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StreetStuff Daily November 17, 2017

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… Figure 1: 2s3s5s fly typically richens going into the 5y auctions

Thu 11/16/2017 9:52 AM

October Industrial Production Stephen Stanley Chief Economist

….Suddenly, with the upward revisions and the October output bonanza, manufacturing production has risen by 2.5% over the least 12 months, putting the factory sector roughly on par with growth in the overall economy for the first time since 2014. Capacity utilization is still quite low by historical standards but the manufacturing operating rate jumped to 76.4%, the highest reading since 2008.

16 November 2017

Treasury RV: Long 2s3s5s going into the intermediate auctions •

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The Treasury is scheduled to announce sizes for 2y, 5y and 7y auctions next week on November 22. The auctions are scheduled for November 27, November 27 and November 28, respectively. We recommend going tactically long the 2s3s5s fly (1:2:1), as it typically richens heading into the intermediate auctions. Figure 1 shows average changes (carry adjusted, bp) in the fly from six business days before the 5y auction to six business days after, over the last 6, 12 and 24 auctions. As can be seen, the fly has on an average richened 2-2.5bp around the 5y auction. Figure 2 shows the carry adjusted changes in the fly from -6b to +2b days from the 5y auction at individual auctions for the past two years. As can be seen, the hit ratio has been high and the maximum cheapening during this period has been limited.

16 November 2017

US Industrial production surges in October; Q4 GDP tracking up by 0.1pp to 2.7% …As it pertains to our GDP tracking, today’s reports on industrial production boosted our tracking estimate for Q4 GDP growth by one-tenth to 2.7% while our tracking estimate for Q3 remains at 3.4%. The rise in utilities production was somewhat above our expectation, implying modestly stronger private consumption, while the strength in auto and other manufacturing production was largely in line with our estimates for inventories, structures investment, and building materials. Altogether, and after rounding, the data bumped our GDP tracking estimate to 2.7%. 16 November 2017

TIC Monthly September

Steady demand from foreign investors •

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Foreign investors net bought $19bn in long-term US fixed income securities in September, led by coupon Treasuries and corporate bonds. They bought $13bn and $10bn in coupon Treasuries and corporate bonds, respectively. They net sold $4bn in agency securities. The buying in coupon Treasuries is likely underestimated as September month end auctions settled in early October. Holdings data, which come from a different survey and include the mark-to-market effect, show that foreign holdings of coupon Treasuries increased $45bn. China’s (and Belgium’s) holdings decreased

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by $13bn, while Japan’s decreased $6bn. Financial center holdings increased $29bn. More recent data show subdued demand from both official and private investors. Custody holding of Treasuries at the Fed increased only modestly in October. Separately, the MOF data show net sales from Japanese private investors. Overall, foreign investors held $10.5trn of US longterm fixed income securities as of August – approximately $5.6trn, $1trn, and $4trn in coupon Treasuries, agency securities, and corporate bonds, respectively. Over the three months ending August 2017, they have increased their holdings of corporate bonds by $158bn, LT Treasury holdings by $154bn and agency security holdings by $11bn.

deleveraging and containing financial risks still the priority, the PBoC will likely maintain its tightening bias unless growth slows more than expected. We expect the policy target rate (DR007) to stay elevated at 2.8-2.9%. That said, our base case of steady growth and rising but contained CPI inflation does not warrant an increase in the OMO/MLF rates following the expected Fed rate hike, and further tightening of financial regulations could bring volatility to the rates and bond markets.

Thu 11/16/2017 3:28 PM

Lyngen/Kohli BMO Close: Lucky Number Five … We maintain that the more time the market spends in the current range, the better the odds become that we see a bullish break in the 10-year sector. The front-end of the curve is a different animal however, anchored to policy expectations, etc. We’ve been watching the 5-year sector and initially characterized the 2.09% level as a potential double-top, but as an astute client pointed out it might also be a cup and handle formation that projects toward higher yields. At the risk of delving deeply into the technicals too early, a cup and handle (worth a google if it’s unfamiliar) is relatively rare and projects well beyond 2.10% in 5s. While ostensibly at odds with a broader bullish move in 10s, it is certainly consistent with our flattening bias – particularly in 5s/30s where 64 bp remains an achievable target.

17 November 2017

China Quarterly Outlook: Strong investment to support growth in 2018 While our forecast of a gradual moderation remains on track into Q4 2017, we think the risks to our 2018 growth forecasts have shifted to the upside, as the potential drag from winter smog controls will likely be outweighed by strong support from investment and exports. With

… Thursday’s price action did very little to inspire trading – as is often the case with in-range moves. Overall, cash traded at 91% of the 10-day movingaverage for the slowest session since Monday. 5s retained the position as the most active benchmark, taking a 33% marketshare, while 10s were a distant second at 28%. 2s and 3s combined to take 24% at 13% and 11%, respectively. 7s took 9% and the long-bond got 7%. Tactical Bias: As we consider themes for 2018, one of the most relevant looming policy questions is whether or not the lowflation seen in 2017 has caused inflation expectations to become unanchored. This is more than an academic exercise as lower medium-term inflation expectations might change the reaction functions of both consumers and businesses.

Policymakers have long struggled with an accurate measure of consumers’ anticipated level of price increases and this episode is no different. That said, Thursday’s data showed a sharp drop in consumer inflation expectations via the Philadelphia Fed survey (down to 2.5% vs. 3.0% prior) that echoes what we’ve seen via the University of Michigan gauge, among others.

… The steady removal of accommodation (a.k.a. tightening) by the Fed in the coming months will surely be accompanied by a narrative that the Fed sees more inflation on the horizon and wants to get in front of it or continued emphasis that the FOMC needs room to act in the event of another slowdown. The latter explanation would flatten the curve more quickly – especially in the absence of inflation to back it up. We’ve glibly made the assertion that the market is expecting a December and March rate hike and if the data doesn’t cooperate by Q2, we might be in for a rethink.

16 Nov 2017

Economic Desknote US US Inflation Watch: Back on the reflation track? •

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That isn’t an entirely fair statement and while that might be our base-case assumption, the market is pricing in lower odds of a December and March rate-hike combo. In fact, using the April 2018 Fed funds contract (clean/non-meeting month), we see that 36.5 bp of tightening is priced in – a December move and 46% odds for March. If our logic holds and December sees another quarter-point hike and March is subsequently priced-in (say to 90%) early in Q1, that would put 2-year yields up 25s bps to 1.96% -- ask for details if you’re interested in our OIS assumptions. It goes without saying that unless we get a comparable selloff in 10s, chatter about an inverted 2s/10s curve in 2018 won’t be such an outlier call. We’re left to ponder if the last four rate hikes haven’t triggered a selloff in 10s, why should lucky number five?

TY and US 5-day moving-average Daily Sentiment Indicators vs. Yields

CPI inflation in October delivered just the second non-disappointment over the last eight months, joining August’s 0.25% outturn. Overall, the October CPI release has the look of a “back-ontrack” print, with no drag from core goods prices and core services prices accelerating to a near 0.3% m/m pace. A likely hurricane-induced pop in used car prices put core goods at 0.05% m/m – its first positive print since January 2017. Core services rose 0.28% m/m, in line with our expectations. The Fed has, at times, flagged inflation weakness as a concern, but this non-disappointment should be a welcomed development that keeps them on track for another rate hike in December.

16 Nov 2017

Global Rates Plus Trading US-EU carry convergence Global: US vs EU volatility vs carry EU volatility should rise as quantitative easing draws to a close, and the current US-EU volatility differential allows a cheap-to-carry US-EU convergence trade, because the volatility spread can be used to offset the rate carry cost. Eurozone: 2018 EGB supply vs QE: Forecast update We expect the flow of European government bonds to the private sector to increase by EUR 225bn in 2018. While Italy will remain the largest issuer to the private sector in 2018, the increase from 2017 will be smaller in Italy than in France,

Germany or Spain. UK: November Budget preview We expect the deficit to widen, putting pressure on gilts to cheapen in ASW. With rising political and economic uncertainty, however, we favour keeping our short 10y gilt ASW recommendation as a tactical recommendation into the Budget.

US: Falling flat The yield curve is at its flattest − and vol at its lowest − in nearly ten years. Vol remaining lower for longer fits with our portfolio of vol trades, which are short gamma and long vega.

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2s10s swap curve and 1y10y bp vol. The R2 is 82%. Financial crisis (2008-2009): There is less correlation and a much lower R2 (37%). 1y10y bp vol was 160bpv when 2s10s swaps was at 80bp, but also when 2s10s swaps were 260bp in these two years. Post-crisis, QE (2010-present): The 2s10s swap curve versus 1y10y bp vol correlation looks pretty strong, but we note the 2s10s swap curve is 40bp steeper in the current regime than the pre-crisis regime with the same level of 1y10y bp vol (66bpv).

The yield curve is at its flattest−and vol at its lowest−in nearly ten years, in bellwether points on the curve at least. Market discussion of the 2s10s UST curve falling to fresh lows (64bp) is widespread.

The Fed is hiking very slowly, which is keeping vol on shorter tails extraordinarily low. While the 2y UST marches higher, as tightening is realised, the 10y UST has range traded for all of 2017.

The 2s10s swap curve would likely be at nearly ten year flats as well, if swap spreads had not been so negative in 2016. The 2s10s swap curve is currently at 45bp, but bottomed at 38bp in August 2016. Both 1y10y and 5y5y swaption vols are at nearly ten-year lows (top chart).

With the long end of the curve mean reverting, vol on long tails has fallen. We continue to expect Fed balance sheet reduction to lift rates, term premium and vol, but until then the curve and vol may continue to flatten. Vol remaining lower for longer fits with our portfolio of vol trades as the 1y1y receiver ladder and 6m10y payer ladder are both short gamma. The 5y5y atmf payer and 5y2s10s CMS cap are longer-term strategies and should be insulated by the ladders to some degree. MBS: House vs Senate tax plans We view both the House and Senate tax reform plans as generally negative for housing (particularly for the jumbo market), but positive for MBS.

Historically, the level of the curve and vols have been correlated. The financial crisis period clouds the long-term relationship between vol and the curve, so we have sliced the last 15 years into three periods (lower chart): 

Pre-crisis (2002-2007): There is a clear positive correlation between the level of the

Japan: Early start to JBZ7 JBH8 roll We think the scarcity of the front contract CTD (JB336) is likely to attract more of a premium for JBZ7 into the roll until its expiry date (13 December). While the back contract CTD (JB338) is equally scarce, the market usually only assigns a premium close to the expiry date.

Macro Matters 16 November 2017 BIG PICTURE: Macroeconomic implications of Bitcoin Price gyrations in crypto currencies are suggestive of a bubble. But bubbles, like the earlier tech bubble, are often based on a solid foundation, in this case blockchain technology. Crypto currencies are probably here to stay. THEMES OF THE WEEK Eurozone: Boom time Activity data are increasingly surprising to the upside. A variety of indicators suggests that the strength will persist through the end of the year. The ECB’s September projections now look too cautious.

US: Mining over matter With crude prices expected to be more or less flat next year, we see energy investment and production decelerating with firm domestic demand supporting non-energy production. Japan: Importing labour Migrant labour has accounted for about 20% of the labour force growth since 2012, much of it due to trainees or students. If foreign labour’s share keeps growing, higher wages and inflation could be delayed further. South Africa: Risky business Event risk will be elevated next week by key inflation data on Wednesday, the central bank’s rate decision on Thursday and two scheduled sovereign ratings reviews on Friday. Mexico: Risks from FX to inflation The MXN is unlikely to prevent inflation from falling in 2018, in our view. We think the bar is high for a rate hike. Other tools to curb MXN look more likely, if needed.

16 Nov 2017

Global FX Plus - Commodity FX Update: Stick With Rates

Risk index update: From caution to possible relief 

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Market risk has corrected from record low levels, according to our updated risk models, and is now at neutral levels. We think there could be further price correction, but to a lesser extent than in the past three weeks. We closed one of our hedge trades (call spread USDBRL 3.17x3.35) on 14 November, recommended in September to take advantage of the low vol environment.

 Our risk index is now available in Bloomberg with the code . The risk premium model is also in Bloomberg with the code . …Risk and risk appetite We assume that risk is structural, while risk appetite is cyclical and changes rapidly. Driven by agents` expectations, the self-supporting nature of upswings and downturns could reflect the fact that during an upturn (a period of high or rising risk appetite) high levels of return easily spring to mind, and the possibility of a crisis is a more distant memory. Conversely, during a decline, the probability of economic distress is given an excessively high weight by investors. Risk appetite falls, safe havens are increasingly in demand and higher premia for risky assets are demanded. To proxy for risk, we constructed an index, using the weighted average of the sixmonth rolling z-score of the following variables: a) equity implied volatility (US, Emerging Markets, Europe); b) yield spread between Baa and B rated corporate bonds; c) the gap between the performance of carry and funding currencies; d) USD European swaption vol ATM OIS discount versus US0003M index 3MoX10Yr; e) average of 2y, 5y and 10y US swap spreads; f) an index of EM government local currency rates performance; and, g) the implied volatility of the global risk free rates.

Weekly FX key themes: EUR squeeze presents opportunity  

We do not expect this week’s squeeze in the EUR to extend much further. US tax reform is still underpriced, in our view. There is plenty of scope for 2018 Fed hike expectations to adjust higher.

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We maintain our bearish GBP view.

The probability of a reversal (market sell-off due to economic agents appears high in the short term,

according to our risk index. Not only was the level of risk historically low but the duration of the cycle was the second-longest since 2010 (Chart 3; January 2017 until now)…

US Rates at the Bell November 16th, 2017 Recap & Discussion:

Asia and Europe did the heavy-hitting today, as TY fut’s barely scratched out a 5-tick range from 8:30am to 3:30pm EST despite the densest data slate of the last two weeks in addition to the successful passage (227-205) of the House GOP tax bill. Indeed, more than 40% of the day’s volume came prior to the NY handoff, while early block sales in futures and ED$ ($480k DV01 FVUS steepener stop-out, 2k TYH8 sale, EDZ8 screen hits after 3ML higher set, and 140k Dec mid-curve 97.875 puts) set the bearish tone early on as European supply from Italy/Spain was welldigested. On the follow, the sharp rebound in domestic shares and tightening of credit spreads saw limited sympathy in the Treasury complex, with the academic rumblings of “radical policy review” at the FOMC plausibly sedating the curve, which closed modestly steeper across the term-structure. In risk-assets, the reversal in fortunes was largely attributed to discounting of stimulus (fiscal domestically vs. monetary in China), as the House Tax Bill hopped a rather low-bar in its passage, while the PBoC injected a 10-month high 820 billion yuan this week. …On the more academic end of the news spectrum, the Fed’s Mester and Kaplan notably joined the growing chorus of policy-makers pushing a pre-emptive policy review/change as Janet Yellen’s term comes to a close. Circumventing what many have suggested is a

push towards higher inflation price-level targeting, Mester stated that “rethinking of the inflation target relatively soon is a good idea”, while Kaplan said that he generally endorses “reviewing Fed governance, frameworks, targets and small bank supervision” in the near-future. Kaplan, also breaking with recent comments/concerns over the yield curve, stated that he “can see the yield curve getting flatter”. On the prospect of a hypothetical 3% inflation target, we think that given the lack of evidence that the Fed can meet its current 2% target on a sustainable basis, such a proposal will only be more corrosive in regards to policy credibility. Additionally, wouldn’t the achievement of a higher inflation target require an even more accommodative policy stance than currently employed (i.e. even lower real rates?). Our advice, if anyone from the committee or staff is listening, would be perhaps to focus policymaker’s efforts on changing the current inflation measurement rather than index targetlevels, as we can’t deny the salient influence of global QE and unconventional policy has been the inflation of financial assets versus relatively stable to falling prices for physical and virtual goods/services. 16 Nov 2017 17:08:12 ET

European Rates Weekly When will volatility regime shift? Is the recent bout of volatility temporary or a sign of things to come? Our measure of Fed policy stance leads VIX by 2-yrs and points to this becoming a more common feature. Further rate hikes should reset volatility towards a higher regime. The ECB policy stance is getting looser as growth pushes up neutral rates and reinforces bear steepening in 2018. 10yr Bunds trade below our latest ECB nominal neutral estimate. …It is not useful to define the policy stance in reference to real rates because the neutral real rate is time-varying. We addressed this

issue in our note, Global Rates Focus: What is the right level of interest rates?

nonetheless still impressive as a tool to think about strategic volatility regime shifts.

In the analysis below we use a slightly different model because the data spans a much longer timeframe from 1990 (not 1999). We define the nominal Fed neutral rate as the FRBSF real neutral rate (r*) plus inflation expectations which are now taken from the Michigan 5-10yr ahead survey (not the 5y5y breakevens cleansed of liquidity and other impurities that we used in the study cited above). The neutral nominal rate is then simply the sum of r* and inflation expectations, and finally the policy stance is the 2y yield gap to our time-varying nominal neutral Fed rate.

4. The Fed policy stance leads the VIX by around 2-year and

Figure 3 below shows that the policy stance

The takeaways are that rising pockets of volatility should become more common on the basis of the baked-in lagged impact of the tightening in the policy stance. We think investors should be more mindful of risk asset volatility as the Fed moves past neutral - which is not that far away at roughly 1.5%. That’s when we would watch for persistently higher volatility.

maps the yield curve very well and gives us confidence that the measure of the Fed nominal neutral rate is in the ballpark of being correct. 3. Measuring the Fed policy stance – our measure tracks the yield well and so makes us confident that it is a useful measure.

That is our reference for when to move on outright long Vol trades. For now, long Vol is best expressed in long-dated payer swaption positions such as 20y20y ATMF, enjoy positive rolldown, as detailed last week in European Rates Weekly - The game plan.

16 Nov 2017 12:58:32 ET

Global Macro Strategy Our estimate here of the nominal neutral Fed rate is 1.4% but based on the methodology in our previous analysis the nominal neutral rate currently stands at 1.6%. This is why we refer to the estimate as being in the right ballpark because some modest variations in estimates are possible. Figure 4

shows the correlation of our policy stance to VIX, where the policy stance (validated by the yield curve) leads VIX by around 2-yrs. The fit is not perfect but

Weekly Views and Trade Ideas – Macro View On EM Fixed Income With markets noisily flip flopping, in this Weekly we take a macro look at EM fixed income markets, an area of client focus recently. We present an analysis of EM local and external debt from a macro perspective, using UST yields, broad USD trends, HY credit, EM specific risk appetite and flows as the potential drivers. We find that when EM specific risk appetite is strong, investors move more into EM external,

observable in both price action and flows, possibly a function of the relative ease to trade EM external compared to local debt.

maturities and the Bund contract is further balanced by an extended short swap position (-2.6). 16 Nov 2017 10:32:53 ET

Otherwise, in determining the relative performance between EM local and external, we find that risk appetite, the broad $ and US yields are important considerations.

Weekly Supply Monitor

In the current backdrop, given our bearish medium term view on the USD, and risks to modestly higher yields on the basis of tax reform, the outlook perhaps is more constructive for local debt. And interestingly, our regression also suggests EM external is too strong relative to EM local.

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16 Nov 2017 15:01:56 ET

US Rates Strategy Flash TIC data: Purchases in September TIC data released this week for September showed that foreign holdings increased by $46 billion in long-term Treasury securities, after August holdings increased by $25 billion. These figures are reported at market value.

On a valuation adjusted basis, we estimate foreign holders bought $112 billion of longterm Treasury securities, after selling $12 billion in August. Foreign holdings of T-bills increased by $10 billion in September after a decrease of $7 billion in August.

Euro, UK and US Supply Outlook EGB supply next week is scheduled from Finland (upto €1bn) and Germany (€1bn). There are €1.8bn of coupons (majority from France) and no redemptions eligible for reinvestment next week.

 The US Treasury will issue around $13bn of 2yr FRN next Tuesday. There are no UST cash flows eligible for reinvestment next week. 

The UK DMO will issue £1bn of IL26 next Tuesday. There are £0.8bn of gilt linker coupons and £16.3bn of linker redemptions that are eligible for reinvestment next week.

US net cash requirement (NCR) over the next 4 weeks On a settlement date basis, the NCR is nonsupportive for USTs as there is $13bn of gross supply but no cash flows settling over this period (Figure 20) 20. US weekly cash flow profile for next four weeks, USD billions

16 Nov 2017 08:55:46 ET

RPM Daily Back with New Longs •

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Summary: Neutral cash (-0.1) / futures (0.0): New longs in core (UST/Bunds) and cross markets (JGB, ACGB, Canada). Normalised 10y sector positioning is long European periphery (Italy/France) and UK against short UST. In North America – $12.7m DV01 in new longs across the curve with half continuing the long extension in WN (now 2.5 normalised). The other half halts the one-sided short action in the shorter end of the curve in the beginning of the week. The dollar libor strip also saw $2.0m new longs, but a reduction in shorts on the reds. In Europe – mild long cash / short futures in Germany: The market is still positioned in futures for flattening with longs in RX vs small shorts in DU/OE. However, the cash market appears short at all three

16 Nov 2017 22:37:17 ET

Japan Rates Weekly Reexamining factors driving market movement •

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Much of the change in the market during FY17 is explained by the repo rate, the level of the 10y bond, and the level of US Treasuries. The macro hedge function of bonds appears to remain weak, but it is necessary to note the potential impact of risk assets on super-long bond yields. We think there could be a correction in the 30y and 40y sectors, which have been strong, within the month.

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We are looking to enter a 20s30s JGB steepener. Please note that the next edition of this weekly will be published on December 1.

16 Nov 2017 22:27:33 ET

Japan Economics Weekly

16 November 2017

Updating our economic forecasts

US Economics: The Week Ahead

Our core view remains intact We are fine-tuning our forecasts for the Japanese economy. However, our core view on the economy remains the same: solid growth and subdued inflation (even in the context of tightening labor markets) will likely continue through the first half of 2019 before the negative impact from the consumption tax hike (slated for October 2019) kicks in. We expect real GDP growth of 1.5% for calendar 2017, another 1.5% for calendar 2018 and 1.1% for calendar 2019.

Inflation likely to remains subdued Despite continued above-trend growth that we anticipate, core inflation (i.e., excluding just fresh food) is likely to stay subdued, especially when the direct impact from yen depreciation and higher oil prices is excluded. We expect core inflation of 0.8% for calendar 2018 and 0.7% (adjusted for the tax hike) for 2019.

The government looks unlikely to declare an end to deflation This week, there was a lot of talk in the financial markets about the possibility that the government will officially declare an end to deflation in the not-too-distant future. We are highly skeptical about this possibility.

16 Nov 2017 23:25:13 ET

Emerging Markets Strategy Weekly Should We Worry About China Again? •

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Anxiety about China is creeping back. The main concern in China is that regulatory tightening could accelerate the expected slowing in economic momentum. We believe in the short run, China may prove to be another headwind for emerging markets, but not a storm. Asia: India: Relief rally on the cards – While the downtrend in yields may have broken, a relief bond rally seems likely with rating upgrade by Moody’s. CEEMEA: We are concerned with a few important aspects in the current market dynamics: 1) the recent disappearance of the classic RM marginal buyer on short lived weakness and 2) the slowing of passive inflows over the past 2 months. LatAm: The macro setup over the past month hasn’t been terrible for EMFX, yet performance has disappointed. Oil matters less than US rates. Idiosyncratic stories have also weighed on EM. We expect a slightly negative environment for EM in the near-term.

Next Week's Highlights The FOMC minutes, durable goods orders, and existing home sales are next week’s key releases. The markets will be closed on Thursday for Thanksgiving Day. The FOMC minutes are likely to tilt a bit more dovish on the inflation front as the November meeting occurred before the recent pick-up in inflation data. The most recent minutes from September showed that “many” participants are concerned that low inflation readings could prove more persistent, with a few arguing for a delay in further rate hikes. This concern likely increased in the November minutes. We would also pay close attention to any discussion on financial conditions, and specifically the impact of tapering reinvestments and the low level of volatility. We expect headline durable goods orders to rise by 0.2% MoM in September after a 2.0% increase in September. Ex transportation, we expect orders to rise a solid 0.6% MoM after three consecutive months of large gains. We expect business investment to be a key driver of GDP growth going forward. We expect existing home sales to increase 1.1% MoM for October. Pending home sales based on contract signings suggest little change in existing sales. However, we expect a pick-up in closings as the market recovers from some of the delays due to recent hurricanes.

17 November 2017

Japan Economic Adviser: Zero real wage growth in a zero productivity growth world Real hourly wage has been virtually unchanged under Abenomics (+0.1% annualized for 1Q 2013-3Q 2017), as indeed has labor productivity (+0.0%). A rise in GDP deflator has been almost fully responsible for nominal hourly wage growth (+0.5% annualized) under Abenomics. 16 November 2017

European Economics: Macronomics Emmanuel Macron, the recently elected president of France, has an absolute majority in parliament to implement his political program.

What is Macron proposing? Is it substantive? Macron has set out an ambitious reforms plan (Appendix 1) aimed at: • Reducing unemployment through more labour market flexibility. • Boosting competitiveness through productive investments and tax cuts. • Improving public finances through gradual fiscal consolidation. We argue that his program has the potential to be substantive as it is tailored to tackle some of France’s biggest weaknesses: • Labour market: unemployment rate among the highest in the EA. • Competitiveness: falling export performance relative to EA countries. • Public finance: highest public expenditure out of all OECD countries. Will he be able to deliver? He has already started to. After just five months in office he has implemented a set of new labour market reforms, put an end to the wealth tax, and approved the 2018 budget ‒ all the while avoiding disruptive popular protests. Will this last? We think so ‒ but he might deviate from his initial program: • Macron is likely to focus more on reforms than reduce public spending. For three reasons: reforms lead to more-short term growth, are easier to implement in a good economic environment, and are politically more acceptable than cutting spending. Thus, reforms are more important than fiscal consolidation from our perspective. • Macron’s very low approval rating could lead to more “social friendly” policies and less public expenditure cuts. • Macron’s failure in the Senate election might block him from making constitutional changes.

Why does it matter? Firstly, reforms should be good for France economy and, secondly, Macron’s ultimate goal is to revive France’s role as co-leader of the EU with Germany and implement his EU vision. In the past, many French and German leaders have had very good personal entente. However, since Jacques Chirac, the Franco-German relationship has somewhat deteriorated from what it used to be and resulted in Germany, most likely unwillingly, rising to a politically dominant position in the EU. As such, Macron wants to reshape the FrancoGerman relationship, for which he will need to (1) resume France political leadership, (2) implement a set of new reforms, and (3) close the gap between the French and German economies.

Deutsche Bank 17 November 2017

Early Morning Reid Macro Strategy For the first 41 years of my life I was always a bit confused about how family life could be so expensive for those that had them. My impression was that parents spent way too much on their kids and associated lifestyle. 2 and a bit years and 3 children later I’m now realising my naivety. As an example I get home last night to find out from my wife that the school we have chosen for all three of our children requires a £1000 deposit each now to secure their place in 2 and 3 years’ time respectively. It’s not a stand-out, in high demand school but a good all round friendly low pressurised one with good facilities. I begrudgingly said that although that was annoying we would at least have it taken off the first terms fees. How wrong I was. The deposit is only refundable when they leave the school at 11! So basically I’ve bought a 10 year zero interest bond at a time when I’ve recently published a note suggesting that in a decade’s time we may have seen the end of fiat money (link) after pretty high inflation due to the end of the demographic disinflation dividend. I did ask my wife whether we could pay with Bitcoin. Alas no! Anyway it’s a good way of advertising the note we published a couple of weeks back…. … Moving onto central bankers’ commentaries. In the US, the Fed’s Mester sounded reasonably balanced and remains supportive of continued gradual policy tightening. She noted “anecdotal feedback from business contacts suggest they are increasing wages”, but it’s going to be hard to see strong wage growth because productivity growth is low. Overall, she sees “good reasons” that inflation will rise back to 2% goal, but “it’s going to take a little longer…” The Fed’s Williams noted one more rate hike this year and three more in 2018 remains a “reasonable guess” subject to incoming data. Finally, the Fed’s Kaplan reiterated the Fed would continue to make progress towards achieving its 2% inflation target, but noted that the neutral fed funds rate is “not that far away”.

… Away from the markets, our US economists have published their latest

outlook for the US economy. They note the US economy is on good footing for continued above-trend growth in 2018 and beyond. Overall, they believe private sector fundamentals are broadly sound, the labour market has more than achieved full employment and financial conditions are highly supportive of growth. On real GDP growth, their forecast for 2018 is unchanged at 2.3%, but 2019 is up a tenth to 2.1% while growth in 2020 is expected to slow to 1.5% as monetary policy tightening gains traction. The Unemployment rate is expected to fall to 3.5% by early 2019, so although inflation should remain low through year-end, our team’s medium-term view that core inflation should normalise is intact. Hence, in terms of rates outlook, they still expect the next rate increase in December, followed by three hikes in 2018 and four more in 2019. Elsewhere, tax reform is a wild card, though it faces significant political challenges. Conversely, potential disruptions to trade policy would be a negative development. For more detail, refer to their note.

wage and price inflation, and Fed policy. We conclude with an analysis of risks and possible scenarios for the termination of the current cyclical expansion over the medium term

■ As

2017 draws toward a close, the US economy is on good footing for continued above-trend growth in 2018 and beyond. Private sector fundamentals are mostly solid, the labor market has more than achieved full employment, and financial conditions are highly supportive of growth. The primary quandary in the economic picture is where is inflation? ■ We continue to expect real GDP growth of 2.5% for 2017 (Q4/Q4), in line with the above-consensus forecast we presented around mid-year. A key development has been a broadening of growth drivers beyond consumer spending, as capex and trade have strengthened in recent quarters. Our

2018 forecast is also unchanged at 2.3%, while we raised our 2019 projection a tenth to 2.1%. We expect growth to slow significantly in 2020.

16 November 2017

US Economic Perspectives US Outlook: A firmer Fed to keep the economy from overheating Peter Hooper, PhD •

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As 2017 draws toward a close, the US economy is on good footing for continued above-trend growth in 2018 and beyond. Private sector fundamentals are mostly solid, the labor market has more than achieved full employment, and financial conditions are highly supportive of growth. The primary quandary in the economic picture is where is inflation? We present our outlook for the US economy over the next three years, including a first look at 2020. In particular, after discussing recent developments, we then assess what is known at this juncture about the possible shape of fiscal, regulatory and trade policies as they could affect the economy in the years ahead. Next we outline our expectations for growth in the real economy, including the key elements of both aggregate demand (GDP) and aggregate supply (potential GDP). This is followed by discussions of the outlooks for the labor market,

■ With

growth above potential over the year ahead, we expect significant further labor market tightening. Contrary to the FOMC median and consensus, which see unemployment leveling off at just above 4%, we have it falling to 3.5% by early 2019. It should begin to rise again in 2020. ■ Although inflation should remain low through yearend, our mediumterm view that core inflation should normalize is intact. Supporting this constructive outlook are positive signals from a variety of leading indicators including real GDP growth and import prices, among others. We also discuss a few structural forces that may weigh on inflation. ■ Our

Fed view is unchanged: we expect the next rate increase in December, followed by three hikes in 2018 and four in 2019. This expectation is above the Fed’s projections, as above-target inflation and an undershoot of unemployment below NAIRU force the Fed to raise

rates further than the median FOMC projection envisions. Fed tightening should be sufficient to begin to move unemployment back toward NAIRU by 2020. ■ The

most notable recent Fed development is a near-wholesale transition in leadership. Jerome Powell's nomination for Chair should represent a good degree of continuity for monetary policy, though consensus may be more difficult to forge if uncertainty lingers about inflation.

■ Potential

policy changes in Washington represent the greatest uncertainty to this outlook. Regulatory reform has already given animal spirits and private spending a lift. Tax reform is an important wild card, though it faces significant political challenges. Conversely, potential disruptions to trade policy would be a negative development.

16 November 2017

Euroland Strategy - Year end technicals and 2018 flows •

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…As the balance sheet shrinks, this should put upward pressure on the term premium on longterm bonds, which remain near record low levels even though the Fed has already started the taper of its reinvestments (Figure 42). Fed staff estimates suggest that the term premium should rise by about 15bp in each of the next two years due to this balance sheet unwind (Figure 43).

Repo rates richened considerably into year-end 2016. Structural risk factors such as regulations and associated window dressing as well as collateral scarcity remain in place However, market awareness has risen, cash use as collateral in the ECB's securities lending programme has increased and diminishing quarter-end price distortions through this year suggest that any yearend repo squeeze will be of lower magnitude than seen last year We look to the 2018 outlook for supply, cashflow and ECB buying trends, where France and Spain in particular will see headwinds Germany, on the other hand, continues to be well supported, with further accommodation provided by (a) the skew of reinvestment flows and (b) the expected increase in the purchase maturity We update our Bund scarcity analysis, highlighting the declining room for further front end purchases which can support longer dated cash We stay short 5Y Germany, maintain 5s30s flatteners in Germany vs. Eonia and EUR 10s30s flatteners vs. US. In semi-core we stay short 5Y France on the credit fly against Germany and Italy (67%,33%) and in the periphery maintain Spain 5Y15Y steepeners against Portugal.

16 November 2017 | 2:27PM GMT

Global Viewpoint: Top Trade Recommendations for 2018 We present the first seven of our recommended Top Trades for 2018. These trades represent some of the highest conviction market expressions of the economic outlook we laid out in the latest Global Economics Analyst and the related investment themes we discussed in our Global Markets Analyst.

Top Trade #1: Position for more Fed hikes and a rebuild of term premium by shorting 10-year US Treasuries. Go short 10-year USTreasuries with a target of 3.0% and a stop at 2.0%. We forecast that the yield on 10-year US Treasury Notes will head towards 3% next year, levels last seen before the decline in oil prices in 2014. By contrast, the market discounts that 10-year yields will be at 2.5% at the end of 2018, a meagre 20bp above spot levels. Our view builds on two main assumptions. First, QE and negative rate policies conducted by central banks in Europe and Japan have amplified the fall in the term premium on bonds globally and have contributed to flatten the US yield curve this year – a central ingredient in our macro rates strategy for 2017. As a result of this, we think that US monetary conditions are too accommodative for the Fed’s comfort in light of the little spare capacity left in the jobs market. This will likely lead the FOMC to deliver policy rate hikes in excess of those discounted by the market (Exhibit 1). On our US Economists’ baseline projections, Dec 2018 Eurodollar futures, trading at an implied yield of 2.0%, will settle at 2.5%. Second, we expect a normalization in the US bond term premium from the current exceptionally low levels over the coming quarters (Exhibit 2). This will reflect the compounding of two forces. One is an increase in inflation uncertainty as the economic cycle continues to mature. The other reflects the interplay of the lower amount of Treasury bonds that the Fed will roll over (quantitative tightening, QT) and higher Treasury issuance. We expect these dynamics to come to the fore particularly in the second half of the year.

Top Trade #2: Go long EUR/JPY for continued rotation around a flat Dollar. Top Trade #3: Go long the EM growth cycle via the MSCI EM stock market index. Top Trade #4: Go long inflation risk premium in the Euro area via EUR 5-year 5-year forward inflation. Top Trade #5: Position for ‘early vs. late’ cycle in EM vs the US by going long the EMBI Global Index against short the US High Yield iBoxx Index. Top Trade #6: Own diversifed Asian growth, and the hedge interest rate risk via FX relative value (Long INR, IDR, KRW vs. short SGD and JPY). Top Trade #7: Go long the global growth and nonoil commodity beta through long BRL, CLP, PEN vs. short USD.

16 November 2017 | 9:21AM EST

Global Markets Analyst: Top Ten Market Themes for 2018: LateCycle Optimism Our Top Ten Themes for 2018: 1. Global Growth: Stable and Synchronized 2. DM Monetary Policy: No Motive for Murder

3. Drawdown Risk: Bear-Market Warning Signs 4. Emerging Markets: More Room for Growth 5. China: A Well-Managed Slowdown

We expect this aspect to be modified further and, more generally, we expect that many lawmakers are likely to seek changes to the bill in return for their support. We note that some lawmakers who opposed the health legislation earlier this year, including Sen. Johnson, ultimately supported it after changes were made.

6. Global FX: Soggy Dollar 7. US Policy Risks: If It Rains It May Pour 8. Bond Term Premia: Gradual Normalization 9. European Risk: Preparing for a Post-Draghi Euro area 10. Late-Cycle Imbalances: Illiquidity Is the New Leverage 16 November 2017 | 10:45AM EST

USA: Industrial Production Strengthens; NAHB Homebuilder Index Rises Further; Q4 GDP Tracking Up to +2.5% BOTTOM LINE: Industrial production strengthened more than expected in October, reflecting normalization in industrial activity following the recent hurricanes. Growth in the third quarter was revised up by 1.2pp cumulatively. We revised up our Q4 GDP tracking estimate by one tenth to 2.5% (qoq ar). The NAHB housing market index edged higher in November. Following this morning’s data, our November Current Activity Indicator moved up to 4.2%

16 November 2017 | 6:13PM GMT

European Economics Analyst: European Outlook: Good growth, feeble inflation, persistent policy 

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16 November 2017 | 8:10AM EST

US Daily: Tax Reform: More Changes Are Likely, But the Odds of Enactment Are Still High (Phillips) 

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We recently raised our subjective odds of enactment of tax reform to 80%, but developments since then have prompted questions as to whether the probability has decreased. We don’t think so. Two developments in the Senate have generated renewed concern in financial markets regarding the prospects for tax legislation, in our view. First, repeal of the individual mandate to purchase health insurance has been added to the Senate bill, which generates more than $300 billion in savings. It is possible that centrist Republicans could oppose this, given their opposition earlier this year. However, we do not expect tax reform to be blocked due to the mandate. We expect that Senate Republican leaders have an indication of sufficient support for including repeal. More importantly, they can remove mandate repeal if it threatens passage. Second, the modified Senate bill makes corporate reforms permanent while setting individual and small business tax cuts to expire after 2025. Senator Johnson (R-WI) announced opposition to the bill over what he views as disparate treatment of small businesses and corporations under the proposal.

A combination of rising domestic and global demand, reinforced by a greater-thananticipated capacity of European labour markets to absorb slack, has seen growth outperforming forecasts in Europe. We upgrade our near-term growth profile to reflect this dynamic, but think the acceleration of activity is already behind us, and expect the path of sequential quarterly growth to moderate from mid-2018 onwards. Euro area inflation will remain substantially below-target over our forecast horizon. German inflation and wage growth remain moderate and, through the structural ‘German inflation cap’, should contain area-wide price developments.

 We remain dovish on the ECB. Our modal forecast is for a 20bp deposit rate hike in Q4 2019, although we see risks skewed towards an earlier hike. We expect the ECB to use its still open-ended asset purchase programme primarily as a communication device for bolstering forward guidance on rates, with purchases continuing until end-2018. The ECB will retain a substantial presence in the market subsequently via reinvestment of the proceeds of maturing bonds in the APP portfolio for the foreseeable future. 

Continued central bank policy accommodation in the face of persistently low inflation risks a build-up of financial imbalances and risks. Over our forecast

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horizon, this will become a more prominent concern of policy makers, particularly in light of stronger activity growth. The debate surrounding the role of monetary policy in securing stable financial conditions will likely re-emerge, and the efficacy of macroprudential policy to constrain such risks be questioned. This implies some hawkish risks to our policy forecasts, especially in Scandinavia and the Euro area core. In the UK, growth remains strong as consumers demonstrate continued resilience in the face of Brexit risks. We expect inflation to remain above target for several years to come on the back of Brexit-related Sterling depreciation The UK outlook thus remains sensitive to news on the outcome of Brexit negotiations. Our base case remains that a “status quo” transitional deal paves the way to containing uncertainty and thereby to a gradual tightening of both monetary and fiscal policy. Scandinavia faces many of the issues highlighted in the Euro area outlook, but at a more advanced stage. Growth has run substantially above potential for some time in Sweden, where a significant positive output gap now prevails. By contrast, Switzerland is lagging continental Europe, and will likely remain reactive to the ECB. We continue to characterise European populism as a fundamental driver of European political dynamics. The underlying appeal of populism is tied to socioeconomic and cultural factors, which are not likely to dissipate in the medium term. This said, we expect a more benign start to the 2018 political calendar compared with 2017. Drawing on these themes, our updated "conviction views" are: (1) Euro area core inflation will remain below target over our forecast horizon; (2) the ECB will keep policy rates on hold until H2 2019; (3) the BoE will hike more than two times over the coming three years; and (4) a Brexit transition deal will be reached, but on the EU-27's terms.

Our updated European forecasts

… but inflation will remain stubbornly low …

… leading the ECB to remain accommodative…

… with implications for financial stability 17 November 2017 | 2:41AM EST

Americas Energy: Oil: The three D(river)'s of oil stocks: Discipline, Disruptions and Demand -- how long can the sweet spot last? Energy equity sentiment may continue to improve until the three forces that have driven the recent strength in oil prices/stocks -- stronger Demand, greater Disruptions and improved perceived Discipline -- reverse. Demand data may stay positive through 1Q18 due to favorable comps; shale capex decisions/productivity gains and OPEC's messaging on extending vs. ending production cuts (we preview the 11/30 meeting) are key. With front month oil futures slightly above the upper end of our $45-$55 per bbl range we remain focused on stocks with favorable FCF/incremental corporate returns vs. those that need higher oil prices. We highlight areas where we differ from consensus in EOG, SU and OXY (upgrade to Buy, add to CL).

November 16, 2017

JEF Economics

Primary Dealer Positions: New Supply Fuels Treasury Positions In the week ended November 8th, Primary Dealer positions rose $24.7 bln to a net long of $266.9 bln

from $242.2 bln. Treasury positions jumped almost $20 bln, accounting for most of the week’s total increase as Treasury auctioned 3s and 10s ahead of the reporting date. Positions in other asset classes were relatively little changed outside of a $3.4 bln increase in MBS positions. …Treasuries Overall Treasury positions rose $19.977 bln to a net long of $117.5 bln. Overall coupon positions rose $13.7 bln to a net long of $76.8 bln. Bill positions rose $7.4 bln to a net long of $28.6 bln, reflecting the significant increases in market supply over the past month. TIPS positions rose $543 mln to a net long of $9.3 bln, and FRN positions fell $1.6 bln to a net long of $2.8 bln. Coupon positions were mixed across the curve but reflect the sort of activity expected during an auction week. The biggest increase was in short coupons as they rose $5.4 bln. Positions in the 2- to 3-year sector rose $3.7 bln and positions in the 7- to 11- year sector rose $2.5 bln after the 3- and 10-year auctions. Positions in the 3- to 6- year sector, which collapsed $13.5 bln in the prior week, were close to unchanged this week, down $58 mln

November 16, 2017

US Economics & Rates Strategy Treasury Market Commentary, November 16 Treasury yields reversed yesterday's move and sold off in a risk-on session. The tax reform bill passed the vote in the House, setting up for the Senate vote after Thanksgiving. 10Y yields closed at 2.38%. …GDP tracking After incorporating upside in equipment investment from this morning's industrial production report, we raise our 4Q tracking estimate to 3.6% (from 3.5% previously).

November 16, 2017

FX Pulse: EUR: The Comeback Kid Fade the risk sell-off. Risk assets sold off over the start of the week but have since reversed, supporting our view that we should not see market risk sentiment materially wane in an environment of strong global growth and ample liquidity. This supports EM FX, particularly against the USD, which should weaken as capital flows out of the USD and into higher yielding environments. EUR crosses remain attractive. The rally in EUR should continue, with the growth outlook in Europe remaining positive as evidenced by strong German GDP and Eurozone trade figures. EURCHF remained well supported despite the decline in risk assets, suggesting the balance of risks for the pair are markedly to the upside. EUR should outperform regional peers including GBP, SEK, and NOK.

US politics to get turbulent. While investors have been squarely focused on the prospects for tax reform, we note that market attention will shift soon to the US debt ceiling and appropriations debate ending December 8. Historically, USD tends to appreciate during these periods as risk sentiment temporarily wanes, though we believe this offers an opportunity to re-enter USD bearish positions. Watch Brexit negotiations closely. Prime Minister May's proposal for the final exit bill to the EU should be watched carefully. The May government walks a fine line between an exit bill high enough to appease EU member states but low enough to assuage Tory party members. A false step could raise the risk of Tory party schisms and early UK elections. EURGBP longs should profit in this environment. Long EM. We have held on to our EM positions throughout the volatility. The only one on which we were stopped out was our short USD/RUB position and the other crosses have been resilient. Short USD/MYR and short USD/CLP have been resilient and with positioning cleaner across higher beta crosses, we think the asset class is much better placed to stabilize, with growth and valuations still supportive

Bottom line: EUR crosses should trade higher as the Eurozone growth recovery continues and the current spike in volatility is expected to be temporary. Interestingly, EURCHF has stayed supported even as equity markets weaken, giving us confidence that this pair is going to continue to rise. USDCNH has remained below a key resistance area at 6.60 and with the PBoC guiding markets towards RMB stability, the USD's upside is limited, we feel. We stay short USDEM.

November 17, 2017

FX Morning Daily Commentary, 11/17 G10 FX: new risk reactions. The title of our FX Pulse a few weeks ago was Navigating New Themes in FX. It seems that no matter what happens to global equity markets, the EUR stays pretty well supported, pushing the USD lower. Oil related currencies (CAD and NOK) have become less sensitive to commodity fluctuations, while the CHF is less sensitive to risk. Even as the USD weakens, the AUD is weakening more and is now approaching key support levels. We think the change in market reaction is because the yield advantage for an Australian 10y bond is now around the smallest since the early 2000’s. AUDUSD’s correlation with global equities has been declining for many months. Now the pair is approaching a key support at 0.7560 and AUDJPY has broken a support this morning, suggesting there could be more downside momentum for this pair. China drained a net CNY10bn from the financial system today, after a record injection yesterday. Asian FX should continue to do well after Moody’s upgraded India’s sovereign rating for the first time since 2004 (Baa2 from BAA3). … JPY: watching inflation. Japan’s 10y breakeven rate has risen to 50bp after trading a low of 28bp in September, keeping the JPY on the weaker side for now. There are increasing signs of a tight labour market in some sectors passing through to higher wages. In the run up to the holiday season, Japan’s largest delivery company is offering a 33% wage rise for drivers relative to last year. USDJPY is still trading extremely closely with real 10y yield differentials and the Topix has stabilized. The BoJ's change in purchases today should have little impact on markets, as high T-bill purchases are to compensate for lower purchases in recent weeks. The risk for the JPY in coming months will be that positioning is already pretty short.

US Markets Closing Notes, November 16th 2017 Recap and Comments: …Turning to the tax bill, we consider today’s House vote the last of the “easy votes”, with the going about to get a lot rougher as the baton is officially passed to the Senate. As we have noted previously, the bill that was passed today by the House is essentially a non-starter in the Senate, as they are planning to replace it with their own version which is much different on nearly all the key issues (corporate tax rate timing, expensing window, pass-through taxes, individual tax rates, sunset provisions, SALT deductions, and deemed repatriation among others). In a sense, that essentially made today’s vote non-binding as House members knew this was merely an opening salvo. This is one of the reasons we were fairly confident the bill would pass – any GOP members with qualms about the current plan (chiefly on SALT deductions) could still vote yes in expectation that their concerns would be addressed in a later version.

NOVEMBER 16, 2017

FX WEEKLY THE FOUNDATIONS OF THE NEXT STAGE OF EURO RECOVERY Kit Juckes Sometimes, a simple way of looking at currency markets is what's needed. The divergent trends in growth between the US/UK and Eurozone/Japan are likely going to drive currency markets in the months and year or two ahead. The rest of 2017 may be more about a tired risk rally and the baggage of positions, but the euro is busily building the foundations of another 10% of upside against the dollar and smaller but sizeable gains against the pound and even the yen. Relative trends in forward rates show why sterling suffered in 2H16 and why the dollar peaked in early 2017, drifted lower, bounced in September and is just beginning to look as though it is running out of steam. A sustained dollar rally requires the market to ramp up hopes of a terminal fed funds rate of 2.5% or higher. Count me a sceptic.

Real GDP growth – US/UK slowing, Europe/Japan picking up

Another strong quarter for Japanese earnings Japan had a stellar earnings season. As the market continues to be supported by improving economic conditions and exporters are benefiting from a depreciating currency; a 2018e P/E valuation of 15.7 doesn't look stretched. Consensus earnings growth expectations for 2018 remain strong at 18%. Invest with SG Earnings Momentum Strategy Basket Our strategy has delivered 10.2% since inception (30 March), versus 3.2% for the Stoxx 600. See our new reshuffled basket on page 5.

The dollar and forward rates – is the correction over?

NOVEMBER 17, 2017

GLOBAL EQUITY COMPASS A GOOD 3Q17 REPORTING SEASON DESPITE FOREX HEADWIND IN THE EUROZONE (28P) How to read the 3Q17 reporting season More than 90% of US and European companies have already published their 3Q17 results. While they look good overall, the strong momentum apparent since 1Q17 is now fading. In Europe, 64% of reporting companies announced EPS in line with or above consensus, very close to the 63% 10y trend. Consensus earnings estimates are no longer being raised for US or eurozone stocks, and earnings momentum remains close to 0% in both regions, above the 10y average of -3%. By contrast, Japan, emerging markets and now the UK are seeing strong upside earnings revisions.

Might a stronger euro impact the earnings cycle trend? As we predicted in our previous quarterly result report, forex has been a headwind for eurozone companies in 3Q17. Looking ahead, a EUR/USD at 1.18 would mean a 0.5% increase from 2Q17 average, but a 9.4% increase from 4Q16. However, consensus expectations for EPS growth (yoy) remain quite stable for the Eurostoxx, with a strong 12% for 2017 and 9% for 2018, while S&P 500 expectations stand at 11% for both 2017 and 2018. Looking at the earnings cycle and the euro index, we observe mostly a positive correlation when earnings are growing, as the euro has been mainly driven by economic news and political stress (as well as monetary policy). Actually, at its current level, the euro index (published by the ECB) is in line with its long-term average.

16 November 2017

US Economic Comment Hurricane-rebound in industrial output Seth Carpenter Hurricane-related swings in industrial-output Industrial output was reported up 0.9% in October (consensus 0.5%, UBSe 0.7%), rebounding from stormrelated weakness in August-September. Manufacturing production alone was up a booming 1.3% in October (consensus 0.6%, UBSe 0.7%), including a boost from autos. For total output, the Fed estimated a stormrecoveryrelated boost of about ½ point in October; without that, output would have risen about 0.3%. The ½ point boost from recovery in hurricane-affected output only partially reversed the 1 pt net drag from the storms in August-September. September output, 0.4% (revised from 0.3%), had been held back by ¼ pt; August output –0.5% (was -0.7%), had been held back by ¾ pt. There is further hurricane rebound to come.

Excluding storm effects, output would have risen 0.3% in October, 0.7% in September, and 0.3% in August. Those increases are well above the 0.2% per month year-to-date average pace.

roughly unchanged. The 10s/30s curve may steepen if meaningful tax reform is implemented.

November 16, 2017

Rate Strategy

The GI* Tract November 16, 2017

Rate Strategy

Rates Express Granular Look into Drivers of Treasury Yields in Coming Months Rate hikes, Fed balance sheet cuts and tax reform impact on various curve sectors •

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Market drivers that are tactical in nature tend to “wash out” in the long run, but they can cause significant fluctuations around trends in the near term. We break down the potential impact on U.S. yields from specific key developments over the next six months to help clients position for and profit from near-term shifts. To be clear, this does not change our longer-term views, and we fully concur with the Treasury yield targets in the WFS 2018 forecast. Fed rate hikes should have the largest impact on the front-end of the Treasury curve, while the intermediate sector should react most strongly to Fed’s balance sheet reduction. We estimate that the 2y yield could increase about 20 bps on policy rate hikes and get a further 15 bps boost from the balance sheet taper. Impact on 5y yields from hikes should be a modest 5 bps, but it could rise by an additional 22 bps on pullbacks in the Fed’s reinvestment purchases. Long-term yields may react strongly to deteriorating U.S. fiscal standing. The passage of tax reform may lead to greater government deficits and higher net Treasury issuance. Larger government financing needs should put some upward pressure on yields, while historically greater deficits caused steepening across the curve. Net-net, if tax reform is implemented in a deficit-additive form, the 30y yield could rise 26bps over the next six months with the 10y rate rising 20bps, in our view. Putting it all together, we can see Treasury 5s/10s flatten about 10 bps six months from now with 2s/5s

… U.S. Federal Housing Finance Agency. Total

Refinance Volume Ticks up Slightly in Third Quarter: The Federal Housing Finance Agency (FHFA) today reported that more than 362,934 refinances were completed in the third quarter of 2017, compared with 356,707 in the second quarter. FHFA's third quarter Refinance Report also shows that more than 6,913 loans were refinanced through the Home Affordable Refinance Program (HARP), bringing the total number of HARP refinances to 3,477,717 since inception of the program in 2009. Link https://www.fhfa.gov/Media/PublicAffairs/Pages/Total -Refinance-Volume-Ticks-Up-Slightly-in-ThirdQuarter.aspx U.S. Federal Housing Finance Agency. FHFA Announces Fannie Mae and Freddie Mac Will Re-enter LIHTC Market: The Federal Housing Finance Agency (FHFA) today announced that Fannie Mae and Freddie Mac (the Enterprises) will be allowed limited re-entry into the Low Income Housing Tax Credit (LIHTC) market as equity investors, effective immediately. The LIHTC, established in the Tax Reform Act of 1986, is the primary government program available to address the shortage of affordable rental housing through the creation and preservation of affordable units in underserved areas throughout the country. FHFA's decision was based on several factors, including furthering the Enterprises' mission to support affordable housing and ensuring that they could provide a countercyclical role in the LIHTC market in the future if needed.[1] https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFAAnnounces-Fannie-Mae-and-Freddie-Mac-Will-Re-enter-LIHTCMarket.aspx [1]

November 16, 2017

Economics Group

Industrial Production Growth Leaps in October Industrial production rose 0.9 percent in October as the factory sector got back on track after Hurricanes Harvey and Irma. The manufacturing output

surge is encouraging but overstated by the hurricane rebound. …Noisy Data Masks Underlying Improvement … The dollar has weakened from its late 2016/early 2017 high, and the broadbased pick-up in global economic growth has created a rising tide for the world’s economies. Net exports have been additive to real U.S. GDP growth for three consecutive quarters, the first time this has occurred since Q3-2012 through Q1-2013. As illustrated in the bottom chart, the improvement in industrial production in the United States has coincided with stronger industrial production growth in other advanced economies and developing economies. With encouraging fundamentals in place, we expect the slow but steady improvement in the U.S. factory sector to continue in the coming months.

November 16, 2017

Economics Group

Fuel and Nonfuel Import Prices Rise in October Energy again lifted import prices in October, but nonfuel prices rose 0.2 percent. The rise in nonfuel prices has been generated by industrial and capital goods, pointing to little pressure on core consumer inflation.

November 16, 2017

Economics Group

Homebuilder Confidence Extends Gains The NAHB/Wells Fargo Housing Market Index (HMI) rose 2 points to 70 in November. Expectations of future sales fell 1 point, but were more than offset by 2-point gains in both current sales and traffic. Index Near Cycle High Despite Shortage Issues • The strength in the HMI reflects growing confidence in employment and income prospects. Builders are selling virtually everything they build relatively quickly but are concerned about rising costs and shortages of lots and skilled workers. • Present sales rose back to its cycle high of 77, while future sales fell 1 point off of its cycle high. Buyer traffic rose back to the critical 50 level, after remaining below that level for 5 months.