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Highlights China's high-profile jawboning draws attention to tightness in metals markets, and raises the odds the State Reserve Board (SRB) will release some of its massive copper and aluminum stockpiles in the near future. Over the medium- to long-term, the lack of major new greenfield capex raises red flags for the IEA's ambitious low-carbon pathway released last week, which foresees the need for a dramatic increase in renewable energy output and a halt in future oil and gas investment to achieve net-zero emissions by 2050. Copper demand is expected to exceed mined supply by 2028, according to an analysis by S&P, which, in line with our view, also sees refined-copper consumption exceeding production this year (Chart of the Week). A constitution re-write in Chile and elections in Peru threaten to usher in higher taxes and royalties on mining in these metals producers, placing future capex at risk. Chile's state-owned Codelco, the largest copper producer in the world, fears a bill to limit mining near glaciers could put as much as 40% of its copper production at risk. We remain bullish copper and look to get long on politically induced sell-offs as the USD weakens. Feature Politicians are inserting themselves in the metals markets' supply-demand evolutions to a greater degree than in the past, which is complicating the short- and medium-term analysis of prices. This adds to an already-difficult process of assessing markets, given the opacity of metals fundamentals – particularly inventories, which are notoriously difficult to assess. Chinese Communist Party (CCP) jawboning of market participants in iron ore, steel, copper and aluminum markets over the past two weeks has weakened prices, but, with the exception of steel rebar futures in Shanghai – down ~ 17% from recent highs, and now trading at ~ 4911 RMB/MT –  the other markets remain close to records.  Benchmark 62% Fe iron ore at the port of Tianjin was trading ~ 4% lower at $211/MT, while copper and aluminum were trading ~ 5.5% and 6.5% off their recent records at $4.535/lb and $2,350/MT, respectively. In addition to copper, aluminum markets are particularly tight (Chart 2). Jawboning aside, if fundamentals continue to keep prices elevated – or if we see a new leg up – China's high-profile jawboning could presage a release by the State Reserve Board (SRB) of some of its massive copper and aluminum stockpiles in the near term. In the case of copper, market guesses on the size of this stockpile are ~ 2mm to 2.7mm MT. On the aluminum side, Bloomberg reported CCP officials were considering the release of 500k MT to quell the market's demand for the metal. Chart of the WeekContinue Tightening In Copper Expected Chart 2Aluminum Remains Tight Brownfield Development Not Sufficient Our balances assessments continue to indicate key base metals markets are tight and will remain so over the short term (2-3 years). Economies ex-China are entering their post-COVID-19 recovery phase. This will be followed by higher demand from renewable generation and grid build-outs that will put them in direct competition with China for scarce metals supplies for decades to come. Markets will continue to tighten. In the bellwether copper market, we expect this tightness to remain a persistent feature of the market over the medium term – 3 to 5 years out – given the dearth of new supply coming to market. Copper prices are highly correlated with the other base metals (Chart 3) – the coefficient of correlation with the other base metals making up the LME's metals index is ~ 0.86 post-GFC – and provide a useful indicator of systematic trends in these markets. Chart 3Copper Correlation With LME Index Ex-Copper Copper ore quality has been falling for years, as miners focused on brownfield development to extend the life of mines (Chart 4). In Chart 5, we show the ratio of capex (in billion USD) to ore quality increases when capex growth is expanding faster than ore quality, and decreases when capex weakens and/or ore quality degradation is increasing. Chart 4Copper Capex, Ore Quality Declines Chart 5Capex-to-Ore-Quality Decline Set Market Up For Higher Prices Falling prices over the 2012-19 interval coincide with copper ore quality remaining on a downward trend, likely the result of previous higher prices that set off the capex boom pre-GFC. The lower prices favored brownfield over greenfield development. Goehring and Rozencwajg found in their analysis of 24 mines, about 80% of gross new reserves booked between 2001-2014 were due not to new mine discoveries but to companies reclassifying what was once considered to be waste-rock into minable reserves, lowering the cut-off grade for development.1 This is consistent with the most recent datapoints in Chart 5, due to falling ore grade values, as companies inject less capex into their operations and use it to expand on brownfield projects. Higher prices will be needed to incentivize more greenfield projects. A new report from S&P Global Market Intelligence shows copper reserves in the ground are falling along with new discoveries.2 According to the S&P analysts, copper demand is expected to exceed mined supply by 2028, which, in line with our view, sees refined-copper consumption exceeding production this year. Renewables Push At Risk Just last week, the IEA produced an ambitious and narrow path for governments to collectively reach a net-zero emissions (NZE) goal by 2050.3 Among its many recommendations, the IEA singled out the overhaul of the global electric grid, which will be required to accommodate the massive renewable-generation buildout the agency forecasts will be needed to achieve its NZE goals. The IEA forecasts annual investment in transmission and distribution grids will need to increase from $260 billion to $820 billion p.a. by 2030. This is easier said than done. Consider the build-out of China's grid, which is the largest grid in the world. To become carbon neutral by 2060, per its stated goals, investment in China’s grid and associated infrastructure is expected to approach ~ $900 billion, maybe more, over the next 5 years.4 The world’s largest fossil-fuel importer is looking to pivot away from coal and plans to more than double solar and wind power capacity to 1200 GW by 2030. Weening China off coal and rebuilding its grid to achieve these goals will be a herculean lift. It comes as no surprise that IEA member states have pushed back on the agency's NZE-by-2050 plan. This primarily is because of its requirement to completely halt fossil-fuel exploration and spending on new projects. Japan and Australia have pushed back against this plan, citing energy security concerns. Officials from both countries have stated that they will continue developing fossil fuel projects, as a back-up to renewables. Japan has been falling behind on renewable electricity generation (Chart 6). Expensive renewables and the unpopularity of nuclear fuel could make it harder for the world’s fifth largest fossil fuels consumer to move away from fossil fuels. Around the same time the IEA released its report, Australia committed $464 million to build a new gas-fired power station as a backup to renewables. Chart 6Japan Will Continue Building Fossil-Fuel Back-Up Generation Just days after the IEA report was published, the G7 nations agreed to stop overseas coal financing. This could have devastating effects for emerging and developing nations‘ electricity grids which are highly dependent on coal. In 2020 70% and 60% of India and China’s electricity respectively were produced by coal (Chart 7).5 Chart 7EM Economies Remain Reliant On Coal-Fired Generation Near-Term Copper Supply Risks Rise Even though inventories appear to be rebuilding, mounting political risks keep us bullish copper (Chart 8). Lawmakers in Chile and Peru are in the process of re-writing their constitutions to, among other things, raise royalties and taxes on mining activities in their respective countries. This could usher in higher taxes and royalties on mining for these metals producers, placing future capex at risk. In addition, Chile's state-owned Codelco, the largest copper producer in the world, fears a bill to limit mining near glaciers could put as much as 40% of its copper production at risk.6 None of these events is certain to occur. Peruvian elections, for one thing, are too close to call at this point, and Chile has a history of pro-business government. However, these are non-trivial odds – i.e., greater than Russian roulette odds of 1:6 – and if any or all of these outcomes are realized, higher costs in copper and lithium prices would result, and miners would have to pass those costs on to buyers. Bottom Line: We remain bullish base metals, especially copper. Another leg up in copper would pull base metals higher with it. We would look to get long on politically induced sell-offs, particularly with the USD weakening, as expected Chart 8Global Copper Inventories Rebuilding But Still Down Y/Y   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com     Commodities Round-Up Energy: Bullish Next Tuesday's OPEC 2.0 meeting appears to be a fairly staid affair, with little of the drama attending previous gatherings. Russian minister Novak observed the coalition would be jointly "calculating the balances" when it meets, taking into account the likely official return of Iran as an exporter, according to reuters.com. We expect a mid-year deal on allowing Iran to return to resume exports under the nuclear deal abrogated by the Trump administration in 2019, and reckon Iran has ~ 1.5mm b/d of production it can bring back on line, which likely would return its crude oil production to something above 3.8mm b/d by year-end. We are maintaining our forecast for Brent to average $64.45/bbl in 2H21; $75 and $78/bbl, in 2022 and 2023, respectively. By end 2023, prices trade to $80/bbl. Our forecast is premised on a wider global recovery going into 2H21, and continued production discipline from OPEC 2.0 (Chart 9). Base Metals: Bullish Our stop-losses was elected on our long Dec21 copper position on May 21, which means we closed the position with 48.2% return. The stop loss on our long 2022 vs short 2023 COMEX copper futures backwardation recommendation also was elected on May 20, leaving us with a return of 305%. We will be looking for an opportunity to re-establish these positions. Precious Metals: Bullish We expect the collapse in bitcoin prices, the US Fed’s decision to not raise interest rates, and a weakening US dollar to keep gold prices well bid (Chart 10). China’s ban on cryptocurrency services and Musk’s acknowledgment of the energy intensity of Bitcoin mining sent Bitcoin prices crashing. The Fed’s decision to keep interest rates constant, despite rising inflation and inflation expectations will reduce the opportunity cost of holding gold. According to our colleagues at USBS, the Fed will make its first interest rate hike only after the US economy has reached "maximum employment". The Job Openings and Labor Turnover Survey reported that job openings rose nearly 8% in March to 8.1 million jobs, however, overall hiring was little changed, rising by less than 4% to 6 million. As prices in the US rise and the dollar depreciates, gold will be favored as a store of value. On the back of these factors, we expect gold to hit $2,000/oz. Ags/Softs: Neutral Corn futures were trading close to 20% below recent highs earlier in the week at ~ $6.27/bu, on the back of much faster-than-expected plantings. Chart 9 Chart 10     Footnotes 1     Please refer to Goehring & Rozencwajg’s Q1 2021 market commentary. 2     Please see Copper cupboard remains bare as discoveries dwindle — S&P study published by mining.com 20 May 2021. 3    Please see Net Zero by 2050 – A Roadmap for the Global Energy Sector, published by the IEA. 4    Please see China’s climate goal: Overhauling its electricity grid, published by Aljazeera.  5    We discuss this in detail in Surging Metals Prices And The Case For Carbon-Capture published 13 May 2021, and Renewables ESG Risks Grow With Demand, which was published 29 April 2021.  Both are available at ces.bcaresearch.com. 6    Please see A game of chicken is clouding tax debate in top copper nation, Fujimori looks to speed up projects to tap copper riches in Peru and Codelco says 40% of its copper output at risk if glacier bill passes published by mining.com 24, 23 and 20 May 2021, respectively.    Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Bank Credit Analyst

Highlights Domestic and foreign supply-side constraints are now exerting a significant effect on the US economy. Consumer prices may increase at a faster pace than we initially expected over the coming 3-4 months, but supply-side constraints are likely to wane later this year and thus do genuinely appear to be transitory. The idea that even a temporary period of high inflation could persist over the longer term has legitimate grounding in macro theory, and is explicitly recognized in the Fed’s inflation framework. But it would necessitate a very large increase in inflation expectations, which have yet to rise to abnormal levels. The baseline for inflation has shifted back closer to the Fed’s target, but deviations above or below target over the coming 12-18 months are likely to be driven by demand-side rather than supply-side factors. The Fed’s checklist for liftoff now entirely depends on employment, and there are compelling arguments in favor of outsized jobs growth in the second half of the year that would move forward the timing of the first rate hike. But the reality for investors is that there is tremendous uncertainty concerning the magnitude of these job gains, given the likelihood of some lasting changes to consumer behavior following the pandemic. Visibility about the employment consequences of these changes will remain very low until investors receive more information about likely urban office footprint and downtown commuter presence, the speed at which international travel will return, and to what degree any pandemic control measures remain in place in the second half of the year. For now, investors should remain cyclically overweight stocks versus bonds, short duration, and invested in other procyclical positions, with an eye to reassess the monetary policy and growth outlook in the late summer / early fall. Feature Chart I-1Investors Have Focused On The April Jobs And Inflation Data Investors’ attention in May was focused squarely on two, ostensibly contradictory US data surprises: an extremely disappointing April jobs report, and a surge in consumer prices (Chart I-1). Abstracting from the typically lagging nature of consumer prices, a weak labor market is typically disinflationary / deflationary, not inflationary. But this is only to be expected in a typical environment where demand-side factors are predominantly driving the jobs market and the pricing decisions of firms, and the April data has made it clear that domestic and foreign supply-side constraints are now exerting a significant effect on the US economy, more forcefully than we initially thought. This warrants a further analysis of our prior view that supply-side effects would have a moderate effect on activity and prices this year, which we present below. A Deep Dive Into April’s Employment And Inflation Data Chart I-2 shows the difference between the April monthly gain in US jobs by industry compared with those of March. Almost all US industries saw a slower pace of jobs gains in April than March, but the slowdown was particularly acute in the professional & business services, transportation & warehousing, education & health services, construction, and manufacturing industries. By contrast, leisure & hospitality, the industry with the largest employment gap relative to pre-pandemic levels, saw a faster pace of April job gains relative to March. Chart I-2Breaking Down Disappointing April Payroll Gains In our view, several facts from the April jobs report characterize the labor market as being in a transition towards a post-pandemic state, but also legitimately impacted by labor supply constraints at the low-skilled and blue-collar levels: Within professional & business services, almost all of the slowdown in monthly job gains occurred within temporary help services. Temp help services is a cyclical employment category over the longer-term, but over short periods of time it can also be negatively correlated with gains in full-time positions. April saw a large decline in the number of employed persons at work part time, suggesting that the slowdown in temp help may reflect a shift back to full-time work. Within transportation & warehousing, the slowdown in jobs was entirely attributed to the couriers and messengers subsector, which includes delivery services. In combination with the acceleration in jobs in the leisure & hospitality sector, this likely reflects a shift away from home food delivery towards in-person restaurant orders and the use of aggressive hiring tactics by restaurant owners (including advertisements of cash bonuses following 90 days of completed work, paid vacations, health insurance, and other perks). The slowdown in jobs growth in the construction & manufacturing industries is likely due to two, separate supply constraints: the negative impact of higher input costs such as lumber, semiconductors, and other raw materials, as well as the disincentivizing effects of supplementary unemployment benefits that appears to be limiting the willingness of lower-wage workers to return to work. Chart I-3April's Rise In Core CPI Was Extreme, Even After Removing Some Outliers On the inflation front, Chart I-3 highlights that the April surge in core consumer prices did not just occur because of year-over-year base effects, but because of significant month-over-month increases in prices. Outsized gains in used car prices driven by the impact of the semiconductor shortage on new car production, as well as surging airline fares, did significantly contribute to April’s month-over-month gain, but the dotted line in the chart highlights that the monthly change would still have been extreme relative to history even if these components had increased instead at a 2% annual rate. Taken together, the April employment and inflation data, in conjunction with surveys of US firms as well as the trend in commodity prices, suggest that the labor market and consumer prices are being affected by four separate but related factors: An underlying demand effect, driven by extremely stimulative fiscal & monetary policy as well as economic reopening; A domestic labor shortage Coordination failures and bottlenecks impacting the production of key supply chain components and resource inputs Coordination failures and bottlenecks impacting the logistics of international trade Strong domestic aggregate demand is not likely to wane over the coming 6-12 months, which has been the basis for our view that inflation would rise to modestly above-target levels this year. Given this new evidence of their prominence and impact, it does seem likely that the remaining three supply-side factors will persist for a few more months, suggesting that core inflation may remain quite elevated over the near term. But several points underscore why it remains difficult to accept a view that supply-side factors will remain an important driver of employment and consumer price trends on a 1-year time horizon. Chart I-4Home Schooling Is Impacting The Labor Market First, domestic labor shortages are occurring in the context of a gap of 8.2 million jobs relative to pre-pandemic levels, underscoring that substantial barriers to returning to work exist. The three most cited barriers are an unwillingness to return to employment for health reasons, an unwillingness to return to work because of supplementary unemployment insurance benefits that are in excess of regular income, and an inability to return to work due to childcare requirements. For example, Chart I-4 highlights that the labor force participation rate has declined the most for women with young children, whose children in many cases are being schooled online rather that in person. But all three of these factors are clearly linked to the pandemic, and are likely to be greatly reduced (or eliminated) in the fall once schools have reopened and income support has ended. Federal supplementary UI benefits are set to expire by labor day, and several US states have already opted out of the program – with benefits set to end in June or July.1 Second, global producers of important commodity inputs (such as lumber) significantly cut production last year under the expectation that the pandemic would greatly reduce spending, only to be whipsawed by a surge in demand stemming from a combination of working from home effects and a massive policy response. Chart I-5 highlights that US industrial production of wood products fell to -10% on a year-over-year basis last April, but that it has subsequently rebounded to a new high. Unlike other supply chain inputs, global semiconductor sales did not decline last April (in the face of enormous PC, tablet, and server/data center demand), but Chart I-6 highlights that DRAM prices, lumber prices, and prices of raw industrial goods may be peaking or have already peaked. Chart I-5Lumber Prices Are Soaring, In Part, Because Supply Was Cut Last Year Chart I-6Costs of Key Inputs May Be Peaking (Or Have Peaked) Chart I-7Logistical Issues, Which Will Be Resolved, Are Driving Shipping Costs Third, while some market participants have attributed the enormous rise in global shipping costs entirely to the underlying demand effect that we noted above, Chart I-7 highlights that this is clearly not the case. The chart shows that the surge in loaded inbound container trade to the Los Angeles and Long Beach ports, to its strongest level since the inception of the data in the mid 1990s, could potentially explain a 75-100% year-over-year rise in shipping costs – less than half of the 250% surge that has occurred over the past 12 months. This strongly points to logistical issues such as the incorrect positioning of cargo containers amid pandemic-related port congestion (and other disruptions such as the temporary grounding of the Ever Given in the Suez canal) as the dominant driver of global shipping costs, which have likely pushed up US non-oil import prices by more than what would normally be implied by the decline in the US dollar (Chart I-8). Global shipping costs have yet to peak, but we expect that these logistical problems will likely be resolved sometime in Q3, or potentially over the summer. This view is underpinned by the fact that the number of global container ships arriving on time rose in March, the first month-over-month increase since June of last year.2 Chart I-8Rising Transport Costs Have Pushed Up US Import Prices For investors, the key conclusion of this review is that while consumer prices may increase at a faster pace than we initially expected over the coming 3-4 months, supply-side factors are clearly driving outsized gains, and have likely or definite end points before the end of the year. As such, despite the surprising magnitude of these supply-side factors, they do genuinely appear to be transitory. The “Transitory” Debate Most investors would agree that 3-4 months of outsized consumer price increases would not be, in and of themselves, economically significant or investment relevant. But the question of whether even a temporary period of high inflation could persist over a 12-month or multi-year time horizon has become prominent in the marketplace, with some investors believing that it has high odds of fueling an already-established, demand-side narrative supporting higher prices in a way that becomes self-reinforcing among consumers and firms. Indeed, this view has a legitimate grounding in macro theory, and is explicitly recognized in the Fed’s inflation framework – which is called the expectations-augmented or Modern-Day Phillips Curve (“MDPC”). In anticipation of the coming debate about inflation and its causes, we thoroughly reviewed the MDPC in our January report.3 One crucial takeaway from the MDPC framework is that economic activity relative to its potential determines the degree to which inflation deviates from expectations of inflation, not the Fed’s inflation target. If, for example, inflation expectations are meaningfully below target, then the Fed would need to aim for an unemployment rate below its natural rate for some period of time in an attempt to re-anchor expectations closer to its target rate (based on the view that inflation expectations adapt to the actual inflation experience). This is essentially what occurred in the latter half of the last economic expansion, and is what motivated the Fed’s shift to its average inflation targeting regime. The Modern-Day Phillips Curve is “modern” because of the experience of inflation in the late 1960s and 1970s, where ever-rising expectations for inflation (alongside extremely easy monetary policy) became self-reinforcing and caused core PCE inflation to rise to high single-digit territory in the second half of the decade. Thus, the notion that elevated consumer prices over the short-term could increase actual inflation over the longer term via higher expectations – meaning that it would not be transitory – is plausible. Chart I-9The Fed's New Index Of Common Inflation Expectations (CIE) Is it likely? In our view, while the odds have increased somewhat over the past month, the answer is no. Chart I-9 presents the Fed’s quarterly index of common inflation expectations (CIE), alongside a model designed to track movements in the index on a monthly frequency. While the Fed’s index includes over 21 inflation expectation indicators, our condensed model uses just six: the 10-year annualized rate of change in headline inflation, the 10-year annualized rate of change in the headline PCE deflator, 5-year/5-year forward and 10-year/10-year forward TIPS breakeven inflation rates, the 3-month moving average of long-term surveyed consumer expectations for inflation, and a proprietary measure of inflation expectations based on an adaptive expectations framework. Chart I-10 highlights that among these six series (shown standardized since mid 2004), three of them have risen quite significantly over the past year: long-dated TIPS breakeven inflation rates (5-5 and 10-10), and long-term consumer expectations for inflation. In our view, the latter series from the University of Michigan is one of the most important for investors to monitor over the coming year, as it is one of the few available measures of “main-street” inflation expectations with a long history. Chart I-10Important Drivers Of The CIE Index Have Risen, But From A Low Base Chart I-11A Deeply Negative Output Gap Last Cycle Made Inflation Expectations Vulnerable To Shocks But while the series in the top panel of Chart I-10 have risen sharply, they are rising from an extremely low base and are currently only fractionally above their average since 2004. As noted in our January report, inflation expectations fell significantly in 2014 first because they were highly vulnerable to shocks following a long period of a deeply negative output gap (Chart I-11), and second because they were catalyzed by a substantial US dollar / oil price shock that occurred in that year. We noted above that the odds of extreme near-term price changes ultimately becoming non-transitory have risen somewhat, and Chart I-12 highlights why. The chart presents the annual change in long-term consumer expectations of inflation alongside the annual change in 2-year government bond yields, and notes that the past three cases of a similar-sized spike in expectations were all ultimately met with either a significant rise in short-term interest rates or a major deflationary shock – neither of which we expect to occur over the coming year. Chart I-12Other Consumer Price Expectation Spikes Have Been Met By Rising Rates Or A Deflationary Shock However, the fact that the rise in expectations clearly has a mean-reversion component to it, and that the supply-side factors driving month-over-month price increases are temporary in nature, argues against the idea that expectations will rise above the average that prevailed from 2002 – 2014. This suggests that while the baseline for inflation has moved back closer to the Fed’s target, deviations above or below target are likely to be driven by demand-side rather than supply-side factors. The Fed’s Checklist: Focus On Employment Table I-1The Fed’s Checklist For Liftoff From an investment perspective, the outlook for inflation is important mostly because of its implications for Fed policy, and thus interest rates and equity valuation multiples. My colleague Ryan Swift, BCA’s US Bond Strategist, has presented the Fed’s checklist for liftoff in Table I-1. The Fed has been explicit that they will not raise interest rates until all three boxes are checked, regardless of what is occurring to inflation expectations or actual inflation. The first box in the list is essentially checked, as tomorrow’s April Personal Income and Outlays report will very likely confirm that the core PCE deflator rose in excess of 2% (the headline PCE deflator was already in excess of this in March). And the third criterion is essentially a derivative of the other two, barring the emergence of a significant deflationary shock at the time that the Fed would otherwise begin to raise rates. This means that investors should be entirely focused on labor market developments, and whether they are consistent with the Fed’s assessment of maximum employment. Table I-2 highlights the average monthly nonfarm payroll growth that will be required for the unemployment rate to reach 3.5-4.5%, the range of the Fed’s NAIRU estimates. The table underscores that large gains will be required for the Fed’s maximum employment criteria to be met by the end of this year or year-end 2022, on the order of 410-830k per month. Table I-2Calculating The Distance To Maximum Employment But the nature of the pandemic and the factors that drove what is still an 8.2 million jobs gap underscore the extreme difficulty in forecasting what monthly job gains are likely to occur on average over the coming 12-18 months. From March to August of last year, monthly changes in nonfarm payrolls exceeded +/-1 million per month, with 20.7 million jobs lost in the month of April 2020 alone. Payroll gains averaged 3.8 million per month in the two months that followed, and if that pace were to be repeated this fall as schools reopen and supplementary unemployment benefits draw to a close in all states it would close 93% of the outstanding jobs gap. This implies that monthly job growth will follow a bimodal distribution over the coming year, with large gains in Q3/Q4 followed by a much more normal pace of jobs growth in Q1/Q2 2022. In our view, the outlook for Fed policy depends significantly on the magnitude of those outsized gains in employment this fall, and there are three main arguments favoring a larger pace of monthly job growth during this period. First, Table I-3 highlights that the jobs gap is most prominent in the leisure & hospitality, government, education & health services, and professional & business services industries, and several observations suggest that Q3/Q4 job gains in these sectors may be sizeable: Table I-3Breaking Down The Pandemic Employment Gap By Industry 70% of the government employment gap shown in Table I-3 can be attributed to education, as government employment also includes education employment at the state and local government level. Many of these jobs, along with those in the education & health services industry, are likely to recover in the fall as schools reopen across the country. As noted in our discussion of the April jobs data, the professional & business services industry includes the “administrative & support services” sector, which accounts for 85% of the overall job gap for the industry. These jobs have likely been impacted heavily by reduced office presence as well as business travel, and may recover further in the fall as many employees shift partially or fully away from working from home. Chart I-13Leisure & Hospitality Employment Is Closely Tracking Hotel Occupancy Chart I-13 highlights that the year-over-year growth rates of leisure & hospitality employment and the US hotel occupancy rate are tracking each other quite closely, and that the latter is in a solid uptrend.4 While international travel is likely to remain muted this summer, the rebound in hotel occupancy suggests that Americans are choosing to travel domestically this year and that further gains in occupancy may occur over the coming months. Chart I-14 highlights the second argument in favor of a larger pace of monthly job growth in the second half of the year. The chart shows the clear relationship between reopening and the employment gap, with states that have fully reopened having substantially smaller gaps than states that have not. It is true that some states that have fully reopened are still experiencing a sizeable gap, but this is at least in part due to leisure & hospitality employment that is dependent on the travel patterns of consumers. For example, Nevada still has a 10% employment gap despite having fully reopened, clearly reflecting the impact of reduced tourism to Las Vegas. Thus, as all states move towards being fully reopened later this year, including large states such as New York and California, Chart I-14 suggests that the US jobs gap is likely to narrow significantly. Chart I-14US States That Have Reopened Have A Smaller Employment Gap Chart I-15Real Output Per Worker Is Not Likely To Rise Further Finally, Chart I-15 highlights that the 2020 recession is the only one in which real output per person rose sharply during the recession. It is true that productivity tends to rise over time and that it usually increases in the early phase of an economic recovery, but the rise in real output per worker last year clearly reflects the massive decline in employment and services spending that resulted from pandemic-related control measures and lockdowns. Our sense is that this sharp rise in real output per worker is not likely to be sustained following full reopening and the elimination of barriers to employment, and if real output per worker were to even modestly converge to its prior trend (the dotted line in Chart I-15) it would more than fully close the jobs gap shown in Table I-3 by the end of the year based on consensus growth forecasts for this year. Investment Conclusions Despite compelling arguments for outsized jobs growth in the second half of the year, the bottom line for investors is that there is tremendous uncertainty concerning its magnitude. It seems likely that there will be some lasting changes to consumer behavior following the pandemic, and visibility about the employment consequences of these changes will remain very low until investors receive more information about the likely urban office footprint and downtown commuter presence, the speed at which international travel will return, and the degree to which any pandemic control measures remain in place in the second half of the year. Given the Fed’s criteria for liftoff, developments that imply a pace of jobs recovery that is in line with or slower than the Fed’s unemployment rate projections will ensure that the monetary policy regime will remain supportive of risky asset prices over the coming year. If the employment gap closes rapidly in Q3/Q4, then investor expectations for the timing of the first rate hike will move sharply closer, which could act as a negative inflection point for stock prices. This is now more probable than it was a month ago, as Chart I-16 highlights that the OIS curve has shifted towards expectations of an initial rate hike at the end of next year or early 2023, from mid 2022 previously. Chart I-16Market Rate Hike Expectations Have Shifted Back To Late 2022 / Early 2023 Still, abstracting from knee-jerk market reactions, it is the pace of hikes and investor expectations for the terminal Fed funds rate that are the more important fundamental drivers of 10-year Treasury yields, and investors would need to see a very large revision to the latter in order for yields to rise to a point that would restrict economic activity or threaten equity market multiples. Such a revision is highly unlikely over the summer unless incoming evidence strongly suggests that the employment gap will be closed by the end of the year. As highlighted above, this may indeed occur later in the year, but probably not over the coming 3 months. For now, investors should remain cyclically overweight stocks versus bonds, short duration, and invested in other procyclical positions, with an eye to reassess the monetary policy and growth outlook in the late summer / early fall. Jonathan LaBerge, CFA Vice President The Bank Credit Analyst May 27, 2021 Next Report: June 24, 2021 II. Global House Prices: A New Threat For Policymakers House prices are rising rapidly across the developed markets, in response to the extraordinary monetary and fiscal policy stimulus implemented to fight the pandemic. Evidence points to the house price surge being driven by monetary policy that has left real interest rates far below equilibrium levels. Supply factors are a secondary cause of the house price boom. Financial stability risks stemming from rising house prices are less acute than the pre-2008 experience, as overall household leverage has grown more slowly during the pandemic and global banks are better capitalized. Rapidly rising house prices are forcing some central banks to turn less accommodative earlier than expected. The recent hawkish turns by the Bank of Canada and Reserve Bank of New Zealand may be canaries in the coal mine for other central banks – perhaps even the Fed – if house prices and household leverage start rising together. The COVID-19 pandemic led to the sharpest economic recession since World War II, alongside an enormous rise in unemployment. Consensus expectations call for the output gap to be closed (or mostly closed) in most advanced economies by the end of this year, but it remains an open question how quickly these economies will be able to return to full employment amid potentially permanent shifts in demand for office space and goods sold at physical, “brick and mortar” retail locations. Despite this sizeable and swift economic shock, house price appreciation accelerated last year in the developed world. Chart II-1 highlights that US house prices rose at an 18% annualized pace in the second half of 2020, whereas they accelerated at a high-single digit pace in developed markets ex-US (on a GDP-weighted basis). This, in conjunction with a sharp rise in the household sector credit-to-GDP ratio (Chart II-2), has unnerved some investors while raising questions about the implications for monetary policy. Chart II-1House Prices Are Surging Around The World Chart II-2Rising Fears About Deteriorating Household Balance Sheets Before we discuss the investment implications of the global housing boom, however, we must first accurately determine the reasons why it is happening. The Work-From-Home Effect: Less Than Meets The Eye When analyzing the surprising behavior of the housing market last year, the working-from-home effect brought upon by the pandemic emerges as an obvious factor potentially explaining house price gains. Last year, following recommended or mandatory stay-at-home orders from governments, most office-based businesses rapidly shifted to work-from-home arrangements as an emergency response. However, in the month or two following the beginning of stay-at-home orders, several national US surveys found many office workers preferred the flexibility afforded by work-from-home arrangements. Many employers, correspondingly, found that the productivity of their employees did not suffer while working from home, or that it even improved. Several prominent corporations in the US have subsequently made some work-from-home options permanent, or even allowed employees to work from offices in a different city than they did prior to the pandemic. Newfound work-from-home options have undoubtedly created new demand for housing, and thus explained the surge in house prices seen over the past year in the minds of some investors. However, in our view, evidence from the US, the UK, and France suggests that the work-from-home effect better explains differences in price gains across housing types and within large metropolitan areas, rather than aggregate or national-level changes in house prices. Chart II-3 provides some quantification of the impact of work-from-home policies by plotting US resident migration patterns by city. This data has been compiled by CBRE, and the impact of COVID is shown as the change in net move-ins from 2019 to 2020 per 1000 people. This helps control for the underlying migration pattern that existed in US cities prior to the pandemic. Chart II-3Work From Home Policies Have Impacted Migration Trends… The chart highlights that the negative migration impact from COVID has been mostly concentrated in New York City and the three most populous cities on the West Coast (by metro area): Los Angeles, San Francisco, and Seattle. And yet, Chart II-4 highlights that house price inflation in these four cities has accelerated to a double-digit pace, only modestly below the national average. Chart II-4...But Cities With Outward Migration Still Have Very Strong House Price Gains The house price indexes shown in Chart II-4 represent aggregate, metro area trends, and clearly some regions within these metro areas have experienced house price deceleration or outright deflation versus gains in areas outside the urban core. But Chart II-5 highlights that house prices have declined in Manhattan basically in line with the change in net move-ins as a share of the population, underscoring that double-digit metro area-wide house price gains appear to be vastly disproportionate to changes in net migration. Similarly, Chart II-6 highlights that rents decelerated in the US over the past year but remained in positive territory and grew at a 3.5% annualized rate from February to April. Chart II-5In Manhattan, House Prices Have Tracked Net Migration Chart II-6Rent Costs Have Decelerated, But Have Not Contracted Evidence from Paris and London also suggests that a work-from-home effect is insufficient to explain broad house price gains. Panel 1 of Chart II-7 highlights that house prices in France have accelerated significantly, but that apartment prices have decelerated only fractionally in lockstep. Panel 2 shows that the acceleration in house prices does reflect a work-from-home effect, as prices have risen faster in inner Parisian suburbs. Panel 3, however, highlights that Parisian apartment prices, the dominant property type in the urban core, have decelerated modestly. Chart II-8 highlights that house price gains have not even decelerated in greater London; they have been merely been modestly outstripped by gains in Outer South East (outside of the Outer Metropolitan Area). Chart II-7In France, Parisian Apartment Prices Are Simply Lagging, Not Falling Chart II-8In The UK, Greater London Property Prices Are Accelerating     The Policy Effect: The Fundamental Driver Of The Housing Market Despite the broader location flexibility that work-from-home policies now provide to potential homeowners, it seems inconceivable that the housing market would have responded in the manner that it has over the past year given the size of the economic shock brought on by the pandemic without significant support from policy. Above-the-line fiscal measures to the pandemic have totaled in the double-digits in advanced economies (Chart II-9), and monetary policy has contributed to easier financial conditions via rate cuts, asset purchases, and sizeable programs to support financial market liquidity. Chart II-9There Has Been A Massive Fiscal Policy Response To The Crisis In fact, Charts II-10-II-13 present compelling evidence that fiscal and monetary policy have been the core drivers of significant house price gains over the past year. Charts II-10 and II-11 plot the above-the-line fiscal response of advanced economies against the year-over-year growth rate in house prices as well as its acceleration (the change in the year-over-year growth rate). The charts show a clearly positive relationship, with a stronger link between the pandemic fiscal response and the acceleration in house prices. Chart II-10Differences In Last Year’s Fiscal Response… Chart II-11…Help Explain Differences In House Price Gains Chart II-12Pre-Pandemic Differences In The Monetary Policy Stance… Chart II-13…Do An Even Better Job Of Explaining 2020 House Price Gains   Charts II-12 and II-13 highlight the even stronger link between house prices and the pre-pandemic monetary policy stance in advanced economies, defined as the difference between each country’s 2-year government bond yield and its Taylor Rule-implied policy interest rate as of Q4 2019. We construct each country’s Taylor Rule using the original specification, with core consumer price inflation, a 2% inflation target, and real potential GDP growth as the definition of the real equilibrium interest rate. The charts make it clear that easy monetary policy strongly explains house price gains in 2020, particularly the year-over-year percent change rather than its acceleration. This makes sense, given that monetary policy was already quite easy in many countries at the onset of the pandemic – meaning that changes were less pronounced than they would have been had interest rates been higher. The explanation that emerges from Charts II-10-II-13 is that historic fiscal easing, combined with an easy starting point for monetary policy – that became even easier last year – enabled demand from work-from-home policies to manifest during an extremely severe recession. We agree that work-from-home policies have shifted the geographic preferences of some home buyers and likely provided a new source of net demand from renters in urban cores purchasing homes in outlying areas. But we strongly doubt that the net effect of work-from-home policies in the midst of an extreme shock to economic activity would have caused the rise in house prices that we have observed, certainly not to this level, without major support from policy. This underscores that policy, and not the work-from-home effect, has and will likely remain the core driver of the global housing market. The Supply Effect: Mostly A Red Herring Chart II-14Countries Fall Into Two Groups In Terms Of The Relative Trend In Real Residential Investment One perennial question that emerges when analyzing the housing market, particularly in markets with outsized house price gains, is the impact of constrained supply. It is frequently argued that constrained supply is squeezing prices higher in many markets, and that the appropriate policy solution to extreme house price gains is to enable widespread housing construction – not to raise interest rates. We do not rule out the potential impact of constrained supply in certain cities or regional housing markets, and we have highlighted in previous research that a positive relationship does exist between population density in urban regions and median house price-to-income ratios.5 But as a broad explanation for supercharged house price gains, the supply argument appears to fall flat. Chart II-14 presents the most standardized measure of cross-country housing supply available for several advanced economies, the trend in real residential investment relative to real GDP over time. These series are all rebased to 100 as of 1997, prior to the 2002-2007 US housing market boom. The chart makes it clear that advanced economies generally fall into two groups based on this metric: those that have seen declines in real residential investment relative to GDP, especially after the global financial crisis (panel 1), and those that have experienced either an uptrend in housing construction relative to output or have seen a flat trend (panel 2). If scarce housing supply was the core driver of outsized house price gains, then we would expect to see stronger gains in the countries shown in panel 1 and smaller gains in the countries shown in panel 2. In fact, mostly the opposite is true: Charts II-15 and II-16 highlight that the relationship between the level of these indexes today relative to their 1997 or 2005 levels is positively related to the magnitude of house price gains last year, suggesting that housing market supply has generally been responding to demand over the past decade. The US and possibly New Zealand stand as possible exceptions to the trend, suggesting that relatively scarce supply may be boosting prices even further in these markets beyond what fiscal and monetary policy would suggest. Chart II-15Countries That Have Seen A Stronger Pace Of Residential Investment… Chart II-16…Have Experienced Stronger House Price Gains   Chart II-17Is This Not Enough Supply, Or Too Much Demand? As a final point about the inclination of investors to gravitate towards supply-side arguments related to the housing market, Chart II-17 presents a simple thought experiment. The chart shows a simple housing supply-demand curve diagram, in a scenario where the demand curve for housing has shifted out more than the supply curve has (thus raising house prices). Is this a scenario in which supply is too tight? Or is it a case in which demand is too strong? In our view, the tight supply answer is reasonable in circumstances where the increase in demand is normal or otherwise sustainable. But Charts II-10-II-13 clearly showed that housing demand is being boosted by easy policy, which in the case of some countries has occurred for years: interest rates have remained well below levels that macroeconomic theory would traditionally consider to be in equilibrium, and this has occurred alongside significant household sector leveraging (Chart II-18). As such, in our view, investors should be more inclined to view the global housing market as generally being driven by demand-side rather than supply-side factors. This Is Not 2007/08 … Yet We highlighted in Chart II-2 above that the household sector debt-to-GDP ratio increased sharply last year, which has raised some questions about debt sustainability among investors. For the most part, the rise in this ratio actually reflects denominator effects (namely a sharp contraction in nominal GDP) rather than a huge surge in household debt. Chart II-19 shows BIS data for the annual growth in total household debt in developed economies was roughly stable last year, at least until Q3 (the most recent datapoint available from the BIS). Chart II-18Low Interest Rates Have Fueled Household Leveraging Chart II-19Total Credit Growth Has Been Stable, But Mortgage Credit Growth Is Accelerating Chart II-20US Mortgage Growth Is Picking Up, As Repayments Slow Consumer Credit Growth But Chart II-19 shows the recent trend in total household debt, which masks diverging mortgage and non-mortgage debt trends. In the US, euro area, Canada, and Sweden, household mortgage debt has accelerated to varying degrees, underscoring that households have likely paid down non-mortgage debt with some of the savings that they have accumulated from a significant reduction in spending on services. Chart II-20 shows this effect directly in the case of the US; mortgage debt growth accelerated by roughly 1.5 percentage points in the second half of the year, whereas consumer credit growth (made up of student loans, auto loans, credit cards, and other revolving credit) decelerated significantly. This aligns with data showing that US households have used some of their savings windfall to pay down their credit card balances. This changing mix within household debt - less higher-interest-rate consumer credit, more lower-interest-rate collateralized mortgage debt – could, on the margin, help mitigate financial stability risks from the housing boom by moderating overall debt service burdens. The starting point for the latter matters, though, in accurately assessing the risks from rising house prices and increased mortgage debt, particularly in countries where household debt levels are already high. According to data from the BIS, the US already has one of the lowest household debt service ratios (7.6%) among the developed economies (Chart II-21).6 This compares favorably to the double-digit debt service ratios in the “higher-risk” countries like Canada (12.6%), Sweden (12.1%) and Norway (16.2%). On top of that, US commercial banks have become far more prudent with mortgage loan underwriting standards since the 2008 financial crisis. The New York Fed’s Household Debt and Credit report shows that an increasing majority of mortgage lending made by US banks since the 2008 crisis has been to those with very high FICO credit scores (Chart II-22). This is in sharp contrast to the steady lending to “subprime” borrowers with poor credit scores that preceded the 2008 financial crisis. The median FICO score for new mortgage originations as of Q1 2021 was 788, compared to 707 in Q4 2006 at the peak of the mid-2000s US housing boom. Chart II-21Diverging Trends In Global Household Debt Servicing Costs Chart II-22US Banks Have Become More Prudent With Mortgage Lending   US bank balance sheets are also now less directly exposed to a fall in housing values. Residential loans now represent only 10% of the assets on US bank balance sheets, compared to 20% at the peak of the last housing bubble (Chart II-23). This puts the US in the “lower-risk” group of countries in Europe, the UK and Japan where mortgages are less than 20% of bank balance sheets. This compares favorably to the “higher risk” group of countries where residential loans are a far larger share of bank assets (Chart II-24), like Canada (32%), New Zealand (49%), Sweden (45%) and Australia (40%). Chart II-23Banks Have Limited Direct Exposure To Housing Here Chart II-24Banks Are Far More Exposed To Housing Here   Like nature, however, the financial ecosystem abhors a vacuum. “Non-bank” mortgage lenders have filled the void from traditional US banks reducing their lending to lower-quality borrowers, and they now represent around two-thirds of all US mortgage origination, a big leap from the 20% origination share in 2007. Non-bank lenders have also taken on growing shares of new mortgage origination in other countries like the UK, Canada and Australia. Chart II-25Global Banks Can Withstand A Housing Shock Non-bank lenders do not take deposits and typically fund themselves via shorter-term borrowings, which raises the potential for future instability if credit markets seize up. These lenders also, on average, service mortgages with a higher probability of default, so they are exposed to greater credit losses when house prices decline. However, the risk of a full-blown 2008-style commercial banking crisis, with individual depositors’ funds at risk from a bank failure, are reduced with a greater share of riskier mortgage lending conducted by non-bank entities. This is especially true with global commercial banks far better capitalized today, with double-digit Tier 1 capital ratios (Chart II-25), thanks to regulatory changes made after the Global Financial Crisis. Net-net, we conclude that the overall financial stability implications of the current surge in house prices in the developed economies are relatively modest on average. The acceleration in mortgage growth has occurred alongside reductions in non-mortgage growth, at a time when banks are better able to withstand a shock from any sustained future downturn in house prices. However, if house prices continue to accelerate and new homebuyers are forced to take on ever increasing amounts of mortgage debt, financial stability issues could intensify in some countries. Services spending will recover in a vaccinated post-COVID world, as economies reopen and consumer confidence improves, which will likely end the trend of falling non-residential consumer debt offsetting rising mortgage debt in countries like the US and Canada. Overall levels of household debt could begin to rise again relative to incomes, building up future financial stability risks when central banks begin to normalize pandemic-related monetary policies – a process that has already started in some countries because of the housing boom. The Monetary Policy Implications Of Surging House Prices Rapidly appreciating house prices are becoming an area of concern for policymakers in countries like Canada and New Zealand, where the affordability of housing is becoming a political, as well as an economic, issue. In the case of New Zealand, the government has actually altered the remit of the Reserve Bank of New Zealand (RBNZ) to more explicitly factor in the impact of monetary policy on housing costs. The Bank of Canada announced in April that it would taper its pace of government debt purchases and signaled that its decision was based, at least in small part, on signs of speculative behavior in Canada’s housing market. Macroprudential measures like limiting loan-to-value ratios of new mortgage loans are a policy option that governments in those countries have already implemented to try and cool off housing demand. Yet while such measures can help alleviate demand-supply mismatches in certain cities and regions, the efficacy of such measures in sustainably slowing the ascent of house prices on a national scale is unclear. In the April 2021 IMF Global Financial Stability Report, researchers estimated that, for a broad group of countries, the implementation of a new macro-prudential measure designed to cool loan demand reduced national household debt/GDP ratios by a mere one percentage point, on average, over a period encompassing four years.7 If macroprudential measures are that ineffective in sustainably reducing demand for mortgage loans, then the burden of slowing house price appreciation will have to fall on the more blunt instruments of monetary policy. Importantly, surging house price inflation is not likely to give a boost to realized inflation measures – an important issue given the current backdrop of rapidly rising realized inflation rates in many countries. Housing costs do represent a significant portion of consumer price indices in many developed countries, ranging from 19% in New Zealand to 33% in the US (Chart II-26), with the euro area being the outlier with housing having a mere 2% weighting in the headline inflation index. Chart II-26A Limited Impact On Actual Inflation From Housing Yet those so-called “housing” categories overwhelmingly measure only housing rental costs and not actual house prices. This is an important distinction because rents – which are often imputed measures like in the US and not even actual rental costs - are rising at a far slower pace than actual house prices in most countries, so the housing contribution to realized inflation is relatively modest. So the good news is that booming house prices will not worsen the acceleration of realized global inflation that has concerned investors and policymakers in 2021. Yet that does not mean that central bankers will not be forced to tighten policy to cool off red-hot housing demand that is clearly being fueled by persistently negative real interest rates. In Chart II-27 and Chart II-28, we show both nominal and real policy interest rates for the “lower risk” and “higher risk” country groupings that we described earlier. The real policy rates are nominal policy rates versus realized headline CPI inflation. The dotted lines in the charts represent the future path of rates discounted by markets. Specifically, the projection for nominal rates is taken from overnight index swap (OIS) forward curves, while the projection for real rates is calculated by subtracting the discounted path of inflation expectations extracted from CPI swap forwards. Chart II-27Markets Discounting Negative Real Rates For The Next Decade Chart II-28Negative Real Rates Are Unsustainable During A Housing Bubble   There are two key takeaways from these charts: Real policy interest rates are at or very close to the most deeply negative levels seen since the 2008 financial crisis. Markets are discounting that real rates will be at or below 0% for most of the next decade. Admittedly, there is room for debate over what the equilibrium level of real interest rates (a.k.a. “r-star”) should be in the coming years. However, we deem it a major stretch to believe that real rates need to be persistently low or negative for the next ten years to support even trend growth across the developed economies. In our view, the current boom in housing demand and mortgage borrowing provides clear evidence that negative real rates are below equilibrium and, thus, are stimulating credit demand. Thus, the only way for a central bank to cool off housing demand will be to raise both nominal and, more importantly, real interest rates. Canada and New Zealand will be the “canaries in the coal mine” among developed market central banks for such a move. According to the latest Bank of Canada Financial Stability Review, nearly 22% of Canadian mortgages are highly levered, with a loan-to-value ratio greater than 450%, a greater share of such mortgages than during the 2016/17 housing boom (Chart II-29). Canadian house prices have risen to such an extent that home prices in major cities like Toronto, Vancouver and Montreal are among the most expensive in North America.8  Stunningly, a recent Bloomberg Nanos opinion poll revealed that nearly 50% of Canadians would support Bank of Canada rate hikes to cool off the red-hot housing market (Chart II-30). The central bank will be unable to resist the pressure to use monetary policy to slam on the brakes of the housing market – investors should expect more tapering and, eventually, rate hikes from the Bank of Canada over at least the next couple of years. Chart II-29Canadians Are Leveraging Up To Buy Expensive Homes Chart II-3050% Of Canadians Want A Rate Hike To Cool Housing   In New Zealand, worsening housing affordability has reached a point where a 20% down payment on the median national house price is equal to 223% of median disposable income (Chart II-31). This is forcing more first-time home buyers to take on levels of mortgage debt that the RBNZ deems highly risky (top panel). Like the Bank of Canada, the RBNZ will prove to be one of the most hawkish central banks in the developed world over the next couple of years as the central bank follows their newly-revised remit to try and cool off housing demand in New Zealand. Who is next? Housing values, measured by the ratio of median national house prices to median national household incomes, are rising in the US and UK but are still below the peaks of the mid-2000s housing bubble (Chart II-32). Meanwhile, housing is becoming more expensive across the euro area, but not in a consistent manner, with valuations in Germany and Spain having increased far more than in France or Italy. Housing valuations have actually improved in Australia over the past couple of years on a price-to-income basis. The most likely candidates for a housing-related hawkish turn are in Scandinavia, with housing valuations in Sweden and Norway closing in on Canada/New Zealand levels. Chart II-31New Zealand Housing Is Wildly Unaffordable Chart II-32Global House Price/Income Ratios Are Trending Higher   Investment Conclusions The current acceleration in global house prices is an inevitable outcome of the extraordinary monetary and fiscal easing implemented during the pandemic. Higher realized inflation is pushing real rates deeper into negative territory in many countries, fueling the demand for housing. Central banks in countries with more stretched housing valuations will be forced to turn more hawkish sooner than expected, leading to tapering and, eventually, rate hikes to cool housing demand. This has negative implications for government bond markets in countries where housing is more expensive and real yields remain too low, like Canada, New Zealand and Sweden (Chart II-33). Investors should limit exposure to government bonds in those markets over the next 6-12 months. Chart II-33Negative Real Yields & Expensive Housing Valuations – An Unsustainable Mix Bond markets in countries where house prices are not rising rapidly enough to force policymakers to turn more hawkish more quickly – like core Europe, Australia and even Japan - are likely to be relative outperformers. The US and UK are “cuspy” bond markets, as housing valuations are becoming more expensive in those two countries but the Fed and Bank of England are not facing the same domestic political pressure to use monetary policy tools to fight the growing unaffordability of housing. That could change, though, if overall household leverage begins to rise alongside house price inflation as the US and UK economies emerge from the pandemic. Current pricing in OIS curves shows that markets expect the RBNZ and Bank of Canada to begin hiking rates in May 2022 and September 2022, respectively (Table II-1). This is well ahead of expectations for “liftoff” from other developed markets central banks, including the Fed in April 2023. The cumulative amount of rate hikes following liftoff to the end of 2024 is highest in Canada, New Zealand, the US and Australia. Those are also countries with currencies that are trading at or above the purchasing power parity levels derived from our currency strategists’ valuation models. This highlights the difficult choice that central bankers facing housing bubbles must confront, as the rate hikes that will help cool off housing demand will lead to currency appreciation that could impact other parts of their economies like exports and manufacturing. Table II-1Hawkish Central Banks Must Live With Currency Strength Tracking the second-round economic consequences of eventual monetary policy actions to control excessive house price inflation, particularly in “higher risk” countries, is likely to be the subject of future Bank Credit Analyst / Global Fixed Income Strategy reports. Jonathan LaBerge, CFA Vice President The Bank Credit Analyst Robert Robis, CFA Chief Fixed Income Strategist III. Indicators And Reference Charts BCA’s equity indicators highlight that the “easy” money from expectations of an eventual end to the pandemic have already been made. Our technical, valuation, and sentiment indicators are very extended, highlighting that investors should expect positive but more modest returns from stocks over the coming 6-12 months. Our monetary indicator has aggressively retreated from its high last year, reflecting a meaningful recovery in government bond yields since last August. The indicator remains above the boom/bust line, however, highlighting that monetary policy remains supportive for risky asset prices. Forward equity earnings already price in a complete earnings recovery, but for now there is no meaningful sign of waning forward earnings momentum. Net revisions remain positive, and positive earnings surprises have risen to their strongest levels on record. Within a global equity portfolio, there has been a modest tick up in global ex-US equity performance, led by European stocks. EM stocks had previously dragged down global ex-US performance, and they continue to languish. Japanese stocks have cratered in relative terms since the beginning of the year, seemingly driven by service sector underperformance resulting from a surge in COVID-19 cases since the beginning of March. While Japanese equity performance may stage a reversal over the coming 3 months as cases counts decline and progress continues on the vaccination front, we expect global ex-US performance to continue to be led by European stocks. The US 10-Year Treasury yield has traded sideways since mid-March, after having risen to levels that were extremely technically stretched. Despite this pause, our valuation index highlights that bonds are still expensive, and that yields could move higher over the cyclical investment horizon if employment growth in Q3/Q4 implies a faster return to maximum employment than currently projected by the Fed. We expect the rise to be more modest than our valuation index would imply, but we would still recommend a short duration stance within a fixed-income portfolio. Commodity prices, particularly copper, lumber, and agricultural commodities, have screamed higher over the past several months. This reflects bullish cyclical conditions, but also pandemic-induced supply shortages that are likely to wane later this year. Commodity prices are extremely technically stretched and sentiment is very bullish for most commodities, suggesting that a breather in commodity prices is likely at some point over the coming several months. US and global LEIs remain in a solid uptrend, and global manufacturing PMIs are strong. Our global LEI diffusion index has declined significantly, but this likely reflects the outsized impact of a few emerging market countries (whose vaccination progress is lagging). Strong leading and coincident indicators underscore that the global demand for goods is robust, and that output is below pre-pandemic levels in most economies because of very weak services spending. The latter will recover significantly later this year, as social distancing and other pandemic control measures disappear. EQUITIES: Chart III-1US Equity Indicators Chart III-2Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators   Chart III-4Revealed Preference Indicator Chart III-5US Stock Market Valuation Chart III-6US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations Chart III-10Yield Curve Slopes Chart III-11Selected US Bond Yields Chart III-1210-Year Treasury Yield ComponentsChart III-13US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets   CURRENCIES: Chart III-16US Dollar And PPP Chart III-17US Dollar And Indicator Chart III-18US Dollar Fundamentals Chart III-19Japanese Yen Technicals Chart III-20Euro Technicals Chart III-21Euro/Yen Technicals Chart III-22Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Chart III-24Commodity Prices Chart III-25Commodity Prices Chart III-26Commodity Sentiment Chart III-27Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop Chart III-29US Macro Snapshot Chart III-30US Growth Outlook Chart III-31US Cyclical Spending Chart III-32US Labor Market Chart III-33US Consumption Chart III-34US Housing Chart III-35US Debt And Deleveraging   Chart III-36US Financial Conditions Chart III-37Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China   Jonathan LaBerge, CFA Vice President The Bank Credit Analyst Footnotes 1 The New York Times “Texas, Indiana and Oklahoma join states cutting off pandemic unemployment benefits,” May 18, 2021. 2 The Wall Street Journal, “Shipments Delayed: Ocean Carrier Shipping Times Surge in Supply-Chain Crunch,” May 18, 2021 3 Please see The Bank Credit Analyst "The Modern-Day Phillips Curve, Future Inflation, And What To Do About It," dated December 18, 2020, available at bca.bcaresearch.com 4 To eliminate the pandemic base effect for both series, we adjust the year-over-year growth rates in March and April of this year by comparing them to March and April 2019. 5 Please see Global Investment Strategy "Canada: A (Probably) Happy Moment In An Otherwise Sad Story," dated July 14, 2017, available at gis.bcaresearch.com 6 Importantly, the BIS debt service ratios include the payment of both principal and interest, thus making it a true measure of debt service costs that includes repayment of borrowed funds – a critical issue in countries with high loan-to-value ratios for home mortgages. 7 Please see page 46 of Chapter 2 of the April 2021 IMF Global Financial Stability Report, which can be found here: https://www.imf.org/en/Publications/GFSR/Issues/2021/04/06/global-finan… 8 “Vancouver, Toronto and Hamilton are the least affordable cities in North America: report”, CBC News, May 20, 2021

特別レポート

Highlights We update our assumptions for the likely 10-15 year return for a wide range of different asset classes. Our methodology is basically unchanged from our last Return Assumptions report published in 2019, though we have refined our analysis and use of data in some areas. Returns over the next decade will be very low compared to history. We project that a standard global portfolio (50% equities, 30% bonds, and 20% alternatives) will return only 3.0% a year in nominal terms. That compares to a historic return of 6.3%. There are still some assets that will produce better returns, most notably small caps (4.9% a year in the US) and alternatives (6.2% for private equity, for example). But they also carry higher risk. Spreadsheets are available with detailed data. Introduction This is the third edition of our work on return assumptions. Since publishing the previous reports in November 2017 and June 2019, we have had many opportunities to discuss our methodologies with clients and in the Global Asset Allocation course at the BCA Academy. This has allowed us to test and, in many cases, refine our approach. We believe the methodologies we use have stood the test of time. We have always emphasized that this sort of capital markets assumptions (CMA) analysis is an art, not a precise science. We continue to prefer to project returns over a somewhat undefined 10-15 year period, since this allows us to think about the underlying trend of likely returns. Many other CMA papers use five (or even three) year time horizons which, in our view, are problematical since they rely heavily on a forecast of the timing, length, and severity of the next recession. Our approach is based on the concept that the return on the risk-free long-term government bond is the cornerstone to projecting asset returns, and that this return is rather predictable: It is approximately the current yield. Most other asset returns can be built up from that – the return on high-yield bonds, for example, by assuming that their historic spread over government bonds, and default and recovery rates will continue in the future. For equities, we continue to use six different methodologies, which are based on a mixture of valuation and projected earnings growth. This approach – that assumed returns can be built up from a combination of current yield plus forecast future growth in capital values – also works for most alternative asset classes, for example real estate. We have made a few minor changes to our methodology in this edition. We have, for example, made our use of historical data (for spreads, profit margins, growth relative to GDP, etc.) more consistent, using the 20-year average where possible. The biggest change this time is that clients can download here a spreadsheet with all the data in this report in order, for example, to use the data as inputs into their own optimizers. In addition, we have set up our detailed spreadsheet to allow clients to see the underlying inputs, the formulae behind our methodologies, and to input their own assumptions. This will also allow us to update the results of our analysis as often as needed. Please let us know here if you would like more details about this additional service. This Special Report is structured as follows. First, we analyze the overall results: What is the probable return from each asset class over the next 10-15 years, and how do these differ from historical returns. Next, we describe in detail the methodologies we use, for (1) economic growth, (2) fixed-income instruments, (3) equities, and (4) 12 different alternative asset classes. Then, we describe our way of forecasting currency returns, and show the return assumptions in different base currencies. Finally, we update the numbers for volatility and correlations, which many investors need as inputs into optimization programs. The summary of our results is shown in Table 1. The results are all average annual nominal total returns, in local currency terms (except for global indexes, which are in US dollars). The data is updated to end-April 2021 (except for some alternative asset classes where only quarterly data is available). Table 1BCA Assumed Returns Overall Results Returns over the coming decade are likely to be very disappointing compared to history. Our assumptions suggest a typical global portfolio, consisting of 50% large-cap equities, 30% bonds, and 20% alternatives, will produce an annual nominal return of only 3.0%, compared to an average of 6.3% over the past 20 years. A US-only portfolio with a similar composition is likely to produce only a 3.1% return, compared to 7% in history. The reason is simple: Valuations currently are very stretched in almost every asset class. The risk-free rate (the 10-year government bond yield) in the US is 1.6% (compared to a 20-year average of 3.1%). It is negative in the euro area (in nominal terms) and zero in Japan. These rates are the anchor for the returns of all other asset classes, which are theoretically priced off the risk-free rate plus a risk premium. We have long argued that valuations are not a good timing tool for investors. An asset can remain very expensive or very cheap for a considerable period. But all the evidence shows that the valuation at the starting point is a very powerful indicator of long-run returns. The yield on government bonds, for example, has a strong correlation with their 10-year return (Chart 1). In the equity market, the Shiller PE has historically had little correlation with the return over one or two years, but has a 90% correlation with the return over the subsequent 10 years (Chart 2). Chart 1Starting Yield Determines Bond Returns Chart 2Valuation Drive Long-Run Equtiy Returns     With valuations in equity markets now expensive relative to history (for example, forward PE for US stocks of 22x compared to a 20-year average of 16x, and 18x in the euro zone compared to 13x), investors should expect that equity market returns will be low relative to history. Our assumptions point to a 2.6% annual return from US stocks, 2.3% from the euro zone, and 1.6% from Japan (compared to 8.5%, 3.9%, and 3.5% over the past 20 years). Our assumptions are significantly lower than when we last published our analysis in 2019; then we projected 5.6% for US stocks, 4.7% for the euro zone, and 6.2% for Japan. The difference is that equity multiples have risen and risk-free rates have fallen significantly since then. So what should investors do? They have only two choices: Lower their return assumptions, or increase their weightings in riskier asset classes. Chart 3Hard To See How US Pension Funds Will Achieve Their Targets The average US public pension fund (Chart 3) still assumes a return of 7% a year, and private pension funds’ assumption is not much lower. And yet corporate pension funds have been pushed by their consultants in recent years to increase their weighting in bonds, to more closely match their liabilities (Chart 4). It is almost mathematically impossible to achieve their targets with that sort of portfolio. In other countries, such as Australia or Canada, pension funds’ return targets are typically inflation or cash plus 3-4 percentage points. But even those targets are challenging.   Chart 4...Especially With Over 50% In Bonds There are asset classes which will produce higher returns. For example, we project a return of 4.9% from US small-cap stocks – and 9.7% from UK small caps. US high-yield bonds should produce a return of 3.2% a year (even after defaults) and Emerging Markets local currency sovereign debt 2.7% (in USD terms) – not exactly exciting, but at least a pick-up over other fixed-income securities. The projected returns from illiquid alternative assets continue to look relatively attractive. An equal-weighted portfolio of the 12 alternatives we cover is projected to return 5.7% a year, not much lower than the forecast of 6.1% from our 2019 report (and compared to an average of 7.1% of the past 20 years). There are some alt assets where returns have started to trend down: Private equity, for instance, is projected to return 6.2% a year, compared to 11.1% in history, and hedge funds 4.5%, compared to 5.9%. But the illiquidity premium should not disappear completely, even if the move of alternative investments to become more mainstream has reduced it to a degree. So adding more risky assets to a portfolio is an answer, at least for those investors with a long enough time-horizon that allows them to bear the inevitable big drawdowns that come with having a more volatile portfolio. And, unfortunately, lower returns mean that the incremental return gained for each unit of risk taken has declined compared to the past 10 or 20 years (Chart 5) – the efficient frontier has flattened significantly. Chart 5You Need To Take More Risk To Produce Return How We Came Up With The Assumptions GDP Growth Several of our methodologies use assumptions (for example, in equity methods (2) and (3), based on projections of earnings growth, real-estate capital-value growth, and commodities prices) which require estimates of nominal GDP growth in each country and region. To make these forecasts, we assume that nominal GDP growth can be decomposed into: (1) growth of the working-age population, (2) productivity growth, and (3) inflation. This ignores capital intensity, but it has been relatively stable over history and is difficult to forecast. Table 2 shows the assumptions we use, and our forecasts for real and nominal GDP in each country and region. Table 2Calculations Of Trend GDP Growth For population growth we use the United Nations’ median forecast of annual growth in the population aged 25-54 between 2020 and 2040. This ranges from -1% in Japan to +1% in Emerging Markets – although note that the range of forecast population growth in EM varies widely from 1.2% in India to -1.1% in Korea (and in China, too, is negative at -0.7%). This estimate is reasonably reliable, although it does miss some possible factors, such as changes in the female participation rate, hours worked, and changing openness to immigration. Productivity is much harder to forecast. Over the past 10 to 20 years, productivity growth has trended down in most countries (Charts 6A & B). We take a slightly more optimistic view, assuming that productivity growth over the next 10-15 years will equal the 20-year average. We base this on the belief that part of the decline in productivity since the Global Financial Crisis is due to cyclical reasons which are now dissipating, and also to expectations that new technologies coming through (artificial intelligence, big data, automation, robotics etc) will boost productivity in the coming years. Others take a more pessimistic view. The Congressional Budget Office’s forecast of trend real US GDP growth in 2022-2031 of 1.8%, for example, is lower than our estimate of 2.2% mainly because of its more cautious estimate of productivity growth. Chart 6AProductivity Growth (I) Chart 6BProductivity Growth (II)   To derive nominal GDP growth, we assume that inflation over the next 10 years will be on average the same as over the past 20 years, for example 2% in the US, 1.6% in the euro area, 0.1% in Japan, and 3.9% in Emerging Markets (using a weighted average of EM by equity market cap). This estimate, too, has a high degree of uncertainty. One could imagine a scenario whereby inflation picks up significantly over the next decade due to excessively easy monetary policy, overly generous fiscal spending, growth in protectionism, rising labor pressure for wage increases, and the effects of a rising dependency ratio (the ratio of non-working people, especially retirees, to total population).1 But another scenario of continued “secular stagnation” and disinflation, caused by automation-driven job losses and a chronic lack of aggregate demand, is also conceivable. We think our middle-path forecast is the most sensible one to use in projecting likely asset returns, but investors might also want to plan based on these alternative scenarios too. Note that for Emerging Markets, we continue to show two different scenarios, which vary according to different projections of productivity growth. EM productivity growth has been declining steadily since around 2010, and in all major emerging economies, not just China. Our first scenario assumes that this decline ends and that, as in our assumption for developed economies, productivity growth reverts to the 20-year average. The more pessimistic (and, in our view, more likely) scenario assumes that the deterioration in productivity continues and that in 10 years’ time, EM productivity is the same as the average of developed economies. Which scenario will be correct depends on whether emerging economies, not least China, are able to implement structural reforms over the next decade, for example liberalizing the labor market, allowing a greater role for the private sector, improving corporate governance, and institutionalizing more orthodox fiscal and particularly monetary policy. Fixed Income Our anchor for calculating assumed returns is the return on long-term risk-free assets, specifically the 10-year government bond in the strongest countries. It is a reasonable assumption that an investor who buys, for example, a 10-year Treasury bond today and holds it for 10 years will make 1.6% a year in nominal US dollar terms. While this is not perfectly mathematically correct (since it ignores reinvested interest payments, for instance), empirically the return on government bonds has been very closely linked to the yield at the start-point in history (see Chart 1). From this starting-point in each country, we can easily build up the return for other fixed-income assets. These assumptions and the results are shown in Table 3. Table 3Fixed-Income Return Calculations Government bonds in most countries have an average duration of less than 10 years. Over the past five years, in the US it has averaged 6.4 years, and in the euro area 8.0 years. Only in the UK is the average over 10 years: 12.4 years to be precise. To calculate the return from the government bond index for each country we therefore assume that the shape of the yield curve (using the spread between 7-year and 10-year bonds) in future will be the same as the historic 20-year average. Cash. We assume that over the next 10 years the yield on cash will gradually revert to an equilibrium level. We calculate a market-implied real long-term neutral rate from the 10-year historical average of 5-year/5-year OIS implied forwards deflated by the 5-year/5-year implied CPI swap rate. This is a change from the methodology we used in 2019, when we based this off the neutral rate, r*, as calculated by the Holston Laubach-Williams model. But the New York Fed has temporarily stopped updating its calculation of this due to pandemic-induced volatility in the data, and anyway it was not available for every country. We turn the real cash rate into a total nominal return using our assumption for inflation described in detail in the GDP section above, the 20-year historical average of CPI. For inflation-linked securities, such as TIPS, we take the average yield over the past 10 years (a 20-year average was not available in many markets) and add the assumption for inflation described above. Corporate credit. We assume that spreads, and default and recovery rates, while highly volatile over the cycle, remain stable in the long run (Chart 7). We use 20-year averages for these, except that data for investment-grade default rates in Japan, the UK, Canada, and Australia are not available and so we use the average of the US and the euro zone. High-yield default rates are not available for the UK either, and so we do the same. Other bonds. For government-related debt (which is a big part of some bond indexes, 28% in the US for example) we assume that the 20-year historical average of the option-adjusted spread over government bonds will apply in the future too. We use the same methodology for securitized debt (for example, mortgage- and asset-based bonds): The 20-year average spread over the return on government bonds. Emerging Market debt. The assumptions and results for the three categories of EM debt (US dollar sovereign debt, US dollar corporate debt, and local currency sovereign debt) are shown in Table 4. We here assume that the 20-year average historical spread will continue in future. Default and recovery rates are a little harder to calculate, due to a lack of data. For USD sovereign debt (where defaults are rare and so hard to project), we use the rating-based default rate, calculated by Aswath Damodaran of NYU Stern School of Business.2 For USD-denominated EM corporate debt, we use the historical average, calculated by Moody's 2.5%.3 For local-currency debt, we use the same rating-based default rate as for USD sovereign debt. To translate the return into hard currency, we assume that currencies will move in line with the inflation differential between Emerging Markets and the US. For EM inflation we use an average of the IMF’s inflation forecasts for the nine largest emerging markets weighted by their weights in the J.P. Morgan GBI-EM Global Diversified local government bond index, and compare this to our US inflation forecast. This produces an EM inflation forecast of 2.9% a year, compared to 2.2% for the US, thus lowering the USD-based return from local EM debt by 0.7 percentage point. (See a more detailed discussion of forecasting long-term EM currency changes in the Currency section below). Index returns. Table 3 also shows the assumed return for the Bloomberg Barclays bond index for each country and for the global bond index, based on a weighted average of our assumption for each fixed-income asset class and country. Chart 7ACredit Spreads & Default Rates (I) Chart 7BCredit Spreads & Default Rates (II)   Table 4Emerging Market Debt   Equities The assumptions and detailed results for seven different equity markets are shown in Table 5. We have not made any substantial changes to our methodology for equities. We continue to use the average of six different methods to calculate the probable equity returns over the next 10-15 years. These are: Equity Risk Premium (ERP). The return from equities equals the yield on government bonds (we use 10-year bonds) plus an equity risk premium. For the US, we use an equity risk premium of 3.5%. This is based on work by Dimson, Marsh and Staunton4 showing that this is approximately the average excess return of equities over bonds in developed economies since 1900. We scale the equity risk premium for other countries using their average beta to the US market over the past 10 years. This varies from 0.66 for Japan (giving an ERP of 2.3%) and 1.2 in the euro area (ERP is 4.2%). Growth model. Here we assume that the return from equities equals the current dividend yield plus dividend growth. We need to adjust the dividend yield, however, to take into account that in some countries, particularly the US, it is more tax efficient for companies to do buybacks than to pay out dividends. We do this by adding equity withdrawals to the dividend yield. But this needs to be done on a net basis (taking into account equity issuance). We calculate this using the average annual change in the index divisor over the past 10 years. For the US, this is -0.8%, meaning there are more buybacks than new share issues. But in all other regions, the number is positive, and as high as 5.9% a year for Emerging Markets. This dilution is something that many calculations of assumed equity returns miss. For dividend growth, we assume that the dividend payout ratio remains stable, and that earnings growth is correlated with nominal GDP growth. However, history shows that earnings grow more slowly than GDP (logically so, when you consider that companies usually grow fastest before they list on a stock exchange). So we deduct 1% from nominal GDP growth to derive our earnings growth assumption. Note that for Emerging Markets, we use two different measures of dividend growth, depending on future productivity growth, as detailed above in our explanation of the GDP projections. Growth model (with reversion to mean). To take into account that valuations and profit margins typically revert to mean over the long run, we adjust the standard growth model (No. 2 above) by assuming that the current 12-month forward PE ratio and forward net profit margin for each country gradually revert over the next 10 years to their 20-year average. In the US, for example, that would mean that the current 12-month forward PE of 22.5x falls back to 16.0x, and profit margin of 12.5% falls to 10.7%. In every country and region, the profit margin is currently above the long-run average, and in all except the UK the PE is too. Note that we have changed from using the trailing PE and margin, because to use these now would be misleading given the big pandemic-driven decline in profits in 2020. Earnings yield. An intrinsically intuitive (and empirically demonstrable) way of estimating future returns is to use the earnings yield. This is based on the idea that an investor’s return from owning a stock comes either from the company paying a dividend, or from it investing retained earnings and paying a dividend in future. In the US, for example, a forward PE of 22.5x translates into an earnings yield of 4.4%. Again, here we switched this time to using 12-month forward forecast earnings yield, rather the trailing. Shiller PE. There is a strong correlation between valuation at the starting-point and the subsequent return from equities, at least over the long-run, although not over a period of less than 3-5 years (Chart 2). We regressed the Shiller PE (current price divided by average real earnings over the past 10 years) against the return from equities over the subsequent 10 years for each country and region. Composite valuation metric. The Shiller PE has its detractors. Using a fixed 10-year period does not reflect the different lengths of recessions and bull markets. It may say more about the mean-reverting nature of earnings than about whether the current price level is too high. So we also use the BCA Compositive Valuation Metric, which comprises eight indicators including, besides standard valuation measures such as price/sales and price/book, more esoteric ones such as market cap/GDP and Tobin’s Q. Again, we regress the metric against the subsequent 10-year return. Table 5Equity Return Calculations Alternative Assets Real Estate & REITs. We use the same basic methodology for both: The current yield (cap rate or dividend yield) plus projected capital value appreciation (linked to GDP growth). For US direct real estate, for example, we use the simple average cap rate of the five categories of commercial real estate (CRE), apartments, office, retail, industrial, and hotels in major cities: 6.1%. We also use the simple average of available city and category data for other countries. Cap rates are notoriously hard to estimate precisely; our data include a range of real estate, not just prime locations. We assume that capital values will grow in line with nominal GDP growth (using the same assumptions for this as we used for equities, 4.2%). We then deduct 0.5% for maintenance. This produces an expected return of 9.8% for the US. The only difference for REITs is that we do not deduct maintenance since this should already be reflected in the dividend yield. US REITs have a dividend yield currently of 3.5%, which produces an assumed return of 7.7% (Table 6). One risk with this methodology is that in the post-pandemic world, work and life practices might change. This will hurt office and residential real estate in major cities (which are overrepresented in investible CRE), though smaller cities and rural areas might benefit. As a result, capital values might fall. Table 6Alternatives Return Calculations Farmland & Timberland. Our methodology is similar to that for real estate: Current yield plus projected growth in capital values. For farmland, we use the farmland renter yield, sourced from the US Department of Agriculture. To estimate future land values, we take the gap between land value growth over the past 40 years (3.7%) and nominal growth of world GDP over that time (5.2%), assume that gap will continue and so deduct it from our estimate of global nominal GDP growth going forward (3.6%). This gives a result of 6.5%. For timberland, we assume that annualized returns in the future are the same as over the past 20 years. This produces a return assumption of 5.7%, which is (logically) moderately lower than our assumed return for farmland. Private Equity & Venture Capital. We project the return for private equity (PE) using the 30-year time-weighted average of the three-year rolling annualized return of PE over US large-cap equities, 3.6% (Chart 8). This produces an assumed return of 6.2%. For venture capital (VC), we use the same historical average for VC over PE (0.4%) to arrive at an assumed return of 6.6%. Hedge Funds. We use the 20-year time-weighted return of the Hedge Fund Composite Index over cash, 3.5% (Chart 9). This projects a future annual nominal return of 4.5%. Commodities. We previously used a methodology based on the idea that commodities’ bear markets in history have been rather fairly consistent, lasting on average 17 years, with an average decline of 50%, and that the current bear market began in 2012 (Chart 10). However, there are arguments that a new “commodities super-cycle” may be starting, driven by government infrastructure spending, and investment in alternative energy.5 We are agnostic for now on whether that will be the case, but it makes sense to switch to a neutral methodology, more in line with what we use for other assets classes: The return from commodities relative to GDP over the long run. Specifically, the CRB Raw Industrials Index has risen by an annualized 1.6% since 1951, during which time US nominal GDP growth averaged 6% (Chart 11). We assume that the differential will continue in future (although we calculate growth using global, not US, GDP), giving an annual return from commodities over the next 10-15 years of -0.9%. Gold. We calculate this using a regression of the gold price against nominal GDP growth and the annual change in the real 10-year yield over the past 40 years. For the forward-looking return assumption, we use a forecast of real rates (based on the equilibrium cash rate plus the average historical spread between the 10-year yield and cash) and a forecast of global nominal GDP growth. This produces an assumed return of 3.8%. Structured products. This asset class consists mainly of mortgage-backed and other asset-backed securitized instruments. In the US, these have historically returned 0.6% over US Treasurys. We assume that this premium continues, producing a total future return of 1.1% a year. Chart 8Private Equity Premium Chart 9Hedge Fund Return Over Cash     Chart 10Commodity Prices In History Chart 11Commodity Prices Vs. GDP Growth     Currencies Chart 12Currencies Tend To Revert To PPP To translate our local currency returns into an investor’s base currency, we need to arrive at some projections for FX movements over the next decade. Fortunately, for developed market currencies at least, it is relatively straightforward to use purchasing power parities (PPP) to do this since, over the long run, all the major currencies have tended to revert to PPP (Chart 12). We assume that in 10 years’ time all currencies will trade at PPP. We use the IMF’s estimate of today’s PPP for each currency to calculate the current under- or over-valuation. We assume that PPP will change in future years according to the relative inflation between each country and the US. The IMF provides five-year inflation forecasts and we assume that inflation will continue at this rate until 2031. For the euro zone, we calculate the PPP of the euro using the GDP-weighted PPPs of the five largest economies. The results (Table 7) suggest that the US dollar is currently overvalued and, given the forecast of higher inflation in the US than elsewhere in the future, will depreciate significantly against all major currencies except the Australian dollar. The USD is projected to depreciate by 1.7% a year against the euro and 1.1% against the yen over the next 10 years. It is likely to appreciate by 1.3% a year against the AUD, however. Table 7Currency Return Calculations Emerging Markets (Table 8) are more complicated. There is no evidence that EM currencies move towards PPP over time. All the major EM currencies are currently very cheap versus PPP (varying from 34% undervalued for the Chinese yuan to 67% for the Indonesian rupiah) but they were 10 years ago, too, and have not significantly moved towards PPP over that time. Table 8EM Currencies To calculate likely EM currency moves against the USD, therefore, we carry out a regression of the nine largest EM currencies against their relative CPI inflation rate to US inflation in history. We assume an intercept of zero. The regression coefficients vary from +0.5 for China to -1.7 for Malaysia. Apart from China, Malaysia, Poland and South Africa, the coefficients were negative, meaning that historically the USD has strengthened against the EM currency at least partly in line with relative inflation. To calculate likely future currency movements, we use the IMF’s five-year inflation forecasts and assume that the same rate of inflation will continue for our whole projection period. This methodology points to moderate annual depreciation of most EM currencies against the USD, varying from 0.8% a year for the Russian ruble to 0.1% for the Indonesia rupiah. The Chinese yuan and Taiwanese dollar are projected to appreciate moderately. We calculate the average EM currency movement using the weights of these nine large economies in the EM J.P. Morgan GBI-EM Global Diversified local-currency sovereign bond index. This produces a small (0.1%) a year appreciation. However, the IMF’s EM inflation forecasts may be too optimistic. It forecasts, for example, that Brazilian inflation will be only 3.3% a year in future, compared to an average of 6.1% over the past 20 years, and Russian inflation 4.0% versus a historical average of 9.3%. This suggests that EM currency performance could be worse than our projections. Table 9 shows the returns for the major asset classes expressed in local currency terms for six base currencies, based on the calculations explained above. Table 9Returns In Different Base Currencies Correlation And Volatility Below, in Table 10, we provide correlations for clients who need these inputs for their optimization calculations. Table 10Long-Run Correlation Matrix Returns can be calculated using the sort of forward-looking methodologies we have described above. For volatility, we think it is reasonable to use historical average data (Table 1, far right column), since volatility does not tend to trend over the long run (Chart 13). But correlation is a different matter. Correlations have varied significantly in history due to structural changes or regime shifts. The correlation of equities to bonds, it is well known, has moved from positive in the 1980s and 1990s, to negative since 2000 – probably because inflation disappeared as a factor moving bond prices (Chart 14). The correlation between equity market has risen as a result of the globalization of investment flows, though note that it fell back in 2010-2019. Chart 13Volatility Is Fairly Stable In The Long Run Chart 14Correlations Are Not Stable   So what correlations should investors use in an optimizer? Our recommendation would be to use the longest period of history available. A US investor, for example, might take the average correlation between Treasury bonds and large-cap US equities since 1945, 0.1%. Table 10 shows the correlation since 1973 of all the major asset classes for which data is available. Unfortunately, this misses some important asset classes such as high-yield bonds and Emerging Market equities, whose history does not go back that far. The results are intuitive – and prudent. From these numbers, it would seem sensible to use an assumption of a small positive correlation between US Treasurys and US equities, for example. US investment-grade debt has a correlation of 0.4 against equities. Global equity markets are all fairly highly correlated to each other, ranging mostly from 0.4 to 0.7. The most non-correlated asset class is commodities, especially gold.   Garry Evans, Senior Vice President Global Asset Allocation garry@bcaresearch.com   Amr Hanafy, Senior Analyst Global Asset Allocation amrh@bcaresearch.com   Footnotes 1 These are themes that BCA Research has been writing about for several years. See, for example, please see Global Investment Strategy, "1970s-Style Inflation: Could It Happen Again? (Part 1)," dated August 10, 2018; and " 1970s-Style Inflation: Could It Happen Again? (Part 2)," dated August 24, 2018. 2 Please see http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html 3 Annual Emerging Markets Default Study: Coronavirus Will Push Up Default Rates https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1214906 4 Please see, for example, https://www.credit-suisse.com/media/assets/corporate/docs/about-us/research/publications/credit-suisse-global-investment-returns-yearbook-2021-summary-edition.pdf. 5 Please see Commodity & Energy Strategy, "Industrial Commodities Super-Cycle Or Bull Market?", dated March 4, 2021.

Highlights The number one risk to our upbeat view on European economic activity and assets is a Chinese economic slowdown. The second most important risk to our view is a potential deterioration in the global credit impulse, even outside of China. The third major risk is that the current bout of US inflation proves to be permanent, which, paradoxically, would prompt a deflationary shock for the global economy. Despite these risks, we maintain our favorable view on European assets over the coming 12 to 18 months. However, favoring industrials over materials, and financials over other cyclicals, Swedish equities and peripheral bonds in balanced portfolios mitigate some of these risks. Do not expect the ECB to announce a tapering of its asset purchases at the June meeting. The ECB will lag well behind the Fed and the BoE. Buy European steepeners and US flatteners as a box trade. Feature Over the past three weeks, a sustained marketing push gave us the opportunity to interact intensively with a large subset of our clients (albeit virtually, courtesy of COVID-19). Generally, our positive stance on European assets was well received, but investors are loosely committing themselves to this view and very few are willing to make an aggressive bet on Europe. In fact, in most meetings, we spent more time than usual discussing the risks to our upbeat view on Europe and European cyclical equities. Three risks to our 12- to 18-month view standout. The first is a serious slowdown in Chinese growth. The second is a greater-than-anticipated impact on economic activity as a result of a deterioration in DM credit impulses. The third is stronger-than-expected US inflation. An also-ran was the risk that the current vaccines do not protect against the two variants of the COVID-19 virus dominant in India. However, an increasing body of recent scientific studies demonstrates that this is not the case; hence, this risk has been lowered to minor. Risk #1: A Chinese Slowdown Authorities in China have been constricting credit policy over the past six months. The key tools used have been a regulatory tightening in shadow-banking activities and real estate transactions, moral suasion on small banks to limit the expansion of their loan books, and slowing liquidity injections in the interbank system. Beijing’s policy tightening reflects the following two worries. First, the financial stability risk has increased meaningfully over the past 16 months. China’s corporate debt-to-GDP has increased 13 points to 163%, and is among the highest for major economies (Chart 1). Moreover, Chinese policymakers remain concerned by the middle-income trap, which would become an increasingly likely outcome if the stability of the country’s financial and banking system were compromised. Second, the latest round of stimulus has worsened wealth inequalities. House prices have been robust, yet household disposable income growth is still low by the yardstick of the past 40 years (Chart 2). Thus, a large proportion of China’s population has experienced a decline in housing affordability. Chart 1China"s Financial Stabilitiy Risk Chart 2Chinese Households Are Not Doing That Well The Chinese economy recently started to feel the impact of the policy tightening. China’s April retail sales data missed expectation by 7.2%, and, as our China Investment Strategy colleagues have observed, the demand side of the economy has lagged behind the recovery in supply ever since China re-opened last year. Credit trends confirm this assessment. The decline in the excess reserve ratio of the Chinese banking system is consistent with the recent deterioration in the credit impulse, which accelerated in April (Chart 3). Since the Great Financial Crisis, weaker Chinese credit flows herald softer global industrial activity and trade (Chart 3, bottom panel). The Chinese slowdown could become a major problem for the European economy and its asset markets. As we recently showed, the sensitivity of European economic activity to global growth has been steadily increasing over the past 20 years (Chart 4). Moreover, the spread between M1 and M2 money supply growth in China best explains the gap between European industrial activity and that of the US (Chart 4, middle and bottom panels). Essentially, M1 minus M2 approximates the Chinese private sector’s marginal propensity to consume, because it captures how fast demand deposits are growing relative to savings deposits. Thus, the recent decline in China’s marginal propensity to consume constitutes a bad omen for European activity and profit growth, both in absolute terms and relative to the US. Chart 3A Policy-Induced Slowdown Chart 4Europe Is More Exposed Than The US The slowdown in China’s economy will hurt European asset prices via multiple channels. Importantly, cyclical stocks are expensive and overbought compared to defensive ones. A meaningful decline in Chinese growth could result in a deep fall in the cyclicals-to-defensives ratio, which would hurt the pro-cyclical EUR/USD exchange rate (Chart 5). A weaker China might also create a significant fall in global yields, because it would hurt global growth, accentuate deflationary forces, and upset investor sentiment. European stocks underperform US equities when global yields decline (Chart 6). Chart 5The Euro Is Pro-Cyclical Chart 6A Key Threat To European Stocks Despite the dire impact that a Chinese economic slowdown normally causes on European growth and assets, this outcome remains a risk and not a base case (albeit, the top risk in our view). First, today is one of the rare occasions when global and European economic activity can decouple from China. The Euro Area’s vaccination campaign is gaining steam, which will allow a re-opening of the economy this summer (Chart 7). The vast pent-up demand in durable goods evident in Europe and the positive impact of the European monetary expansion on the contribution of consumer expenditure to real GDP growth also create powerful offsets (Chart 8). Chart 8European Pent-Up Demand As An Offset Chart 7Improving Vaccine Rollout The global industrial cycle is more buffered than usual against a Chinese economic slowdown. The collapse in the inventory-to-sales ratios around the world will fuel several quarters of restocking, which will boost the global manufacturing sector (Chart 9). Moreover, governments across advanced economies are unleashing large-scale infrastructure plans, such as the $2 trillion bill proposed by the Biden administration in the US or the EUR250 billion budget proposal by the Draghi government in Italy. As the EUR750 billion NGEU funds are disbursed, the tailwind to infrastructure spending will only grow (Chart 10). Additionally, the current spurt in inflation around the world is a relative price shock driven by scarcity created during the pandemic. This price shock incentivizes companies to expand production and capacity to meet demand. As a result, global capex intentions are rising, which will create an additional offset to China. Chart 9Restocking Ahead Chart 10More Fiscal Support This Way Comes Finally, constraints on Chinese policymakers limit to how far Chinese growth will decelerate. The Chinese Communist Party Congress, in which the make-up of the politburo is determined for the next five years, takes place in October 2022. However, the weak growth rate of household disposable income creates a headache for China’s leadership. While another round of massive stimulus is unlikely to shore up household disposable income (it has not worked thus far), Beijing will not take the chance to generate another deflationary shock. This constraint creates a natural floor under the growth deceleration that Beijing can tolerate. Thus, while a policy mistake is still possible, it is not our base case scenario. Investment Implication Faced with the aforementioned dynamics, BCA recommends that investors with a short-term investment horizon go neutral on cyclical equities relative to defensive ones. Practically, this means that EUR/USD is likely to continue to churn between 1.18 and 1.235 for the coming two to three months. Additionally, European equities are likely to move sideways relative to their US counterparts over this period. Within cyclical equities, we favor industrials over materials. Commodity prices, and thus the materials sector, are the most exposed to China. Meanwhile, the outlook for infrastructure spending and capex in DM economies has a greater impact on industrial stocks than on materials ones. Technically, industrials remain toward the bottom of their upward-slopping trend channel relative to materials, which suggests further catch up is likely (Chart 11). We also favor European financials over the rest of the cyclical sectors. The negative impact of a greater-than-expected Chinese economic slowdown on global yields will hurt financials. Nonetheless, domestic economic activity affects financials more than it influences the more internationally focused industrials and materials sectors. Thus, if the Eurozone service PMI can slingshot higher, a result of the re-opening of the economy this summer, then European financials will outperform industrials and materials stocks even if the Chinese economy slows (Chart 12). Moreover, financials trade at a large discount compared to these other two cyclical sectors (Chart 12). Chart 11Overweight Industrials Vs Materials Chart 12Financials As A Protection Against China Finally, we continue to favor Swedish equities. Industrials and financials account for 65% of the Swedish MSCI benchmark compared to 30% for that of the Euro Area. Therefore, they are particularly exposed to the positive outlook on global infrastructure spending and capex. Moreover, Swedish equities generate a return on equity of 15%, compared to 6% for the Eurozone stocks. To protect against the risk created by a weakening Chinese economy, we recommend investors hedge a long / overweight bet on Sweden with a short / underweight position in Norwegian equities that massively over-represent energy and materials. Risk #2: A Global Credit Impulse Deterioration According to the BIS data, the global credit impulse is on the verge of deteriorating, even outside of China. The G10 plus China annual credit impulse is elevated and peaking (Chart 13, left). Meanwhile, quarterly credit impulses in the US, the Euro Area, and China are negative (Chart 13, right), which often leads to turning points in the annual change in credit flows. Chart 13A Global Credit Impulse Problem Chart 13A Global Credit Impulse Problem A deterioration in the credit impulse could result in a sharp slowdown in global economic growth, because the deceleration in credit creation is broad-based among the major economies. If global growth decelerates, then European economic activity will also suffer. Table 1Essential Sector Breakdowns The impact on European financial markets will come from lower yields. A growth deceleration prompted by a falling credit impulse will put downward pressure on yields and will hurt the performance of value stocks relative to growth equities. Cyclical equities will also underperform defensive ones. In this scenario, European stocks will lag behind their US counterparts because of their relative sectoral biases (Table 1). Within the European benchmark, Tech-heavy Dutch stocks would perform best once yields begin to decline. The effect on growth of the slowing credit impulse remains a risk and not a base case scenario. Last year’s surge in credit intake mostly reflected precautionary demand. Companies around the world tapped their credit lines or the capital markets early in the crisis to build liquidity buffers. They then continued to borrow to take advantage of the exceptionally low interest rates that prevailed throughout most of the year. Similarly, a large proportion of household borrowing amounted to debt refinancing. As a result, last year’s explosion in credit growth had a limited impact on spending. Thus, the credit impulse’s decline in advanced economies should minimally hurt aggregate demand in the coming months. Investment Implication Investors can protect against this risk by overweighting Italian and Spanish bonds in a balanced portfolio. First, these instruments continue to offer better value than other government bonds around the world. Moreover, if global growth turns out to be weaker than expected, the ECB might have to increase the envelope of the PEPP program, which has greatly benefited peripheral bonds. Moreover, the NGEU and REACT EU program buttress weaker European sovereign borrowers. Therefore, yield-hungry global investors will resume their aggressive purchase of the high-yielding peripheral bonds if global interest rates decline anew because of softening economic activity. Risk #3: Stronger Than Expected US Inflation BCA’s house view is that the current surge in global and US inflation is transitory, even if the pressures could last a few months before ebbing. It is mainly a consequence of inadequate aggregate supply in the face of a sudden surge in demand. We cannot be dogmatic about the inflation risk. The price-components of all the major activity surveys in the world are rising, and, in the US, the inflation expectations of households have risen meaningfully (Chart 14). If an inflation mentality were to take root, then core CPI would not decelerate toward yearend. Stronger-than-expected US core CPI would put significant upward pressure on Treasury yields. First, long-dated inflation expectations could begin to converge to the breakeven rates in the shorter tenors of the curve (Chart 15). More importantly, the Fed would become more hawkish sooner. This faster policy tightening would lift the OIS curve and result in higher real yields as well. Chart 14Are Inflation Expectations Becoming Unmoored? Chart 15Long-Dated Market-Based Inflation Expectations Still Lag The euro would therefore weaken, and the dollar would rally across the board. European inflationary pressures are limited compared to those of the US. The Eurozone suffers from a larger output gap due to the lagging nature of the European recovery, which more timid fiscal stimulus and Europe’s late start to the vaccination campaign compounded. Consequently, the ECB will not match the Fed’s faster tightening of policy, even in this scenario. Higher US TIPS yields and a stronger dollar would ultimately be deflationary blows to global growth. The dollar would directly tighten EM financial conditions. Higher real yields would destabilize stretched equity prices around the world. The resulting shock to global financial conditions would cause a major slowdown in global growth to occur much earlier than we currently foresee. While yields would rise at first, they would end 2022 at much lower levels than we currently expect because of this deflationary outcome. This combination would be very harmful to European equities, both in absolute terms and relative to the global benchmark. At first, European stocks would probably briefly fare well. Once investors begin to digest the deleterious impact of stronger inflation on global growth, however, the pro-cyclical European market will begin to suffer. Tighter EM financial conditions and underperforming financials will only accentuate the European stock market ills. Much stronger inflation is a risk and not a base case for now, because the current bout of inflation is transitory. The supply-side of the economy is already responding to the signal created by higher prices. Firms are set to increase their inventories and capex intentions are moving higher. Moreover, many of the bottlenecks constraining global supply chains will loosen, as the global economy re-opens in response to the international vaccination campaign. Additionally, current labor shortages in low-wage industry will also dissipate, once the $300 weekly support by the US government ends after the month of September. Thus, the supply of labor will also pick up in the fourth quarter of 2021. Moreover, the Fed could remain tolerant of an inflation overshoot, which would limit the pain of its impact. That being said, there is a real inflation risk due to the global deterioration in the dependency ratio and the shift to the left in terms of the economic preferences of the median voter. However, this danger is backdated to 2024 and beyond, once global labor markets are closer to full employment. Investment Implication There is little protection in our current set of recommendations against this risk, but this is a smaller threat than the previous two risks. However, when viewed alongside the first and second set of risks, the combined probability of a dangerous outcome for the market in general and for Europe in particular has grown compared to six months ago. Thus, while the jury is still out on these questions, it makes sense to de-risk portfolios temporarily, until the reward-to-risk ratio has once again improved. Hence, a tactical neutral stance on cyclical relative to defensive equities and on Europe relative to the rest of the world is appropriate for now. Will The ECB Join The BoC? At its April meeting, the Bank of Canada jolted the market by announcing a much earlier-than-anticipated start to its tapering program. We do not believe that the ECB will follow up at its June meeting. In a recent report, BCA’s Global Fixed-Income Strategy team highlighted the constraint that will prevent the ECB from adjusting policy next month.  The main factors are as follows: The results from the ECB’s strategic review have yet to be announced. Adjusting policy before an eventual change in the inflation mandate of the central banks creates an unnecessary risk of policy whipsaw. Yet another policy flip-flop would further mar the ECB’s credibility. Chart 16The ECB Does Not Want To Upend Credit Growth Loan growth in Europe is slowing down, led by France. However, Italian credit activity is improving in response to the generous TLTRO uptake in the southern economy (Chart 16). At this juncture, a rapid policy adjustment would threaten the recovery, while Europe has yet to re-open. Italian spreads remain fragile. The ECB’s asset purchases are an important contributor to the easing in financial conditions across the periphery. The recent 25bps widening in the BTP-Bund spread is a reminder that European fixed-income markets are not fully tension-free. Thus, a rapid removal of support could prompt a reflex selloff in Italian bonds. The subsequent tightening in financial conditions would unnecessarily feed deflationary pressures in Europe. The euro is strong. If the ECB unsettled the market and removed monetary accommodation as fast or even faster than the Fed, the euro’s rally would suddenly accelerate. This would generate a powerful deflationary shock for Europe that would force the ECB to adjust its inflation forecasts downward. Chart 17Especially When China Creates A Threat The Chinese economy is weak, which increases uncertainty around European economic outcome via the trade channel (Chart 17). Instead, the meetings in the back half of the year are much more likely candidates for the ECB to begin talking about its tapering program. By then, the European economic re-opening will have taken place, to which growth will have responded. The results of the ECB’s strategic reviews will have been announced. Finally, plans will have been ratified for the usage of NGEU funds across the EU, and thus, fiscal clarity will improve. Even if the ECB starts talking before yearend of terminating the PEPP, its communications will indicate that the program’s full envelope will be deployed within the original time frame. Thus, the PEPP program will be in place until the end of March 2022. Moreover, to prevent a rapid deterioration in bank credit, the ECB will continue to provide generous financing to deposit-taking institutions via the TLTRO program. Under these circumstances, the ECB is unlikely to increase its deposit rate before 2014. These views imply that the ECB policy tightening (both on the balance sheet and interest rate fronts) will lag behind that of the Fed, the BoE, the Norges Bank, and the Riksbank. Only the BoJ and the SNB will move after the ECB. The continued involvement of the ECB in the European fixed-income market, along with the elevated likelihood that we remain years away from the first rate hike, confirms that an overweight stance in European peripheral bonds is appropriate. We also continue to overweight corporate credit within European fixed-income portfolios. Our fixed-income colleagues also share these views. Chart 18Justifying A Box Trade Finally, the German yield curve should steepen compared to that of the US. Even if the ECB lags well behind the Fed when it comes to tightening policy, the current terminal rate proxy embedded in the EONIA curve is too low (Chart 18). Meanwhile, the earlier lift-off date for interest rates in the US relative to the Euro Area points to rising short rates west of the Atlantic. In this context, a box trade buying steepeners in Europe and flatteners in the US is appropriate, especially since it generates a positive carry of 167 bps (hedged into USD).   Mathieu Savary, Chief European Investment Strategist Mathieu@bcaresearch.com Cyclical Recommendations Structural Recommendations Currency Performance Fixed Income Performance Government Bonds Corporate Bonds Equity Performance Major Stock Indices Geographic Performance Sector Performance Closed Trades

Dear client, In addition to this weekly report, we also sent you a Special Report on cryptocurrencies, authored by my colleagues Guy Russell and Matt Gertken. The conclusion is that government authorities are likely to lean against the proliferation of cryptocurrencies, something we suspected in our most recent report on the topic. Regards, Chester Highlights Net foreign inflows into US assets probably peaked in March. Meanwhile, there are strong reasons to believe outflows from US securities will accelerate in the coming months. As such, the 12-18-month outlook for the US dollar remains negative. Cryptocurrencies are correcting sharply amidst a crackdown in China, a risk we warned investors about in our Special Report last month. We are increasingly favoring the yen. Lower the limit-sell on USD/JPY to 109. Hold long CHF/NZD positions recommended last week. Feature Chart I-1Current Account Deficit = Capital Account Surplus The US runs a sizeable trade deficit. As such, it must import capital to finance this deficit (Chart I-1). Over the last year, this has been driven by equity and agency bond purchases by foreigners. However, we might be at the apex of a shift, where foreign appetite for US securities starts a meaningful decline. Financing The US Deficit TIC data is usually a lagging indicator for FX markets, but still holds valuable insights into foreign appetite for US assets. On this front, the March data was particularly instructive: There were strong inflows into US Treasury notes and bonds, to the tune of almost $120 bn. This was the greatest driver of monthly inflows. This was also the largest monthly increase since the global financial crisis. Net inflows into US equities stood at $32.2 bn in March. This is on par with the three-month average, but a sharp deceleration from December inflows of $78.3 bn. Corporate bonds commanded particularly strong inflows in March to the tune of $43.1 bn. It appears that foreign private concerns swapped their agency bond purchases with corporate bonds. US residents repatriated $54.1 bn back home in March. Official concerns were big buyers of long-term US Treasury bonds, but this was offset by a large sale of US T-bills. Net foreign official purchases of overall US securities were just $6.5 bn. With the dollar down since March, it is a fair assumption that the strong inflows we saw since then have somewhat reversed. The question going forward is whether there has been a regime shift in US purchases, specifically the purchase of equities (and agency bonds). And if so, can the purchase of US Treasurys pick up the slack (Chart I-2). Foreign inflows into the US equity market tend to be driven by expected rates of return, either from an expected rerating of the multiple or from profit growth. A rerating of the US equity multiple, relative to the rest of the world, has inversely tracked interest rates (Chart I-3). This is due to the higher weighting of defensive sectors in the US equity market. Concurrently, we showed in a recent report that profit growth on an aggregate level also tends to move in sync with relative economic momentum.1  Chart I-2Equity Inflows Have Financed ##br##The US Deficit Chart I-3Rising Bond Yields Would Curtail Equity Inflows If growth is rotating away from the US, and global bond yields still have upside, this will curtail foreign appetite for US equities. This appears to be the story since March, as non-US bourses have outperformed (Chart I-4). Chart I-4ANon-US Markets Are Bottoming Chart I-4BNon-US Markets Are Bottoming In terms of fixed income flows, the rise in US bond yields towards a peak of circa 180bps in March undoubtedly triggered strong inflows into the US Treasury market. Since then, yields outside the US have been moving somewhat higher, especially in Germany. This should curtail bond inflows, and also fits with a growth rotation away from the US. While foreign central banks were net buyers of US Treasurys in March, the “other reportables” category from the CFTC data show a huge short position in US 10-year futures. Foreign central banks are usually grouped in this category. This will suggest the accumulation of Treasurys should reverse in the coming months (Chart I-5). Chart I-5Did Central Banks Hedge Their March Purchases? A rotation of growth from the US towards other parts of the world would also make it more difficult to finance the US current account deficit. This is because it will compress real interest rate spreads between the US and the rest of the world. From a historical perspective, inflows into US Treasury assets only tend to accelerate when real rates in the US are at least 50-100 bps above that in other G10 economies (Chart I-6). That could explain why despite a positive Treasury-JGB spread of 165 basis points, Japanese investors were very much absent buyers in March (Chart I-7). Chart I-6Real Rate Differentials And Bond Capital Flows Chart I-7The Big Boys Did Not Buy Much Treasurys In March Critical to this view is the outlook for US inflation. On this front, we note the following: First, the output gap in the US should close faster than most other economies, at least according to the OECD (Chart I-8). Ceteris paribus, US inflation should outpace that in other countries in the near term and put downward pressure on real rates. Chart I-8The US Should Generate Higher Inflation Fiscal spending has been more pronounced in the US compared to other countries, which will further fan the inflationary flames. The Fed is the only central bank in the G10 committed to an inflation overshoot. In a nutshell, there is compelling evidence to suggest US inflows peaked in March from both foreign equity and bond investors. Upside surprises in inflation are more likely in the US in the very near term compared to other economies, which will depress real rates. Meanwhile, higher global yields are also a negative for the US equity market. There Is No Alternative Chart I-9A Deep And Liquid Pool Of Treasurys My colleague, Mathieu Savary, has made the case that there is no alternative to US Treasurys. The treasury market is the most liquid and the deepest safe haven pool in the capital market universe (Chart I-9). Ergo, a flight to safety will always bid up Treasurys, as we saw in March 2020. We do agree that Treasurys will continue to act as the world’s safe haven benchmark for now. However, that privilege is fraying at the edges, and it is the marginal changes that matter for dollar investors. Competition for safe haven assets continues to intensify as the narrative switches from 40 years of disinflationary forces to the rising prospect of an inflation overshoot. Inflation is anathema to fiat currencies, including the dollar. For investors, precious metals have been a preferred habitat for anti-fiat holdings. That said, cryptocurrencies are also rising in the ranks as an alternative. In our Special Report2 released a month ago, we suggested government regulation was a huge risk for cryptocurrencies. But more specifically, the degree to which cryptocurrencies can benefit from a shift away from dollars will depend on whether private investors or central banks drive the outflows. Since the peak in the DXY index in 2020, the biggest sellers of US Treasurys have been private investors. Cryptocurrencies benefited from this diversification. That has changed since March, which partly explains the big drawdown in crypto prices. In general, you always want to align yourself with strong buyers who are price indiscriminate. Foreign central banks (the biggest holders of US Treasurys) prefer gold as their anti-dollar asset. This puts an solid footing under gold prices, compared to cryptocurrencies or other anti-fiat assets. It is worth noting that competition between the dollar and gold often run in long cycles. In the 1970s, as inflation took hold in the US, the dollar depreciated and gold soared. In the 1980s, the dollar took off and gold fell sharply, as the Federal Reserve was able to bring down inflation. The 1990s were relatively disinflationary, which supported the dollar (Chart I-10). A whiff of rising inflation in the early 2000s hurt the dollar, while the 2010s were characterized by very low inflation, supporting the dollar. More recently, the dollar is weakening as inflationary trends accelerate faster in the US (Chart I-11). Chart I-10The Dollar And Inflation Move Opposite Ways (1) Chart I-11The Dollar And Inflation Move Opposite Ways (2) One of our favorite indicators for gauging ultimate downside in the dollar is the bond-to-gold ratio. The rationale is that the bond-to-gold ratio should capture investor preference at the margin for either US Treasurys or gold. This in turn has been a good measure of investor confidence in the greenback. On this basis, the bond-to-gold ratio (TLT-to-GLD ETF) is breaking down to fresh cycle lows (Chart I-12). This has historically pointed towards a lower US dollar. Chart I-12The Dollar And The Bond-To-Gold Ratio Within precious metals, we like gold but love silver. As such, we are short the gold-to-silver ratio since an entry point of 68. Our bias is that initial support for this ratio is 60. Meanwhile, we also like platinum, and will go long versus palladium at current levels. A Few Other Indicators A few other market developments are pointing to a lower dollar in the coming months. The dollar tends to decline in the second half of the year. This has been true since the 1970s (Chart I-13). Importantly, even during the Paul Volcker years in the 80s when the dollar staged a meaningful rally, it often fell in the second half of the year. The winner in the second half of the year has usually been the Swiss franc and the Japanese yen (Chart I-14).  Chart I-13The Dollar Usually Strengthens In H1 Chart I-14The Dollar Usually Weakens In H2 The OECD leading economic indicators still suggest US growth remains robust relative to the rest of the G10. However, our expectation is that this gap will decrease sharply in the second half of this year. That said, the current reading is a risk to our dollar bearish view (Chart I-15). Chart I-15US Exceptionalism Is A Risk For Dollar Bears Lumber has started to underperform Dr. Copper. Lumber benefits from solid US housing activity, while copper is more tied to global growth and the emerging investment in green technology. As a counter-cyclical currency, the dollar also tends to underperform higher beta currencies when lumber is underperforming copper (Chart I-16). The copper-to-gold ratio has also bottomed, suggesting ample liquidity is now fueling growth (Chart I-17). We suggested last week that the velocity of money across countries was a key variable to watch in getting the dollar call right. So far, the collapse in money velocity is least acute in China, explaining the rise in the copper-to-gold ratio and the improvement in non-US yields compared to the US. Chart I-16Lumber/Copper Prices And The Dollar Chart I-17Copper/Gold Prices And Bond Yields In summary, many cyclical indicators still point to a lower dollar. The key risk to this view is an equity market correction, and/or persistent relative strength in US growth.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Report, "Trading Currencies Using Equity Signals," dated May 7, 2021. 2 Please see Foreign Exchange Special Report, "Will Cryptocurrencies Displace Fiat," dated April 23, 2021. Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The drubbing that cryptocurrencies have received over the past two weeks is just a taste of things to come. Crypto markets will continue to face tighter regulation, as this week’s announcements from China and the US Treasury underscore. The hope that cryptocurrencies can ever truly “go green” is wishful thinking. Given their decentralized nature, cryptocurrencies require real resources to be expended to permit secure transactions to take place. In addition to their technical limitations, cryptocurrencies face a fundamental constraint, which we dub the “Crypto Impossibility Theorem.” The Crypto Impossibility Theorem states that cryptocurrencies will be viable only if they offer a higher return than equities. The assumption that cryptos can generate a return in excess of equities is almost certain to be false since it would require that cryptocurrency holdings rise more quickly than income in perpetuity. In the near term, the pain in crypto markets could drag down other speculative assets such as tech stocks. In the long term, diminished investor interest in cryptos will benefit the stock market, as investor attention focuses back on equities. Cryptos: Can’t Have It All Investors who track the cryptocurrency market might be aware of the “blockchain trilemma.” It posits that cryptocurrencies can possess only two of the following three attributes: decentralization, security, and scalability. Bitcoin is both highly decentralized and reasonably secure. However, because control of the Bitcoin blockchain is distributed across thousands of individual computer nodes, it is also very slow. The Bitcoin network can barely process five transactions per second, compared to over 20,000 for the Visa network (Chart 1). The average fee for a Bitcoin transaction is around $30, a number that has risen over the past few years (Chart 2). Chart 1Speed Of Transactions, Or Lack Thereof Chart 2Rising Cost Per Transaction   The elaborate puzzles that the Bitcoin algorithm must solve to verify transactions are extremely energy intensive. Bitcoin mining consumes more energy than entire countries such as Sweden, Argentina, and Pakistan (Chart 3). About two-thirds of Bitcoin mining currently takes place in China, often using electricity generated by burning coal. Chart 3Bitcoin And Ethereum: How Dare You! Some claim that Bitcoin and other cryptocurrencies are shifting to renewable energy sources, a trend that will continue in the years ahead. However, this argument misses the point, which is that the “proof of work” mechanism that underpins Bitcoin requires that real resources be expended. Suppose that all Bitcoin mining could be performed entirely for free using solar energy. This would reduce the cost of running a “mining rig,” incentivizing more mining. The Bitcoin algorithm operates in such a way that the difficulty of mining coins increases as the total computational power of all miners grows. In this computational rat race, miners would need to purchase more servers with ever more powerful specifications to keep up with their competitors. And semiconductors do not grow on trees. It takes real resources to produce them. As this recent Bloomberg article pointed out, Taiwan Semiconductor generates almost 50% more greenhouse emissions than General Motors. Like Bitcoin, Ethereum uses the “proof of work” mechanism to verify transactions. There have been active discussions to shift Ethereum to a “proof of stake” mechanism, which would greatly expedite transactions.1 However, some have argued that a proof of stake system would degrade security, allowing for “double-spend attacks” where someone transfers coins to someone else but then spends the coins before the transaction is completed. The Crypto Impossibility Theorem We will not delve any further into the technical nature of the blockchain trilemma other than to note that it poses a serious challenge to the entire cryptocurrency project. Instead, let us highlight another obstacle that has received less attention – one that could be even more damaging for the prospects of cryptocurrencies in the long run. Let us hyperbolically call it the “Crypto Impossibility Theorem.” The Crypto Impossibility Theorem states that a cryptocurrency will be viable only if it offers a higher return than equities. As we discuss below, the assumption that cryptos can generate a return in excess of equities is almost certain to be false since it would require that cryptocurrency holdings rise more quickly than income in perpetuity. This implies that the value that investors currently attach to cryptos will turn out to be illusory. To see the theorem in action, recall that money serves three functions: As a unit of account, as a medium of exchange, and as a store of value. It is doubtful that anyone seriously thinks that the price tag on a box of cereal will ever be displayed in units of Bitcoin, ether, or any of the various dog coins currently in vogue. Thus, we can scratch “unit of account” off the list of possible crypto uses. What about medium of exchange? One can imagine a scenario where the prices of goods and services are still listed in dollars, but one may transfer the equivalent in cryptocurrencies to purchase them. However, this raises an obvious question: Why would anyone choose to hold a cryptocurrency if wages and prices are denominated in fiat currencies such as US dollars or euros? The only possible answer is that people must see cryptocurrencies as fulfilling the third function of money, namely being a store of value. Would people be willing to hold cryptocurrencies if their prices generally moved sideways? It is doubtful. Cryptocurrencies are risky. Cryptocurrency accounts are not subject to deposit insurance. Crypto prices are also extremely volatile. During the pandemic, the S&P 500 fell by 34%, but the price of Bitcoin sank by an even greater 53%. Other cryptocurrencies fared even worse. In contrast, the trade-weighted US dollar strengthened by about 4% while gold prices only fell marginally (Chart 4). Thus, to incentivize people to hold cryptos, the prospective capital gain has to be large enough to offset the inherent volatility in owning these currencies. Chart 4Cryptocurrencies Fared Badly During Last Year’s Equity Sell-Off This is where the Crypto Impossibility Theorem comes in. Unlike dividend-paying stocks, cryptocurrencies do not provide any income to their holders. Thus, even if cryptos were just as risky as stocks, the price of cryptos would still need to rise more than the price of stocks in order to ensure that investors remain indifferent between the two asset classes. In practice, as the experience of the pandemic demonstrates, cryptos are even riskier than stocks. Thus, the expected return on cryptos has to exceed the expected increase in stock prices by more than the dividend yield. The problem for crypto holders is that this is not mathematically possible. Even if one controls for the rise in price-earnings multiples over time, equity returns have generally exceeded nominal GDP growth (Table 1). Hence, if cryptos need to offer superior returns to equities, and if the return on equities is at least equal to nominal GDP growth, then the market capitalization of cryptocurrencies will not only end up rising faster than for stocks, it will rise faster than aggregate national income. In a digital world where people need ever-less money to facilitate transactions, there is no good reason to expect this to happen. Table 1Equity Returns And GDP Growth A Fashion Choice Crypto-optimists might argue that the required rate of return to holding cryptos will decline as the market matures. This is wishful thinking. Equities derive their value from the fundamentals of a company’s business. In contrast, cryptocurrencies have no intrinsic value. Their value is whatever others are willing to pay for them. Not only does this make cryptocurrencies inherently more risky than equities, it also makes them highly susceptible to fashion trends. It is not surprising that many upstart cryptocurrencies have crafted ties with celebrities and other “influencers.” The whole point is to get enough people interested in a cryptocurrency to generate a feedback loop of wider adoption, thus allowing the currency’s early backers to cash out. The drubbing that cryptocurrencies have received over the past two weeks is just a taste of things to come. In this sense, cryptocurrencies are even more vulnerable to affinity scams than other assets such as precious metals. While apocalyptic warnings of “currency debasement” have long been used to sell bullion, at least with gold and silver, you truly do get something that is in short supply. In the case of cryptocurrencies, while the supply of any individual cryptocurrency may be limited, the overall supply is unbounded. This means that the average price of each currency is likely to rise much less than the aggregate value of all cryptocurrencies, making the entire asset class even less viable over time.   Cryptogeddon The drubbing that cryptocurrencies have received over the past two weeks is just a taste of things to come. As Matt Gertken and Guy Russell discuss in this week’s Geopolitical Strategy report, crypto markets will continue to face tighter regulation (Table 2). Just this week, China reiterated its ban on financial companies offering cryptocurrency services. As part of its broader effort to crack down on tax evasion, the US Treasury Department also announced that it will require any cryptocurrency transfer worth $10,000 or more to be reported to the IRS. Table 2Regulation Of Cryptos: What Can And Cannot Be Done The blockchain trilemma will make it impossible for cryptos to overcome ESG concerns, while the Crypto Impossibility Theorem will prevent cryptocurrencies from ever being stable stores of value. In the meantime, an ebbing of input price inflation will take some of the wind out of the sails from the argument that cryptos are an indispensable hedge against the “inevitable” debasement of fiat monies. Chart 5 shows that DRAM prices have rolled over. Lumber prices have dropped 11% so far this week. Corn, soybean, and steel prices have also backed off their highs. Cryptos are like sharks; they need to move forward or they will sink. Back when they were unknown to most investors, a speculative case could have been made for buying cryptos. However, that case vanished earlier this year when the aggregate value of cryptocurrencies briefly surpassed the entire stock of US dollars in circulation (Chart 6). Even with the recent correction, there are 17 cryptocurrencies with market capitalizations above $10 billion (Table 3). Chart 5To The Moon And Back? Chart 6Aggregate Value Of Cryptos Briefly Surpassed The Entire Stock Of US Dollars In Circulation Table 3Close To 20 Cryptos Have A Market Cap In Excess Of US$10bn What will the ongoing crypto collapse mean for the broader investment landscape? In the near term, the pain in crypto markets could drag down other speculative assets such as tech stocks. In the long term, diminished investor interest in cryptos will benefit the stock market, as investor attention focuses back on equities. For the broader economy, the impact of a crypto bear market will be limited. The banking system has very little exposure to cryptos. There will be a modest adverse wealth effect from falling crypto prices. However, the inability of a few laser-eyed crypto traders to buy their Lambos is hardly going to matter much against the backdrop of strong stimulus-fueled consumption growth in the US and a number of other economies. Investors should continue to overweight stocks in a global asset portfolio, favoring value over growth, cyclicals over defensives, and non-US stocks over their US peers. Peter Berezin Chief Global Strategist pberezin@bcaresearch.com Footnotes 1 Proof of Work (PoW) and Proof of Stake (PoS) are two methods used to ensure the integrity of a coin’s ledger or record of transactions. PoW achieves this by requiring miners (those who add transactions to the ledger) to solve a time-consuming mathematical puzzle. PoS achieves this through a different mechanism, where anyone who stakes their own coin can be randomly selected to add new transactions to the ledger. Those holding or “staking” more coin have a higher probability of being selected. Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores

ハイライト ECBのテーパリング？：ECBがカナダ銀行やイングランド銀行に続き、予想より早く国債買入を縮小し始める—ひょっとすると来月の政策会合で—かもしれないという投資家の懸念は的外れです。ECBが最も避けたいのは、欧州の成長とインフレの加速を先取りして金融緩和の縮小に踏み切った結果としてユーロ高とイタリア国債利回りの急騰を招くことです。 ユーロ圏債券ストラテジー：我々は現在の欧州債券に関する推奨を維持します：グローバル債券ポートフォリオ内で欧州をオーバーウェイトとし、コア国の国債に対してペリフェラル（周辺国）ソブリンおよびコーポレートを優先する一方、ブレークイーブンが割安なフランス、イタリア、ドイツのインフレ連動債もオーバーウェイトとします。また、ECBの利上げ織り込みを織り戻す新たな戦術取引として、2023年12月ユーロイボー金利先物（3か月）ロングを提案します。 特集 親愛なる顧客の皆様へ、 来週、月刊のバンク・クレジット・アナリスト誌の同僚と共同で、現在の世界的な住宅ブームが投資に与える影響についてのスペシャルレポートを発表します。そのレポートは5月28日金曜日にお届けします。通常の週次発行スケジュールには6月1日火曜日に戻ります。 - Rob Robis 今週のチャート 欧州債利回りの期待外れの上昇 欧州債券利回りの期待外れの上昇 欧州債券利回りの期待外れの上昇 来月の金融政策会合に向けて、欧州中央銀行（ECB）総裁のクリスティーヌ・ラガルドは、パンデミック開始以来初めて理事会メンバーを対面で招集する予定だと伝えられています。これは、ワクチン接種が進んでCOVID-19の深刻な局面から脱しつつある欧州に対して、どの程度の金融支援がまだ必要かを巡る議論が行われるであろう会合において興味深い副次的要素を提供します。先の4月のECB会合の議事要旨によれば、既に一部のECB関係者は経済成長とインフレ期待のリスクが「上振れに傾いている」と指摘しています。 欧州の景況感が改善する中、欧州の債券利回りは反応して上昇しています（今週のチャート）。ベンチマークである10年ドイツ国債利回りは現在-0.11%で、年初来46bp上昇しましたが、その半分は過去１か月での動きです。利回りの上昇はドイツやフランスといったコア国に限定されたものではなく、10年イタリア国債利回りは現在1.11%に達し、2021年初めの水準（0.52%）の倍以上になっています。インフレ期待も急速に高まっており、5年先5年物フォワードのユーロ消費者物価指数スワップは現在1.63%で、2018年12月以来の水準です。 これらの利回り上昇は他国で見られる大きな上昇に比べると遅れています。米国とカナダの10年国債利回りは年初来それぞれ72bp、90bpの上昇を記録しています。これらの国々で利回りが急騰したのは、インフレ期待の上昇と中央銀行の国債買入縮小（テーパリング）への懸念が原因であり、カナダについては先月、実際にカナダ銀行が国債買入ペースの減速を発表して的中しました。 我々の見解では、ECBがよりタカ派的な政策スタンスへの転換を検討するにはまだ時期尚早です。この見解は、上昇したものの依然としてより引き締めを示唆していない我々のECBモニターによって裏付けられます。欧州の債券売りは「過剰で、速すぎる」ケースに見えます。 ECBは今や多くの課題を抱えている 最近のユーロ圏の経済指標は、米国で先行して見られた強さに追いついただけでなく、場合によっては長年見られなかった水準に戻っています。ドイツのZEW景気期待指数の期待項目は5月に約14ポイント急上昇し、2000年以来の水準に達しました。製造業のMarkit PMIは4月に過去最高の62.9に達しました。欧州委員会のユーロ圏消費者信頼感指数はほぼパンデミック前の水準に戻っており（チャート2）、サービス業のMarkit PMIの回復継続に良い前兆です。 パンデミックに関する良いニュースが成長見通しの急伸を後押ししています。新規COVID-19感染者の増加ペースは着実に低下しており、パンデミック初期に最も深刻な被害を受けた地域の一つであるイタリアでは現在（7日移動平均）10月以来で最も低い新規感染率を示しています。一方で、ワクチン接種のペースは当初の遅い立ち上がりから加速しており、1日あたりの接種回数（100人当たり）はドイツ、フランス、イタリアで米国を上回っています（チャート3）。 チャート2 欧州の成長は回復中 欧州の成長は回復している 欧州の成長は回復している チャート3 欧州での接種加速 欧州におけるワクチン接種の加速 欧州におけるワクチン接種の加速 チャート4 欧州の余剰生産能力はどの程度か？ 欧州にはどれだけの余剰生産能力があるのか？ 欧州にはどれだけの余剰生産能力があるのか？ 接種の急速な進展は、2020年Q4と2021年Q1のロックダウンによる二番底型リセッションからの確かな回復を欧州にもたらす見込みです。欧州委員会は先週、ユーロ圏の成長見通しを上方修正し、実質GDPは2021年に4.3%、2022年に4.4%の拡大を見込むとしました（従来見通しは両年とも3.8%）。NGEU（ネクスト・ジェネレーションEU）パッケージを通じた公共投資の回復が夏の後半に資金支出を始めることで、全てのユーロ圏諸国は2022年末までにパンデミック前の生産水準に回帰する見込みです。 ECBは6月の会合で、自らの経済成長およびインフレ見通しを引き上げることは確実でしょう。後者の見通しは、ECBの理事会内で最大の議論材料になる可能性が高いです。 製造業PMIのような調査ベースの指標が比較的協調的に回復しているにもかかわらず、失業率や一般的な余剰生産能力の指標にはユーロ圏内で大きなばらつきが残っています（チャート4）。これは、ヘッドラインHICPインフレ率の年次増加率が多くのユーロ圏国で約2%に近づいている一方で、イタリアやスペインのように依然として非常に高い失業率に苦しむ国々があるため、ECBがこの実現インフレの上昇が持続するかを判断するのを難しくします。 ユーロ圏内の失業率の広い分布は、現行の政策金利水準（0%前後かそれ以下）が適切であることも示唆しています。ヨーロッパの労働市場の強さの「幅」を測る単純な指標の一つは、OECDが推定する完全雇用のNAIRU以下の失業率を有するユーロ圏国の割合を見ることです。1 この指標は、基本的なテイラールールにより算出されるユーロ圏短期金利の適正水準の推定と良く相関します。現時点では、ユーロ圏諸国のうち完全雇用を超えているのはわずか43%であり、これはECBの政策金利がおおむね0%付近である状況と整合します（チャート5）。 チャート5 政策金利が0%付近であるのが依然適切 政策金利が0％近辺でも依然として適切である 政策金利が0％近辺でも依然として適切である やや多めの国（47%）は賃金上昇の加速を見ています（下段）。これは、一部の国のNAIRU推定が低すぎる可能性があり、2015年以降のユーロ圏全体の賃金上昇加速と整合します。しかし、多くのユーロ圏国がパンデミックで増加した失業の処理途上にあることを踏まえると、ECBが労働市場の動態を十分に把握し、必要な金融政策の調整を決めるまでには時間がかかるでしょう。 データトレンドの「幅」はテイラールールのような理論的な金利指標とだけ相関するわけではありません。実際のECBの政策決定は、高い成長とインフレがユーロ圏全域にどの程度広がっているかによって動機付けられます。 チャート6では、チャート5の労働市場の幅指標と類似の指標を、他の経済・インフレデータを用いて示しています。具体的には、以下を観察するユーロ圏各国の割合を示しています： チャート6 ECBは成長とインフレが広範に及ぶときに引き締める傾向 成長かつインフレが広範に及ぶとき、ECBは通常、金融政策を引き締める 成長かつインフレが広範に及ぶとき、ECBは通常、金融政策を引き締める a) OECD景気先行指数が1年前の水準より高く、成長モメンタムが加速していること； b) ヘッドラインHICPインフレの最新値が1年前と比べて上昇しており、インフレモメンタムが加速していること； c) ヘッドラインHICPインフレがECBの「ほぼ2%未満」目標を上回っており、比較的高いインフレであること。 1998年のユーロ導入以降の過去のECBの金融引き締め局面（実際の政策金利の引上げ、あるいはECBのバランスシートの横ばい～縮小トレンドの形をとったもの）をすべて見ると、ECBは少なくともユーロ圏国の75%が成長とインフレの両方で加速していない限り引き締めに踏み切らないことが明らかです。実際の利上げは、2000年、2005～2007年、2011年の利上げサイクルのように、少なくとも75%の国でインフレ率が2%を超えていたときに発生しました。より最近では、2017年にECBは成長とインフレが加速した際にバランスシートの拡大を停止しましたが、インフレが2%を超える国が50%にとどまったため、政策金利の調整は行いませんでした。 今日、実質的に全てのユーロ圏国がパンデミックで落ち込んだ1年前の水準と比べて成長モメンタムが加速しています。ユーロ圏の59%の国でインフレが加速しており、この数字は欧州のさらなるロックダウン解除と世界的なコモディティ価格の上昇に伴いさらに上昇する可能性があります。しかし、ヘッドラインインフレが2%を超える国はわずか12%にとどまっており、2017年の経験に照らすと、実現インフレはECBのバランスシート調整を引き起こすほど強くはありません。 6月のECBテーパリングに賭けるな 過去のECBの行動から判断すると、6月の政策会合で国債買入のテーパリングを発表するのは時期尚早です。より可能性が高いのは、ECBの成長・インフレ見通しの上方修正がきっかけとなり、量的緩和、TLTROのような銀行向け資金供給プログラム、政策金利といったECBの金融刺激策の各要素をどう扱うかという議論が始まることです。しかし、ECBが方針の次の一手を決定するには、インフレ目標自体の性質がまもなく変わる可能性があるため、6月会合で結論に達するのは不可能でしょう。 ECBは現在、2003年以来初となる金融政策ストラテジーのレビューを行っており、今年後半に完了する予定です。インフレ目標にはある程度の柔軟性を持たせる調整が予想されますが、その具体的な内容はまだ不明です。ECBが連邦準備制度（Fed）の先例に倣い「平均インフレ目標」政策へ移行し、目標を下回る期間の後にインフレ目標の超過を許容する可能性はあるのでしょうか？ ECBのチーフエコノミストであるフィリップ・レーンは3月に、FRBの新たなアプローチには「非常に強い論理性がある」と述べています。同時に、いくつかの欧州諸国における「非常に異なるインフレの歴史」が、一時的に高めのインフレを許容するような制度について合意に達することを難しくする可能性があるとも指摘しました。2 より最近では、フィンランド中央銀行総裁であり理事会の穏健派メンバーで現在のECB総裁候補とも見なされたオッリ・レーンが、5月9日のフィナンシャル・タイムズのインタビューでECBが米国型の平均インフレ目標へ移行することを支持すると述べました。3 レーンは、失業を最小化することに重きを置く米国型の焦点は「より低い自然利子率という現状では理にかなっている」と述べ、ECBの現在のインフレ目標の文言は「非対称性の認識を生んでおり、『2%が上限である』と見なされてインフレ期待を抑制している」と説明しました。 我々は、ドイツ連銀のイェンス・ヴァイトマンが、ECBのインフレ目標を2%超の一時的な上振れを容認するように変更することに激しく反対するだろうと想像します。ドイツのヘッドラインHICPインフレは既に4月に2.1%に達しており、ドイツ経済の長期にわたるロックダウン解除に伴いさらに上昇する可能性があります。しかし、たとえヴァイトマンが「緩和」のいかなる動きにも強硬に反対しないとしても、ECBのストラテジーレビューの完了が近づいていることを考えると、テーパリングのような政策変更がそれ以前に信頼性を持って発表される可能性は非常に低いでしょう。もし高めのインフレが容認されるなら、そもそもなぜテーパリングを行う必要があるのでしょうか？ インフレ戦略レビューを越えて見れば、ECBが次の金融政策の一手を検討する際に重荷となり得る他の要因もあります： 中国の政策引き締め：欧州の最大の貿易相手である中国は、2020年にパンデミック対応で成長を支えるために許容した借入の急増後、信用成長や財政支出を抑制し始めています。我々の中国クレジット・インパルス指標は、欧州から中国への輸出の年次成長率を約9か月先行しており（チャート7）、今年後半に輸出の劇的な減速を示唆しています。これは特にドイツのように中国向け輸出依存度が高い国々にとってユーロ圏成長の下振れリスクとなります。 貸出成長の鈍化：ユーロ圏全体の銀行貸出の年次成長率は2月に12.2%でピークを迎え、現在は10.9%に低下しています（チャート8）。軟化の多くはドイツとフランスで発生しており、これらの国はECBのTLTROを通じた優遇銀行資金の大幅な活用を見ていました。最新のTLTROプログラムのためにECBが設定した価格面でのインセンティブは非常に魅力的であり、ドイツとフランスの銀行は安い資金を利用して貸出を拡大したようです。これは銀行貸出データの経済的解釈をECBにとってより難しくしており、特にイタリアの貸出成長とTLTRO利用が現在加速している点がそれに拍車をかけています。 チャート7 欧州の輸出需要に対する警告サイン 欧州の輸出需要の警戒サイン 欧州の輸出需要の警戒サイン チャート8 ECBのTLTROはイタリア重視に ECBのLTROがイタリアに焦点を当てつつある ECBのLTROがイタリアに焦点を当てつつある NGEU支出：前述の通り、€7,500億のNGEU（ネクスト・ジェネレーションEU、別名「リカバリー・ファンド」）からの支払いは、各国の政府投資提案がEUの承認を得れば今年後半に開始される見込みです。NGEU資金はデジタルやグリーン関連の投資など、将来の経済成長を押し上げるイニシアティブを資金供給することを目的としています。多くのユーロ圏国がすでに提案を提出しており、イタリアは€1,920億の要求で主導しています。 チャート9 NGEUは今後5年間で欧州成長に大きく寄与する ECBの見通し：卵の殻の上を歩く ECBの見通し：卵の殻の上を歩く チャート10 NGEUの影響は前倒しで現れる NGEUの影響は前倒しで現れる NGEUの影響は前倒しで現れる S&Pグローバルの最近の研究は、NGEU投資によりユーロ圏全体の成長が2021年から2026年にかけて累積で1.3～3.9ポイント押し上げられる可能性があると結論づけています（チャート9）。4 同研究はまた、支出の影響は次の2年間に前倒しで現れるだろうと指摘しています（チャート10）。イタリア政府はNGEU投資がイタリアの低迷するトレンド成長率を1.5%まで倍増させる可能性があると考えています。多くのECB関係者は、NGEUのような構造的財政刺激があれば極めて緩和的な金融政策を維持する必要性が低くなると指摘しています。しかし、NGEU提案が最終化され、承認された資金額が配分されるまでは、ECBは政府投資を考慮に入れた経済予測を調整することができません。 これらの即時的な不確実性、特に欧州がパンデミックのロックダウンからどれだけうまく再開できるかを含め、我々はECB理事会が6月の政策会合で現行の金融政策ツールやガイダンスの即時変更が必要だと結論付けるという筋の通ったシナリオは見ていません。 結論：ECBがカナダ銀行やイングランド銀行に続いて予想より早く国債買入を縮小し始める—ひょっとすると来月の政策会合で—という投資家の懸念は的外れです。 ECBの次の可能性のある動きと投資への影響 6月にテーパリング発表があるとは考えにくい一方で、将来の動きに向けた示唆が出る可能性は十分あります。ECBは政策転換のかなり前から市場を準備させることで悪名高く、したがって6月会合後の公式声明やラガルド総裁の記者会見には、ECBの次の動きに関する手がかりが含まれる可能性があります。 チャート11 ECBの緩和は多様な形態をとる ECBの金融緩和は様々な形を取る ECBの金融緩和は様々な形を取る 来年3月に終了予定のパンデミック緊急購入プログラム（PEPP）についての議論が6月に持ち上がる可能性はあります。欧州経済の再開の成功やNGEU資金の最終承認額がより明確になる9月の政策会合で取り上げられる可能性の方が高いと考えられます。これらが、COVID-19ショックに起因して導入された資産買入プログラムを維持する必要性を決定づけるからです。 緩和を段階的に縮小する際にECBが選択できる政策オプションは多岐にわたります。 調整可能な政策金利は複数あります。ECBが次に利上げを試みる際、最初に動く金利はおそらく短期金利の「下限」を示す預金金利（現在-0.5%）になるでしょう（チャート11）。 ただし、利上げはバランスシート関連ツールの縮小・巻き戻しの前には発生しないでしょう。つまり、まず資産買入が縮小されます。市場参加者はその政策選択の順序を良く認識しており、短期金利の非常にフラットな経路が欧州のOISカーブに織り込まれています。 OISとCPIスワップ曲線のフォワードレートのスプレッドは、市場の実質金利のフォワード価格付けの代理として使えます。現状、市場が示唆する実質ECB政策金利は今後10年で-2%から-1%の間にとどまると織り込まれています（チャート12）。言い換えれば、市場は今後10年間で予想インフレを上回らない非常にフラットなECB政策金利の経路を織り込んでいます。 欧州の自然実質利子率はトレンド成長が低いため非常に低い可能性がありますが、実質金利が-2%といった水準にあるということは、欧州経済に関する多くの悪い構造的ニュースを織り込んでいることを意味します。比較すると、NY連銀がパンデミック前の2020年第2四半期に算出した欧州の自然実質利子率（r-star）は+0.6%とプラスでした。 このように実質金利のマイナス期待が長期化すると、ベンチマークであるドイツ国債利回り曲線上に実質的にマイナスの実質利回りが持続することの説明がつきます。単純に言えば、ECBが本格的な利上げサイクルを演出できると信じられていないのです—これは日本のフィクスト・インカム投資家には馴染みのある結果です。 ECBがユーロの水準を常に懸念しており、それが欧州の成長とインフレ期待に影響する役割を果たすことを考えると、市場がECBにとって金利を大きく引き上げるのは通貨高を招きかねず難しいと考えるのは正しいでしょう。ECBが2014年にマイナス金利政策に移行して以来、購買力平価（PPP）ベースで一貫してユーロが過小評価されてきたのは偶然ではありません（チャート13）。 チャート12 市場は今後10年の欧州実質金利のマイナスを予想 市場は今後10年間、欧州の実質金利がマイナスになると予想している 市場は今後10年間、欧州の実質金利がマイナスになると予想している 先を見れば、ECBは市場に対して金利の将来経路を上方修正させユーロを大幅に押し上げるような政策変更（テーパリングを含む）を示唆する際には慎重である必要があります。 チャート13 低いECB金利がユーロの過小評価を維持 低いECB金利がユーロの割安感を維持している 低いECB金利がユーロの割安感を維持している つまり、欧州の実質債利回りは少なくとも2021年後半にかけて深くマイナスのままである可能性が高く、名目利回りの追加上昇は主にインフレ期待の上昇によることになります（チャート14）。これにより、現在水準から欧州債利回りがさらに上昇できる余地は限定されます。 チャート14 欧州債券ストラテジーの要約 欧州債券ストラテジー概要 欧州債券ストラテジー概要 我々は引き続き、コア欧州債利回りは少なくとも2021年後半は米国債利回りに対して「低いイールドベータ」で推移すると考えており、2022年にフェデラル・リザーブが国債買入のテーパリングを開始すると予想しています。したがって、グローバル債券ポートフォリオではコア欧州国債を米国債に対して戦略的にオーバーウェイトするという推奨を維持します。米国でのテーパリングの発生確率が欧州より高く、その後の利上げもECBよりFRBの方が実施する可能性が高いと見ているからです。 専用の欧州債券ポートフォリオ内では依然としてベンチマークよりやや短めのデュレーションを推奨しますが、もし10年ドイツ国債利回りが大きくプラス領域に上昇した場合には、欧州のデュレーションエクスポージャーを引き上げることを検討します。 我々はまた、ドイツ、フランス、イタリアのブレークイーブンが我々のグローバル評価モデル群で唯一割安であるため、欧州のインフレ連動債に対するオーバーウェイト推奨を維持します。 欧州のクレジットでは、スプレッド商品をソブリン債に対してオーバーウェイトすることを引き続き推奨します。これはイタリアやスペインの国債だけでなく、投資適格およびハイイールドのコーポレート債を含みます。これらの市場に対してより弱気になるべきタイミングは、ECBが資産買入をテーパリングし始めた時です。クレジットスプレッドはECBのバランスシートの成長が鈍化している期間に拡大する傾向があります（チャート15）。 ECBが最終的にテーパリングを決定した際には、TLTROのネット残高は現在水準近くで維持される可能性が高いと考えています（満期を迎えるものを置き換える新たなTLTROを導入することで）。これにより、イタリアのような脆弱な国々でECBのイタリア国債買入減少と安価なECB資金へのアクセス減少という二重の打撃で借入コストが急騰する事態を避けることができます。 最後に一言—我々は今週、戦術的オーバーレイ・ポートフォリオの第19ページで、市場がよりタカ派なECB見通しを織り込むのを織り戻すための新たなトレードを導入します。最初のECBによる利上げの最も可能性の高い規模は10bpであり、これはOISカーブで2023年中頃に織り込まれています。2023年末までにはフォワードレート曲線でほぼ25bpの利上げが織り込まれています。我々はECBが2023年に利上げするとは予想していませんが、たとえ利上げがあっても、6か月以内に累積で25bpの利上げが実現する可能性は低いと考えます。したがって、エントリープライス100.27で2023年12月限の3か月ユーロイボー金利先物ロングを推奨します（チャート16）。 チャート15 ECBのテーパリングは欧州クレジットにとって悪材料 ECBのテーパリングは欧州クレジットにとって悪いニュースになるだろう ECBのテーパリングは欧州クレジットにとって悪いニュースになるだろう チャート16 2023年12月ユーロイボー先物をロング 2023年12月限ユーロイボー・フューチャーズをロングする 2023年12月限ユーロイボー・フューチャーズをロングする 結論：ECBが最も避けたいのは、欧州の成長とインフレの加速に事前対応して金融緩和を縮小し始めた結果として必然的に生じるユーロ高とイタリア国債利回りの急騰です。我々は現在の欧州債券に関する推奨を維持します：グローバル債券ポートフォリオ内で欧州をオーバーウェイトとし、コア国の政府債に対してペリフェラルのソブリンおよびコーポレートを優先するとともに、ブレークイーブンが割安なフランス、イタリア、ドイツのインフレ連動債もオーバーウェイトとします。   Robert Robis, CFA チーフ・フィクスト・インカム・ストラテジスト rrobis@bcaresearch.com 脚注 1 NAIRUは失業率の非加速的インフレ率（Non-Accelerating Inflation Rate of Unemployment）の略称です。 2 レーンのコメントは、2021年3月16日にフィナンシャル・タイムズで掲載された広範なインタビューに由来します。記事はこちらで参照できます： https://www.ft.com/content/2aa6750d-48b7-441e-9e84-7cb6467c5366 3 レーンのコメントは今月初めの5月9日に公表され、こちらで参照できます： https://www.ft.com/content/05a12645-ceb2-4cd5-938e-974b778e16e0 4 S&Pグローバルのレポート「Next Generation EU Will Shift European Growth Into A Higher Gear」はこちらで参照できます： https://www.spglobal.com/ratings/en/research/articles/210427-next-generation-eu-will-shift-european-growth-into-a-higher-gear-1192994 推奨 GFIS推奨ポートフォリオ対カスタムベンチマーク指数 ECBの見通し: 卵の殻の上を歩く ECBの見通し: 卵の殻の上を歩く デュレーション 地域配分 スプレッド商品 戦術的トレード 利回りとリターン グローバル債利回り 過去のリターン