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Highlights Trade #1: Go Short The December 2018 Fed Funds Futures Contract. The trade has gained 64 bps since we initiated it. We are lifting the stop to 60 bps and targeting a profit of 75 bps. Trade #2: Go Long Global Industrial Stocks Versus Utilities. The trade is up 13.1%. We are targeting a profit of 15%, and are tightening the stop further to 12%. Trade #3: Go Short 20-Year JGBs Relative To Their 5-Year Counterparts. The trade is up 0.7%. We see this as a multi-year trade with significant upside potential. The unwinding of heavy short positions could cause the yen to strengthen temporarily. The euro is vulnerable to negative growth surprises. A retracement of some of its recent gains is likely. Feature Looking Back, Thinking Forward I had the pleasure of speaking at BCA's Annual Investment Conference held in New York on September 27th of last year where I offered three "tantalizing" trade ideas. Chart 1 reviews their performance. They were the following: Trade #1: Go Short The December 2018 Fed Funds Futures Contract We argued last summer that U.S. growth was likely to accelerate, taking rate expectations higher. That has indeed happened. Aggregate hours worked rose by 2.5% in Q4 over the previous quarter. Assuming that productivity increased by 1.5% in Q4 - equal to the pace recorded in Q3 - real GDP probably increased by nearly 4%. A variety of leading indicators point to continued above-trend growth in the months ahead (Chart 2). Chart 1Three Tantalizing Trades: ##br##An Update Chart 2Leading Indicators Pointing ##br##To Above-Trend U.S. Growth We think the Fed will raise rates four times this year, one more hike than projected by the dots and roughly 35 bps more in tightening than implied by current market expectations. The median Fed dot calls for an unemployment rate of 3.9% by end-2018, only marginally lower than today's rate of 4.1%. We have been saying for a while that above-trend growth will take the unemployment rate down to a 49-year low of 3.5% by the end of this year. If the unemployment rate falls this much, the Fed will probably turn more hawkish. Stronger inflation numbers should also give the Fed confidence to keep raising rates once per quarter. Core inflation surprised on the upside in December. We expect this trend to continue in the coming months, as the ISM manufacturing index, the New York Fed's Inflation Gauge, and our own proprietary pipeline inflation index are already foreshadowing (Chart 3). Chart 3U.S. Inflation ##br##Should Accelerate Chart 4A Pick-Up In Wage Growth ##br##Would Put Upward Pressure On Service Inflation As we noted two weeks ago,1 service sector inflation should get a lift from faster wage growth this year (Chart 4). Goods inflation should also rise on the back of higher oil prices and the lagged effects of a weaker dollar (Chart 5). In addition, health care inflation is likely to pick up from its current depressed level, especially if the Congressional Budget Office is correct that insurance premiums will rise due to the elimination of the individual mandate (Chart 6). Housing inflation will moderate, but this is unlikely to stymie the Fed's tightening plans since excessively low interest rates could lead to even more overbuilding in the increasingly vulnerable commercial real estate sector. Chart 5Higher Oil Prices And A Weaker Dollar ##br##Are A Tailwind For Inflation Chart 6Health Care Inflation ##br##Should Move Higher Granted, four rate hikes equal four opportunities to defer raising rates. It is easy to imagine scenarios where the Fed stands pat, but hard to conjure scenarios where the Fed has to raise rates five times or more this year. Thus, the risk to our four-hike view is to the downside. As such, we will be looking to take profits of 75 bps on the trade, and are putting in a stop of 60 bps. Trade #2: Go Long Global Industrial Stocks Versus Utilities Capital spending tends to accelerate in the late innings of business-cycle expansions. We are in such a phase now, as evidenced by capital goods orders, capex intention surveys, and our global capex model (Chart 7). Increased capital spending will benefit industrial companies. Conversely, rising bond yields will hurt rate-sensitive utilities. Valuations in the industrial sector have gotten stretched, but are not at extreme levels (Chart 8). Based on enterprise value-to-EBITDA, industrials are still only slightly more expensive than utilities compared to their post-1990 average. Chart 7Capex Is Shifting Into ##br##Higher Gear Chart 8Industrial Stocks: Valuations Are Stretched, ##br## But Not Yet Extreme While we do think global growth will slow this year from the heady pace of 2017, it should remain firmly above-trend. A bigger-than-expected slowdown - especially if it is concentrated in China - would undoubtedly hurt industrials. A stronger dollar could also be a headwind. Thus, we are keeping this trade on a short leash, with a target of 15% and a stop of 12%. Trade #3: Go Short 20-Year JGBs Relative To Their 5-Year Counterparts The Japanese economy is on fire. Growth almost reached 2% in 2017 and leading indicators suggest a solid start to 2018 (Chart 9). The unemployment rate has fallen to 2.7%, a full point below 2007 levels. The ratio of job openings-to-applicants has surpassed its bubble peak. The Tankan Employment Conditions Index is pointing to an exceptionally tight labor market. Wages excluding overtime pay are rising at the fastest pace in twenty years (Chart 10). Chart 9Japanese Growth Momentum Is Positive Chart 10Signs Of A Tight Labor Market Inflation is low but is starting to edge up. The most recent release surprised on the upside. Inflation expectations moved higher on the news, benefiting our long Japanese 10-year CPI swap trade recommendation (Chart 11). A simple scatterplot between the unemployment rate and core inflation suggests the Phillips curve remains intact in Japan -- amazingly, it even looks like Japan (Chart 12)! Chart 11Inflation Expectations Have Edged Higher Chart 12The Phillips Curve In Japan Looks Like Japan Still, with core inflation excluding food and energy running at only 0.3%, there is a long way to go before inflation reaches the BoJ's target -- and even longer if the BoJ honours its promise to generate a meaningful overshoot to compensate for the below-target inflation of prior years. This suggests the BoJ will not meaningfully water down its Yield Curve Control regime anytime soon. As such, five-year yields are likely to stay put while yields with maturities in excess of ten years should move higher. Our "tantalizing trade" being short 20-year JGBs versus their 5-year counterparts still has a long way to run. Too Risky To Short The Yen The exceptionally strong correlation between USD/JPY and U.S. Treasury yields has broken down this year (Chart 13). Had the relationship held, the yen would have actually weakened against the dollar. Still, we are reluctant to get too bearish on the yen (Chart 14). The yen real effective exchange rate is close to multi-decade lows. Positioning on the currency is heavily short. The current account surplus has mushroomed from close to zero in 2014 to 4% of GDP at present. And even if the BoJ keeps the Yield Curve Control regime in place, investors may still anticipate its demise, leading to a temporary bout of yen strength. Chart 13Strong Correlation Is Broken Chart 14Too Risky To Short The Yen What's Propping Up The Euro? The euro has been on a tear since last week, egged on by the ECB minutes, which hinted at a faster pace of monetary normalization. Growing confidence that Angela Merkel will be able to form a grand coalition also helped the common currency, along with hopes that the new government will loosen the fiscal purse strings. The euro is often thought of as the "anti-dollar." And sure enough, the euro's strength has been reflected in a broad-based decline in the dollar index in recent days. BCA's Global Investment Strategy service went long the dollar on October 31, 2014. We "doubled up" on this call in the fall of 2016, controversially arguing that "Trump will win and the dollar will rally." Obviously, in retrospect, I should have rung the register and declared victory on our long dollar view when I had the chance. EUR/USD fell to 1.04 on December 2016, within striking distance of our parity target. Bullish dollar sentiment had reached unsustainably lofty levels. That was the time to sell the greenback. But hubris got the best of me. While our other currency trade recommendations have delivered net gains of 11% since the start of 2017, the long DXY trade has stuck out like a sore thumb. Hindsight is 20/20. The key question is what to do today. EUR/USD is still trading below the level it was at when we went long the DXY. Relative to the IMF's Purchasing Power Parity exchange rate of 1.32, the euro is 7% undervalued. That said, PPP exchange rates may not be a reliable benchmark in this case. Given current market expectations, EUR/USD would need to strengthen to 1.41 over the next ten years just to cover the carry cost of being short the dollar. Even assuming lower inflation in the euro area, that would still leave the euro trading above its long-term fair value. It is possible, of course, that rate differentials will narrow further, but the scope for this is more limited than it might appear. The market currently expects policy rates ten years out to be 95 basis points higher in the U.S., down from a spread of nearly 180 basis points in late December (Chart 15). Given that euro area inflation expectations are 40-to-50 bps lower than in the U.S., this implies a real spread of about 50 bps - broadly in line with our estimate of the real neutral rate gap between the two regions. Ultimately, the fate of the euro in 2018 will rest on the same question that drove the currency in 2017: Will euro area growth surprise on the upside, prompting investors to price in a faster pace of monetary normalization? The bar for success is certainly higher at present. Chart 16 shows that euro area consensus growth estimates have risen significantly since the start of last year. The expected lift-off date for policy rates has also shifted in by more than a year to mid-2019. Considering that Jens Weidmann stated earlier this week that he thinks current market pricing is broadly consistent with when the ECB expects to hike rates, there is little scope for the lift-off date to move forward. Chart 15Little Scope For Rate Differentials ##br## To Narrow Further Chart 16Euro Area Growth Estimates Have Been Revised Up ##br##Since The Start Of 2017 Meanwhile, financial conditions have tightened significantly in the euro area relative to the U.S., the euro area credit impulse has turned negative, and the U.S. economic surprise index has jumped above that of the euro area (Chart 17). Euro area inflation has also dipped. Especially worrying is that core inflation in Italy has fallen back to a near record-low of 0.4% (Chart 18). How is Italy supposed to navigate its way out of its debt trap if nominal growth stays this weak? On top of all that, long speculative euro positions have soared to record-high levels (Chart 19). Given the choice of betting whether EUR/USD will first hit 1.30 or 1.15, we would go with the latter. If our bet turns out to be correct, we will use that opportunity to shift to neutral on the dollar. Chart 17The Euro Is Vulnerable ##br##To Negative Growth Surprises Chart 18Euro Area Core Inflation ##br##Has Dipped Chart 19Euro Positioning: From Deeply Short ##br##To Record Long Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com 1 Please see Global Investment Strategy Weekly Report, "Four Key Questions On The 2018 Global Growth Outlook," dated January 5, 2018. Strategy & Market Trends Tactical Trades Strategic Recommendations Closed Trades
Highlights The euro is in a cyclical bull market. It is supported by attractive valuations, improving balance of payments dynamics, declining political risk, potential shifts in reserves preferences, and a re-rating of the European terminal rate. This positive cyclical backdrop hides a more treacherous short-term outlook. EUR/USD is vulnerable because ECB members are increasingly worried, the European periphery is displaying early strains, European inflation will slow versus the U.S., global industrial activity may experience a mini down cycle, and sentiment measures are massively stretched. Short EUR/JPY for now, and use any move in EUR/USD to 1.15 or lower to buy this pair. Feature The euro has undergone a major paradigm shift over the course of the past 16 months. In December 2016, the euro was trading near parity, and expectations were uniform that it would fall well below that threshold. The narrative was simple: Europe was turning Japanese, with inflation forever moribund; also, Europe was succumbing to the siren call of nationalism and populism, which meant the euro was bound to break up within the next five years. Meanwhile, the U.S. was on the rebound. Core consumer price inflation was above 2.2%, and U.S. President Donald Trump was set to massively stimulate the American economy, giving a free hand for the Federal Reserve to hike to its heart's content. Today, the picture could not be more different. Investors expect the European Central Bank's first hike to materialize in the summer of 2019, European growth is stellar, and European inflation is not low enough to warrant emergency-level policy rates. As a result, not only is EUR/USD trading above 1.20, but consensus forecasts increasingly see the euro trading into the 1.25 to 1.30 zone by year end. Is EUR/USD at 1.22 a buying or a selling opportunity? Short-term risks are currently elevated for the euro, but a move toward 1.15 would represent a buying opportunity, as the cyclical bear market in the euro is over. The Long-Term Bull Case A crucial long-term positive factor for the euro is that it is cheap. EUR/USD currently trades at a 10% discount to its purchasing-power-parity equilibrium, even after a nearly 17% rally since its December 2016 low. Encapsulating this concept, the real effective exchange rate for the euro remains well below equilibrium (Chart I-1). Additionally, our fundamental long-term fair value model pegs the euro as being almost 1-sigma undervalued. The euro area's balance of payment is also very favorable. It is well known among the investment community that the euro area sports a surplus of 3.5% of GDP, but significant changes are also materializing in the capital account. Portfolios outflows out of the euro area have begun to decrease, as equity inflows are rising and bond outflows are becoming smaller. Moreover, the euro area basic balance is moving into positive territory, which historically has been a precursor to sustainable euro rallies (Chart I-2). The supply of euro for international markets is therefore decreasing. Additionally, the euro area's net international investment position (NIIP), which was as low as -17% of GDP in 2014, will likely move into positive territory toward the end of the year. The NIIP has historically been a strong driver of long-term exchange rate moves.1 Chart I-1The Euro Is Still Cheap Chart I-2The European Balance Of Payments Has Improved Politics too have been moving in the right direction. Euro skepticism is not taking hold in the euro area: Last year's French election was a vivid demonstration that "more Europe" is not electoral poison. Even the Italian elections this coming March may not land much of a blow to the European project: The Five Star Movement is rapidly softening its anti-euro rhetoric, and support for centrist parties is strengthening (Chart I-3). Moreover, a German move toward a grand coalition means Angela Merkel's CDU is very likely to be governing along with a pro-euro SPD, whose campaign theme was "MEGA": Make Europe Great Again. Already, Germany is lending a listening ear to some of Macron's integrationist proposals, and fiscal stimulus could well be in the pipeline. Long-term reserves diversification is also in the euro's favor. A headline last week suggested that China would unload some of its vast holdings of Treasurys. This leak was soon condemned as "Fake News" by China's State Administration of Foreign Exchange. However, while the news clearly lacked substance, the reality remains that despite the euro area and the U.S. being similarly sized economies, the euro only represents 20% of allocated global reserves, compared to 65% for the greenback. The greater depth and liquidity of U.S. bond markets contributes to this discrepancy, but the ECB's bond buying, by creating a scarcity of euro denominated securities, has exacerbated the disparity. This latter handicap for the euro will end sometime next fall, and if Europe's integrates further, European bond markets will increasingly become alternatives to U.S. ones. A rebalancing of reserves would principally help the euro by hurting the U.S. dollar: It will become more tenuous for the U.S. to achieve a positive international income balance while sporting a NIIP of -40% of GDP if official international demand for dollars falls (Chart I-4). Chart I-3Italian Centrists Are Gaining Ground Chart I-4The USD Needs Its Reserve Status Finally, the terminal rates differential between the U.S. and the euro area remains well above its long-term average of 110 basis points. Thus, there is scope for a normalization of European terminal rates relative to the U.S. on a long-term basis (Chart I-5). However, an average is only a number. What forces could cause the terminal rate spread between the euro area and the U.S. to normalize over the coming years? European policy is currently very loose when compared to the U.S., which will enable the ECB to play catchup over the coming years. To make this judgment, we look at broad money supply in excess of money demand. Because money demand is an unobserved variable, we have to estimate it. Economic theory argues it should be a positive function of economic activity, wealth and uncertainty. Therefore, to get a sense of what money demand may be, we regress the real broad money aggregates of various countries on uncertainty indices and real wealth.2 The difference between real broad money supply numbers and these estimates represent excess money supply. If a country's excess money is being generated today, it ends up stimulating future economic activity and inflation. This increase in expected nominal growth should contribute to lifting expected interest rates at the long end of the yield curve - i.e. expected terminal rates. As Chart I-6 shows, the stock of excess money supply in the U.S. has stopped growing since 2015. However, it is currently exploding in the euro area as European commercial banks are regaining their health and lending again. The money supply dynamics in Europe signal that the easy policy of the ECB is finally bearing fruit. And as the bottom panel of Chart I-6 illustrates, when European excess money supply increases relative to the U.S., as is currently the case, EUR/USD experiences cyclical rallies.3 This counterinituitive result exists because previous ECB easing is bearing fruits, European asset returns are rising, and economic activity is increasing. As a result, the European terminal rate now has more scope to rise vis-à-vis the U.S. The steepening of the German yield curve relative to the Treasury curve only confirms this message (Chart I-7). Chart I-5The U.S. Terminal Rate Has Room To Fall##br## Against That Of Europe Chart I-6European Excess##br## Money Is Surging Chart I-7Listen To Yield ##br##Curves The five forces described above imply that the euro's move from 1.03 to 1.21 was the first salvo in what is likely to be a long cyclical bull market that could end up driving the euro above 1.40 over many years. However, these factors provide little insight regarding the euro's path over the next three to six months. Bottom Line: The euro is likely to have embarked on a cyclical bull market at the beginning of 2017. Five factors support this judgment: The euro is cheap, the European balance-of-payment backdrop is favorable, political winds in the euro area remain favorable to further European integration, global foreign exchange reserves are very underweight the euro, and the spread between U.S. and euro area expected terminal rates remains well above its long-term average, and has scope to narrow. Murkier Short-Term Outlook While the long-term outlook is very favorable for the euro, the shorter-term outlook is much more clouded. First, the chorus of complaints against the euro's strength is growing among European central bankers. In recent days, not only have Vitor Constâncio and Francois Villeroy voiced concerns over the euro's recent strength, but so has Ewald Nowotny, the rather hawkish Austrian central banker. Additionally, Bundesbank President Jens Weidmann stated that the market should not anticipate a rate hike before the summer of 2019, suggesting he would not want to see a more aggressive rate pricing than what is currently at play (Chart I-8). Second, the less competitive and more fragile European periphery is already showing early signs that the sharp appreciation in the euro is causing some pain. Peripheral equities have begun to underperform the stocks of core euro area nations, and are also sharply underperforming U.S. equities. This phenomenon tends to be associated with a weakening euro. Moreover, peripheral inflation excluding food and energy has already weakened to 1.3% from a high of 2% in February last year, the consequence of a tightening in financial conditions (Chart I-9). Chart I-8ECB Doesn't Want This To Change Chart I-9Peripheral Core Inflation In Free Fall Third, the economic environment points to underperformance of aggregate European inflation relative to the U.S. A fall in the gap between euro area and U.S. inflation tends to be associated with short-term gyrations in EUR/USD (Chart I-10). This is because a fall in relative inflation against the euro area causes investors to temporarily tweak the perceived path of future policy differentials. Over the course of 2018, U.S. inflation is set to increase. A simple model based on U.S. capacity utilization and the velocity of money shows that U.S. core CPI could hit 2.1% (Chart I-11). While this model has done a good job picking the turning points in U.S. core inflation, it has consistently overestimated inflation since 2013. Correcting for this bias, the model still forecasts a significant pick-up in inflation to 1.8% (Chart I-11, bottom panel). Chart I-10Higher European Inflation Equals Higher Euro Chart I-11A U.S. Inflation Pick Up Is Coming The same cannot be said for euro area inflation. Not only is the European periphery already feeling the pain caused by the euro's strength, but also we have entered the window of time where the previous tightening in euro area financial conditions vis-à-vis the U.S. puts a brake on euro area relative inflation.4 Moreover, the diffusion index of the components of the euro area core CPI index has been below 50% for four months in a row now. Historically, this has been associated with a fall in core CPI. Fourth, over the past year or so, EUR/USD has traded in line with risk assets. The euro area has benefited from EM growth improvement, which has lifted all corners of the global economy levered to the global industrial cycle. As a result, as investors become increasingly bullish on industrial metals, EM assets or momentum plays, so they have of the euro.5 However, clouds are slowly forming over the global economy, at the very least pointing to a mini-cycle downturn. For one, Chinese producer prices have rolled over, and Chinese import growth has significantly underperformed expectations in recent months, slowing to a 5% pace from a 20% pace as recently as September 2017. Essentially, industrial activity has slowed in response to a tightening in Chinese monetary conditions. This slowdown is already beginning to impact various corners of the globe: Korean and Taiwanese export growth continues to decelerate; BCA's Global LEIs Diffusion Index is well below the 50% mark, which normally precedes slowdowns in the global LEI itself; Our boom/bust and global growth indicators have slowed further - two precursors to global industrial production decelerations. Our global economic and financial A/D line, which tallies 100 pro-cyclical variables, has also rolled over sharply, another early warning sign for the global economy (Chart I-12). Finally, as we highlighted in December, EM/JPY carry trades, a canary for the global economy, have lost momentum - a signal that has normally preceded a slowdown in global industrial activity.6 All these signals only confirm the "Yellow Flags" we highlighted last October.7 In an environment where complacency is rampant and assets levered to growth are priced for perfection, this is worrisome. The euro's recent elevated correlation to such risk assets, along with the fact that the gap between European and U.S. core inflation is itself led by Chinese PPI, suggests that the euro is tactically vulnerable. Fifth, from a technical perspective speculators have never been this long the euro, which represents a significant danger as the euro is trading at a sharp premium to its short-term interest rate driver (Chart I-13). Moreover, risk-reversals for EUR/USD point to heightened susceptibility of a selloff if the bad omen on global growth and European inflation come to fruition (Chart I-14). Chart I-12Rising Risks For Global Growth Chart I-13The Euro Is Vulnerable Chart I-14Risk Reversals Point To Euro Downside This short-term picture suggests that the probability of a move in EUR/USD toward 1.15 is growing over the course of the next three to six months. Bottom Line: While the cyclical picture for the euro is bright, the short-term snapshot is much more dangerous. Not only are an increasing number of ECB officials weighing in on the impact of the euro's recent rally, but the European periphery is showing growing signs that the euro rally has indeed taken a bite. Additionally, European inflation is set to underperform U.S. inflation, and the global economic cycle could enter a short burst of disappointment. Finally, investors are not positioned for such developments, increasing the likelihood of a downward move in the euro. What To Do? Caught between a cyclically propitious backdrop and a tactically dangerous environment, EUR/USD presents a riddle for FX investors right now. The odds of a euro correction over the next three to six months are substantially greater than 50%. But as we highlighted last week, instead of taking a direct bet on EUR/USD, we recommend investors short EUR/JPY. Shorting EUR/JPY is an even cleaner way to take advantage of the cloudy weather building over the global economy.8 Moreover, in recent years, EUR/JPY has fallen when the 52-week rate-of-change of momentum trades began to weaken (Chart I-15). This highly mean-reverting indicator is currently in the 96th percentile of its distribution for the past 25 years, suggesting an imminent rollover. Additionally, EUR/JPY tends to perform well when the LIBOR-OIS spread widens. Today, the three-month FRA-OIS spread has been widening, even as the end-of-year dollar funding shortage has passed (Chart I-16). These kinds of dynamics point to a potential drying out in global liquidity, a phenomenon which historically hurts risk assets, especially when they are as frothy as they are now. This should once again hurt EUR/JPY. Chart I-15EUR/JPY And Momentum Stocks Chart I-16Funding Stresses Point To A Fall In EUR/JPY Thus, shorting EUR/JPY is our highest conviction trade for the next six months or so. If, as we foresee, EUR/USD weakens during the first half of 2018, we will look to buy this pair. Mathieu Savary, Vice President Foreign Exchange Strategy mathieu@bcaresearch.com 1 Please see Foreign Exchange Strategy Special Report, "Assessing Fair Value In FX Markets" dated February 26, 2016 available at fes.bcaresearch.com 2 We do not include real GDP in the models because since wealth is affected by GDP, they are two co-integrated variables, which creates strong multi-collinearity in the regressions. Of the two variables, real wealth was the stronger explanatory variable. 3 While the focus of this report is on the euro, the relationship between relative excess money supply and currency performances works across many exchange rates. We will develop this theme over the coming weeks. 4 Please see Foreign Exchange Strategy Special Report, "Assessing Fair Value In FX Markets" dated February 26, 2016 available at fes.bcaresearch.com 5 Please see Foreign Exchange Strategy Weekly Report, "Euro: Risk On Or Risk Off" dated November 17, 2017 available at fes.bcaresearch.com 6 Please see Foreign Exchange Strategy Weekly Report, "A Cold Snap Doesn't Make A Winter" dated January 5, 2018 available at fes.bcaresearch.com 7 Please see Foreign Exchange Strategy Weekly Report, "The Best Of Possible Worlds?" dated October 6, 2017 available at fes.bcaresearch.com 8 Please see Foreign Exchange Strategy Weekly Report, "Yen: QQE Is Dead! Long Live YCC!" dated January 12, 2018 available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Data out of the U.S. was strong this week: Industrial production increased by 0.9% on a monthly pace; Capacity utilization increased to 77.9% from 77.2%; Continuing jobless claims increased to 1.952 million from 1.876 million, beating expectations of 1.9 million; Initial jobless claims however decreased to 220K from 261K, beating expectations of 250K. We continue to expect the Fed to hike more than is priced by the market. A tightening labor market will eventually feed inflationary pressures, causing upward pressure on the dollar. Report Links: A Cold Snap Doesn't Make A Winter - January 5, 2018 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - December 15, 2017 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 European data was decent: German CPI came in unchanged and at expectations, at 1.6%; European headline and core CPI also remained unchanged and at consensus, coming in at 1.4% and 1.1% respectively. However, the euro seems to be losing momentum his week. Comments by ECB board members such as Ewald Nowotny, Vitor Constâncio, and Francois Villeroy, all pointed to issues with the euro's sharp rise, and how they "don't reflect changes in fundamentals". Additionally, relapsing inflation data in the peripheries shows that the strength in the euro is beginning to cause strains and may even negatively affect the ECB's mandate. Report Links: The Unstoppable Euro - January 19, 2018 Yen: QQE Is Dead! Long Live YCC! - January 12, 2018 A Cold Snap Doesn't Make A Winter - January 5, 2018 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan has been mixed: Domestic corporate goods year on year inflation underperformed expectations, coming in at 3.1%. It also decreased substantially from November. Moreover, the Eco Watchers Survey for current conditions underperformed expectations, coming in at 53.9. It also decreased from the November reading. However, machinery orders yearly growth outperformed expectations substantially, coming in at 4.1%. USD/JPY is relatively flat from last week. Overall we expect upside to the yen to be limited against the U.S. dollar, given that bond yields are set to go up in the U.S. That being said, the yen has upside against the euro, as financial conditions have eased significantly in Japan relatively to the euro area. This should cause rate expectations in Japan to improve relative to those of Europe's, pushing EUR/JPY lower. Report Links: Yen: QQE Is Dead! Long Live YCC! - January 12, 2018 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Riding The Wave: Momentum Strategies In Foreign Exchange Markets - December 8, 2017 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. has been mixed: The DCLG House Price Index yearly growth outperformed expectations, coming in at 5.1%. However, core consumer price inflation underperformed expectations, coming in at 2.5%. It also decreased from the 2.7% reading of November. Moreover, headline inflation came in line with expectations at 3%. This also marks the first decrease in inflation in the U.K. since July 2017. Lifted by the USD's weakness, cable has now reached the pre-Brexit low 1.38 hit in February 2016. However, GBP has been experiencing a downtrend versus the euro since last September Overall, we continue to be skeptical of the ability of the BoE to raise interest rates meaningfully. Thus, we would fade any further rally from GBP/USD. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Reverse Alchemy: How To Transform Gold Into Lead - November 3, 2017 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Australian data was strong this week: Home loans grew at a 2.1% annual pace in November, higher than the expected -0.2%; Employment grew by 34.7K, beating expectations of 9K. The part-time component increased by 19.5K, while the full-time component grew by 15.1K; The participation rate increased to 65.7% from 65.5%; Unemployment rate increased to 5.5% from 5.4%. Foreign exchange traders lifted the AUD further this week. While the headline employment data remains stellar, the heavy concentration part-time job creation means that overall labor utilization measures is staying low. This will cap wage and inflationary pressures, especially as the AUD is once again expensive, further exacerbating deflationary pressures. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Currency Hedging: Dynamic Or Static? - A Practical Guide For Global Investors - September 29, 2017 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand has been negative: The month-on-month growth of food prices declined from -0.4% to -0.8%. Moreover, Electronic Card retail sales yearly growth slowed from 4.3% to 3.3%. Finally the ANZ Commodity Price Index year on year growth declined from -0.9% to -2.2%. The New Zealand Dollar has surges by almost 3% year to data against the U.S. dollar. This has been largely due to the depreciation of the greenback itself, as global growth continues to beat forecast. On a short term basis we are positive on the NZD relative to the AUD, as Chinese tightening should weigh more on Australia than New Zealand. However, the new populist government in New Zealand worsens the outlook of the kiwi on a long term basis. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Reverse Alchemy: How To Transform Gold Into Lead - November 3, 2017 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Movements in the petrocurrency were muted following the 'dovish hike' by the Bank of Canada. Numerous factors were highlighted to justify the rate hike to 1.25%, such as: strong employment growth; higher wages; robust consumption; and exceptional GDP growth in 2017. While the Bank's Business Outlook Survey suggests the labor market is tightening due to labor shortages, the BoC underplayed this factor, pointing to much more muted overall labor utilization metrics. The BoC also noted the expected decline in the contribution of housing and consumption to growth this year due to higher mortgage and borrowing rates. While the economy is firing on all fronts, the spread between the West Canada Select and West Texas Intermediate oil prices continues to widen due to a lack of pipeline capacity to ship the oil out of Canada. According to the Bank, these bottlenecks should be temporary, which means that the CAD could catch up to oil later. Report Links: Yen: QQE Is Dead! Long Live YCC! - January 12, 2018 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 On Tuesday, Thomas Jordan, the president of the SNB once again reiterated that the franc is still "highly valued", and thus interest rates need to stay low so as to prevent the franc from appreciating. Moreover, he emphasized that while expansionary monetary policy was necessary, it was important to not wait too long to normalize rates. Overall, we believe that the SNB will want to see sustained inflation at relatively high levels to justify an exit from their radical monetary policy. In the meantime the Swiss Central bank will stay accommodative, and thus, EUR/CHF is likely to have limited downside. If the mini down cycle takes hold of the global economy, this would temporarily weigh on EUR/CHF. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Updating Our Long-Term Fair Value Models - September 15, 2017 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 The krone continued to appreciate this week, and is now UP 3.3% year-to-date. The krone has been helped mostly by the surge in oil prices and by the fall in the dollar. Overall, we are bullish on this cross against the CAD, as there are 60 basis points of hiked priced in the Canadian curve, even after this week's hike. In the meantime, there are only 21 basis points in the Norwegian curve. We believe this spread is too high, and thus, that the krone should appreciate against the Canadian dollar. Moreover, further downside in EUR/NOK is limited, given that near 70 dollars, there is not much room for oil prices to go up. Thus, we are closing our EUR/NOK trade with a 3.40% gain but keep our long NOK/SEK call in place. Report Links: Yen: QQE Is Dead! Long Live YCC! - January 12, 2018 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - December 15, 2017 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 In a recent speech in Uppsala, Sweden, Deputy Governor Henry Ohlsson reminded the audience of his view from the December meeting that it would have reasonable to hike rates in "early 2018". He pointed to Sweden's robust economic performance, highlighting population growth, migration into cities, and higher real wages. Inflation has also been on target since mid-2017. This assessment is in line with our view of the economy, however Governor Ingves consistently supported a strong dovish tone which undermined our view. Now that the ECB has begun tapering, the consensus within the Riksbank seems to also be shifting. Falling house prices need to be monitored closely, especially when one keeps in mind Governor Ingves dovish inclinations. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - December 15, 2017 The Xs And The Currency Market - November 24, 2017 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades
Highlights Our new pecking order for currencies is: yen first, euro second, pound third, dollar fourth. Long-term (real) interest rate differentials are the dominant driver of currencies right now. EUR/USD should continue to trend higher to around 1.30. Equity investors should prefer the broader based 300-constituent Euro Stoxx over the 50-constituent Euro Stoxx 50. Underweight Basic Materials equities versus Healthcare equities on a 6-9 month horizon. Feature Nine months ago, our report Euro First, Pound Second, Dollar Third 1 encapsulated our recommended pecking order for the three major currencies. Subsequent performance has fully justified the title. The euro has appreciated by 6% versus the pound, and by 13% versus the U.S. dollar (Chart I-2). Today we are tweaking our currency pecking order: yen first, euro second, pound third, dollar fourth. Chart of the WeekHigher Euro Area Inflation Has Strengthened The Euro Chart I-2Euro First, Pound Second, Dollar Third The Euro Has Moved The 'Right' Way, The Yen Has Moved The 'Wrong' Way The Chart of the Week illustrates an excellent explanation for the euro/dollar exchange rate. It shows euro area versus U.S. core inflation differentials, and provides a great rule of thumb. If the euro area's core inflation were underperforming by 2% vis-à-vis the U.S., EUR/USD should stand at 1.00. But thereafter, every half-percent of euro area inflation catch-up strengthens the euro by 10 cents. At the start of 2017, our thesis was that the underperformance of euro area inflation by almost 2% - and the associated EUR/USD rate near 1.00 - was an anomaly. And that core inflation in the euro area would converge with that in the U.S. Which it duly has. Still, if the euro area's inflation underperformance vis-à-vis the U.S. converges to its long run average of half a percent, EUR/USD should continue to trend higher to around 1.30. One equity market implication is to prefer the broader based 300-constituent Euro Stoxx over the 50-constituent Euro Stoxx 50 (Chart I-3). The puzzle is that for the yen, the same inflation relationship has worked the 'wrong' way. Through the past ten years, every half-percent of Japanese core inflation catch-up has weakened the yen by around 10 yen (Chart I-4). To complicate the puzzle, the relationship for the yen used to work the 'right' way. Through 1999-2008, every half-percent of Japanese inflation catch-up strengthened the yen by around 10 yen (Chart I-5). Chart I-3A Stronger Euro Favours The Euro Stoxx ##br##Over The Euro Stoxx 50 Chart I-4Through 2008-17 Higher Japanese##br## Inflation Weakened The Yen... Chart I-5...But Through 1999-2007 Higher Japanese##br## Inflation Strengthened The Yen! So higher relative inflation in the euro area has driven the euro up; whereas higher relative inflation in Japan has driven the yen down, but previously used to drive the yen up! How can we explain the puzzle? The answer is to think in terms of both inflation and its impact on long-term interest rate expectations. What Are The Drivers Of Currencies? Foreign exchange demand serves one of four broad purposes: To buy foreign exchange reserves. To buy foreign goods and services. To buy long-term investments denominated in a foreign currency, also known as foreign direct investment (FDI) To buy shorter-term financial investments like bonds and equities denominated in that currency, also known as portfolio flows.2 Of these four components, the demand for foreign exchange reserves tends not to suffer wild gyrations, except at the rare moment that a currency peg starts or ends.3 The net foreign demand for euro area goods and services and FDI are also not particularly volatile. Which means that the usual swing-factor in foreign exchange demand is portfolio flows (Chart I-6), and especially fixed income portfolio flows. Chart I-6Portfolio Flows Are The Swing Factor In Foreign Exchange Demand What causes swings in fixed income portfolio flows? The answer is expected changes in real interest rates. Fixed income investors gravitate to the bonds with the highest real yield adjusted for likely currency losses or hedging costs. So when the expected real interest rate in the euro area rises relative to that in the U.S., euro bonds becomes de facto relatively more attractive. Meaning that international fixed income investors will shift into euro bonds until the flow pushes up EUR/USD to make the currency valuation symmetrically less attractive. At this new higher level for EUR/USD, the fixed income portfolio flow will stop because a new equilibrium has been established. International investors now have more upside from the more attractive bonds, but symmetrically less upside from the less attractive currency valuation - and the two factors cancel out. Furthermore, at major turning points in monetary policy, the main issue for the largest fixed income investors is not the exact pattern of short-term interest rate changes. Whether the Fed hikes in March, June and December or whether the ECB hikes next year is largely irrelevant. The big issue centres on the so-called real terminal rate: the average real interest rate over the very long term. Solving The Currency Puzzle Let's now return to our currency puzzle. If core inflation increases, but the expected terminal interest rate increases more, it means that the expected real terminal rate will also increase - causing the exchange rate to rise. This is what tends to happen in the euro area versus U.S. comparison, and explains why the relationship between relative core inflation and EUR/USD movements works the 'right' way. In effect, the nominal terminal rate is the driving factor for the currency. It is also what tended to happen in Japan before 2008 (Chart I-7), and explains why the relationship between relative core inflation and the yen also used to work the 'right' way. However, if core inflation increases, and the expected terminal interest rate increases less, it means that the expected real terminal rate will decrease - causing the exchange rate to fall. Since 2008, this is what has happened in Japan (Chart I-8). The expected nominal terminal rate has gone into stasis, so higher core inflation has pulled down the real terminal rate. Which explains why the relationship between relative core inflation and the yen has worked the 'wrong' way. The key question is what happens next? Will the expected terminal rate in the euro area go into stasis, as it did in Japan? Almost certainly no. The euro area's expected terminal rate has already risen by over 0.5% in the past year (Chart I-9). Chart I-7Expectations For Japan's Terminal ##br##Rate Used To Fluctuate... Chart I-8...But After 2008, Expectations For Japan's ##br## Terminal Rate Have Gone Into Stasis Chart I-9The Terminal Interest Rate Differential##br## Is Driving EUR/USD More plausibly, the expected terminal rate in Japan could come out of its stasis. With every other major central bank backing away from ultra-accommodation, and Japanese growth and inflation now looking little different from other G10 economies, is it realistic - or indeed feasible - for the Bank of Japan to maintain its extreme policy? The slightest hint from the Bank of Japan that it is following other central banks out of its ultra-accommodation would cause the expected terminal rate - and the yen - to gap (up) sharply. On this basis, the one major currency that we would short the euro against is the Japanese yen. The Global Mini-Upswing Is Losing Steam Finally and briefly, an update to our 'mini-cycle' framework for global growth. Last week in The Cobweb Theory And Market Cycles, we explained the existence of these mini-cycles, and argued that the current mini-upswing - which started last May - is getting long in the tooth. Right on cue, the latest credit data out of both China and the U.S. show that their 6-month credit impulses are losing steam (Chart I-10). The implication is that global growth will experience a mini-downswing during the first half of 2018. In all of the last five such mini-downswings, cyclical sectors ended up underperforming defensive sectors (Chart I-11). Accordingly, on a 6-9 month horizon, equity investors should underweight Basic Materials versus Healthcare. Chart I-106-Month Credit Impulses Have Rolled##br## Over In The U.S. And China Chart I-11Expect A Mini-Downswing: Underweight ##br##Basic Materials Vs. Healthcare Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com 1 Please see the European Investment Strategy Weekly Report 'Euro First, Pound Second, Dollar Third' published on April 27 2017 and available at eis.bcaresearch.com 2 In this discussion, portfolio flows include short-term speculative flows. 3 For example, when the Swiss National Bank broke the franc's peg to the euro, it just stopped buying euro reserves. Fractal Trading Model* There are no new trades this week, leaving two open positions. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment's fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-12 The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report "Fractals, Liquidity & A Trading Model," dated December 11, 2014, available at eis.bcaresearch.com Fractal Trading Model Recommendations Equities Bond & Interest Rates Currency & Other Positions Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch ##br##- Interest Rate Expectations Chart II-6Indicators To Watch##br## - Interest Rate Expectations Chart II-7Indicators To Watch##br## - Interest Rate Expectations Chart II-8Indicators To Watch##br## - Interest Rate Expectations
ハイライト
日本経済は好調です。これにより日銀はQQE（量的・質的金融緩和）プログラムから段階的に離脱することが可能になっています。
しかし、インフレが金融環境の直接的な関数であり続けるため、YCC（イールドカーブ・コントロール）プログラムは当面維持されるでしょう。
円のポジショニングとバリュエーションがこれほど歪んでいるため、特にユーロに対して円のリレーが生じる可能性があります。EUR/JPYをショートします。
米連邦準備制度と同様に、カナダ銀行（BoC）も今年に3回利上げするでしょう。しかし、市場はすでにカナダの利上げを米国よりも多く織り込んでいます。USD/CADはニュートラルを維持します。ただし、CADはNOKに対して下落圧力を受けるでしょう。CAD/NOKをショートします。
特集
チャート I-1
JPY 対 債券：決別
JPY対債券：決別
JPY対債券：決別
ここ数か月、USD/JPYに興味深い変化が起きました。米国の国債利回りから切り離され始めたのです（チャート I-1）。大部分は、2017年にドル指数が10%下落したことに起因するドル自身の弱さが反映されています。しかし昨年のドルの弱さにもかかわらず、9月7日以降は実質的に横ばいでした。円が債券利回りから切り離されたもう一つの要因は、欧州中央銀行（ECB）が独自の資産購入プログラムの終了を発表したことで、次に購入縮小の対象になるのは日銀だと見なされたことです。
1月8日、日銀はその方向に動き始め、長期JGBの買入れを縮小し始めました。その日以降、世界の債券は売られ、円も勢いを取り戻しました。我々は円のベア相場が終わったとは考えていませんが、ユーロに対してプレイ可能なリレーが生じる可能性が高いと見ています。
太陽は昇る
日銀が一部の金融刺激を取り除きたいと考えるのは正当です。日本経済は全てのシリンダーで稼働しており、改善は幅広く見られます。
資産価格の上昇と23年ぶりの低水準の失業率に支えられた消費者信頼感は過去最高水準に達しています（チャート I-2）。これは実質家計支出を引き続き支え、2015年から2017年初めまでの持続的な縮小の後、現在はほぼ年率2%のペースで成長しています。
家計支出を支えるもう一つの要因は賃金面です。契約賃金はすでに2006年以来の最速ペースで伸びており、残業代を除く賃金は1998年以来見られなかったペースで拡大しています（チャート I-3）。さらに、求人倍率は1974年以来の高水準にあります。これにより、安倍晋三首相が企業と賃上げを巡って繰り広げている圧力が実を結び、今春の賃金交渉で加速的な上昇が生じる可能性が高まります。
チャート I-2
日本の家計は意気軒昂
消費者信頼感調査
日本の世帯は活気にあふれている
消費者信頼感調査
日本の世帯は活気にあふれている
チャート I-3
賃金成長が加速
賃金の伸びが加速している
賃金の伸びが加速している
企業の信頼感も急上昇しています。日本の製造業PMIは日本基準で高い水準にあり、現在54であり、中小企業の信頼感は工業生産の加速を示唆しています（チャート I-4）。
金融市場もこの状況を裏付けています。日経平均の急騰が投資家の注目を集めていますが、さらに印象的なのは小型株の強さで、2015年以降大型株を17%アウトパフォームしています（チャート I-5）。この動きは信用成長の回復と一致しており、通常は堅調な成長見通しと関連します。
我々の系列誌であるザ・バンク・クレジット・アナリストが開発したGDPモデルは、これらの諸現象を要約しており、日本の実質GDP成長率は2018年前半に年率3%に達する可能性があると予測しています（チャート I-6）。したがって、日本経済はさらに勢いを増すと見られます。
チャート I-4
日本企業も好況感を実感##br##している
日本企業も好調を実感している
日本企業も好調を実感している
チャート I-5
小型株は明るい見通しを示唆##br##している
スモールキャップは明るい見通しを示す
スモールキャップは明るい見通しを示す
チャート I-6
日本の成長は##br##勢いを持っている
日本の成長に勢いがある
日本の成長に勢いがある
では、こうした改善を支えている要因は何でしょうか。
第一に、日本の財政の流れが変わりました。2012年から2016年にかけて財政政策は日本の経済活動に年間平均0.6%分のブレーキをかけていました。しかし2017年には財政政策は緩和に転じ、GDPに0.2%の押し上げをもたらしました。
第二に、日本は新興市場（EM）成長の回復から大きな恩恵を受けています。IMFによれば、新興市場の成長が1%ショックした場合、日本の成長に与える影響は50ベーシスポイントであり、これは米国への同じショックのほぼ5倍に相当します。これは日本の輸出の43%が新興市場向けであるためです。
第三に、新興市場の活動が日本に与える影響は、円の逆循環的な性質によって増幅されます。世界および新興市場の成長がより力強くなると円は弱含み、これが日本の金融環境を緩和します。この現象は昨年顕著に表れ、過去16か月で金融環境は1標準偏差分緩和しました。
これらの動きが成長改善と日銀のトーンの変化の土台を築いたのです。
結論： 日本は非常に好調です。消費者と企業の期待は高く、支出は増加しており、GDPはさらに加速する見込みです。財政引き締めの緩和、強い新興市場、そして金融環境の緩和がこれらの改善を支えています。日銀はこれに注目しています。
日銀はどこまで踏み込めるか？
日銀はここ数か月、政策変更に動きたがっていました。2017年11月、日銀総裁の黒田氏は「リバーサル・レート」という概念について言及していました。リバーサル・レートとは、金利をそれ以下に下げると追加の利下げが経済活動にとって収縮的になる金利水準を指します。これは、その水準を下回ると金利の低下が銀行の金利マージンを損ない、商業銀行が民間部門への貸し出しを抑制し始めるためです。
日銀がリバーサル・レートについて声を大きくしていた理由は、このレートが商業銀行のバランスシートに保有される証券の量と逆相関関係にあるからです。商業銀行が政府債を多く保有している場合、金利が非常に低い水準に下がるとこれらの証券の評価額が上昇し、低い金利マージンの悪影響を相殺します。日本の問題は、日銀が政府の発行額より多くのJGBを吸い上げたため、銀行の保有残高が急速に減少していたことです（チャート I-7）。これはリバーサル・レートの上昇を意味し、日銀の政策運営がやや制約されていることを示していました。
12月にインフレが上振れサプライズを起こしたとき、金融市場は激しく反応しました。日本の名目利回りはあまり動きませんでしたが、日本のインフレ期待が急上昇し、それが日本の実質金利の急落を促しました（チャート I-8）。これは日本の金融環境を事実上緩和させ、日銀が資産購入を調整するための絶好の口実を作りました：債券購入の微調整による負の影響は緩和され、日銀の見解ではリバーサル・レートの低下により金融環境の制御を失うことはないと考えられたのです。
このような政策行動とレトリックの変化にもかかわらず、我々はまだイールドカーブ・コントロール（YCC）プログラムの終わりを予想していません。食料とエネルギーを除くインフレはわずか0.3%にとどまり、日銀の2%目標や1%ですら大きく下回っています。1%台は緩和をより現実的に解除するレベルでしょう。
さらに、日銀はやや板挟みの状況にあります。確かに経済は大きく改善していますが、これはインフレ動向を十分に説明するものではありません。日本の設備稼働率は日本のコアインフレ変動のわずか3%しか説明しておらず、世界の稼働率は10%にとどまります。むしろ日本のインフレを説明する最良の要因は金融環境（FCIs）でした。他のどの国でも金融環境がこれほどまでにインフレ動向を説明することはありません。最近の日本のインフレの動きは、2010年以来の日本の金融環境の変化と完全に整合しています。この関係に基づくと、食料とエネルギーを除くCPIは2018年6月に0.7%でピークに達する可能性が高いです（チャート I-9）。
チャート I-7
QQEのために##br##リバーサル・レートは低下している
日本のリバーサル・レートはQQEのために低下している
日本のリバーサル・レートはQQEのために低下している
チャート I-8
インフレ期待の急上昇
インフレ期待の急上昇
インフレ期待の急上昇
チャート I-9
金融環境の緩和で##br##インフレは上昇している
金融環境が緩和されたため、インフレが加速している
金融環境が緩和されたため、インフレが加速している
しかし、日銀が緩和をあまりに速く取り除けば、円は上昇し金融環境は急激に引き締まります。おそらくインフレは大幅に弱まり、当初の利上げ理由が無効化されるでしょう。これらの力学は少なくとも今後12～18か月はYCCが継続されることを示唆しています。
結論：日銀は間もなくQQEプログラムを完全に廃止するでしょう。しかし、これはイールドカーブ・コントロールの解除を意味するものではありません。これは日本のインフレが日銀の目標から極めてかけ離れていることと、日本のインフレ率が金融環境に非常に敏感であることの両方によります。したがって、よりタイトな政策による市場の反応としての強い円が金融環境を引き締めれば、インフレは崩壊し、引き締めの必要性自体がなくなってしまうのです。
投資への示唆
USD/JPYは割高で、購買力平価が示す公正価値より16%高く取引されています。さらに、円はGDP比4%の好ましい経常黒字に支えられています。加えて、グローバル投資家はデュレーションをアンダーウェイトしてきました。こうした現象は円にとってネガティブになる傾向があります。投資家が現在のようにデュレーションを大幅にアンダーウェイトしている場合、円がリレーする可能性が高まります（チャート I-10）。
確かに2014年にも投資家は現在と同様に債券にネガティブでしたが、USD/JPYは下落しました。これは当時、日銀が資産購入プログラムの拡大を発表したためです。今日は日銀がQQEを放棄する方向に動いており、これはショートカバーを伴うリレーを誘発する可能性が高いです。
では、投資家は円に対してどの通貨を売るべきでしょうか。我々はユーロが米ドルに代わる興味深い選択肢であると考えます。
現在、EUR/JPYは極めて割高です。長期的には、購買力平価ベースでEUR/JPYは通常のレンジから大きく外れて取引されています（チャート I-11）。さらに、金利差やリスクアペタイトを織り込む指標ではUSD/JPYはやや割高ですが、同様の比較でEUR/USDは非常に高値圏にあります。つまり、短期的なバリュエーションの観点からEUR/JPYは非常に需要が高い水準で取引されていることになります（チャート I-12）。したがって、戦術的にはこのクロスをショートするタイミングが徐々に整いつつあります。
チャート I-10
デュレーションのポジショニングは##br##円に上昇リスクを示唆
デュレーションのポジショニングは円の上方リスクを示している
デュレーションのポジショニングは円の上方リスクを示している
チャート I-11
EUR/JPYは割高
EUR/JPYは割高です
EUR/JPYは割高です
チャート I-12
EUR/JPYに対する戦術的リスク
EUR/JPY向けタクティカル・リスク
EUR/JPY向けタクティカル・リスク
.
EUR/JPYをショートすることを支持する追加の理由として、相対的な金融環境があります。ユーロ圏の金融環境は日本に対して米国よりもはるかに引き締まっています（チャート I-13）。その結果、セクターの偏りを調整しても、欧州株は現在日本株に対して米国株よりも大きくアンダーパフォームしています。これは、日本の相対的な経済見通しが米国と比較するよりもユーロ圏と比較した場合により明るいことを示しています。つまり、円は米ドルよりもユーロに対してより大きく上昇する余地があるということです。
最後に、ユーロと円の間のポジショニングも極めて偏っています。チャート I-14 が示すように、投機筋が同時にユーロをロングし円をショートしているとき、EUR/JPYはその後に調整を経験する傾向があります。
チャート I-13
ユーロ圏の金融環境は##br##米国よりも大きく引き締まった
ユーロ圏の金融環境指数は米国のそれよりも一層引き締まった
ユーロ圏の金融環境指数は米国のそれよりも一層引き締まった
チャート I-14
ユーロの##br##偏ったポジショニング
EURにおける偏ったポジショニング
EURにおける偏ったポジショニング
以上の要因は円の大きなリレーの可能性を示唆しますが、このリレーの持続力は限定的である可能性が高いです。日銀が放棄しようとしているQQEは、ここ数か月にわたって半ばしか実施されておらず、債券買入れは8兆円の目標を大きく下回っていました。
日銀は当面YCCの維持にコミットしています。このプログラムを放棄して初めて円に対する持続的なサポートが生まれます。それまでは、どのような円のリレーも金融環境を引き締めインフレを傷つけるため、円高は「レンタル」するもの（短期的に借りるベット）であり、保有するものではありません。日本の最終的な政策金利が上昇できる余地はまだ小さいのです。
結論：QQEの放棄は円高を引き起こす可能性が高いです。そのリレーは、評価、ポジショニング、金融環境が欧州通貨と比べて特に悪化しているため、ユーロに対して最も顕著になるでしょう。明確に言えば、円高は反動的な動きとなる可能性が高く、強い円は日本に深刻なデフレ圧力を与えるため、日銀のYCCプログラムは堅く維持されるでしょう。我々はEUR/JPYを133.79でショートしています。
CAD：BoCとNAFTAの狭間に
チャート I-15
カナダは賃金上昇を経験する見込み Canada:##br## インフレ環境が出現
カナダの賃金は上昇する見込み
カナダ：インフレ圧力が高まり始めている
カナダの賃金は上昇する見込み
カナダ：インフレ圧力が高まり始めている
カナダ銀行（BoC）は来週会合を開き、今月政策金利を引き上げる確率が高まっています。カナダ経済も国内部門主導で非常に堅調です。実質消費支出は約10年ぶりの速さで伸び、失業率は40年ぶりの低水準にあり、設備投資は2014年から2016年の原油価格暴落で打撃を受けた後回復しています。
この背景により、カナダ経済は既に自国のキャパシティ制約に達しつつあります。BoCはカナダの産出ギャップが閉じたと見積もっています。さらに、最近のビジネス・アウトルック調査はこのメッセージを裏付けています：記録的な割合のカナダ企業がキャパシティ制約のため需要に応えられないと述べており、人手不足の数と深刻度の増加は労働市場の逼迫を示しています（チャート I-15）。逼迫したキャパシティと賃金上昇は、すでに可視化されているコアインフレの回復を支えるでしょう。現在コアインフレはすでに1.8%に達しています。
その結果、我々はBoCが今年はFRBと同程度に利上げするだろうと見ています。しかし、この展開がCADに与える影響は限定的かもしれません。投資家は今後12か月でカナダの利上げを米国より多く織り込んでおり、それぞれ82ベーシスポイント対60ベーシスポイントとなっています。さらに、投機筋は再びルーニー（カナダドル）を大幅にロングしており、強い経済指標が実際にCADをさらに押し上げるためのハードルは高いままです。
さらに、NAFTAはカナダにとって依然大きなリスクです。当社のチーフ・ジオポリティカル・ストラテジスト、マルコ・パピッチが11月のスペシャル・レポートで述べたように、トランプ大統領はNAFTAの破棄に関してほとんど制約がない権限を持っています（表 I-1）。1 もしNAFTAが崩壊すれば、カナダは最終的に依然として優遇措置のあるカナダ・米国自由貿易協定に戻る可能性が高いでしょう。したがって、カナダと米国間の貿易への影響は一時的である可能性が高いです。しかし、痛みの大部分はカナダの設備投資に及ぶはずです。NAFTA解消に伴う高い不確実性は企業にカナダでの拡張計画を放棄させ、北米の生産能力を直接米国で拡大させるよう促し、サプライチェーンにおける規制リスクを回避するでしょう。これによりカナダの将来の成長プロファイルは抑制されます。
表 I-1
トランプは貿易に関してほとんど制約を受けない
円：QQEは終わった！YCC万歳！
円：QQEは終わった！YCC万歳！
石油がCADの穴埋めをする可能性は低いです。ブレントがほぼ70米ドル/バレルに達した時点で、当社のコモディティ＆エネルギー戦略担当の目標に到達しました。OPEC 2.0は価格がさらに大幅に上昇することを容認しないでしょう。なぜならそれはシェール生産者に能力拡大のインセンティブを与え、2014年前の供給過剰のダイナミクスを再生してしまうからです。さらに、カナダにとって最も関連性の高い指標であるウエスト・カナダ・セレクト（WCS）はWTIやブレントに対して大きくディスカウントされたままです。これはアルバータ州外に油を輸送するパイプライン容量が不足しているためで、カナダは自国の石油に溺れている状況です。この状況はすぐには変わりません。
チャート I-16
CAD/NOKは伸び過ぎている
CAD/NOKは行き過ぎている
CAD/NOKは行き過ぎている
これらを踏まえ、我々は12か月ベースでUSD/CADを中立と見ていますが、今後数週間で1.29への戻りは起こり得ると考えます。しかし、カナダ産原油がディスカウントで取引されている一方で、CADはG10のもう一つのペトロ通貨であるNOKよりも良好に推移しています。これは、CADのリスクを織り込むよりクリーンな方法としてCAD/NOKのショートが考えられることを示唆しています。
第一に、カナダドルは現在ノルウェークローネに対して非常に割高で、購買力平価比で11%高く取引されています（チャート I-16）。生産性やコモディティ価格のような他の要因で調整しても、CADは1994年以来の最大のNOKに対するプレミアムで取引されています。これはCAD/NOKにとってリスクを示します。ルーニーは貿易政策リスクにさらされている一方、ノッキー（NOK）はそうではありません。
第二に、国際収支の面はNOKにとって非常に有利です。ノルウェーは経常収支黒字がGDP比で5.5%であるのに対し、カナダは2.8%の赤字です。さらに、ノルウェーはGDP比210%のネット国際投資ポジション（NIIP）を有しており、G10で最大です。強いNIIPは実効実質為替レートの上昇と関連します。
第三に、カナダ経済の勢いは投資家によく知られているため、投資家がCADをこれほどロングし、BoCから多数の利上げを期待している理由となっていますが、ノルウェーの良好な側面は見過ごされています。ノルウェーの先行指標は依然上昇しており、産業生産と実質GDP成長は加速しています。
第四に、ノルゲス銀行はNOKの弱さに反応しています。12月の会合で同行はトーンを調整し、NOKはノルウェー中央銀行の目から見ると金融環境を過度に緩和していると述べました。これはノルウェーから期待される25ベーシスポイントの利上げが過小評価されている可能性を示唆します。また、カナダとノルウェーの間で期待される12か月の利上げ差が現在約60ベーシスポイントと異常に開いていることが正常化する可能性も示しています。
最後に、CAD/NOKは長期的および短期的なヒストリカルレンジの上限に向かって取引されています。CADのポジショニングはロング側にかなり偏っていますが、ノルウェークローネは投機筋によりショートされています（ノルゲス銀行のデータ）。したがって、NAFTAの不確実性、BoCの見通しが既に織り込まれていること、WCSとブレントのディスカウントが縮小する可能性が低いことを考えると、リスクはCAD/NOKの下落方向に偏っています。
結論: カナダ経済は好況です。これはBoCがFRBに歩調を合わせ、今年少なくとも3回は利上げすることを意味します。しかし、市場はすでに米国よりもカナダの利上げを多く織り込んでいます。さらに、原油価格の上方余地は限られており、WCSベンチマークは引き続きブレントに対して大幅なディスカウントで取引されるでしょう。したがって、USD/CADは上値余地が限定的である一方、下値も限定的です。しかし、CAD/NOKは現在水準から多くの下落リスクを抱えています。我々は今週このクロスをショートし、エントリーポイントを6.398に設定します。
マチュー・サヴァリー, 副社長 外国為替ストラテジー mathieu@bcaresearch.com
1 BCAのグローバル・インベストメント・ストラテジー スペシャル・レポート「NAFTA - Populism Vs. Pluto-Populism」（2017年11月10日付）を参照ください。gis.bcaresearch.comで入手可能です。
通貨
米ドル
チャート II-1
USD テクニカル 1
米ドルのテクニカル 1
米ドルのテクニカル 1
チャート II-2
USD テクニカル 2
米ドル テクニカル 2
米ドル テクニカル 2
米国の最近のデータは混在しています：
非農業部門雇用者数は下振れし、148千人となりました。
さらに、労働参加率は下振れし、62.7%となりました。
ISM非製造業PMIも予想を下回り、55.9となりました。
しかし、消費者信用の変化は予想を上回り、279.5億ドルとなりました。
週の始め、ドルは強含みで始まりましたが、やがて収束しました。背景には比較的タカ派的なECB議事録や日本の政策調整があります。総じて、市場がフェドのドットプロットを織り込み続けるため、ドルに上昇圧力がかかると予想しています。
レポートリンク：
A Cold Snap Doesn't Make A Winter - 2018年1月5日
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - 2017年12月15日
ユーロ
チャート II-3
EUR テクニカル 1
EUR テクニカル指標 1
EUR テクニカル指標 1
チャート II-4
EUR テクニカル 2
EUR テクニカル指標 2
EUR テクニカル指標 2
ユーロ圏の最近のデータは良好でした：
コアインフレは予想を上回り、1.1%となりました。
さらに、経済センチメント指標も予想を上回り、116となりました。
小売売上高の前年比成長も上振れし、2.8%となりました。
最後に、失業率は8.8%から8.7%に低下しました。
ポジティブなデータにもかかわらずユーロは今週下落しました。ユーロは週初は弱含みでしたが、その後ECBのタカ派的議事録を受けて急騰しました。これは米国での利上げ期待の高まりによるものです。総じて、日銀が超ハト派政策を後退させる余地はECBよりも大きいため、EUR/JPYは下押しされると予想します。
レポートリンク：
A Cold Snap Doesn't Make A Winter - 2018年1月5日
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
The Xs And The Currency Market - 2017年11月24日
円
チャート II-5
JPY テクニカル 1
JPY テクニカル 1
JPY テクニカル 1
チャート II-6
JPY テクニカル 2
JPY テクニカル分析 2
JPY テクニカル分析 2
日本の最近のデータは混在しています：
現金給与の前年比成長は予想を上回り、0.9%となりました。10月からも増加しています。
しかし消費者信頼感は下振れし、44.7となり前月から低下しました。
今週、円は急上昇しており、USD/JPYは1.7%下落しました。これは日銀が長期債の買入れを減らす意向を示したためです。市場はこれを日銀が超ハト派の金融政策からの出口に動き始めるシグナルと解釈しました。これらの動きは、特にユーロに対して円に上昇圧力を与え続けるでしょう。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
Riding The Wave: Momentum Strategies In Foreign Exchange Markets - 2017年12月8日
The Xs And The Currency Market - 2017年11月24日
英ポンド
チャート II-7
GBP テクニカル 1
GBPのテクニカルズ 1
GBPのテクニカルズ 1
チャート II-8
GBP テクニカル 2
GBP テクニカル分析 2
GBP テクニカル分析 2
英国の最近のデータは混在しています：
鉱工業生産の前年比成長は予想を上回り、2.5%となりました。
さらに、製造業生産の前年比成長も上振れし、3.5%となりました。
しかし、Halifaxの住宅価格の前年比は予想を下回り、2.7%となり、月次では0.6%の下落となりました。
今週ポンドは対ドルで横ばい、一方で対ユーロでは約1%下落しました。総じて、イングランド銀行（BoE）は大幅な利上げ余地が限られています。さらに、利上げとポンド高の結果としてインフレは緩和し始めるはずで、これがポンドに下押し圧力をかけるでしょう。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
The Xs And The Currency Market - 2017年11月24日
Reverse Alchemy: How To Transform Gold Into Lead - 2017年11月3日
豪ドル
チャート II-9
AUD テクニカル 1
AUDのテクニカル分析 1
AUDのテクニカル分析 1
チャート II-10
AUD テクニカル 2
AUD テクニカルズ 2
AUD テクニカルズ 2
オーストラリアの最近のデータは混在しています：
建築許可の前年比成長は予想を上回り、17.2%となりました。
しかし、11月の貿易収支は予想を下回り、-6.28億となりました。前月の-3.02億から悪化しています。
AUD/USDは今週横ばいでしたが、AUD/NZDは約1%下落しました。世界経済の成長は依然強いものの、韓国や台湾の輸出成長などの主要指標は減速に転じています。さらに、中国のマネーサプライ成長は減少を続けています。これらは中国の工業活動の一時的な減速を示唆しており、AUD/USDの弱含みにつながるでしょう。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
The Xs And The Currency Market - 2017年11月24日
通貨ヘッジ：動的か静的か？ - グローバル投資家のための実践ガイド - 2017年9月29日
ニュージーランド・ドル
チャート II-11
NZD テクニカル 1
NZDテクニカル 1
NZDテクニカル 1
チャート II-12
NZD テクニカル 2
NZドルのテクニカル指標 2
NZドルのテクニカル指標 2
キウイは年初来でほぼ5%上昇しており、世界成長が堅調に推移していることを反映しています。総じて、NZDは今年AUDをアウトパフォームすると予想します。ニュージーランドは金融環境の引き締まりに対してオーストラリアよりも感応度が低いためです。しかし長期的には、上昇余地は限定的です。新しいポピュリスト政権は移民抑制と、RBNZに複数目標（デュアル・マンダテ）を課すことを公約しており、これらはニュージーランドの中立金利を押し下げ、キウイに下押し圧力をかけるでしょう。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
The Xs And The Currency Market - 2017年11月24日
Reverse Alchemy: How To Transform Gold Into Lead - 2017年11月3日
カナダドル
チャート II-13
CAD テクニカル 1
CADのテクニカル 1
CADのテクニカル 1
チャート II-14
CAD テクニカル 2
CADのテクニカル指標 2
CADのテクニカル指標 2
カナダの最近のデータは概ね良好でした：
失業率は5.9%から5.7%へと改善し、ポジティブなサプライズとなりました。
さらに、雇用者数の純増も予想を上回り、78.6千人となりました。
住宅着工件数の年間成長も予想を上回り、217千戸となりました。
しかし、Ivey購買担当者指数は予想を下回り、60.4となりました。
USD/CADは火曜日、トランプがNAFTAから撤退するとの報道を受けて急騰しました。総じて、カナダドルの上値余地は限定的であると考えています。市場はすでにカナダの利上げを米国より多く織り込んでいるためです。この弱さはCAD/NOKのショートで利用できる可能性があります。複数の指標でこのクロスは大きく過大評価されています。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
The Xs And The Currency Market - 2017年11月24日
Market Update - 2017年10月27日
スイスフラン
チャート II-15
CHF テクニカル 1
CHF テクニカル 1
CHF テクニカル 1
チャート II-16
CHF テクニカル 2
CHF テクニカル指標 2
CHF テクニカル指標 2
スイスの最近のデータは良好でした：
ヘッドラインインフレは予想通り0.8%でした。一方で月次のインフレは上振れし、0%となりました。
失業率も非常に低い水準で予想通り3%でした。
最後に、小売売上高の前年比成長は前月の2.6%に対し-0.2%と大きく上振れしました。
EUR/CHFは先週から比較的横ばいです。総じて、フランの上昇余地は限定的だと見ています。SNBは対外為替市場で積極的に介入を続けるでしょう。SNBが政策を変更するためには、スイスのインフレが相当期間高水準で推移する必要があります。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
The Xs And The Currency Market - 2017年11月24日
長期フェアバリューモデルの更新 - 2017年9月15日
ノルウェー・クローネ
チャート II-17
NOK テクニカル 1
NOK テクニカル指標 1
NOK テクニカル指標 1
チャート II-18
NOK テクニカル 2
NOK テクニカル 2
NOK テクニカル 2
ノルウェーの最近のデータは混在しています：
ヘッドラインインフレは予想を上回り、1.6%となりました。
さらに、コアインフレも上振れし、1.4%となりました。
しかし製造業の生産成長は予想を下回り、0.3%となりました。
USD/NOKは原油価格が70ドル近辺に迫る中、約0.7%下落しています。それでも、USD/NOKの上値余地はここから限定的だと考えています。市場はフェドのさらなる利上げを織り込み始めるでしょう。それでも、より強い原油を見込む投資家はEUR/NOKをショートすることを検討できるでしょう。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - 2017年12月15日
The Xs And The Currency Market - 2017年11月24日
スウェーデン・クローナ
チャート II-19
SEK テクニカル 1
SEK テクニカルズ 1
SEK テクニカルズ 1
チャート II-20
SEK テクニカル 2
SEKのテクニカル分析 2
SEKのテクニカル分析 2
2017年末に急落した後、USD/SEKは今年に入って比較的横ばいです。総じて、イングヴェス総裁は依然として非常にハト派ですが、最新の議事録では金融政策の変更が近づいていることを認めました。一方、副総裁のヤンソンは資産購入を継続することを支持しつつも、レポ金利を据え置くことは「受け入れがたい」と述べました。金融環境の引き締まりによるユーロ圏の減速を見込む投資家はEUR/SEKをショートすることを検討できます。
レポートリンク：
10 Charts To Digest With The Holiday Trimmings - 2017年12月22日
Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - 2017年12月15日
The Xs And The Currency Market - 2017年11月24日
トレード & 予測
予測サマリー
コア・ポートフォリオ
戦術的トレード
クローズド・トレード
ハイライト
ビットコインの「合成」供給が金融デリバティブを通じて増加し、大手既存テクノロジー企業によるビットコイン類似の代替通貨の立ち上げが加わると、暗号通貨市場は自らの重みで崩壊するでしょう。
今後数年で供給増に起因する圧力を受け得る他の分野としては、原油、ハイイールド債、世界の不動産、低ボラティリティ取引が挙げられます。
対照的に、米国株式市場は自社株買いと自発的な上場廃止により株式供給の減少が観察されています。
投資家はハイイールド債に対して米国株をロングすることを検討しつつ、ボラティリティ上昇に備えるべきです。
このような結果は1990年代後半に起きた状況に類似している可能性があり、その期間はVIXとクレジットスプレッドが上昇傾向にある一方で株式は史上最高値を更新し続けました。
NAFTA交渉の決裂はカナダドルとメキシコ・ペソにとって依然として主要なリスクです。
特集
供給過剰でバブルが崩壊する
価格上昇の「治療法」はさらなる価格上昇である。ドットコムと住宅バブルは完全に自然消滅したわけではない。その崩壊は市場に新たな供給が波のように押し寄せたことで促進された。ドットコム・バブルの場合、2000年には新規公開（IPO）や二次公募による株式の洪水が投資家を圧倒し（チャート1）、インターネット株の価格に大きな下押し圧力を与えた。住宅ブームも同様に新規建設の急増によって覆された。住宅投資は2006年にGDP比6.6%と55年ぶりの高水準に達した（チャート2）。
チャート1
供給過剰による崩壊：例1
Burst By Too Much Supply: Example 1
Burst By Too Much Supply: Example 1
チャート2
供給過剰による崩壊：例2
Burst By Too Much Supply: Example 2
Burst By Too Much Supply: Example 2
ビットコインは同様の運命をたどろうとしているのだろうか？表面的には「いいえ」のように見えるかもしれない。より多くのビットコインが「マイニング」されるにつれ、追加生産の計算上のコストは指数関数的に上昇する。理論上、流通可能なビットコインは2100万枚に制限され、その約80%は既に生成されている（チャート3）。しかし、表面の下を見れば、ビットコインはさまざまな「供給側」要因に脆弱である可能性がある。
チャート3
ビットコイン：大部分は既に採掘済み
ビットコイン：大部分はすでにマイニング済み
ビットコイン：大部分はすでにマイニング済み
まず第一に、ビットコインの価値に連動する金融デリバティブの拡大は、暗号通貨の「合成」供給を生み出す脅威となる。
株式のコールオプションを売る（ライトする）とき、オプションの売り手は実質的に弱気の賭けをし、買い手は強気の賭けをしている。オプションを売るという行為自体が追加のロング・ポジションを生み、それは追加のショート・ポジションによってちょうど相殺される。さらに、特定のコールオプションを売る決定が類似のコールオプションの価格を押し下げる程度に、基礎となる株価も押し下げられるだろう。これは単純に、株式に対するロングエクスポージャーは現物株を保有するかそのコールオプションを保有することで得られるからである。後者の価格を傷つけるものは前者の価格も傷つける。
ビットコイン先物が取引され始めると、ビットコインに対して弱気の投資家はショートポジションを作り、結果として流通するビットコインの実質的な数量を増加させることができる。これは公式の発行枚数が同じままであっても起こり得る。
模倣は最大の賛辞
ビットコインの合成的な供給増はビットコイン投資家の懸念の一つである。もう一つの懸念は、ビットコイン類似の代替通貨からの競争の増大である。現在、数百もの暗号通貨が存在し、その多くはビットコインを支えるブロックチェーン技術のわずかな変形を使用している。
チャート4
政府は取り分を要求するだろう
政府は取り分を求めるだろう
政府は取り分を求めるだろう
これまで新通貨の拡散は主に寝室やガレージで働く技術に精通した起業家によって牽引されてきた。しかし今や企業も参入している。営業しているらしいコダックの株価は、今週自社の暗号通貨を発表したことで3倍になった。これはこれから起こることのほんの一例に過ぎない。
フェイスブック、アマゾン、ネットフリックス、グーグルのような巨大企業が自社の暗号通貨を発行するのを妨げるものは何だろうか。彼らはすでに安全なグローバルネットワークを持っている。アマゾンは販売ごとに数コインを配り始め、消費者が新通貨で同社のオンラインストアから商品を購入できるようにすることもできる。やり方は簡単だ。1
唯一のもっともらしい制約は法的なものである：政府が自国の法定通貨への需要が落ちることを恐れて新興の暗号通貨を潰す脅威だ。数週間前に述べたように、米政府は通貨を印刷しその資金で財やサービスを購入する能力から年間約$100 billion、約1000億ドルのシニョレッジ収入を得ている（チャート4）。2 大企業が暗号通貨分野に参入すると、政府は遅かれ早かれ厳しい対応を取る可能性が高い。今週の韓国政府が取引所での暗号通貨取引禁止を検討するという報道は、その兆候である。
他にどの分野が？
新規供給の津波に脆弱な他の分野はどこか？四つが思い浮かぶ：
原油：BCAの強気の原油見通しは大当たりだった。ブレントは昨年6月の44ドルから現在の69ドルまで上昇した。しかし今後の追加上昇はそれほど容易ではないかもしれない。当社のエネルギー・ストラテジストは米国シェール生産者の損益分岐点を50ドル台前半と見積もっている。3 現在はその水準を大きく上回っており、シェール供給は加速するだろう。これは短期的に価格がさらに上昇し得ないという意味ではないが、原油の長期的な上昇余地を制限する。
不動産：世界の多くで超低金利が住宅価格の急増を後押しした。カナダ、オーストラリア、ニュージーランド、および欧州の一部では、インフレ調整後の住宅価格は大不況前の水準を大きく上回っている（チャート5）。米国の実質住宅価格はまだ2006年のピークを下回っているが、商業用不動産（CRE）価格は新高値に達している（チャート6）。米国のCREセクター内の賃料上昇は鈍化し始めており、供給が徐々に需要に追いつきつつあることを示唆している（チャート7）。
チャート5
低金利が##br##住宅価格を押し上げた地域
低金利が住宅価格を押し上げた地域
低金利が住宅価格を押し上げた地域
チャート6
商業用不動産価格が##br##不況前の水準を上回った
商業用不動産の価格は景気後退前の水準を上回っている
商業用不動産の価格は景気後退前の水準を上回っている
チャート7
賃料の伸びは鈍化している
家賃の伸びが鈍化している
家賃の伸びが鈍化している
企業債務：低金利は企業にクレジットを活用させた。米国および多くの国で企業債務の対GDP比はほぼ過去最高水準にある（チャート8A およびチャート8B）。クレジットスプレッドは依然として非常にタイトだが、これも企業債が市場に出てくるにつれて変わる可能性がある。
チャート8A
企業債務の対GDP比が##br##過去最高水準に近い
企業債務対GDP比は過去最高水準に迫っている
企業債務対GDP比は過去最高水準に迫っている
チャート8B
企業債務の対GDP比が##br##過去最高水準に近い
企業債務の対GDP比は記録的高水準に迫っている
企業債務の対GDP比は記録的高水準に迫っている
低ボラティリティ取引：最近のブルームバーグの見出しは「ショート・ボラティリティ・ファンドに史上最多の資金が流入」と叫んでいた。4 Cboeで取引されるボラティリティ契約の数は2012年以降で10倍以上に増加した。ネットのショート投機ポジションは現在史上最高水準にある（チャート9）。トレーダーはここ数年、ボラティリティが低下することに賭けて巨額の利益を上げてきた。問題は、ボラティリティが上昇し始めると、同じトレーダーがポジションを一斉に手放す可能性があり、さらにボラティリティが高まる懸念があることだ。
前掲の分野とは対照的に、株式市場は自社株買いと自発的な上場廃止により株式供給の侵食を受けている。S&Pの除数（ディバイザー）は2005年以降8%以上低下している。米国の上場企業数は1990年代後半以降ほぼ半減している（チャート10）。この傾向がすぐに逆転する可能性は低く、利益率の高止まりと多くの企業が法人税減税を利用して自社株買いを加速させる誘惑があることを考えれば、なおさらである。
チャート9
低ボラティリティへの需要が高い
低ボラティリティへの需要が高まっている
低ボラティリティへの需要が高まっている
チャート10
株式市場における供給の減少
株式市場における供給の侵食
株式市場における供給の侵食
株価上昇に賭ける一方、ボラティリティとクレジットスプレッドの上昇も見込む
前述の議論は、今後数か月で株価とボラティリティ、クレジットスプレッドの関係が変化する可能性を示唆している。これは初めてのことではない。チャート11は、1990年代後半にVIXとクレジットスプレッドが上昇傾向に転じた一方でS&P500は史上最高値を更新し続けたことを示している。今、我々は類似の局面に入る可能性がある。
米国でのトレンド超過の成長継続とインフレ上昇は米国債利回りを押し上げるだろう。我々は2016年7月5日に「35年間の債券ブルマーケットの終焉」と宣言したが、これはちょうど10年物米国債利回りが終値で史上最安の1.37%を記録したその日だった。5
利上げは資金繰りに苦しむ借り手を苦しめ、クレジットスプレッドを拡大させる。企業の業況が悪化し次の景気後退の時期が近づくにつれて株式のボラティリティも上昇するだろう。我々の基本シナリオでは、米国および世界は2019年後半に景気後退に陥ると見ている。
金融市場は景気後退を実際に起こる前に嗅ぎつける。ただし歴史が示すように、それは景気後退開始の約6か月前にしか起こらないことが多い（表1）。これは、世界の株式は今後12か月程度は上昇を続け得ることを示唆する。これを念頭に、我々はS&P500のロング対ハイイールド債を新規トレードとして開始する。
チャート11
株価が上昇する中でもボラティリティは上昇し、スプレッドは##br##拡大し得る
株価が上昇すると、ボラティリティが高まり、スプレッドが拡大する可能性があります。
株価が上昇すると、ボラティリティが高まり、スプレッドが拡大する可能性があります。
表1
手仕舞いにはまだ早い
ビットコインはDeFANG化されるか？
ビットコインはDeFANG化されるか？
通貨に関するクイック・ヒット（4点）
今週は4つの項目が通貨およびフィクスト・インカム市場を揺るがした。第一は中国が米国債の購入を減速または停止するという報道だ。中国の国家外為管理局（SAFE）はその報道を「フェイクニュース」と非難した。
騒ぎの中で見落とされがちなのは、中国の保有する米国債残高が2011年以降ほぼ横ばいで推移しているという事実である（チャート12）。中国は依然として高度に管理された通貨を持つ。資本流出がもはや発生していないため、中国人民銀行（PBoC）は外貨準備の再構築を始めるだろう。米国債市場が世界で最大かつ最も流動的であることを考えれば、中国が余剰外貨の多くを米国に置かざるを得ないのは避けがたいように思える。
第二は日本銀行が保有する国債の買入目標を引き下げると発表したことだ。これは既に1年以上続いている動きを形式化したに過ぎない。日本銀行のJGB買入は過去12か月で急減しており、主因は80兆円という目標が国債の年間ネット発行額30〜35兆円のほぼ2倍であるためだ（チャート13）。
チャート12
中国の米国債保有：##br##2011年以降ほぼ横ばい
中国の米国債保有高：2011年以降ほぼ横ばい
中国の米国債保有高：2011年以降ほぼ横ばい
チャート13
日銀は国債買入を##br##削減している
日本銀行（BoJ）は国債の買入を縮小している
日本銀行（BoJ）は国債の買入を縮小している
最終的には、これらはそれほど重要ではないはずだ。日本銀行は価格（JGBの利回り）をターゲットにすることも、数量（保有国債の枚数）をターゲットにすることもできるが、両方を同時にターゲットにすることはできない。日銀がすでに前者を行っているという事実は後者を無意味にする。そして長期インフレ期待が日銀の目標からほど遠い現状では、前者が変わる見込みは低い。
では円には何を意味するのか。円は割安であり、経常収支の黒字はGDP比で4%に膨らんでいる（チャート14）。投機筋の円ショートも非常に大きい（チャート15）。これは短期的な上昇の可能性を高めるが、同僚のMathieu Savaryが今週指摘したように、6世界の国債利回りが上昇する一方で日本の利回りが据え置かれる場合、円が大きく上昇して持続するのは難しい。総合的には、今年はUSD/JPYがやや強含むと予想している。
チャート14
円は既に割安...
円はすでに安い…
円はすでに安い…
チャート15
...かつ不人気
...そして愛されない
...そして愛されない
第三の項目はECBの12月議事録で、中央銀行が2018年初めにコミュニケーション方針を見直すと示唆された点だ。市場が織り込んでいるより速くECBが金融政策を正常化するという憶測がある。もしそうなればEUR/USDはさらに強含むだろう。
もちろんこれは起こり得るが、それにはユーロ圏の成長が上振れサプライズを出す必要があるだろう。それは決して確実ではない。ユーロ圏の経済サプライズ・インデックスは下落に転じ始めており、相対的には米国に対して急落している（チャート16）。米国とは異なり、ユーロ圏のクレジット・インパルスは現在マイナスである（チャート17）。ユーロ圏の金融環境も米国に比べて大幅に引き締まっている（チャート18）。
チャート16
ユーロ圏の経済サプライズが##br##下落に転じ始めている
ユーロ圏の経済サプライズが小幅に低下
ユーロ圏の経済サプライズが小幅に低下
チャート17
ユーロ圏のクレジット・インパルスのマイナスは##br##成長の重しとなる
ユーロ圏のマイナスのクレジット・インパルスが成長を圧迫するだろう
ユーロ圏のマイナスのクレジット・インパルスが成長を圧迫するだろう
チャート18
金融環境の乖離は##br##米国をユーロ圏より有利にする
金融環境の乖離は米国をユーロ圏よりも有利にする
金融環境の乖離は米国をユーロ圏よりも有利にする
一方で、EUR/USDは2016年以降、金利差の変化から予想される以上に上昇している（チャート19）。ユーロに対する投機的ポジショニングも、2017年初頭の大幅ショートから今日では大幅ロングへと変化している（チャート20）。妥当な割安感と健全な経常収支の黒字はユーロに有利に働くが、我々の最良の見立てはEUR/USDが今後数か月で上昇分の一部を手放すだろうというものである。
チャート19
金利差で説明される以上にユーロは##br##強含んだ
ユーロは金利差で正当化される以上に上昇している
ユーロは金利差で正当化される以上に上昇している
チャート20
ユーロのポジショニング：大幅ショートから##br##史上最高のロングへ
ユーロ・ポジショニング：大幅にショートから過去最高のロングへ
ユーロ・ポジショニング：大幅にショートから過去最高のロングへ
最後に、今週は米国がNAFTA交渉から撤退するという報道を受けてカナダドルとメキシコ・ペソが圧迫された。ここで述べた4項目のうち、これが我々にとって最も懸念材料である。グローバルなサプライチェーンは高度に統合されている。それを破壊するものは大きな混乱を招くであろう。ある程度、トランプはこれを理解しているが、支持基盤は貿易に厳しくあってほしいと望んでおり、そうしなければ再選の見込みはさらに厳しくなることも彼は知っている。最終的には新たなNAFTA合意が成立すると期待しているが、そこに至る道のりはでこぼこだろう。
事務連絡
当社のグローバル・インダストリアルのロング／ユーティリティのショートのトレードは、9月29日に開始して以来12.4%の利益が出ている。利益保護のためストップを10%に引き上げる。2年物USD/サウジ・リヤルのフォワード契約のロングは損失2.9%で満了とし、サウジアラビアの財務状況が最近改善していることを踏まえ、同トレードは再導入しない。
ピーター・ベレジン, チーフ・グローバル・ストラテジスト グローバル・インベストメント・ストラテジー peterb@bcaresearch.com
1 本トピックに関する貴重な示唆を頂いたSHIG Partners LLC代表イゴール・ヴァッセルマン氏に感謝する。
2 グローバル・インベストメント・ストラテジー・スペシャル・レポート「ビットコインのマクロ的影響（Bitcoin's Macro Impact）」、2017年9月15日付；およびグローバル・インベストメント・ストラテジー・ウィークリー・レポート「フラット化したイールドカーブを恐れるな（Don't Fear A Flatter Yield Curve）」、2017年12月22日付を参照されたい。
3 エネルギー・セクター・ストラテジー・ウィークリー・レポート「損益分岐点分析：シェール企業が自立するには約50ドルの原油が必要（Breakeven Analysis: Shale Companies Need ~$50 Oil To Be Self-Sufficient）」、2017年3月15日付を参照。
4 Dani Burger, "Short-Volatility Funds Are Being Flooded With Cash," Bloomberg, 2017年11月6日。
5 グローバル・インベストメント・ストラテジー・スペシャル・アラート「35年間の債券ブルマーケットの終焉（End Of The 35-year Bond Bull Market）」、2016年7月5日付を参照。
6 フォーリン・エクスチェンジ・ストラテジー「円：QQEは死んだ！YCC万歳！（Yen: QQE Is Dead! Long Live YCC!）」、2018年1月12日付を参照。
タクティカル・グローバル・アセット・アロケーションの推奨
ストラテジー & マーケット・トレンド
タクティカル・トレード
戦略的推奨
クローズド・トレード
Highlights The dollar continues to suffer as global growth remains strong. The year-end performance of the dollar rarely heralds things to come for the next six to twelve months. Signs are slowly accumulating that global growth may soften, but it could take a quarter to happen. In the meanwhile, the dollar could continue to weaken. Already boosted by global growth, the euro received a further fillip as markets upgraded the anticipated terminal interest rate in Europe. The U.S. terminal rate will be upgraded too, but only when this happen will the dollar be able to rally. Stay cautious. Feature As a cold snap engulfed North America, the U.S. dollar finished 2017 falling as fast as the mercury. This move is worrisome, as it pushed the greenback to the edge of a cliff. If the DXY punches below 91, the low hit on September 7, the greenback could hit 88. For EUR/USD, a decisive break above 1.21 constitutes the same threshold, and would indicate that the euro will rally to 1.25. Vigilance is required. A December Signal? The performance of the dollar in the last two weeks of December rarely offers a reliable signal of things to come. As Table I-1 illustrates, based on more than 20 years of data, the performance of the dollar index in the last weeks of a year has been negatively correlated with the dollar's performance over the following six to 12 months. This would imply that investors fighting dominating trends over the course of the prior 12 months capitulate in the last two weeks of the year, cleaning the slate in the process. Table I-1A Cold Snap Doesn't Make A Winter When it comes to specific pairs, relationships vary. The correlation of EUR/USD's subsequent six-month and 12-month returns with its year-end performance is zero, thus there is little to glean from the euro's recent strength in terms of its implications for 2018. However, interestingly, there is a strong negative correlation between the AUD/USD's year-end performance and the Aussie's returns over the next six to 12 months. It would seem the AUD's blistering rally is to be sold, not bought. The weakness in the USD was supercharged by the greenback's countercyclical nature. Our global synchronicity indictor - which measures the proportion of DM economies with PMIs above 50 - displays a negative correlation with the dollar's returns. This indicator's extraordinarily strong performance elucidates why the dollar was so weak last year, and also why the euro performed so well (Chart I-1). Going forward, two key leading indicators of our global synchronicity measure are saying that the global upswing could lose power (Chart I-2). The performance of Swedish equities relative to U.S. stocks and the annual change in U.S. 10-year yields reveal that even if global growth remains above trend, it will decelerate from current elevated readings. This could support the dollar index. However, we should keep an eye on the performance of EM carry trades.1 EM carry trades had been indicating that the best days for global growth are also behind us (Chart I-3), but lately EM carry trades have regained some vigor. If this strength is maintained, the message from the relative performance of Swedish equities and of U.S. bond yields will be invalidated. Such a move could be associated with a DXY breaking down below 91, potentially hitting 88; and EUR/USD rallying above 1.21 to 1.25. Chart I-1Strong Global Growth Hurts The Dollar Chart I-2Will This Synchronized Boom Peter Off? Chart I-3EM Carry Trades And Growth When all these forces are taken together, the picture for the dollar remains murky. The recent weakness in the Baltic Dry Index as well as the outperformance of oil relative to metals prices suggests we are entering a late cycle environment where even if global growth remain above trend, it is likely to be peaking. Thus, even if the dollar were to sell off further in the coming weeks, the downside will be limited. Nonetheless, a rally in the USD will have to wait for clear signs that U.S. inflation is picking up. It is best to stay on the sidelines for now. Bottom Line: The performance of the dollar in the last weeks of the year is rarely a good gauge of the dollar trend for the next six to 12 months. However, the dollar has been suffering on the back of strong global growth. While important metrics are suggesting that global growth could lose some momentum, other essential indicators such as EM carry trades are regaining some vigor. For now, limiting directional dollar bets is a safer strategy. The dollar will only rally once U.S. inflation picks up. EUR/USD And Terminal Rates The recent strength in the euro is linked to strong global growth. However, EUR/USD has been supercharged by domestic factors. In December, the differential in expected terminal policy rates between the European Central Bank and the Federal Reserve moved violently in favor of the euro. This move reflected a forceful upgrade of the anticipated terminal policy rate in the euro area (Chart I-4). This sudden upgrade in Europe makes sense: the European economy is strong. Euro area PMIs are at record highs, German unemployment has hit post-unification lows and German inflation regained gumption. Moreover, Benoit Coeure, a member of the ECB's Executive Board, expressed some very hawkish views. The market is correct to upgrade the outlook for the ECB. However, interest rate markets continue to expect too-shy-a-Fed over the remainder of the cycle. This leaves room to upgrade the expected terminal interest rate for the U.S. The U.S. economy is also firing on all cylinders. The U.S. ISM came in at 59.7 this week, with the new order component standing at a very strong 69.4. Additionally, total hours worked have been accelerating (Chart I-5). Together, these point to very robust GDP growth. Already, the Atlanta Fed GDPNow tracker foresees growth of 3.2% for Q4. Chart I-4EM Carry Trades And Growth Chart I-5U.S. Growth Set To Accelerate Strong U.S. growth is materializing in an environment of increasingly significant capacity constraints, which has historically been associated with rising inflationary pressures (Chart I-6). The recent easing in U.S. financial conditions only reinforces this message, and argues that U.S. inflation has upside (Chart I-7). Moreover, U.S. compensation costs have been accelerating, from a low of 1.9% in 2016 to 2.5% today. Hence, U.S. inflation should perk up this year, letting the Fed increase rates more than what markets currently foresee. Chart I-6Inflationary Backdrop In The U.S. Chart I-7U.S. Financial Conditions Furthermore, the relative growth picture indicates that the increase in U.S. terminal rate should outpace the eurozone's. The Goldman Sachs Current Activity Indicator in the euro area has rolled over relative to the U.S., highlighting that the euro has tightened relative financial conditions enough to now harm the growth profile of Europe vis-à-vis the U.S. (Chart I-8). Moreover, European economic surprises are slowing sharply relative to the U.S. and the Euro Stoxx is re-testing its cycle low against the S&P 500, further corroborating the message from the Current Activity Indicator (Chart I-9). Chart I-8EUR/USD Starting To Hurt European ##br## Relative Growth Prospects Chart I-9Strains In The ##br##Eurozone Despite these dynamics, it is not clear that making a bet today on a weak euro is the proper tactic. At the time of writing, EUR/USD was flirting with its previous high of 2017; any break above 1.21 would likely push EUR/USD toward 1.25. Thus, we recommend investors continue to play pairs like short EUR/SEK to take advantage of the tightening in euro area financial conditions rather than bet outright on EUR/USD. To make this latter bet, investors will need either a marked failure of EUR/USD to break out, thus invalidating previous bullish technical signals, or a pick-up in U.S. inflation, whose timing remains unclear. Bottom Line: The euro's rally has been supercharged by an upgrade of the market's expected terminal policy rates in Europe relative to the U.S. While upgrading the ECB makes sense, markets should also upgrade the U.S. policy path as the American economy is just as strong and closer to capacity constraints, thus more likely to generate inflation. However, fighting the momentum in EUR/USD is currently dangerous. Thus, we recommend investors to wait for U.S. inflation to pick up before selling the euro. Instead, sell EUR/SEK. Mathieu Savary, Vice President Foreign Exchange Strategy mathieu@bcaresearch.com 1 Please see Foreign Exchange Strategy Weekly Report, titled "Canaries In The Coal Mine Alert: EM/JPY Carry Trades", dated December 1, 2017, available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. has been positive: Personal consumption expenditure and core personal expenditure grew at 1.8% YoY and 1.5% YoY respectively. Both measures increased from last month's reading. ISM manufacturing PMI came in at 59.7, surprising significantly to the upside. This measure also increased from last month. Meanwhile, ISM prices paid came in at 69, smashing expectations. The dollar ended 2017 on a free fall, as the enigma of low inflation in an environment of very low unemployment continues to puzzle investors. Meanwhile global growth continues to be very strong, adding an additional handicap to the dollar. We continue to believe that the Fed will hike more than expected, pushing the dollar upwards. However for this process to star, inflation must first emerge in the U.S. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - December 15, 2017 Riding The Wave: Momentum Strategies In Foreign Exchange Markets - December 8, 2017 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in Europe has been positive: M3 Money supply yearly growth surprised to the upside, coming in at 4.9%. Moreover, Europe's Markit manufacturing PMI, came in line with expectations at 60.6. Finally, Germany's headline inflation also outperformed expectations, coming in at 1.6%. However this number did decline from the previous month. EUR/USD has rallied by almost 2% since Christmas. This has been mainly due to the rhetoric by ECB members, who appear to be much less dovish than before. Indeed, ECB board member Mersch warned that the ECB "must be careful not to act too timidly and too late and to fall behind the curve". Overall, we continue to believe that the Fed will surprise the market more than the ECB will. However to have an outright bullish dollar view inflation will have to pick up in the U.S. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Temporary Short-Term Rates - November 10, 2017 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan has been positive: Retail trade yearly growth came in at 2.2%, exceeding expectations by a wide margin. Meanwhile, housing starts also surprised to the upside, as they contracted by only 0.4%. Tokyo CPI ex fresh food yearly growth also beat expectations, coming in at 0.8%. Finally, the unemployment rate declined to 2.7%. The yen has appreciated against the U.S. dollar, with USD/JPY falling by about 0.7%. Meanwhile, Kuroda continued to assert that no change is needed to the BoJ's yield curve control program. Overall, in spite of the improved global outlook which is benefiting the Japanese economy, it is unlikely that Japan will abandon its extremely dovish monetary policy unless inflation rises much further. This is unlikely to happen in the near future. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Riding The Wave: Momentum Strategies In Foreign Exchange Markets - December 8, 2017 The Xs And The Currency Market - November 24, 2017 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. has been mixed: Gross domestic product growth surprised to the upside, coming in at 1.7%. However this number did decline from the previous quarter. Additionally, total business investment yearly growth also outperformed expectations, coming in at 1.7%. However, Markit manufacturing PMI underperformed expectations, coming in at 56.3. Moreover, construction PMI also surprised to the downside, coming in at 52.2. Since Christmas, cable has gone up by roughly 1.5%. Overall we believe that the BoE is unlikely to raise rates meaningfully, as they will be more cautious than otherwise as the U.K. muddles through the Brexit negotiations. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Reverse Alchemy: How To Transform Gold Into Lead - November 3, 2017 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia has been mixed: Private sector credit yearly growth increased relatively to last month, coming in at 5.4%. However the AiG Performance of Manufacturing Index declined relatively to last month, coming in at 56.2 in December versus 57.3 in November. Finally, the RBA Commodity SDR Index, which in an early indicator of export price changes, contracted by 5.9%, a decline from last month's 4% contractions. The Australian dollar has rallied by more than 2.6% since Christmas, as multiple indicators point to continued strength in global growth. However we expect a temporary slowdown, as a result of tightening financial conditions in China. This will be negative for the AUD. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Currency Hedging: Dynamic Or Static? - A Practical Guide For Global Investors - September 29, 2017 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 The kiwi has increased by roughly 1.2% since Christmas, partly because of the decline of the U.S. dollar. However the New Zealand dollar has depreciated against almost every single G10 currency. Overall, we expect the NZD to appreciate relative to the AUD, given that the Australian dollar is much more sensitive to Chinese tightening financial conditions. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Reverse Alchemy: How To Transform Gold Into Lead - November 3, 2017 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada has been mixed: Gross Domestic Product month-on-month growth underperformed expectations, coming in at 0%. However, Markit manufacturing PMI surprised to the upside, coming in at 54.7. This measure also increased relatively to last month's. USD/CAD has plunged by nearly 2.8%. We expect the Canadian dollar to outperform the AUD and the NZD, as oil should outperform metals in the commodity space. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Market Update - October 27, 2017 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland has been positive: The KOF leading indicator surprised to the upside, coming in at 111.3 in December. This measure also increased relative to November's reading. Meanwhile, the SVME Purchasing Manager's Index also outperformed expectations, coming in at 65.2. Finally, the ZEW survey expectations component increased relatively to last month, coming in at 52. EUR/CHF has continued its appreciation into the New Year. This is good news for the SNB, as this will provide an easing in financial conditions. Overall, we expect the franc to have limited downside against the euro, as the still low inflation in Switzerland will keep the SNB intervening in currency markets. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 The Xs And The Currency Market - November 24, 2017 Updating Our Long-Term Fair Value Models - September 15, 2017 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway has been mixed: Retail sales growth for November increased relatively to last month's number, coming in at 2.1%. However, registered unemployment surprised negatively, as it increased from 2.3% to 2.4%. Since Christmas, USD/NOK has plunged by nearly 3%, as it has been battered by very strong oil prices. Overall, we expect USD/NOK to find upside, however this will happen only when rate expectations in the U.S. rise meaningfully. In order for this to happen, inflation must once again accelerate. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - December 15, 2017 The Xs And The Currency Market - November 24, 2017 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden has been mixed: Retail sales yearly growth outperformed expectations, coming in at 2.8%. This measure also increased from last month's reading. Producer price inflation also increased from last month's number, coming in at 2.7%. However, Manufacturing PMI declined in December relatively to November, coming in at 60.4. In line with multiple indicators signaling that global growth continues to improve, USD/SEK has plunged by more than 2.5% since Christmas. Investors willing to bet on a temporary slowdown in the euro area, caused by tightening financial conditions should short EUR/SEK. Report Links: 10 Charts To Digest With The Holiday Trimmings - December 22, 2017 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - December 15, 2017 The Xs And The Currency Market - November 24, 2017 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades
Highlights Question #1: Will global growth remain above trend? Yes. Question #2: Will growth continue to outperform outside the U.S.? No. Question #3: Will productivity growth pick up? Yes, but only cyclically. The structural outlook remains bleak. Question #4: Will continued strong global growth finally deliver higher inflation? Yes, although the increase in inflation will be gradual and concentrated in economies that already have little spare capacity. Feature Global Growth In Focus We wish all our readers a joyous and prosperous 2018. As the new year begins, four questions about the global growth outlook loom large. Question #1: Will global growth remain above trend? Our answer: Yes. It is likely that global growth will come down a notch from its current elevated pace. However, it should remain firmly above trend. For one thing, the global economy continues to exhibit a lot of positive momentum. Real-time measures of economic activity, such as the Goldman Sachs Current Activity Indicator (CAI), highlight that global real GDP is rising at a robust pace (Chart 1). Our global leading indicator, as well as a wide swath of PMI data, suggest that this trend has legs (Chart 2). Chart 1APositive Global Growth Momentum Can Be Seen Here Chart 1BPositive Global Growth Momentum Can Be Seen Here Since 1980, above-trend global growth in one year has been accompanied by above-trend growth in the following year nearly three-quarters of the time. This bodes well for 2018. Chart 2... And Here Too Chart 3Financial Conditions Tend To Lead Growth By Six-To-Nine Months Global financial conditions eased significantly in 2017, thanks mainly to higher equity prices and narrower credit spreads. Easier financial conditions tend to benefit growth with a 6-to-9 month lag (Chart 3). The 6-month global credit impulse, which tends to lead activity, is also positive (Chart 4). Fiscal policy should remain stimulative. The fiscal thrust moved into positive territory in advanced economies in 2016-17 and this should remain the case in 2018 (Chart 5). Tax cuts will add about 0.3 percentage points to U.S. growth, while hurricane reconstruction spending and a likely congressional agreement to raise the cap on federal discretionary spending will add another 0.2 points. Chart 4Positive Credit Impulse Is Another Tailwind For Growth Chart 5Fiscal Policy Has Turned More Stimulative Our political strategists expect further fiscal easing in Japan this year. They also believe that German coalition talks will produce more government spending, with the SDP extracting concessions from Merkel on public investment and the CSU securing a commitment for more defense expenditure. On the flipside, our strategists expect some fiscal tightening in France as President Macron takes steps to trim France's bloated welfare state. Question #2: Will growth continue to outperform outside the U.S.? Our answer: No. Global revisions were more favorable outside the U.S. in the first nine months of 2017, which helps explain why the dollar came under downward pressure (Chart 6). More recently, U.S. growth estimates have begun to drift higher. As a result, the U.S. surprise index has surged relative to those of other economies (Chart 7). Chart 6U.S. Growth Expectations Were Lagging... ##br## But Not Anymore Chart 7U.S. Economic Surprise Index Increased ##br## Relative To Those Of Other Countries We expect the data to continue to favor the U.S. Aggregate U.S. hours worked in November was up 3.4% at an annualized rate over Q3 levels. If we add in productivity growth, Q4 GDP growth was probably in excess of 4% - well above current consensus estimates. Financial conditions have eased a lot more in the U.S. than in the rest of the world. Fiscal policy is also set to loosen relatively more in the U.S. Euro area growth is likely to tick lower next year from its current stellar pace, as the impact of a stronger euro begins to bite. The 6-month credit impulse has already turned negative there. Japanese growth should also cool somewhat from the heady pace of 2.7% seen over the past two quarters. The Chinese economy will decelerate modestly in 2018. The authorities are tightening the screws on the shadow banking system, expediting efforts to reduce excess capacity in the industrial sector, and clamping down on corruption. All of these reforms will pay off in the long run, but they could dent growth in the short run. Question #3: Will productivity growth pick up? Our Answer: Yes, but only cyclically. The structural outlook remains bleak. U.S. nonfarm productivity rose by 1.5% over the prior year in Q3, well above the post-2010 average of 0.8%. This improvement occurred despite the fact that low-skilled workers continue to re-enter the labor market - dragging down output-per-hour in the process - a phenomenon that is not well captured by the official productivity data. Productivity growth elsewhere in the world also appears to be on the upswing (Chart 8). Increased business investment should support productivity in 2018. Corporate surveys indicate that a rising percentage of companies anticipate boosting capital budgets (Chart 9). This often happens in the last few innings of business-cycle expansions, as more companies begin to experience capacity constraints. Chart 8Productivity Growth Showing Signs Of ##br## A Tentative Recovery Chart 9Surveys Are Signaling Acceleration ##br## In Capex Unfortunately, while the cyclical outlook for productivity is improving, the structural backdrop remains downbeat. As we have discussed in the past, flagging educational achievement, decreased creative destruction, and a shift in technological innovation towards consumers and away from businesses all augur poorly for future productivity trends.1 The much-hyped Amazon effect makes for good news stories, but is not borne out by the data.2 Question #4: Will continued strong global growth finally deliver higher inflation? Our answer: Yes, although the increase in inflation will be gradual and concentrated in economies that already have little spare capacity. Chart 10A Pick-Up In Wage Growth Would Put Upward Pressure ##br## On Service Inflation Going into 2017, the Fed had expected core PCE inflation to end the year at 1.9%. It is likely to have finished the year at only 1.5%. We expect core PCE inflation to move toward 2% by the end of 2018. Wage growth should accelerate as the labor market continues to tighten. This should put upward pressure on service inflation (Chart 10). Goods price inflation should also recover due to the lagged effects of a weaker dollar and the bleed-through of higher energy prices into several core components of the CPI (airline fares being a notable example). Slower rent growth will dampen inflation. However, this will be partially offset by higher health care prices. The cost control measures introduced in the Affordable Care Act helped push down PCE health care services inflation from 3% in late 2010 to less than 0.5% in early 2016 (Chart 11). Many of these measures have been realized, and as a consequence, health care inflation has begun to revert to its long-term trend (though in level terms, the savings to consumers remain). The Republican tax bill could put some upward pressure on health care costs. The Congressional Budget Office estimates that the repeal of the Individual Mandate will raise premiums on health care exchanges by 10% because a larger share of healthy individuals will decide to forgo buying health insurance.3 Japanese inflation should move modestly higher in 2018, but from extremely depressed levels. The Japanese unemployment rate is now a full percentage point lower than in 2007 and the ratio of job opening-to-applicants has reached the highest level since 1974 (Chart 12). Chart 11U.S. Inflation Breakdown Chart 12Japan's Tightening Labor Market Euro area inflation will be held down by the lagged effects of a stronger euro and continued high levels of slack across southern Europe. Outside Germany, labor market underutilization is still 6.3 percentage points higher than it was in 2008 (Chart 13). U.K. inflation should edge lower as the spike in import prices stemming from the post-Brexit pound depreciation dissipates. Chart 13There Is Still Labor Market Slack Outside Of Germany Investment Conclusions A shift in global growth leadership back towards the U.S. would benefit the beleaguered U.S. dollar. Higher U.S. inflation will prompt the Fed to raise rates four times in 2018, one more hike than implied by the dots and two more hikes than implied by current market expectations. Rising inflation should also keep Treasury yields on an upward trajectory. We expect the 10-year yield to finish 2018 at around 3%. As long as inflation is rising in response to stronger growth, and from below-target levels, both U.S. and global risk assets should continue to rally. Only once U.S. inflation rises above 2% in 2019, and growth begins to slow on the back of binding supply-side constraints, will equities flounder. Stay long stocks for now, but look to significantly trim exposure towards the end of the year. Regionally, we favor euro area and Japanese equities over U.S. stocks for the next 12 months on a currency-hedged basis. Both the euro area and Japanese stock markets are dominated by large multinational companies whose prospects are geared more towards global growth than demand in their own regions. Above-trend global growth and rising capital spending should disproportionately benefit European and Japanese bourses, given that they have a greater tilt towards cyclically-sensitive companies. Valuations also tend to favor non-U.S. stocks. Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com 1 Please see Global Investment Strategy Special Report, "Is Slow Productivity Growth Good Or Bad For Bonds?," dated May 31, 2017; Weekly Report, "A Secular Bottom In Inflation," dated July 28, 2017; and Weekly Report, "Is The Phillips Curve Dead Or Dormant?" dated September 22, 2017. 2 Please see Global Investment Strategy Special Report, "Did Amazon Kill The Phillips Curve?" dated September 1, 2017. 3 Please see "Repealing the Individual Health Insurance Mandate: An Updated Estimate," Congressional Budget Office, dated November 8, 2017. Strategy & Market Trends Tactical Trades Strategic Recommendations Closed Trades
Highlights Global bourses celebrated solid earnings growth and the passage of U.S. tax cuts heading into year-end. The direct effect of the tax cuts will likely boost U.S. real GDP growth in 2018 by 0.2 to 0.3 percentage points. It could be more, depending on the impact on animal spirits in the business sector and any fresh infrastructure spending. The good news on global growth continue to roll in. Real GDP growth is accelerating in the major advanced economies, driven in part by a surge in capital spending. Nonetheless, record low volatility and a flat yield curve in the U.S. highlight our major theme for 2018; policy is on a collision course with risk assets because output gaps are closing and monetary policy is moving away from "pedal to the metal" stimulus. We expect inflation to finally begin moving higher in the U.S. and some of the other advanced economies. This will challenge the consensus view that "inflation is dead forever", and that central banks will respond quickly to any turbulence in financial markets with an easier policy stance. The S&P 500 would suffer only a 3-5% correction if the VIX were to simply mean-revert. But the pain would likely be more intense if there is a complete unwinding of 'low-vol' trading strategies. We will be watching inflation expectations and our S&P Scorecard for signs to de-risk. Government yield curves should bear steepen, before flattening again later in 2018. Stay below benchmark in duration for now and favor bonds in Japan, Italy, the U.K. and Australia versus the U.S. and Canada (currency hedged). Interest rate differentials in the first half of the year should modestly benefit the U.S. dollar versus the other major currencies. Investors should remain exposed to oil and related assets, and bet on rising inflation expectations in the major bond markets. The intensity of forthcoming Chinese reforms will have to be monitored carefully for signs they have reached an economic 'pain threshold'. We do not view China as a risk to DM risk assets, but even a soft landing scenario could be painful for base metals and the EM complex. Bitcoin is not a systemic threat to global financial markets. Feature Chart I-1Policy Collision Course? Global bourses celebrated solid earnings growth and the passage of U.S. tax cuts heading into year-end. Ominously, though, a flatter U.S. yield curve and extraordinarily low measures of volatility hover like dark clouds over the equity bull market (Chart I-1). The flatter curve could be a sign that the Fed is at risk of tightening too far, which seems incompatible with depressed asset market volatility. This combination underscores the major theme of the BCA Outlook 2018 that was sent to clients in November; policy is on a collision course with risk assets because output gaps are closing and monetary policy is moving away from "pedal to the metal" stimulus. Analysts are debating how much of the decline in volatility is due to technical factors and how much can be pinned on the macro backdrop. For us, they are two sides of the same coin. Betting that volatility will remain depressed has reportedly become a yield play, via technical trading strategies and ETFs. Trading models encourage more risk taking as volatility declines, such that lower volatility enters a self-reinforcing feedback loop. The danger is that this virtuous circle turns vicious. On the macro front, many investors appear to believe that the structure of the advanced economies has changed in a fundamental and permanent way. Deflationary forces, such as Uber, Amazon and robotics are so strong that inflation cannot rise even if labor becomes very scarce. If true, this implies that central banks will proceed slowly in tightening, and that the peak in rates is not far away. Moreover, below-target inflation allows central banks to respond to any economic weakness or unwanted tightening in financial conditions by adopting a more accommodative policy stance. In other words, investors appear to believe in the "Fed Put". Implied volatility is a mean-reverting series. It can remain at depressed levels for extended periods, especially when global growth is robust and synchronized. Nonetheless, we believe that the "outdated Phillips curve" and the "Fed Put" consensus views will be challenged later in 2018, leading to an unwinding of low-vol yield plays. For now, though, it is too early to scale back on risk assets. Global Growth Shifts Up A Gear... The good news on global growth continue to roll in. Easy financial conditions and the end of fiscal austerity provide a supportive growth backdrop. A measure of fiscal thrust for the G20 advanced economies shifted from a headwind to a slight tailwind in 2016 (Chart I-2). Our short-term models for real GDP growth in the major countries continue to rise, in line with extremely elevated purchasing managers' survey data (Chart I-3). The major exception is the U.K., where our GDP growth model is rolling over as the Brexit negotiations take a toll. Chart I-2Fiscal Austerity Is Over Chart I-3GDP Growth Models Are Upbeat Much of the acceleration in our GDP models is driven by the capital spending components. Animal spirits appear to be taking off and it is a theme across most of the advanced economies. G3 capital goods orders pulled back a bit in late 2017, but this is more likely due to noise in the data than to a peak in the capex cycle (Chart I-4). Industrial production, the PMI diffusion index and advanced-economy capital goods imports confirm strong underlying momentum in investment spending. Chart I-4Capital Spending Helping To Drive Growth In the U.S., tax cuts will give business outlays and overall U.S. GDP growth a modest lift in 2018. The House and Senate hammered out a compromise on tax cuts that is similar to the original Senate version. The new legislation will cut individual taxes by about $680 billion over ten years, trim small business taxes by just under $400 billion, and reduce corporate taxes by roughly the same amount (including the offsetting tax on currently untaxed foreign profits). The direct effect of the tax cuts will likely boost U.S. real GDP growth in 2018 by 0.2 to 0.3 percentage points. However, much depends on the ability that the tax changes and immediate capital expensing to further lift animal spirits in the business sector and bring forward investment spending. Any infrastructure program would also augment the fiscal stimulus. The total impact is difficult to estimate given the lack of details, but it is clearly growth-positive. ...But The U.S. Yield Curve Flattens... Bond investors are unimpressed so far with the upbeat global economic data. It appears that long-term yields are almost impervious as long as inflation is stuck at low levels. In the U.S., a rising 2-year yield and a range-trading 10-year yield have resulted in a substantial flattening of the 2/10 yield slope (although some of the flattening has unwound as we go to press). Investors view a flattening yield curve with trepidation because it smells of a Fed policy mistake. It appears that the bond market is discounting that the Fed can only deliver another few rate hikes before the economy starts to struggle, at which point inflation will still be below target according to market expectations. We would not be as dismissive of an inverted yield curve as Fed Chair Yellen was during her December press conference. There are indeed reasons for the curve to be structurally flatter today than in the past, suggesting that it will invert more easily. Nonetheless, the fact that the yield curve has called all of the last seven recessions is impressive (with one false positive). The good news is that, in the seven episodes in which the curve correctly called a recession, the signal was confirmed by warning signs from our Global Leading Economic Indicator and our monetary conditions index. At the moment, these confirming indicators are not even flashing yellow.1 Our fixed-income strategists believe that the curve is more likely to steepen than invert over the next six months. If inflation edges higher as we expect, then long-term yields will finally break out to the upside and the curve will steepen until the Fed's tightening cycle is further advanced. If we are wrong and inflation remains stuck near current levels or declines, then the FOMC will have to revise the 'dot plot' lower and the curve will bull-steepen. In other words, we do not think the FOMC will make a policy mistake by sticking to the dot plot if inflation remains quiescent. Rising inflation is a larger risk for stocks and bonds than a policy mistake. A clear uptrend in inflation would shake investors' confidence in the "Fed Put" and thereby trigger an unwinding of the low-vol investment strategies. A sharp selloff at the long end of the curve in the major markets would send a chill through the investment world because it would suggest that the Phillips curve is not dead, and that central banks might have fallen behind the curve. ...As Inflation Languishes For now there is little evidence of building inflation pressure in either the CPI or the Fed's preferred measure, the core PCE price index. The latter edged up a little in October to 1.4% year-over-year, but the November core CPI rate slipped slightly to 1.7%. For perspective, core CPI inflation of 2.4-2.5% is consistent with the Fed's 2% target for the core PCE index. The Fed has made no progress in returning inflation to target since the FOMC started the tightening cycle. A risk to our view is that the expected inflation upturn takes longer to materialize. The annual core CPI inflation rate fell from 2.3 in January 2017 to 1.7 in November, a total decline of 0.55 percentage points. The drop was mostly accounted for by negative contributions from rent of shelter (-0.31), medical care services (-0.13) and wireless telephone services (-0.1). These categories are not closely related to the amount of slack in the economy, and thus might continue to depress the headline inflation rate in the coming months even as the labor market tightens further. Recent regulatory changes, for example, suggest that there is more downside potential in health care services inflation. We have highlighted in past research that it is not unusual for inflation to respond to a tight labor market with an extended lag, especially at the end of extremely long expansion phases. Chart I-5 updates the four indicators that heralded inflection points in inflation at the end of the 1980s and 1990s. All four leading inflation indicators are on the rise, as is the New York Fed's Underlying Inflation Indicator (not shown). Importantly, economic slack is disappearing at the global level. The OECD as a group will be operating above potential in 2018 for the first time since the Great Recession (Chart I-6). Finally, oil prices have further upside potential. Higher energy prices will add to headline inflation and boost inflation expectations in the U.S. and the other major economies. Chart I-5U.S. Inflation: Indicators Point Up Chart I-6Vanishing Economic Slack The bottom line is that we are sticking with the view that U.S. inflation will grind higher in the coming months, allowing the FOMC to deliver the three rate hikes implied by the 'dot plot' for 2018. In December, the FOMC revised up its economic growth forecast to 2.5% in 2018, up from 2.1%. The projections for 2019 and 2020 were also revised higher. Growth is seen remaining above the 1.8% trend rate for the next three years. The FOMC expects that the jobless rate will dip to 3.9% in 2018 and 2019, before ticking up to 4.0% in 2020. With the estimate for long-run unemployment unchanged at 4.6%, this means that the labor market is expected to shift even further into 'excess demand' territory. If anything, these forecasts look too conservative. It is unreasonable to expect the unemployment rate to stabilize in 2019 and tick up in 2020 if the economy is growing above-trend. This forecast highlights the risk that the FOMC will suddenly feel 'behind the curve' if inflation re-bounds more quickly than expected, at a time when the labor market is so deep in 'excess demand' territory. The consensus among investors would also be caught off guard in this scenario, resulting in a rise in bond volatility from rock-bottom levels. How Vulnerable Are Stocks? How large a correction in risk assets should we expect? One way to gauge this risk is to estimate the historical 'beta' of risk asset prices to mean-reversions in the VIX. The VIX is currently a long way below its median. Major spikes to well above the median are associated with recessions and/or financial crises. However, as a starting point, we are interested in the downside potential for risk asset prices if the VIX simply moves back to the median. Table I-1 presents data corresponding to periods since 1990 when the VIX mean-reverted from a low level over a short period of time. We chose periods in which the VIX surged at least to its median level (17.2) from a starting point that was below 13. The choice of 13 as the lower threshold is arbitrary, but this level filters out insignificant noise in the data and still provides a reasonable number of episodes to analyze.2 Table I-1Episodes Of VIX 'Mean Reversion' The episodes are presented in ascending order with respect to the starting point for the 12-month forward P/E ratio. This was done to see whether the valuation starting point matters for the size of the equity correction. The "VIX Beta" column shows the ratio of the percent decline in the S&P 500 to the change in the VIX. The average beta over the 15 episodes suggests that stocks fall by almost a half of a percent for every one percent increase in the VIX. Today, the VIX would have to rise by about 7½% to reach the median value, implying that the S&P 500 would correct by roughly 3½%. Investment- and speculative-grade corporate bonds would underperform Treasurys by 22 and 46 basis points, respectively, in this scenario. Interestingly, the equity market reaction to a given jump in the VIX does not appear to intensify when stocks are expensive heading into the shock. The implication is that a shock that simply returns the VIX to "normal" would not be devastating for risk assets. The shock would have to be worse. Chart I-7Market Reaction To 1994 Fed Shock The episodes of VIX "mean reversion" shown in Table I-1 are a mixture of those caused by financial crises and by monetary tightening (and sometimes both). The U.S. 1994 bond market blood bath is a good example of a pure monetary policy shock. It was partly responsible for the "tequila crisis", but that did not occur until late that year. Chart I-7 highlights that the U.S. equity market reacted more violently to Fed rate hikes in 1994 than the average VIX beta would suggest. The VIX jumped by about 14% early in the year, coinciding with a 9% correction in the S&P 500. Investors had misread the Fed's intension in late 1993, expecting little in the way of rate hikes over the subsequent year. A dramatic re-rating of the Fed outlook caused a violent bond selloff that unnerved equity investors. We are not expecting a replay of the 1994 bond market turmoil because the Fed is far more transparent today. Nonetheless, the equity correction could be quite painful to the extent that the VIX overshoots the median as the large volume of low-volatility trades are unwound. A 10% equity correction in the U.S. this year would not be a surprise given the late stage of the bull market and current market positioning. Yield Curves To Bear Steepen Upward pressure on inflation, bond yields and volatility will not only come from the U.S. We expect inflation to edge higher in the Eurozone, Canada, and even Japan, given tight labor markets and diminished levels of global spare capacity. The European economy has been a star performer this year and this should continue through 2018. Even the periphery countries are participating. The key driving factors include the end of the fiscal squeeze in the periphery and the recapitalization of troubled banks. The latter has opened the door to bank lending, the weakness of which has been a major growth headwind in this expansion. Taken at face value, recent survey data are consistent with about 3% GDP growth (Chart I-3). We would dis-count that a bit, but even continued 2.0-2.5% GDP growth in the euro area would compare well to the 1% potential growth rate. This means that the output gap is shrinking and the labor market will continue tightening. Despite impressive economic momentum, the ECB is sticking to the policy path it laid out in October. Starting in January, asset purchases will continue at a reduced rate of €30bn per month until September 2018 or beyond. Meanwhile, interest rates will remain steady "for an extended period of time, and well past the horizon of the net asset purchases." If asset purchases come to an end next September, then the first rate hike may not come until 2019 Q1 at the earliest. Thus, rate hikes are a long way off, but the deceleration of growth in the Eurozone monetary base will likely place upward pressure on the long end of the bund curve (shown inverted in Chart I-8). Chart I-8ECB Tapering Will Be Bond-Bearish Canada is another economy with ultra-low interest rates and rapidly diminishing labor market slack. The Bank of Canada will be forced to follow the Fed in hiking rates in the coming quarters. In Japan, strong PMI and capital goods orders are hopeful signs that domestic capital spending is picking up, consistent with our upbeat real GDP model (Chart I-3). Recent data on industrial production and retail sales were weak, but this was likely due to heavy storm activity; we expect those readings to bounce back. Nonetheless, it is still not clear that the Japanese economy has moved away from a complete dependency on the global growth engine. We would like to see stronger wage gains to signal that the economy is finally transitioning to a more self-reinforcing stage. It is hopeful that various measures of core inflation are slightly positive, but this is tentative at best. That said, the BoJ may be forced to alter its current "yield curve control" strategy by modestly lifting the target on longer-term JGB yields later in 2018, in response to pressures from robust growth and rising global bond yields. Thus, the pressure for higher bond yields should rotate away from the U.S. in the latter half of 2018 towards Europe, Canada and possibly Japan. This could eventually see the U.S. dollar head lower, but we still foresee a window in the first half of 2018 in which the dollar will appreciate on the back of widening interest rate differentials. We are less bullish than we were in mid-2017, expecting only about a 5% dollar appreciation. China: Long-Term Gain Or Short-Term Pain? The Chinese cyclical outlook remains a key risk to our upbeat view on risk assets. Significant structural reforms are on the way, now that President Xi has amassed significant political support for his reform agenda. These include deleveraging in the financial sector, a more intense anti-corruption campaign focused on the shadow-banking sector, and an ongoing restructuring in the industrial sector. The reforms will likely be positive for long-term growth, but only to the extent that they are accompanied by economic reforms. This month's Special Report, beginning on page 19, highlights that 2018 will be pivotal for China's long-term investment outlook. In the short term, reforms could be a net negative for growth depending on how deftly the authorities handle the monetary and fiscal policy dials. We witnessed this tension between growth and reform in the early years of President Xi's term, when the drive to curtail excessive credit growth and overcapacity caused an abrupt slowdown in 2015. Managing the tradeoff means that China's economy will evolve in a series of growth mini cycles. China is in the down-phase of a mini cycle at the moment, as highlighted by the Li Keqiang Index (LKI; Chart I-9). The LKI is a good proxy for the business cycle. BCA's China Strategy service recently combined the data with the best leading properties for the LKI into a single indicator.3 This indicator suggests that the LKI will end up retracing about 50% of its late 2015 to early 2017 rise before the current slowdown is complete. The good news is that broad money growth, which is a part of the LKI leading indicator, has re-accelerated in recent months. This suggests that the current economic slowdown phase will not be protracted, consistent with our 'soft landing' view. The intensity of forthcoming reforms will have to be monitored carefully for signs they have reached an economic pain threshold. We will be watching our LKI leading indicator and a basket of relevant equity sectors for warning signs. We do not view China as a risk to DM risk assets, but even a soft landing scenario could be painful for base metals and the EM complex (Chart I-10). Chart I-9China: Where Is The Bottom? Chart I-10Metals At Risk Of China Soft Landing Equity Country Allocation For now we continue to recommend overweight positions in stocks versus bonds and cash within balanced portfolios. We also still prefer Japanese stocks to the U.S., reflecting our expectation for rising bond yields in the latter and an earnings outlook that favors the former. Chart I-11 updates our earnings-per-share growth forecast for the U.S., Japan and the Eurozone. We expect U.S. EPS growth to decelerate more quickly in 2018 than in Japan, since the U.S. is further ahead in the earning cycle and is more exposed to wage and margin pressure. European earnings growth will also be solid in 2018, but this year's euro appreciation will be a headwind for Q4 2017 and Q1 2018 earnings. European and Japanese stocks are also a little on the cheap side versus the U.S., although not by enough to justify overweight positions on valuation grounds alone. We have extended our valuation work to a broader range of countries, shown in Chart I-12. All are expressed relative to the U.S. market. These metric exclude the Financials sector, and adjust for both differing sector weights and structural shifts in relative valuation. Mexico is the only one that is more than one standard deviation cheap relative to the U.S. Nonetheless, our EM team is reluctant to recommend this market given uncertainty regarding the NAFTA negotiations. Russia is not as cheap, but is in the early stages of recovery. Our EM team is overweight. Chart I-11Top-Down EPS Projection Chart I-12Valuation Ranking Of Nonfinancial Equity Markets Relative To The U.S. A Note On Bitcoin Finally, we have received a lot of client questions regarding bitcoin. The incredible surge in the price of the cryptocurrency dwarfs previous asset price bubbles by a wide margin (Chart I-13). As is usually the case with bubble, supporters argue that "this time is different." We doubt it. Chart I-13Bitcoin Bubble Dwarfs All The Rest BCA's Technology Sector Strategy weighed into this debate in a recent Special Report.4 In theory, blockchain technology, including cyber currencies, can be used as a highly secure, low cost, means of transfer value from one person to the next without an intermediary. However, the report highlights that bitcoin is highly subject to fraud and manipulation because it is unregulated. Liquidity and accurate market quotes are questionable on the "fly by night" exchanges. Its use as a medium of exchange is very limited, and governments are bound to regulate it because cryptocurrencies are a tool for money laundering, tax evasion and other criminal activities. Another fact to keep in mind is that, although the supply of new bitcoins is restricted, the creation of other cryptocurrencies is unlimited. Would the bursting of the bitcoin bubble represent a risk to the economy? The market cap of all cryptocurrencies is estimated to be roughly US$400 billion (US$250 billion for bitcoin alone). This is tiny compared to global GDP or the market cap of the main asset classes such as stocks and bonds. The amount of leverage associated with bitcoin is unknown, but it is hard to see that it would be large enough to generate a significant wealth effect on spending and/or a marked impact on overall credit conditions. The links to other financial markets appear limited. Investment Conclusions Our recommended asset allocation is "steady as she goes" as we move into 2018. The policy and corporate earnings backdrop will remain supportive of risk assets at least for the first half of the year. In the U.S., the recently passed tax reform package will boost after-tax corporate cash flows by roughly 3-5%. Cyclical stocks should outperform defensives in the near term. Nonetheless, we expect 2018 to be a transition year. Stretched valuations and extremely low volatility imply that risk assets are vulnerable to the consensus macro view that central banks will not be able to reach their inflation targets even in the long term. The consensus could be in for a rude awakening. We expect equity markets to begin discounting the next U.S. recession sometime in early 2019, but markets will be vulnerable in 2018 to a bond bear phase and escalating uncertainty regarding the economic outlook. If risk assets have indeed entered the late innings, then we must watch closely for signs to de-risk. One item to watch is the 10-year U.S. CPI swap rate; a shift above 2.3% would be consistent with the Fed's 2% target for the PCE measure of inflation. This would be a signal that the FOMC will have to step-up the pace of rate hikes and aggressively slow economic growth. We will also use our S&P Scorecard Indicator to help time the exit from our overweight equity position (Chart I-14). The Scorecard is based on seven indicators that have a good track record of heralding equity bear markets.5 These include measures of monetary conditions, financial conditions, value, momentum, and economic activity. The more of these indicators in "bullish" territory, the higher the score. Currently, four of the indicators are flashing a bullish signal (financial conditions, U.S. unemployment claims, ISM new orders minus inventories, and momentum). We demonstrated in previous research that a Scorecard reading of three or above was historically associated with positive equity total returns in the subsequent months. A drop below three this year would signal the time to de-risk. Our thoughts on the risks facing equities carry over to the corporate bonds space. Our Global Fixed Income Strategy service notes that uncertainty about future growth has the potential to increase interest rate volatility that can also push corporate credit spreads wider (Chart I-15).6 Elevated leverage in the corporate sector adds to the risk of a re-rating of implied volatility. For now, however, investors should continue to favor corporate bonds relative to governments for the (albeit modest) yield pickup. Chart I-14Watch Our Scorecard To Time The Exit Chart I-15Higher Uncertainty & ##br##Vol To Hit Corporate Bonds Overall bond portfolio duration should be kept short of benchmark. We may recommend taking profits and switching to benchmark duration after global yields have increased and are beginning to negatively affect risk assets. While yields are rising, investors should favor bonds in Japan, Italy, the U.K. and Australia within fixed-income portfolios (on a currency-hedged basis). Underweight the U.S. and Canada. German and French bonds should be close to benchmark. Yield curves should steepen, before flattening later in the year. Interest rate differentials in the first half of the year should modestly benefit the U.S. dollar versus the other major currencies. Finally, investors should remain exposed to oil and related assets, and bet on rising inflation expectations in the major bond markets. Mark McClellan Senior Vice President The Bank Credit Analyst December 28, 2017 Next Report: January 25, 2018 1 Please see BCA Global ETF Strategy service, "A Guide to Spotting And Weathering Bear Markets," August 16, 2017, available at etf.bcaresearch.com 2 Note that we are not saying that a rise in the VIX "causes" stocks to correct. Rather, we are assuming that a shock occurs that causes stocks to correct and the VIX to rise simultaneously. 3 Please see China Investment Strategy Special Report, "The Data Lab: Testing The Predictability Of China's Business Cycle," November 30, 2017, available at cis.bcaresearch.com 4 Please see BCA Technology Sector Strategy Special Report, "Cyber Currencies: Actual Currencies Or Just Speculative Assets?" December 12, 2017, available at tech.bcaresearch.com 5 Market Timing: Holy Grail Or Fool's Gold? The Bank Credit Analyst, May 26, 2016. 6 Please see BCA Global Fixed Income Strategy service, "Our Model Bond Portfolio Allocation In 2018: A Tail Of Two Halves," December 19, 2017, available at gfis.bcaresearch.com II. A Long View Of China 2018 is a pivotal year for China, as it will set the trajectory for President Xi Jinping's second term ... and he may not step down in 2022. Poverty, inequality, and middle-class angst are structural and persistent threats to China's political stability. The new wave of the anti-corruption campaign is part of Xi's attempt to improve governance and mitigate political risks. Yet without institutional checks and balances, Xi's governance agenda will fail. Without pro-market reforms, investors will face a China that is both more authoritarian and less productive. Hearts rectified, persons were cultivated; persons cultivated, families were regulated; families regulated, states were rightly governed; states rightly governed, the whole world was made tranquil and happy. - Confucius, The Great Learning Comparisons of modern Chinese politics with Confucian notions of political order have become cliché. Nevertheless, there is a distinctly Confucian element to Chinese President Xi Jinping's strategy. Xi's sweeping anti-corruption campaign, which will enter "phase two" in 2018, is essentially an attempt to rectify the hearts and regulate the families of Communist Party officials and civil servants. The same could be said for his use of censorship and strict ideological controls to ensure that the general public remains in line with the regime. Yet Xi is also using positive measures - like pollution curbs, social welfare, and other reforms - to win over hearts and minds. His purpose is ultimately the preservation of the Chinese state - namely, the prevention of a Soviet-style collapse. Only if the regime is stable at home can Xi hope to enhance the state's international security and erode American hegemony in East Asia. This would, from Beijing's vantage, make the whole world more tranquil and happy. Thus, for investors seeking a better understanding of China in the long run, it is necessary to look at what is happening to its governance as well as to its macroeconomic fundamentals and foreign relations.1 China's greatest vulnerability over the long run is its political system. Because Xi Jinping's willingness to relinquish power is now uncertain, his governance and reform agenda in his second term will have an outsized impact on China's long-run investment outlook. The Danger From Within From 1978-2008, the Communist Party's legitimacy rested on its ability to deliver rising incomes. Since the Great Recession, however, China has entered a "New Normal" of declining potential GDP growth as the society ages and productivity growth converges toward the emerging market average (Chart II-1). In this context, Chinese policymakers are deathly afraid of getting caught in the "middle income trap," a loose concept used to explain why some middle-income economies get bogged down in slower growth rates that prevent them from reaching high-income status (Chart II-2).2 Chart II-1The New Normal Chart II-2Will China Get Caught In The Middle-Income Trap? Such a negative economic outcome would likely prompt a wave of popular discontent, which, in turn, could eventually jeopardize Communist Party rule. The quid pro quo between the Chinese government and its population is that the former delivers rising incomes in exchange for the latter's compliance with authoritarian rule. The party is not blind to the fate of other authoritarian states whose growth trajectory stalled. The threat of popular unrest in China may seem remote today. The Communist Party is rallying around its leader, Xi Jinping; the economy rebounded from the turmoil of 2015 and its cyclical slowdown in recent months is so far benign; consumer sentiment is extremely buoyant; and the global economic backdrop is bright (Chart II-3). Yet these positive political and economic developments are cyclical, whereas the underlying political risks are structural and persistent. China has made massive gains in lifting its population out of poverty, but it is still home to 559 million people, around 40% of the population, living on less than $6 per day, the living standard of Uzbekistan. It will be harder to continue improving these workers' quality of life as trend growth slows and the prospects for export-oriented manufacturing dry up. This is why the Xi administration has recently renewed its attention to poverty alleviation. The government is on target in lifting rural incomes, but behind target in lifting urban incomes, and urban-dwellers are now the majority of the nation (Chart II-4). The plight of China's 200-250 million urban migrants, in particular, poses the risk of social discontent. Chart II-3China's Slowdown So Far Benign Chart II-4Urban Income Targets At Risk Moreover, while China knows how to alleviate poverty, it has less experiencing coping with the greatest threat to the regime: the rapid growth of the middle class, with its high expectations, demands for meritocracy and social mobility, and potential for unrest if those expectations are spoiled (Chart II-5). Democracy is not necessarily a condition for reaching high-income status, but all of Asia's high-income countries are democracies. A higher level of wealth encourages household autonomy vis-à-vis the state. Today, China has reached the $8,000 GDP per capita range that often accompanies the overthrow of authoritarian regimes.3 The Chinese are above the level of income at which the Taiwanese replaced their military dictatorship in 1987; China's poorest provinces are now above South Korea's level in that same year, when it too cast off the yoke of authoritarianism (Chart II-6). Chart II-5The Communist Party's Greatest Challenge Chart II-6China's Development Beyond Point At Which Taiwan And Korea Overthrew Dictatorship This is not an argument for democracy in China. We are agnostic about whether China will become democratic in our lifetime. We are making a far more humble point: that political risk will mount as wealth is accumulated by the country's growing middle class. Several emerging markets - including Thailand, Malaysia, Turkey and Brazil - have witnessed substantial political tumult after their middle class reached half of the population and stalled (Chart II-7). China is approaching this point and will eventually face similar challenges. Chart II-7Middle Class Growth Troubles Other EMs The comparison reveals that an inflection point exists for a society where the country's political establishment faces difficulties in negotiating the growing demands of a wealthier population. As political scientists have shown empirically, the very norms of society evolve as wealth erodes the pull of Malthusian and traditional cultural variables.4 Political transformation can follow this process, often quite unexpectedly and radically.5 Clearly the Chinese public shows no sign of large-scale, revolutionary sentiment at the moment. And political opposition does not necessarily result in regime change. Nevertheless, it is empirically false that the Chinese people are naturally opposed to democracy or representative government. After all, Sun Yat Sen founded a Republic of China in 1912, well before many western democratic transformations! And more to the point, the best survey evidence shows that the Chinese are culturally most similar to their East Asian neighbors (as well as, surprisingly, the Baltic and eastern European states): this is not a neighborhood that inherently eschews democracy. Remarkably, recent surveys suggest that China's millennial generation, while not wildly enthusiastic about democracy, is nevertheless more enthusiastic than its peers in the western world's liberal democracies (Chart II-8)! Chart II-8Chinese People Not Less Fond Of Democracy Than Others China is also home to one of the most reliable predictors of political change: inequality. China's economic boom is coincident with the rise of extreme inequalities in income, wealth, region, and social status. True, judging by average household wealth, everyone appears to be a winner; but the average is misleading because it is pulled upward by very high net worth individuals - and China has created 528 billionaires in the past decade alone. A better measure is the mean-to-median wealth ratio, as it demonstrates the gap that opens up between the average and the typical household. As Chart II-9 demonstrates, China is witnessing a sharp increase in inequality relative to its neighbors and peers. More standard measures of inequality, such as the Gini coefficient, also show very high readings in China. And this trend has combined with social immobility: China has a very high degree of generational earnings elasticity, which is a measure of the responsiveness of one's income to one's parent's income. If elasticity is high, then social outcomes are largely predetermined by family and social mobility is low. On this measure, China is an extreme outlier - comparable to the U.S. and the U.K., which, while very different economies, have suffered recent political shocks as a result of this very predicament (Chart II-10). Chart II-9Inequality: A Severe Problem In China Chart II-10China An Outlier In Inequality And Social Immobility "China does not have voters" unlike the U.S. and U.K., is the instant reply. Yet that statement entails that China has no pressure valve for releasing pent-up frustrations. Any political shock may be more, not less, destabilizing. In the U.S. and the U.K., voters could release their frustrations by electing an anti-establishment president or abrogating a trade relationship with Europe. In China, the only option may be to demand an "exit" from the political system altogether. Note that there is already substantial evidence of social unrest in China over the past decade. From 2003 to 2007, China faced a worrisome increase in "mass incidents," at which point the National Bureau of Statistics stopped keeping track. The longer data on "public incidents" suggests that the level of unrest remains elevated, despite improvements under the Xi administration (Chart II-11). Broader measures tell a similar story of a country facing severe tensions under the surface. For instance, China's public security spending outstrips its national defense spending (Chart II-12). Chart II-11Chinese Social Unrest Is Real Chart II-12China Spends More On ##br##Domestic Security Than Defense In essence, Chinese political risk is understated. This conclusion may seem counterintuitive, given Xi's remarkable consolidation of power. But is ultimately structural factors, not individual leaders, that will carry the day. The Communist Party is in a good position now, but its leaders are all-too-aware of the volcanic frustrations that could be unleashed should they fail to deliver the "China Dream." This is why so much depends upon Xi's policy agenda in the second half of his term. To that question we will now turn. Bottom Line: The Communist Party is at a cyclical high point of above-trend economic growth and political consolidation under a strongman leader. However, political risk is understated: poverty, inequality, and middle-class angst are structural and persistent and the long-term potential growth rate is slowing. If we assume that China is not unique in its historical trajectory, then we can conclude that it is approaching one of the most politically volatile periods in its development. Chart II-13Xi's Anti-Corruption Campaign The Governance And Reform Agenda Since coming to office in 2012-13, President Xi has spearheaded an extraordinary anti-corruption campaign and purge of the Communist Party (Chart II-13). The campaign has understandably drawn comparisons to Chairman Mao Zedong's Cultural Revolution (1966-76). Yet these are not entirely fair, as Xi has tried to improve governance as well as eradicate his enemies. As Xi prepares for his "re-election" in March 2018, he has declared that he will expand the anti-corruption campaign further in his second term in office: details are scant, but the gist is that the campaign will branch out from the ruling party to the entire state bureaucracy, on a permanent basis, in the form of a new National Supervision Commission.6 There are three ways in which this agenda could prove positive for China's long-term outlook. First, the regime clearly hopes to convince the public that it is addressing the most burning social grievances. Corruption persistently ranks at the top of the list, insofar as public opinion can be known (Chart II-14). Public opinion is hard to measure, but it is clear that consumer sentiment is soaring in the wake of the October party congress (see Chart II-3 above). It is also worth noting that the Chinese public's optimism perked up in Xi's first year in office, when the policy agenda on offer was substantially the same and the economy had just experienced a sharp drop in growth rates (Chart II-15). Reassuring the public over corruption will improve trust in the regime. Second, the anti-corruption campaign feeds into Xi's broader economic reform agenda. Productivity growth is harder to generate as a country's industrialization process matures. With the bulk of the big increases in labor, capital, and land supply now complete in China, the need to improve total factor productivity becomes more pressing (Chart II-16). Unlike the early stages of growth, this requires reaching the hard-to-get economic conditions, such as property rights, human capital, financial deepening, entrepreneurship, innovation, education, technology, and social welfare. Chart II-14Chinese Public Grievances Chart II-15Anti-Corruption Is Popular Chart II-16Productivity Requires Institutional Change On this count, the Xi administration's anti-corruption campaign has been a net positive. The most widely accepted corruption indicators suggest that it has made a notable improvement to the country's governance. Yet the country remains far below its competitors in the absolute rankings, notably its most similar neighbor Taiwan (Chart II-17 A&B). The institutionalization of the campaign could thus further improve the institutional framework and business environment. Chart II-17AAnti-Corruption Campaign Is A Plus... Chart II-17B...But There's A Long Way To Go Third, the anti-corruption campaign can serve as a central government tool in enforcing other economic reforms. Pro-productivity reforms are harder to execute in the context of slowing growth because political resistance increases among established actors fighting to preserve their existing advantages. If the ruling party is to break through these vested interests, it needs a powerful set of tools. Recently, the central government in Beijing has been able to implement policy more effectively on the local level by paving the way through corruption probes that remove personnel and sharpen compliance. Case in point: the use of anti-corruption officials this year gave teeth to environmental inspection teams tasked with trimming overcapacity in the industrial sector (Chart II-18). And there are already clear signs that this method will be replicated as financial regulators tackle the shadow banking sector.7 Chart II-18Reforms Cut Steel Capacity, ##br##Reduced Need For Scrap These last examples - financial and environmental regulatory tightening - are policy priorities in 2018. The coercive aspect of the corruption probes should ensure that they are more effective than they would otherwise be. And reining in asset bubbles and reducing pollution are clear long-term positives for the regime. Ideally, then, Xi's anti-corruption campaign will deliver three substantial improvements to China's long-term outlook: greater public trust in the government, higher total factor productivity, and reduced systemic risks. The administration hopes that it can mitigate its governance deficit while improving economic sustainability. In this way it can buy both public support and precious time to continue adjusting to the new normal. The danger is that these policies will combine to increase downside risks to growth in the short term.8 Bottom Line: Xi's anti-corruption campaign is being expanded and institutionalized to cover the entire Chinese administrative state. This is a consequential campaign that will take up a large part of Xi's second term. It is the administration's major attempt to mitigate the socio-political challenges that await China as it rises up the income ladder. Absolute Power Corrupts Absolutely? The problem, however, is that Xi may merely use the anti-corruption campaign to accrue more power into his hands. As is clear from the above, Xi's governance agenda is far from impartial and professional. The anti-corruption campaign is being used not only to punish corrupt officials but also to achieve various other goals. Xi has even publicly linked the campaign to the downfall of his political rivals.9 In essence, the campaign highlights the core contradiction of the Xi administration: can Xi genuinely improve China's governance by means of the centralization and personalization of power? Chart II-19China's Governance Still Falls Far Behind Over the long haul, the fundamental problem is the absence of checks and balances, i.e. accountability, from Xi's agenda. For instance, the National Supervision Commission will be granted immense powers to investigate and punish malefactors within the state - but who will inspect the inspectors? Xi's other governance reforms suffer the same problem. His attempt to create "rule of law" is lacking the critical ingredients of judicial independence and oversight. The courts are not likely to be able to bring cases against the party, central government, or powerful state-owned firms, and they will not be able to repeal government decisions. Thus, as many commentators have noted, Xi's notion of rule of law is more accurately described as "rule by law": the reformed legal system will in all probability remain an instrument in the hands of the Communist Party. Likewise, Xi's attempt to grant the People's Bank of China greater powers of oversight in order to combat systemic financial risk suffers from the fact that the central bank is not independent, and will remain subordinate to the State Council, and hence to the Politburo Standing Committee. This is not even to mention the lamentable fact that Xi's campaign for better governance has so far coincided with extensive repression of civil society, which does not mesh well with the desire to improve human capital and innovation.10 Thus it is of immense importance whether Xi sets up relatively durable anti-corruption, legal, and financial institutions that will maintain their legitimate functions beyond his term and political purposes. Otherwise, his actions will simply illustrate why China's governance indicators lag so far behind its peers in absolute terms. Corruption perceptions may improve further, but there will be virtually no progress in areas like "voice and accountability," "political stability and absence of violence," "rule of law," and "regulatory quality," each of which touches on the Communist Party's weak spots in various ways (Chart II-19). Analysis of the Communist Party's shifting leadership characteristics reinforces a pessimistic view of the long run if Xi misses his current opportunity.11 The party's top leadership increasingly consists of career politicians from the poor, heavily populated interior provinces - i.e. the home base of the party. Their educational backgrounds are less scientific, i.e. more susceptible to party ideology. (Indeed, Xi Jinping's top young protégé, Chen Miner, is a propaganda chief.) And their work experience largely consists of ruling China's provinces, where they earned their spurs by crushing rebellions and redistributing funds to placate various interest groups (Chart II-20). While one should be careful in drawing conclusions from such general statistics, the contrast with the leadership that oversaw China's boldest reforms in the 1990s is plain. Chart II-20China's Leaders Becoming More 'Communist' Over Time Bottom Line: Xi's reform agenda is contradictory in its attempt to create better governance through centralizing and personalizing power. Unless he creates checks and balances in his reform of China's institutions, he is likely to fall short of long-lasting improvements. The character profiles of China's political elite do not suggest that the party will become more likely to pursue pro-market reforms in Xi's wake. Xi Jinping's Choice Xi is the pivotal player because of his rare consolidation of power, and 2018 is the pivotal year. It is pivotal because it will establish the policy trajectory of Xi's second term - which may or may not extend into additional terms after 2022. So far, the world has gained a few key takeaways from Xi's policy blueprint, which he delivered at the nineteenth National Party Congress on October 18: Xi has consolidated power: He and his faction reign supreme both within the Communist Party and the broader Chinese state; Xi's policy agenda is broadly continuous: Xi's speech built on his administration's stated aims in the first five years as well as the inherited long-term aims of previous administrations; China is coming out of its shell: In the international realm, Xi sees China "moving closer to center stage and making greater contributions to mankind"; The 2022 succession is in doubt: Xi refrained from promoting a successor to the Politburo Standing Committee, the unwritten norm since 1992. Markets have not reacted overly negatively to these developments (Chart II-21), as the latter do not pose an immediate threat to the global rally in risk assets. The reasons are several: Chart II-21Market Not Too Worried About ##br##Party Congress Outcomes Maoism is overrated: While the Communist Party constitution now treats Xi Jinping as the sole peer of the disastrous ruler Mao Zedong, the market does not buy the Maoist rhetoric. Instead, it sees policy continuity, yet with more effective central leadership, which is a plus. Reforms are making gradual progress: Xi is treading carefully, but is still publicly committed to a reform agenda of rebalancing China's economic model toward consumption and services, improving governance and productivity, and maintaining trade openness. Whatever the shortcomings of the first five years, this agenda is at least reformist in intention. China's tactic of "seeking progress while maintaining stability" is certainly more reassuring than "progress at any cost" or "no progress at all"! Trump and Xi are getting along so far: Xi's promises to move China toward center stage threaten to increase geopolitical tensions with the United States in the long run, yet markets are not overly alarmed. China is imposing sanctions on North Korea to help resolve the nuclear missile standoff, negotiating a "Code of Conduct" in the South China Sea, and promoting the Belt and Road Initiative (BRI), which will marginally add to global development and growth. Trump is hurling threatening words rather than concrete tariffs. 2022 is a long way away: Markets are unconcerned with Xi's decision not to put a clear successor on the Politburo Standing Committee, even though it implies that Xi will not step down at the end of his term in five years. Investors are implicitly approving Xi's strongman behavior while blissfully ignoring the implication that the peaceful transition of power in China could become less secure. Are investors right to be so sanguine? Cyclically, BCA's China Investment Strategy is overweight Chinese investible equities relative to EM and global stocks. Geopolitical Strategy also recommends that clients follow this view and overweight China relative to EM. Beyond this 6-12 month period, it depends on how Xi uses his political capital. If Xi is serious about governance and economic reform, then long-term investors should tolerate the other political risks, and the volatility of reforms, and overweight China within their EM portfolio. After all, China's two greatest pro-market reformers, Deng Xiaoping and Jiang Zemin, were also heavy-handed authoritarians who crushed domestic dissent, clashed with the United States from time to time, and hesitated to relinquish control to their successors. However, if Xi is not serious, then investors with a long time horizon should downgrade China/EM assets - as not only China but the world will have a serious problem on its hands. For Deng Xiaoping and Jiang Zemin always reaffirmed China's pro-market orientation and desire to integrate into the global economic order. If Xi turns his back on this orientation, while imprisoning his rivals for corruption, concentrating power exclusively in his own person, and contesting U.S. leadership in the Asia Pacific, then the long-run outlook for China and the region should darken rather quickly. Domestic institutions will decay and trade and foreign investment will suffer. How and when will investors know the difference? As mentioned, we think 2018 is critical. Xi is flush with political capital and has a positive global economic backdrop. If he does not frontload serious efforts this year then it will become harder to gain traction as time goes by.12 If he demurs, the Chinese political system will not afford another opportunity like this for years to come. The country will approach the 2020s with additional layers of bureaucracy loyal to Xi, but no significant macro adjustments to its governance or productivity. It is not clear how long China's growth rate is sustainable without pro-productivity reforms. It is also not clear that the world will wait five years before responding to a China that, without a new reform push, will appear unabashedly mercantilist, neo-communist, and revisionist. Bottom Line: The long-run investment outlook for China hinges on Xi Jinping's willingness to use his immense personal authority and concentration of power for the purposes of good governance and market-oriented economic reform. Without concrete progress, investors will have to decide whether they want to invest in a China that is becoming less economically vibrant as well as more authoritarian. We think this would be a bad bet. Matt Gertken Associate Vice President Geopolitical Strategy Marko Papic Senior Vice President Chief Geopolitical Strategist Geopolitical Strategy 1 Please see BCA Geopolitical Strategy Special Report, "Taking Stock Of China's Reforms," dated May 13, 2015, available at gps.bcaresearch.com. 2 Chinese policymakers are expressly concerned about the middle-income trap. Please see the World Bank and China's Development Research Center of the State Council, "China 2030: Building A Modern, Harmonious, And Creative Society," 2013, available at www.worldbank.org. Liu He, who is perhaps Xi Jinping's top economic adviser, had a hand in drafting this report and is now a member of the Politburo and shortlisted to take charge of the newly established Financial Stability and Development Commission at the People's Bank of China. 3 Please see Indermit S. Gill and Homi Kharas, "The Middle-Income Trap Turns Ten," World Bank, Policy Research Working Paper 7403 (August, 2015), available at www.worldbank.org 4 Please see Ronald Inglehart and Christian Welzel, Modernization, Cultural Change and Democracy: the Human Development Sequence (Cambridge: CUP, 2005). 5 For example, the collapse of the Soviet Union and the Arab Spring, as well as the downfall of communist regimes writ large, were completely unanticipated. 6 Specifically, Xi is creating a National Supervision Commission that will group a range of existing anti-graft watchdogs under its roof at the local, provincial, and central levels of administration, while coordinating with the Communist Party's top anti-graft watchdog. More details are likely to be revealed at the March legislative session, but what matters is that the initiative is a significant attempt to institutionalize the anti-corruption campaign. Please see BCA Geopolitical Strategy Special Report, "China's Party Congress Ends ... So What?" dated November 1, 2017, available at gps.bcaresearch.com. 7 China has recently drafted top anti-graft officials, such as Zhou Liang, from the powerful Central Discipline and Inspection Commission and placed them in the China Banking Regulatory Commission, which is in charge of overseeing banks. Authorities have already imposed fines in nearly 3,000 cases in 2017 affecting various kinds of banks, including state-owned banks. On the broader use of anti-corruption teams for economic policy, please see Barry Naughton, "The General Secretary's Extended Reach: Xi Jinping Combines Economics And Politics," China Leadership Monitor 54 (Fall 2017), available at www.hoover.org. 8 Please see BCA Geopolitical Strategy Special Report, "Three Questions For 2018," dated December 13, 2017, available at gps.bcaresearch.com. 9 Please see Gao Shan et al, "China's President Xi Jinping Hits Out at 'Political Conspiracies' in Keynote Speech," Radio Free Asia, January 3, 2017, available at www.rfa.org 10 Xi has cranked up the state's propaganda organs, censorship of the media, public surveillance, and broader ideological and security controls (including an aggressive push for "cyber-sovereignty") to warn the public that there is no alternative to Communist Party rule. This tendency has raised alarms among civil rights defenders, lawyers, NGOs, and the western world to the effect that China's governance is actually regressing despite nominal improvement in standard indicators. This is the opposite of Confucius's bottom-up notion of order. 11 Please see BCA Geopolitical Strategy Special Report, "China: Looking Beyond The Party Congress," dated July 19, 2017, available at gps.bcaresearch.com. 12 Xi faces politically sensitive deadlines in the 2020-22 period: the economic targets in the thirteenth Five Year Plan; the hundredth anniversary of the Communist Party in 2021; and Xi's possible retirement at the twentieth National Party Congress in 2022. At that point he will need to focus on demonstrating the Communist Party's all-around excellence and make careful preparations either to step down or cling to power. III. Indicators And Reference Charts Global equity indexes remained on a tear heading into year-end on the back of robust earnings growth in the major countries and U.S. tax cuts. There are some dark clouds hanging over this rally, as discussed in the Overview section. The technicals are stretched, but none of our fundamental indicators are warning of a market top. Implied equity volatility is very low, which can be interpreted in a contrary fashion. Investor sentiment is frothy and our Speculation Indicator is very elevated. Moreover, our equity valuation indicator has finally reached one standard deviation, which is our threshold of overvaluation. Valuation does not tell us anything about timing, but it does highlight the downside risks. Our monetary indicator also deteriorated a little more in December, although not by enough on its own to justify downgrading risk assets. On a positive note, earnings surprises and the net revisions ratio are not sending any warning signs for profit growth (although net revisions have edged lower recently). Moreover, our new Revealed Preference Indicator (RPI) continued on its bullish equity signal in November for the fifth consecutive month. The RPI combines the idea of market momentum with valuation and policy measures. It provides a powerful bullish signal if positive market momentum lines up with constructive signals from the policy and valuation measures. Conversely, if constructive market momentum is not supported by valuation and policy, investors should lean against the market trend. Our Willingness-to-Pay (WTP) indicators are also bullish on stocks in the U.S., Europe and Japan. These indicators track flows, and thus provide information on what investors are actually doing, as opposed to sentiment indexes that track how investors are feeling. The small dip in the Japanese WTP in December is a little worrying, but we need to see more weakness to confirm that flows no longer favor Japanese equities. In contrast, Europe's WTP rose sharply in December, suggesting that investors are allocating more to their European equity holdings. We are overweight both Europe and (especially) Japan relative to the U.S. (currency hedged). U.S. Treasury valuation is still very close to neutral, even following December's backup in yields. There is plenty of upside potential for yields before they hit "inexpensive" territory. Similarly, our technical bond indicator suggests that technical factors will not be headwind to a further bond selloff in 2018. Little has change for the dollar. The technicals are neutral. Value is expensive based on PPP, but less so by other valuation metrics. We see modest upside for the greenback in 2018. EQUITIES: Chart III-1U.S. Equity Indicators Chart III-2Willingness To Pay For Risk Chart III-3U.S. Equity Sentiment Indicators Chart III-4Revealed Preference Indicator Chart III-5U.S. Stock Market Valuation Chart III-6U.S. Earnings Chart III-7Global Stock Market And ##br##Earnings: Relative Performance Chart III-8Global Stock Market And ##br##Earnings: Relative Performance FIXED INCOME: Chart II-9U.S. Treasurys And Valuations Chart II-10U.S. Treasury Indicators Chart II-11Selected U.S. Bond Yields Chart II-1210-Year Treasury Yield ComponentsChart II-13U.S. Corporate Bonds And Health Monitor Chart II-14Global Bonds: Developed Markets Chart II-15Global Bonds: Emerging Markets CURRENCIES: Chart II-16U.S. Dollar And PPP Chart II-17U.S. Dollar And Indicator Chart II-18U.S. Dollar Fundamentals Chart II-19Japanese Yen Technicals Chart II-20Euro Technicals Chart II-21Euro/Yen Technicals Chart II-22Euro/Pound Technicals COMMODITIES: Chart II-23Broad Commodity Indicators Chart II-24Commodity Prices Chart II-25Commodity Prices Chart II-26Commodity Sentiment Chart II-27Speculative Positioning ECONOMY: Chart II-28U.S. And Global Macro Backdrop Chart II-29U.S. Macro Snapshot Chart II-30U.S. Growth Outlook Chart II-31U.S. Cyclical Spending Chart II-32U.S. Labor Market Chart II-33U.S. Consumption Chart II-34U.S. Housing Chart II-35U.S. Debt And Deleveraging Chart II-36U.S. Financial Conditions Chart II-37Global Economic Snapshot: Europe Chart II-38Global Economic Snapshot: China