs due to US tax plan

more difficult by another debt limit vote in the first half of 2018 and the election in November. … and the economic effects will not be a game changer, anyway A massive tax cut would change our forecast, but the multipliers matter. The multipliers are almost surely less than one, and probably below 0.5. Even a tax cut of 1 percent of GDP would lower unemployment only a bit and raise inflation only a touch. The result would likely be an additional rate hike next year.

The US Big 6 tax plan released yesterday discussed repatriation of foreign profits at an undetermined rate. A large repatriation of dollars could create funding stress for some issuers as they will need to find dollars to replace what gets repatriated back to the US. Given the plan's lack of detail on key points, we expect a large amount of contention once negotiations actually begin, making the passage of a tax plan an uphill slog, particularly in 2017. But it is possible that the market is starting to price in a greater chance of repatriation.

September 28, 2017

Rate Strategy Rates Express 28 September 2017

US Economic Perspectives New hopes on taxes, but likely the same story Our baseline is for only modest fiscal stimulus in 2018 We have baked in very little change to fiscal policy for 2017 and next year, and the release of the Administration's reform proposal does not change our minds. We could be wrong Fiscal stimulus is an upside risk to our baseline for 2018 of 2¼ percent real GDP growth, unemployment to 4 percent, PCE inflation to 1¾ percent, and two hikes by the Fed. . . . nonetheless, we're still sceptical The Congress, not the Administration, will develop the legislation. A tax reform package that adds substantially to the deficit is made

Buy Long-Term U.S. “Fiscal Health Insurance” Out of the money conditional 10/30 bear steepener should capture jump in term premium •

• •

The 10/30 area of the U.S. swap rate curve could bear-steepen substantially if U.S. fiscal standing deteriorates significantly. This is not our baseline view, but a risk scenario well worth assessing. Furthermore, 30y may be the tenor most vulnerable to increasing term premium as the Fed unwinds its balance sheet. We recommend 2-y expiry conditional bear steepeners struck 25 bps out of the money to hedge against that scenario. 10/30 Treasury and swap curves are near the bottom of the multi-year trading range, while forward-starting curve steepener positions carry positively to spot.

… Insurance against a big move, rather than

a tactical view We have had quite a few spirited discussions with clients and colleagues around the shape of U.S. yield curves. We find nearly an equal split between those who think the long-end should steepen versus

flatten. Does it mean that we are flipping a coin here by recommending 10/30 steepeners? The answer is, of course, “no,” because we are targeting a long-term shift under a very specific scenario, rather than a short-term view. We expect the 10/30 area to steepen in the long run. However, we do not have a firm view whether 10/30 would steepen or flatten in case of moderate-sized yield moves in the near term. For example, it is very difficult to say if 10s or 30s would lead in a 10-15 bps selloff over the next few weeks. Instead, we suggest that 10/30 could steepen quite a bit if there is a substantial and protracted increase in U.S. long-term yields. The likelihood of this scenario may have grown. … Voice from the skeptics: 10/30 flattened in 2004-2005, why would it steepen this time around? The key point is that we are making the case for the 10/30 curve to steepen if long-term U.S. yields rise significantly, probably due to substantial deterioration of the U.S. fiscal picture. True, 10/30 flattened substantially during the 2004-6 Fed cycle, even reaching zero at one point. During that time the Fed pushed the Fed funds rate to a much higher level in real terms than it will this time. In other words, Fed policy flattened the curve in 2006 but probably will not do so today. Instead, we argue that fiscal policy the curve to steepen. September 28, 2017

Economics Group

Special Commentary Will Euro Appreciation Derail the Eurozone Economy? Executive Summary The broad-based appreciation of the euro this year raises some interesting macroeconomic questions. Specifically, will euro strength reduce export growth and thereby weigh on overall GDP growth? Will CPI inflation, which is benign already, recede further due to euro appreciation? In our view, we are still a long way away from worrying about the growthrestraining and CPIdepressing effects of euro appreciation, because the effects that the exchange rate has on export growth and CPI inflation tend to be rather modest. September 27, 2017

Economics Group

Interest Rate Weekly

Taking the Long-View on Recession Forecasting In a recent special report we proposed a new framework for predicting recessions that goes beyond a yield curve inversion. Our new method has significant implications as the Fed prepares to hike rates in December. Yield Curve – The Price of False Negatives Predicting recessions is one of the most important elements of decisionmaking in the public and private sector. As such, a different set of policy tools is needed during a recession than that used for an economic expansion. The yield curve (spread between the 10-year Treasury and federal funds rate), in particular the inversion point of the yield curve, is thought to be a very good predictor of a recession, top graph. However, the yield curve as a predictor delivers a number of false negatives—predicting no-recession when one follows. Is there a better way? Is This Time Different? The inverted yield curve has predicted the last seven recessions but missed the 1957-1958 and 1960-1961 recessions. That is, the yield curve remained positive (did not hit the inversion point) during the 1954-1965 period. Furthermore, the misses associated with the 1957-1958 and 1960-1961 recessions (false negative) raises questions about the yield curve’s effectiveness in predicting the next recession. This begs the question, is there an alternative method for recession prediction that is more effective?

A Better Way to Drive Investment Decisions In our recent work, we propose a new framework that identifies a threshold between the fed funds rate and the

10-year Treasury yield (we call it FFR/10-year threshold) as a better leading indicator of recession. 1 In a rising fed funds rate environment, the threshold is breached when the fed funds rate touches/crosses the lowest level of the 10-year Treasury yield in that cycle, middle graph. When this occurs, the risk of a recession in the near future is significant. Our framework has successfully predicted all recessions since 1955 with an average lead time of 17 months. Furthermore, our framework predicted several recessions before the yield curve inversion point and, therefore, serves as a more effective tool in predicting recessions given the more advanced warning. That is, with our framework, we do not need to wait for the yield curve to invert to predict a recession. September 26, 2017

Rate Strategy

Rates Express

Treasury and TIPS Investor Month-End Shopping Cart Politics, Central Banks, Global Flows Drive U.S. Curves and Relative Value Crossing Over: The Importance of Signaling Signals are an important characteristic in economic behavior. The analyst does not need to wait for the actual recession if, instead, a signal is present that provides information that a future event is coming. The crossover of the funds rate from below to above the prior cyclical low of the 10-year Treasury rate provides two signals. First, crossing the threshold signals the intentions of the central bank to continue to raise rates and thereby eventually tighten credit and possibly invert the yield curve. Second, the increase in the funds rate puts a number of existing fixed income holdings under the threat that their total return value could turn negative if the central bank continues to pursue a tighter policy. Investors do not have to wait for the yield curve to invert – the crossing of the funds rate above the prior cyclical low of the 10-year yield is enough, bottom graph.

Just as back-to-school fervor began to subside across the United States, many portfolio managers may feel like going “back to school” dealing with the tough task of month-end adjustments in sovereign bond portfolios. The ritual of benchmark extensions and reinvestment of principal and coupon proceeds is upon us. As usual, we aim to help Treasury and TIPS portfolio managers seek (relative) bargains and implement market views. Here is a quick summary of our views with detailed analysis to follow below: •





As expected, the FOMC delivered clarity around balance sheet normalization at its September meeting, announcing it will begin allowing roll-offs in October. This bolsters our call for the intermediate part of the U.S. yield curve to flatten in the next 6-12 months.

Equity indices (developed and EM) outperformed investment grade bond indices in Q3. We estimate that U.S. pensions will need to add about $9 billion in bonds versus pairing $13 billion in stocks into quarter-end. In a relatively new development, carry term structure in Treasuries appears to pivot around the 2y-3y point. The 2022-2023 sector looks attractive on a carry/total return basis and seems to enjoy steady sponsorship from asset swap buyers.











The money market sector has enjoyed relief from debt ceiling worries, albeit very temporary. With the debt ceiling suspended just to Dec. 8, we already see December maturities yielding 5 bps-7 bps higher than Nov./Jan. maturities.

We still find it prudent to monetize gains and raise liquidity in the front end switching from fully valued off-the-runs into currents. It is also worth looking at extending from the 1.5y sector into old 3s and 5s in the 2yr bucket.

We recommend intermediate mandates keep some exposure in the 6y-7y sector. It should continue to attract sponsorship from LIBORbased buyers, thanks to the steep rolldown in the asset-swapped curve. Until markets begin to gain more clarity on future inflation trends and the supply-demand dynamics in the long end, the 10/30 curve may continue to trade directionally with the overall Treasury “beta.” Our defensive 5/30 breakeven steepener trade hit a revised stop, and we closed it on Sept. 22 at 15 bps for a gain of 10 bps. Conversely, we initiated a recommendation to buy 2yr real yields in our Rates Express: TIPS Update – Green Shoots, Sept. 14, which we like as a cheap option on energy and other potential upside surprises.

…Moderate quarter-end pension

activity buying bonds, paring equities U.S. defined benefit funds that rebalance their portfolios both quarterly and monthly look to be a seller of domestic equities and buying bonds going into quarter-end. S&P 500 and Russell 2000 indices, which we use as proxy for pension large and small cap portfolios, have outperformed the broad domestic investment grade bond index both in Q3 and September, thus far. As of the pixel time, SPX and RTY were up 3.8% and 3.0% in Q3 compared to 1.2% return for the Bloomberg Aggregate Bond index. Pension portfolios also got a nice boost in Q3 from their allocations to global equities with the developed country index up 3.8% and the EM equities index shining an 8.6% return in Q3. With stocks besting domestic bonds, we project a moderate quarter-end rebalancing by U.S. pensions at the moment: about $13 billion of outflows from equities versus about $9 billion inflows into bonds. The net difference between redemptions from equities and purchases of bonds would typically be reinvestment, according to pension asset allocation policy, and used to make

payments to retirees. Our usual disclaimer: if stocks and bonds diverge into month-end, pensions may find themselves in a last-minute need to adjust asset allocations in their portfolios.