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StreetStuff Daily November 8, 2017

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… 8 November 2017

China 8 November 2017

US Economics Research Assessing the Tax Cut and Jobs Act •

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We review the main components of the Tax Cut and Jobs Act as they relate to our economic assumptions in US Tax Policy: What is priced in for different assets, October 25, 2017. We focus on the major components of the Act and how they may alter household and business spending patterns. The Act, in our view, is skewed in the direction of tax cuts over reform and it generates a larger reduction in taxes for the corporate sector relative to the household sector than we anticipated. This alters our view of the economic effects in two ways: tax cuts tend to produce temporary effects, rather than permanent ones, and changes in corporate spending are likely to come with relatively longer lags.

If it is passed in its current form, we would pencil in an impulse to real GDP growth in 2018 of a bit below 0.5pp. Versus our baseline outlook, where calendar year growth in 2017 is 2.2%, this would suggest growth of about 2.5% or modestly stronger. Given the elongated state of the US business cycle, the Act would likely generate a small boost to inflation, and we would be more likely to add a third rate hike next year, versus our current outlook of two (our current baseline does not include expansionary fiscal policy). Contrary to what some supporters of the Act claim, we believe any improvement on the supply side of the economy is likely to be more limited, for several reasons, including an aging US economy, low elasticity of business spending to changes in the cost of capital, and restrictive immigration and trade policies that work against productivity improvements. To this list we add two more salient points, which we believe are not commonly understood: the cost of capital is already at historic lows, and the US corporate tax code is much more favorable for investment than it used to be. Using a standard economic framework to estimate the cost of capital, we find changes to the corporate tax code in the Act will reduce the cost of capital only 25bp. A reduction of this magnitude is unlikely to ignite business spending.

October trade moderates, but remains on solid footing China’s October trade data softened, broadly in line with expectations. Consistent with the moderating NBS manufacturing PMI export orders index, China’s export growth slowed last month. Exports rose 6.9% y/y after growth rebounded to 8.1% in September, but remained above the Q3 average (Figure 1). Given the strong rebound in trade in September, we think the October print likely reflects, in part, the frontloading of activity due to the interruption by the Party Congress, as well as fewer working days in October (eight-day National Day holiday). Given this, we do not expect the moderation in export growth to persist in the coming months and think a rebound in December is more likely. Moreover, we see potential upside risks to our outlook for exports in the near term owing to: 1) likely improving external demand, as suggested by buoyant global PMIs (Figure 2) and better-than-expected Q3 growth in China’s major trading partners (eg, the US and euro area); and 2) President Trump’s state visit to China (8-10 November), which is likely to make progress on bilateral economic and trade relations and reduce friction-driven downward pressure on China’s exports in the near term… 7 November 2017

US Credit Strategy Appraising a Multi-Faceted Tax Bill Last Thursday’s tax reform proposal will likely go through a number of iterations this week before a potential House vote on a finalized bill as early as next week. We believe there are several core principles and elements of the proposal that would have a direct effect on corporate credit should they survive the legislative process. As a refresher, we have discussed various tax policy-driven potential effects on credit this year in prior publications. In particular, see A Tax on Leverage, US Tax Policy: What is priced in for different assets, and The Hunt for Spread: October for some detail on our prior thoughts. While there are detailed proposed changes across a number of issues, including corporate AMT, NOLs, excise taxes, and earnings stripping, we focus here on the effect of the following key elements of the current proposal that we see as being the most broadly applicable and having the most sizeable considerations across credit markets.

…Other Effects Accelerated expensing of capital spending could modestly prop issuance …Given the secular decline of capex/sales economy wide, peaking nearly 40 years ago, (Figure 9), this proposal may merely act as an accelerant to already existing plans to ramp up capex in years to come. On the margin, we see the prospects for higher corporate bond issuance across the higher-quality issuer base to fund capital spending nearer term, given the tax incentives to do so. For instance, our base case is for a GCP/capital spending to rise to 14% of overall high yield issuance in 2018, and this proposal could support that issuance (see 2018 High Yield Supply Outlook). This effect could be magnified if corporate tax rate cuts are phased in. The incentive to make and deduct investments at a higher tax rate now, when tax rates are higher, could meaningfully pull forward investment and likely supply

and challenging the 61.8% retracement of the postSeptember selloff. The move is important for a few reasons, not least of which is that the long-bond has rallied 21 bp since the end of October and steadily improved into the November Refunding. For those of us who have been in the market for a cycle or two, once upon a time Treasury auctions led to higher yields by way of an auction accommodation. That certainly hasn’t been the case recently, which only serves to embolden our bullish bias on the Treasury market with an eye on 2.25% 10-year yields. We’ll be the first to wince at the notion of being long 10s ahead of a known seller of $23 bn on Wednesday afternoon at 1 pm, but as a sage of the repo market once aptly concluded, ‘hey, everyone knows that auctions bring out buyers.’ Wise to be sure, although painful in the moment for anyone anticipating the return of term premium via the introduction of $15 bn more in long bonds to the market. Let us not snatch defeat from the jaws of victory, after all we came into this week with a bias to see 5s/30s breakout flatter with a target of 75 bp. The market is not there yet at this point, but Tuesday’s price action saw the curve reach 78.7 bp intraday. We don’t point this out to lure compliments (although ‘fishing starts with throwing in your line’ -- name that lyric/artist?), but rather to highlight that the flattening has further to run before encountering meaningful resistance. … Tactical Bias: Having seen some satisfaction

Tue 11/7/2017 3:48 PM

Lyngen/Kohli BMO Close: Once Upon a Time... The Treasury curve flattened further on Tuesday and that was really the only thing of note that happened. There are moments in the market, like this one, when the price action itself is the ‘event’ rather than anything truly fundamental. The flattening was driven by a rally in the long-bond which outperformed in outright terms as well as on the curve with yields dipping to 2.767% intraday

on our curve flattening call, we are going to stick with it despite the upcoming auctions. We’re all too aware that the bias might be too early – although as we continue to see 75 bp in 5s/30s as the path of least resistance, any resteepening will be an opportunity for better placement. The reception to Tuesday’s 3-year auction was ‘good enough’ given the fact that the Fed is widely expected to deliver another rate hike in December and at least one in 2018 as a show of policy continuity. That said, in outright terms a yield on 3s of 1.75% is attractive by recent standards – particularly when 10-year yields are trading at 2.30%. …In our efforts to put forth a less cynical explanation (although that is admittedly our go-to), one can characterize the flattening of the curve as

just further evidence that the Fed has been successful in building up creditability as a forward inflation fighter. Imagine a world in which inflation returns to normal levels in 2018 and we see corePCE print at 1.7% to 1.8% on a regular basis. First, this will embolden the Fed to tighten further toward their 2.9% terminal rate estimate and thereby flatten the curve even more. What would another 75 bp in 2s do to the shape of the curve? Second, given the delayed impact of monetary policy (call it 12-18 months), we can all acknowledge that the mystery of lowflation in 2017 might have nothing to do with the first four rate hikes that started in December 2015. The flipside is that the impact might only begin to flow-through to the real economy in 2018 and that would suggest that the Fed was ahead of the inflation curve versus early – only further reinforcing the perception that that Fed is very good at fighting inflation, whereas deflation can be far more challenging. This argues for a lower range for 10s and 30s going forward. We’ve been watching the 200-day moving-average at 2.31% in 10-year yields and while the market is challenging that level as we write, we’d like to see confirmation overnight or at Wednesday’s auction. This would clear the way for a retest of 2.25% with the only resistance of relevance on the road to lower yields the 74-day moving-average at 2.26%. We expect a solid reception to the 10-year auction and would look to leave the auction-process long the sector – not the first time we’ve mentioned that. Although 10s have richened in recent history with yields falling 16 bp from their late-October highs, we believe the curve-wide flattening bias has further to go. 10s tend to perform relatively well in Fed hiking cycles as the 7-year sector acts as a fulcrum with 10s and 30s outperforming the frontend. Additionally, although we saw a slight uptick in foreign demand in the October auction (up to 13.4% from 10.4%), we believe it may have further to go.

US Rates at the Bell November 7th, 2017

Trader’s Tab

ECB Trying to Fight the tape? While we knew that Coeure and Weidmann were unhappy with the open-ended APP guidance, the addition of a disgruntled Villeroy is a new development, as today’s ‘sources’ article would suggest (https://bloom.bg/2Ar7O5d). We still do not expect any near-term impact from this, but it could foreshadow a more hawkish tilt when they finally decide to amend their guidance. 

Recap & Discussion:

The UST power-flattening persisted (2s10s 1.1bp, 5s30s -2.5bp) ex-catalyst today, as volumes (ex-auction) and vol continue to leave something to be desired. Amid a number of admittedly noisy risk-off indications across credit-centric products, bonds were the lone sector to realize more than a 3bp range, while EGB yields continue to melt in the wake of the ECB despite what may be a budding sense of regret coming from the hawks in the GC (https://bloom.bg/2Ar7O5d). Notably, Belgian and Danish 10yr yields dropped below key resistance levels (figs. 4-5). In terms of the daily US px-action, weakness in USTs overnight was slowly mitigated upon the NY open, as the longend bid (steepener covering) appears unsated as we saw another 915k/01 WN buyer around 8:45am, while new cyclical ‘flats’ across the curve printed. Additionally, the JPM Tsy client report out around 7:30am showing ‘all-client’ shorts rising 6pts to a cyclical high did no favors for shorts, while our own RPM measure shows the TY short at -1.3/5 on a normalised basis…

Elsewhere, EM’s saw some idiosyncratic weakness, with EMB -0.5% (EM Bond ETF) trading below its 200dma for the first session since June (fig. 2) following the lead of HYG (fig. 3)… 07 Nov 2017 09:05:39 ET

Energy Weekly Oil Potentially Has Further Upside Ahead of the OPEC Meeting as Geopolitics Comes Front and Center •

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Stronger fundamentals and investor inflows have been the catalyst for higher oil but adding further support is a focus on geopolitical risks that have been looming over oil markets for a while. The next move in oil prices is likely to be driven by investor flows which will likely be driven by OPEC’s November decision, geopolitical risks and positive crude carry. Geopolitical risks have been underpriced in oil markets this year yet countering this is a potential disappointment at the November 30th OPEC meeting. Money managers hold a record net long position on Brent in terms of both lots (+530-k) and as a % of open interest (18.1%), but that doesn’t mean it can’t go higher. Saudi Arabia has garnered much of the headline news flow to start this week but developments in Iraq, Nigeria and Latam last week present a clearer bullish risk to oil markets in our opinion.

08 Nov 2017 05:04:25 ET

China Commodities Trade Data Slowdown of commodities imports points to an early start of seasonal demand weakness •

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October crude oil imports came off to 7.3-m b/d, down 16.2% m/m but up 11.9% y/y. Jan-Oct crude imports have accumulated to 8.4-m b/d, up 11.8% y/y. Crude imports weakened in October as crude runs might have tapered off at the same time due to domestic petroleum product inventory builds and somewhat weak petroleum product exports. Iron ore imports fell sharply in October to 79.5Mt, down 1.6 % y/y despite that shipping volumes data from Brazil and Australia showed consistent improvement during September. The fall of iron ore imports in October may reflect that the slowdowns in Chinese steel production have started to affect steel mills’ appetite for ores purchase.

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Copper (cathode, blister and products) imports came in at 330kt, the lowest since April. This was below expectation as the market anticipated refined copper imports to pick up given restrictions over scrap imports and improved import arbs.

07 Nov 2017 10:08:59 ET

RPM Daily Moving out of Shorts … •

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Summary - Long cash (+0.2) and futures (+0.1): Global positioning has switched back into a (small) net long bias (across futures and cash). Meanwhile heavier positioning / profits in the ECB carry trades remain intact. North America - Short futures (-0.3) offset by long cash (+1.4): An additional $6m DV01 to the long bias, mainly focused in 2-10y sectors as yields grind lower. In 10y the market is still short (in futures, cash and swaps at -0.7) and is accruing losses.

8 November 2017

FX Compass: Crude expressions The recent reduction in uncertainty on US policy risk, with Jerome Powell appointed as Fed chair and the US House of Representatives releasing its tax reform plan last week, has not driven a reversal of the bout of USD strength triggered by the move in US 10-year yields surged from 2.09% to nearly 2.50%. This is particularly evident in the case TRY, MXN, RUB, ZAR and BRL, which continue to trade poorly despite lower US 10-year yields, rising commodity prices and global PMIs flashing green across the board. Amongst other factors (looming Fed board uncertainty, US tax reform expectations and stale long positioning in several EM currencies), we believe this is partly related to the recent concentration of idiosyncratic events with negative implications for EM assets. The latest surge in political turbulence in Saudi Arabia might qualify as one of these events. The response in EM FX to the repricing higher in oil prices has been mixed, with several currencies defying the traditional correlation to terms of trade (Figure 1). We see scope for the EM FX response to re-align with commodity prices, but primarily for currencies that are devoid of significant negative local factors. MXN represents an important exception, given looming NAFTA negotiations and the threat of a contentious election in 2018. In G10 space, our current set of views in G10 space remains geared towards constructive shift in terms of trade for oil exporters, as per our bullish forecasts on CAD and on NOK.

In this issue of the FX Compass we review recent monetary policy decisions in the UK and Australia, which leave us unwilling for the time being to revise our mildly bullish GBP forecasts and more downbeat view on AUD. We also highlight the complex set of risks the RBNZ faces in the near term, in light of the political push to review its mandate triggered by the election outcome. The risk that policy will skew dovish going forward keeps us bearish on the NZD with our AUDNZD 12m forecast at 1.18.Finally, we review the impact of the recent rise in oil prices on Asia FX and recommend closing our short PHPINR trade recommendation for a profit. 8 November 2017

China: Slower trade growth into the winter China’s nominal export growth moderated to 6.9% yoy in October, below the Bloomberg consensus of 7.1%. Nominal import growth slowed to 17.2%, vs. the Bloomberg consensus of 17% and the prior month’s 18.6%. This set of numbers suggests a continuation of the down-swing into the winter after the export growth recovery peaked in the middle of the year. We expect export growth to moderate further in the coming months. Import growth is likely to decelerate further in the coming months too. The base was set high for 4Q, and the level of imports seems to show some signs softness in this data point.

Deutsche Bank 08 November 2017

Early Morning Reid Macro Strategy …The most eye-catching move yesterday in markets though was perhaps that of peripheral bond markets. BTPs rallied 8bps yesterday to 1.689% while 10y yields in Spain and Portugal closed 6.1bps and

9.7bps lower respectively – with the latter below 2% for the first time since April 2015. We’ve been scratching our heads a bit to explain the price action. With Treasuries (-0.2bps) and Bunds (-0.8bps) little changed there was some suggestion that the move was a bit of a delayed reaction to the Sicily regional election result on the weekend given the fairly muted price action on Monday. In any case the moves stood out given the relatively benign changes elsewhere. It is however worth noting that yesterday was another day of flattening across the Treasury curve. The 2s10s curve

dropped below 69bps and has now flattened for 8 sessions in a row which is the longest run since November 2015. The 5s30s curve also fell below 79bps and both are at 10 year lows. Clearly rates markets are telling us something about the prospect of the tax bill as it stands so it’ll be interesting to see if that changes when we see the Senate version. 08 November 2017

Macro Bites - A Happy 12 Month Trumpiversary For Markets? Today marks the one year anniversary of President Trump securing victory in the 2016 presidential election. Needless to say that the victory was unprecedented and also a massive shock around the world. Following Trump’s victory, it was widely expected that we’d see a much higher chance of fiscal spending but also a reinforcement of the backlash against globalisation and associated forces of which migration policy and trade were probably first and foremost. In reality what we have seen in the last twelve months is plenty of evidence of backlash against globalisation, hostility and controversy, but very little in the way of fiscal policy. Indeed we’ve regards to the latter, the debacle around healthcare reform probably best characterises the difficulties the President has faced in that regard.

So with today marking the one year anniversary, we thought we would take a look at how markets have performed over that time period. For the purpose of this we’ve included our usual monthly performance review assets, as well as a few other US assets. Click on the link to the report to see which assets have come out on top. As a teaser only 3 different assets in our sample have seen a negative total return, so see if you can guess which. …In bond markets, as we know Treasuries have seen some huge ranges but ultimately performance has been benign. Indeed Treasuries have returned -0.1%. In fairness the big move for Treasuries came in the first

few weeks of the election victory where we saw 10y yields spike nearly 80bps. If we take performance from the yield highs of last December then performance is actually more like +3.5%. More significant for bonds though has been the shape of the yield curve. Having spiked as high as 136bps, the 2s10s curve has now flattened to just 68bps and is at the flattest since 2007. The 5s30s curve (79bps) is also at the flattest in 10 years. Alternatively 2y yields have moved from 0.854% on election day to 1.629% now and the highest in the last year. 10y yields were at 1.855% on election day, touched as high as 2.626% in March and are now at 2.309%. The equivalent for 30y yields is 2.616% on election day, 3.212% high in March and 2.770% now. So while equity markets may have benefited from high expectations for fiscal spending, US Treasuries have by and large priced out any expectation with each passing day under Trump’s presidency.

Figure 1: Performance of various assets in USD terms since the US election on 8th November 2016

More banks tightened underwriting on credit card and auto loans in Q3 according to Fed survey We discuss the Q3 Fed senior loan officer opinion survey and recent rating actions on SLABS. Global Air Traffic examined; Benchmark ABS deals evaluated Global Air Traffic examined; Benchmark ABS deals evaluated More SFR new issuance in 2H 2017 amid strong rental housing fundamentals Strong rental fundamentals should boost the new issuance SFR market.

Higher deficits versus foreign, pension demand We remain tactically and strategically bearish, and look for 10y yields to rise to 2.60% by year end, driven primarily by market re-pricing for a higher terminal real short rate. 07 November 2017

Global Financial Strategy Rates declining after Lower House election; share prices remain high

07 November 2017

The Outlook - MBS and Securitized Products Mall Crawls, fall foliage edition Mall crawls to central NY Monthly review In our monthly review, we see repayment rates dropping as CLO resets increasingly replace deal calls.

Drivers of rising Japan stock: 27% due to weaker yen; 61% to higher US stock Off a 2.04% bottom on 7 September, 10y UST yields climbed to 2.46% on 26 October before falling back to 2.33% on 6 November (Figures 1-2). In this report, we use our model in discussing these market movements. We have seen a solid uptrend in TOPIX as it rose from 1,598 on 7 September (UST yield bottom) to 1,731 on 20 October (before the Lower House election) to 1,754 on October 26 (UST yield peak) to 1,793 on 6 November. The USD/JPY rose from ¥108.9 to ¥113.5 to ¥113.6 to ¥114.3. TOPIX has risen 12.2% since 7 September. We attribute 3.3% (27%) of the rise to yen depreciation, 7.4% (61%) to a rise in the Dow Jones Industrial Average, and 1.5% (12%) to other factors (Figure 19: R2 is 95%; Note). The outcome of the Lower House election resulted in falling interest rates, yen depreciation, and rising stock prices, but we think the impact on stock prices was moderate.

Forex (USD/JPY): Yen depreciation in line with our model We are hearing some observers say that changes in forex have been subdued versus movements in longterm UST yields. However, forex movements since October have been roughly in keeping with our forex model (Figures 5-6).

Though 10y UST yield does not have a high correlation with forex, the yen appears to have weakened a little beyond the approximation line (Figure 24). Yen interest rates declined after LDP landslide victory Long-term rates in Japan reached a peak on 20 October just before the Lower House election (Figure 9), and have declined following the election. The drop in yen interest rates is likely due to (1) falling long-term rates in the US, (2) the removal of monetary and fiscal policy uncertainty with the LDP's victory over the Party of Hope, (3) an outlook for the prolonged monetary easing with greater certainty that PM Shinzo Abe will remain the leader of the LDP and that BoJ Governor Haruhiko Kuroda will retain his post. Short-term interest rates dropped as uncertainties in monetary and fiscal policy receded (Figures 9-11). Sovereign CDS dropped (Figure 12) with the removal of political uncertainties. Dollar funding (hedging) costs remain high (Figure 13) because Fed rate hikes look increasingly likely and there is strong demand for US securities. US stocks: Drivers are commodity, IT, and financial sectors The sectors that have driven US stocks since September are energy and materials, information technology, and financials (Figure 14). Energy and materials was boosted by rising commodity prices, and the financials by rising long-term rates (Figures 15-18). IT sector has been supported by expectations for earnings and rising valuations with falling rates since Oct 27 (Figure 17). Japanese stocks: Drivers are commodity, machinery, and appliances sectors The rise in Japanese stocks has been driven by the commodity, machinery, and electrical appliances sectors (Figure 14). We think that the rise in machinery and electrical appliances share prices reflects expectations for earnings, similar to movements in Sony's share price following its results announcement. Meanwhile, insurers are only up 1.0% versus TOPIX, and banks are down 0.3%, as Japanese financials lag the US financial sector (+4.0%). With the Lower House election outcome, investors likely expect the BoJ’s quantitative and qualitative easing to be drawn out, which could dampen investor appetite for financial stocks. (Continued on next page.)

07 November 2017

FX Blog - Alpha Alert – Why a Saudi-led risk retreat helps the USD, a little Alan Ruskin The big event in macro this week has been events around the Arabian peninsula. The “corruption crackdown” in combination with the missile attack from Yemen, is widely seen to have added another dimension to instability in the region. One question is why should the USD benefit from a flight to quality that emanates from this source, when the USD seems to benefit very little when N.Korea is the catalyst for negative risk? Here are a few reasons: i) The impact of higher oil prices on Central Bank policies. Higher oil prices will tend to lead to some increase in inflation expectations across many countries. The correlation between US inflation breakevens and oil is often stronger than we would expect. In current circumstances, breakevens are NOT responding to the oil spike (see Figure 1 and Figure 3). However, it is still reasonable to assume that of the G10 Central Banks, the Fed is likely to be the most (hawkishly) responsive to higher inflation at least over the next 6 months, in no small part because it is the only major Central bank already on a persistent rate hiking path. ii) The SAR peg to the USD essentially means that spec and non-spec private sector pressures tend to concentrate on the USD. The counterweight is that Saudi USD reserves will tend to be pressured. In an Alpha Alert, FX blog on Oct 2nd, it was noted that “After being fashionable a couple of years ago, speculation surrounding the Gulf currency peg trades went silent. Meanwhile IMF data shows reported Saudi Arabian reserves have dwindled by a stunning $250bn off their peak. The current pace of the drawdown probably

cannot continue for more than another 2 years without a confidence based self-fulfilling acceleration in capital outflows.” While higher oil prices may help Gulf oil producer trade balances, this is apt to be swamp by the capital flow implications of the crackdown and freezing of bank accounts. iii) Terms of trade. The US trade deficit on petroleum products is running around a negligible 0.3% of GDP that separates itself from other flight to quality alternatives like Japan and the EUR area that are much more dependent on the region for energy supplies. This may also explain some of the unambiguous Trump administration (tweeted) support for recent shifts in Saudi Arabian policy. At least as important from a currency risk perspective, higher oil prices are simply rotating the shock around, this time adding to problems with the popular INR carry trade, while digging a deeper hole for the likes of TRY and ZAR.

7 November 2017 | 12:17PM EST

In sum, normally (see Figure 2) the causality tends to run from a stronger (weaker) USD to a weaker (stronger) oil price. More rarely, like now, do we see stronger oil prices associated with a stronger USD. At least in the short-term this causal link between higher oil prices helping the USD is expected to be maintained. However, the link will be weak, mostly because oil prices impact on inflation/policy is seen muted as oil futures backwardation (see Figure 3) shows a market skeptical that oil price gains will be maintained.

1. Counter-trend Euro weakness can continue a bit longer. Over the past two months, EUR/USD has declined about 3.5%, from a high of just over 1.20 to 1.16 today. We see three main drivers behind the move: (1) open-ended bond purchases by the ECB, which look likely to continue longer than investors had expected, (2) the nomination of Governor Powell for Fed Chair, a candidate likely supportive of continued funds rate increases, in contrast to expectations in late summer that the White House would opt for a more dovish choice, and (3) further progress in the US Congress on tax reform. While the first two catalysts have played out, we expect that Congressional Republicans will continue to move the tax reform ball down the legislative field over the next month. Moreover, investor positioning still appears long EUR. In futures, for example, aggregate USD positioning has swung from a short of $20bn in late September to a short of $4bn as of last week. However, much of this move was against currencies other than the Euro: futures length in EUR has declined by just $3bn over this period, and net length of +$10bn remains close to multi-year highs. Over the medium term, the Euro probably has more upside than downside, but we think the near-term trajectory is still lower, and are sticking with our year-end target of 1.15.

7 November 2017 | 10:53AM EST

USA: JOLTS Job Openings Rise in September BOTTOM LINE: Job openings rose against expectations for a modest decline, according to the JOLTS report. The hiring rate fell by one tenth while the quits rate increased by the same amount.

Market Intelligence: US Midday focus on stocks not the index What the markets are saying

US stocks are unchanged Tuesday as September earnings season winds down, Monday's move in commodities pulls back a bit, and a bit of a "risk-off" tone emerges as Utilities and Staples lead the S&P 500 sector. 7 November 2017 | 1:41PM GMT

Global FX Views: The Return of Idiosyncratic Risk (Trivedi/Pandl)

…6. Monetary policy is unlikely to pressure the Pound, but politics might. Markets saw a relatively dovish signal in the BoE’s rate decision last week, as the Bank no longer said that policy needs to be tightened “by a somewhat greater extent over the forecast period than current market expectations”. However, we read the accompanying Inflation Report (IR) as saying the Bank remains in tightening mode (albeit at a very slow pace). Conditional on current market pricing, CPI inflation in the IR does not converge fully back to the Bank’s 2% target even by the end of 2020 (it sits just above at 2.15%)—which,

taken literally, means that a higher policy rate path would be desirable. This point also came across in Governor Carney’s press conference, where he noted: “…we, in fact, need those two additional rate increases in order to get that return of inflation to target. In fact, if you look closely at the forecast, inflation approaches the target, it doesn't quite get there, and the economy is likely to be in a position of excess demand, in other words, running a little hot at that point”. So we do not think the BoE gave an all clear for going long EUR/GBP. We ultimately expect more Sterling weakness, but surprises from the increasingly messy political environment are more likely catalysts than new dovish signals from the BoE.

JGBs rallied impressively in a catch-up session to other G4 bond markets since Tokyo was out on Friday. Governor Kuroda gave a speech to business leaders which reiterated that the “BOJ will persistently continue powerful easing”, which set the tone for global duration to trade lower throughout the day. This headline initially caused both USDJPY and US rates to pop higher, but before Tokyo went home US rates closed lower in sympathy with the bull flattening move in JPY rates.

…GDP tracking We continue to track 4Q GDP at 3.4%.

November 8, 2017 November 7, 2017

JEF Economics

Job Openings Hold Above 6 mln, Quits Rise …The bottom line is that the private sector demand for labor remains strong. The private sector still has plenty of job openings to be filled despite the 1.95 mln increase in private sector hiring over the past year and 17.4 mln increase to-date this cycle. This bodes well for continued job growth on a trend basis, and supports our expectation that private payrolls growth will continue to be solid once the effect of the hurricanes has washed through the data.

November 7, 2017

US Economics & Rates Strategy: Treasury Market Commentary, November 7 Treasury yields twist flattened today in a déjà vu session of quiet economic data and news. Today marks the 9th consecutive day of flattening, ahead of long-end supply in 10Y and 30Y later this week. 10Y yields closed at 2.32%.

FX Morning Daily Commentary, 11/08 Booming Financial Conditions. Real yields have continued to decline with Australia, Canada, France, Germany, Italy, Japan, Spain showing implied 10-year real yield levels trading at their lowest levels within the past quarter. Simultaneously, economic data continue coming in strong. In the US, real yields have come down too but have not declined as much as elsewhere, with the Fed’s senior loan officer survey for October showing another net easing in lending conditions. Importantly, a net 10% of respondents cut the cost of credit lines to corporate borrowers over the past 3 months, suggesting banks are turning increasingly risk and yield seeking and implying rising US monetary velocity. US Sept consumer credit $20.83bn (17.5bn est) rose most since Nov 2016. US economic strength. The US Jolts report suggests strong labour demand, but wages have remained muted as indicated by the October NFP seeing hourly earnings growth easing back from 2.9% to 2.4%Y. Meanwhile, rising capex has brought back productivity growth. Our economists see declining QE related incentives and labour market tightness pushing capex and productivity growth higher which initially will allow inflation to stay muted. The Fed's Harker suggested overnight that he sees no sign that inflation is about to run out of control. Therefore he backs a slow and steady tightening. With the Fed going slow and financial conditions boosted by easing lending conditions, spread tightness and high asset valuations adding to an already strong wealth effect the US seems to be heading towards releveraging, allowing its economy to grow above income. China needs a booming Rest of the World. China stays central within our framework. Here investment and productivity growth have diverged, suggesting potential misallocation. Its debt levels are high, but domestically funded. The sealed capital account allows China to rebalance its economy by draining resources from its investment sector and adding means towards its

household sector. For this policy to be successful China does need the global economy to stay strong. Its internal rebalancing suggests higher wages eroding its competitiveness and, to limit its domestic economic impact, China requires strong external demand. Today’s release of China October trade balance (USD38.2bln after USD28.5bln) showed export growth easing from 8.1%Y to 6.9%Y. Slowing global demand would increase China’s export growth slowing, which is unwelcome. The exhibit below shows that China's 10y bond yield is widening relative to the US.

US tax reform momentum slows. Within an environment of weak inflation prints other central banks may provide as much assistance to China’s rebalancing as possible and this means keeping global demand strong. Real DM funding costs have declined over recent weeks, but EM has not yet responded positively. In the absence of geo-politics turning risk off we see an increasing chance of EM pushing higher. Latest US news on the tax reform bill adds to our conviction. Senate Republican leaders are considering holding corporate tax cuts back by a year, and news that House Republicans changed tax proposals that would result in a USD74 billion revenue hole do not leave the impression of reform running on a fast track.

China's yield differential...USD set to weaken

following several months of volatility. We expect 3.3% real PCE growth in 4Q on top of 2.4% in 2Q

November 7, 2017

Cross-Asset Playbook: Still Running it Hot Macro: Still Running it Hot Muted inflation is keeping policy easy despite some of the strongest global growth since 2010. We think that this dynamic supports overshooting valuations and expect it to persist until next year, when the Fed will hike more than the market expects.

Strategy: Late-Cycle Positioning, USD to Pause We continue to overweight equity over credit over government debt. We prefer DM exposure in equities (US and Japan), EM exposure in fixed income and Treasuries within DM sovereigns. We remain cautious on US high yield, given valuations and the state of the cycle. Our tax expectations leave us expecting USD to pause.

Comparing Through-the-Cycle Returns Based on updated long-term return estimates, we compare outright and risk-adjusted expected returns across asset classes. We also dig deep into our expectations for US fiscal policy.

Strategy Changes and Key Trades

November 7, 2017

US Economics & AlphaWise Macro: US Retail Sales Tracker: Smoother Sailing After the Hurricanes Our primary data points to 0.3% growth in the retail control group in October—a healthy pace for the first clean read

We’ve recently added short MBS vs. Treasuries as a hedge to tight spreads and low US rate volatility and exit a short GBP breakeven trade. Otherwise, our trades and allocations remain unchanged. Our most out-of-consensus call is for stronger reflation in Japan.

Fear of Missing Out | Against This Backdrop, Room for Risk Appetite to Increase

The Risks | Risks to Tightening, Earnings and Technicals Are Skewed to Next Year

Rate Risk | When Are Higher Rates a Problem? •

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Global Rates | We Prefer Duration in the US and UK Over Europe; Expect Curve Divergence

Monetary Policy | 2017 Tightening Is Manageable; We’re More Worried about 2018 •

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A manageable risk this year: Our forecasts for 2017 Fed tightening are in line with the market (one hike in December). Fed balance sheet reduction is well flagged, will start slow, and will be buffered by ECB and BoJ purchases. A bigger risk for 2018: We forecast three Fed hikes in 2018 (vs. the market at ~1), as US balance sheet reduction accelerates, the ECB tapers and the BoJ exits YCC. Investment advice: Remain OW equities. Long USTs vs. DBRs. US curve flatter vs. EU curve steeper. Cautious on Agency MBS basis

US levels are key: Ex-US markets still have historically high risk premiums versus rates, and are earlier in the policy cycle. It’s in the US where we think this debate will matter. And US real yields are still ‘in the range’: 10yr US real yields have stayed in a relatively stable 0-80bp range since the middle of 2013. Breaking that range would be a risk. But until we do, we think it may be too early to worry. The data really matter: There are plenty of instances where equity and credit did fine while US rates were going higher, because the data were also strong.

China | Modest Growth Slowdown in 2H17 Oil | Strong Demand Offsetting Supply; Brent in Backwardation

Trade #5 | Long 30y US Treasuries vs. 30y Bunds

Trade #14 | Short MBS Basis (Short FNCL 3s vs. Treasuries) NEW

November 8, 2017 05:01 AM GMT

Morgan Stanley Insight: US Economics, Quantitative & Equity Strategy Research: The Productivity Pickup: Who's Driving After nearly a decade of subpar productivity growth, we see a sustainable positive inflection, supported by both higher labor costs and the end of QE-driven disincentives. Our above-consensus view on the rate of productivity growth has positive implications for asset prices and sector performance. Over the past six years, productivity growth has fallen sharply, to levels not far above zero, leading many investors to question if the rate of productivity will ever pick up. The dropoff in growth was primarily caused by lower capital investment, owing to a substitution away from (higher-cost) capital to labor and a disincentive for corporate managers to invest during the QE era. A higher sustained rate of productivity is important because it implies stronger GDP growth and therefore has far-reaching implications for asset prices across the economy. We now see a change in the trend. Incentives to invest are rising for corporate managers. As the economy is closer to full employment, rising costs of labor relative to capital are incentivizing a shift back toward capital investment, and QE-era incentives to seek return of capital rather than return on capital are dissipating. Importantly, our economists are tracking four straight

quarters of rising real equipment spend in the economy—a notable inflection—while MS’s proprietary 6-month Capex Plans Index is showing the highest readings since 2006. Labor productivity is now on track to rise 1.3% in 2017e, a level which we think can be sustained over the medium term with above-trend GDP and further slowing in job growth. Incremental investment is most pronounced in service industries, according to our top-down and bottom-up analyses. Our top-down analysis shows labor market tightness across service sectors encouraging rising investment levels. Our bottom-up work identifies not only the sectors where capital spending (among publicly traded companies) is rising overall, but also 13 industries where the quality of investment spending—or capital deepening—may promise the greatest future pickup in efficiency. Service sector-related industries that are engaged in capital deepening include air freight & logistics, internet & catalog retail, apparel & luxury goods, and health care providers & services.

We see a positive read-through to equity markets. We think an inflection in productivity that lifts the path of GDP growth is positive for equity markets, due not only to the first order effects of increased revenue that flows through to businesses that meet those investment demands but also to the ability of increasingly productive firms to absorb rising compensation costs and preserve margins. Increased confidence inspired by faster growth should also lead to a further normalization of the equity risk premium. What’s new: Our US macroeconomists, our US Quantitative Equity analysts, and our US equity strategy teams take a multifaceted look at labor productivity and capital spending in the US, including: 1) a detailed review of the components of labor productivity over the past 50 years, 2) a review of the relative costs of labor versus capital, 3) a quantitative analysis among publicly traded companies to identify those with the highestquality capex spending trends, and 4) an analysis of how equity markets stand to benefit from rising productivity.

US Markets Closing Notes, November 7th 2017 Recap and Comments: Another bland US session, in terms of releases and headlines, left markets seemingly driven more by positioning rather than events or changing sentiment. The seemingly endless flattening in the Treasury curve continued today, as the 30yr point rallied while 5yr notes sits unchanged on the session and the 3yr note is just

marginally higher in yield following today’s supply, which came in essentially in line with the WI levels at auction time and with stats that were in line with recent averages. The curve flattening also continued despite the jump in oil prices and looming long-end supply, each perhaps making a case for a tactical relaxation, rather than intensification, of flattening pressure (though, to be fair, oil prices today were little changed following three consecutive daily increases). Elsewhere, USD performance was mixed through the US session following a rally overnight. The USD added to overnight gains against the antipodes while reversing part of its overnight rally against the EUR and the entirety of its rally against GBP. 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): • Long 50% 10s at 2.34%, add 50% at 2.43%, target 2.20% stop on close over 2.475%. • •

Established 2s10s Swaps Flattener at 55bp, target 40bp, stop on a close over 65bp. Long 5yr UST vs. German 5yr bund at 236bp, target 220bp, stop on a close over 243bp which marks the 2017 high weekly close.

NOVEMBER 8, 2017

FX BLOG

Credit spreads haven't been this low in over 10 years. And on Monday, the SG Sentiment indicator, based on credit, equity and FX vol, credit and swap spreads and the gold/equity ratio, reached its highest level ever (we have data to 2000). If you measure happiness by financial market sentiment, everything is awesome. Obviously, market sentiment and happiness aren't the same thing but market senitment is also failing to correlate with carry performance. The chart shows G10FX carry returns, EMFX carry returns, both indexed to 100 a year ago, plotted against the SGSI. The non-performance of G10 ‘carry' in a world where the highest yielding 3-month rate is under 2% isn't all that surprising really (with rates clustered around very low evels, other factors just matter more). But in EMFX, what had been a steadily improving performance has been knocked off its stride. The correction in EM carry correlates very well with the turn in DXY, and indeed in the EUR/USD rate, in early September. Which also means it happened at the same time as the USD/CNY rate troughed. More fodder for PBoC conspiracy theorists. … The turn in USD/CNY happened at the same time as Treasury yields turned higher too, but USD/CNY peaked in late September, whereas US yields peaked in October and are falling, and yet the EM carry index is doing poorly, partly because TRY, MXN ZAR and BRL have all been weaker since the end of September, for differing reasons. As for the Euro and the DXY, you could look at charts of EUR/USD and real yields and conclude either that they have are now moving broadly in the same direction, or that there's still a huge gap between the two lines. The real yield gap is where it was when EUR/USD was at 1.05 back in January. The break between FX and real yields coincides with the Sintra conference and the first mention of further tapering, and markets are re-assessing the significance of that move (another year of bond-buying, and a rate hike sometime after that). The “europhoria” that built over the summer was reflected in the build-up of large EUR longs on the CFTC data, and we will need to wash those out before the correction ends. We still expect this to be gradual and Stephanie still cites 1.1480 as a realistic downside target. Meanwhile, the euro correction seems to be important in terms of FX risk sentiment (appetite for higher-yielding currencies in general). We might need to flush out euro longs to unlock a more ‘risk-on' mood across FX.

IF MARKET SENTIMENT IS HAPPINESS, EVERYTHING IS AWESOME (3P) After a year of President Trump, 10year note yields are 45bp higher, of which 14bp is a rise in real yields and 31bp comes from higher inflation expectations. The dollar's gained almost 8% against the yen, but lost 5% to the Euro and 6% to sterling, resulting in a 3% fall for the DXYover this period. But all of this is dwarfed by the move in equities (the S&P is up 21%) and in credit spreads (the IG index is 22bp tighter to 54bp).

NOVEMBER 6, 2017

FI SPECIAL TREASURY AUCTION PREVIEW (6P) Key points - The Treasury is scheduled to auction $24bn in 3y notes on 7 November, $23bn in 10y notes on 8 November, and $15bn in 30y bonds on 9 November. This will raise new cash of approximately $19.3bn. - The 3y sector seems to have set up for the upcoming auction from the relative-value perspective, with the current 3s trading cheap on asset swap and on the curve (versus 2s and 5s). The auction will also benefit from cheap outright valuation, as the sector has cheapened since the last auction, with the 3y benchmark yield now well above the auction stops since April 2010. This is a positive for the auction, along with dealers increasing their shorts in the sector.

- The upcoming 10y auction will likely need concession to be underwritten smoothly even though relative-value metrics show some set up, with the current 10y note cheap on asset swap versus the old 10s and fair to slightly cheap on the curve versus 5s and 30s. Negatives include richer outright yield levels, with the current 10y yield below the last month's auction stop, and a flatter curve since the last auction. - The upcoming 30y bond auction will likely need concession to be underwritten smoothly, as the current 30y yield is below last month's auction stop and the 5s30s curve is near its lowest level since 2007. The curve has flattened since the last auction, especially over the last week after the Treasury decided against increasing the size of auctions at the refunding announcement and it does not anticipate a meaningful increase in the weighted average maturity. Demand at the long end of the curve at the last auction and the current 30y trading slightly cheap on asset swap are positives for the auction.

NOVEMBER 2, 2017

FX WEEKLY ANOTHER FALSE DAWN FOR DOLLAR BULLS 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.

3 November 2017

Global Rates Weekly As Good As It Gets …

Treasury Auction Preview 15

Treasury will auction a combined $62bn (issue sizes unchanged after November refunding announcement) next week, selling $24bn in 3s on Tuesday, $23bn in new 10s on Wednesday, and $15bn in new 30s on Thursday. With $42.7bn maturing at mid-month settlement, the auction will raise $19.3bn in new cash. There will also be $11bn in SOMA holdings maturing, with the Fed allowing only $6bn to run off the balance sheet. This would lead the Fed to add on $2.3bn to 2s, $2.2bn to 10s and $1.5bn to 30s. Note that there is some uncertainty about how much the Fed will allow to run off at the current auction series, potentially allowing just $3bn to run off now and $3bn to run off at the 2s5s7s auction series later in the month. This could impact add-on amounts at the current auction series. Treasury yields have moved away from recent highs as Powell was nominated for Fed Chair, the BOE delivered a dovish rate hike, and the market saw a mixed reaction to the GOP tax plan. Fed funds futures are nevertheless currently pricing more than 85% odds of a December hike and 1.5 additional hikes in 2018. We expect to see relatively solid demand at next week’s auctions as Treasuries have cheapened sharply on an outright basis across the curve. Last month’s auction series showed decent results, with 3s, 10s and 30s stopping through 1pm levels by 0.1bp, 0.2bp and 0.4bp, respectively.

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…10s: Recent 10yr auctions have seen softer demand as five out of past six auctions tailed. However, the recent cheapening on the outright basis may draw some interest from buyers. Averages suggest a 0.9bp tail and 68% buy side

takedown (62% to indirects and 6% to directs). 

30s: The long end of the curve faced significant buying pressures as investors entered 5s30s flattener trade. Averages hint at a 0.3bp tail, with the buy side taking an average of 69% (62% to indirects and 7% directs).

8 November 2017

China Economic Perspectives China Economic Outlook 2018-2019 Growth to moderate in 2018-19 but less hard landing risk than before We see China's GDP growth slowing modestly from 6.8% this year to 6.4% in 2018 and 6.3% in 2019, as property sales and construction slow on incrementally tighter policies and fading market momentum, infrastructure investment decelerates on tighter local government financing, and supply-side reforms dampen industrial production and investment. Resilient consumption and a positive net trade contribution should offer some support. Supply-side reforms supportive of prices and earnings Supply-side reforms including excess capacity reduction, tougher environmental regulations and faster SOE consolidation are expected to dampen production and investment in related sectors but should help narrow China's output gap and sustain recent improvements in industrial prices and corporate earnings. Sustained profitability can support a more positive corporate outlook, underpinning a modest corporate capex rebound from H2 2018, despite the slowing economy. Drive to deleverage should persist with frequent fine-tuning We expect financial regulations and supervision tightening to continue in 2018-19, further unwinding inter-FI leverage and shadow banking credit, though less sharply than in 2017. Tighter rules will likely slow adjusted TSF credit growth from 14%+ this year to around 13% in 2018E and 12% in 2019E. The modest pace of credit slowdown should have limited impact on GDP growth, as improved corporate balance sheets may reduce credit demand somewhat. We also expect the pace of deleveraging to be gradual and frequently adjusted to avoid too much of a growth slowdown or market volatility.

Inflation rebounds but not enough to trigger monetary tightening We expect PPI inflation to decelerate sharply as commodity and raw material prices decline or stagnate, but the pass-through of recent input cost increases should push up mid and downstream prices, keeping 2018's PPI print positive. Higher manufacturing goods prices and a modest rebound in food prices will likely drive CPI inflation to 2.2% in 2018, but a remaining output gap and stable USDCNY (6.7 at end-2018 and 2019) should keep inflation in check. We do not expect any benchmark rate change through 2019, but ongoing financial regulatory tightening should keep market rates elevated. Balanced risks to our forecasts Growth could reach 6.7% in 2018 if robust property market sentiment supports property sales and investment for longer and/or global demand for Chinese exports is stronger than expected. Downside risks include sharper property sales and investment slowdown, larger-than-expected production cuts or a sharper slowdown in credit growth, and weaker exports due to serious trade friction or weaker global demand. In which case, growth could dip to 6.2%, although the downside would be limited by a likely easing of deleveraging measures and the government's fiscal policy stance.

6 November 2017

Global Economic Perspectives Global Economic Outlook 2018-2019 Nothing will change, yet everything will be different The main engines of the global growth pick-up in 2017 were Chinese property, US shale, and the wider commodity rebound (including Brazil and Russia emerging from recession). Those engines are starting to sputter, so substantial growth rotation is necessary in 2018 to sustain the current 3.8% global growth pace. The surveys have been suggesting for a while that it will happen, but we're still waiting. Recovery to date seems mile wide but inch deep The global recovery is broad-based by number, but much of the improvement is owed to a handful of commodity producers. The commodity rebound accounts for nearly all of the inflation normalization in DM, about 80% of the global trade normalization, and about 70% of the global growth acceleration (almost the entire US acceleration in 2017 was energy investment). We expect Brazil and India to provide the largest boost to growth in 2018, helping to offset modest slowdowns in over half of the countries in our coverage universe (including heavily-weighted China, the Eurozone and Canada). Energy is to global investment, as China is to global trade The recovery in the Chinese property sector helped jumpstart EM import volumes (China accounted for about 30% of that acceleration). With property now slowing alongside infrastructure investment, we project a 200bp drop in QoQ annualized growth between Q2-17 and Q2-18. Compensating mechanisms will kick in, but the import intensity of growth will

drop. We doubt DM will fully pick up the slack and therefore see global trade growth slowing about 60bp.

Figure 4: But most of the improvement seems to be coming from a narrow set of commodity exporters

Inflation is not dead, just sleeping Twenty per cent of the countries we cover have already closed their output gaps and we see the first stirrings of wage and price pressures. The transitory weakness in core inflation in the US is an outlier: the number of countries with increasing core inflation is at its highest since 2011. The process is still slow for most, but there are notable exceptions: wage growth in Central Europe has doubled over the last few quarters, and we view Japan as being on the cusp of a substantial pick-up in inflation.

…Positive survey signals and the coming end of the debt super-cycle

Where do we deviate from 2018 consensus? We are -20bp below consensus on US and UK growth, +70bp above consensus on Japan's growth and inflation, +10bp above consensus on Eurozone growth, and +70bp above consensus on Brazil's growth. We continue to project that the Fed will resume buying US Treasuries in three years' time, and that by 2025 it will hold US$1½ trillion more UST than it does today. What can go right? The biggest upside risks to our forecast are (i) a larger-thanexpected tax cut in the US, and (ii) abating policy uncertainty on both sides of the Atlantic leading to a much stronger investment response. What can go wrong? The largest downside risks are (i) a failure of global non-energy investment to pick up from where this year's commodity rebound left off; (ii) running out of labour-market slack, forcing markets to sharply reprice inflation risks and the pace of policy normalization; (iii) growth disappointment, for example in the US, due to a combination of a collapse in NAFTA talks, failed attempts at tax reform, or large retail bankruptcies.

Figure 3: Global real GDP growth back at its long-run (50y) average

Ok, so much for the 'glass-half-empty' discussion. Surely the market is not oblivious to all of the aforementioned (though arguably it is to some of it). The first reason to be optimistic about the outlook is that businesses appear so. In particular, manufacturing confidence has surged, reflecting the improved price and trade environment, better demand conditions and fuller order books. We run two proprietary surveys twice a year across US and Eurozone corporates (CFO/CEO/CIO level). Seventy-five per cent of US respondents in our last survey expected to increase capex in the next 12 months (so, consistent with some investment rotation from energy to non-energy). In our most recent UBS Evidence Lab survey for Europe, investment intentions surged across the board (see Figure 14), likely reflecting dissipating political risk and a recovery that is looking increasingly robust (17th consecutive positive quarter of growth and 12th quarter above potential).

…2018-19 US Outlook: Steady as she goes Q: What is the US growth outlook for 2018/19? We expect real GDP growth to remain roughly unchanged at about 2¼% in 2018 and 2019. Consumption spending moderates as employment gains slow slightly. Inventories and state and local government spending stop being a drag on growth. We do not see a material pickup in investment spending, because essentially all investment we have seen recently appears to have been driven by the energy sector. Q: What will happen with inflation? We see inflation moving slightly higher, with core and headline PCE inflation ending 2018 at 1¾%. This rise in inflation is less than the rise that the FOMC projects. The outlook is predicated on the unemployment rate falling to 4% by the end of 2018 and an end to the transitory downdrafts to inflation seen this year. Q: What is the outlook for monetary policy? The Fed should hike rates twice next year instead of the three times that is in the Summary of Economic Projections. Inflation is lower than they project, instilling more caution, but with the unemployment rate continuing to fall, the FOMC remains confident that inflation will eventually rise.

UBS VIEW We see a roughly balanced economy that has almost eliminated the slack from the recession.

United States

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GDP growth expected to hold around 2¼% in 2018 and 2019. Consumption slows, the drag from government ends. Slack in the economy should be exhausted over the next year, unemployment should fall to 4% by end2018. Transitory inflation weakness fades; core PCE rises to 1.75%, lower than in the Fed's projections, and so they only hike twice in '18. Figure 5: Wage measures have shown little additional upward movement in the past year

this business cycle. A pattern of over-forecasting the fed funds rate has become apparent. Likewise, and somewhat unsurprisingly, this trend of over-shooting is also associated with predicting the future value of the 10year Treasury, as its value is influenced by federal funds rate expectations. In this special report we present several possible contributing factors as to why this business cycle, in particular, has given forecasters so much trouble predicting the level of the fed funds rate.

Factor One: Stubbornly Low Inflation… Factor Two: Muted GDP Growth… Factor Three: Political Uncertainty… Factor Four: Tapering the Balance Sheet…

The Outlook from Here Most of these factors continue to occupy space in today’s economic environment. Thus, we largely expect the FOMC to proceed along their policy tightening path, albeit at a more cautious and restrained pace. A clear disconnect in predicting the fed funds rate exists between the market consensus, as measured by fed funds futures, and the Fed’s dot plot, which represents the FOMC members’ beliefs of where the fed funds rate should be at the end of a given year. While the market consensus has historically been a better gauge of the actual rate in the future, both forecasts tend to overshoot the actual fed funds figure. As of now, we expect the Fed to raise rates in December, and just two more times in 2018.

November 7, 2017

Economics Group Special Commentary

Persistently Overshooting the Fed Funds Rate A pattern of over-forecasting the fed funds rate has become apparent. In this special report we present several possible contributing factors as to why this business cycle, in particular, has given forecasters so much trouble predicting the level of the fed funds rate. Attempting to predict future increases in the federal funds rate has proven to be a challenge for decision makers from both the public and private sides during

November 7, 2017

Rate Strategy

Rate Express

Government Bond Fund Flows Update •

Investors become net sellers of Treasury funds. Treasury funds experienced outflows for the week ended Nov. 1 to the tune of $1.1 billion, the largest outflow since Dec. 2016 (Figure 2). This marks a flip from modest inflows the prior week, as investors digested heavy news flow from central banks and fiscal authorities. Selling was most pointed in the long end, notching a $779 million outflow, offset by a modest inflow into the short end ($165 million). The intermediate sector saw outflows for just the second time in four months. The selling in the long end comes as the 10yr has retreated 15bps since reaching a recent high of 2.46% on Oct. 27.

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Demand for inflation protection remains moderate. TIPS flows were steady on a week to week basis, with funds gathering $148 million (Figure 2). Inflation data have been noisy in recent months, but the impact from recent hurricanes should fade. Therefore, investors should get a better feel for the pulse of the underlying inflation trend going forward. Headline CPI has rebounded in recent months, but core CPI remains well below the rates in excess of 2% experienced in 2016. Weak inflation may remain a headwind for TIPS demand. Divergence between monthly and weekly data on the short end. Demand for short-term funds posted the only monthly deceleration in demand, albeit a modest one (Figure 1). However, data for the week ended Nov. 1 show that only the short end experienced an inflow (Figure 2). This comes as short end yields have been rising consistently over the past couple of months with the 2yr at its YTD high of 1.62% at pixel time. Open end funds see outflows across board. Selling was focused at the short and intermediate end.ETFs were buyers of the short end and inflation protected funds. ETF inflows have been concentrated on the short end throughout 2017.

Bottom line: Recent news of Jerome Powell’s nomination to be Chairman of the Federal Reserve Board is likely a relief for Treasury and TIPS investors as he is expected to continue many policies of the Janet Yellen Fed. Since the announcement, the curve has bull

flattened with short rates holding relatively steady and the long end rallying. More attractive rates at the front end of the curve with the probability of an additional rate hike in December largely priced in - may attract investors in the near term.

November 7, 2017

Economics Group Q4 Net Treasury Issuance Outlook: An Update Net Treasury issuance is expected to accelerate over the next two quarters with T-bills and interestbearing issuance rising significantly. The longer-term outlook also indicates greater issuance at the long-end. … There are two major implications of our net issuance outlook for the shape of the yield curve over the next two quarters. First, we expect volatility to increase, especially at the front end of the curve as T-bill issuance picks up then begins to slow in advance of December 8th then subsequently picks up again with the use of extraordinary measures. Second, we fully recognize that in a period of balance sheet normalization by the FOMC, and the fact that net Treasury issuance is beginning to pick up, there will be increasing upward pressure on longer-term yields.

November 7, 2017

Economics Group Consumer Credit Growth Strong in September Consumer credit rose $20.8 billion in September and is up 6.6 percent year over year. While revolving and nonrevolving credit growth accelerated from August's gain, nonrevolving credit continues to lead the charge.

…Consumer Credit at Elevated Levels?

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Consumer credit as a percent of disposable income continues to set all-time highs each month. On the surface, this trend may be interpreted as a potential concern. However, this ratio is a bit misleading as it compares a flow series with a stock series.

job switches as a sign of labor market strength and source of stronger wage growth.

Examining the debt service ratio, which compares the flow of consumer credit to the flow of disposable personal income, is a more useful exercise. In this instance, the most recent data point is well below the all-time series high reached in late 2001.

November 8, 2017

Economics Group Monthly Economic Outlook U.S. Overview

Growth Momentum Continues in Q4

November 7, 2017

Economics Group JOLTS: Demand for Workers Remained Strong in September Job openings were little changed in September, keeping the opening rate at a record high 4.0 percent. Turnover remains low relative to the number of job openings even as the number of quits rose. Quits Rise, but Still Range Bound

Total separations edged down over the month, driven by fewer layoffs. The quit rate rebounded to 2.2 percent, but has not been able to break through this level. Demographic factors may be weighing on the quit rate, as older workers tend to change jobs less frequently. Nevertheless, the Fed would welcome more voluntary

For the second half of 2017, the growth momentum in the U.S. economy shifted up a gear relative to a year ago. On the domestic side, consumer spending and equipment investment have provided the push.The fundamentals of real disposable income and corporate profit growth have improved over the last three quarters. Gains in employment and an upturn in factory orders indicate further progress ahead. Our outlook is for growth of 2.5 percent in Q4 and 2.6 percent next year. Inflation continues to surprise–to the downside. Despite the continued decline in the unemployment rate, the PCE deflator is expected to come in at 1.5 percent in Q4—same as Q3. The much awaited acceleration of inflation will wait another day. Meanwhile, the Employment Cost Index has drifted up signifying rising labor cost pressures and potential pressure on profits ahead. Improved growth and steady inflation, along with a lower unemployment rate, provides a basis for another FOMC move to raise the funds rate in December. Meanwhile, the benchmark 10-year rate is expected to continue to drift upward in the fourth quarter and into the first half of 2018.

We are still expecting to see some sort of tax cut enacted, but the magnitude will be less than has been proposed and the timing will likely be a bit later. We have shifted effect of the tax cuts into Q2 2018, assuming passage of a $1.5 trillion cut over 10 years in early spring of next year. We anticipate the tradeweighted dollar will continue to decline.

International Overview

Global Economic Growth Is Strengthening

Global economic output appears to have strengthened this year, an observation that is corroborated by recently released GDP data. The year-over-year rate of real GDP growth in the Eurozone rose to a six-year high in Q3, and the British economy continued to expand at a modest pace. Growth in China edged down a bit in the third quarter, but the economy continued to grow at a respectable rate of nearly 7 percent. Looking forward, we expect that the global economic expansion will remain intact, although a return to the “boom” years of 20032007 does not look likely anytime soon. Sluggish GDP growth and benign inflation has induced many central banks to adopt extraordinarily accommodative policy stances over the past few years. However, policy stances in many foreign economies are starting to evolve. The Bank of Canada has raised rates 25 bps on two separate occasions since July, and the Bank of England recently took back the 25-bp rate cut that it implemented in the aftermath of the Brexit referendum last year. The European Central Bank is dialing back the monthly purchase rate of its quantitative easing (QE) program. Looking forward, we expect that many foreign central banks will remove policy accommodation further, albeit at a measured pace. The Bank of Canada likely will follow the Fed by hiking rates further next year, and the ECB should wind down its QE program by late 2018. As policy stances abroad become less accommodative, we look for the U.S. dollar to trend modestly lower vis-à-vis most foreign currencies.