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Nov 3, 2017 - household liabilities as a share of disposable income remain well below prior peaks ..... complement Powel
StreetStuff Daily November 3, 2017

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones…

2 November 2017

Thu 11/2/2017 2:48 PM

October Employment Report Preview Stephen Stanley Chief Economist

Data preview: October employment report We expect the October employment report, scheduled for release tomorrow, to show a strong rebound in hiring after September data were suppressed by hurricanerelated effects. At the headline level, we expect non-farm payrolls to rise by 325k. This is consistent with a quick retracement of storm-related effects as signaled by initial jobless claims and other activity data. We expect nearly all of this improvement to come in private sector payrolls, which we expect to increase by 320k. Within private payrolls, we look for a significant rebound in services employment, in particular, leisure and hospitality employment. Elsewhere, we look for the unemployment rate to hold steady at 4.2% and average hourly earnings to rise by 0.2% m/m (2.6% y/y).

2 November 2017

…I am looking for a 330k rebound for October with a pretty good chance of an upward revision to the September reading…

Appointment of Federal Reserve Chair: Meet the new boss, mostly the same as the old boss …The big question: Is some variant of the Bernanke

Meet the New Boss: Same as the Old Boss?

playbook in effect during the next downturn? In our view, the short answer is yes. In leading up to this announcement, we felt there would be little difference between the potential candidates in terms of the conduct of the current tightening cycle. Balance sheet runoff is fully predefined, with no remaining parameters left to decide; the rate hike cycle is “well under way”; and the US economy has been consistently delivering modestly above-trend growth. Room to maneuver is limited, and, in our view, the next chair could only tinker with policy on the margin, based on any assessment of where the neutral/terminal rate is.

…The market consensus is that on monetary policy, Powell will be roughly a clone of Janet Yellen, but that he was preferable to President Trump (over a Yellen renomination) because he is more amenable to lighter financial regulation. I would argue that, while this characterization might be roughly accurate, we know a lot less about Powell than the markets think they do…

That said, we felt the more important question is the conduct of policy during the next downturn. Some of the candidates under consideration (eg. Warsh and Taylor), as well as voices in Congress, have been critical of the unconventional policies put in place to respond to the crisis and believe Fed policy choices should be more constrained. In our view, it would be reasonable to question whether the reaction function in the next downturn includes unconventional policies or, instead, only interest rate policy.

Thu 11/2/2017 4:47 PM

Fed Sentinel: Fed Chair Powell Stephen Stanley Chief Economist

In our view, Governor Powell believes unconventional policies have provided more benefit than cost and would likely use a combination of zero or near-zero interest rates, assertive forward guidance, and unconventional balance sheet policies to combat any future downturn. As he said in June, “Unconventional monetary policy was an appropriate means of providing a boost to spending by households and firms during a period of economic slack, when our ability to provide accommodation by conventional means was limited by the fact that the federal funds rate had reached almost zero.” While the implementation of the tool kit may change based on what the FOMC and staff believe to have worked well during the recovery, the point is that the tool kit remains in place…





Figure 1: Dove-Hawk Line-up •

payments due largely to the shorter maturities of such debt relative to mortgage debt. Using our model of consumption, we examine whether factors such as delinquency rates, bankruptcies, debt service burdens, and consumer credit have additional predictive power for future consumer spending. We find little evidence in support the idea that delinquency rates are important predictors of growth in private consumption. Instead, we find that changes in the growth of consumer credit and changes in credit conditions are more important for understanding household spending behavior. We see the gradual tightening in standards and terms on all forms of consumer lending and slower growth rates of consumer credit as posing modest headwinds for consumer spending in 2018, but not so much as to change our outlook for continued modest expansion. Should congress pass fiscal stimulus in the form of personal and corporate tax cuts later this year, the boost to demand is likely to far outweigh any further worsening in bank willingness to lend, leaving the economy operating well above potential for much of the next year, if not longer.

FIGURE 1 Consumer credit delinquency rates are heading higher 2 November 2017

US Economics Research Tighter credit conditions and slower credit growth not enough to derail household spending •





Consumer delinquency rates are on the rise. After peaking in 2009, delinquency rates were on a steady decline until 2016 when they flattened and, more recently, have begun to head higher. In many cases, rising consumer delinquency rates have been associated with economic downturns and we examine the rise in delinquencies against our outlook for further recovery in the US economy. We believe the rise in delinquencies reflects growth in consumer credit, even as mortgage debt and household liabilities as a share of disposable income remain well below prior peaks. After dipping modestly following the recession, consumer credit now stands at $3.7trn, or about $1trn above 2008 levels. Growth has come mainly from nonrevolving credit, including auto and student loans. With the increase in consumer credit has come an associated rise in the consumer debt service burden. Even though total mortgage debt is 2.7 times that of consumer credit, the consumer credit debt burden is higher on account of higher required

Delinquencies do not foreshadow consumption, but consumer credit does Historically, rising debt service burdens have been associated with higher delinquencies. Figure 5 plots the ABA’s series on closed-end delinquencies against the total household debt burden, which is the sum of the mortgage and consumer debt service ratios in Figure 4. The data suggest that changes in the household debt burden tend to lead changes in delinquencies. Hence, we conclude that the rise in consumer credit has been sufficient to lead to a higher overall debt service ratio and, more recently, a rise in delinquencies.

FIGURE 4 Consumer credit debt burden is on the rise

FIGURE 7 Growth in consumer credit is associated with durables consumption

FIGURE 5 Changes in the debt service ratio tend to lead delinquencies

Slower credit growth poses a modest headwind to household spending in 2018

…We find a statistically significant positive relationship between changes in real consumer credit and the growth rate of private consumption. Faster growth in consumer credit in the previous period is associated with stronger growth in household spending in the current period. We believe this result derives from the association between consumer credit and durables consumption, given the need for many households to purchase such items on credit (Figure 7). Even though our framework here is somewhat simplified, the relationship between credit growth and household spending also has support from other strains of academic research, including financial accelerator models.8

…One factor behind the slowing in consumer credit, in our view, is the elimination of the pent-up demand for autos following the recession. The solid demand for autos and an industry willingness to use incentives and easy credit meant motor vehicle loans were growing nearly 10.0% y/y for much of 2014 and 2015. As the pent-up demand has been filled and auto producers are more inclined to move away from high production at any cost to a better balance between quantity and quality of sales, motor vehicle loan growth is likely to moderate further once the effects of the hurricanes on auto demand move through the data (see Quantity of auto sales may be falling, but quality is likely rising, July 7, 2017). Rather than use credit conditions and credit growth separately, we prefer to use them together when forming our view about what changes in consumer credit, eg, about our outlook for consumer spending. Figure 10 shows that credit growth tends to lag changes in bank willingness to lend to consumers by about a year. Hence, the trend toward less favorable credit conditions suggests that further moderation in consumer credit growth remains likely over our forecast horizon. In turn, and if history is any guide, we would view further slowing in the growth of consumer credit as more negative for our outlook on

consumption than a further rise in debt burdens, bankruptcies, or delinquencies... FIGURE 10 Less favorable credit conditions point to further moderation in growth in consumer credit

Should congress pass fiscal stimulus in the form of personal and corporate tax cuts later this year, the boost to demand is likely to far outweigh any further worsening in bank willingness to lend, leaving the economy operating well above potential for most, if not all, of next year. As we wrote in US Tax Policy: What’s priced in for different assets, October 25, 2017, the budget bill that was recently passed by the House and Senate provides room for a tax cut of about $1.5trn over a 10-year horizon. Under the assumptions that the multiplier on tax policy well below 1 at this stage of the business cycle, the response of consumers to tax cuts is front loaded, and any pickup in business fixed investment comes with a lag, we estimate the impulse to real GDP growth from consumption and investment is 0.5pp, with Q4/Q4 growth rising to around 2.8% in 2018 from 2.4% currently. Consumer spending, in this environment, would be unlikely to slow until well into 2019.

consistent with our forecast of 2.5% consumption growth in Q4.

2 November 2017

Global Global manufacturing confidence moderates in October, but remains on a strong footing …In sum, global manufacturing confidence remains in solid territory. The synchronous global growth environment is proving to be supportive of production and new orders, and we can expect another strong quarter for the global manufacturing sector.

2 November 2017 November Supply Monthly • The US Treasury is set to take $22bn from the market in November and $60bn in December. • •

Euro area governments are due to take €24.2bn ($28.2bn) from the market in November and €5.8bn ($6.8bn) in December. The Japanese government is set to take JPY7.1trn ($62.4bn) from the market in November and return JPY8.86trn ($77.6bn) in December.

2 November 2017

US auto sales: 18.0mn units in October sales suggest continued post-hurricane rebound Motor vehicle sales in October were 18.0mn units, higher than what we and the consensus had expected (Barclays: 17.7mn; consensus: 17.5mn). The spike in auto sales in September was likely reflective of pent-up demand for autos following the landfall of Hurricane Harvey in end-August (Figure 1). Another month of sales around the 18.0mn mark suggests further pent-up demand following Hurricanes Irma and Maria making landfall in early September. We expect sales to normalize to more sustainable levels, at 16.0-17.0mn, in the coming months. We will not begin tracking Q4 GDP until the release of October retail sales on November 15. Nevertheless, we view this level of vehicle sales as

Thu 11/2/2017 3:52 PM

Lyngen/Kohli BMO Close: Trump's Mark (attached/link) The Treasury market rallied on the details of the House tax bill, specifically the cap of mortgage tax deductibility at $500k in principal (versus the current $1 million limit) and the elimination of the state and local tax (SALT) deduction. The double-

hit to the residential house sector was clear – loss of the ability to exclude mortgage interest and real estate taxes effectively increases the costs of ownership and weighs heavily on property values in high-tax markets (NY, NJ, CT, CA). While attempts were made to soften the blow via a $10k cap for real estate taxes and the mortgage interest rules apply only to new purchases (refi’s get a pass), the impact will nonetheless be significant if the deal ultimately passes. This begs the obvious question – does it pass in its current form? We think not and we can almost hear the lobbyists spinning their rolodexes in response to a call to arms from the National Association of Realtors. …Despite the relatively sharp price action, activity

in the Treasury market was only at 102% of the 10day moving-average in cash. Frankly, we would have expected a more tangible spike in flows.

sterling: in other words, the markets seem to be convinced that this was a “dovish” rate hike.

Such responses have become standard: markets have likewise treated as dovish policy tightenings from the Fed’s first rate hike 23 months ago to the ECB’s recent taper in the pace of its QE programme.

… Tactical Bias:

…At the very least, this tax plan adds to what is likely to be a very fractious year end and put one more issue on an already crowded docket where Congress is expected to address everything from defense spending to health insurance (Obamacare CSR payments and CHIP) to ideological questions like immigration and funding of the border wall. In a less fractious year, any of these individual topics would be enough to make for difficult passage. Combined, they offer some extreme headwinds to a smooth year-end. Anecdotes for this month’s employment report are skewed decidedly stronger with 8 positive proxies versus 3 negative ones. The constructive anecdotes include ADP, Claims, as well as the Labor Differential (best since 2001). That said, we won’t see ISM non-manufacturing until after the release and it really all comes down to the unwind of the hurricane impact at this stage. 02 Nov 2017

Global Rates Plus - Yet another dovish hike The Bank of England’s first rate hike in a decade was met by a fall in gilt yields and in

Why is every tightening perceived as dovish? It’s true that central banks couch each tightening in dovish terms, expressing concerns over the pace of inflation and the vulnerability of the economy, and reminding markets that policy remains very accommodative (this is the same in every tightening cycle – recall 2004-5, where policy was described as “accommodative” throughout the first 175bp of rate hikes). Also, they carefully prepare markets for tightening moves. But markets are not central bankers’ slaves: we doubt that market participants would continue to support such low yields (especially forward yields) if they believed that central banks were moving too slowly. But investors too believe that inflation pressures remain subdued; that trend GDP growth has slowed; and they worry that the next downturn will lead to a return to QE. In short, markets so far fundamentally agree with the central bankers about the appropriate pace of tightening. So, how to position? in this context, it makes sense that inflation expectations should probably rise before markets feel the need to push up real yields; so it makes more sense to be long breakeven inflation than short real yields, as we recommend. Also, carry is still valuable because markets support central banks moving slowly, and bearish-leaning trades have to carry as painlessly as possible, hence our

recommendations for forward curve steepeners in the US and UK; and short 2s5s10s in euros. Also is this week's Global Rates Plus Eurozone: Buy 2y 2y/10y conditional bull steepener Eurozone spreads: Juice left in BTPs UK: Positive carry steepeners still make sense post hike US: Supply to hurt the belly MBS: Implications of rising extension risk Japan: Receive 2y OIS

US: Supply to hurt the belly The US Treasury curve continues to flatten strongly, but is more muted in swaps. Since June 2017, 2s30s UST curve has flattened by 30bp+ vs. ‘only’ 14bp on 2s30s swap curve. The prospect of financial deregulation, especially under a new Fed chair, and most recent recommendations from TBAC regarding future UST issuance are supporting 30y USTs.

MBS: Implications of rising extension risk

The underperformance of 2y UST vs. swaps but sharp outperformance of 30y UST vs. swaps is apparent in the steepening of the swap spread curve (top chart). We maintain our trade idea of buying 10y UST vs. swaps targeting +10bp (current: -2bp, entry: -5bp, carry: +1.3bp at 3m).

The risks to the MBS market are skewed towards the extension side, and they will likely become more pronounced in a further bond selloff. The November FOMC states that U.S. “Economy has been rising at a solid rate despite hurricane-related disruptions”. We now expect a rate hike in December and three hikes next year. Higher US rates should increase the overall duration of the MBS market.

The Quarterly Refunding Statement suggests that the US Treasury will maintain coupon issuance sizes at current levels for this quarter. At February’s 2018 refunding, “Treasury anticipates announcing gradual adjustments to its nominal coupon and 2-year FRN auction sizes”. Looking ahead, TBAC strongly believe increased issuance should favour T-bill and the belly (2-year, 3year and 5-year coupon bonds and 2y FRNs) – along with longer-term issuance to keep weighted average maturity of issuance (WAM) similar. 30y USTs benefited most with a implicit bias towards stable/lower WAM of supply, further lowering the possibility of ultra-long UST issuance. We continue to favour trade ideas where we are short the ‘belly’ of the curve – 6m fwd, pay 2s5s10s and 6m fwd, 2s5s steepeners (both carry somewhat positively). BNPP economists expect the tightening cycle to end at the end of 2018. The next easing cycle usually begins six months to one year later (lower chart), and the curve typically steepens for up to nine months after first rate cut. This time is different, with tightening at both end of the curve and higher term premium likely to result from Fed balance sheet reduction. Given the market’s resistance to pricing this, it could take longer for the curve to steepen than we originally thought. Overleaf, we consider ways to position for a structural steepening in swaps over the longer-term.

At the 2.40% 10yr UST yield, about 20% of the agency MBS market is refinanceable (with 50bp in-the-money). Across coupons, 3% and 3.5% coupons are almost completely out-of-themoney, and only 26% of the 4% coupon is still refinanceable. If rates further rise by 50bp, less than 10% of the MBS market will be in the money – and thus the extension risk will be asymmetrically greater for MBS (top chart). Meanwhile, there has been a significant shift in the MBS coupon composition due to premiums being replaced by lower coupons. The percentage of the 4.5% coupon has dropped to 8% in 2017 from 26% since 2012, while the percentage of the 3% coupon has increased to 28% from zero. The effect of rebalancing into lower coupons is similar to an orderly sell-off, which has also reduced the MBS refinanceability, as the market has become less callable (lower chart). Implications for trades:  We favor up-in-coupon TBAs (4s versus 3s-3.5s) as higher coupons should have less extension risk than lower coupons.  We expect MBS basis to widen at least 20bp in 2018. Apart from having to cope with a sharp decline in Fed demand (due to balance sheet reduction), the MBS market will have to manage the extension risk, as well as servicer selling on mortgage hedges. The risk to our call is if rates rally and MBS duration shortens, the MBS hedge adjusted carry could improve, which could keep tight spreads anchored.

02 Nov 2017

Economic Desknote - US: Powell nominated for next Fed Chair • •

• •

Federal Board Governor Jerome Powell is seen as the continuity candidate who will likely make no major changes to the Fed’s recent policy stance. Powell could face massive challenges, such as toolow inflation, balancing monetary policy coming tax reforms, political pressures and possibly insufficient ammunition, if it is needed. With his training as a lawyer, will five years at the Fed and a background in financial services give him the sufficient economic expertise needed? The next major questions are who will be picked as Federal Reserve Vice Chair, and will that person complement Powell enough to create a dream team.

02 Nov 2017

Macro Matters BIG PICTURE: Global implications of US developments The combined impact of the Fed rate hikes, apparently faster US growth and tax reform is likely to spell higher rates along the curve, a stronger dollar and more headwinds for emerging markets. 2–3 THEMES OF THE WEEK Germany: Output breather 4–5 We think softer industrial output might persist for a couple of months. However, loose monetary policy and a robust outlook for the global economy are consistent with renewed German industrial strength heading into 2018. UK: Pessimistic hike 6–7 The BoE’s decision to raise rates by 25bp was in line with consensus expectations, but the markets took the Bank’s comments dovishly – yields and currency lower. We don’t envisage the next hike until November 2018 though. US FOMC: December hike looks “solid” 8–9 Since solid growth and labour markets seem to weigh more with the Fed in assessing future inflation than recent inflation data, we now expect a rate hike in December.

US: Powell nominated for next Fed Chair 10-11 Federal Board Governor Jerome Powell is seen as the continuity candidate who will likely make no major changes to the Fed’s recent policy stance. He could face major challenges ahead, however. Bank of Japan: Easy come, easy go 12–13 The Bank of Japan looks disinclined to introduce further easing as long as the output gap is improving. If subdued inflation results in protracted monetary easing, the central bank might have to fine-tune policy to reduce side effects. Argentina: Reforms and bargaining ahead 14–15 Macri unveiled the reform path for the next two years. Potential social security-related savings are the key to preserving fiscal sustainability. Upcoming negotiations with provincial governors on fiscal issues are in the spotlight. 02 Nov 2017

Global FX Plus More Room For USD To Run   

USD recovery has further to go, in our view – we now target EURUSD at 1.14 and USDJPY at 116 in one month. Following the BoE’s rate hike, we continue to recommend bearish GBP positions. RBA and RBNZ up next week; sentiment towards the NZD remains very poor, our metrics suggest.

The USD continues to recover in line with our bullish targets. In our view, there is scope for this recovery to continue, and we have revised up our one-month targets for the USD, expecting EURUSD to reach 1.14 and USDJPY to reach 116 over the next month – for more details, see pages 4-6. The very negative sentiment towards the USD during the summer has improved significantly, but BNP Paribas FX Positioning Analysis suggests the market still has room to add to long USD positions. In addition, we remain of the view that tax reform is not yet priced into the USD. Our economics team sees a 65% chance of tax reform being passed by

mid-2018, and as progress continues on this, the USD should remain supported.

considerable scope for markets to build long exposure if the price and news momentum remains favourable.

We continue to recommend bearish GBPUSD positions following the Bank of England’s rate hike. The market was fully prepared for a hike, and dovish tones to the statement meant that expectations for further rate hikes have reduced. In our view, further deterioration in economic data should keep GBP under pressure. The market was positioned slightly long GBP into the meeting, according the BNP Paribas FX Positioning Analysis, so there is plenty of scope for the market to add to short GBP positions over the coming months. For more details, see page 22…

Chart 1: USD Short position has been eliminated

USD update: Too much of a good thing?   

The USD is rallying this quarter in line with our expectations, but the longer-term trend for the currency remains lower. Our metrics signal it is still premature to consider short positions at this time. We expect EURUSD to reach 1.14 and USDJPY to be at 116 over the next month

The USD has firmed broadly so far in Q4, with the DXY now up about 5% from its early September lows, after sliding over 10% in the first eight months of the year. The USD rebound has been consistent with our forecasts for the USD to trade better in Q4, as Fed policy gets repriced and tax legislation efforts gather momentum. However, a number of USD pairs have now reached and exceeded our once-bulish, year-end 2017 targets and are approaching our objectives for Q1 2018, raising questions about whether it is time to consider trading the USD from the short side. In our view, the USD remains in the early stages of a multiyear correction lower, back towards equilibrium fair value levels, and the current period of USD recovery will ultimately be viewed as a counter-trend bounce from oversold levels. Still, our judgement is that it is premature to trade the USD from the short side and that the current period of USD recovery could persist for a bit longer. Below, we summarize the key metrics we are monitoring as we evaluate when to move on to the next period of anticipating renewed USD weakness.

Positioning At the end of the summer, our BNPP FX Positioning Analysis framework highlighted extreme short positioning in the USD. In fact, the -41 score recorded on 14 August was the most negative reading observed in the 10-year history of the series. The short exposure was vulnerable to a turn in fundamental views, and the framework now suggests that short positioning has been nearly fully eliminated for the first time since May. While the potential for a USD short squeeze has been largely exhausted, the positioning measure highlights

FOMC pricing Pricing for further FOMC rate hikes had fallen to minimal levels at the end of the summer, despite the Fed having already delivered two rate hikes in the first half of the year. As we have moved into Q4, pricing has recovered amidst improvement in US data and a consistently hawkish message from key Fed officials. With the Fed having continued to downplay soft inflation readings at its November meeting, our Economics team now expects the FOMC to deliver a 25bp rate hike in December, and to follow up with three additional hikes next year. As Chart 4 shows, there is still room for the rates markets to adjust and more fully price in this view. When to sell? We remain bearish on the USD in the medium-to-longer term, but would wait until long USD positioning has become a bit extended and the chance of a tax reform is more fully priced in before considering entering new shorts. We expect the next few weeks to be characterized by gradual (albeit, uneven) progress towards tax reform, but we see scope for markets to grow concerned again in December, as the heavy lifting around passing final bills gets underway. The need to extend the government’s spending authority around 9 December could provide an additional element of fiscal risk for the USD at that time. At this time, in order to better reflect our economics team’s updated Fed forecast, we are raising our tactical one-month forecasts for the USD against the EUR and JPY to EURUSD 1.14 and USDJPY 116, and flattening our Q4-end targets in line with our Q1 forecasts of 1.15 and 115, respectively. We are also flattening our Q4end and Q1-end forecast profile for USDCAD and AUDUSD to 1.25 and 0.76 respectively, while adjusting our 1m targets for those pairs to 1.28 and 0.76.

Chart 4: Fed close to fully priced

US Rates at the Bell nd

November 2 , 2017

Trader’s Tab

 What’s Next: The unveiling of the bill summary -

that runs 82 pages - kicks off what is sure to be a challenging schlep to get legislation to POTUS Trump by Christmas time. Republicans are hoping to move it quickly through the House, with committee action penciled in for next week. However, Senate Republicans are apparently already working on their own competing plan they aim to unveil next week. So it will be critical to see how the CBO will be dynamically scoring the first bill, as market expectations remain pretty low given the congressional track record in 2017. Recap & Discussion: USTs closed modestly richer and flatter across the curve, as the risk-parity friendly Powell announcement was realized and the obfuscation surrounding tax-reform reflects relatively low market expectations. Additionally, in a rare touch of gilt market irony, 5y gilt yields dropped -10bps, the most since (8/4/16, a BoE rate cut) as Carney raised rates and the GBP dropped -1.4%. The outstanding domestic market reaction to the tax plan was the marked underperformance of homebuilders’ equity (-

2%) and “weak balance-sheet” style factors (GS basket -1.7%), which were hit off of the limit on home mortgage-interest deduction on new loans up to $500k (from $1mn) and the provision capping the amount of deductible corporate interest expense at 30% of EBITDA. All in all though, our limited flows and the lack of volatility (plenty of systematic sellers this week) would suggest the event was fairly welldiscounted, with obviously a long-way to go before we see the final product. The only other minor concerns would appear to be the fairly swift reprisals from the likes of lobbying/interest groups (NAHB, NFIB, Black Chambers) as well as the modest disappointment on the repatriation rate (12%), which was a bit higher than business-friendly expectations (10%?). This put the damper on the DXY on the session, though FX vol was quite muted outside of cable, while USDJPY reversed almost the entirety of its intraday decline by end of day. …Away from the tax-related myopia, the data beats go on however, as preliminary class 5-8 commercial truck orders surged in October; monthly net orders of 55.7k rose 65% YoY as class 8’s hit a 34-month high on an absolute basis, and a 27-month high on a seasonally adjusted basis. On a seasonally adjusted basis, class 5-8 net orders of 48.9k rose 5.7% sequentially and have remained relatively consistent to-date in 2017, ranging from 41.4k in May to 48.9k in October. Additionally, tomorrow Citi Economics is expecting 335k increase in nonfarm payrolls and 0.1% MoM (2.6% YoY) growth in AHE. Obviously, the softer AHE earnings will be the market focus, but as Citi Econ warns, this is largely a function of a volatile and seasonally inconsistent series. Better yet, they also expect base effects to reverse very favorably in November, implying that the sharp pullback in YoY AHE is likely to be temporary. Paired with the decent ECI and Atlanta Fed Wage readings of late (all trending higher YoY and sequentially), which the Fed is watching closely, we think that this keep our medium-term bearish inclinations in good-standing, despite what appears to be a fairly high bar to a local selloff (as cross-market spreads to EGBs remain challenging to duration weakness domestically).

02 Nov 2017 10:55:39 ET

RPM Daily Positioning in a Neutral Gear •



Summary - Long cash (+0.4) / short futures (-0.3): The market has low conviction on duration, with light positioning held across core markets. Global flattener plays remain in place while ECB carry trade favours European Periphery spreads. North America - Short futures (-0.8) / long cash (+1.3): On the back of the supply announcement, flows were dominated by flattening plays - around $2.5 DV01 added to the long end. The market remains short 10y (in futures, cash and swaps at 1.0) but small PnL implies little stress.

02 Nov 2017 10:15:27 ET

UK Economics Flash BoE: Dovish Bank Rate Hike …Not ‘one and done’, but not much more – The MPC dropped guidance that Bank Rate may need to rise more than markets imply. Carney said two additional 25bp rate hikes over three years “are consistent with” inflation falling back towards target by the end of the forecasting horizon. However, he also said that the economy “might be running a little hot by the end of the forecast horizon” with forecast inflation staying as much above target as in the August forecast, despite the hike. This is an acceptable trade-off for the MPC for now, given Brexit risk. The MPC statement concludes that “all members agree that further increases will be limited and gradual”, and sees “considerable risks to outlook from Brexit”.

What next? – The BoE is embarking on a rate hike cycle, but not as “fearlessly” as expected. We now think only one hike next year is likely. Much hinges on whether productivity growth stays lower than elsewhere. If not, the UK might be facing growing slack and lower inflation as it has been the 4th weakest economy in the OECD so far this year (see Fig. 1 overleaf). The risk of no further hike, or even a reversal due to Brexit risks, stays very high. Markets reacted by selling sterling and buying gilts. Ironically, the rate hike has thus eased financial conditions and may boost growth and inflation projections at the next meetings. Hawkish MPC members may soon push against this dovish interpretation, so we cannot rule out that the MPC will be forced to hike twice in 2018 to bolster its credentials

CitiFX | 02 Nov 2017 12:21

EUR model update: Measuring impact of ECB’s QE reduction •

ECB’s QE reduction is thought to have little impact on EURUSD, and its marginal positive influence may well be completely offset by the Fed’s B/S normalization.



German Bund/US Treasury yield spread has a significantly strong impact. The spread is recently widening in favor of the USD, pushing the pair estimate below 1.10.



The fair value of USDJPY is expected to follow a stable uptrend and EURJPY looks likely to climb steadily toward 140 over the next year

02 Nov 2017 19:53:14 ET

European Rates Weekly Trading growth vs inflation divergence Solid Euro area growth & low inflation are consistent with forward ECB tightening. The kicker could be that the ECB has opted for too much gradualism against the robust economic backdrop. On inflation, the baseline is low/unanchored, but not static. The HICP trend looks to be gently upward sloping. Elsewhere, we look at ASW cheapening levels and trades on ECB taper. Box trades look most robust to flow/stock debates. The first MPC hike in 10 years was taken as dovish. The upshot is that the MPC has gone to a lot of effort for minimal re-pricing of the front-end. We doubt that was the intention, making the front-end vulnerable to a fightback from the MPC. We also discuss drivers and risk factors for periphery tightening, declining net supply of euro linkers in 2018, bearish medium-term plays via spread caps, EFSF/ESM spread differentials going into 2018 and next week's supply.

02 Nov 2017 16:02:26 ET

US Economics Flash Fed Chair Nominee Powell – in his own words

conforming to the budget resolution reconciliation instructions.

02 Nov 2017 08:35:20 ET

Weekly Supply Monitor Euro, UK and US Supply Outlook

As expected, President Trump nominated Governor Jerome Powell to serve as the next Chair of the Federal Reserve Board of Governors.



Recent statements from Governor Powell are consistent with the consensus view that as Chair he will continue the “gradualist” approach to rate hikes currently being pursued by the Fed. We maintain our call for three rate hikes in 2018.



More interestingly, Powell may advocate for a larger terminal balance sheet and policy rate control based on a “floor system.” Powell will likely work closely with newly-confirmed Vice Chair for Financial Supervision Quarles on changes to bank regulation and may take a more active role in housing finance reform. We expect Powell to be confirmed by the Senate in the next few months. Bernanke was first nominated on Oct 24th and confirmed Jan. 31st. Yellen was nominated Oct 9th and confirmed January 6th.



EGB supply next week is scheduled from Austria (€1.15bn), Germany (€3.5bn) and Ireland (estimated €1bn). There are €0.2bn of coupons and €18.1bn of redemptions that are eligible for reinvestment next week. The US Treasury will issue around $62bn across the 3yr, 10yr and 30yr sectors next week. There are no cash flows that are eligible for reinvestment next week. The UK DMO will issue an estimated combined £6.25bn across the new IL48 and 0.75% Treasury gilt 2023 next week. There are no gilt cash flows eligible for reinvestment next week.

US net cash requirement (NCR) over the next 4 weeks On a settlement date basis, the NCR is neutral for USTs next week as there are no supply/cash flows settling over this period (Figure 20). 20. US weekly cash flow profile for next four weeks, USD billions

Focus will now shift to potential nominees for Vice Chair. Speculation centers on a Vice Chair with academic credentials, but we think John Taylor is not the most likely choice. 02 Nov 2017 17:52:48 ET

US Economics View Tax Reform Countdown – House $1.5 Trillion Tax Bill: First Draft •

• •



The House Ways and Means Committee posted its Tax Cut and Jobs Act, which aims to produce the most comprehensive overhaul of the US tax code since 1986. The bill is a first draft and will undergo several revisions over the next week before it is voted on by the committee. The legislation offers permanent tax cuts for firms and individuals, while eliminating most deductions, and transforming the int’l tax code. Provisions will take effect mostly starting in 2018, not retroactive to 2017. Cost/Savings Estimate — The bill would reduce revenue by $1.501 trillion over the 2018-2027 span,

2 November 2017

US Economics: The Week Ahead Next Week's Highlights The data calendar is fairly light in a holiday-shortened week, with Veteran’s Day observed next Friday. We will get an updated look at labor market dynamics with the release of the September JOLTS report on Tuesday. On Friday, we receive the preliminary estimate of consumer sentiment. We expect sentiment to increase to 102.0 versus 100.7.

New York Fed President Dudley and Fed Governor Quarles will speak on monetary policy and financial regulation next week.

Deutsche Bank

monetary policy. From a market perspective, then, the beta of both interest rates and FX to the outcome of talks on transition by year-end should increase further. We previously argued that Bank of England would struggle to tighten beyond today's meeting without more clarity on a Brexit transitional deal. Today's Inflation Report reaffirms this and underlines the importance of upcoming political outcomes for the economy and markets. Even with a transitional deal, however, we still think interest rates will remain at these levels throughout next year due to a more pessimistic view on growth. The risk to this view is that the Bank of England hikes again due to continued concerns about supply.

02 November 2017

03 November 2017

UK economic notes - A very reluctant hike: Bank of England review

UK Strategy - Tangled tightening

A very reluctant hike As widely expected, the MPC voted 7-2 to hike rates for the first time in over a decade at the Inflation Report today. Today's decision was more dovish than we expected, however. There have been few occasions, at least since the adoption of inflation targeting, in which a developed market central bank has tightened monetary policy while talking down the economy so much. First, the BoE endorsed very dovish current market pricing by removing the forward guidance on the yield curve in the monetary policy statement and making this explicit during the press conference. With the market only pricing three rate hikes out to 2020, at a pace of 10bp per quarter (versus an average of 40bp in the last five hiking cycles), the Bank signaled this was no typical hiking cycle. Second, the Bank made clear that the need for tighter policy was a result of the reduced productive capacity of the economy rather than growth. The Bank highlighted that Brexit would exacerbate existing supply constraints, particularly in the labour market, which was 'running out of road', as immigration fell. Rather than becoming more conventional, then, the MPC still faces a difficult trade-off between balancing supply and demand. This was reflected in their inflation forecasts at the two and three year horizon, which were revised down only moderately (3y 2.15% vs. 2.22% and 2y 2.19% vs. 2.21% previously) despite today's tightening. In this sense, the Bank feels it is still running a relatively too expansive monetary policy in order to compensate for the potential impact of Brexit on demand. Third, Carney clarified that future monetary policy will hinge on the outcome of Brexit negotiations. In the past, the Bank had assumed that households and businesses would continue to assume a smooth transition towards new trading arrangements. Today, Carney said that political developments on both the UK's future trade relationship and a transitional deal would likely warrant a revised assessment of the economy and recalibration of













The BoE’s hike came with dovishness attached. Of particular focus was the decision to remove the previous yield curve guidance – endorsing a historically dovish tightening cycle of only two further hikes into 2020 This may drive expectations that front end pricing is capped at 1%. In the short term this may be valid and help steepen the curve, but it is dangerous to jump too quickly to such a conclusion Carney referenced a reassessment of the policy outlook should the outcome of Brexit negotiations shift. Sign of a transitional deal before year end could therefore generate more hawkish pricing Even in the case of hard Brexit, however, the impact on monetary policy is unclear. While the growth hit is unambiguously negative, the negative supply shock and inflation pass through from weaker FX could maintain hawkish pressure on the BoE The monetary policy response in the various Brexit scenarios is therefore not straightforward, reflected in the fact that the BoE hiked rates while keeping relatively dovish messaging. Fiscal, therefore, continues to represent the first response to Brexit headwinds from here Following the dovish reaction to the November meeting, we exit the rec. May18 Sonia that we had added two weeks ago as a hedge. With the GBP term premium depressed, we maintain GBP 5s10s steepeners vs 20% 2s, with an alternative carry positive expression paying GBP 5s10s15s. On a cross market basis we stay short 30Y UK vs Germany and in RV are long 2Y ASW vs the 7Y point

01 November 2017

Thematic Research - The Future of Money Part 1 - The Start of the End of Fiat Money? We’ve just finished a 5 week marketing tour of our latest annual long-term study entitled “The Next Financial

Crisis”. As we road-showed the document a theme that had minor billing in the report (on pages 24-25) started to gain more and more prominence in the discussions and as such we wanted to expand upon it in this short follow-up thematic note. The basic premise is that a fiat currency system - the likes of which we’ve had since 1971 - is inherently unstable and prone to high inflation all other things being equal. However for the current system to have survived this long perhaps we’ve needed a huge offsetting disinflationary shock. We think that since around 1980 we’ve had such a force and there is evidence that this influence is now slowly reversing. If we’re correct, the fiat currency system may be seriously tested over the coming decade and ultimately we may need to find an alternative. This is not necessarily a story for the next few months or quarters but we think the trend reversal is already slowly in place. If we’re correct that the secular lows for inflation are already behind us then policy makers will have a much more challenging environment to conduct policy over the medium to longer-term. We also show that rather than being in an ultra low inflation world that most people believe us to be in, we’re actually in a relatively high inflation world relative to very long-term history.

bedfellows with only a gradual upward creep in inflation as new precious metals were mined or governments periodically punched holes in existing coins and thus slightly debasing the currency.

Figure 1 shows our global median inflation index back over 800 years and then isolates the period post 1900 where inflation exploded relative to long-term history

2 November 2017 | 1:14PM EDT

US Daily: October Payrolls Preview (Hill) 



Figure 2 then shows this in year-on-year terms and as can be seen, in the 700 years before the twentieth century inflation and deflation were near equal

We estimate that nonfarm payrolls increased 340k in October, above consensus of +310k and the 3-month average pace of +91k. Our forecast reflects solid underlying job growth and a sharp rebound in employment in hurricaneaffected areas, as we estimate flooding and power outages reduced the level of September payrolls by approximately 180k. We estimate the unemployment rate was unchanged at 4.2%, as the two-tenths drop in September was not driven by unusual declines in hurricane-affected states. Finally, we expect average hourly earnings to increase 0.2% month over month and 2.7% year over year. We view the risks to our earnings growth forecast as skewed slightly to the downside,

given neutral-to-slightly-negative calendar effects and the possibility that the hurricanes temporarily boosted September average hourly earnings in Florida 2 November 2017 | 5:31PM EDT

USA: House Tax Reform Proposal Released but Details are Likely to Change BOTTOM LINE: The House Ways and Means Committee has released its tax reform proposal, which is estimated to cut taxes by a net $1.5 trillion over ten years. The bill included more aggressive reforms than expected, including a 20% corporate rate and substantial limitations on itemized deductions for individuals. That said, some of those changes have already generated pushback from affected groups, and further changes are likely. We continue to believe tax legislation has a 65% chance of enactment by Q1 2018. 2 November 2017 | 9:35AM EDT

USA: Unit Labor Costs Edge Up as Productivity Rises at Above-Trend Pace; Initial Jobless Claims Drop BOTTOM LINE: Nonfarm productivity was slightly stronger than expected in Q3, and unit labor costs increased at a modest pace. Following the report, our Wage Tracker held steady at 2.7% in Q3. Initial and continuing jobless claims declined, in contrast to consensus expectations for a small gain. 2 November 2017 | 9:16AM EDT

US Daily: Jerome Powell on Monetary Policy and Financial Regulation (Mericle/Hatzius/Phillips) 



President Trump is expected to nominate Fed Governor Jerome Powell to be the next Chairman of the Federal Reserve. Powell’s appointment should preserve continuity at the Fed, as his stated economic and monetary policy views largely mirror those of the current leadership Powell thinks the economy is at full employment, views inflation as “kind of a mystery” but expects it to rise, and supports gradually raising rates if the economy performs as expected. On bigger-picture monetary policy issues, Powell puts significant



emphasis on the role of financial conditions, believes financial stability concerns deserve some weight in general but are not problematic yet, supports the balance sheet normalization plan, and agrees that the neutral rate has declined. On financial regulation, Powell supports the core elements of the post-crisis reforms affecting large banks, but has expressed openness to considering changes to CCAR testing, the Volcker rule, resolution planning, supplementary leverage ratios, and regulation of smaller banks. Overall, he is likely to bring a somewhat lighter touch to financial regulation.

2 November 2017 | 6:57AM EDT

Americas Automobiles: SAAR stays strong in October at 18.1mn; incentive growth stays muted, inventory up sequentially October SAAR of 18.1mn was up 1.2% yoy but down 2.6% sequentially. This comes as incentives continued to grow in the month but at a muted pace (+5.4% yoy), and inventories came up sequentially (70 days vs 63 days). Although results for the month were strong, especially versus 1H17, YTD SAAR of 17.1mn is tracking about in line with our full year estimate (17.2mn), and we believe the October sales were again somewhat helped by Hurricane-recovery demand as well as improved fleet sales yoy.

November 2, 2017

JEF Economics

Primary Dealer Positions: Corps Up $5B, Quiet Elsewhere In the week ended October 25th, Primary Dealer positions rose $4.2 bln to a net long of $239.7 bln from $235.6 bln. Treasury positions rose modestly, edging up $1.7 bln. Positions in other asset classes were very little changed as well, aside from a $5.7 bln increase in corporate bond positions.

Treasuries

Overall Treasury positions rose $1.7 bln to a net long of $99.6 bln. Overall coupon positions fell $3 bln to a net long of $67.1 bln. Bill positions rose $1.5 bln to a net long of $18.1 bln. TIPS

positions fell $867 mln to a net long of $7.5 bln, and FRN positions rose $4.1 bln to a net long of $7 bln.

MBS securities, which could widen the yield spreads between mortgages and benchmark Treasuries.

Coupon positions were mixed across the curve. There were $3.6 bln and $1.2 bln increases in the 3- to 6-year and 11+ year sectors, respectively, but elsewhere there were declines. The most significant declines were the $3.9 bln and $2.9 bln declines in the 2- to 3-year and 6- to 7-year sectors, respectively.

Base metals price inflation stems from improving world economy

… Corporates

Dealer inventories of corporates rose $5.7 bln to a net long of $31 bln. Positions in IG bonds rose $7.8 bln, while high yield positions rose $301 mln and CP positions fell $2.4 bln. Across the IG curve, positions in bonds with 13-months to 5years rose the most, up $4.9 bln

02 Nov 2017 | Market Outlook Slower Labor Costs and Pricier Metals Help Stocks Soar To the benefit of credit quality, the world economy is humming. However, the pace of global expansion has yet to significantly boost inflation expectations or the real return demanded from credit market instruments. Thus, benchmark government bond yields remain low. For 10-year sovereign government bond yields, the US Treasury’s recent 2.35% was well above Japan’s 0.04%, Germany’s 0.37%, the UK’s 1.26%, and Canada’s 1.95%. The very low benchmark yields of most other advanced economies should limit the upside for US interest rates. Perhaps that expectation helps to explain why the 33.3% surge of US housing sector share prices since the end of 2016 has far outpaced the accompanying 14.6% increase by the market value of US common stock. The lift-off by housing-related stock prices is all the more remarkable given forthcoming reductions in Fed holdings of agency

On November 1, Moody’s industrial metals price index soared higher by 2.3% for its biggest one-day advance since January 31, 2017. The base metals price index’s 25% year-over-year surge of the last 13 weeks stems from a notable expansion of global industrial activity. Nevertheless, the countrywide ISM and PMI indices of manufacturing activity have not been especially lively outside the US and Europe. Since the mid-1980s, the annual percent changes of world economic growth (as measured by the IMF) and Moody’s industrial metals price index show a relatively strong correlation of 0.80. In 2017, the base metals price index is expected to grow by 25% annually. For those previous 12 years since 1985 showing at least a 10% annual increase by the base metals price index, the median annual advances were 23% for the base metals price index and 4.6% for world economic growth….

T-Bond yields may follow base metals prices higher Moreover, Treasury bond yields are likely to ascend if the industrial metals price index extends its latest climb. In response to a -43% plunge by the base metals price index’s moving three-month average from an April 2011 peak to a January 2016 bottom, the 10-year Treasury yield’s three month average sank from 3.48% to 2.19%. Since January 2016, the base metals price index’s three-month average has advanced by 56% which helped to lift the 10-year Treasury yield’s three-month average to a recent 2.25%. (Figure 2.)

November 2, 2017

November 2, 2017

US Economics: Employment Report Preview •







We expect the labor market to have generated 315,000 net new jobs in October, with the unemployment rate stable at 4.2% and a 0.3% monthly increase in average hourly earnings (AHE), lowering the year-over-year rate slightly to 2.8% from 2.9% last month (Exhibit 1). Our expectation for headline payroll growth is just slightly above consensus at 312k, and our earnings forecast is above the consensus median estimate of 0.2%. October's employment data will likely see a sharp rebound in payrolls following September's 33k decline, as the hurricane effects are unwound and the labor market normalizes. Looking through the hurricane-related noise, our range of models points to a strong rate of underlying net new job growth in the 170K to 180K range. Our forecasted 0.3% gain in average hourly earnings is slightly below the 0.5% gain posted in September, but still consistent with gradually building wage pressures. Some of last month’s upside represented a compositional bias as more lower-paying industries were impacted by the hurricane (see US Economics: Payrolls & Wages: Some Legitimate Signs of Wage Pressures (6 Oct 2017)), and the composition should normalize in October as workers in these industries reenter the employment pool. Still, we expect earnings growth will remain strong even after accounting for this normalization. We expect the unemployment rate to remain stable at 4.2% in October. After hitting a 3-year high of 63.1% in September, we expect the participation rate will normalize back around 62.9%. Together with a lower participation rate, we expect softer employment in the household survey as the data reverts back to trend after last month’s unusually strong 906K gain. We note some downside risk to our forecast—if the participation rate falls as we expect, but household employment does not fully normalize, we see some risk that the unemployment rate could fall as low as 4.0% in October.

US Economics & Rates Strategy: Treasury Market Commentary, November 2 Treasury yields fell again, led by longer maturities after details of the "Tax Cuts and Jobs Act" trickled out. The JCT scored the bill as adding $1.487 trillion to the deficit over 10 years. President Trump named Powell as the next Fed Chairman. Markets didn't react. 10y yields ended at 2.34%. …Position squaring ahead of a major risk event is not unusual, but the rally in UK gilts that occurred ahead of the BoE policy announcement seemed overly aggressive. 10y gilt yields fell 6.5bp between 7:40 AM and 8:00 AM at which point the BoE announced it was raising rates by 0.25% in a 7-2 vote, which was a larger majority than our UK economists expected. Gilt yields ground lower after the announcement, but accelerated lower after BoE Governor Carney spoke. On QE, Carney said that Bank rate remains the marginal instrument of policy and the MPC want to hike it so they have the capacity to cut it, and so they had no desire to give a signal about something which is further down the track at this point.

…GDP tracking We continue to track 4Q GDP at 3.0%.

November 2, 2017

US Economics: Governor Powell Named as Next Fed Chair President Trump has officially nominated current Federal Reserve Board Governor Jerome Powell as next Fed Chair. Compared with Chair Yellen, Governor Powell is likeminded on monetary policy and will likely maintain consistency and continuity, but support a lighter regulatory stance.

November 3, 2017

US Public Policy Brief: Tax Reform Still at the Drawing Board Takeaways: Outcomes skew toward modest stimulus with execution risk; a controversial international system; limited

loss of corporate & mortgage interest deduction. We now focus on the markup & whether pay-for battles risk an 'all or none' stimulus scenario Today the Chairman of the House Ways & Means Committee, Representative Kevin Brady, released draft tax reform legislation. Unlike previous summaries, the draft constitutes a full, detailed piece of legislation. Here are our key takeaways from the draft. 1) Legislative makeup supports our base case: modest stimulus and plenty of execution risk. The Joint Committee for Taxation (JCT) scored the bill as costing $1,487 billion over 10 years, and slightly more front-loaded than our base case (which, given the lack of previous detail, assumed a straight-line average over 10 years) Joint Committee on Taxation, November 2, 2017. Although this could certainly still change during the coming markup process and subsequent negotiations, we see this draft as a key indicator of Republican legislators' intentions to work within the $1.5 trillion deficit ceiling. The score shows deficits increasing as they approach year 10, which may indicate that there is an issue with Byrd rule compliance for out-year deficits that the Senate will need to address in their draft. This suggests 2 takeaways for investors: 1. Deficit expansion potential appears constrained by Senate rules (see Tax Reform & Deficits: Moderate? or Raise the Stakes?, October 16, 2017) 2. Risks of failure are meaningful as Congress will continue to negotiate on contentious pay-for provisions. Hence, outcomes appear skewed away from material stimulus (see Tax Reform-Better to Travel than Arrive, October 30, 2017) 2) 'One in, one out' - Pay-fors & rates are far from settled The delay of the initial rollout appears to have been a function of lingering disagreements on provisions being considered for the bill (i.e., eliminating the SALT deduction, 401k Rothification, corporate rate phase-in, etc.). This makes sense considering legislators' intention to comply with allowances regarding static revenue losses under the budget resolution. Moving forward, if controversial pay-fors are eliminated or watered down, money will have to be raised from a changed or new provision somewhere else. The dynamic is likely to be 'one in, one out' in terms of changing provisions, in our view. That drives three highlights from us: 1. Personal brackets could still be shifted, & tax cuts could be made temporary 2. There will be a tremendous amount of noise around bill provisions in the coming weeks 3. Many 'surprise' pay-fors could still emerge. We recommend combing the provisions of the Camp

plan from 2014 for potentials. The Senate will likely have different pay-fors based on their own political calculations. 3) Corporate tax rate could still go higher, be phased in Building on the previous point, many pay-for provisions in the bill are likely to be challenged by members and lobbyists. Hence, proponents of an immediate corporate rate cut may still be disappointed. A phase-in would be a way to raise money to offset potentially lost pay-fors that is consistent with historical tax action. A rate closer to 25% (our base case) could also be a necessary maneuver to compel votes, particularly in the Senate given their reticence on some 'pay-for' items under consideration. 4) Bill included details on pass-throughs, but are already getting pushback 5) Mortgage surprise On the surface, today’s plan preserves the mortgage interest deduction. However, the devil, as always, is in the details. While the current mortgage interest deduction is preserved for existing mortgages, for homes purchased going forward, the mortgage interest deduction will be capped at $500k, reduced from its current cap of $1 million. However, we note that the change in the cap does not change for refinancing of existing mortgages – in other words, the existing interest deduction cap is grandfathered for refinancing. Our first cut of analysis shows that the proposed change would scope in ~3% of mortgage holders by outstanding loan count. The share is much larger on a regional level, with some of the largest shares of mortgages between $500k and $1 million being found in Washington DC, New York and California. In addition to the change in caps on the loan amount for new purchase mortgages, the near doubling of the standard deduction (from $12,700 to $24,000 for married couples and from $6,350 to $12,000 for individuals) as well as changes to deductibility of state and local income taxes (eliminated) and property taxes (capped at $10,000) have to be taken into consideration in the analysis of the impact of the proposed legislation on housing and mortgage markets. Thus, the impact is dependent upon both if you took a standard deduction previously and your current loan amount. Ownership households that previously took the standard deduction (mostly in starter homes) are likely to be better off as they will have more disposal income. Renter households in the same category will also experience a positive impact with more cash in their pocket to theoretically save more towards a down payment. Thus on the margin, their ability to purchase a home may improve. Homeowners with more than $500k in loan value would have their next purchase be more expensive from an after-tax perspective and should be slightly worse off.

Homeowners in the middle, on the other hand, may have slightly more money in their pocket but now have less of an incentive to own vs renting. 6) Repatriation and territoriality, trick or treat? As expected, the bill proposes a one-time favorable repatriation rate and transition to a territorial-style system from today's worldwide system. However, a 12% mandatory tax on cash-backed foreign retained earnings is higher than expectations and prior Republican proposals. As we have discussed (see Tax Reform Implications for Credit Markets, September 27, 2017), repatriation should drive lower IG supply, though that would be in part offset by increased issuance for 'other' purposes (i.e., M&A), when tax reform is no longer a source of uncertainty. We believe companies will prioritize distributions to shareholders and M&A with the repatriated cash. A global minimum tax of 10% comes in on the low end of the range of expectations and appears to be limited to passive income (rents, royalties, etc.). However, we believe the most controversial component is the 20% surtax on related party transactions with foreign affiliates. We expect significant opposition from the business community on this particular component – already being dubbed a stealth border tax. This surtax would apply to both US- and foreign-domiciled multinationals importing into the United States. 7) Interest deductibility capped at 30% of EBITDA 8) A better day for muni investors than for muni issuers Though the draft is far from a done deal, munis fared relatively well, all things considered. Kevin Brady’s Tax Cuts and Jobs Act drew heavily from former Ways and Means Chair Dave Camp’s Tax Reform Act of 2014. Considering news headlines had suggested a lastminute scurry for additional revenue, we were worried by the outside chance that the Camp Act’s 10% surtax on muni interest would return. Instead, the draft bill largely preserves the muni interest exemption. Moreover, the top individual rate remained unchanged, though the corporate income tax rate fell. That said, the draft's proposed curbs to the muni interest exemption for new (but not existing) pre-refunded, 501(c)3 hospital and university, and private activity bonds, as well as additional taxation on property & casualty muni portfolios, warrant consideration. Of these, we think investors should monitor the repeal of favorable tax treatment for advance refunding (prerefunded) bonds in particular, given the nearly $300B in prerefunded bonds currently outstanding. A repeal of private activity bonds also bears mention, given that nonprofit hospitals and private universities may be blocked from issuing taxexempt debt in the future. Of course, hospitals and private universities (501(c)3s) can already find attractive financing terms in the taxable bond market: as with advance refunding bonds, we think these repeals would

be more of a concern to muni issuance than to muni credit quality itself. Though issuance could fall, grandfathering should provide tailwinds to existing bonds. We expect modest impacts to muni valuations, primarily based on lower corporate income tax rates and a somewhat higher proration rate for P&C insurance companies. 9) Bullish for commercial real estate (CRE) 10) What should markets watch? The markup & the bill's implied deficit expansion

November 3, 2017

FX Morning Daily Commentary, 11/03 What is an FX canary? We have been using the phrase "Canary in the Coal Mine" to describe currencies that we think should weaken significantly over the coming quarters (NZD, AUD, CAD, NOK, SEK and GBP). All these economies have seen rapidly rising household debt levels over recent years, particularly in their cities where house prices have appreciated significantly. Rising debt levels can support consumption, helping growth in the economy and thus the currencies (to some extent). The issue today is that continual rise of debt levels at this pace is unsustainable. At the same time many of these economies have banking sectors that rely on foreign currency funding (mostly USD and EUR). As the Fed continues to raise interest rates, these funding costs will rise, if not compensated by lower borrowing costs in their home currency. The currency valuation is often an easy initial hit when consumption or related data start to weaken… … Canary case study: GBP. The BoE delivering a rate hike as expected but then also implicitly stating that the market is fairly priced for rate hikes was underwhelming for fixed income investors, who hoped the BoE would be moving towards a hiking cycle. With Brexit negotiations continuing, it would have been very difficult for the BoE to communicate anything other than what it did yesterday, causing GBPUSD to fall by almost 1.5%. EURGBP bounced from the 0.8750 support level. We see further weakness in store for GBP over the medium term as economic data weaken. GBPUSD has become increasingly sensitive to the 10y yield differential, therefore each incoming data point should be viewed in this light. On our list of "Canaries", GBP doesn't stand out as being as weak as NZD or AUD but for signs of the concept in action, we need to monitor consumer and employment related data. GBPUSD falling below 1.30 would see more downside as this is a key support area and around the bottom end of a channel.

November 3, 2017

UK Economics, Strategy & Banks: MPC: One Hike per Year In a low-key lift-off, the MPC voted 7-2 to hike rates, and guided to a central case of rates rising at ~ 1 hike per annum Low-key lift-off: In line with its hawkish September guidance, the MPC voted 7-2 for the first UK rate hike since summer 2007. Unlike a 'normal' hiking cycle, this hike has not been driven by a pick-up in demand – which has actually slowed and is set to remain sub-par – but by a downgrade to supply, the MPC's estimate of the economy's growth potential. While not driven by accelerating growth, we do not think that MPC tightening will accelerate in response. One a year: The MPC inflation forecast is above target in three years' time, but falling and approaching 2%Y, implying that the market-implied path of policy rates, which fully prices two more rates hikes by mid-2020, is broadly appropriate. However, given that the MPC sees potential growth at only 1.5%Y, pay growth has yet to rise and the output gap is small, we see the balance of risk as weighted to modestly more tightening than the market prices, implying a pace of tightening in the central case of about one per year. Brexit driving rates: The MPC was more explicit today that monetary policy will be driven by Brexit, which implies flexibility on rates. In the near term, with talks progressing to trade, we expect growth to run above potential, and support another hike, probably in May 2018. But then we expect disruption associated with the Brexit endgame to drive a growth slowdown, a reopening of the output gap and the MPC to go on hold until after Brexit in March 2019. FX strategy (Sheena Shah): We expect GBP to remain an underperforming currency within G10, guided by 10y yield differentials. GBP should be sensitive to employment and consumption data. Rates strategy (Shreya Chander): Today’s MPC served as a reality check for the rates markets, which had geared up for somewhat more of a proper hiking cycle before explicit confirmation from the MPC. The MPC did deliver on one hike, but made it clear that the future path of policy is entirely dependent on data and the Brexit outlook. The market is now in line with our economists’ forecasts as well as MPC guidance, so what’s left is to wait and see. Equity strategy (Graham Secker): The start of previous hiking cycles signalled a rotation away from domestic cyclicals in favour of defensives, but we think

that historical precedents are less relevant at this point and believe that GBP developments will remain the key macro driver of UK equity markets for now. UK banks (Alvaro Serrano/Alice Timperley): Rate rises are supportive of absorbing asset margin headwinds. While it remains to be seen just how impactful today's rate move will be for the banks, given competitive dynamics, at a minimum we see the rate hike as a cushion against ongoing asset margin headwinds. Furthermore, at current levels, the expected rate rises are too small to significantly alter the asset quality picture, we believe…

November 2, 2017

FX Pulse: EM Rebound The momentum for the USD has eased and we now think the DXY is topping out. The CNY has continued to strengthen on a trade-weighted basis, moving to the highest level in over a year. The current level of USDCNY points to a weaker DXY. We are buyers of EUR crosses like EURCHF and EURCAD. The "canary" currencies like NZD, AUD, and CAD should see the bulk of their weakness next year. EM rebound: With the tailwinds behind the USD now easing, we think EM currencies are in a position to recover. Barring some specific exceptions, the driving force of the EM sell-off was the USD, which has now lost momentum. We believe ZAR is the best candidate to position for a rebound. We have positioned vs MXN as a medium-term trade, but expect gains versus USD over the short term as well. GBP remains on our currencies to sell. The BoE did as they said they would: hike today but caveat the longer-term outlook on the impact of Brexit on the economy and strength of the labour market. Going forward, GBPUSD will likely be driven by economic data, in particular employment and consumption. Negative real rates in the UK keeps GBP an underperformer, in our opinion.

USDJPY is driven by rate differentials and the performance of equity markets. The US 2s10s curve has continued to flatten but has failed to take USDJPY with it. Instead, it has been the rally in the Nikkei causing Japanese inflation expectations to rise, and the rally in the Nikkei has held up USDJPY. If USDJPY crosses above 114.50, then we should see more upside momentum. Looking for short AUDKRW entry point: We also take a look at the relative outlook for KRW vs AUD, and believe that KRW can outperform. We look for a retracement higher in AUDKRW to enter a short position at better levels. We have a balanced mix of relative

value trades and outright long EM vs USD or JPY positions, with no outright EM shorts.

severe crisis. What caused the 2008 crisis and are the same factors that triggered this crisis present today? At the time: 

2 November 2017

U.S. Rates Strategy: Our Preliminary October Nonfarm Payroll Forecast is +344.4K mom SA Based upon stress-testing of the 24-industries that our bottoms-up labor models forecast, our models forecast a gain of +344.4K mom in total nonfarm payrolls for the month of October – see Table 1. Last month in September, our models stress-testing forecast was a -17.2K mom change in payrolls versus the actual -33K mom. Our models forecast for October’s gain in total nonfarm payrolls is stronger than the Bloomberg consensus estimate of +312K mom and stronger than the ADP estimate of +235K mom – see Table 1 ! Our models forecast very strong employment rebounds in THREE industries: • • •

Construction +51.0K mom; Professional Services +74.0K mom and Leisure+Hospitality +95.0K mom – see Table

  

Private-sector debt ratios were high and there were asset-price bubbles; The poor quality of securitised debt was unknown and not priced in; Interest rates were rising, which triggered the crisis; Banks’ balance sheets were vulnerable.

In the cases of the United States and the euro zone, which of these factors are present today?     

The private-sector debt ratio remains high in the euro zone; Asset-price bubbles are few and far between; The scale of securitisation has become much smaller (but ABS spreads have become very low); The increase in interest rates will probably be small; Banks are much more solid.

The situation is therefore much less dangerous at present than in 2007.

US Markets Closing Notes, November 2nd 2017 Recap and Comments:

1. Our models also forecast a solid establishment survey response-collection rate – see Chart 1.

02 November 2017 – 1291

Flash Economics What is different from 2007? Many investors are wondering whether the current economic and financial situation in OECD countries is similar to that in 2007 and therefore foreshadows a

…Lastly, if you had asked me a week ago if the Fed nomination wouldn’t be mentioned until the fourth paragraph of the closing notes, I would have laughed. But at this point, given the newspaper leaks on Powell’s nomination, there was little new news in his nomination announcement. In turn, there was little market reaction. With regards to our views, today’s developments did nothing to dissuade us from our core bull flattener call. If anything, the passage of them to the rear view mirror makes us more steadfast, rather than less. … Rates Flows: In Treasuries, we saw real money selling of the front end, real money buying in 10s, macro buying in 7s, In swaps, we saw small two way flows broadly, more specifically real money paying in 10yr rates and 10yr spreads, and some receiving in 5y5y. Treasury inter-broker volume (6am –4pm) was 98% of the 10-day average volume for the NY session. Strategic/medium term bias (changes in bold): • Direction: We are still bullish, expecting the next tactical move to be lower in yields, not higher. • Curve: We are in favor of 2s10s flatteners here, which has been our top thematic trade of 2017. • Curvature: We see 10s as cheap on the curve and established longs 10s on 5s10s30s on October 13th.



Inflation: We are constructive on inflation breakevens but would wait to seek entry for a pullback to the 1.65%-1.75% area. Softer CPI, and energy impacts waning in November leave us patient. • FX: Stronger USD is still the base view, with the Fed looking more committed to reducing accommodation than others now. Current trades (changes in bold): • Established 2s10s Swaps Flattener at 55bp, target 40bp, stop on a close over 65bp. • Established Long 5yr UST vs. German 5yr bund at 236bp, target 220bp, stop on a close over 243bp which marks the 2017 high weekly close. • Long 10s on 5s10s30s at -15.5bp, targeting -20bp on a close at -12bp, confirmed break of trendline support zone (see chart, see Global Macro Weekly here)

NOVEMBER 2, 2017

FI WEEKLY TANGLED UP IN BLUE The globally entangled rate environment seems to be paying little attention to a shift in paradigm, with central banks engaged in policy tightening and stronger global economies arguing for higher rates. We see global rates in a metastable equilibrium state. Outside what appears to be a relatively wide range for state variables, there is a significant potential for large moves, but in the absence of a meaningful shock, the environment continues to support goldilocks carry. Yet, a low volatility carry environment is a dangerous configuration, which we paralleled recently to dancing on the rim of a volcano. A conservative prescription for such an environment consists of taking advantage of cheap volatility to hedge carry positions, positioning conditionally and looking for safe carry, mainly bearish in spirit. - Consensus now projects the ECB's QE continuing after September 2018 for six months or so, followed by timid rate hikes from mid-2019 onwards. We see this view as too accommodating, given the prospects for further euro area economic strength. Lower inflation is already factored into ECB projections, leaving no space for negative surprises. We favour relatively safe carry trades, like EUR 2-30y steepeners spot or 2y forward. - A cold winter for Euro inflation. We recommend longs in French CPI inflation vs Euro HICP.

- The BoE put a dovish spin on its rate hike. This should see the front end well supported into year-end, and we look for 5y to perform.

- US rates are the only candidate for some volatility, given that both the ECB and the BoE are “done” for now. We recommend USD 5y5y vol vs GBP at historically low levels. - Euro area peripherals still have potential, but more prudent positioning favours 5s and 30s over 10s BTP, and the 30y PGB vs the 10y BTP.

… With the pick-up in momentum in the rollout of these reports (the first was published 12 June, the second in 2 October, and the third on 26 October) it is legitimate to anticipate the fourth report (on nonbanking financial institutions) by end-2017, in which case we expect a push towards an implementation phase of these recommendations by early-2018, well ahead of the mid-term elections. All these (rate hikes, fiscal easing, balance sheet normalisation, regulatory easing) call for a drift higher in yields over the near to medium term. In addition, we have seen a significant pick-up in US fundamentals since June, which as we noted in our last FI Weekly (see here) pushed the 10yT fair value to 2.7% (from 2.5% in late-August/early-September – see Graph 8).

Graph 7. 10yT yield range bound year-todate

Graph 8. 10yT fair value reacting to pick-up in US fundamentals

Why, then, do US rates continue to be so stubbornly range bound? At least in part, the improved fundamentals and bearish headlines are perhaps balanced by investor sentiment. We were here not too long ago, most recently with the Trump trade earlier in the year but indeed several times over the last few years, and for one reason or another momentum always seems to fizzle out prematurely. Given the significant scope for disappointment, the threshold is quite high for pricing all the newsflow and improved fundamentals in the rates space (although that threshold seems to be much lower in the equity space, one may argue easily). Also, as we noted in recent publications, as long as expectations for potential growth and inflation stay contained, the market is likely to continue to price the prevailing 10yT peak-cycle yield around the 2.5-2.6% range, particularly if global yields continue to be anchored. Macro fundamentals have improved, but likely not to the extent necessary to challenge this view. Finally, and building on the previous argument, when global asset allocators, who necessarily have a portion of their portfolios in safe-haven bond assets, look at available assets they will likely find significant value in Treasuries at the current levels in the context of a latestage cycle, as opposed to Eurozone, UK or Japanese bonds, for example (see our recent Multi Asset Portfolio). There are also exogenous factors supporting the range in US rates: 1) a context of heightened geopolitical risks, although this has faded meaningfully since August; and more significantly 2) stubbornly low global yields that have failed to normalise even in a context whereby global monetary policy recoupling is gaining momentum. On the latter, however, causality is less than straightforward, with frequent role reversals in a globally entangled rates environment. These arguments point to an environment of metastable equilibrium in global rates. Outside of what appears to be a relatively wide range for state variables, there is significant potential for large moves, but in the absence of a meaningful shock (clearly more than a €30bn ECB taper or the start of SOMA portfolio normalisation), the environment continues to support Goldilocks carry. Yet, a low volatility carry environment is a dangerous configuration, which we paralleled recently to dancing on the rim of a volcano (see here). A conservative prescription for such an environment consists of: 1) taking advantage of cheap volatility to hedge carry positions, 2) positioning conditionally and 3) looking for safe carry, mainly bearish in spirit.

(again). The global economy is doing well, but more thanks to Europe than the US. OK growth, not much inflation, glacial pace of monetary tightening - if the dollar's rally is to get any further traction at all, it will have to come from signs that wage growth is responding to rising employment. Reading the runes of October's Labor Report is going to be hard however, given hurricane-distortions.

As the Bund/Treasury yield differential edges back below 200bp, the EUR/USD correction has lost momentum. We prefer CZK, PLN and NOK to the Euro in Europe and against the dollar in the medium-term. We like those four against GBP and CHF too. We are sticking with yen shorts for now. Stay long USD/JPY as well as long CAD/JPY and in the longer run, EUR/JPY. One day, the yen's extreme undervaluation is going to come back and bite yen bears but for now, the BOJ is holding (very) firm and the correlation with relative yields is helped by Japanese real yields falling. We missed the signs that an ‘as expected' dovish hike would be bad for the pound but it probably just drifts around now, driven by the EUR/USD trend. It's cheap, and will stay that way as growth slows and the rest of the world normalises monetary policy. The recent euro tumble triggered a large sell-off in the EUR/USD vol market. However, the short-dated skew did not turn negative, ensuring that out-of-the-money shortdated euro puts remain a cheap hedge against a deeper correction.

NOVEMBER 2, 2017

FX WEEKLY ANOTHER FALSE DAWN FOR DOLLAR BULLS The dollar's latest rally appears to have run aground as TIPS yields fail to hold above 50bp

Another false dawn for dollar bulls? Another bond market sell-off has run out of steam, and the dollar’s latest attempt at a rally appears to have run aground as a result. The global economy is doing well, but the acceleration is due to Europe more than the US, where the story isn’t changing

much, with okay growth, not much inflation and a glacial pace of monetary tightening. If the dollar’s rally is to gain any further traction at all, it will have to come from signs that wage growth is responding to rising employment. Reading the runes of October’s Labor Report is going to be hard, however, given hurricane-related distortions. 2 November 2017

The 10-year Treasury yield has fallen by nearly 3.5% over the last 20 years but has increased, on average, in 4Q. That might be one reason why, at the end of the year, the consensus is so frequently that yields will rise in the following year. Or maybe it’s because yields have fallen in 60% of the years since 1982 and we (strategists) persist in forecasting mean reversion. I’m wondering about this today firstly because US yields have once again fallen back from a spike higher, which is most easily seen in the way TIPS have failed to hold above 50bp for the fifth time in the last year. And secondly because tomorrow sees the US Labor Report, with all eyes on wage growth yet again. I wrote this morning that bond bears have largely capitulated now (just as we arrive at the time of year when yields usually rise), and everyone’s given up any hope of seeing the Phillips curve make an appearance. It would be a contrarian’s dream if US wage growth now showed signs of picking up.

Market Musings Powe ll as Fed Chair: Meet the New Boss, Same as the Old Boss? 





The White House has nominated current Fed Governor Jerome (Jay) Powell as the next Chair of the Federal Reserve Board, to succeed Janet Yellen. He is widely seen as a “continuity” candidate to lead the Fed. Although he may face some opposition among congressional Republicans, we expect he will be confirmed by the Senate by early 2018, if not late this year. With his nomination widely anticipated in the press, the news is largely already priced into markets . Powell is not expected to materially change the direction of policy or the operation of the Fed, so any further market reaction should be minimal. There is some optimism that Powell will be more willing to engage the Trump Administration’s deregulatory objectives, but those hopes may be too high. He is more likely to modify existing rules on the margin than make wholesale changes to the post-crisis regulatory framework, in our view

In practice, tomorrow’s data are still going to be heavily affected by the September hurricanes. After last month’s 33k fall in payrolls, we expect a 200,000 bounce, but that still leaves the 3-, 6- and 12-month growth rates slowing. And after a jump in wage growth to 2.9% (due to lowerpaid workers being more likely not to get paid at all at times like this), a correction to 2.7% seems likely. Still, as the chart below shows, if we look at the relationship between the employment rate and wage growth (instead of unemployment, which is more distorted), wage growth is responding to a rising employment rate. Much more of that and maybe the bond bears will have their day in the sun.

Rates implications We think that the market has been gradually pricing in a Powell nomination over the past week. This will mute the market impact as rates have come off from the Taylorinduced highs last week (Figure 1). However, the actual announcement may still have some effect as it takes out the uncertainty of a Warsh or Taylor Fed Chair. We see the following rate market implications:  Status quo framework for monetary policy: As discussed above, Powell has generally echoed Yellen’s





framework of an economy at full employment, inflation weakness and low short term and long term r*. The market has priced in an 85% chance of a hike in December and 35bp of hikes next year. (Figure 2). This seems reasonable given a s trong labor market but not a lot of conviction about the pickup in inflation in 2018. Deregulation to cheapen cost of balance sheet and widen 30yr spreads: As discussed above, we believe that the Treasury’s recommendations of easing the SLR and LCR constraints on banks will probably see the light of day. This should widen 30yr swap spreads toward -20bp. Lower vol and cheaper skew: The risk of a Taylor (and Warsh to some extent) nomination resulted in higher levels of implied vol and higher payer skew (Figure 3). That has been getting priced out in recent days and we think vol stays low.

2 November 2017

Market Musings Taxing Times Begin for GOP 







The House GOP tax blueprint was released today, outlining key details that were broadly in line with previous plans and supporting Republicans’ goals of simplifying the tax code, reducing the tax burden and incentivizing firms’ domestic operations. But despite some concessions, certain points of contention remain that call into question whether it can pass the House in its current form, or would be acceptable to the Senate. These questions keep uncertainty over the bill’s passage high. We continue to expect it is more likely that a smaller-scaled plan will be passed sometime early next year. The rise in deficits associated with the GOP tax plan could pressure Treasury yields higher, steepen the 5s30s curve, and tighten swap spreads. However, given the likely difficulty in passing the tax plan in its current form, we continue to like 30yr swap spread wideners and 5s30s curve flatteners. Given the uphill battle we see in passing the bill this year we are cautious on the USD from current levels. Should the bill pass however, we think provisions around deemed repatriation would introduce some USD upside but view this as temporary.

Rates implications The knee-jerk market reaction to the release of the tax plan took rates lower and the curve flatter. However, the market reaction may also have been a function of the dovish BoE, which moved gilt yields significantly lower, as well as the Powell nomination for Fed Chair. There was also some disappointment in terms of the scope of the tax plan and market participants also likely lowered the perceived odds of passage. We see the following as the potential Treasury market implications of the tax plan: Deficit impact: We expect any eventual tax plan to add to the deficit. Dynamic scoring can help offset a $1.5tn deficit increase over 10 years, so we will assume that any eventual tax plan will ultimately have that effect. Note that the deficit-to-GDP ratio was already slated to increase from

3.5% in FY2017 to 3.7% in FY2018 due to hurricane relief spending. With an estimated $150bn added to the FY2018 deficit due to tax cuts (the exact amount depends on the details of the plan), the deficit-to-GDP ratio could rise to 4.6%

Rates: Analyzing the impact of fiscal easing on 10yr Treasuries is not as straightforward. Taking the median estimate across a number of studies, a 1pp increase in the primary deficit to GDP ratio leads to a 9bp increase in 10yr Treasury yields. This would therefore argue for a 10bp rise in 10yr Treasuries. However, fiscal easing is typically countercyclical, meaning that it coincides with a downturn in economic activity. There are often numerous shocks and policy changes occurring at the same time, complicating the “true” impact. For example, the Fed is typically cutting interest rates and GDP growth and inflation expectations are typically falling when fiscal stimulus is being delivered, suggesting that studies may have underestimated the impact of fiscal easing on yields when the economy is nearer to full employment. Curve: The countercyclicality of fiscal policy also affects the behavior of the curve. Historically, higher deficits are associated with a steeper 5s30s curve (Figure 2). But this is also a function of Fed policy since both monetary and fiscal easing typically coincides with a weak economy. Thus only the long end faces the pressure of greater supply. However if tax cuts help bolster growth this time, we would expect the Fed to hike faster in order to compensate. This should actually flatten the 5s30s curve over the medium term. The nomination of Powell for Fed Chair increases our confidence that the Fed will respond to additional stimulus. In addition, Treasury is likely to issue more paper in the sub-5yr part of the curve, which is another reason to favor the flattener. 2 November 2017

US Data Preview SETTING UP FOR NONFARM PAYROLLS (OCTOBER) We expect nonfarm payrolls to nearly fully give back its hurricaneinduced weakness and post a 330k gain. Uncertainty, however, is high with scope for a surprise in either direction, but on balance data in the past week on ADP and ISM do reinforce our above-consensus forecast. Our forecast assumes a 200-250k drag from the hurricanes, which we expect to recover to a significant extent in October. Previous hurricane episodes such as Katrina episode suggest a complete reversal in payrolls could be delayed, yet we believe the

2017 experience should be different given that jobless claims have fully recovered. With labor market indicators consistent with monthly payroll gains of 175-200k, October payrolls could easily print closer to +400k or higher. However, we are more cautious that the full rebound may not be realized until subsequent revisions, as has been the case in previous natural disasters. In addition, September payrolls have the potential to be upwardly revised. We expect the unemployment rate to remain at 4.2%. Average hourly earnings are expected to print a relatively weak 0.2% m/m increase, though there is risk for a softer 0.1% rise taking into account calendar effects and hurricane distortions. That would push the annual pace lower to 2.7% y/y, or 2.6% y/y if downside risks are realized. Consistent with the November FOMC statement, the Fed is likely to look past any softness in this report that might be attributed to residual hurricane distortions. A solid pickup in payrolls and a low unemployment rate should reinforce expectations for a December rate hike.

Fixed Income With the rates market already pricing in 85% odds of a December rate hike, a storm-impacted rebound in payrolls is unlikely to affect rates too much. However, a disappointment in wage growth following last month’s extremely strong 0.5% m/m gain could leave the rates market disappointed even in the event of a larger than expected rebound in headline payrolls.

2 November 2017

US Economic Comment Tax reform details problematic for passage This morning the House released talking points for its tax bill To our read, the release confirms our view that tax reform is far from being a done deal. The bill contains several specifics that we believe will prove sticking points, which increase the difficulty of finding the votes to support the plan in both the House and the Senate. We maintain our view that tax reform is unlikely this year or next.

On the cost side, the plan includes several items that are expensive On the revenue boosting side, the plan includes items that are unpopular We await the details; we maintain our view that tax reform is unlikely this year We have long held the view that finding the revenue offsets for the ambitions tax reform plan would be difficult. By our estimate, the plan needs to find something on the order of $3 to $4 trillion in revenues. The only way to achieve such large offsets is to eliminate or drastically reduce current deductions or subsidies. Any group that loses their specific subsidy will likely oppose the plan.

US economy A new Fed chair, but very similar policy Chief Investment Office Americas, Wealth Management | 2 November 2017 





President Trump nominated Fed Governor Jay Powell to be the next chair of the Federal Reserve, replacing Janet Yellen. This represents continuity in Fed policy, in our view, as Powell has been consistently in line with Fed leadership and expressed very similar views on policy. The most likely policy difference under a Powell-led Fed is a lighter touch on financial regulation, with a priority on easing rules on bank stress tests, bank trading activities, and smaller banks. Overall, we expect monetary policy to remain supportive of risk assets, and we remain overweight global equities relative to US government bonds.

November 02, 2017

Economics Group Special Commentary

Powell on Policy: What to ask? Jerome Powell has been nominated to head the Federal Reserve Board. The official changing of the guard will not occur until Chair Yellen's term expires on February 3, 2018. Not surprisingly, financial markets have not reacted strongly one way or the other on the heels of this announcement, as Governor Powell is largely expected to pick up where Chair Yellen leaves off. Jerome Powell has been nominated to head the Federal Reserve Board. The official changing of the guard will not occur until Chair Yellen’s term expires on February 3, 2018. Not surprisingly, financial markets have not reacted strongly one way or the other on the heels of this announcement, as Governor Powell is largely expected to pick up where Chair Yellen leaves off. Powell’s nomination does not change our outlook for monetary policy at this time. However, reviewing Powell’s previous public comments is an interesting exercise to discern how his views may differ slightly from the current Fed Chair. How might we view his comments on policy and financial markets? What would we ask at confirmation hearings? … Low Interest Rates and the Financial System 77th Annual Meeting of the American Finance Association (Jan. 7, 2017)3

“And low rates can lead to excessive leverage and broadly unsustainable asset prices—things that we watch carefully for and do not observe at this point.”

OK, Governor Powell, but would you have said the same in 2005-2007 about housing, recall that the Fed issued reassurance that the housing issues were well contained. Moreover, the resiliency of any system is not revealed when the economy is doing well but when it is stressed. Finally, the government, not the private sector, appears to be the most leveraged at this time (Figure 4). Do you see a policy conflict ahead? No Change to Our Outlook at this Time Powell’s term as Fed chair is likely to represent a continuation of Chair Yellen’s monetary policies. Against the backdrop of cycle-low unemployment and modest economic growth, the new Fed chairman should be able to continue to gradually raise interest rates from historic lows. Powell’s nomination does not change our outlook for monetary policy at this time

November 02, 2017

Economics Group Another Strong Output Gain Boosts Productivity in Q3 Nonfarm productivity increased at a 3.0 percent annual rate in Q3, lifting the year-over-year pace up to a still modest 1.5 percent. Unit labor costs edged up modestly on the quarter. Rising Productivity Mirrors Recent GDP Gains Compensation Costs Rise, More to Come? The pickup in productivity growth was able to temper the impact of the strong gain in compensation costs, up at a 3.5 percent annual rate. As a result, unit labor costs rose 0.5 percent in Q3. While the debate over the wage outlook remains robust, we expect to see gains gradually climb in the year ahead as the U.S. economy continues to expand and firms face greater competition for increasingly scarce labor resources.

November 02, 2017

Economics Group Capitol Hill Update: House Tax Bill Finally Released Today's release of the Tax Cuts and Jobs Act marks a major milestone for Republicans' tax reform efforts. That said, there are still several hurdles to clear before it becomes law, and the timeline is a bit tight. … On balance, our biggest takeaway is that this a bold opening bid from Republican House leaders. A key question throughout this process has been whether policymakers would be willing to eliminate/reduce popular tax breaks, such as the mortgage interest deduction, to help offset the acrossthe-board tax cuts for individuals and businesses. If passed, the controversial pay-fors in the House bill are likely to face stiff opposition from several interest groups in the Senate. In the absence of some of these large revenue raisers, deficit neutrality beyond the 10-year budget window becomes a challenge. Senate reconciliation rules require deficit-neutrality beyond the 10-year window, which is why policymakers often consider making some tax cuts temporary…

November 02, 2017

Economics Group Special Commentary

A Primer on the Architectural Billings Index The Architectural Billings Index (ABI), constructed from a monthly survey of architectural firms, is one of the few regularly published leading indicators for construction spending. The ABI is most valuable as an early indicator of recovery in the construction sector but also may help identify a reacceleration

in construction following a mid-cycle slowdown. Construction spending has averaged almost $1 trillion annually over the past decade, accounting for about 6.0 percent of GDP. Construction is also one of the most cyclical components of the economy, with nominal spending falling 37 percent from its peak in 2006 to its most recent trough in 2011, only to rebound more than 60 percent in the six years since (Figure 1). The recovery in construction spending has been relatively modest, and the construction spending-toGDP ratio remains 0.8 percentage points below its long term average. Construction activity tends to peak earlier and trough later than other parts of the economy. Understanding the underlying momentum within the construction sector is important to gauging the health of the overall U.S. economy. So far this year, growth in construction spending has moderated following stronger gains earlier in the cycle (Figure 2). That stronger growth was highly concentrated, namely power plant construction, energy infrastructure and investment in several massive new petrochemical complexes along the Gulf Coast. Office construction has been slower to come back online, with development activity largely limited to metro areas driven primarily by energy and technology. Industrial projects have been a notable bright spot, with the rapid emergence of e-commerce driving demand for fulfillment centers and growing volumes of international trade fueling demand for warehouses and distribution centers near the nation’s leading ports. Part of the strength in industrial development, however, has come at the expense of retail construction, which has endured a much slower recovery. Most data on construction spending are available with a relatively long lag. The Census Bureau typically publishes construction spending data on the first business day a full month following the month that is being reported. The September data were reported on November 1, at the same time the Institute for Supply Management released its survey for October manufacturing activity.

…Key Takeaways

The AIA reports that the ABI tends to lead construction activity by 9-12 months. As a leading indicator, the ABI tends to be a better predictor of upturns in construction spending rather than downturns. Heading into

the Great Recession, for instance, the ABI began to decline at virtually the same time as actual construction spending, making it a coincident indicator on the downside, but led the subsequent upturn in construction spending by roughly eight months. The difference in lead time between upturns and downturns may be due to the increase in delayed or abandoned projects during downturns, which show up in billings for design services but do not translate into future construction spending. According to a September 2013 AIA survey, 11.5 percent of architectural firm billings during the downturn came from projects that were later postponed or cancelled, as projects had a harder time finding tenants to commit to pre-lease new space and project financing became more difficult to obtain…