Developed Countries

Clearly the president will benefit from being vindicated in such an authoritative way. He will not only avoid any mushrooming scandal, which can hurt a president seeking reelection, but will also gain sympathy from at least some voters for having been falsely accused. While Mueller technically did not exonerate Trump from charges of obstruction of justice, he also did not make any such charges. This means that House Democrats could conceivably still use the Mueller report’s evidence of potential obstruction to impeach Trump. But if they do they will fail. Attorney General Anthony Barr and his deputy, Rod Rosenstein, have both determined that there was no obstruction. With the special counsel having ruled out any collusion or even coordination with Russia, Trump will remain secure among grassroots Republicans. Hence the senators in his party will not convict him and any impeachment trial will be a charade. Thus to some extent Trump’s odds of reelection must be going up. Right? Wrong. The problem is that any positive impact on Trump’s reelection odds from the Mueller report ultimately matters much less than the inversion of the yield curve on March 22. This curve is the most reliable indicator of forthcoming economic recession. If the inversion is deep and persistent then it makes an election year recession probable. Presidents can survive a grand scandal, but they live or die by recessions. There have only been two presidents in the post-Civil War era who won reelection despite a recession in the calendar year of the election. These were William McKinley in 1900 and Theodore Roosevelt in 1904. Yet in 1900, the recession was drawing to a close and economic conditions were better than when McKinley first took office in 1896. And in 1904, the recession technically ended in August, before the fall campaign began. In ten other cases the ruling party has lost the White House amid a recessionary environment. In recent decades yield curve inversion precedes recessions by anywhere from five to sixteen months. The average is eleven months. This means that if the 10yr/3mo signal proves accurate once again, Trump would get extremely lucky to see the economy rebounding by the fall campaign. Granted, the yield curve could send a false signal. For instance, some take the view that the term premium is historically low for structural reasons and that this makes inversion easier and less indicative than in the past. However, when it comes to politics, President Trump cannot afford to assume that this time is different. It is already clear from his waivers on Iranian oil sanctions and trade negotiations with China that he lives in great fear of the business cycle expiring before November 3 next year, when it will be very long-in-the-tooth. Trump is also more vulnerable to recession than the usual president. He is a self-styled commercial leader – a CEO president and Washington outsider who staked his credibility on the claim that he will create jobs and grow the economy. Trump can possibly survive an election with a large trade deficit or a surge in immigrants on the southern border because these developments would highlight the very policy concerns that he did so much to emphasize: they would not necessarily invalidate his approach. But if unemployment is rising, it is hard to see how this president, let alone any other, could wriggle out of it. If he tries to shift the blame to the Federal Reserve or China in any concrete way, the equity market will riot and exacerbate the downturn. The takeaway is, first, that we should continue to see President Trump show relative risk aversion on market-relevant matters like Iran, China, and the “stimulus cliff” affecting the U.S. budget next fiscal year. Second, that if the current economic wobbles pass and the economic expansion gets a new breath of life, then Trump’s chances of retaining the White House will soar. Trump’s reelection odds have important investment consequences. His reelection will entail policy continuity and the maintenance of a low-tax, deregulatory environment that encourages animal spirits and pads corporate earnings. The more likely it appears that Trump will lose the White House, the more animal spirits will sag. A Democratic win will mean yet another violent vacillation in U.S. policy, like 2016, which will cause a spike in policy uncertainty. It will also bring a probable increase in taxes (including possibly the corporate rate) and regulations across a range of sectors. If a Democrat wins in 2020, he or she will most likely have a fairly left-wing agenda, due to trends in the party, and whoever takes the White House will likely also take the Senate. Since the same goes for the House, a presidential win will deliver full Democratic control of the executive and legislative branches: a window of minimal political constraints in which a sweeping piece of legislation can be enacted, like in 2009 or 2017. In short, a Trump loss would not only mean the end of the status quo but likely a united government in favor of a rather left-leaning Democratic agenda. If the market has reason to believe a recession is looming, and that a recession will occasion a lurch to the “anti-business” side of the Left, then the impact on investment decisions and capex intentions will be negative and immediate. Economic policy uncertainty has nowhere to go but up. Matt Gertken,  Geopolitical Strategist mattg@bcaresearch.com

Highlights The correlation between oil and petrocurrencies has deeply weakened in recent years. One of the reasons has been the prominence of new, important producers, notably the U.S. Oil prices should trend towards $75/bbl by year-end. This will favor the NOK, but the CAD and AUD will be held hostage to domestic slowdowns. Sell the CAD/NOK at current levels. Meanwhile, aggressive investors could begin accumulating USD/NOK shorts, given the Fed’s complete volte-face. Both the SNB and the BoE have delivered dovish messages, joining the chorus echoed by other central banks. However, the BoE remains a sideshow until the final chapter of the Brexit imbroglio unfolds. Feature Oil price dynamics have tended to have a profound impact on the trend of petrocurrencies. In theory, rising oil prices allow for increased government spending in oil-producing countries, making room for the resident central bank to tighten monetary policy. This is usually bullish for the currency. An increase in oil prices also implies rising terms of trade, which further increases the fair value of the exchange rate. Balance-of-payments dynamics also tend to improve during oil bull markets. Altogether, these forces combine to be powerful undercurrents for petrocurrencies. In the case of Canada and Norway, petroleum represents around 20% and 60% of total exports. For Saudi Arabia, Iran or Venezuela, this number is much higher than in Norway. It is easy to see why a big fluctuation in the price of oil can have deep repercussions for their external balances. Getting the price of oil right is usually the first step in any petrocurrency forecast. The Outlook For Oil1 Our baseline calls for Brent prices to touch $75/bbl by year-end. Oil demand tends to follow the ebbs and flows of the business cycle, with demand having slowed sharply in the fourth quarter of 2018 (Chart I-1). With over 60% of global petroleum consumed fueling the transportation sector, the slowdown in global trade brought a lot of freighters, bulk ships, large crude carriers and heavy trucks to a halt. If, as we expect, the impact of easier global financial conditions begins to seep into the real economy, these trends should reverse in the second half of the year. BCA’s Commodity & Energy Strategy group estimates that this would translate into a 1.5% increase in oil demand this year. Chinese oil imports have already started accelerating, and should Indian consumption follow suit, this will put a floor under global demand growth (Chart I-2). Chart I-1Global Oil Demand Has Been Weak Chart I-2Oil Demand Green Shoots This increase in oil demand will materialize at a time when OPEC spare capacity is only at 2%. In its most recent meeting, OPEC decided not to extend the window for production cuts beyond May, waiting to see whether the U.S. eases sanctions on either Venezuela, Iran or both. At first blush, this appeared bearish for oil prices. However, the bottom line is that global spare capacity cannot handle the loss of both Venezuelan and Iranian exports. Unplanned outages wiped off about 1.5% of supply in 2018. Lost output from both countries will nudge the oil market dangerously close to a negative supply shock (Chart I-3). Bottom Line: If Venezuelan sanctions continue, we expect the U.S. will likely extend the current waivers to Iranian exports further out into the future. Meanwhile, demonstrated flexibility by OPEC makes it increasingly the fulcrum of the oil market. That said, the balance of risks for oil prices remain to the upside since a miscalculation by both sides is a possibility. The Good Old Days Historically, the above analysis would have been largely sufficient to buy most petrocurrencies, especially given the gaping wedge that has opened vis-à-vis the price of oil (Chart I-4). But the reality is that the landscape for oil production is rapidly shifting, with the U.S. shale revolution grabbing market share from both OPEC and non-OPEC members. Chart I-4Opportunity Or Regime Shift? In 2010, only about 6% of global crude output came from the U.S. Collectively, Canada, Norway and Mexico shared about 10% of the oil market. Meanwhile, OPEC’s market share sat just north of 40%, having largely been stable among constituents like Saudi Arabia, Iran and even Venezuela. Fast forward to today and the U.S. produces almost 15% of global crude, having grabbed market share from both developed and politically-fragile economies (Chart I-5). Chart I-5A New Oil Baron At the same time, the positive correlation between petrocurrencies and oil has been gradually eroded as the U.S. economy has become less and less of an oil importer. Put another way, rising oil prices benefit the U.S. industrial base much more than in the past, while the benefits for countries like Canada and Norway are slowly fading. U.S. shale output in the Big 5 basins rose by about 1.5 million barrels in 2018, close to the equivalent of total Libyan production. Meanwhile, Norwegian production has been falling for a few years.  The reality is that the landscape for oil production is rapidly shifting, with the U.S. shale revolution grabbing market share from both OPEC and non-OPEC members. In statistical terms, petrocurrencies had a near-perfect positive correlation with oil around the time U.S. production was about to take off (Chart I-6). Since then, that correlation has fallen from around 0.8 to around 0.3. At the same time, the DXY dollar index is on its way to becoming positively correlated with oil as the U.S. becomes a net energy exporter. Chart I-6Shifting Landscape For Petrocurrencies Bottom Line: Both the CAD and NOK remain positively correlated with oil. So do the Russian ruble, and the Colombian and Mexican pesos. That said, a loss of global market share has hurt the oil sensitivity of many petrocurrencies. Transportation bottlenecks for Canadian crude and falling production in Norway are also added negatives. The conclusion is that rising petrodollar reserves have historically been bullish for the currency (Chart I-7) but expect this correlation to be weaker than in the past.  Chart I-7Rising Petrodollar Reserves Will Be Bullish The Fed As A Catalyst The Federal Reserve recently completed the volte-face that it launched at its January FOMC meeting. The dots now forecast no rate hikes in 2019 and only one for 2020. Previously, three hikes were baked in over the forecast period. GDP growth has been downgraded slightly, and CPI forecasts have also been nudged down. Rising petrodollar reserves have historically been bullish for the currency but expect this correlation to be weaker than in the past. The reality is that U.S. growth momentum relative to the rest of the world started slowly rolling over at a time when external demand remained weak.2 Recent data confirm this trend persists: Industrial production peaked last year and continues to decelerate; the NAHB housing market index came in a nudge below expectations; and the U.S. economic surprise index is sitting close to its one-year low of -40. With bond yields having already made a downward adjustment by circa 100 basis points, the valve for financial conditions to get looser could easily be via the U.S. dollar (Chart I-8). We have been selectively playing USD shorts, mostly via the SEK and the euro, as per our March 8th report. Today, we add the Norwegian krone to the list. Chart I-8Bond Yields Down, Dollar Next? Sell CAD/NOK The Norges Bank hiked interest rates to 1% at yesterday’s meeting, which was widely expected, but the hawkish shift took the market by surprise. Governor Øystein Olsen signaled further rate increases later this year, at a time when global central banks are turning dovish. This lit a fire under the Norwegian krone. The 6.60 level for the CAD/NOK has proven to be a formidable resistance since 2015.   The Norwegian economy remains closely tied to oil, with the bottom in oil prices in 2016 having jumpstarted employment growth, business confidence and wage growth. With inflation slightly above the central bank’s target and our expectation for oil prices to grind higher, we agree with the central bank’s assessment that the future path of interest rates is likely higher (Chart I-9). Chart I-9The Norwegian Economy Is Faring Well Our recommendation is that NOK long positions should initially be played via selling the CAD, as an indirect way to express USD shorts (Chart I-10). The 6.60 level for the CAD/NOK has proven to be a formidable resistance since 2015, and our intermediate-term indicators suggest the next move is likely lower. Meanwhile, relative economic surprises are moving in favor of Norway, with export growth, retail sales and employment growth all outpacing Canadian data. The discount between Western Canadian Select crude oil and Brent has closed, but our contention is that the delay in Enbridge’s Line 3 replacement will likely push the discount back closer to $20/bbl. Chart I-10Sell USD Via CAD/NOK Over the longer term, both the Canadian and Norwegian housing markets are bubbly, but in the latter it has been concentrated in Oslo, with Bergen and Trondheim having had more muted increases. In Canada, the rise in house prices could rotate to smaller cities, as macro-prudential measures implemented in Toronto and Vancouver nudge investors away from those markets (Chart I-11).  Chart I-11Bubbly Housing In Norway And Canada The Canadian government has decided to provide residents with a potential line of credit in exchange for equity stakes of up to 10% in residential homes. The maximum home value that qualifies for this line of credit has been capped at C$480,000. While this does little to improve the affordability of houses in expensive cities, it almost guarantees that those in competitive markets will be bid up. This will encourage a continued buildup of household leverage. Historically, when the leverage ratio for Canada peaked vis-à-vis the U.S., it was a negative development for the Canadian dollar (Chart I-12).   Chart I-12The CAD Looks Vulnerable Bottom Line: Go short CAD/NOK for a trade, but more aggressive investors should begin accumulating short positions versus the U.S. dollar outright. Hold USD/SEK shorts established a fortnight ago, currently 3% in the money. Housekeeping We are taking profits on our short AUD/CAD position this week, with a 1.4% profit. As highlighted in our March 8th report, the Australian dollar has been severely knocked down, and is becoming more and more immune to bad news. Despite home prices falling by more than 5% year-on-year, worse than during the financial crises, the Aussie was actually up on the week. Meanwhile, Australian exports will be at the top of the list to benefit from China’s reflationary efforts.   Chester Ntonifor,  Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Commodity & Energy Strategy Weekly Report, titled “OPEC 2.0: Oil’s Price Fulcrum,” dated March 21, 2019, available at ces.bcaresearch.com 2 Please see Foreign Exchange Strategy Special Report, titled “Into A Transition Phase,” dated March 8, 2019, available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 The recent data in the U.S. have shown more signs of a slowdown: February industrial production growth missed expectations, coming in at 0.1% month-on-month. Michigan consumer sentiment in March came in higher than expected at 97.8. NAHB housing market index in March came in at 62, below consensus. January factory orders slowed to 0.1% month-on-month.  Philadelphia Fed business outlook came in at 13.7, surprising to the upside. Initial jobless claims in March were 221k, also outperforming analysts’ forecast. The DXY index slumped by 0.8% post-FOMC, and is now slowly recovering on the strong data from the Philly Fed business outlook and initial jobless claims. The Fed left interest rates unchanged on Wednesday, while further signaling that no rate hike is likely through 2019. Moreover, 2019 GDP forecast was downgraded to 2%. The dovish turn by the Fed could weigh on the dollar in the coming weeks. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 The recent data in the euro zone have been mostly positive: February consumer price index came in line at 1.5% year-on-year; core consumer price index also stayed at 1% year-on-year. The seasonally-adjusted trade balance in January improved to 17 billion euros. Q4 labor cost fell to 2.3%. ZEW economic sentiment survey came in at -2.5 in March, outperforming the consensus of -18.7. EUR/USD increased by 0.5% this week. The FOMC-led sharp rebound sent EUR/USD to a new week-high of 1.145 on Wednesday. We expect more positive data coming from the euro zone, which will further lift the euro. Report Links: Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Balance Of Payments Across The G10 - February 15, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have continued to soften: The merchandise trade balance came in at 339 billion yen in February. Total imports contracted by 6.7% year-on-year, while total exports fell by 1.2% year-on-year. Industrial production increased by 0.3% year-on-year in January. Capacity utilization in January fell by 4.7% month-on-month, missing expectations. The leading economic index in January fell to 95.9 from a previous reading of 97.2. USD/JPY slumped by 0.9% this week. Last Friday, the Bank of Japan left its key interest rate unchanged at -0.1%, as wildly expected. The 10-year government bond yield target also stayed unchanged at around 0%. Like many global central banks, the BoJ has been blindsided by the deep external slowdown that is beginning to seep into the domestic economy. Report Links: A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mostly positive: Average earnings excluding bonuses in January grew in line by 3.4%. ILO unemployment rate in January fell to 3.9%. The retail price index in February stayed in line at 2.5% year-on-year. The February consumer price index increased to 1.9% year-on-year. Retail sales growth in February increased to 4% year-on-year, outperforming expectations.  GBP/USD fell by 1.1% this week, erasing the gains triggered by dollar weakness earlier on Wednesday. The BoE left its interest rate unchanged at 0.75%, and the sterling continues to show more volatility with a delayed Brexit. Report Links: A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have shown the housing market is toppling over: The housing price index in Q4 fell sharply by 5.1% year-on-year. New jobs created in February were 4,600, missing the expectations by 9,400. Moreover, 7,300 full-time employment jobs were lost, while 11,900 positions were created for part-time employment. The unemployment rate in February fell to 4.9%, while the participation rate decreased to 65.6%. AUD/USD appreciated by 0.6% this week. It pulled back a little after reaching a 0.7168 high on Wednesday following the dovish Fed decision. During a speech this week, RBA highlighted the concerns over the ability of households to service their debt. Both external and internal constraints remain headwinds for the Australian dollar. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been weak: Credit card spending growth in February slowed to 6.4% year-on-year. Q4 GDP growth came in at 2.3% year-on-year, underperforming consensus of 2.5%. The current account deficit widened to 3.7% of GDP in Q4. NZD/USD appreciated by 0.5% this week. The Q4 GDP breakdown showed that growth was mainly driven by the rise in service industries. Primary industries, however, fell by 0.8%. Agriculture was down 1.3%, mining was down 1.7%, forestry and logging fell 1.6%, and lastly, the fishing activity was down 0.9% quarter-on-quarter. The Kiwi will benefit from any dollar weakness, but is not our preferred currency. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Updating Our Intermediate Timing Models - November 2, 2018 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada continue to paint a mixed picture: January manufacturing shipments increased to 1% month-on-month. Foreign portfolio investment in Canadian securities saw an increase of C$49 billion in January, while Canadian portfolio investment in foreign securities decreased by C$8.4 billion. January wholesale sales growth increased to 0.6% month on month. USD/CAD rebounded overnight after falling sharply on a dovish Fed. CAD finally ended the week flat. On Tuesday, Bill Morneau, the Finance Minister of Canada, unveiled the new federal budget for 2019. It showed several new measures aiming to assist young and senior Canadian citizens, including first-time home buyers. While these measures might appease Canadian millennial voters, they will also result in significant deficits. The deficit projection for the year 2019-2020 widened to $19.8 billion, which could crowd out private spending. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 The trade balance in February came above expectations at 3,125 million CHF. Exports came in at 19,815 million CHF, while imports came in at 16,689 million CHF, respectively. USD/CHF depreciated by 1% this week. The Swiss National Bank left the benchmark sight deposit rate unchanged at -0.75%, as wildly expected. We struggle to see any upside potential for the franc, amid a dovish central bank, an expensive currency and muted inflation. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Waiting For A Real Deal - December 7, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway has been positive. The trade balance in February fell to 15.8 billion NOK, from a previous reading of 28.8 billion NOK. USD/NOK fell by 1.3% this week. The Norges Bank raised rates by 25 bps to 1%, in line with expectations, while signaling further rate hikes in the second half of this year. The Norges Bank once again demonstrated to be the most hawkish among G10 members. The bank reiterated that the economy is running at a solid pace and capacity utilization is above normal levels, while inflation keeps navigating above the bank’s target. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 There has been no major data release from Sweden this week. USD/SEK fell by 1.5% this week. Our short USD/SEK position is now 3% in the money since we initiated it 2 weeks ago. As we see more signs of recovery in the euro zone, we expect the exports of Sweden to pick up, which is a tailwind for the Swedish krona. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Dear Client, I had the pleasure of visiting clients in Seattle, Anchorage, and Juneau last week. In this week’s report, I address some of the questions that routinely came up during our meetings. Among other things, the topics discussed include our optimistic global growth outlook, waning dollar bullishness, implications of a more dovish Fed on the business cycle, and where we think equities are headed. Next week we will be publishing our Quarterly Strategy Outlook, which will provide a detailed discussion of our key global macro and investment views. Best regards, Peter Berezin, Chief Global Strategist Feature Q: You have predicted that global growth will stabilize in the second quarter and then accelerate in the second half of the year. Are you seeing much evidence in support of this view? A: We are seeing signs of green shoots, but they are still fairly tentative. Current activity indicators appear to have stabilized (Chart 1). The global manufacturing PMI edged lower in February, but the services component increased. Consumer confidence has risen, although that may simply reflect the rebound in global equities. Chart 1Global Growth Appears To Have Stabilized The data on international trade has been quite soft. That said, the weekly Harpex shipping index, which measures global container shipping activity, has improved. The Baltic Dry Index has also shown some signs of bottoming (Chart 2). Chart 2Shipping Data Pointing To A Recent Pickup In Global Trade The diffusion index of our global leading economic indicator, which tracks the share of countries with rising LEIs, has also moved higher (Chart 3). It generally leads the global LEI. The fact that global financial conditions have eased significantly since the start of the year is also an encouraging sign. Chart 3The Uptick In The LEI Diffusion Index Suggests Global Growth Will Firm Up Q: What’s your take on the most recent Chinese economic data? A: It has been generally soft, but not abysmal. Manufacturing output continues to decelerate. Retail sales remain lackluster, with auto sales showing little evidence of improvement. Property prices are still rising, but floor space sold has begun to contract. Fixed-asset investment has held up so far this year. However, this is mainly due to a pickup in spending among state-owned companies. Both exports and imports contracted in February. In a rather unusual step, the government announced last week that exports increased by nearly 40% in the first nine days of March compared with the same period last year.1 Electricity production has also apparently rebounded. We would not place a huge weight on these statements, as the data probably has been skewed by the timing of the lunar new year, but it does seem that economic momentum may be starting to turn the corner. We are seeing signs of green shoots, but they are still fairly tentative. There is little doubt that the government is trying to jumpstart growth. Household and business taxes have been cut. The PBOC has reduced reserve requirements by 350 bps over the past year. Interbank rates have dropped. Despite the fact that the February credit data fell short of expectations, the six-month credit impulse has turned decisively higher. The Chinese credit impulse leads imports by about six-to-nine months (Chart 4). This bodes well for global trade in the second half of the year. Chart 4Global Trade Will Benefit From A Chinese Reflationary Impulse Q: Given that Chinese debt levels are already quite high, by how much more can they realistically increase? A: We do not expect credit growth to rise by as much as it did in 2009 or 2016. However, this is because the economy is in better shape, not because there is some intrinsic constraint to increasing debt from current levels. China’s elevated savings rate has kept interest rates well below trend nominal GDP growth, which is the key determinant of debt sustainability (Chart 5).2 As long as the government maintains an implicit guarantee on most local and corporate debt, as it is currently doing, default risk will remain minimal. Chart 5China's High Savings Rate Has Kept Interest Rates Well Below Trend Nominal GDP Growth In any case, given that debt now stands at 240% of GDP, a mere one percentage-point increase in credit growth would still produce a hefty 2.4% of GDP in credit stimulus. In this sense, China may be better off with a higher debt-to-GDP ratio since in steady state this will allow for a larger flow of credit-financed stimulus into the economy. Q: A revival in Chinese growth would presumably help Europe? A: Yes. Our conversations with clients revealed an ongoing negative bias towards Europe among investors (Chart 6). This is echoed in the latest BofA Merrill Lynch Global Fund Manager Survey which, for the first time in history, identified “short European equities” as the most crowded trade. Chart 6European Equities: Unloved And Unwanted We think that such deep pessimism about Europe is largely unwarranted. Faster global growth will help the European export sector later this year, while domestic demand will benefit from more accommodative fiscal policy and lower bond yields, especially in Italy. The ECB will not raise rates this year even if growth speeds up, but the market will probably price in a few more rate hikes in 2020 and beyond. This will allow for a modest re-steepening in the yield curves in core European bond markets, which should be positive for long-suffering bank profits. Political risk remains a concern. The Brexit saga has reached the farcical stage where: 1) The U.K. has voted to leave the EU; but 2) Parliament has voted to stay in the EU unless it reaches a satisfactory deal with Brussels; while 3) rejecting the only deal with Brussels that was on offer. Given that most British voters no longer want Brexit (Chart 7), we think that the government will kick the proverbial can down the road until a second referendum is announced or a “soft Brexit” deal is formulated. Either outcome would be welcomed by markets. Chart 7U.K.: In The Case Of A Do-Over, The Remain Side Would Likely Win Q: You seem less bullish on the U.S. dollar than you were last year? A: That is correct. As we discussed last week, the dollar is a countercyclical currency, meaning that it tends to move in the opposite direction of global growth (Chart 8). If global growth strengthens later this year, the trade-weighted dollar will probably weaken. Chart 8The Dollar Is A Countercyclical Currency Moreover, as this week’s FOMC meeting highlighted, the Fed’s reaction function has shifted in a more dovish direction. The median Fed dot now foresees no rate hikes this year and only one rate hike in 2020. In contrast, the December Summary of Economic Projections envisioned two rate hikes this year and one next year. The dollar is a countercyclical currency, meaning that it tends to move in the opposite direction of global growth. In a far cry from his October “rates are far from neutral” comment, Jay Powell stressed during this week's post-FOMC meeting press conference that the fed funds rate is currently in the “broad range of estimates of neutral.” While we would not rule out the possibility that the FOMC will raise rates at some point later this year, we now expect a more gradual pace of rate tightening than we had earlier envisioned. Q: Does a more dovish Fed imply that the economic expansion has even further to run? A: Yes. Expansions tend to end when monetary policy turns restrictive. We had previously thought that this point could be reached in late-2020, but it is now starting to look as though it will occur later than that. Broadly speaking, we see the Fed tightening cycle unfolding in two stages. In the first stage, which is the one we are in today, the Fed will raise rates in baby steps in response to better-than-expected growth and falling unemployment. In the second stage, the Fed will hike rates more aggressively as inflation starts to accelerate. Risk assets will be able to digest the first stage, but not the second. The good news is that most of our favorite indicators are not yet pointing to a major inflationary upswing (Chart 9): Despite higher tariffs, consumer import price inflation has slowed; core intermediate producer price inflation has decelerated; the prices paid components of the ISM and regional Fed surveys have plunged; inflation surprise indices have rolled over; and both survey and market-based measures of inflation expectations remain below where they were last summer. In keeping with these developments, BCA’s propriety Inflation Pipeline Indicator has fallen to a two-and-a-half-year low. Chart 9No Signs Of An Imminent Major Inflationary Upswing In The U.S. ... Wage growth has accelerated, but productivity growth has increased by even more. Unit labor cost inflation has actually been coming down since the middle of last year. Unit labor costs lead core CPI inflation by about 12 months (Chart 10). This implies that consumer price inflation is unlikely to reach uncomfortably high levels at least until the second half of next year. Chart 10... And Decelerating Unit Labor Costs Will Dampen Inflationary Pressures For The Time Being Beyond then, the risks are high that inflation will move up as the economy continues to overheat. This could force the Fed to start raising rates aggressively late next year, a course of action that will push up the dollar and cause equities and spread product to sell off. The resulting tightening in financial conditions will probably plunge the U.S. and the rest of the world into recession in 2021. Q: So stay overweight stocks for now, but consider selling at some point next year? A: Correct. The MSCI All-Country World Index (ACWI) has risen by over 14% since we upgraded it in December after having moved to the sidelines six months earlier. Given this run-up, we are not as bullish now as we were at the start of the year. Most of our favorite indicators are not yet pointing to a major inflationary upswing. Nevertheless, the path of least resistance for equities remains to the upside. While the forward P/E ratio for the MSCI ACWI has returned to where it was last September, analyst earnings expectations are currently much more conservative: Bottom-up estimates foresee EPS rising by 4.1% in the U.S. and 5.3% in the rest of the world in 2019 (Chart 11). The combination of faster growth, easier financial conditions, and ongoing corporate buybacks implies some upside to those estimates. Chart 11Analyst Expectations Are Quite Muted Moreover, real yields have fallen over the past five months – the 10-year U.S. TIPS yield is 48 basis points below its Q4 average, for example. A simple dividend discount model would suggest that global equities are about 10%-to-15% cheaper than they were prior to last year’s autumn selloff. The path of least resistance for equities remains to the upside. Q: Aren’t you worried that rising labor costs will push down profit margins even if GDP growth accelerates? A: Not really. As noted above, productivity growth has picked up. Whether this is the start of a new trend remains to be seen, but at least for now, it is dampening unit labor costs. Historically, real unit labor costs – nominal unit labor costs divided by the corporate price deflator – have tracked economy-wide profit margins very closely (Chart 12). Chart 12Real U.S. Unit Labor Costs Historically Have Tracked Economy-Wide Profit Margins Very Closely In practice, it is very rare for earnings to contract outside of recessions (Chart 13). This is why recessions and equity bear markets generally overlap (Chart 14). With the next recession still two years away, it is too early to turn defensive. Indeed, as Table 1 shows, the second-to-last year of business-cycle expansions is often the most lucrative for stock market investors. Chart 13Earnings Rarely Contract Outside Of Recessions Chart 14Recessions And Bear Markets Usually Overlap Table 1Too Soon To Get Out Q: What do you recommend in terms of regional equity allocation? A: If global growth accelerates later this year and the dollar weakens, this will create an excellent environment for international stocks – EM and Europe in particular. Investors should prepare to overweight those regions at the expense of the United States (currency unhedged). Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com Footnotes 1      Elaine Chan, “China spreading ‘positive news’ of strong export rebound in early March after February plunge,” South China Morning Post, March 11, 2019. 2      Please see Global Investment Strategy Weekly Report, “Is There Really Too Much Government Debt In The World?” dated February 22, 2019.   Strategy & Market Trends MacroQuant Model And Current Subjective Scores Tactical Trades Strategic Recommendations Closed Trades

Neutral We have been offside on the high-conviction overweight call on the S&P air freight & logistics index and the recent FedEx warning suggests that profits will come under pressure for this index for the rest of the year and will trail the SPX. As such, we are trimming exposure to neutral and removing it from the high-conviction overweight list today for a loss of 14%. The chart shows that all the profit drivers we had identified in early December last year have taken a sharp turn for the worse. Energy costs are no longer in deflation as oil prices have jumped from $42/bbl to near $60/bbl. Not only is global growth still decelerating, but also U.S. growth is in a softpatch: the manufacturing shipments-to-inventory ratio is on the verge of contraction, warning that delivery services’ selling prices are in for a turbulent ride (second panel). In addition, definitive news of Amazon becoming a formidable competitor in courier delivery services is structurally negative for the industry. Nevertheless, we refrain from turning outright bearish as air freight stocks are technically oversold and valuations are trading at the steepest discount to the broad market since mid-2002. Bottom Line: Downgrade the S&P air freight & logistics index to neutral and also remove it from the high-conviction overweight list today. The ticker symbols for the stocks in this index are: BLBG: S5AIRF - UPS, FDX, CHRW, EXPD.

Highlights Venezuela’s oil production likely fell ~ 500k b/d last week in the wake of nationwide power outages, reducing total output to ~ 500k b/d. However, neither OPEC 2.0 nor U.S. President Donald Trump drew much attention to it. During an industry gathering in Houston last week, an administration official conceded events in Venezuela could affect whether U.S. waivers on its Iranian oil-export sanctions are extended beyond May 4, but that was pretty much it.1 This is consistent with the thesis we laid out last month, which reflects our view OPEC 2.0 is evolving a more flexible production strategy that allows it to adjust production quickly in response to exogenous events over which it has little control; chiefly, U.S. foreign, trade and monetary policy.2 This will result in higher prices, satisfying the sometimes-conflicting goals of OPEC 2.0’s leadership – i.e., KSA’s budgetary need for prices closer to $80/bbl, and Russian producers’ need to increase revenue through higher volumes. Given this backdrop, our updated balances and price forecasts remain largely unchanged, with minor adjustments to the overall supply side and no change on the demand side. We continue to expect Brent to average $75/bbl this year. For 2020, we continue to expect Brent to average $80/bbl – higher U.S. shale output will be offset by delays in building out deepwater export facilities in the U.S. Gulf for most of the year. We expect WTI to trade $7 and $5/bbl lower in 2019 and 2020, respectively. The balance of price risk remains to the upside, as policy risk – i.e., a miscalculation on all sides – is elevated. Highlights Energy: Overweight. We are closing our 2020 long WTI vs. short Brent position at tonight’s close, given delays in the buildout of deepwater-harbor capacity in the U.S. Gulf caused by additional environmental assessments. This likely will push the spread out to $5/bbl+, vs. our target of $3.25/bbl. Base Metals: Neutral. Copper got another endorsement from Fitch Solutions, which is predicting LME prices will average $6,900 and $7,100/MT this year and next, on the back of lower inventories and improving supply-demand fundamentals. We remain long copper, which is up 2.7% since we recommended it on March 7. Precious Metals: Neutral. Our colleagues at BCA Research’s Global Investment Strategy expect the USD to weaken in 2H19, which, all else equal, will support gold and precious metals.3 Our long gold portfolio hedge is up 6.3% since inception on May 4, 2017. Agriculture: Underweight. Grain markets likely will trade sideways ahead of the USDA’s Prospective Plantings survey of farmer intentions next Friday.   Feature The sudden loss of Venezuelan output – and exports – was barely noticed in price action over the past week.  U.S. foreign and trade policy will continue to keep oil supply and demand uncertainty elevated, particularly as sanctions against Venezuela play out against the backdrop of a collapsing infrastructure. Last week’s nationwide power outage likely caused crude oil production to drop 500k b/d from ~ 1mm b/d previously.4 The sudden loss of Venezuelan output – and exports – was barely noticed in price action over the past week. Global inventories remain swollen (Chart 1), and OPEC 2.0’s spare capacity is increasing as it cuts production (Chart 2). This allows Venezuelan production losses to be covered with little or no disruption to supply or demand, and little or no increase in the level of agita in oil markets. Chart of the WeekOECD Inventories Still High, But Continue to Drain That cushion allows the U.S. to continue to prosecute its sanctions strategy against Venezuela and Iran. But it does not give the U.S. carte blanche to pursue regime change in both countries at the same time. As we noted in our New Political Economy of Oil report last month, OPEC 2.0 possibly could cover the loss of 500k b/d of Venezuelan exports and maybe up to 1.5mm b/d of Iranian exports.5 We continue to expect waivers on the Iran sanctions to be extended, although Trump administration officials remain guarded in terms of providing markets any forward guidance. However, it would tighten the heavy-sour market even more than it is now.6 And, full-on sanctions campaigns conducted simultaneously on Venezuela and Iran following the expiration of U.S. waivers on export sanctions against the latter would leave spare capacity dangerously thin, and push the risk premium in oil prices up sharply, given the volumes Iran already is supplying (Chart 3, Table 1). Table 1Iran Exports By Country 2018 (‘000 b/d) We continue to expect waivers on the Iran sanctions to be extended, although Trump administration officials remain guarded in terms of providing markets any forward guidance. The most that’s been offered came last week in Houston at an industry convention, where Brian Hook, special representative for Iran at the U.S. State Department, indicated the U.S. administration is aware of the supply-side pressure associated with its campaigns against Venezuela and Iran. However, he offered nothing definitive one way or another, so markets will continue to assign a non-zero probability that waivers will not be extended.7 Oil Supply Expectations Remain Stable For our part, we believe waivers on the U.S. Iranian export sanctions will be extended out of necessity. While more than 2mm b/d of Venezuelan and Iranian production can be offset by increased OPEC 2.0 spare capacity – now running ~ 2.1mm b/d based on U.S. EIA estimates – it is not sufficient to cover any additional losses due to unplanned outage of the sort seen in May 2016, when 1mm b/d of Canadian oil production was lost to wildfires. These are real risks, not abstractions meant to illustrate a point.8 For 2H19, our base case now assumes OPEC 2.0’s production rises by ~ 0.5mm b/d vs. 1H19 production of 44.5mm b/d. This will smooth out the loss of Venezuelan output as it falls to 500k b/d by the end of this year, vs. the 650k b/d we expected last month. We also expect Iranian production to remain close to the 3mm b/d it will average in 1H19, likely increasing as global storage levels fall and waivers are exercised (much like a call option). News reports suggest KSA continues to advocate the extension of production cuts by OPEC 2.0 to year end. However, if the coalition’s goal is to keep Brent prices close to $75/bbl this year, and closer to $80/bbl next year – the assumptions we’re working with – OPEC 2.0 likely will have to raise production by 0.5mm b/d in 2H19 and 0.72mm b/d next year. Maintaining production cuts into 2H19 risks sending prices significantly higher, in our estimation. Globally, the big driver of growth on the supply side continues to be U.S. shales, which we now expect to increase 1.2mm b/d in 2019 and 0.9mm b/d next year, a small increase of ~ 60k b/d versus our estimates last month.9 While it is true the Permian bottleneck will be cleared by the end of this year – adding some 2mm b/d of new takeaway capacity – export capacity will remain challenged by new delays to the build-out of deepwater-harbor capacity in the U.S. Gulf well into 2020, following requests of Carlyle Group and Trafigura AG to provide additional information in environmental filings to regulators before work begins.10 This will push the Permian bottleneck from the basin to the U.S. Gulf refining market. On the back of this development, we are closing our 2020 long WTI vs. short Brent recommendation at tonight’s close, given these delays likely push the deep-water expansion in the Gulf to 4Q20 or later. Oil Demand Also Remains Stable Oil demand will continue to be supported by the easing of monetary policy in DM and EM economies to offset a slowdown in global growth. In addition, we expect China’s credit cycle to bottom in 1Q19, which will be supportive of oil demand there and in EMs generally (Chart 4). We continue to expect the Sino – U.S. trade war to be resolved in 1H19, as both presidents Trump and Xi need to get a deal done to satisfy domestic audiences – i.e., U.S. elections next year and the upcoming 100th anniversary of the Chinese Communist Party in 2021, respectively. Chart 4EM Growth Will Lift In 2H19 During the second half of this year, we expect a more significant pick-up in China’s credit cycle, which will set the stage for a year-end rally in commodities generally – oil and base metals in particular. We also expect global demand to get a lift from a weaker USD beginning in 2H19 and extending to the end of 2020.11 We expect demand growth of 1.5mm b/d this year and 1.6mm b/d next year, slightly more than the EIA and IEA. We expect EM to account for 53.7mm b/d of growth this year and 55mm b/d next year. Total global demand will average 101.8mm b/d and 103.4mm b/d in 2019 and 2020. U.S. policy is keeping the supply- and demand-side uncertainty elevated, but OPEC 2.0’s hand has been strengthened by the fact that it is, more than ever, the fulcrum of the oil market. OPEC 2.0’s Balancing Strategy U.S. policy is keeping the supply- and demand-side uncertainty elevated, but OPEC 2.0’s hand has been strengthened by the fact that it is, more than ever, the fulcrum of the oil market: It can balance shortfalls out of spare capacity – boosted some by its production cuts – and it can reduce unintended inventory accumulation via its demonstrated ability to cut output rapidly. Our 2019 and 2020 Brent price forecasts remain at $75 and $80/bbl (Chart 5). Delays in building out U.S. Gulf deepwater-harbor capacity next year will keep exports constrained. This will back production up behind the pipe in the Permian Basin next year, and keep inventories fuller than they otherwise would be. And it means Brent markets will remain tighter than we previously expected in 2020, as WTI won’t be exported in the volumes needed to tighten the Brent - WTI spread as much as we previously expected. For 2019, we expect WTI to trade $7/bbl under Brent, and $5/bbl under in 2020 (vs. our earlier expectation of $3.25/bbl), on the back of these delays. This compels us to liquidate our long WTI vs. Brent recommendation in 2020 at tonight’s close. Chart 5OPEC 2.0 Output Hike Needed To Keep Market Balanced in 2H19 OPEC 2.0’s position as the fulcrum effectively means it can balance the market to achieve its price goals (Chart 6, Table 2). This does not drive our forecast, but it does line up with what we would expect an economically rational agent to do. Chart 6Our Ensemble Forecasts Remain Fairly Stable Table 2BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) We believe OPEC 2.0 is succeeding in evolving a strategy that allows it sufficient flexibility to respond to exogenous forces affecting oil prices, which are, for the most part, out of its control. Bottom Line: Policy uncertainty is elevated, but we believe OPEC 2.0 is succeeding in evolving a strategy that allows it sufficient flexibility to respond to exogenous forces affecting oil prices, which are, for the most part, out of its control – i.e., U.S. foreign, trade and monetary policy.12 As such, we believe it will adjust output to achieve price targets, which, despite the sometimes-public disagreements between KSA and Russia, are closer to our forecast levels of $75 and $80/bbl for Brent this year and next than not.     Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger, Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com       Footnotes 1      OPEC 2.0 is the name we coined for the OPEC/non-OPEC producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia.  U.S. waivers were granted by the Trump administration just before the sanctions against Iranian oil exports went into effect November 4; these waivers expire May 4, 2019. 2      Please see “The New Political Economy of Oil,” published by BCA Research’s Commodity & Energy Strategy February 21, 2019.  It is available at ces.bcaresearch.com. 3      Please see “What’s Next For The Dollar,” published by BCA Research’s Global Investment Strategy published March 15, 2019.  It is available at gis.bcaresearch.com. 4     In its March 2019 Oil Market Report, the IEA notes, “The electricity crisis in Venezuela has paralysed most of the country for significant periods of time. Although there are signs that the situation is improving, the degradation of the power system is such that we cannot be sure if the fixes are durable. Until recently, Venezuela’s oil production had stabilised at around 1.2 mb/d. During the past week, industry operations were seriously disrupted and ongoing losses on a significant scale could present a challenge to the market.”  We await better data to assess the full extent of the production lost in Venezuela. 5      Please see “The New Political Economy of Oil,” published by BCA Research’s Commodity & Energy Strategy February 21, 2019.  It is available at ces.bcaresearch.com. 6      Please see “Oil Price Diffs: Global Convergence,” published by BCA Research’s Commodity & Energy Strategy March 7, 2019.  It is available at ces.bcaresearch.com. 7      Please see “CERAWeek: US waivers for Iran oil imports may hinge on Venezuela sanctions impact: State official,” published by S&P Global Platts March 13, 2019. 8      We treat these waivers as quasi call options on Iranian crude oil in our analysis.  As inventories draw, importers holding waivers can be expected to exercise their option and lift more crude from Iran without running afoul of U.S. sanctions. 9      We approximate our shale production based on the big 5 basins (Anadarko, Bakken, Permian, Eagle Ford and Niobrara). 10     Please see “US Suspends Review On Trafigura Oil-Port Project” published by Hart Energy March 18, 2019.  See also “Exclusive: Environmental review could delay Carlyle deepwater oil export project up to 18 months,” published by reuters.com March 14, 2019. 11     See footnote 3 above. 12     A perfect example of this can be seen OPEC 2.0’s decision to move its ministerial meeting to June: A decision from the U.S. on whether to extend waivers on the Iranian sanctions will come May 4, right around the time OPEC 2.0 member states are deciding on export schedules.  If waivers are extended, member states can maintain production discipline or add volumes to the market as needed; if sanctions are re-imposed in full, they can increase production as needed. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2019 Summary of Closed Trades

  Underweight Our previous Insight referenced the deterioration of indicators that caused us to grow more negative in last year’s downgrade of the S&P railroads index to a benchmark allocation but what kept us from moving to an outright bearish position at that time was exceptionally strong pricing power.1 After a multi-year expansion, pricing power has now rolled over (second panel), taking away the remaining pillar supporting a neutral view and we are compelled to move to an underweight allocation today. Pricing power is one of the key determinants in our earnings model which, when combined with the contracting volumes noted in the previous Insight, is indicating the end to the industry’s above-trend earnings growth is nigh (third panel). With relative earnings growth slowing and rising leverage adding incremental risk, the S&P railroads index’s premium valuation multiple looks increasingly dicey (bottom panel). Bottom Line: Broad based declines in traffic volumes, falling pricing power and high leverage suggest that earnings will underwhelm. Accordingly we are moving to an underweight recommendation on the S&P railroads index as we expect a de-rating phase to materialize. Please see the next Insight for another transportation subsector change. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, CSX, NSC, KSU.     1 Please see BCA U.S. Equity Strategy Report, “Critical Reset“, dated October 29, 2018, available at uses.bcaresearch.com.

Underweight In our downgrade of the S&P railroads index late last year to a benchmark allocation, we highlighted that two of our key industry Indicators, the Railroad Indicator and our Rail Shipment Diffusion Indicator, had turned negative.1 These indicators have continued to deteriorate, including total rail shipments which have now started to contract for the first time since the 2015-16 manufacturing recession (third panel). Intermodal shipments in particular have nosedived, likely a result of weak retail sales, as we highlighted earlier this month.2 Such a contraction would be far less concerning were it not for the rapid degradation of industry balance sheets as firms have sought to increase relatively cheap leverage in order to retire equity. Railroads are now significantly more indebted than the broad market which itself has not shown an aversion to adding leverage (bottom panel). Such a change in railroad capital structure has kept EPS growth rates artificially high while simultaneously adding an extra measure of equity risk premium that does not yet appear fully reflected in relative share prices. Our concerns surrounding the S&P railroads index have amplified as our Indicators have deteriorated and leverage has mounted; please see the following Insight for our change in recommendation.   1 Please see BCA U.S. Equity Strategy Report, “Critical Reset“, dated October 29, 2018, available at uses.bcaresearch.com. 2 Please see BCA U.S. Equity Strategy Report, “The Good, The Bad And The Ugly“, dated March 4, 2019, available at uses.bcaresearch.com.

The S&P transports index’s recovery rally has stalled recently and is a cause for concern for the overall market. In more detail, the recent gulf between relative share prices and the SPX has widened and warns that the overall market will likely pullback. As a reminder, we first became tactically cautious on the overall market in the March 4thWeekly Report, and today we reiterate this short-term cautious stance, especially given FedEx’s recent warning. Thus, we are making two subsurface transport changes today, downgrading a subgroup to underweight that commands lofty valuations at a time when leading profit indicators are flashing red, and also downgrading to neutral a globally exposed transport subindex. Please see the following three Insights detailing our intra-transportation industry moves.