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Listen to a short summary of this report.     Executive Summary Back From The Future: An Investor’s Almanac Stocks will rally over the next six months as recession risks abate but then begin to swoon as it becomes clear the Fed will not cut rates in 2023. A second wave of inflation will begin in mid-2023, forcing the Fed to raise rates to 5%. The 10-year US Treasury yield will rise above 4%. While financial conditions are currently not tight enough to induce a recession, they will be by the end of next year. In the past, the US unemployment rate has gone through a 20-to-22 month bottoming phase. This suggests that a recession will start in early 2024. The US dollar will soften over the next six months but then get a second wind as the Fed is forced to turn hawkish again. Over the long haul, the dollar will weaken, reflecting today’s extremely stretched valuations.   Bottom Line: Investors should remain tactically overweight global equities but look to turn defensive early next year. Somewhere in Hilbert Space I have long believed that anything that can possibly happen in financial markets (as well as in life) will happen. Sometimes, however, it is useful to focus on a “base case” or “modal” outcome of what the world will look like. In this week’s report, we do just that, describing the evolution of the global economy from the perspective of someone who has already seen the future unfold. September 2022 – Goldilocks! US headline inflation continues to decline thanks to lower food and gasoline prices (Chart 1). Supply-chain bottlenecks ease, as evidenced by falling transportation costs and faster delivery times (Chart 2). Most measures of economic activity bottom out and then begin to rebound. The surge in bond yields earlier in 2022 pushed down aggregate demand, but with yields having temporarily stabilized, demand growth returns to trend. The S&P 500 moves up to 4,400. Chart 1ALower Food And Gasoline Prices Will Drag Down Headline Inflation (I) Chart 1BLower Food And Gasoline Prices Will Drag Down Headline Inflation (II)   October 2022 – Europe’s Prospects of Avoiding a Deep Freeze Improve: Economic shocks are most damaging when they come out of the blue. With about half a year to prepare for a cut-off of Russian gas, the EU responds with uncharacteristic haste: Coal-fired electricity production ramps up; the planned closure of Germany’s nuclear power plants is postponed; the French government boosts nuclear capacity, which had been running at less than 50% earlier in 2022; and, for its part, the Dutch government agrees to raise output from the massive Groningen natural gas field after the EU commits to establishing a fund to compensate the surrounding community for any damage from increased seismic activity. EUR/USD rallies to 1.06.  November 2022 – Divided Congress and Trump 2.0: In line with pre-election polling, the Democrats retain the Senate but lose the House (Chart 3). Markets largely ignore the outcome. To no one’s surprise, Donald Trump announces his candidacy for the 2024 election. Over the following months, however, the former president has trouble rekindling the magic of his 2016 bid. His attacks on his main rival, Florida governor Ron DeSantis, fall flat. At one rally in early 2023, Trump’s claim that “Ron is no better than Jeb” is greeted with boos. Chart 2Supply-Chain Pressures Are Easing Chart 3Democrats Will Lose The House But Retain The Senate   December 2022 – China’s “At Least One Child Policy”: The 20th Party Congress takes place against the backdrop of strict Covid restrictions and a flailing housing market. In addition to reaffirming his Common Prosperity Initiative, President Xi stresses the need for actions that promote “family formation.” The number of births declined by nearly 30% between 2019 and 2021 and all indications suggest that the birth rate fell further in 2022 (Chart 4). Importantly for investors, Xi says that housing policy should focus not on boosting demand but increasing supply, even if this comes at the expense of lower property prices down the road. Base metal prices rally on the news. Chart 4China's Baby Bust January 2023 – Putin Declares Victory: Faced with continued resistance by Ukrainian forces – which now have wider access to advanced western military technology – Putin declares that Russia’s objectives in Ukraine have been met. Following the playbook in Crimea and the Donbass, he orders referenda to be held in Zaporizhia, Kherson, and parts of Kharkiv, asking the local populations if they wish to join Russia. The legitimacy of the referenda is immediately rejected by the Ukrainian government and the EU. Nevertheless, the Russian military advance halts. While the West pledges to maintain sanctions against Russia, the geopolitical risk premium in oil prices decreases. February 2023 – Credit Spreads Narrow Further: At the worst point for credit in early July 2022, US high-yield spreads were pricing in a default rate of 8.1% over the following 12 months (Chart 5). By late August, the expected default rate has fallen to 5.2%, and by January 2023, it has dropped to 4.5%. Perceived default risks decline even more in Europe, where the economy is on the cusp of a V-shaped recovery following the prior year’s energy crunch. Chart 5The Spread-Implied Default Rate Has Room To Fall If Recession Fears Abate March 2023 – Wages: The New Core CPI? US inflation continues to drop, but a heated debate erupts over whether this merely reflects the unwinding of various pandemic-related dislocations or whether it marks true progress in cooling down the economy. Those who argue that higher interest rates are cooling demand point to the decline in job openings. Skeptics retort that the drop in job openings has been matched by rising employment (Chart 6). To the extent that firms have been converting openings into new jobs, the skeptics conclude that labor demand has not declined. In a series of comments, Jay Powell stresses the need to focus on wage growth as a key barometer of underlying inflationary pressures. Given that wage growth remains elevated, market participants regard this as a hawkish signal (Chart 7). The 10-year Treasury yield rises to 3.2%. The DXY index, having swooned from over 108 in July 2022 to just under 100 in February 2023, moves back to 102. After hitting a 52-week high of 4,689 the prior month, the S&P 500 drops back below 4,500. Chart 6Drop In Job Openings Is Matched By Rise In Employment Chart 7Wage Growth Remains Strong   April 2023 – Covid Erupts Across China: After successfully holding back Covid for over three years, the dam breaks. When lockdowns fail to suppress the outbreak, the government shifts to a mitigation strategy, requiring all elderly and unvaccinated people to isolate at home. It helps that China’s new mRNA vaccines, launched in late 2022, prove to be successful. By early 2023, China also has sufficient supplies of Pfizer’s Paxlovid anti-viral drug. Nevertheless, the outbreak in China temporarily leads to renewed supply-chain bottlenecks. May 2023 – Biden Confirms He Will Stand for Re-Election: Saying he is “fit as a fiddle,” President Biden confirms that he will seek a second term in office. Little does he know that the US will be in a recession during most of his re-election campaign. Chart 8Consumer Confidence And Real Wages Tend To Move Together June 2023 – Inflation: The Second Wave Begins: The decline in inflation between mid-2022 and mid-2023 sows the seeds of its own demise. As prices at the pump and in the grocery store decline, real wage growth turns positive. Consumer confidence recovers (Chart 8). Household spending, which never weakened that much to begin with, surges. The economy starts to overheat again, leading to higher inflation. After having paused raising rates at 3.5% in early 2023, the Fed indicates that further hikes may be necessary. The DXY index strengthens to 104. The S&P 500 dips to 4,300. July 2023 – Tech Stock Malaise: Higher bond yields weigh on tech stocks. Making matters worse, investors start to worry that many of the most popular US tech names have gone “ex-growth.” The evolution of tech companies often follows three stages. In the first stage, when the founders are in charge, the company grows fast thanks to the introduction of new, highly innovative products or services. In the second stage, as the tech company matures, the founders often cede control to professional managers. Company profits continue to grow quickly, but less because of innovation and more because the professional managers are able to squeeze money from the firm’s customers. In the third stage, with all the low-lying fruits already picked, the company succumbs to bureaucratic inertia. As 2023 wears on, it becomes apparent that many US tech titans are entering this third stage. August 2023 – Long-term Inflation Expectations Move Up: Unlike in 2021-22, when long-term inflation expectations remained well anchored in the face of rising realized inflation, the second inflation wave in 2023 is accompanied by a clear rise in long-term inflation expectations. Consumer expectations of inflation 5-to-10 years out in the University of Michigan survey jump to 3.5%. Whereas back in August 2022, the OIS curve was discounting 100 basis points of Fed easing starting in early 2023, it now discounts rate hikes over the remainder of 2023 (Chart 9). The 10-year yield rises to 3.8%. The 10-year TIPS yield spikes to 1.2%, as investors price in a higher real terminal rate. The S&P 500 drops to 4,200. The financial press is awash with comparisons to the early 1980s (Chart 10). Chart 9The Markets Expect The Fed To Cut Rates By Over 100 Basis Points Starting In 2023 Chart 10The Early-1980s Playbook October 2023 – Hawks in Charge: After a second round of tightening, featuring three successive 50 basis-point hikes, the Fed funds rate reaches a cycle peak of 5%. The 10-year Treasury yield gets up to as high as 4.28%. The 10-year TIPS yield hits 1.62%. The DXY index rises to 106. The S&P 500 falls to 4,050. November 2023 – Housing Stumbles: With mortgage yields back above 6%, the US housing market weakens anew. The fallout from rising global bond yields is far worse in some smaller developed economies such as Canada, Australia, and New Zealand, where home price valuations are more stretched (Chart 11). Chart 11Rising Rates Will Weigh On Developed Economies With Pricey Housing Markets January 2024 – Unemployment Starts to Rise: After moving sideways since March 2022, the US unemployment rate suddenly jumps 0.2 percentage points to 3.6%, with payrolls contracting for the first time since the start of the pandemic. The 22-month stretch of a flat unemployment rate is broadly in line with the historic average (Table 1). Table 1In Past Cycles, The Unemployment Rate Has Moved Sideways For Nearly Two Years Before A Recession Began February 2024 – The US Recession Begins: Although there was considerable debate about whether the US was entering a recession at the time, in early 2025, the NBER would end up declaring that February 2024 marked the start of the recession. The 10-year yield falls back below 4% while the S&P 500 drops to 3,700. Lower bond yields are no longer protecting stocks.  March 2024 – The Fed Remains in Neutral: Jay Powell says further rate hikes are unwarranted in light of the weakening economy, but with core inflation still running at 3.5%, the Fed is in no position to ease. April 2024 – The Global Recession Intensifies: The US unemployment rate rises to 4.7%. The economic downdraft is especially sharp in America’s neighbor to the north, where the Canadian housing market is in shambles. Back in June 2022, the Canadian 10-year yield was 21 basis points above the US yield. By April 2024, it is 45 basis points below. Europe and Japan also fall into recession. Commodity prices continue to drop, with Brent oil hitting $60/bbl. May 2024 – The Fed Cuts Rates: Reversing its position from just two months earlier, the Federal Reserve cuts rates for the first time since March 2020, lowering the Fed funds rate from 5% to 4.5%. The Fed funds rate will ultimately bottom at 2.5%, below the range of 3.5%-to-4% that most economists will eventually recognize as neutral. August 2024 – Republican National Convention: Unwilling to spend much of his own money on the campaign, and with most donations flowing to DeSantis, Trump’s bid to reclaim the White House fizzles. While the former president never formally bows out of the race, the last few months of his primary campaign end up being a nostalgia tour of his past accomplishments, interspersed with complaints about all the ways that he has been wronged. In the end, though, Trump makes a lasting imprint on the Republican party. During his acceptance speech, in typical Trumpian style, Ron DeSantis attacks Joe Biden for “eating ice cream while the economy burns” and declares, to thunderous applause, that “Americans are sick and tired of having woke nonsense hurled in their faces and then being dared to deny it at the risk of losing their jobs.” Chart 12The Dollar Is Very Overvalued October 2024 – The Stock Market Hits Bottom: While the unemployment rate continues to rise for another 12 months, ultimately reaching 6.4%, the S&P troughs at 3,200. The 10-year Treasury yield settles at 3.1% before starting to drift higher. The US dollar, which began to weaken anew after the Fed starts cutting rates, enters a prolonged bear market. As in past cycles, the dollar is unable to defy the gravitational force from extremely stretched valuations (Chart 12). November 2024 – President DeSantis: Against the backdrop of rising unemployment, uncomfortably high inflation, and a sinking stock market, Ron DeSantis cruises to victory in the 2024 presidential election. Unlike Trump, DeSantis deemphasizes corporate tax cuts and deregulation during his presidency, focusing instead on cultural issues. With the Democrats still committed to progressive causes, big US corporations discover that for the first time in modern history, neither of the two major political parties are willing to champion their interests. Peter Berezin Chief Global Strategist peterb@bcaresearch.com Follow me on LinkedIn & Twitter Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores      

Listen to a short summary of this report.     Executive Summary Chart 1The Dollar Has Broken Below The First Line Of Support The softer CPI print in the US boosted growth plays and pushed the DXY index below its 50-day moving average (Feature Chart). This suggests CPI numbers will remain the most important print for currency markets in the coming weeks and months. If US inflation has peaked, then the market will price a less aggressive path for Fed interest rates, which will loosen support for the dollar. At the same time, other G10 central banks are still seeing accelerating inflation. This will keep them on a tightening path. This puts the DXY in a tug of war. On the downside, the Fed could turn less hawkish. On the other hand, currencies such as the EUR, GBP and even SEK face high inflation but deteriorating growth. This will depress real rates. Within this context, the most attractive currencies are those with relatively higher real rates, and a real prospect of a turnaround in growth. NOK and AUD stand out as potential candidates. Our short EUR/JPY trade has been performing well in this context. Stick with it.  RECOMMENDATIONS INCEPTION LEVEL inception date RETURN Short EUR/JPY 141.20 2022-07-21 3.29 Bottom Line: Our recommended strategy is a neutral dollar view over the next three months, until it becomes clear inflation has peaked and global growth has bottomed. Feature The DXY index peaked at 108.64 on July 14 and has dropped to 105.1 as we go to press. There have been two critical drivers of this move. First, the 10-year US Treasury yield has fallen from 3.5% to 2.8%. With this week’s all important CPI release, which showed a sharp deceleration in the headline measure, bond yields may well stabilize at current levels for a while. Second, the drop in energy prices has boosted the JPY, SEK and EUR, which are heavily dependent on imported energy. Related Report  Foreign Exchange StrategyA Montreal Conversation On FX Markets Another development has been happening in parallel – as US inflation upside surprises have crested, so has the US price impulse relative to its G10 counterparts (Chart 1). To the extent that this eases market pricing of a hawkish Fed (relative to other G10 central banks), it will continue to diminish upward pressure on the dollar. Much will depend on the incoming inflation prints both in the US, and abroad. With the DXY having broken below its 50-day moving average, the next support level is at 103.6. This is where the 100-day moving average lies, which the dollar tested twice this year before eventually bouncing higher (Chart 2). The next few sections cover the important data releases over the last month in our universe of G10 countries, and implications for currency strategy. What is clear is that most foreign central banks are committed to their tightening campaign, which argues for a neutral stance towards the DXY for now. Chart 1US Inflation Momentum Has Rolled Over Chart 2The Dollar Has Broken Below The First Line Of Support US Dollar: Consolidation Chart 3The Conditions For A Fed Hike Remain In Place The dollar DXY index is up 10% year to date. Over the last month, the DXY index is down 2.1% (panel 1). Incoming data continues to make the case for a strong dollar. Job gains are robust. In June, the US added 372K jobs. The July release was even stronger at 528K jobs. This pushed the unemployment rate to a low of 3.5% (panel 2). Wages continue to soar. Average hourly earnings came in at 5.2% year-on-year in July. The Atlanta Fed wage growth tracker continues to edge higher across all income cohorts (panel 3). The June CPI print was above expectations at 9.1% for headline, with core at 5.9%. The July print for headline that came out this week was 8.5%, below expectations of 8.7%. At 5.9%, the core measure is still well above the Fed’s target (panel 4). June retail sales remained firm, but consumer sentiment continues to weaken. While the University of Michigan current conditions index increase from 53.8 to 58.1 in June, this is well below the January 2020 level of 115. Correspondingly, the Conference Board consumer confidence index fell from 98.7 to 95.7 in July. On June 17, the Fed increased interest rates by 75bps, as expected. The US entered a second consecutive quarter of GDP growth contraction in Q2, falling by an annualized 0.9%. The ISM manufacturing index was flat in July suggesting Q3 GDP is not starting on a particularly strong foot. The Atlanta Fed Q3 GDP growth tracker is, however, printing 2.5%. Unit labor costs are soaring, rising 10.8% in Q2. This is sapping productivity growth, which fell 4.6% in Q2.  The key for the dollar’s outlook is the evolution of US inflation and the labor market. For now, inflation remains sticky, and wages are rising. Meanwhile, labor market conditions remain robust. This will keep the Fed on a tightening path in the near term. We initially went short the DXY index but were stopped out. We remain neutral in the short term, though valuation keeps us bearish over a long-term horizon. The Euro: A European Hard Landing Chart 4The Euro Is At Recession Lows The euro is down 9.2% year to date. Over the last month, the euro is up 2.7%, having faced support a nudge below parity. Incoming data continues to suggest weak economic conditions, with a stagflationary undertone: The ZEW Expectations Survey for July was at -51.1, the lowest reading since 2011 (panel 1). The current account remains in a deficit, at -€4.5bn in May. Consumer confidence continues to plunge. The July reading of -27 is the worst since the 2020 Covid-19 crisis (panel 2). Despite the above data releases, the ECB surprised markets by raising rates 50bps. CPI continues to surprise to the upside. The preliminary CPI print for July came in at 8.9%, well above the previous 8.6% print. PPI in the euro area was at 35.8% in June, a slight decline from the May reading (panel 3). The German Ifo business expectations index fell to 80.3 in July. Historically, that has been consistent with a manufacturing PMI reading of 45 (panel 4). The Sentix confidence index stabilized in August but remains very weak at -25.2. This series tends to be trending, having peaked in July last year. We will see if the next few months continue to show stabilization. The ECB mandate dictates that it will continue to fight soaring inflation. As such, it may have no choice but to generate a Eurozone-wide recession. This is the key risk for the euro since it could push EUR/USD below parity again. We continue to sell the EUR/JPY cross. In a risk-off environment, EUR/JPY will collapse. In a risk-on environment, like this week, the yen can still benefit since it is oversold. Meanwhile, investors remain overwhelmingly bearish (panel 5). The Japanese Yen: Quite A Hefty Rally Chart 5Some Green Shoots In Japan The Japanese yen is down 13.4% year-to-date, the worst performing G10 currency (panel 1). Over the last month, the yen is up 3.3%. Incoming data in Japan has been worsening as the rising number of Covid-19 cases is hitting mobility and economic data. According to the Eco Watcher’s survey, sentiment among small and medium-sized Japanese firms deteriorated in July. Current conditions fell from 52.9 to 43.8. The outlook component also declined from 47.6 to 42.8. Machine tool order momentum, one of our favorite measures of external demand, continues to slow. Peak growth was at 141.9% year-on-year in May last year. The preliminary reading from July was at 5.5% (panel 2). Labor cash earnings came in at 2.2% year-on-year, a positive sign. Household spending also rose 3.5%. Rising wages could keep inflation momentum rising in Japan (panel 3). On that note, the Tokyo CPI report for July was also encouraging, with an increase in the core-core measure from 1% to 1.2%. The Tokyo CPI tends to lead nationwide measures. The labor market remains robust. Labor demand exceeds supply by 27%. The Bank of Japan kept monetary policy on hold on July 20th, a policy move that makes sense given incoming data. The BoJ still views a large chunk of inflation in Japan as transitory. For inflation to pick up, wages need to rise. While they are rising, inflation expectations remain well anchored, suggesting little rationale for the BoJ to shift (panel 4). That said, the yen is extremely cheap after being the best short this year (panel 5).  British Pound: Coiled Spring Below 1.20? Chart 6Cable Is Vulnerable The pound is down 9.8% year to date. Over the last month, the pound is up by 2.5%. Sterling broke below a soft floor of 1.20, but quickly bounced back and is now sitting at 1.22, as sentiment picked up (panel 1). We find the UK to have an even bigger stagflation problem than the eurozone. CPI came in at 9.4% in June. The RPI came in at 11.8%. PPI was at 24%. All showed an acceleration from the month of May (panel 2). Nationwide house price inflation has barely rolled over unlike other markets, increasing from 10.7% in June to 11% in July. The Rightmove national asking price was 9.3% higher year-on-year in July, compared to 9.7% in June (panel 3). Meanwhile, mortgage approvals have been in steady decline over the last two years, which points toward stagflation. Retail sales excluding auto and fuel fell 5.9% year-on-year in June, the weakest reading since the Covid-19 crisis. Consumer confidence is lower than in 2020 (panel 4). Trade data continues to be weak, which has dipped the current account towards decade lows (panel 5). The external balance is the biggest driver of the pound, given the huge deficit. The above environment has put the BoE in a stagflationary quagmire. Last week, they raised rates by 50 bps suggesting inflation is a much more important battle than growth. Politically, the resignation of Prime Minister Boris Johnson, and broader difficulties for the Conservative Party, is fueling sterling volatility. We are maintaining our long EUR/GBP trade as a bet that at 1.03, the euro has priced in a recession (well below the 2020 lows), but sterling has not. On cable, 1.20 will prove to be a long-term floor but it will be volatile in the short term.  Australian Dollar: A Contrarian Play Chart 7Relatively Solid Domestic Conditions In Australia The AUD is down 2.3% year-to-date. Over the last month, the AUD is up 5.3%. AUD is fast approaching its 200-day moving average. If that is breached, it could signal that the highs of this year, above 76 cents, are within striking distance (panel 1). Inflation is accelerating in Australia. In Q2, the inflation reading was 6.1%, while the trimmed-mean and weighted-median measures were above the central bank’s 1-3% band (panel 2). As a result, the RBA stated the benchmark rate was “well below” the neutral rate. It increased rates by an additional 50bps in August, lifting the official cash rate to 1.85%. Further rate increases are likely. There are a few reasons for this. First, labor market conditions are the most favorable in decades. In June, unemployment reached 3.5%, its lowest level in 50 years, against a consensus of 3.8% (panel 3). The participation rate also increased to 66.8% in June from 66.7%, which has pushed the underutilization rate to multi-decade lows (panel 4). Despite this, consumer confidence continued its decline in August, dropping to 81.2 from 83.8. A pickup in Covid-19 cases and high consumer prices are the usual suspects. Beyond the labor market, monetary policy seems to be having the desired effect. Demand appears to be slowing as retail sales grew 0.2% month-on-month in June from 0.9%. Home loan issuance declined by 4.4% in June, driven by a 6.3% decline in investment lending. House price growth continued to decline in July, particularly in densely populated regions like Sydney and Melbourne. The manufacturing sector remains strong, with July PMI coming in at 55.7, suggesting the RBA might just be achieving a soft landing in Australia.  The external environment was largely favorable for the AUD in June, as the trade balance increased substantially by A$17.7bn with commodities rallying early in the month. However, commodity prices are rolling over. The price of iron for example, is down 24% from its peak in June. This will likely weigh on the trade balance going forward (panel 5). A weakening external environment are near-term headwinds for the AUD, but we will be buyers on weakness (panel 6).  New Zealand Dollar: Least Preferred G10 Currency Chart 8Near-Term Risks To NZD The NZD is down 6.1% this year. Over the last month, it is up 5% (panel 1). The Reserve Bank of New Zealand raised its official cash rate (OCR) in July by 50bps to 2.5%, in line with market expectations. Policymakers maintained their hawkish stance and guided towards increased tightening until monetary conditions can bring inflation within its target range of 1-3%. Inflation rose in Q2 to 7.3% from a 7.1% forecast, largely driven by rising construction and energy prices (panel 2). As of the latest data, monetary policy appears to be continuing to have the desired effect on interest rate sensitive parts of the economy. REINZ home sales declined 38.1% year-on-year in June. Home price growth continues to roll over (panel 3). The external sector continues to slow. Dairy prices, circa 20% of exports, saw a 12% drop in early August after remaining flat in July. The 12-month trailing trade balance remains in deficit. This is most likely due to a substantial slowdown in Chinese economic activity, given that China is an important trade partner with New Zealand. What is important is that the RBNZ’s “least regrets” approach seems to be working. Despite a cooling economy, sentiment seems to be stabilizing. ANZ consumer confidence improved to 81.9 in July from 80.5. Business confidence also improved to -56.7 from -62.6 (panel 4). Ultimately, the NZD is driven by terms of trade, as well as domestic conditions (panels 1 and 5). Thus, short-term headwinds from a deteriorating external sector do not make us buyers of the currency for now, though a rollover in the dollar will help the kiwi.  Canadian Dollar: Lower Oil, Hawkish BoC Chart 9The BoC Will Stay On A Hawkish Path The CAD is down 1.2% year to date. Over the last month, it is up 1.8%. The Canadian dollar did not fully catch up to oil prices on the upside. Now that crude is rolling over, CAD remains vulnerable, unless the dollar continues to stage a meaningful decline (panel 1). Canadian data has been rather mixed over the last month. For example: There have been two consecutive months of job losses. This is after a string of positive job reports. In July, Canada lost 31K jobs. In June, it lost 43K. The reasons have been mixed, from women dropping out of the labor force, to lower youth participation (the participation rate fell), but this is a trend worth monitoring (panel 2). CPI growth remains elevated and is accelerating both on headline and core measures(panel 3). Building permits and housing starts have started to roll over, as house price inflation continues to lose momentum. June housing starts were at 274K from 287.3K. June building permits also fell 1.5% month-on-month though annual inflation is still outpacing house price growth (panel 4). The Canadian trade balance is improving, hitting a multi-year high of C$5.05 bn in June. This has eased the need for foreign capital inflows. The BoC raised rates 100bps in July, the biggest interest rate increase in one meeting among the G10. Unless the labor market continues to soften, the BoC will continue to focus on inflation, which means more rate hikes are forthcoming. The OIS curve is pricing a peak BoC rate of 3.6% in 9 months (panel 5). Two-year real rates are still higher in the US compared to Canada. And the loonie has lost the tailwind from strong WCS oil prices. As such, unless the dollar softens further, the loonie will remain in a choppy trading pattern like most of this year.  Swiss Franc: A Safe Haven Chart 10The Franc Will Remain Strong Against The Euro For Now CHF is down 3.2% year-to-date and up 4.3% in the past month. The Swiss franc has been particular strong against the euro, with EUR/CHF breaching parity (panel 1). Switzerland remains an island of relative economic stability in the G10. Although slowing, the manufacturing PMI was a healthy 58 in July. The trade surplus was up to CHF 2.6bn in June, despite a strong franc. While most European countries are preparing for a tough winter with energy rationing, prospects for Switzerland, which derives only 13% of its electricity from natural gas, look more favorable.  Still, as a small open economy, Switzerland is feeling the impact of global growth uncertainty. The KOF leading indicator dropped to 90.1 in August with a sharp decline in the manufacturing component. This broader measure suggests the relative resilience of the manufacturing sector might not last long (panel 2). Consumer confidence also fell to the lowest level since the onset of the pandemic. Swiss headline inflation stabilized at 3.4% in July. The core measure rose slightly to the SNB’s 2% target (panel 3). The UBS real estate bubble index rose sharply in Q2, suggesting inflation is not only an imported problem. Labor market conditions also remain tight, with the unemployment rate at 2%, a two-decade low. The SNB will continue to embrace currency strength while inflation risks persist (panel 4), as can be seen by the decline in sight deposits and FX reserves (panel 5). The market is still pricing in another 50 bps hike in September although August inflation data that comes out before the meeting will likely be critical for that decision. CHF is one of the most attractive currencies in our ranking. Despite the recent outperformance, CHF is still down year-to-date against the dollar. A rise in safe-haven demand, and a possible energy crunch in winter will be supportive, especially against the euro.  Norwegian Krone: Oil Fields Are A Jewel Chart 11NOK Will Reap Dividends From Energy Exports NOK is down 7.4% year-to-date and up 7.1% over the last month. It is also up 4.2% versus the euro, despite softer oil prices (panel 1). Inflation in Norway continues to accelerate. In July, CPI grew 6.8% year-on-year, above the market consensus and the Norges Bank’s forecast. Underlying inflation jumped sharply to an all-time high of 4.5%, compared to the Bank’s 3.2% forecast made just over a month ago (panel 2). These figures are adding pressure on the central bank to increase the pace of interest rate hikes, with 50bps looking increasingly likely at the meetings in August and September. NOK jumped on the inflation news. The housing market is starting to show signs of slowing with prices down 0.2% on the month in July, the first decrease since December. This, together with household indebtedness (panel 3), makes the task of policy calibration challenging. Our bias is that a persistently tight labor market and strong wage growth (panel 4) will allow the bank to focus on inflation. Economic activity remains robust in Norway but is softening. The manufacturing PMI fell to 54.6 in July, while industrial production was down 1.7% month-over-month in June. Consumer demand remains frail with retail sales and household consumption flat in June from the previous month. On a more positive note, trade surplus remains near record levels and is likely to stay elevated as high European demand for Norwegian energy is likely to last at least through the winter (panel 5). As global risk sentiment picked up, the krone became the best performing G10 currency over the past month. If the risk appetite reverses, the currency is likely to feel some turbulence. Swedish Krona: Cheap, But No Catalysts Yet Chart 12SEK = EUR On Steroids SEK is down 10% year-to-date and up 5.6% over the past month. The vigorous rebound highlights just how oversold the Swedish krona is (panel 1). The Swedish economy grew 1.4% in Q2 from the previous three months, rebounding from a 0.8% contraction in the first quarter. This is impressive, given high energy prices and a slowdown in global economic activity. Going forward, growth is likely to slow. In July, the services and manufacturing PMIs declined, and consumer confidence fell sharply to the lowest reading in almost 30 years. Retail sales were down 1.2% month-on-month in June. The housing market is also feeling the pain of rising borrowing costs (panel 2). The Riksbank’s latest estimate sees a 16% decline in prices by the end of next year.  For now, inflation is still accelerating in Sweden. CPIF, the Riksbank’s preferred measure, increased from 7.2% to 8.5% in June. Headline inflation rose from 7.3% to 8.7% (panel 3). Headline inflation is likely to decline in July, given the drop in the price component of the PMIs, but inflation will remain well above target. This will keep real rates weak (panel 4). This suggests that the Riksbank is facing the same conundrum as the ECB: accelerate policy tightening and tip the economy towards recession or remain accommodative and risk inflation becoming more entrenched. Our bias is that the Riksbank is likely to frontload rate hikes as currently priced in the OIS curve, with a 50 bps hike in September, ahead of major labor union wage negotiations (panel 5). Much like the NOK, the Swedish krona rebounded strongly in the past month on global risk-on sentiment. Fundamentally, the krona remains more vulnerable to external shocks due to higher energy dependency and a strong dollar. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Artem Sakhbiev Research Associate artem.sakhbiev@bcaresearch.com Thierry Matin Research Associate thierry.matin@bcaresearch.com   Trades & Forecasts Strategic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Forecast Summary

Informe especial

Resumen Ejecutivo Con la materialización de la cuarta crisis del Estrecho de Taiwán, las probabilidades de una gran guerra entre las potencias mundiales han aumentado. Nuestros árboles de decisión sugieren que las probabilidades son alrededor del 20%, o el doble de lo que estaban sólo por la guerra rusa en Ucrania. El mundo está jugando a la “ruleta rusa” … con un revólver de cinco cartuchos. De cara al futuro, nuestro caso base es que las tensiones sobre Taiwán se aplanarán (pero no disminuirán) después de que concluyan los eventos políticos domésticos en EE. UU. y China este otoño. Sin embargo, si China intensifica las tensiones después del vigésimo congreso nacional del partido, entonces las probabilidades de una invasión aumentarán significativamente. Si estalla un conflicto en Taiwán, entonces las probabilidades de que Rusia se vuelva aún más agresiva en Europa aumentarán. Es muy probable que Irán persiga armas nucleares.   Pocos Catalizadores Positivos en la 2.ª Mitad de 2022 Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros Recomendación TácticaFecha de InicioRetorno IR LARGO EN TESOROS A 10 AÑOS DE EE. UU.2022-04-141.3% IR LARGO EN VALORES DEFENSIVOS / CICLÍCOS GLOBALES2022-01-2013.8% Conclusión: Los inversores deberían mantenerse posicionados de forma defensiva al menos hasta que el congreso del partido chino y las elecciones intermedias de EE. UU. concluyan este otoño. El riesgo geopolítico del próximo año dependerá de las acciones de China en el Estrecho de Taiwán. Artículo   Gráfico 1 Crece la Especulación Sobre la Tercera Guerra Mundial Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros Los pesimistas que prestan atención a los acontecimientos mundiales se han preocupado en los últimos años por el riesgo de que pueda estallar la tercera guerra mundial. El término ha aumentado en las búsquedas en línea desde 2019, aunque es la tendencia subyacente de multipolaridad global, más que los eventos críticos específicos, lo que justifica la preocupación (Gráfico 1).1 ¿Cuáles son las probabilidades de una gran guerra entre EE. UU. y China, o EE. UU. y Rusia? ¿Cómo podría calcularse eso? En este informe presentamos una serie de “árboles de decisión” para formalizar los diferentes escenarios y probabilidades. Si definimos la Tercera Guerra Mundial (WWIII) como una guerra en la que Estados Unidos se involucra en combate directo con Rusia o China, o con ambos, entonces llegamos a una probabilidad del 20% de que estalle la Tercera Guerra Mundial en los próximos un par de años. Esas son probabilidades inquietantemente altas, pero la historia enseña que estas probabilidades no son irreales y que los inversores no deben ser complacientes. El politólogo Graham Allison ha mostrado que las probabilidades de una guerra entre EE. UU. y China a largo plazo son de aproximadamente el 75% basándose en analogías históricas. La conclusión es que las naciones tendrán que afrontar este riesgo de Tercera Guerra Mundial y rechazarlo para que el entorno político global mejore. Lo más probable es que lo hagan, ya que la Tercera Guerra Mundial, y el riesgo de guerra nuclear que conllevaría, constituyen la restricción última. Pero el comportamiento actual de las grandes potencias sugiere que aún no han reconocido sus restricciones y están dispuestas a continuar con maniobras de riesgo a corto plazo. Las Probabilidades de Una Invasión China de Taiwán La primera pregunta es si China invadirá Taiwán. En abril de 2021 predijimos que la cuarta crisis del Estrecho de Taiwán ocurriría dentro de 12-24 meses pero que no derivaría en una guerra a gran escala. Esta opinión ahora está siendo puesta a prueba. En Diagrama 1 ofrecemos un árbol de decisión para trazar las opciones políticas de China hacia Taiwán y asignar probabilidades a cada opción. Diagrama 1 Árbol de Decisión para la Cuarta Crisis del Estrecho de Taiwán (Próximos 24 Meses) Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros   Aunque China ha alcanzado la capacidad para invadir Taiwán, las probabilidades de fracaso siguen siendo demasiado altas, especialmente sin mayor progreso en su tríada nuclear. Por lo tanto, damos sólo un 20% de probabilidad a que China se movilice para una invasión de inmediato. No hace falta decir que cualquier signo concreto de que China está planeando una invasión debe tomarse en serio. Los inversores y los medios subestimaron la acumulación militar de Rusia en torno a Ucrania en 2021 en su detrimento. Al mismo tiempo, existe una buena probabilidad de que EE. UU. y China simplemente estén probando el statu quo en el Estrecho de Taiwán, que se reforzará tras el episodio actual. Después de todo, esta crisis fue la cuarta crisis del Estrecho de Taiwán: ninguna de las crisis anteriores condujo a la guerra. Si los presidentes Biden y Xi Jinping simplemente están mostrando músculo antes de importantes eventos políticos domésticos este otoño, entonces ya han logrado su objetivo. No son necesarias más demostraciones de fuerza por ninguna de las partes, al menos durante los próximos años. Damos un 40% de probabilidad a este escenario, en el cual las tensiones de la semana pasada persistirán pero se reforzará el statu quo. En ese caso, el problema estructural del Estrecho de Taiwán volvería a estallar en algún momento después de las elecciones presidenciales de EE. UU. y Taiwán en 2024, es decir, fuera del marco temporal del diagrama. Desafortunadamente somos pesimistas a largo plazo y daríamos alta probabilidad a la guerra en Taiwán. Por esa razón, otorgamos probabilidades iguales (40%) a una situación que se deteriore dentro de los próximos dos años. Si China amplía los simulacros y las sanciones después del congreso del partido, una vez que Xi haya consolidado el poder, entonces quedará claro que Xi no está simplemente actuando para su audiencia interna. De manera similar, si la administración Biden continúa presionando por controles de exportación de alta tecnología más estrictos contra China después de las elecciones intermedias, e insiste en que los aliados y socios de EE. UU. hagan lo mismo, entonces EE. UU. implícitamente cree que China se está preparando para algún tipo de operación ofensiva. El peligro de invasión aumentaría del 20% al 40%. Incluso en ese caso, aún se debería creer que la diplomacia de crisis entre EE. UU. y China evitará una guerra a gran escala en 2023-24. Pero el riesgo de cálculo erróneo sería muy alto. El último elemento de este árbol de decisión sostiene que China preferirá las “tácticas de zona gris” o la guerra híbrida en lugar de una invasión anfibia convencional del tipo visto en la Segunda Guerra Mundial. Las razones son varias. Primero, las invasiones anfibias son las operaciones militares más difíciles. Segundo, las fuerzas chinas son inexpertas mientras que EE. UU. y sus aliados están atrincherados. Tercero, la guerra híbrida sembrará división entre los aliados de EE. UU. sobre la mejor respuesta. Cuarto, Rusia ha demostrado varias veces en los últimos 14 años que la guerra híbrida funciona. Es una forma de maximizar los beneficios estratégicos y minimizar los costos. El mundo sabe cómo reacciona Occidente ante invasiones pequeñas: aplica sanciones económicas. Aún no sabe cómo reaccionaría Occidente ante invasiones grandes. Por eso China estará incentivada a dar mordiscos pequeños. Y, sin embargo, en el caso de Taiwán esas tácticas pueden no ser sostenibles. Nuestro árbol de decisión sobre Taiwán no contempla la probabilidad de que una guerra híbrida o una “guerra por poder” evolucione hacia una guerra mayor. Pero esa probabilidad es, de hecho, alta. Así que no estamos sobreestimando el riesgo de una gran guerra entre EE. UU. y China. Conclusión: En los próximos dos años, las probabilidades subjetivas de una guerra por poder entre EE. UU. y China por Taiwán son de aproximadamente el 32%, mientras que las probabilidades de una guerra directa EE. UU.-China son de alrededor del 4%. La verdadera prueba llega después de que Xi Jinping consolide el poder en el congreso del partido de este otoño. Esperamos que Xi se concentre en reiniciar la economía por lo que seguimos favoreciendo los mercados emergentes asiáticos excluyendo China y Taiwán. Las Probabilidades de Guerra de Rusia con la OTAN La segunda pregunta es si la guerra de Rusia en Ucrania derivará en una guerra más amplia con Occidente. Las probabilidades de una gran guerra Rusia-Occidente son mayores en este caso que en el de China, ya que una guerra ya está en curso, mientras que las tensiones en el Estrecho de Taiwán hasta ahora son meros desfiles de fuerza. El caso base de un inversor debería mantener que la guerra en Ucrania permanecerá contenida en Ucrania, ya que los europeos no quieren pelear una guerra devastadora con Rusia sólo por el Donbás. Pero a menudo las cosas salen mal en tiempos de guerra. La pregunta crítica es si Rusia atacará a algún miembro de la OTAN. Eso desencadenaría el Artículo Cinco del tratado de la alianza, que establece que “un ataque armado contra uno o más [miembros de la alianza] en Europa o América del Norte se considerará un ataque contra todos ellos,” justificando el uso de la fuerza armada si es necesario para restaurar la seguridad. Desde la invasión rusa de Ucrania este año, el presidente Biden ha declarado repetidamente que EE. UU. “defenderá cada pulgada del territorio de la OTAN,” incluidos los estados bálticos de Letonia, Lituania y Estonia, que se unieron a la OTAN en 2004. Esto no es un cambio de política pero sí es la línea roja de EE. UU. y es muy probable que sea defendida. Por lo tanto, es una restricción importante para Rusia. En Diagrama 2 trazamos las diferentes opciones de Rusia y asignamos probabilidades. Diagrama 2 Árbol de Decisión para la Guerra Rusia-Ucrania (Próximos 24 Meses) Ruleta con un revólver de cinco disparos Ruleta con un revólver de cinco disparos   Damos un 55% de probabilidad de que Rusia declare la victoria tras completar la conquista de la región del Donbás en Ucrania y el corredor terrestre hacia Crimea. Comenzará a buscar legitimar sus conquistas mediante algún acuerdo diplomático, es decir, un alto el fuego. Este es nuestro caso base para 2023. Hay evidencia de que Rusia ya está empezando a moverse hacia la diplomacia.2 La razón es que la economía rusa está sufriendo, los precios globales de las materias primas están cayendo, se está gastando sangre y tesoro ruso. El presidente Putin habrá logrado en gran medida su objetivo de incapacitar a Ucrania mientras controle la boca del río Dniéper y el resto del territorio que ha invadido. Putin necesita sellar sus conquistas e intentar rescatar la economía y la sociedad. Cuanto antes mejor para Rusia, de modo que se pueda prevenir que Europa forme un consenso e implemente un embargo total de gas natural en los próximos años. Sin embargo, existe el riesgo de que la ambición de Putin lo supere. Por eso damos un 35% de probabilidad a que la invasión se expanda al suroeste de Ucrania, incluyendo la estratégica ciudad portuaria de Odesa, y al este de Moldavia, donde tropas rusas están estacionadas en la región separatista de Transnistria. Esta nueva campaña dejaría a Ucrania totalmente sin salida al mar, neutralizaría a Moldavia y daría a Rusia mayor acceso marítimo. Pero unificaría a la UE, precipitaría un embargo de gas natural y debilitaría a Rusia hasta un punto en que podría volverse desesperada. Podría contraatacar y esa represalia podría concebirse que conduzca a una guerra más amplia. Asignamos sólo un 7% de probabilidad a que Putin ataque a Finlandia o Suecia por intentar unirse a la OTAN. Stalin fracasó en Finlandia y el ejército de Putin ni siquiera pudo conquistar Kiev. El Reino Unido se ha comprometido a apoyar a estos estados, por lo que un ataque contra ellos muy probablemente desencadenaría una guerra con la OTAN. Una decisión de atacar a Finlandia solo ocurriría si Rusia creyera que la OTAN planea desplegar bases militares allí, es decir, la línea roja declarada de Rusia. Cualquier ataque ruso contra los estados bálticos es menos probable porque ya están en la OTAN. Pero existe cierto riesgo de que ocurra si Putin se vuelve desesperado. Ponemos el riesgo de una invasión de los bálticos en un 3%. En resumen, si Rusia usa su estrangulamiento energético sobre Europa no para negociar un alto el fuego favorable sino para expandir sus invasiones, entonces las probabilidades de una guerra más amplia aumentarán. Conclusión: El resultado es una probabilidad del 55% de desescalada durante los próximos 24 meses, un 35% de una pequeña escalada (por ejemplo Odesa, Moldavia) y un 10% de una escalada mayor que involucre a miembros de la OTAN y probablemente conduzca a una guerra OTAN-Rusia. Tácticamente, los inversores deberían comprar moneda y activos de mercados desarrollados europeos si la economía global se recupera y Rusia realiza un claro giro hacia detener su campaña militar y perseguir conversaciones de alto el fuego. Cíclicamente, se necesita una comprensión más profunda entre EE. UU. y Rusia para un mercado alcista duradero en activos europeos. Las Probabilidades de Ataques de EE. UU. e Israel contra Irán La tercera crisis geopolítica que tiene lugar este año podría posponerse mientras salimos a impresión, si el presidente Biden y el ayatolá Ali Khamenei acuerdan reincorporarse al acuerdo nuclear EE. UU.-Irán de 2015. Pero seguimos siendo escépticos. La administración Biden quiere reincorporarse al acuerdo nuclear de 2015 y liberar alrededor de un millón de barriles por día de crudo iraní para reducir los precios en la bomba antes de las elecciones intermedias. La gran estrategia de EE. UU. también quiere comprometerse con Irán y estabilizar Oriente Medio para que EE. UU. pueda reorientarse hacia Asia. La UE propone el acuerdo ya que tiene una necesidad aún mayor de los recursos iraníes y quiere prevenir que Irán obtenga armas nucleares. Rusia y China también apoyan porque quieren eliminar las sanciones estadounidenses para comerciar con Irán y no necesariamente desean que Irán tenga armas nucleares. Solo hay un problema: Irán necesita armas nucleares para asegurar la supervivencia de su régimen a largo plazo. La pregunta es si Khamenei está dispuesto a autorizar un acuerdo con los estadounidenses por segunda vez. El primer acuerdo fue traicionado a gran costo para su régimen. El presidente Ebrahim Raisi, que espera reemplazar al supremo Khamenei de 83 años antes o después, seguramente se opone firmemente a apostar su carrera y seguridad personal a que los republicanos ganen las elecciones de 2024. Irán ya ha alcanzado la capacidad de ruptura nuclear – tiene suficiente uranio enriquecido al 60% para construir dispositivos nucleares – y no está claro por qué alcanzaría esta capacidad si no pretendiera finalmente obtener un elemento disuasorio nuclear. Especialmente dado que podría necesitar algún día proteger su régimen de ataques militares por parte de EE. UU. y sus aliados. Sin embargo, nuestro nivel de convicción es medio porque el presidente Biden quiere levantar las sanciones y puede hacerlo unilateralmente. La administración Biden no ha tomado ninguna de las acciones preliminares para que un acuerdo se materialice, pero eso podría cambiar.3 Hay un buen caso cíclico que favorecería un acuerdo temporal y de corta duración. Según Bob Ryan, estratega de materias primas y energía de BCA, Arabia Saudita y los EAU sólo tienen aproximadamente 1.5 millones de barriles de capacidad de producción de petróleo excedente entre ambos. El embargo petrolero de la UE y las sanciones occidentales sobre Rusia forzarán la detención de alrededor de dos millones de barriles por día, absorbiendo la mayor parte de la capacidad de la OPEP. Por tanto, la administración Biden necesita el millón de barriles que Irán puede aportar. No podemos negar que los iraníes podrían firmar un acuerdo para permitir que Biden levante las sanciones. Eso beneficiaría su economía. Podrían permitir inspectores nucleares mientras secretamente desplazan su foco al desarrollo de ojivas y misiles balísticos. Aunque Irán no renunciará a la larga a la búsqueda de un disuasivo nuclear, es experto en ganar tiempo. Aun así, la política doméstica de Irán no respalda un acuerdo, y su gran estrategia sólo apoya un acuerdo si EE. UU. puede proporcionar garantías de seguridad creíbles, cosa que EE. UU. no puede hacer porque su política exterior es inconsistente. La gran estrategia de EE. UU. apoya un acuerdo pero sólo si es verificable, es decir, no si Irán lo utiliza como cobertura para perseguir una bomba de todas formas. Irán no se ha rendido después de tres años de sanciones máximas de EE. UU., una pandemia y la agitación global. Y Irán ve una perspectiva mucho mayor de extraer beneficios estratégicos de Rusia y China ahora que se han vuelto agresivos contra Occidente. Moscú y Pekín pueden ser socios estratégicos debido a su acrimonia compartida hacia Washington. Mientras que EE. UU. puede traicionar a la administración Raisi tan fácilmente como traicionó a la de Rouhani, con el resultado de que la economía volvería a ser zarandeada y el Líder Supremo y el establecimiento político serían, a los ojos del público, el doble de engañados. Diagrama 3 expone las opciones de Irán. Diagrama 3 Árbol de Decisión para la Crisis Nuclear de Irán (Próximos 24 Meses) Ruleta con un revólver de cinco disparos Ruleta con un revólver de cinco disparos   Si las negociaciones colapsan (50% de probabilidad), entonces Irán dará una carrera loca por un arma nuclear antes de que EE. UU. e Israel ataquen. Si EE. UU. e Irán acuerdan un pacto (40%), entonces Irán podría cumplir los términos del acuerdo hasta las elecciones de EE. UU. de 2024, retirando el tema de las preocupaciones de los inversores por ahora. Pero su interés a largo plazo en obtener un disuasivo nuclear no cambiará y el conflicto se reavivará después de 2024. Si las conversaciones continúan sin resolución (10%), Irán hará progresos graduales en su programa nuclear sin las restricciones del acuerdo (aunque puede que no necesite apresurarse). En resumen, Rusia y China necesitan a Irán independientemente de si éste congela su programa nuclear, mientras que EE. UU. e Israel formarán una alianza Abraham de equilibrio de poder para contener a Irán incluso si congela su programa nuclear. Conclusión: Los inversores deberían asignar un 40% de probabilidad a un acuerdo nuclear temporal y de corta duración entre EE. UU. e Irán. La caída del precio del petróleo sería fugaz. La oferta a largo plazo no se expandirá porque EE. UU. no puede proporcionar a Irán las garantías de seguridad que necesita para detener irreversible su programa nuclear. Las Probabilidades de la Tercera Guerra Mundial Ahora viene la parte imposible, donde intentamos poner estas tres crisis geopolíticas juntas. En lo que sigue estamos simplificando en exceso. Pero el propósito es formalizar nuestro pensamiento sobre los diferentes actores y sus opciones. Diagrama 4 comienza con nuestras conclusiones respecto al conflicto China/Taiwán, ajusta las probabilidades de una guerra rusa más amplia como resultado, y añade nuestra opinión de que es muy probable que Irán persiga armas nucleares. De nuevo, el marco temporal es de dos años. Diagrama 4 Árbol de Decisión para la Tercera Guerra Mundial (Próximos 24 Meses) Ruleta con un revólver de cinco disparos Ruleta con un revólver de cinco disparos   El escenario alternativo de conflicto a la Tercera Guerra Mundial consiste en “guerras limitadas”: un concepto peligroso que se refiere a guerras híbridas y por poder en las que EE. UU. no está involucrado, o sólo está involucrado de forma indirecta. O podría ser un conflicto con Irán que no involucre a Rusia y China. Comenzamos con China porque es la potencia global más capaz y ambiciosa en la actualidad. El ascenso estratégico de China está trastornando el orden global y desafiando a Estados Unidos. También empezamos por China porque tenemos alguna evidencia este año de que Rusia no pretende expandir la guerra más allá de Ucrania. O China toma acciones agresivas adicionales en Taiwán – creando una oportunidad única para que Rusia asuma mayores riesgos – o no. Si no, las probabilidades de la Tercera Guerra Mundial caerán drásticamente durante el período de dos años. Este escenario es nuestro caso base. Pero si China ataca Taiwán y EE. UU. defiende a Taiwán, damos una alta probabilidad a que Rusia invada los bálticos. Si China realiza ataques híbridos y EE. UU. sólo apoya a Taiwán de forma indirecta, entonces aumentamos las probabilidades de agresión rusa sólo marginalmente. El resultado es una probabilidad del 20% de la Tercera Guerra Mundial, es decir, una guerra directa entre EE. UU. y Rusia, o China, o ambos. Si esta guerra podría permanecer limitada es debatible. Los ejercicios de guerra desde 1945 muestran que cualquier guerra entre grandes potencias nucleares es más probable que escale que lo contrario. Pero las armas nucleares traen destrucción mutuamente asegurada, la restricción última. El riesgo de escalada nuclear es la razón por la que redondeamos a la baja la probabilidad de la Tercera Guerra Mundial en nuestros árboles de decisión. El escenario más probable del 59% de “guerras limitadas” puede parecer un resultado positivo, pero incluye aumentos importantes en las tensiones geopolíticas respecto al nivel actual, como una guerra híbrida china contra Taiwán. Conclusión: Según este ejercicio, las probabilidades de la Tercera Guerra Mundial podrían ser tan altas como el 20%. Esto es el doble del nivel en nuestro árbol de decisión sobre Rusia, lo cual es apropiado dado que nuestro pronóstico sobre la crisis de Taiwán se ha materializado. El factor crítico es si Pekín continúa escalando la presión sobre Taiwán después del congreso del partido este otoño. Eso podría desencadenar una peligrosa reacción en cadena. La economía global y los mercados financieros todavía enfrentan riesgo a la baja por la geopolítica, pero 2023 podría ver mejoras si Rusia se mueve hacia un alto el fuego y China retrasa la acción contra Taiwán para reiniciar su economía. Conclusiones para la Inversión Cuando Rusia invadió Ucrania a principios de este año, nuestro colega Peter Berezin, estratega global jefe, argumentó que las probabilidades de un Armagedón nuclear eran del 10%. Como mínimo, esta es una probabilidad razonable para las probabilidades de que Rusia y la OTAN lleguen a las manos. Ahora la esperada crisis de Taiwán se ha materializado. Calculamos que las probabilidades de una gran guerra se han duplicado al 20%. La correlación es una probabilidad del 80% de un mejor resultado. Analíticamente, seguimos viendo a Rusia persiguiendo un objetivo limitado – neutralizar a Ucrania para que no sea próspera ni militarmente poderosa – mientras que China también persigue un objetivo limitado – intimidar a Taiwán para que busque la subordinación en vez de la condición de nación. A menos que estos objetivos cambien, todavía estamos lejos de la Tercera Guerra Mundial. El mundo puede convivir con una Ucrania lisiada y un Taiwán subordinado. Sin embargo, no se puede negar que la trayectoria de los asuntos globales desde la crisis financiera global de 2008 ha seguido un camino incómodamente similar al que condujo a la Segunda Guerra Mundial: crisis financiera, recesión económica, deflación, agitación interna, depreciación de la moneda, proteccionismo comercial, monetización de la deuda, rearme militar, inflación y guerras de agresión. Si la ruleta es el juego, entonces las probabilidades de una guerra global son de una sexta parte o 17%, no muy lejos del resultado del 20% de nuestros árboles de decisión. Incluso suponiendo que seamos alarmistas, el hecho de que podamos formular un argumento coherente y formal de que las probabilidades de la Tercera Guerra Mundial son tan altas como el 20% sugiere que los inversores deberían esperar a que las tensiones actuales sobre Ucrania y Taiwán disminuyan antes de hacer grandes apuestas nuevas y arriesgadas. Una lista de comprobación simple muestra que el contexto macro global y geopolítico es sombrío (Tabla 1). Necesitamos mejoras en la lista antes de mostrarnos más optimistas. Tabla 1 Pocos Catalizadores Positivos en la 2.ª Mitad de 2022 Ruleta con un revólver de cinco tiros Ruleta con un revólver de cinco tiros     Gráfico 2 Mantenerse en Posición Defensiva en la 2.ª Mitad de 2022 Manténgase en posición defensiva en el segundo semestre de 2022 Manténgase en posición defensiva en el segundo semestre de 2022 Específicamente, lo que los inversores necesitan es estar razonablemente tranquilos de que Rusia no expandirá la guerra a la OTAN y de que China no invadirá Taiwán en el corto plazo. Esto requiere un nuevo entendimiento diplomático entre Washington y Moscú y entre Washington y Pekín que evite el conflicto. Ese tipo de entendimiento sólo puede forjarse en la crisis. Las crisis relevantes están en curso pero aún no han concluido. Es probable que haya más caídas para los inversores en renta variable global antes de que los riesgos de guerra se disipan mediante la solución habitual: la diplomacia. Espere mejoras concretas y creíbles en el sistema global antes de adoptar una postura generalmente sobreponderada hacia activos de riesgo. Favorezca los bonos gubernamentales sobre las acciones, las acciones estadounidenses sobre las globales, los sectores defensivos sobre los cíclicos, y desfavorezca la moneda y los activos chinos y taiwaneses (Gráfico 2).     Matt Gertken Director de Estrategia Geopolíticamattg@bcaresearch.com  Notas al Pie 1      Véase Graham Allison, Destined For War: Can America and China Escape Thucydides’s Trap? (Nueva York: Houghton Miffin Harcourt, 2017). 2     Por ejemplo, el acuerdo mediado por Turquía para enviar grano desde Odesa, el apoyo diplomático para reincorporarse al acuerdo nuclear de Irán de 2015, los referendos en territorios conquistados como Jersón y los intentos de aumentar la influencia en conversaciones de reducción de armamentos. Cortar la energía de Europa es en última instancia un plan para coaccionar a Europa a aceptar un alto el fuego favorable para Rusia. 3     Irán sigue planteando demandas extraneous – más recientemente que el OIEA deje de investigar cómo ciertas partículas de uranio producidas por el hombre aparecieron en sitios nucleares no divulgados en Irán. El OIEA no ha abandonado esta investigación y su credibilidad sufriría si lo hiciera. Mientras tanto, Biden está aumentando y no reduciendo sanciones sobre Irán, aunque el alivio de sanciones es una demanda iraní central. Biden no ha eliminado a la Guardia Revolucionaria Iraní ni a la Fuerza Quds de la lista de terrorismo. Ninguno de estos obstáculos es prohibitivo pero al menos esperaríamos ver algún movimiento antes de cambiar nuestra opinión de que un acuerdo es más probable que fracase que que tenga éxito. Temas Estratégicos Posiciones Tácticas Abiertas (0-6 Meses) Recomendaciones Cíclicas Abiertas (6-18 Meses) Matriz Regional de Riesgo Geopolítico "Promedio de Aciertos": Operaciones de Estrategia Geopolítica ()

Executive Summary Unit Labor Costs, Not Oil Prices, Are The Key To US Core Inflation Inflation is not about oil, food or used car prices. Looking at prices of individual components of a consumer basket is akin to missing the forest for the trees. Despite the latest drop in US headline inflation, various core CPI measures continue trending up and registered considerable month-on-month rises in July. Wages and, more specifically, unit labor costs are the true measure of genuine and persistent inflation. US wage growth is very elevated, and the pace of unit labor cost gains has surged to a 40-year high. The conditions for sustainable and persistent disinflation in the US are not yet present. US inflation will prove to be much stickier and more entrenched than many market participants presently believe. The recovery in China will be U- rather than V-shaped, with risks tilted to the downside. The mainland’s property market breakdown is structural, not cyclical. Excesses are very large, and problems are snowballing, rendering the enacted policy stimulus insufficient. Bottom Line: US core inflation lingering above 4% and easing financial conditions will compel the Fed to continue hiking rates. This will cap global risk asset prices and put a floor under the US dollar.  We continue to recommend an underweight allocation to EM in global equity and credit portfolios. Consistently, we are also reluctant to chase EM currencies higher. Feature The bullish macro narrative circulating in the investment community is that conditions for a cyclical rally in global risk assets have fallen into place. Specifically: US inflation will drop sharply as US growth has crested and commodity prices have plunged; The Fed is nearing the end of a tightening cycle; China has stimulated sufficiently, and its economy is about to recover, which will boost economic conditions among its trading partners in general and EM in particular. These assumptions along with the fact that the S&P 500 index has found support at a 3-year moving average – a proven line of defense – suggest that US share prices have likely bottomed (Chart 1). Are we witnessing déjà vu of the 2011, 2016, 2018 and 2020 market bottoms? Chart 1Déjà Vu? Is 2022 Like The 2011, 2016 And 2018 Bottoms In The S&P 500? We have reservations about all of the above fundamental conjectures. We elaborate on these reservations in this report. On the whole, we contend that the current environment is different, and the roadmaps of all post-2009 equity market bottoms are not necessarily currently applicable. BCA’s Emerging Markets Strategy team believes that (1) US consumer price inflation is much more entrenched and will prove stickier than is commonly believed; and (2) the Chinese property market’s breakdown is structural, not cyclical; hence, the recovery will not gain traction easily.  Is This The End Of The US Inflation Problem? Not Quite This week’s US inflation data confirmed that headline CPI inflation has probably peaked: prices in several categories plunged. However, inflation is not about oil, food or used car prices. Chart 2 reveals that historically there have been several episodes whereby core inflation remains elevated despite plunging oil prices. Chart 2US Core Inflation Does Not Always Follow Oil Prices Looking at price dynamics among the individual components of the CPI basket is akin to missing the forest for the trees. Inflation is a very inert and persistent phenomenon. Underlying inflation does not change its direction often and/or quickly. That is why we believe that it is premature to celebrate the end of the US inflation problem. A few observations on this matter: Despite the drop in US headline inflation, various core CPI measures − like trimmed-mean CPI, median CPI and core sticky CPI − all continue trending up and registered substantial month-on-month rises in July (Chart 3). The range of core inflation based on these annual and month-month annualized rates is between 4-7%. In brief, the rate of genuine/sticky inflation is well above the Fed’s 2% target. Given its unconditional commitment to bringing inflation down to 2%, the Fed will continue hiking interest rates ceteris paribus. Chart 3US Core CPI Measures Are Still Very High Chart 4US Wages Growth Has Been Surging   We continue to emphasize that wages and, more specifically, unit labor costs are the true measures of persistent and genuine inflation. We have written at length about why wages and unit labor costs are more important to inflation than oil or food prices. US wage growth is very elevated and is accelerating (Chart 4). Unit labor costs, calculated as hourly wages divided by productivity, have also been surging to a 40-year high (Chart 5, top panel). Chart 5Unit Labor Costs, Not Oil Prices, Are The Key To US Core Inflation The reason for this very strong wage growth and swelling unit labor costs is the very tight labor market. The bottom panel of Chart 5 demonstrates that labor demand is still outpacing labor supply by a wide margin. Hence, wage inflation will not subside until the unemployment rate rises meaningfully. Bottom Line: Conditions for sustainable and persistent disinflation in the US are not yet present.  Inflation will prove to be much stickier and more entrenched than many market participants presently believe. Core inflation lingering above 4% and easing financial conditions will compel the Fed to continue hiking rates. This will cap risk asset prices and put a floor under the US dollar.   China: Is This Time Different? If one believes that China’s current business cycle is similar to all previous ones seen since 2009, odds are that a buying opportunity in China-related financial markets is at hand. Chart 6 illustrates that the credit and fiscal spending impulse leads the business cycle by about nine months. Given that this impulse bottomed late last year, a trough in the Chinese business cycle is due. Chart 6Is A Recovery In China's Business Cycle Imminent? It is always risky to suggest that this time is different. Nevertheless, at the risk of being wrong, we contend that a combination of (1) property markets woes, (2) an impending export contraction, and (3) the dynamic zero-COVID policy will reduce the multiplier effect of current stimulus measures. Hence, a meaningful recovery in economic activity will likely fail to materialize in the coming months. The challenges facing the mainland property market are now well known. Yet, excesses are very large, and problems are snowballing, making policy stimulus insufficient. In particular: Authorities are contemplating bailout funds for property developers in the range of RMB 300-400 billion to enable them to complete housing that has been pre-sold. This is not sufficient financing for overall property construction. Table 1How Large Are Property Developers Bailout Funds? Table 1 illustrates that these amounts are equal to just 3-4% of annual fixed-asset investment in real estate excluding land purchases, 1.5-2% of total financing of developers, and 3-4% of the advance payments that property developers received for pre-sold housing in 2021. Property developers will not be receiving any cash upon the completion and delivery of presold housing units because they were paid in advance. Hence, without liquidating their other assets, homebuilders cannot repay the bailout financing. Consequently, only state financing can work here because, from the viewpoint of providers of this financing, this scheme de-facto means throwing good money after bad. The property industry in China is extremely fragmented. This makes bailouts difficult to organize and execute. There are officially about 100,000 property developers in China. The overwhelming majority of them are not state-owned companies. Plus, the two largest property developers, Evergrande (before defaulting) and Country Garden, had only 3.8% and 3.3% of market share respectively in 2020. The failure of homebuilders to complete and deliver pre-sold housing units could unleash a death spiral for them. In recent years, 90% of housing units have been pre-sold, i.e., buyers made advance payments/prepayments, often taking out mortgages (Chart 7, top panel). Witnessing the inability of developers to deliver on presold units, a rising number of people may decide to wait to buy. The largest source of developers’ financing – advance payments for pre-sold housing units – might very well dry up. This source has accounted for 50% of real estate developers’ total financing in recent years (Chart 7, bottom panel). In brief, a vicious cycle is possible. The lack of financing for homebuilders bodes ill for construction activity (Chart 8). Chart 7China: Housing Presales And Pre-Payments Are Critical To Developers Chart 8Lack Of Homebuilder Financing = Shrinking Construction Activity Chart 9Chinese Property Developers Are Extremely Leveraged Besides, property developers are very leveraged with an assets-to-equity ratio close to nine (Chart 9). They have grown accustomed to borrowing heavily to accumulate real estate assets. They have been starting but not completing construction (Chart 10, top panel). We have been referring to this phenomenon as the biggest carry trade in the world. The bottom panel of Chart 10 shows two different measures of residential floor space inventories held by property developers. One measure subtracts completed floor space from started floor space, and another one deducts sold floor space from started floor space. On both measures, residential inventories are enormous. In theory, they could raise funds by selling their real estate assets. However, if they all try to sell simultaneously, there will not be enough buyers, and asset prices will plunge, which could lead to a full-blown debt deflation spiral. The last time the real estate market was similarly distressed in 2014-15, the central bank launched the Pledged Supplementary Lending (PSL) facility. This was effectively a QE program to monetize housing. This was the reason why housing recovered strongly in 2016-2017. There is currently no such program up for discussion. On the whole, odds are that the current property market breakdown is structural, not cyclical. Financial markets – the prices of stocks and USD bonds of property developers – convey a similar message and continue to plunge (Chart 11). Chart 10Excessive Property Inventories Chart 11No Green Light From Property Stocks And Corporate Bond Prices Chart 12There Has Been No Recovery In China Without A Revival in Real Estate Without an improvement in the housing market, a meaningful business cycle recovery is unlikely in China. Chart 12 illustrates that all recoveries in the Chinese broader economy since 2009 occurred alongside a revival in property sales. The importance of the property market goes beyond its size. Rising property prices lift household and business confidence, boosting aggregate spending and investment. The sluggish housing market and falling house prices will impair consumer and business confidence. This, along with uncertainty related to the dynamic zero-COVID policy, will dent consumer spending and private investments. Finally, the upcoming contraction in Chinese exports will dampen national income growth. Taken together, the multiplier effect of stimulus in the upcoming months will be lower than it has been in previous periods of stimulus. There are two areas that will see meaningful improvement in the coming months: infrastructure spending and autos. BCA’s China Investment Strategy service discussed the outlook for auto sales in a recent report. Chart 13Green Shoots In China's Infrastructure Investment On the infrastructure front, there has been mixed evidence of an improvement in activity. The top and middle panels of Chart 13 demonstrate that Komatsu machinery’s operational hours and the number of approved infrastructure projects might be bottoming. However, the installation of high-power electricity lines has fallen to a 15-year low (Chart 13, bottom panel).   As we elaborated in last month’s report, the new financing/stimulus for infrastructure development will not result in new investments. Rather, it will by and large offset the drop in local government (LG) revenues from land sales this year. In short, there is little new stimulus for infrastructure beyond what was approved in the budget plan earlier this year. Bottom Line: The recovery in China will be U- rather than V-shaped, with risks tilted to the downside. Investment Recommendations Our bias is that the rebound in global risk assets could last for a few more weeks. The basis is that investor positioning in risk assets was very light when this rebound began. Plus, falling oil prices could reinforce the idea among investors that US inflation is no longer a problem. Looking beyond the next several weeks, the outlook for global and EM risk assets is dismal. Markets will realize that the Fed cannot halt its tightening with core inflation well above 4-5%. Hawkish Fed policy and contracting global trade will boost the US dollar and weigh on cyclical assets. We continue to recommend an underweight allocation to EM in global equity and credit portfolios. Consistently, we are also reluctant to chase EM currencies higher. EM local bonds offer value, as we have argued over the past couple of months, but for now we prefer to focus on yield curve flattening trades. We continue betting on yield curve flattening/inversion in Mexico and Colombia and are long Brazilian 10-year domestic bonds while hedging the currency risk. In addition, we recommend investors continue receiving 10-year swap rates in China and Malaysia.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Strategic Themes (18 Months And Beyond) Equities Cyclical Recommendations (6-18 Months) Cyclical Recommendations (6-18 Months)

Listen to a short summary of this report.     Executive Summary The Euro And The Chinese Credit Impulse The US dollar has bounced off its 50-day moving average. In the recent past, that had led to a period of cyclical strength. The yen rally can be explained by the decline in Treasury yields and the fall in energy prices. Where next for the yen will depend on the time horizon. For investors trying to time the bottom, the euro is not yet a buy, but the common currency is incredibly cheap. Much depends on global/Chinese growth (Feature Chart). One of the key drivers of the dollar is volatility, and the correlation with the MOVE index. Less uncertainty will ease safe-haven demand. Stay short EUR/JPY and CHF/JPY. Remain long EUR/GBP. Maintain a limit sell on CHF/SEK at 10.76. RECOMMENDATIONS inception date RETURN Short EUR/JPY 2022-07-21 3.68 Bottom Line: We are tactically neutral the dollar but will be sellers on strength. Questions And Answers Chart 1Currencies And Yield Differentials It is rare that we receive clients in our Montreal office. This has obviously been doubly the case due to the pandemic and the general hassle of travel nowadays. But when we do, it is a delight. In this week’s report, we got asked a few difficult questions on a tea date. The most important was not surprisingly the dollar view, but also our highest conviction trades in FX markets. We enjoyed the conversation and the intellectual debate, so we thought we would share this with our clients. Hopefully, this answers some of the most pressing questions. We have sliced this into as brief and concise a conversation as we could. Question: It is hard not to notice the steep decline in the dollar over the last few weeks. Should we fade this decline or lean into it? That is a tough question, but our educated guess is to fade it for now. That said, longer-term asset allocators should really be looking at buying extremely cheap G10 currencies on any declines. The drivers of dollar downside have been clear. First, long-term interest rates in the US have fallen substantially. The US 10-year Treasury yield has fallen from 3.5% to 2.7%. In real terms, they have also declined. The 10-year TIPS yield has fallen from 0.85% to 0.23%. On a relative basis, the market is also pricing in that the Fed will cut interest rates next year much faster than other central banks. More simply put, 2-year real bond yields in the US are rolling over, relative to the euro area and Japan, the biggest components of the DXY index (Chart 1). Related Report  Foreign Exchange StrategyHow Deep A Recession Is The Dollar Pricing In? Specific to Japan and the euro area, there has also been another critical factor – the decline in energy import costs. Germany’s trade balance improved markedly in June (Chart 2). This has been the first genuine improvement in a year. There is also discussion to extend the life of existing nuclear power plants, which will help assuage energy import costs. In Japan, trade balance data comes out on Monday next week, so we will see what it reveals. But what has been clear is a political drive to restart nuclear power and wean the Japanese economy off its dependence on oil and gas (Chart 3). Japanese prime minister Fumio Kishida has been very vocal about this in recent speeches. Chart 2Euro Area And Japanese Trade Balances Are Improving Chart 3A Nuclear Renaissance In Japan? Turning to the more important part of your question, should we fade the decline or lean into it? We are of two minds on this to be honest, and here is why. The DXY has bounced off its 50-day moving average, which has been a sign in the past that the rally is not over (Chart 4). Our Geopolitical and Commodity & Energy colleagues are telling us not to trust the decline in oil prices. Our bond strategists think US yields are heading higher, with a whisper floor of 2.5%. Chart 4The DXY Has Support At The 50-Day Moving Average Given these crosscurrents, there are many better opportunities that exist in FX at the crosses, rather than playing the dollar outright. But of course, the dollar call is critical. We would be neutral over the next three-to-six months but be incremental sellers of the dollar on strength. Question: Okay, neutral dollar for now, but bearish long term. We tend to consider longer-term investments as well, and we are confused about the euro, but even more so about the yen. Would you buy the yen today? If so, why? Our starting point for many currencies is valuation. On this basis, the yen is incredibly cheap. So, if you have a five-to-ten-year horizon, you can unlock incredible value in Japan, simply on a buy-and-hold basis. Our in-house curated model shows that the yen is at a multi-general low in value terms (Chart 5). Currencies mean-revert. Consider this for a minute – we are not equity experts, but Toyota trades at a P/E of 10.75, while Tesla trades at a P/E of 109.15. And yes, Toyota has electric cars. Chart 5The Japense Yen Is Incredibly Cheap Chart 6The Yen Is A Favorite Short It is true that a winner-takes-all mantra can be attributed to Tesla’s valuation over Toyota, but our colleagues in the Global Investment Strategy are telling us this era is over. As such, at a 40% discount, the yen is a long-term buy in our books. Interestingly, nobody likes the yen, at least by our preferred measure – net speculative positions. It is one of the most shorted G10 currencies (Chart 6). A cheap currency that is the most shorted ranks quite well in our evaluation of bargains in currency markets. Given my discussion above about the dollar, we have played the yen at the crosses. We are short EUR/JPY and CHF/JPY. On the euro, Japanese car manufacturers are simply becoming more competitive than their eurozone or US counterparts. This is not only related to the car industry, but according to the OECD, EUR/JPY is expensive on a purchasing power parity basis (Chart 7). Meanwhile, a short EUR/JPY trade is a perfect hedge for a pro-cyclical portfolio. The DXY index has historically traded in perfect inverse correlation to the euro-yen exchange rate (Chart 8). This suggests the collapse in the yen, relative to the euro, is very much overdone. In a risk-off environment, EUR/JPY will sell off. Meanwhile, there are also fundamental reasons to suggest that the yen should trade higher vis-à-vis the euro. Chart 7Remain Short ##br##EUR/JPY Chart 8The DXY And EUR/JPY Usually Track Each Other Question: Okay, let’s switch to the euro. I know you are short EUR/JPY, which has been working out well in the last few days. But the euro touched parity and I get a sense that it has bottomed. You have often mentioned that the euro has priced in one of the deepest recessions in the eurozone. I am surprised you are not trumpeting this currency and a once-in-a-lifetime buying opportunity. We agree somewhat with your conclusion but not the premise. Let’s consider the narrative over the last few months in the media. The first was that eurozone inflation will never catch up to the US, because the economy was structurally weak. Well, it did, albeit due to an exogenous shock.  So, among a ranking of stagflationary candidates, the euro area is a top contender. If you believe in the idea that currencies are driven by real interest rates, rising inflation, and falling growth are an anathema for the exchange rate. When we typically have doubts about the euro area economy, and the outlook for its financial markets, we consult with our European Investment Strategy colleagues. We did just that and Mathieu Savary, who heads the service, mentioned two things: one – Chinese import volumes are imploding. For net creditor nations, this is a negative as their source of income is waning. The euro area falls into that category. The second thing to consider is that the dollar is a momentum currency. So is the euro. We mentioned earlier that the dollar bounced off its 50-day moving average, which explains euro weakness in recent trading days. In the end, Mathieu and the FX team did not really disagree, but I highlighted two charts to track. The euro tracks the Chinese credit impulse due to the importance of Chinese import demand for the euro area. It looks like our measure of that impulse has bottomed (Chart 9). If it has, you buy the euro on a long-term view. Relatedly, financial conditions are easing in China. As the Chinese bond market becomes more open and liberalized, bond yields become a financial conditions valve. That has been the case and has perfectly tracked the propensity for imports in the last few years (Chart 10). Chart 9The Euro And The Chinese Credit Impulse Chart 10Financial Conditions Are Easing In China In short, we will buy the euro if it touches parity, and even more so below parity with a 5–10-year view, but we think EUR/USD could touch 0.95 in the near term. I guess what we are saying is that a 5%-7% move is big in FX markets, but a 26% move (the undervaluation of the euro) is a whale. We do not see the catalyst for a whale in our current compass. Question: We have talked about the yen and the euro. I do not want to get into the pound, Australian dollar, and other currencies as you have told me your team has upcoming reports on those. But the Chinese yuan is very important in my investment portfolio. Any ideas on its next move? USD/CNY topped out near 6.8 in May. Since then, it has been in a trading range despite the DXY breaking to multi-decade highs (Chart 11). When a pattern like this emerges, it is always useful to revisit fundamentals. Those fundamentals are real interest rate differentials. We care about the yuan because China is a big trading partner of the US. As such, it is also a huge weight in the broad trade-weighted dollar index. China has huge problems, especially related to the property market, which need to be resolved. Bond yields have also collapsed. But the real interest rate in China is very attractive (Chart 12). It is also important to consider that if the dollar is the global safe haven, that means that the yuan could be becoming the haven in Asia. So, yuan downside is not a big risk for our long-term dollar bearish call. That said, we will be short CNY versus the yen, but not the dollar. Chart 11The RMB Has Been Relatively Resilient Chart 12The RMB Has Undershot Real Rate Differentials Question: I think I could sit with you all morning to discuss other aspects of FX,  but I respect you have a tight stop due to the BLU meeting. Any concluding thoughts? I have one. Very often, we debate with our colleagues about capital flows. The dollar rises (in general), as capital inflows accelerate into the US and vice versa. It is often said that getting the dollar call right gets everything else right. So, if you can predict the path of the dollar, the performance of, say, US versus non-US equities becomes easy. Chart 13The Dollar And Earnings Revisions We agree that the dollar is a real-time indicator of relative fundamentals. But here is one important observation: relative earnings revisions are deteriorating in the US vis-à-vis other countries (Chart 13). That has historically had an impact on exchange rates, as it affects equity capital flows. If the Federal Reserve also cut rates next year as the market is predicting, that will also be a negative for bond inflows. We think the global economy will avoid a deep recession, and that will allow growth to pick up outside the US. When the euro area and China bottom, then the dollar will truly peak, as capital flows to these economies will accelerate. So we are watching relative earnings and bond yield differentials closely.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Trades & Forecasts Strategic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Forecast Summary

Counterpoint’s August schedule: Next week, I am travelling to see clients in Australia, New Zealand, and Singapore, so we will send you a report on China’s 20th National Party Congress written by our Chief Geopolitical Strategist, Matt Gertken. Given that the outlook for the $100 trillion Chinese real estate market is crucial for the global economy and markets, Matt’s insights will be very interesting. Then on August 18, I will host the monthly Counterpoint webcast, which I hope you can join. We will then take a week’s summer holiday and return with a report on September 1. Executive Summary In the topsy-turvy recession of 2022, real wages have collapsed. This means profits have stayed resilient and firms have not laid off workers. Making this recession a ‘cost of living crisis’ rather than a ‘jobs crisis’. If inflation comes down slowly, then the ‘cost of living crisis’ will persist. But if inflation comes down quickly while wage inflation remains sticky, firms will lay off workers to protect their profits, turning the ‘cost of living crisis’ into a ‘jobs crisis’. Either way, this will keep a choke on consumer spending, and particularly the spending on goods, which is likely to remain in recession. Meanwhile, until mortgage rates move meaningfully lower, housing investment will also remain in recession.  The double choke on growth means that the bear market in the 30-year T-bond is likely over. This suggests that the bear market in stock market valuations is also over, but that ‘cyclical value’ is now vulnerable to profit downgrades. Hence, equity investors should stick with ‘defensive growth’, specifically healthcare and biotech. Fractal trading watchlist: GBP/USD and Hungarian versus Polish bonds. In The 2008 Recession, Real Wage Rates ##br##Went Up So Employment Went Down… …But In The 2022 Recession, Real Wage Rates##br##Went Down So Employment Went Up! Bottom Line: The bear market in the 30-year T-bond and stock market valuations is likely over, but equity investors should stick with ‘defensive growth’, specifically healthcare and biotech. Feature The US economy has just contracted for two consecutive quarters, meeting the rule-of-thumb definition of a recession. Other major economies are likely to follow. Yet many economists and strategists are in denial. This cannot be a ‘proper’ recession, they say, because the economy remains at full employment. But the recession-deniers are wrong. It is a recession, albeit it is a ‘topsy-turvy’ recession in which employment remains high (so far) because real wage rates have collapsed, circumventing the need for lay-offs. This contrasts with a typical recession when real wage rates remain high, forcing the need for lay-offs.1 The Topsy-Turvy Recession Of 2022 When do firms lay off workers? The answer is, when they need to protect their profits. Profits are nothing more than revenues minus costs, and in a typical recession revenues slow much faster than the firms’ biggest cost, the wage bill. In this event, the only way that firms can protect their profits is to lay off workers. Chart I-1 confirms that every time that nominal sales have shrunk relative to wage rates, the unemployment rate has gone up. Without exception. Chart I-1Unemployment Goes Up Whenever Firms' Wage Rates Rise Faster Than Their Revenues... But what happens during a recession in which nominal sales do not shrink relative to wage rates? In this event, profits stay resilient, so firms do not need to lay off workers. Welcome to the topsy-turvy recession of 2022! In the topsy-turvy recession of 2022, there has been much greater inflation in consumer prices and nominal sales than in nominal wage rates (Chart I-2). The result is that real wage rates have collapsed, profits have stayed resilient, and firms have not needed to lay off workers… so far. Chart I-2...But In The 2022 Recession, Wage Rates Have Risen Slower Than Revenues, So Unemployment Hasn't Gone Up In a typical recession, the pain falls on the minority of workers who lose their jobs, as well as on profits. Paradoxically, for the majority that keep their jobs, real wages go up. This is because sticky wage inflation tends to hold up more than collapsing price inflation. For example, in the 2008 recession, the real wage rate surged by 4 percent (Chart I-3), and in the 2020 recession it rose by 2 percent. Chart I-3In The 2008 Recession, Real Wage Rates Went Up So Employment Went Down... Yet in the 2022 recession, the real wage rate has shrunk by 4 percent, meaning that the pain of the recession has fallen on all of us (Chart I-4). In one sense therefore, this recession is ‘fairer’ because ‘we’re all in it together’. This is confirmed by the current malaise being characterised not as a ‘jobs crisis’, but as a ‘cost of living crisis’. In another sense though, the recession is unfair because the pain has not been shared by corporate profits, which have remained resilient… so far. Chart I-4...But In The 2022 Recession, Real Wage Rates Went Down So Employment Went Up! The crucial question is, what happens next? Using the US as our template, wage rates are growing at 5-6 percent, and this growth rate is typically stickier than sales growth. Assuming inflation drifts lower, nominal sales growth will also drift lower from its current 7 percent clip, meaning that it could soon dip below sticky wage growth. Once the growth in firms’ revenues has dipped below that in nominal wage rates, profits will finally keel over. To repeat, profits are nothing more than revenues minus costs, where the biggest cost is the wage bill (Chart I-5).2 Chart I-5Profits Are Nothing More Than Revenues Minus Costs At this point, the downturn will become more conventional. To protect profits, firms will be forced to lay off workers who will bear the pain of the downturn alongside falling profits. Meanwhile, with inflation easing, real wage growth for the majority that keep their jobs will turn positive. But to repeat, this is the typical pattern in a recession. Accelerating real wage rates are entirely consistent with a contracting economy as we witnessed in both 2008 and 2020.  As Two Huge Imbalances Correct, Demand Will Be Pegged Back All of this assumes that real demand will remain under pressure, so the question is what is pegging back real demand? The answer is: corrections in two huge imbalances in the global economy. A breakdown of the -1.3 percent contraction in the US economy reveals these two corrections:3   Spending on goods, which contributed -1.2 percent Housing investment, which contributed -0.7 percent. These corrections are not over. As we presciently explained back in February in A Massive Economic Imbalance, Staring Us In The Face: “The pandemic overspend on goods constitutes one of the greatest imbalances in economic history. An overspend on goods is corrected by a subsequent underspend; but an underspend on services is not corrected by a subsequent overspend. The pandemic overspend on goods constitutes one of the greatest imbalances in economic history. This unfortunate asymmetry means that the recent overspend on goods at the expense of services makes the economy vulnerable to a recession. And the risk is exacerbated by central banks’ intentions to hike rates in response to inflation” (Chart I-6). Chart I-6The Pandemic Overspend On Goods Constitutes One Of The Greatest Imbalances In Economic History Then, in The Global Housing Boom Is Over, As Buying Becomes More Expensive Than Renting, we identified a second major imbalance that is starting to correct. Specifically, the global housing boom of the past decade, which has doubled the worth of global real estate to $370 trillion, was predicated on ultra-low mortgage rates that made buying a home more attractive than renting. But in many parts of the world now, buying a home has become more expensive than renting (Chart I-7). Disappearing US and European homebuyers combined with a flood of home-sellers will weigh on home prices and housing investment – at least until policymakers are forced to bring down mortgage rates (Chart I-8 and Chart I-9). Chart I-7Buying A Home Has Become More Expensive Than Renting! Chart I-8Homebuyers Have Disappeared... Chart I-9...While Home-Sellers Are Flooding The Market Meanwhile, as Chinese policymakers try and gently let the air out of the $100 trillion Chinese real estate market, a collapse in Chinese property development and construction activity will have negative long-term implications for commodities, emerging Asia, and developing countries that produce raw materials. More Investment Conclusions In addition to the long-term investment conclusions just described, we can draw some shorter-term conclusions: If inflation comes down slowly, then the current ‘cost of living crisis’, which is pummelling everyone’s real incomes, will persist. But if inflation comes down quickly while wage inflation remains sticky, firms will be forced to lay off workers to protect their profits, turning the ‘cost of living crisis’ into a ‘jobs crisis’. Either way, this will keep a choke on consumer spending, and particularly the spending on goods, which is likely to remain in recession. Meanwhile, until mortgage rates move meaningfully lower, housing investment will also remain in recession.  Equityinvestors should stick with ‘defensive growth’, specifically healthcare and biotech. This double choke on growth is likely to keep a lid on ultra-long bond yields, even if central banks need to hike short-term rates more than expected to slay inflation. Our proprietary fractal analysis confirms that the sell-off in the 30-year T-bond is likely over (Chart I-10). Chart I-10The Bear Market In The 30-Year T-Bond Is Likely Over For the stock market, this suggests that the valuation bear market is now over, but that ‘cyclical value’ sectors are now vulnerable to profit downgrades. Hence, equity investors should stick with ‘defensive growth’, specifically healthcare and biotech. Fractal Trading Watchlist This week we noticed that the sudden 20 percent collapse of Hungarian versus Polish 10-year bonds, has reached the point of short-term fractal fragility that suggests an imminent rebound. Hence, we are adding this to our watchlist. Go long GBP/USD. But our trade is GBP/USD. UK political risk is diminishing, the BoE is likely to be as, or more, hawkish than the Fed, and the 260-day fractal structure of GBP/USD is at the point of fragility that has signalled major turning points in 2014, 15, 16, 18 and 21 (Chart I-11). Accordingly the recommendation is long GBP/USD, setting the profit target and symmetrical stop-loss at 5 percent.   Chart I-11Go Long GBP/USD Expect Hungarian Bonds To Rebound Chart 1CNY/USD At A Potential Turning Point   Chart 2Expect Hungarian Bonds To Rebound Chart 3Copper's Selloff Has Hit Short-Term Resistance Chart 4US REITS Are Oversold Versus Utilities Chart 5CAD/SEK Is Reversing Chart 6Financials Versus Industrials Has Reversed Chart 7The Outperformance Of Resources Versus Biotech Has Ended Chart 8The Outperformance Of Resources Versus Healthcare Has Ended Chart 9FTSE100 Outperformance Vs. Euro Stoxx 50 Is Vulnerable To Reversal Chart 10Netherlands' Underperformance Vs. Switzerland Has Ended Chart 11The Sell-Off In The 30-Year T-Bond At Fractal Fragility Chart 12The Sell-Off In The NASDAQ Is Approaching Fractal Fragility Chart 13Food And Beverage Outperformance Is Exhausted Chart 14German Telecom Outperformance Has Started To Reverse Chart 15Japanese Telecom Outperformance Vulnerable To Reversal Chart 16ETH Is Approaching A Possible Capitulation Chart 17The Strong Trend In The 18-Month-Out US Interest Rate Future Has Ended Chart 18The Strong Downtrend In The 3 Year T-Bond Has Ended Chart 19A Potential Switching Point From Tobacco Into Cannabis Chart 20Biotech Is A Major Buy Chart 21Norway's Outperformance Has Ended Chart 22Cotton Versus Platinum Has Reversed Chart 23Switzerland's Outperformance Vs. Germany Is Exhausted Chart 24USD/EUR Is Vulnerable To Reversal Chart 25The Outperformance Of MSCI Hong Kong Versus China Has Ended Chart 26A Potential New Entry Point Into Petcare Chart 27US Utilities Outperformance Vulnerable To Reversal Chart 28The Outperformance Of Oil Versus Banks Is Exhausted   Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Footnotes 1 The best measure of wage rates is the employment cost index (ECI) because it includes all forms of compensation including benefits and bonuses. 2  In fact, stock market profits are even more cyclical because, as well as wages, there are other sticky deductions from revenues such as interest and taxes. 3 All expressed as annualised rates. Fractal Trading System Fractal Trades 6-12 Month Recommendations Structural Recommendations Closed Fractal Trades Indicators To Watch - Bond Yields Chart II-1Indicators To Watch - Bond Yields - Euro Area Chart II-2Indicators To Watch - Bond Yields - Europe Ex Euro Area Chart II-3Indicators To Watch - Bond Yields - Asia Chart II-4Indicators To Watch - Bond Yields - Other Developed   Indicators To Watch - Interest Rate Expectations Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations