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StreetStuff Daily January 9, 2018

Mon 1/8/2018 4:52 PM

A Tale of Two Visions Stephen Stanley Chief Economist

A couple of recent Wall Street Journal articles provide a very illuminating contrast in the economic outlook and the effect that the passage of tax reform will have on it. In last Friday’s paper, an op-ed piece was published by Harvard Economics Professor Robert Barro, who I would say is widely respected and pretty credible, though, as you will see, is not necessarily a good representation of the consensus among the academic Economics community. His piece walks through research that he has conducted, augmented by citations of other scholarly research, to estimate the growth effects of tax reform. He finds big impacts. He cites estimates from the Tax Policy Center that the weighted-average marginal individual income and payroll tax rates will fall by 3.2 percentage points, a sizable cut (larger than the 2002-03 Bush tax cuts but not as big as the 1986-88 Reagan tax reform or the 1963-65 Kennedy/Johnson tax reductions), and his research suggests that this will lead to a 0.8 percentage point boost to real GDP growth on average over the next two years. He also examines corporate tax reform and finds that the drop in the user cost of capital should be sufficient to add about ¼ percentage point per year to growth over the next decade. Thus, he concludes that growth will be boosted by a little more than 1 percentage point in 2018 and 2019 and by about ¼ percentage per year over the following eight years. Note that the corporate tax effect, by boosting investment and thus worker productivity, should also raise the pace of growth in potential output. For those with a WSJ subscription, his article is here: https://www.wsj.com/articles/tax-reform-willpay-growth-dividends-1515110902 This is far from the consensus view about the effects of the tax reform. The FOMC barely nudged its growth estimates higher, the CBO is sticking with its dismal 1.8% estimate for potential real GDP growth, and it sounds like, based on an article in today’s Wall Street Journal, the most popular view at the annual American Economic Association meetings over the weekend was that the tax cuts will have limited and fleeting impacts. To be fair, I did not attend the AEA meetings, so I can’t speak to whether the author accurately

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones… captured the consensus in the room, but I would be pretty comfortable going with his characterization. At a minimum, I think we know, based on SEP projections and recent comments from Fed officials, that the Federal Reserve is pooh-poohing the significance of tax reform. In any case, that article is here: https://www.wsj.com/articles/economistsstick-with-long-view-for-slower-u-s-growth-despite-recentuptick-1515346276 I believe that this debate is going to be a key theme over the next few years. My projections are more consistent with the Robert Barro view of the world than with the Federal Reserve/official version. I think the latter gets it wrong because their models are Keynesian in nature, which is to say that they mainly focus on the demand side of the economy and take the supply side as given. These models appear to work well when the supply side of the economy is stable, which it is the majority of the time. However, when there are important changes on the supply side of the economy, these models are at a loss to explain the economy’s behavior. This is what happened in the 1970s, when a negative supply shock led to stagflation, a scenario that the 1960s Phillips Curve consensus could not explain or deal with. The failure of these models goes a long way toward explaining how the Federal Reserve pursued such a disastrous monetary policy during that period. Conversely, in the 1990s, a burst of productivity, in essence a positive supply shock, allowed the economy to burst ahead without creating much inflation (though, somehow, the Fed apparently messed up by running a tooeasy monetary policy then too, as we eventually ended up with the first of several asset bubbles). The swing from extremely growth-unfriendly tax and regulatory policies to quite growth-friendly policies will likely represent another episode of significant (positive) change for the supply side of the economy, and the consensus models will undoubtedly miss it and thus struggle to explain economic developments. Already, economists are talking about scrapping the Phillips Curve model (which probably never should have been salvaged out of the scrap heap in the 1970s), but very few of them seem to want to spend any time thinking or talking about how policy affects economic growth (economists still can’t agree on the impact of similarly growth-unfriendly tax and regulatory policies in the 1930s!). All I can say is don’t be surprised if real GDP growth approaches 3% this year and next but the unemployment falls more slowly than it has up to now. And don’t be surprised if Federal Reserve and CBO staffers are among the last ones to figure it out. One of my 10 themes for 2018 is that “Policy Matters.” This discussion encapsulates that theme nicely.

plans, while some in the GOP prefer the time be spent on welfare reform

8 January 2018

US Public Policy Update: 2018 Policy Agenda

Executive Summary With tax cuts enacted and eyes on the November mid-term elections, policymakers must address government funding and may tackle immigration, infrastructure, entitlement/welfare reform, and healthcare. NAFTA’s future remains unclear, and the FBI investigation will continue to cast a shadow Government Shutdown and Debt Limit: As we expected, Congress passed a short-term spending agreement, funding the government through Jan 19 and waiving the mandatory PAYGO spending cuts triggered by the tax cut. Democratic demands for immigration /DACA and the president’s demand for the border wall remain unresolved While DACA and the border remain obstacles, we think a government shutdown remains a low probability event. Congress may tie a spending agreement to the necessary increase in the debt limit (Treasury’s use of “extraordinary measures” is expected to run out in March/April) Trade: While many of the aggressive trade policy actions did not materialize last year, 2018 offers ample opportunities to pursue a more protectionist America First trade agenda NAFTA: Negotiators remain divided over several controversial provisions, including a five-year sunset clause, adjusting the rules of origins, and dispute resolutions. We expect negotiations to continue into 2018 and possibly to be suspended ahead of the Mexican elections (July) and/or the US mid-term elections (November). If the US withdraws and the president’s subsequent tariff schedules conflict with Congress's Implementation Act, courts ultimately may have to determine the final outcome Infrastructure: Trump wants to implement a national infrastructure program. Democrats initially applauded the idea and released preliminary policy

Welfare Reform: Speaker Ryan and others want to reform welfare programs and reduce the deficit, which are expected to increase, given the tax cut. This traditional GOP position may face opposition, as other Republicans want to focus elsewhere ahead of the mid-term elections Major Policy Risks: FBI investigation, party infighting, aggressive trade policy, geopolitics, Fed tightening

Tax Cuts: Starve the beast Trump’s tax cut builds on the traditional GOP goal of limiting government spending by cutting revenues (“starve the beast”). The CBO estimates the current tax cut proposals would increase growth by ~0.7pp and add $1.0-1.4trn to the national debt (depending on the dynamic macroeconomic effects) over 10 years

2018-19 US Outlook: Tax cutinduced bounce in activity

5 January 2018

UNITED STATES: TREASURIES

Global Rates Weekly

Improving performance of long-end auctions

Rising tide …We remain neutral on duration and curve, given current levels. We maintain our view that the markets are underpricing the risk of a slowdown and continue to recommend low-strike 2yf2s10s bull-steepeners. We also maintain our recommendation of 5y UST-Bunds convergence trade. While there is scope for the market to price in additional hikes in the US, we believe there is far greater scope for this in the euro area. Further, the next five years are likely to include a business cycle downturn in the US, which should keep a lid on 5y UST yields, even as the very front end reprices higher with additional Fed hikes. In terms of positioning, data look mixed; while hedge fund positioning appears neutral, mutual funds appear underweight duration versus their benchmarks (Figure 5 and 6).

The tax plan is likely to have a significant effect on budget deficits and on issuance in the coming years. We continue to expect the Treasury to raise auction sizes starting at the February refunding meeting. We expect the Treasury to initially focus up to the intermediate sector but ultimately raise sizes out the curve as well. Separately, auction performance has improved recently with increasing foreign demand at long end auctions.

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10y, and 30y auctions: Improving long-end performance

The Treasury is scheduled to auction $24bn, $20bn, and $12bn in 3s, 10s, and 30s on 9, 10 and 11 January, respectively. All auctions will settle on 16 January.

3y: A pickup in domestic demand •

3y auctions have cleared very close to the 1pm EST WI levels over the past six months with the latest month clearing at 1pm EST levels. (Figure 9).

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Final demand has remained stable because while foreign demand has declined, domestic demand has increased. On a three-month moving average, foreign demand has declined 6pp, to 16%, while domestic demand has increased about 5pp, to 46%.

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While OTR 3s appear rich on a spot basis, that is attributable to specialness in the repo markets. Figure 4 shows that OTR3s are trading in line with the previous pairs (say vs the 5y series) on a one month forward basis. Separately, the issue is trading very special in repo, suggesting the presence of a short base (Figure 5).

10y: A pickup in foreign demand •

10y auctions performance has improved. The past three auctions have tailed on an average by 0.1bp versus the previous three by 1.1bp (Figure 9).

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The improvement has been driven by a pickup in foreign demand. On a three-month moving average basis, foreign demand has risen 5pp, to 16%. Domestic demand has also risen by 2pp, to 52%. OTR 10s are trading in line with the previous cycles (Figure 6) but there appears to be room for setup. Figure 7 shows that the BW 3s7s10s fly typically richens more.

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30y: A pickup in foreign demand • •

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30y auctions performance has improved as well. The past three auctions have all come through by 0.2bp to 0.4bp (Figure 9). Final demand has increased somewhat. On a three-month moving average basis, foreign demand has increased 5pp, which has only been partially offset by slightly lower demand from investment funds. The US-WN curve has steepened from the recent flat levels. Figure 8 shows that the steepening has typically not lasted until the bond auction. Over the past year, the curve has begun to flatten before the bond auction.

8 January 2018

Lyngen/Kohli BMO Close: Define 'Gradual' (attached/link) …The Treasury market spent much of the session caught between the dueling impulses of supply and the early weakness in risk assets which gave an early bid to the long-end of the curve. The 5s/30s curve steepened late in the morning though the 2bp moves off the flattest levels wasn’t a clear indication of a direction change as much as a response to the drumbeat of corporate supply and a likely setup for the 30-year in the days ahead. Earnings kept the stock market choppy and the resurgence in risk assets added to bounce higher in Treasury yields late in the day. Bostic’s slightly dovish comments and Williams’ mixed comments came in the afternoon, after much of the steepening had already occurred but offered the most interesting events of the day. The fact that Secretary Mnuchin asked Congress to raise the debt limit by Feb 28 brings up more than a few interesting questions. First and foremost among these is whether Mnuchin is simply trying to force the issue into the current negotiations over the continuing resolution to fund the government or whether he’s genuinely concerned that the “dropdead” date might be earlier than the CBO’s current March/April forecast. It would certainly make life much easier for the Treasury if a debt ceiling hike (or suspension) was passed sooner as it would allow Treasury’s debt managers more leeway to announce its issuance strategy for the coming months at the February refunding. As a result, it’s unclear to us so far whether this is a negotiating tactic to get the issue included in current discussions around government funding, or whether it originates from an actual need to get the issue through Congress before the end of February. Should a debt-ceiling hike not be passed before the refunding, the Treasury might be forced to delay its plans or to proceed with coupon size increases, knowing that increasing sizes without a debt ceiling agreement in hand might then necessitate delaying coupon auctions. So, even if the hike is not actually

needed before March, it’s likely to help the Treasury’s issuance strategy immensely to get legislation passed in the current round of CR talks. Alternatively, if the hike is actually needed sooner than CBOs estimates, Democrats could view a second set of negotiations as extending the leverage that they currently have and may be reluctant to fold the issue into current discussions without a corresponding concession. Tactical Bias: The $24 bn 3-year auction is one of the more meaningful events in the day ahead and that’s saying something about just how light the calendar actually is. We’re expecting a solid reception for 3s as we like the relative cheapness versus the belly though the obvious caveat of Fedspeak applies as much to 3s as any other part of the curve. We’ve stated before that we would not look to fade our flattening bias till we get some capitulation from the Fed and the only sign of sharp steepening on Friday was not a result of the data, but of Harker’s dovish turn from a more solidly hawkish posture he has shown in the past. Much has been made of the fact that 10-year inflation expectations in the market (as priced by breakevens) moved over 2% in the last few weeks as flows into the sector kept pace. While we’ve often looked at the inflation markets as an important barometer of investor views over longer horizons, we’re a bit more guarded in our assessment of whether this latest move suggests a sea shift or whether it simply speaks to the notion that the jump in energy prices along with the passage of tax cuts has added some upside risk to inflation. The high correlation between energy and 10-year breakevens (0.77 over the past year) is one of the factors that suggests to us that this latest move may at least partly be driven by volatile energy prices. If crude does retrace a bit, we might get a better sense of what portion of the runup in breaks has been driven by optimism over the effects of fiscal policy (something we would look to fade) and how much of the current move is a result of energy jumps (harder to time a fade of this factor). We’ve noted a crude spike as a potential risk for the year and wouldn’t be surprised by a much larger move higher (not our base case by any means) but we don’t necessarily believe that a transitory spike will have

much effect over a longer horizon even though the market initially trades as if it will. Going back over some of what we heard Williams and Harker say over the last few days, we’re a bit struck by how our strongest agreements aren’t just with the doves who worry about inflation undershoots, but also with the hawks, who have offered that too easy monetary conditions present financial risks that the Fed may later have to deal with. In saying this, we don’t obviously mean that we agree with the opposing policy prescriptions (we’re clearly on the dovish side), simply that we can draw a clear line from the reasoning to the policy action for the hawkish and dovish speakers at the ends of the spectrum. More baffling to us are the centrists like Williams who are in favor of hiking three times in 2018 while insisting that inflation will return to 2% over a longer horizon despite the lack of recent supporting economic data. We’ll get a mark-tomarket of this view with CPI on Friday, but it will take several positive prints to help us erase what have been persistent inflation misses in 2017.

Key trades: 1. Long vol-low carry via SX5E pre-set option premium (PoP) 2. Bearish on consumption via short European autos 3. Inexpensive Korea/Taiwan downside to hedge EM risks Consecutive months of S&P500 positive returns

US Rates at the Bell January 8th, 2018

09 Jan 2018

BNPP Lens Plus - 2018: Fully aware of the risks •

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Uptight, everything's alright: Page 2 of this note presents our base case for 2018, extracted from our Global Equity & Derivative Outlook – Uptight, Everything's Alright – 11 December 2017. What risks for 2018? The year has started on a positive note with economic strength lifting equity markets. Here we focus on some key risks facing equities this year. We suggest trades to hedge these risks which may be considered by investors who share our view. Equity market risks for 2018 include: a turn in the US credit cycle hurting US high-yield credit, driving credit spreads wider; a substantial steepening of sovereign yield curves as wage inflation makes a reappearance; an unexpected surge in inflation driven by higher commodity prices; and a consumption slump.

Traders Tab:  Inflation (Target) Balloons Fly: Academic inertia behind an inflation target review was the untold story of Q4 2017 (Bernanke from OCT: http://brook.gs/2i55egH), but there’s no hiding it now (fig. 1) as price-level targeting is the topic de jure. Today we heard it from Williams and Bostic, while comments from the Fed’s Mester and Harker last week suggested a “policy review” is in the interest of many governors (http://on.mktw.net/2ACuQoK). Recap & Discussion:

Interestingly, the policy review inquiry from the Fed’s Bostic and William’s today, juxtaposed by the labor-tightness findings of the BoC’s Q4 Outlook Survey (above), saw the 2s10s curve bull-steepen 0.5-1.25bps. And while this is a …

tough one to unpack with little concrete detail to go on (Bernanke’s “temporary” price-targeting policy being the most readily discussed), the obvious issues here are credibility and timing; the first being the herculean task of effectively signaling that “temporary” price shocks are now “actionable”, while “making up for” (i.e. “running it hot”) a period of target misses at a time of fiscal looseness and historically rigid labor markets seems rather misguided. Either way, we see an inflation rule change as a significant tailrisk to rates markets, which theoretically could result in inflation uncertainty, inflation volatility, and/or policy error, which net-net, decompresses term-premiums. 08 Jan 2018 14:36:03 ET

Global Rates Strategy Focus 2018 outlook and themes Interest rate outlook We forecast only marginally higher US long end yields in the face of Fed tightening. Our year-end target of 2.6% is driven by stable terminal rate expectations and with inflation pricing recognizing sub-2% trend. Bund yields are expected to rise (end-2018 0.75%) but beating forwards will be challenging on ECB QE stock effects and as low inflation caps. Gilts are a coin toss on Brexit. JGBs will be where the BOJ place them. Expect AUD/NZD rates to lag the Fed tightening.

Anchoring to a lower inflation norm The systematic undershoot of inflation is no accident. It’s probably related to hyperglobalisation, which flattens Phillips curves, and the effective lower bound. Central banks can reassert higher trend inflation but only via bubbles. The Fed has rejected that option. The ECB will likely do the same in 2018. Sell USD breakevens. We argue that it is implausible to see serial inflation undershoots across time and countries as bad luck. Inflation is low for many reasons of which we would cite hyperglobalization and inferences from being at the lower bound as being the most important. Breakevens will price

to the ‘trend’ level of inflation - which remains weak. Getting higher ‘trend’ inflation will require looser policy and engineering of asset price bubbles. Central banks are rejecting this path. We expect the ECB to join the Fed in tacitly accepting sub-2% as a norm.

Borrowing from the future (again) is a recipe for liquidity traps What explains the observation that higher total economy debt co-exists with ever lower real rates? It’s because this borrows demand from the future, requiring ever lower rates to maintain consumption or else wealth effects. Debt loads and term premia It would seem intuitive that the more debt that needs to be held by the private sector, the higher the associated term premia, to induce this holding behavior. The picture is however much more complex. For instance, Figure 24 shows the global term premium in 10yr bonds and its strong correlation to the amount of duration risk held by the private sector. Yet, the right hand scale is inverted, meaning that higher debt loads, have been correlated to lower term premia. This could be a statistical fluke (correlation is not causation) but there is also good reason to believe in the relationship. For one, higher debt loads are associated with recessions which could dominate the impact. More interestingly, it is also likely to be the case that while higher debt is stimulative in the short run there are negative effects in the long run for Advanced Economies (AEs) owing to the corrosive effects of debt loads on future demand. 24. Global 10yr term premium is well correlated to the levels of duration risk held by the private sector….except that the correlation is the opposite of what you are probably thinking. Higher debt loads = lower term premium.

08 Jan 2018 11:22:04 ET

RPM Daily Front End Shorts Maintained •

A more direct connection to interest rate trends is shown in Figure 27 via the relationship between US total economy debt against real 10yr rates. The ranges and the transitions to lower real rates correspond to the evolution of total economy debt. 27. US total economy debt (ex-financials) % GDP versus real 10yr rates. Higher debt has tended to coincide with lower ranges for real 10yr rates.

Summary: Long cash (+0.8) / futures (0.4): Short positioning and PnL remains firmly anchored at the front end in USTs and Libors. Meanwhile risk appetite remains firmly bid with notable long positions / PnL in $ markets, EM and EUR FX. Historically as elevated positions / profits build, RPM finds the likelihood of a short term risk reversal increases.

• In North America – Short futures (2.2) / long cash (at 1.9): Little change in positioning on light flows. Large shorts / profits maintained at the short end (at around -4.0 / +4.0 in TU and ED whites). However asset-swap tighteners and long futures basis trade remain offsetting. •

In Europe – Long futures (1.0) / cash (0.5) in Germany: Long duration positions are intact (in both core and periphery Europe) despite being mildly underwater. Meanwhile as EUR FX rallies, investors have built large long (at 4.5) however attached PnL is small.

08 Jan 2018 11:07:38 ET

US Rates Vol Lab Sell Eurodollar convexity in Blues In other words, low term premia and the low rate backdrop are the symptoms of ever higher debt loads borrowing demand from the future.

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Global balance sheets Global 10yr term premia shift slowly higher on AE balance sheets and reserve shifts. A 1% decline ($500bn) lifts the term premium +11bp. Balance sheets do not easily correlate to yields unlike equities/credit. They impact in valuation alongside more regular fundamentals. We estimate 2018 impacts for 10yr Treasuries between +11bp to +22bp, and Bunds at +25bp to +40bp. These measures assume no preemption by markets, which is more plausible for Bunds.

Measuring term premia Financial Conditions Indices (FCIs) help measurement of 2y term premia. In Treasuries and Schatz these have been consistently negative post-crisis. At the long end, our term premium measure underscores that the expected short rate in 10yrs time has been stable in the current economic and Fed tightening cycles. It looks more reasonable to us than the Fed’s ACM model results.

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Eurodollar convexity adjustments in Blues have significantly widened to theoretical fair value due to stretched shorts and steepeners. We like selling Blues convexity adjustment hedged with a curve steeepener to fade this richness of Eurodollar convexities with positive carry. Implieds look generally cheap to rates, especially in long expiries. Upper-left vols look relatively rich on the surface.

About $1.14bn initial notional of longdated callables was issued in the first week of January. We continue to expect January supply to be relatively weak (about $5-7bn) relative to last year.

36. Net callable notional supply

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Receiver skews in the upper-left part of the surface look rich optically and relative to realized skews. US vol looks cheap to swaptions if compared to recent realized vols. Call skew looks rich to receiver skew. We continue to like 3m 2s3s5s conditional receiver flies to position for a dovish Fed surprise.

08 Jan 2018 14:32:11 ET

Global Equity Strategy Global Earnings Revisions Index Hits All-Time High •

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Best Weekly Revisions On Record - Global earnings revisions remained positive this week (+41%) for the fourteenth week in a row, recording the best weekly upgrades since 2000 (when our data starts). Regions – All major markets posted net upgrades WoW. The US recorded its best weekly revision since May 2000, possibly due to tax-reform related upgrades. Tax Impact – According to our US Strategist, Tobias Levkovich, each 1% of tax rate decline theoretically adds nearly $2 of EPS. Although several company management teams are suggesting that a portion of the tax savings could be reinvested back into the business. Overall, the tax cut should help deliver 11% US EPS growth in 2018. Global Sectors – Cyclical sectors led the upgrades WoW, while defensives continued to lag (Figure 3). Within cyclicals, upgrades were led by Financial, Energy and Industrials. The Cyclical Sectors Earnings Revisions Index reached the previous alltime high posted in September 2009. Earnings Outlook For 2018 – The consensus analyst forecast of 12% 2018E global EPS growth looks achievable according to our GDP-driven model. Citi regional strategists forecast another year of synchronised earnings growth. What’s Next? – High ERI levels are usually seen at the start or end of the economic/market cycle. Our Bear Market Checklist says it is still too early to call the end of this cycle.

1. Global Earnings Revisions Index and MSCI AC World Index

08 Jan 2018 15:10:54 ET

Energy Weekly Top 10 Things to Watch for in Oil Markets at the Start of 2018 •

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Bullish momentum in oil markets has carried into 2018 with spot Brent up ~$1/bbl YTD as investors now hold a record net long position on financial crude of 962-m bbls. Citi continues to believe that the higher oil prices now will lead to a correction later in the year, but a combination of momentum, bullish risk asset sentiment, and supportive shortterm supply/demand oil factors are supporting prices. With oil prices at a three-year high, and our fundamental 2018 view laid out in our Annual Commodities Market Outlook 2018, we focus this week on our “Top 10” signposts for 1Q’18 that will likely determine how oil trades over the quarter. Netting off our “Top 10” factors and with expected crude builds of ~500-k b/d in 1Q’18 we believe that there is a bearish bias for oil prices from here. A step-up in global oil supply disruptions is the biggest worry.

08 Jan 2018 22:55:54 ET

Municipal Weekly The new New Jersey Governor’s tryst with destiny Weekly yield recap and near-term outlook The 5YR, 10YR, and 30YR municipal Treasury ratios ended the year at 76%, 82%, and 93%, respectively. While 5YR and 10YR ratios have declined marginally since then, the long end has yet to benefit from reduced supply this month. We maintain our bullish stance, and while we expect ratios to tighten across the curve over the next month, we expect the long end to provide the best returns.

The new New Jersey Governor’s tryst with destiny New Jersey is the lowest-rated state after Illinois, and while its GOs (and the appropriated debt) are still a few notches away from speculative grade territory, the threat of downgrade remains given that the state continues to face numerous fiscal challenges. Mr. Phil Murphy will take over as the new Governor of New Jersey on January 16, 2018, and he has an onerous road ahead if he intends to engineer the rehabilitation of New Jersey’s credit rating. That being said, we believe that New Jersey’s debt continues to offer opportunities and we discuss. What’s up with SIFMA We also discuss the factors behind the recent spike in the SIFMA index and the near-term outlook for VRDN rates.

January 08, 2018

European Economics Quick Take: Euro area cyclical indicators point to a further pickup in growth Economic data released this morning point to a further acceleration in euro area growth in late 2017. This bodes well with our euro area GDP growth forecast of 2.6% in 2018, above consensus of 2.1%. Economic confidence rose to a 17-year high of 116.0 in December, above consensus . Retail sales grew more than expected (1.5%m/m) in November.

Figure 1: Economic confidence points to a further pickup in growth

Deutsche Bank 09 January 2018

Early Morning Reid Macro Strategy Jim Reid …The eyes of the holders of US equities continue to stream tears of joy at the moment, as yesterday marked the 5th up day out of 5 so far this year for the S&P (+2.77% so far). Since 1928 we’ve only seen the first 5 days of the year to be consecutively up 7 times and this is the first occurrence since 2010. When the first 5 days are up, the average price return for the year is +13.44%, with the low of +2.03% and high of 20.09%. Notably, the longest streak was in 1976 and 1987 when the S&P rose for 7 consecutive days at the start of the year. Staying in the US, in a quiet week for data leading up to Friday’s CPI, Fed speakers grabbed the headlines yesterday. The Fed’s Bostic seemed dovish and noted “I’m comfortable continuing with a slow removal of policy accommodation”, but “I would caution that doesn’t necessarily mean as many as three or four moves per year”. On inflation, his main concern is that inflation expectations risk becoming anchored below 2% and if this happened, “it would be increasingly difficult for the Fed to hit our 2% target”. In terms of impacts from the tax cuts, he is making a “positive, but modest boost” to his near term GDP growth profile for the coming year, but is treating a more substantial breakout of tax reform related growth as a “upside risk” to his outlook. Elsewhere, at the Inflation targeting conference, the Fed’s Rosengren said his “own view is that we should be focused on inflation range (rather than the 2% target), with flexibility to move within the range as the optimal inflation rate changes”. He added that a range of 1.5%-3% could provide flexibility and “don’t think most people are going to notice”. The former Fed governor Bernanke also noted there will be “some pretty serious discussions” on monetary policy frameworks over the next 18 months under the new Fed leadership…

08 January 2018

Fed Watcher - Minutes, ISMs and payrolls do little to move the needle

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(4.8%) reflecting GE, while median growth is a much higher 13.1%; The macro drivers of earnings have been supportive in concert. Versus Q3, US growth (+1.3%), a weaker dollar (+1.3%), stronger foreign growth (+0.6%), higher oil prices (+0.5%), a dissipation of the direct insurance losses from the hurricanes (+3%) and a wider snap back from them (1.1%) have all contributed positively to the acceleration in growth; Sales growth at 6 year highs and margins at new highs. Sales growth is expected to be up to 7.0% in Q4 (assuming a typical 0.3% beat), boosted by strengthening US and global growth and the depreciation of the dollar. Quarterly operating margins at 10.8%, are expected to slightly better the high in this cycle of 10.7% hit in Q2 2017; Meeting a high bar. Since last earnings season (mid-Nov), the bottom up consensus for Q4 2017 has moved up +0.4%, unusually so compared to a typical -1.1% cut, implying a higher bar for companies to beat. The move up reflects higher Energy estimates (+9.2%) which have followed oil prices, more than offsetting the downgrade to Industrials (-0.8%). But compared to the bottom up consensus (plus typical beat) of 14.6%, our model predicts 15.2% and we expect earnings to beat at or slightly above the historical average.

One-off items associated with tax reform to add noise in Q4 • • •

Repatriation charges More deferred tax liabilities than assets should offset repatriation charges In the aggregate a wash

08 January 2018

Asset Allocation - Robust Earnings Before Tax Reform: Q4 Earnings Preview Expect Q4 EPS growth to come in very robust (14.6%) near 6-year high before tax reform  S&P 500 Q4 EPS growth expected to bounce back sharply (14.6%). The bottom up consensus (11.0%) combined with a typical beat (3.4%) points to a strong bounce back in earnings growth from Q3 (7.8%). This would take EPS growth back up to near the six year high seen in Q1 2017 (15.4%) though that performance was off a low base;  Plenty of outliers but it’s not about them: median growth (12.4%) is expected to be the strongest in 6 years. Across sectors, growth is expected to be led by Energy (+138%) but is also strong at Tech (+18.6%), Financials (+16.6%), Staples (+16.9%) and Utilities (+16.8%). Strong growth in Staples is being driven by a couple of positive outliers with median company growth running lower (10.6%). On the other hand, Industrials growth is notably low

Reaffirming our post tax reform 2018 EPS estimates and price target  Cut in corporate tax rate to lift 2018 S&P 500 EPS significantly. We estimate the aggregate S&P 500 effective tax rate should fall from 27% to 19%, raising EPS growth in 2018 by 11% (If Tax Reform Passes, Dec 2017). While all sectors gain in absolute terms, the biggest relative beneficiaries are Energy, Retailing (both discretionary and staples), Transportation and Telecom, while the biggest losers are Pharma, Insurance and Technology companies.  But a lower multiple (-5%) as earnings rise above normalized levels. As we have noted previously, changes in tax rates have not had a long run impact on the level of EPS which have grown around a clear and steady trend of 6.5% over the last 80 years. With cyclical growth alone poised in our view to take EPS back up to the long term trend level in 2018, the cut in the corporate tax rate would raise them well above (+11%). Above normalized levels earnings tend to be discounted and we see the multiple derating to 18.5x in response (previous forecast 19.5x).

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2018 S&P 500 EPS of $162 and price target of 3000. In turn we raise our forecast for 2018 S&P 500 EPS by 11% from $146 to $162 and our S&P 500 target by 5% from 2850 to 3000 (10% above current levels).

What to look for? Corporate commentary during earnings calls is a great source of bottom up insight. Last quarter, managements highlighted the broad-based global acceleration in growth but coping with late cycle pressures. This quarter we look for clues on:  What will corporates do with the extra cash? Tax reform naturally is the most important theme for this earnings season. The key issue in our view is what corporates plan to do with the extra cashflow generated by lower taxes and access to foreign cash. The range of options available to corporates is wide: more dividends, buybacks, capex, wages, hiring, M&A, deleveraging or just hoarding cash.  How will they deal with the tight labor market amidst strong growth? As we have noted previously, tax reform is not happening in a vacuum but rather in the context of an unusually strong surge in growth late in the cycle. How companies deal with a very tight labor market amidst strong growth is critical to determine how much further this cycle lasts. We look for signals that they will raise capital spending aggressively in order to meet demand and also increasingly tap on the pricing lever to offset cost pressures.  Is stronger cyclical growth starting to outweigh ongoing secular shifts?

08 January 2018

Focus Europe Special - Five questions for 2018 •

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As the new year begins, we use our 2018 Outlook to answer some of the major macroeconomic questions that lie ahead in Europe, including whether euro area GDP growth could set another post-crisis high in 2018, whether this will be the year that perceptions of inflation normalisation take hold and whether the ECB will be able to engineer a softlanding for financial conditions. We also ask whether integration or exit will be the dominant political theme in Europe and whether 2018 will be the year the UK and EU27 reach a Brexit deal. The title of our 2018 Outlook was “The return of macro volatility”. Last year’s picture of strong, stable, convergent and synchronized growth in Europe was unusual and cannot last, in our view. The economic outlook is sensitive to monetary policy and the evolution of financial conditions. We update our financial conditions index and find it at the tightest levels since the nervousness ahead of the French election.

January 8, 2018

08 January 2018

Monday Morning Outlook

Monthly Housing Report October 2017

Bond Bull-Market Is Over

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We show home price performance data as reported in the October S&P/Case-Shiller Home Price Report and summarize the home price trends for 20 cities in the S&P/Case-Shiller Home Price Index. U.S. current home price has already surpassed its pre-crisis peak by 6.0%;  Among 20 cities, the following cities already fully recovered: Denver, Dallas, Seattle, Portland, Boston, San Francisco, Charlotte, and Atlanta.  US home price appreciation has accelerated since June 2016. U.S. YoY home price appreciated 6.2%. October is 65th month with consecutive YoY home price appreciation.

Bonds have been in a "bull market" for the past thirty-seven years. Not every quarter, or every month, but bond yields have fallen consistently since Paul Volcker ended the inflation of the 1970s. And just like any long-term bull market or bubble justifications proliferate. The current 10-year Treasury yield is 2.46%, which equates to a 40.7 price-earnings multiple. If the stock market had a P-E multiple anywhere near that, the nattering nabobs would be screaming from the mountaintops. But the bond market has become the "knower of all things" – it's never wrong according to the bulls. Low yields are not only justified, they tell us the future. There are three main bullish arguments. 1) The U.S. faces secular stagnation – permanently low growth and low inflation.

2) Foreign yields are lower than U.S. yields, so market arbitrage will keep U.S. yields from rising. 3) The Fed is raising short-term rates which will cause the yield curve to invert, leading to recession and lower yields over time. But there are serious issues with all these arguments. …This year, the Fed is on track to ratchet the federal funds rate higher in three, possibly four, quarter point moves. With real GDP growth picking up to roughly 3%, and inflation moving toward 2.5%, or higher, nominal GDP will grow at roughly a 5.5% rate. That's the fastest topline growth the U.S. has experienced since 2006. And in 2006, the 10-year Treasury yield averaged 4.8%. We don't think yields are headed back to 4.8% any time soon. Our forecast for the 10-year Treasury is 3.0% in 2018. But, the risk is to the upside on bond yields, not the downside. The bullish case for bonds has finally run out of steam.

drastically down the road. Based on these possibilities, in this report, we explore the conceivable risk scenarios in which the BOJ could embark on the normalization process during 2018. Our four risk scenarios are categorized as: (1) virtuous cycle scenario of more bullish price setting by Japanese corporates triggered by significant wage hikes in the 2018 shunto, (2) tie-up scenario with the government's declaration that deflation is finally defeated, (3) scenario of changes in BOJ's policy reaction function with more focus on ensuring latitude for future policy options while the US is in a rate hike cycle and/or possible side effects of the current policy, and (4) scenario of sharp yen depreciation primarily driven by much higher UST yields. We note that each scenario is not necessarily independent and a combination of some may be more realistic.

8 January 2018 | 11:19AM EST

Where to Invest Now: Up, up and away Key conclusions: Bull market will continue in 2018 with a year-end target of 2850, 7% above the current level

9 January 2018 | 2:29PM JST

Japan Views: Exploring risk scenarios to our call of BOJ keeping status quo on yield curve control in 2018

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One of the market's focuses in 2018 is whether the BOJ will follow the lead of the Fed and other central banks in embarking on the rate hikes. Our baseline scenario is for the BOJ to keep the status quo on yield curve control during 2018, chiefly because we do not expect the new core CPI, which excludes energy and fresh food, to stay stably above 1% yoy. That said, economic activity entails large uncertainty and the BOJ may undergo a meaningful leadership reshuffle in the upcoming spring as the term of governor and two deputy governors expires. Furthermore, the Abe administration might decide to declare that Japan is finally out of the deflationary territory depending on the outcome of the 2018 shunto wage negotiation. Accordingly, the environment surrounding the BOJ could change

Profit cycle: Earnings growth will be the dominant driver of a 15% gain in the index level during next 3 years to 3100 by year-end 2020. Business optimism: Deregulation and tax reform have lifted small business optimism to highest level in 35 years. High Valuation: S&P 500 index trades at high valuation on most metrics vs. last 40 years (89th percentile). Median stock trades at 99th percentile

Fundamentals: 2.7% economic growth; 14% EPS growth; Buybacks key source of net share demand •

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Economy: GS economics forecasts abovetrend 2.7% GDP growth, core PCE inflation of 1.8%, and 4 Fed hikes in 2018 (market implies only 2). Earnings: Sales growth of 6% and a tax reform-assisted 50 bp margin expansion to 10.5% will drive 14% rise in EPS to $150.

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Money Flow: Positive net demand for shares only because Buybacks offset aggregate net selling by combination of other ownership categories

Strategies: (1) Investing for the future; (2) Secular growth stocks; (3) M&A targets 1. Firms investing for the future: Stocks consistently redirecting Cash Flow from Operations back into the company through capex and R&D. 2. Secular growth stocks: Stocks with revenues forecast to rise 10%+ annually for several years without excessive valuation. 3. M&A: Stocks that GS equity research analysts view as likely acquisition targets in industries with low market concentration.

margin expansion. Risks for a global equity bear market remain low. Asia-Pacific

14% return in 2018 will be supported by firm economic growth and rising corporate profits. Tighter financial conditions suggest a firm start but headwinds in 2H18. Favor markets with stronger growth, notably China, India, Korea.

Japan Further market upside in 2018 (+12%) fueled by domestic demand-driven economic growth, a supportive fiscal/monetary policy backdrop, sustained profit growth, and an improved flow of funds landscape. Goldman Sachs Global Equity Market Forecasts

8 January 2018 | 1:40PM EST

Global Equity Macroscope: Strategies for equity markets around the world in 2018 Key conclusions:

United States Bull market will persist in 2018. S&P 500 will rise to 2850 and deliver a 9% total return. EPS growth of 14% will benefit from a 5 pp boost from tax reform. High starting valuation and rising rates suggest P/E multiple will remain flat at 18x. Exhibit 1: Goldman Sachs global equity index forecasts

Europe

EPS growth of 10% will drive a 12% SXXP total return during the next 12 months. A strong global economy will drive positive top-line growth and

8 January 2018 | 9:22PM GMT

GOAL Kickstart: Crossasset corrections So far this year, risk appetite has picked up materially (Exhibit 17), nearing its all-time high, led by equities (Exhibit 18), which have rallied across regions, the most in Asia and EM (Exhibit 11). The underperformance of "safer" low vol stocks has also become pronounced (Exhibit 20). Credit total returns have been positive, in particular high yield, notwithstanding bonds selling off. Cross-asset volatility has fallen back to near its lowest levels (Exhibit 32), with equity skew also declining sharply (Exhibit 36). Our sense is that many investors we talk to have benefited from this rally, being long risk and having

added exposure in EM last year. Based on CFTC data, equity exposure is high (Exhibit 39), while bond positioning has fallen (Exhibit 42). In our asset allocation we entered 2018 overweight equities and underweight bonds, with a preference for EM over DM assets, particularly in equities (Exhibit 6). We think this is an allocation well-supported by the macro, although investors have been worried if the cycle can go longer. MSCI World ($) is currently at its longest streak in history without a 5% correction, and MSCI EM ($) is at its longest streak in history without a 10% correction. While we think equity correction risk in 2018 is high after a strong rally and at high valuations, we also think an equity bear market is unlikely given the supportive macro backdrop. In comparison, historically commodities can frequently correct given their high volatility, while government bonds and credit correct less as coupon income can buffer capital losses (Exhibits 1-5). As we forecast commodities to also have positive carry this year, this should help lower their correction risk - we are OW 12m. For bonds, lower yields provide less buffer, increasing correction risk - we are UW 3 and 12m 8 January 2018 | 6:34PM GMT

Global FX Views: Off to the Races (Trivedi/Pandl) 1. Solid growth, soggy Dollar in 2017H2. We expect more of the same in 2018. The US Dollar had a weak finish to 2017 and a poor start to this year. But it’s arguably the greenback’s performance since last August that has been the most striking. Since that time the Federal Reserve raised the funds rate again and began the process of shrinking its balance sheet, the prospects for tax reform went from dim to done deal, and the US economy chugged along at an annualized growth rate of 3-4% (with GDP growth at the lower end of the range and our Current Activity Indicator at the higher end). Yet despite the robust macro news, the trade-weighted Dollar essentially moved sideways. We expect 2018 to look much the same: solid US growth, continued rate hikes from the Fed, but a Dollar moving flat-to-down against most crosses. 2. The EM rally has room to extend. 3. Two flavours of growth in EM FX—both on the move. 4. Long EURJPY remains our preferred positioning within G4 exchange rates.

5. The “next Canada” looks to be, once again, Canada. 6. US protectionism was the dog that did not bark in 2017, but remains a risk again in 2018. 7. Moving our forecasts to stay constructive on ZAR (11.50 in 12m), but there may be better entry levels.

8 January 2018 | 12:19PM EST

Americas Banks: Deposit Rate Monitor 1/8/2018: Online bank competition picks up, but larger bank retail betas remain low As we enter the new year, we update our Deposit Rate Monitor to capture the industry's retail deposit rate movements and take a deep dive into recent online bank rate movements. Competition has increased for online banks as they have passed through 45% of 2017 rate hikes in CD rates and 30% in savings. That said, deposit rates at large and regional banks have been broadly resilient to rate increases, as they continue to realize near 0% retail deposit betas, which should support continued NIM improvements in the short term. 8 January 2018 | 7:44PM EST

Americas Automobiles: 2018 guidance and tax rates: Detroit Auto Show likely a positive catalyst as companies lower corporate tax rates Looking ahead to the Detroit Auto Show next week (January 16 and 17), we see an overall positive set up for company guidance announcements as investors appear content with a flatter global automotive production forecast, most companies are pivoting communication to performance in excess of underlying addressable market growth, and corporate tax rates have been lowered. As a result, we believe auto shares will likely continue to climb into next week. However, we still believe that softer data points for US SAAR are coming and, combined with potential choppiness in China, new vehicle sales could derail Auto share momentum beyond January (see our 2018 Outlook); therefore, we believe investors should use this positive event to either monetize positions or re-engage more bearish views. In this note, we detail our thoughts for individual company 2018 guidance as well as 2018+ tax rates:

overall, we see potential for positive company updates relative to FactSet consensus and investor expectations for Ford, BWA, CPS, and VC. On tax, we expect our entire coverage to benefit from a lowered corporate tax rate to varying degrees, and see upward pressure to FactSet consensus EPS as we forecast US tax reform to lower 2018 effective tax rates by 400bps vs. current consensus estimates. 8 January 2018 | 7:07PM EST

USA: GS Economic Indicators Update

MARKET MUSINGS & DATA DECIPHERING

The GS US Financial Conditions Index fell by 13.8bp to 98.58, with most of the easing coming from a weaker trade-weighted dollar and a lower 10-year Treasury yield:

2018 MARKET AND MACRO OUTLOOK – FREE EDITION Dear Readers, I published this report for our paying subscribers two weeks ago, but I wanted all of you to read it. So I’m pleased to now publish it as a free edition. Feel free to share it with your friends and colleagues …No doubt the debate over inflation will be center stage, but with the Fed raising interest rates and shrinking its balance sheet alongside the already-evident decelerating trend in the monetary and credit aggregates, it is very difficult to see what the factors are that will generate any sustainable inflation pressure that would not have already occurred this cycle. Yes, tight labor markets may yet ignite a wage uptrend, but given the intesnse competitive environment, especially in the broad retail sector, any acceleration in labour costs will likely impinge more on lofty profit margins than on the pricing outlook. Not only that, but the productivity gains that are now showing through in the midst of this technological revolution – automation, AI, robotics and the shared economy – will likely keep unit labour costs, the root cause of inflation, flat or negative. So the risk is not really about inflation any more than it was in the late 1980s, the late 1990s or the mid-to-late 2000s, for that matter – the risk is the Fed’s perceptions of inflation and its willingness to be pre-emptive in a classically latecycle setting.

…SO HOW TO INVEST IN 2018? ANSWER: be aware of where we are in the cycle and construct your portfolio appropriately:

…8. Long-term bond yields never rise during a recession – so no matter how low they are, they can indeed go even lower unless this cycle goes to extra innings; if the Fed fully inverts or flattens the yield curve and growth slows sharply, high-quality longduration bonds will be a nice escape valve.

US Economics & Rates Strategy Treasury Market Commentary, January 8, 2018 Treasury yields closed slightly higher in a quiet day, with volumes running 65% of the recent average. Supply in 3s, 10s, and 30s hits the market over the coming 3 days before US CPI and US retail sales on Friday. We increased our Treasury supply projections for 2018. 10y yields ended at 2.48%. … US CPI and US retail sales arrive on Friday and the tension over the inflation print is palpable. While we see US core CPI printing 0.18% M/M and 1.7% Y/Y in line with current consensus forecasts - we project a 0% M/M reading for control group retail sales versus the current consensus of 0.4% M/M (see US Retail Sales Tracker: Falling Flat). While we see a disappointing retail control group, we note that it comes on the heels of the strongest three-month run since 2014.

Until the data speak, the market will have to absorb Treasury supply. And Treasury supply is something investors will have to deal with increasingly in 2018. Given the final version of the Tax Cuts and Jobs Act, and a higher deficit than our base case expectation, we revised our

expectations for the calendar year 2018 deficit from $840bn to $891bn and the net coupon issuance from $807bn to $907bn (see Top 10 Global Rates Surprises for relevant exhibits). In 10y notional equivalent, we revise 2018 supply estimates from $1523bn to $1579bn.

… To prepare for higher deficits after 2018, the Treasury Department is likely to gradually increase issuance in 2018 to avoid the need for a massive increase in T-bill issuance in 2019 and 2020 that would shorten the WAM. By the end of 2018, we expect the monthly auction sizes for 2s, 3s, and 5s to have increased by $12bn each, while 7s increase by $8bn, and 10s and 30s increase by $4bn each. We believe Treasury will spread out the increase in measured steps. Specifically, we expect the Treasury to target an increase, on a quarterly basis, in auction sizes for 2s, 3s, and 5s of $3bn each; an increase of $2bn for 7s; and $1bn in 10s and 30s.

…GDP tracking We continue to track 4Q GDP at 3.1%.

January 8, 2018

US Economics & AlphaWise Macro: US Retail Sales Tracker: Falling Flat Our primary data points to 0.0% growth in the retail control group in December—a disappointing forecast, but one that comes on the heels of the strongest three-month run since 2014. We expect 3.2% real PCE growth in 4Q following 2.2% in 3Q.

January 9, 2018

FX Morning Hans W Redeker Hawkish Rinban, dovish Fed: With the BoJ cutting the size of its 10-25-year maturity Rinban operation, the focus has returned to the performance of global bond markets and their impact on risk appetite. Tactical risk indicators warn that a short-term setback may be in the making, which could see JPY crosses coming under selling pressure. GBPJPY shorts should offer the best protection for a long risk portfolio. USDJPY needs to break below 112.05 to open the door to our mediumterm 105 target. The Fed’s Rosengren and Williams suggesting the Fed to debate target ranges for inflation or price level targeting may need to be seen in the context of the Fed looking for ways to boost inflation expectations, aiming to reduce the economy's high liquidity preference – a theme we discussed in the last edition of the FX Pulse. The Fed's Bostic suggesting that hiking rates three times may be too much points towards outright dovishness, not boding well for USD. Aiming for a steep JGB curve: The BoJ cut purchases of debt maturing in the 10-25-year and more than 25year sectors. While we would warn against viewing the long-term maturity JGB Rinban purchase programme as an early indication of the BoJ adjusting its yield curve management policy, it does support our thesis of the BoJ aiming for a relative steepening of the back end of its yield curve to provide support for banks and real money investors. The BoJ is seemingly differentiating between the cost and the availability of capital. The steeper yield curve boosts financial institutions' profitability, which tends to ease lending standards, with banks willing to take additional risks on their balance sheets. JPY dynamics: The relative steepening of the back end of the JGB curve acts in support of JPY, reducing the incentive for Japanese investors to export capital into non-JPY-denominated bond markets. This meets an FX market showing that one-month USDJPY risk reversals are more skewed towards USD calls than at any point since May 2017. Additionally, the correlation between the performance of the Topix and USDJPY is easing as the market prices in a higher probability of Abenomics turning into a success story. November labour cash earnings have increased by 0.9%Y, showing a highest reading since July 2016. Tax changes due in April are likely to provide corporates with a wage growth and investment-linked tax relief. The aim of this policy is to push inflation and inflation expectations towards levels reducing the incentive to hold cash. Japan’s corporates had been holding high cash reserves often held in yieldgenerating foreign currencies, so reducing Japan’s private sector liquidity preference should see JPY going up.

A risk correction… Optimism for risky assets has reached an extreme, but with the equity risk premium (comparing equity with a risk-free return) not yet near alarming levels, it may require higher bond yields to push equity markets into a downside correction. It will need to be seen how much today's Rinban operation change will impact bond markets globally. Our GRDI* has exceeded the level of 2, suggesting that there may be a tactical risk setback. The Daily Sentiment Index, which is a survey of traders' short-term sentiment, shows 95% of traders running portfolios under the assumption of a bullish risk outlook. The latest economic letter from the San Francisco Fed takes a look at asset market valuations, questioning whether they are unduly high. The conclusion is that stock prices are generally elevated and consistent with a real return of close to zero over the next decade. Technical indicators such as the 9-week RSI (84) for the S&P 500 have reached the highest level since the start of this bull market in March 2009. …and its FX consequences: A yield-driven setback for risky assets does not bode well for highly leveraged current account deficit currencies, with GBP, AUD and CAD falling into this category. These currencies could be traded against JPY. This is why better-than-expected UK December BRC like-for-like sales (0.6%Y, expected 0.3%Y) and impressively strong Australia November building approvals (17.1%Y, expected 4.6%Y) are unlikely to lend support to GBP and AUD.

BoJ reduces Rinban purchases in the long end, steeper JGB curve should drive JPY higher

years of expansion have already put most Americans back to work following the worst economic downturn since the Great Depression.

5 January 2018

Financial Market Weekly CHRISTOPHER S. RUPKEY, CFA PAYROLL JOBS JUST 148K THIS MONTH, TAX CUTS AND JOBS ACT IN NAME ONLY Breaking economy news on Friday. The monthly employment situation report, trade deficit too if anyone cares. The biggest trade deficit since 2012 will make it hard for GDP growth to hit 3% again this quarter Q4 2017. Not sure many cared about the employment report either as bond trading stalled after 1030am. Even with the Dow Jones industrials soaring 220 points to a new record Friday.

Only 148 thousand new payroll jobs in December. Better get used to it. Philly Fed President Harker volunteered the view on Friday that payroll jobs might slow permanently to just 100K monthly increases by the end of 2019. Payroll jobs are fated to slow eventually we guess as the economy hits the wall of full employment. Companies don't need to increase headcounts materially in the ninth year of an economic expansion as they have hired enough people already to run their operations and meet the demand from customers for their goods and services for some time. Besides with a rock bottom low 4.1% unemployment rate, there aren't very many potential workers left to bring aboard anyway.

So that's 148K in December and the average in 2017 is now 171K. You can see the hiring slowdown pattern quite clearly. 250K in 2014, 226K in 2015, and 187K in 2016. Fewer jobs, jobs, jobs as the long

…148K is not enough in many people's minds, were there any special industries seeing a reduction in hiring or was it across the board the jobs slowdown? Well manufacturing and construction hiring was very strong at 25K and 30K, respectively. Retail jobs fell 20K in December after adding 26K in November, but retail fell 20K in October as well when the total jobs count was 211K. Nevertheless, retail jobs remain one of the key elements behind the low 148K jobs number this month as do business services where new jobs slowed to 19K from 49K in November and 47K in October.

To conclude, if it looks too good to be true, it usually is. Payroll jobs were just 38K in September due to the hurricanes, and bounced back rising 211K in October and another 252K in November, but now it is mean reversion time. Job gains have not averaged more than 200K since the year 2015. Those trying to stimulate the economy with a massive tax cut in order to create jobs, jobs, jobs, have a lot of explaining to do. Either that or they could form another presidential commission to look at the underreported jobs that must be out there, but just cannot be found and improperly counted. Jobs growth is slowing and so too is the economy's momentum and this will make Fed officials even more cautious on the outlook for inflation. Without strong economic growth, it is hard to be confident that inflation will make it back to the Fed's 2% objective. The slow 148K jobs number is just the ammunition the Fed doves need to scuttle one or two of the rate hikes the committee forecasts in 2018-19. The path of higher rates this year is no longer assured. The market based odds of a March 21, 2018 rate hike have not changed after today's employment data, but one wonders for how long. The odds of a rate hike are staying high at 76% in this morning's post-jobs report trading. The bottom line is that the market isn't panicking, but we haven't heard yet what Fed officials think about today's report. 148K is no reason to speed up the path of rate hikes in 2018, that's for sure.

MARKETS OUTLOOK Yields moved back up this week on the first day of the year. Payroll jobs were weaker at 148K on Friday, but 10-yr yields only dropped briefly from 2.46% to 2.43% on the news before closing the week at 2.48%. It is surprising the market is not adjusting its Fed rate hike expectations downward. Philly Fed President Harker gave a speech Friday after the employment data saying he looked for two rate hikes in 2018 which is one short of the FOMC 3 hike median forecast. The problem with the market’s “analysis” is that quite a few, 6 out of 16 members of the FOMC, want just two rate hikes in 2018. Even before today’s 148K jobs #.

According to our models, core PCE inflation likely may remain lower than +1.91%, on balance, over the coming three years. In turn, as our models forecast, should the FOMC implement the SIX twenty-five bps short-end interest rate hikes over 2018-2019, then the 2s-10s yield curve in Treasuries and swaps likely may “invert” in 2H-2019, possibly sooner – see Chart 2 and Table 1 !

Desk Strategy

Fade BoJ Fine-Tuning FX | Insights 9 Jan 2018 • • Mon 1/8/2018 3:03 PM

U.S. Week Ahead: Federal Reserve continues to Struggle with the Efficacy its "Inflation Target" …

Dollar-yen fell to 112.50 after the Bank of Japan announced it was cutting its purchases of long term JGB at today’s Rinban auction The BoJ reduced its bid by ¥10bn for 10-25Y JGBs (to ¥190bn) and also by ¥10bn for JGBs longer than 25Y (to ¥80bn)

• The central bank has been steadily cutting its JGB purchases since adopting Yield Curve Control in September 2016 (Chart 1)

While the FOMC has a +2.00% inflation “target,” looking back over the prior 23-years, with the exception of the four-years of 2004-2008, inflation has been LOWER than the Committee’s +2.00% target – see Chart 1 ! Core PCE inflation since 1994 has had: • •

An average mean rate of 1.714% and A median rate of 1.719%.

So, why Federal Reserve’s emphasis upon hitting +2.00% inflation ??? Plus, the years when inflation ran “either at or hotter than the target rate” (2004-2008) were years characterized by a reckless surge in gasoline’s retail price – not exactly a “desirable” economic objective !!!!

Looking Ahead: Our models forecast that core PCE Inflation likely remains lower than +1.91% over 20182019-2020, on Balance …

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But most of the decline in bond buying has been in 1-10Y JGBs as the BoJ has targeted 10Y yields to stay ‘around zero’ (Chart 2) We think today’s move only represents fine tuning to stop the long end of the JGB curve following the recent flattening in the US curve

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The BoJ faced strong criticism after its January 2016 deposit rate cut below zero caused long end JGB yields to collapse (Chart 3) In response the BoJ adopted its YCC framework to facilitate longer end steepening and support financial institutions (Chart 3 again) We don’t think the BoJ is signalling it will exit its super-loose monetary policy stance by formally raising its 10Y JGB yield target Today’s earnings data in Japan showed real wages only rising 0.1%y/y. Core CPI at 0.9% also is well below the BoJ’s 2% target We would thus fade dollar-yen’s dip. Instead the pair should rise towards 115-120 as the BoJ keeps 10Y yields near zero (Chart 4)

Desk Strategy

US Markets Closing Notes, January 8th 2018 Cross Asset | Strategy Daily 8 Jan 2018 Recap and Comments: …One of our traders and I were discussing the rates price action and cautiously noted that for the first time in what seemed like a while, the curve started flatter and re-steepened, as opposed to the usual pattern of starting flatter and ending flatter or starting steeper and ending flatter. Still, I don’t want to jump to any premature conclusions: it was a quiet day in a week likely to be dominated first by UST supply (which may be the culprit behind today’s minor long end pressure) before turning to the main course of CPI and retail sales on Friday. So we are careful not to read too much into today’s price action. If one is looking for headline events to drive the market out of its range, tomorrow doesn’t look like the session to provide them. European data centers on unemployment, and in the US we only have JOLTS data, a 3yr auction, and Kashkari’s panel appearance. So we will likely be left watching market price action again to see if we can glean anything about positioning or sentiment, though, like today, we will need to be cautious about making too many conclusions either way. Strategic/medium term bias (changes in bold): • Direction: Neutral for the moment. • Curve: Steeper, prefer 5s10s targeting 35bps or 5s30s targeting 75bps. • Curvature: We are long 5s on the curve, as the belly looks cheap in our view. • Inflation: We are constructive on inflation breakevens but would wait to seek entry for a pullback to the 1.65%-1.75% area.

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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): • Entered 5s30s steepeners at 55bps, targeting 75bps , stop on close under 45bps. 3m carry/roll ~9bps. • Received 5s on 2s5s10s swaps at +5bps, target 10bps, stop on close over +10bps • Entered 2y swap spread widener at 18.3bp, targeting 25bp with a stop on a close below 15bp. Support and Resistance Levels (Strong in BOLD): • 2s – Support: 1.96%, 2.16%. Resistance: 1.77%, 1.485%, 1.22%, 1.13%. Daily momentum is back bearish. • 5s – Support: 2.35%, 2.42%. Resistance: 2.10%, 1.89%, 1.60%, 1.54%, ~1.43%, 1.365%, 1.15%. Daily momentum is mixed/bearish. • 10s – Support: 2.50%, 2.64%, 2.72% trendline, 2.68%, 2.71%, 2.82%, 3.05%. Resistance: 2.40%, 2.34%, 2.30%, 2.15%, 1.98-2.00%, 1.88%, 1.71%, 1.52%. Daily momentum is mixed. • 30s – Support: 2.95%, 3.06%, 3.21-3.25% zone, 3.23% multi-year trendline, 3.57%. Resistance: 2.67%, 2.63%, 2.52%, 2.25%. Daily momentum is mixed. Sentiment/positions: • Updated 5-Day DSI in TY Futures 27% Bulls (US TBond Futures at 55% bulls) and we also have 86% Bulls in the 5-day DSI in S&P futures. • Stone & McCarthy Survey: The SMR Asset-Weighted Actual/Target Duration Ratio was at 99.4% from 99.6%. The Arithmetic Actual/Target Duration Ratio was at 99.7% from 99.8%. • JP Morgan survey: Longs 15 from 11, shorts 40 from 45, and neutrals 45 from 44. Attachments: • EUR/USD daily – momentum rolling bearishly from elevated levels. • 10s30s daily – impressively still in its impressive downchannel.

Desk Strategy

The Fed Watcher Economics | Policy Flash 8 Jan 2018 Our Fed Call: We see four hikes in 2018; markets have moved in that direction Nonfarm payrolls came in short of expectations in December (+148,000), though other aspects of the employment report (e.g. hourly earnings and the unemployment rate) matched expectations. On balance,

nothing in the report is likely to change anyone's opinion about the economy or the Fed at the start of 2018. At this point, the Fed’s focus is tilted more toward inflation than growth anyway. To that end, the release of the CPI this week will be closely watched. We expect the December report to show a modest acceleration, with the core measure forecast to have advanced by 0.2% after 0.1% in November. Such a result is likely to have kept the year/year growth rate steady at 1.7%. With the inflation rate making only slow progress back towards the Fed’s mandate, this week’s data should not challenge the market’s expectation of just over two hikes by the end of 2018 and only three rate hikes (in total) by the end of 2019. Nevertheless, the Fed raised rates three times in 2017, consistent with its year-end 2016 projection. In addition, the Fed began shrinking its balance sheet in October – a development that few market participants had anticipated at the start of 2017. In other words, after years of “under-delivering,” Fed officials in 2017 followed through on their guidance for rates (and more). We expect that will be the case again in 2018. The December Summary of Economic Projections showed no change in thinking among the FOMC that three rates hikes would likely be appropriate in 2018 (followed by at least two more increases in 2019). With the unemployment rate solidly below the Fed’s NAIRU estimate, financial conditions continuing to ease in the face of Fed action, the global economy stronger and more synchronized than at any point in the cycle, and new personnel at the Fed more hawkishly disposed, we look for policymakers to continue to hike rates once per quarter, raising the fed funds target range to between 2.25%- 2.50% by the end of 2018

FOMC Composition: 2017 vs. 2018 President Trump selected Jerome Powell to serve as the next Fed Chair (Yellen has announced that she will depart the Fed after Powell is sworn in). In 2018, Trump will have the opportunity to name four additional Governors to the Fed Board, including a new Vice Chair (Stan Fischer resigned from the Fed in mid-October for “personal reasons”). Personnel turnover is also underway at some of the regional Federal Reserve banks, including New York and Richmond, whose Presidents will be voting members of the FOMC this year (NY Fed President Dudley will depart around the middle of 2018, and Thomas Barkin has just taken over at the Richmond Fed). In 2018, the regional voters (besides the NY and Richmond Fed Presidents) will be Cleveland Fed Pres Mester, San Francisco Fed Pres Williams, and Atlanta Fed Pres Bostic. On balance, we believe the rotation among the regional bank presidents will contribute to a less dovish voting FOMC contingent in 2018. As shown in the charts below, in 2017, most voting (i.e. “important”) members of the FOMC were in the upper (i.e. “dovish”) quadrant. However, in 2018, the voting FOMC members are more broadly dispersed between hawks and doves, and that skew could shift further if the new Board appointees lean hawkish.

JANUARY 8, 2018

FI SPECIAL TREASURY AUCTION PREVIEW (6P) Key points - The Treasury is scheduled to auction $24bn in 3y notes on 9 January, $20bn in 10y notes on 10 January, and $12bn in 30y bonds on 11 January. - On 15 January, $24bn of Treasuries is maturing. It will be the second reopening of the 10y and 30y benchmarks before the next refunding in February, where the Treasury is expected to announce an increase in 2y, 3y, and 5y issuance size.

- The cheapening of the 3y sector on an outright basis since the last auction should support demand at the upcoming auction, though the sector does not appear to have a clear set up from a relative-value perspective. The 3y whenissued (WI) yield is near 2.07%, which is 13.8bp cheaper than the last auction stop and above the auction stops since 2007. Leveraged funds are net short at the front end of the curve (TU

contract) for the first time since 1 August, which is a positive for the auction on the margin even though primary dealer holdings in the 2-3y sector have increased since the last auction. Also a positive is the uptick in demand at the previous auction, which stopped through by 0.2bp, with the highest bid/cover ratio since September 2015. - The upcoming 10y auction will likely need concession to be underwritten smoothly. Positives for the auction include cheap outright valuation, with the 10y WI yield now trading above the auction stops since March. Negatives for the sale include the large IG issuance expected this week, lack of a clear set up from a relative-value perspective, and a flatter 2s10s curve since the last auction. The December auction was soft, tailing by 0.5bp, with the highest award to primary dealers since September. - We are slightly positive on the upcoming 30y bond auction on the back of continuing demand at the long end of the curve. However, it will likely need concession to be underwritten smoothly, as the sector seems rich on valuation given that the 5s30s curve continues to drop and is now trading near its lowest level since late 2007. The expected heavy IG credit issuance this week is another negative for the auction. Positives include four stopthroughs in the last six 30y auctions and the benchmark outright yield trading above the stops from the past two 30y auctions.

JANUARY 8, 2018

ON OUR MINDS: US - HIGH FREQUENCY DATA/INFLATION A LONG DECEMBER: MAYBE THIS MONTH WILL BE BETTER THAN THE LAST Summary: The final CPI print of 2017 is likely to have shown a 0.1% monthly advance, which would push the yoy rate down from 2.2% to 2.0%. Following the soft November core CPI, however, we look for the core rate to have eked out a 0.2% rise in December. Frankly, our conviction level is low this month given the historic declines in several components in November. In any case, we look for the NSA index to have printed 246.306.

JANUARY 4, 2018

FI WEEKLY REMAIN SHORT DURATION Growth remains strong just about everywhere, while forward inflation expectations are rising somewhat as oil creeps up. Yet we find the pace of central bank normalisation to be slow, and bond yields only rose moderately over the holiday period. There is ample scope for a further upwards correction in yields as we digest 1Q bond supply. Investors can balance shorts with a long in yields, either through credit spreads or by holding the very long end.

…Tactical yield and curve ranges and trade recommendations The curve dynamic continues to be driven by the front end. The back end of the curve remains anchored in the tight 2.32.5% range that has prevailed since mid-October, while the 2yT yield sold off by 50bp over the same period. This process reflects the market’s willingness to price the three hikes in the Fed’s dot plot for 2018, but perhaps more significantly, little beyond that. Indeed, the market is now pricing two hikes fully in 2018, with the third hike priced with 54% probability (see Graph 6). The recent bias has been for frontloading hikes rather than pricing more hikes on the curve, which is in line with the 2-2.25% expectation for the neutral rate in this cycle and contributes meaningfully to the range-bound environment at the back end of the curve in a context whereby inflationary pressures remain subdued (if one expects the curve to invert at the peak of the cycle and the neutral rate to be in the 2-2.25% range, then the prevailing yield for the 10yT at the peak of the cycle should be in the same range). It is also worth discussing the implications of this 2-25% neutral rate scenario that the market seems to be converging towards in terms of the expected dynamic at the front end of the curve. Let’s consider no overshoot of the neutral rate by the Fed and two cases: (1) March, June and September hikes (our economists’ base case), and (2) June, September and December hikes. In both these cases the Fed reaches 2.25% for IOER and stays on hold for the remainder of this cycle. Assuming a flat spread to IOER (reasonable in a context whereby front-end rates peak by end-2018), this implies that:

to price the former fully, the 2yT should now be trading at 2.05% (three months of IOER at 1.5%, three months at 1.75%, three months at 2% and 15 months at 2.25%) and at a yield of 2.2% in six months’ time.

to price the latter fully, the 2yT should now be trading at 1.8% and at a yield of 1.95% in six months’ time

These simple back-of-the-envelope calculations provide useful limiting cases for the evolution of the 2yT and a tactical range for positioning in the near term: short 2yT bias in the 1.8- 1.95% range and long bias in the 2.05-2.25% range. It’s also not surprising therefore to see the 2yT currently on neutral ground at 1.96%.

… Upcoming Treasury auctions The Treasury is scheduled to auction $24bn in 3y notes on 9 January, $20bn in 10y notes on 10 January and $12bn in 30y bonds on 11 January. On 15 January, $24bn of coupon Treasuries is maturing. It is the second reopening of the 10y and 30y benchmarks before the next refunding in February, when Treasury is expected to announce an increase in 2y, 3y, and 5y issuance size. The upcoming 3y note auction will likely benefit from the cheap outright levels compared to the previous auction stop, continuing flattening pressure and an uptick in the last auction’s demand, whereas it faces headwinds from rich curve valuation. The current 10y benchmark note is outright cheap compared to the last auction stop, while the drop in demand at the last auction is a negative. The 30y sector seems to be rich on valuation, as the outright yield is trading below the stops from the past two 30y auctions and the 5s30s curve is trading near its lowest levels since 2007.

lowest for the sector since May, whereas foreign investors took 13%, their highest amount since March. JANUARY 9, 2018

FX BLOG YUAN TURN, HIGHER YIELDS, STRONGER DOLLAR. (2P)

Kit Juckes The Euro correction continues, the BOJ has slowed the pace of bond-buying slightly and given the yen a lift, strong Australian building approvals are helping the AUD, oil prices are still rising and the Yuan's rally has stalled. When the Chinese authorities signalled that enough was enough and they didn't want to see further Yuan strength last September, the following weeks saw a significant rise in Treasury yields, a correction in the EUR/USD rally and a broadly stronger dollar. I've mentioned before that Chinese policy matters more for global markets than it used to, and Chinese policy moves tend to be decided rather faster than those in the US or Europe. I wouldn't dream of pretending that I understand the thinking in Beijing, but it's noteworthy that US yields are still rising after the slightly soft payroll data on Friday and an extension of a synchronised move higher in yields and the dollar would be similar to what we saw in September/October.

Recent auctions’ performance The $24bn 3y note auction in December stopped through. It was awarded at 1.932% compared to the 1.934% 11:30am when-issued (WI) yield (see Table 1). It was the highest stop for the sector since June 2009’s 1.934%. The 3.15x bid/cover ratio was highest since the 3.23x of September 2015, indicating strong demand likely because of cheap outright valuation and cheapness on the curve. The 53% award to investment funds was their highest share of the sector since at least May 2003, whereas foreign investors 10% was their lowest share since December 2016. The $20bn 10y note auction in December tailed. It was awarded at 2.384% compared to the 2.379% 1pm WI yield (see Table 2). It was the highest 10y auction stop since May. The bid/cover ratio dropped to 2.37x, which was the lowest for a 10y auction since September, indicating cheap outright levels and specialness in repo provided little support. Primary dealers took 37% of the offered amount, their highest share since September, whereas foreign investors’ (15%) and funds’ (48%) takedown was lower than their shares in the previous month. The $12bn 30y bond auction last month stopped through. The auction was awarded at 2.804%, stopping through by 0.4bp compared to the 1pm WI yield (see Table 3). The 2.48x bid/cover ratio was higher than the 2.32x average for the past six auctions. Investment funds’ 56% takedown of the offered amount was their

The Yuan and US yields - which is egg, which chicken

JANUARY 8, 2018

GLOBAL EQUITY MARKET ARITHMETIC (TOO) PERFECT MARKETS? (36P) Global equity markets have started 2018 in buoyant mood with MSCI World already up 2.5% and with most markets making strong gains. Emerging Markets are up 3.7%, the Nikkei 225 is 4.2% higher and the Nasdaq has risen by 3.4% only the UK is a notable laggard rising just 0.6% so far this year. Over the last 12 months not only have the vast majority of stocks produced a positive return (82% of all

MSCI World stock) but also 76% of all stocks in the index saw their earnings rise year-on-year. Indeed for the first time in a while MSCI World made strong gains which were down to higher earnings and not higher valuations.

Last month’s 3s10s30s auction series showed mixed results, with 3s and 10s tailing by 0.3bp and 0.4bp, respectively, and 30s stopping through the screens by 0.3bp.

We have used the charts below before to demonstrate how relative stock performance is almost always driven by relative changes in earnings expectations. We rank the global stock universe (MSCI World) into deciles based on by realised changes in analysts 12m forward EPS expectations and record the average performance of each of those deciles over the same 12-month period. So the chart measures coincident changes between share prices and EPS changes and usually the relationship is pretty strong. But even we have been surprised at the unusually strong link between realised share price performance changes in analysts' expectations last year. The relationship was almost perfect and the highest level we have ever recorded. How should you interpret such market “efficiency”? Well on the one hand it is reassuring that equities are responding to better earnings and that relative moves seem to correspond to the confident market outlook. On the other hand, the strength of the relationship is somewhat suspicious and smacks of analysts upgrading simply to justify share price moves (i.e. share prices driving EPS expectations and not the other way around). The truth probably lies somewhere in between, but the message is clear, earnings are as important as ever.

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3s: This sector has cheapened 10bp since last auction cycle and 3s have continued to cheapen on the curve. Recent 3yr auctions have shown some mixed results, but the cheapening of 3s on the curve could help support demand. Averages suggest a modest 0.1bp stop through the screens and 64% buy side takedown — 55% to indirects and 9% to directs.

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10s: Recent 10yr auctions have seen mixed results as four of past six auctions tailed. However, 10yr yields have increased by 40bp since the September auction, which may draw more interest from buyers. Averages suggest a 0.5bp tail and 69% buy side takedown (62% to indirects and 7% to directs). 30s: The long end has richened notably on the curve as investors continue to look for sustained flattening. Averages hint at a 0.1bp stop through, with the buy side taking an average of 70% (62% to indirects and 8% directs).

5 January 2018

January 8, 2018

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Global Rates Weekly

Economics Group

No, Mr. Wage, I Expect You To Rise

The Case for Higher Interest Rates in 2018: The Fundamentals

…

Treasury Auction Preview

Treasury will auction a combined $56bn next week, selling $24bn in 3s on Tuesday, $20bn in reopened 10s on Wednesday and $12bn in reopened 30s on Thursday. With $40.5bn maturing at mid-month settlement, the auction will raise $15.5bn in new cash. With balance sheet runoff accelerating, the Fed will allow an increased $12bn to run off this month vs $6bn previously. Nevertheless, there will be only $3.1bn in SOMA holdings maturing mid-month, with the Fed adding on $1.9bn — $0.7bn to 3s, $0.7bn to 10s and $0.5bn to 30s. Front end Treasury yields continued to move substantially higher since last auction cycle and the curve continued to flatten as the market has lifted rate hike expectations for 2018. Fed funds futures are currently pricing in 80% odds of a March hike and a total of 2.3 hikes by the end of 2018.

Day-to-day, countless factors drive gyrations in the Treasury market. The key fundamentals, however, drive the underlying trend, and we believe these factors are poised to drive U.S. Treasury yields higher in 2018. Fundamental #1: Economic Growth and Inflation … Faster economic growth/inflation has pushed nominal GDP growth back to a 4 percent year-over-year pace, and we expect the upward trend to continue in 2018. We expect real GDP growth of 2.7 percent this year and for inflation to drift closer to the Fed’s 2 percent target. A

continued acceleration in GDP and prices suggests these two key fundamentals will be supportive of higher yields on U.S. Treasuries this year. Fundamental #2: Monetary Policy … With regards to the Fed’s balance sheet, monetary policy remains more accommodative, but here too the fundamentals suggest upward pressure on Treasury yields. The balance sheet reduction program initiated last October will see the run-off caps rise to $50 billion/month in Q4-2018 for Treasuries and MBS. If the Fed follows its stated plan, approximately $230 billion in Treasury debt would mature and not be reinvested in 2018 (middle chart). Steady increases in the fed funds rate and snowballing balance sheet reductions suggest an upward shift for the yield curve in 2018.

upside adds further credence to the claim that the consumer feels confident about the economy. … Outlier or a Sign of Things to Come?

November’s print will certainly draw different reactions from various market participants. While the monthly jump in credit financing can be interpreted as reflecting confidence of the U.S. consumer and perhaps is a positive sign for continued economic activity, others may see the spike in credit as a sign of consumption hubris. As the Fed prepares to hike rates multiple times in 2018, charge-off rates are likely to rise as well.

Fundamental #3: Treasury Supply After steadily falling through FY 2015, the federal budget deficit has begun to rise again (bottom chart). As a result, the supply side of the Treasury market will see a surge of new issuance due to several factors: secular pressures related to the aging Baby Boom generation, additional spending from an expected budget deal and for hurricane/wildfire related emergencies and lower tax collections as a result of the tax overhaul bill passed in December. A jump in net issuance represents an additional catalyst for higher Treasury yields in 2018.

January 8, 2018

Economics Group

Consumer Credit Growth Hits Cycle High in November Consumer credit jumped nearly $28 billion in November, its largest monthly increase since 2001. The large surprise to the

January 8, 2018

Economics Group

Special Commentary

U.S. Trade Deficit Widening: Trouble Brewing? Executive Summary

The U.S. trade deficit widened in November to its highest level in nearly six years. Because a current account deficit is caused by a shortfall of national savings relative to national investment, the red ink in the current account likely will widen further going forward due, at least in part, to recent tax legislation. In our view, the modest current account deficit that the United States is incurring is not a “problem,” at least not

from a purely economic standpoint. The country is having few troubles attracting the capital inflows that are needed to finance the deficit, and the dollar’s depreciation to date has been orderly. However, the bilateral trade deficits that the United States incurs with China and Mexico have not gone unnoticed in Washington, and wider deficits going forward could provoke a policy response from the United States. A trade war, should one develop, likely would have negative financial and economic consequences. January 8, 2018

Foreign Exchange Research

Special Edition

Can Emerging Currencies Withstand Further Global Monetary Policy Normalization?

Summary. By and large, emerging (EM)

currencies showed gains against a weakening U.S. dollar in 2017, even as the Federal Reserve delivered three rate hikes and began the process of shrinking its balance sheet. As we begin 2018, a year in which the Fed—as well as other major global central banks—is expected to continue normalizing monetary policy, we consider in this report the outlook for emerging currencies in the context of the ongoing, and broadening, theme of a reduction in global monetary policy accommodation. In our view, as long as the removal of monetary policy accommodation we are seeing remains gradual and the synchronous global economic expansion continues, emerging currencies should in general still be able to appreciate versus the greenback in 2018. Indeed, analysis of capital flows into emerging markets in recent years suggests that the positive effects for emerging currencies from synchronous global growth could offset any negative effect from gradually rising interest rates in key major developed economies. Accordingly, we maintain our view that most emerging market currencies will appreciate against the U.S. dollar in 2018.