Asia

特別レポート

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

Executive Summary Lingering Weakness In The Economy Is Reflected In Low Core Inflation The Philippine economy will struggle to gain traction as the fiscal thrust remains negative and monetary policy is tightening. Consistent with tepid growth, there are no genuine inflationary pressures in the Philippines. The country’s bond yields should drop in the months to come. Soaring trade and current account deficits will abate soon. Net debt portfolio outflows should ease and could turn into net inflows. These will help the peso find a bottom. Philippine stocks’ relative performance versus the EM benchmark will likely remain rangebound. The reason is that an uninspiring domestic economy in the Philippines is juxtaposed with a poor outlook for the overall EM equity benchmark. Recommendation Inception Date RETURN Book Profits On Long USD/Short PHP  2021-03-18 10.9% Go Long Philippine Local Currency 10-year Government Bonds 2022-08-18   Bottom Line: A struggling Philippine economy warrants that absolute return investors avoid Philippine stocks. EM and Emerging Asian equity portfolios should continue with a neutral allocation to the Philippines. Feature Chart 1Philippines Stocks Are Failing To Outperform Despite EM Being In A Bear Market Despite being traditionally a defensive market within EM, Philippine stocks failed to outperform the EM benchmark; even though the latter continues to do poorly in absolute terms (Chart 1, top panel). In November 2021, we upgraded this bourse from underweight to neutral, rather than overweight, because of our negative outlook on the peso and the headwinds emanating from rising US/ global interest rates for the rate-sensitive Philippine markets. That call has worked out in line with our view (Chart 1, bottom two panels).  Going forward, a neutral stance on the Philippines makes sense, but this time for a different reason than a vulnerable peso. The tepid domestic economic recovery does not justify turning bullish on this bourse in absolute or relative terms. On the currency front, the peso has depreciated markedly versus the dollar since early 2021. We now book profits on our short peso call as the risk-reward trade-off is no longer attractive.  Tight Policy Is Choking Growth The Philippine economy contracted marginally (-0.1%) in the second quarter of 2022 vis-à-vis the first on a seasonally adjusted basis. The drag was mostly from household consumption which shrank by 2.7% QoQ (also seasonally adjusted). A major cause for the insipid growth is the authorities’ rather tight policy. The hope that the government could ramp up fiscal spending during an election1 year did not pan out. The reason had to do with the already very steep fiscal and primary deficits, at 7.9% and 5.6% of GDP respectively (Chart 2, top panel). Notably, the country’s fiscal revenues have remained tepid as well. This also prevented authorities from ramping up fiscal spending. Weak tax collections (especially internal revenue collections), in turn, are a sign of feeble economic activity (Chart 2, bottom two panels). Further, over the coming year, the country’s fiscal stance will remain rather tight and provide little reprieve to the economy. The IMF estimates that the fiscal thrust for both 2022 and 2023 will be negative (Chart 3). Chart 2Already Steep Fiscal Deficts And Weak Revenues Preclude Further Stimulus Chart 3A Negative Fiscal Thrust Means Little Reprieve For The Economy   The Philippines’ monetary stance has also tightened over the past year. Banking system liquidity has fallen measurably since mid-2021. More recently, the central bank has raised rates by a cumulative 125 basis points since May to 3.25%. It has also indicated further hikes in the near future.  All this credit and fiscal tightening amid tepid domestic demand is weighing on business activity and credit growth. Bank loans were already rather weak since the advent of the pandemic in all sectors of the economy, barring real estate (Chart 4). Now, the credit impulse for the private sector appears to be peaking again – which does not bode well for economic growth (Chart 5).     Chart 4Tightening Policy Amid Weak Domestic Demand Will Hurt Credit Growth Chart 5Peaking Credit Impulse Does Not Augur Well For Economic Growth There is yet another reason why credit could be struggling to grow: firms’ reluctance towards capital investments. The share of capex in the economy has languished in a much lower level than it was before the pandemic (Chart 6). That is unlikely to change in any meaningful way in the foreseeable future as firms’ capacity-utilization levels are still low (Chart 8, bottom panel). Philippine Inflation Is Transitory The tepid growth in domestic demand is reflected in several aspects of the Philippine economy. Manufacturing sales, in both value and volume terms, are barely at 2018−2019 levels. Car sales are well below those levels (Chart 7). Chart 6Firms' Reluctance To Boost Capex Is Weighing On Domestic Demand Chart 7The Demand Side Of The Economy Remains Quite Weak   The supply side data are giving a similar message. Industrial production volumes are no higher than they were in 2018. The same holds true for manufacturing production (Chart 8, top panel). This might have weakened further recently, as the latest PMI data suggests (Chart 8, middle panel).  On another note, money supply has also begun to decelerate. Both narrow and broad money measures have rolled over (Chart 9), which is not a good sign for the economy. Chart 8The Supply Side Is Faring Not Much Better Chart 9Decelerating Money Supply Is Not A Positive Sign For The Economy   The lingering weakness in growth is evident in rather muted core inflation. While headline inflation has risen well above the central bank’s upper target of 4%, it is mostly due to a sharp rise in fuel prices, and to some extent in food prices. Once all the fuel and food related items are excluded, the core CPI turns out to be much lower at 2.3%, near the lower end of the central bank’s target band (Chart 10). Notably, crude oil prices might have peaked in this cycle given the deteriorating Chinese and global growth outlook. If so, that will bring down the Philippines’ headline CPI prints over the next several months. Easing headline inflation, in turn, will likely lead the country’s bond yields to roll over (Chart 11). Chart 10Lingereing Weakness In The Economy Is Reflected In Low Core Inflation Chart 11As Headline CPI Ease With Subsiding Fuel Prices, So Will Bond Yields Stay Neutral On Stocks The near-term outlook on Philippine stocks in absolute terms is not promising. The nation’s economic recovery is uninspiring, while the fiscal and monetary stance is unsupportive. Chart 12Philippine Stocks Will Struggle As Foreign Investors Continue To Leave The wider EM and global growth outlooks are also deteriorating. Foreign equity investors continue to be net sellers of Philippine stocks (Chart 12). Given this backdrop, it is hard to imagine that this market could usher in a sustainable bull market in absolute terms any time soon. Relative to the EM benchmark, Philippine stocks will likely remain rangebound. The reason is that overall EM stocks are also vulnerable. Notably, Philippine stocks usually do well relative to EM when the latter do poorly in absolute terms (Chart 1, top panel). The basis is as follows: EM stocks fall when EM/China (and global) growth decelerates. But growth deceleration generally comes with falling global interest rates. Falling global/US interest rates/bond yields are typically a tailwind for the rate sensitive Philippine stock markets. The reason is the prevalence of real estate, banking and utility sectors in the Philippines equity index. In the current episode, however, despite a growth deceleration in EM/China, interest rates are still rising globally – robbing Philippine stocks of their tailwinds. This is why this market is struggling to outperform the EM benchmark. The situation is unlikely to change in the next several months, as sticky inflation in much of the developed world will preclude their central banks from cutting interest rates. It therefore makes sense to continue with a neutral allocation to the Philippines in an EM equity portfolio for now.  Go Overweight Philippine Domestic Bonds Chart 13Elevated Bond Yields, Despite Little Genuine Inflation Indicates Relative Value In Bonds Philippine domestic bond yields are around 6%. Such high yields are unsustainable given the softness in the economy, and the lack of genuine inflationary pressures therein. As such, Philippine domestic bonds are a buy in absolute terms. Relative to their EM counterparts also, they have become attractive. Odds are that they will outperform their EM peers: Philippine bond yields are now nearly at par with that of EM – which is historically on the higher side (Chart 13, top panel). This is despite genuine inflationary pressures in the Philippines being on the lower side vis-à-vis most other economies in Latin America and EMEA. This entails that Philippine yields will come down relative to other EM yields in the months ahead as and when food and fuel prices ease. Philippine bond yields have also risen measurably relative to safe-haven (US treasuries) bonds over the past year and a half. Foreign investors are marginal buyers of Philippine bonds, and their appetite for the latter depends on how much extra yield the Philippines offers over safe-haven bonds. Chart 14 shows that whenever the yield differential widens enough (to over 300 basis points), the Philippines begins to attract net debt inflows. This is what is likely to happen now: the net debt outflows of the recent past should abate and could even turn into net inflows over the coming quarters. The fact that Philippine bond yields are likely to fall due to domestic considerations − weak growth and subsiding inflation − will also entice foreign investors. Finally, the peso has already fallen significantly over the past year and a half (discussed in more detail in the next section). As and when local bond yields will begin to fall, these bonds will attract more foreign debt inflows, which will support the peso. A stable exchange rate will make domestic bond investments more attractive for foreigners (Chart 13, bottom panel, and Chart 15). Chart 14Net Debt Portfolio Outflows Should Abate, And Could Turn Into Inflows Chart 15As Foreign Debt Inflows Resume, Bond Yields Will Fall And The Peso Will Bottom All this suggests that investors would do well to upgrade their allocation to Philippine domestic bonds from neutral to overweight. We also initiate a long position in 10-year domestic bonds, currency unhedged. Book Profits On The Short Peso Trade Chart 16The Peso Will Get A Support As The Current Account Deficit Bottoms Philippine external accounts deteriorated in a major way over the past year. As a result, the peso depreciated markedly − in line with our previous forecast. Now, however, investors should book profit on this trade, as the vulnerability of the peso has diminished: The root cause behind the peso depreciation has been this country’s plunging current account balance (Chart 16).  Current account deterioration, in turn, was caused by high crude prices. The latter led to mammoth trade deficits as exports rose at a much slower pace. But crude prices are now dropping and the nation’s oil import bill will likely subside meaningfully in the months ahead. The import cost of raw materials will also fall in line with falling resource prices. As a result, Philippine trade and current account deficits will likely bottom soon (Chart 17). That will help put a floor under the currency. Philippine capital account balance has remained in healthy surplus – buoyed by FDI and other investment inflows (Chart 18, top panel). Chart 17As Oil Import Costs Subside, The Trade Deficit Will Find A Floor Chart 18A Resumption In Debt Portfolio Inflows Will Keep Capital Account In Healthy Surplus If the ongoing net debt portfolio outflows subside and/or turn into inflows (as explained in the previous section), that will help keep the financial account balance afloat (Chart 18, bottom panel). Finally, the peso is no longer expensive vis-à-vis the US dollar in purchasing power terms (Chart 19). This entails only a limited downside from now on. Book Profits On Sovereign Credit Our negative outlook on the EM sovereign credits prompted us to recommend an overweight stance on Philippine credit relative to the EM benchmark. The reason is the defensive nature of the Philippine sovereign bond market: during periods of EM stress, Philippine sovereign spreads widen much less than their EM counterparts. That call has worked out well. This market has massively outperformed its EM peers (Chart 20). But now, we recommend that investors protect profits by downgrading their allocation to the Philippines from overweight to neutral. Chart 19The Peso Is No Longer Expensive Versus The US Dollar Chart 20Sovereign Bond Investors Should Book Profits After The Recent Outperformance One reason for that is that the relative excess return on Philippine bonds have surged recently to levels seen only during the height of EM stress in 2008-09 and then again in early 2020. As such, the relative performance might already be discounting a massive rise in EM spreads, and further outperformance may be hard to come by. Another reason for our cautious stance is Philippine external public debt. Though still low as a share of the economy at 15% of GDP, this has surged in the recent past. It therefore makes sense to pare back some of the exposure to Philippine sovereign credit and await a better entry point in future. Investment Recommendations Currency: The vulnerability of the peso has eased, and investors should book profits on our short PHP/long USD call. This trade has yielded 10.9% (including carry) since our recommendation on March 18, 2021. Equities: Absolute return investors should avoid Philippine stocks as its near-term outlook is not promising. EM and Emerging Asian equity portfolios should continue with a neutral allocation to the Philippines relative to the EM benchmark. Domestic Bonds: Given the improved peso outlook, and rather high relative yields, local currency bond investors should upgrade their allocation to the Philippines from neutral to overweight in EM domestic bond portfolios. For absolute-return investors, we recommend buying 10-year domestic government bonds, currency unhedged. Sovereign Credit: Philippine sovereign credit has massively outperformed its EM counterparts. We recommend that investors protect profits by downgrading their allocation from overweight to neutral. Rajeeb Pramanik Senior EM Strategist rajeeb.pramanik@bcaresearch.com Footnotes 1      The Philippines held its federal elections in May 2022. The new President Ferdinand Marcos Jr. took office on June 30, 2022.

Executive Summary Russia’s Crude Oil Output Will Fall Russia will have to lower oil production to ensure output it hasn’t placed with non-EU buyers does not tax its limited storage facilities, ahead of the bloc’s December 5 embargo. The EU’s insurance/reinsurance ban on ships carrying Russian material also commences in December. It will profoundly affect Russian output, if fully implemented. Russian and Chinese firms will expand ship-to-ship transfers on the high seas, along with external processing and storage services to mask crude and product exports. The EU embargos will force Russia to shut in ~ 1.6mm b/d of output by year-end, rising to 2mm b/d in 2023, by our reckoning. Gas-to-oil switching in Europe will boost distillate and residual fuel demand by ~ 800K b/d this winter. Chinese policymakers will be compelled to deploy greater fiscal and credit support to reverse weakening GDP. Tighter monetary policy in DM economies will dampen aggregate demand. Bottom Line: EU embargoes on Russian oil imports will significantly tighten markets, and lift Brent to $119/bbl by year-end. This has a 60% chance of being offset by ~ 1mm b/d of Iranian oil exports in 2023, in our estimation. We are maintaining our Brent forecast at $110/bbl on average for this year, and $117/bbl next year. WTI will trade $3-$5/bbl lower. At tonight’s close we are re-establishing our long COMT ETF position. Risks remain to the upside. Feature Chart 1Russia’s Crude Oil Output Will Fall Following an unexpected increase in production during June and July, Russia will have to begin reducing its oil output ahead of the implementation of the EU’s embargo on its seaborne crude oil imports, which kicks on December 5. EU, UK and US shipping insurance and reinsurance sanctions also are scheduled to be implemented in December. If fully implemented, ~ 2.3mm b/d of seaborne imports of Russian crude oil will be excluded from EU markets by year-end. Come February, another 800k b/d of refined products will be embargoed. On the back of these lost sales, and production that cannot be loaded on ships due to insurance/reinsurance bans, we expect Russian production to fall ~ 2mm b/d by the end of next year (Chart 1).1 As noted in previous research, a goodly chunk of Russian crude continues to go to China and India. Together, these two states accounted for just over 40% of Russia’s crude sales last month – ~ 1.9mm b/d of a total of ~ 4.5mm b/d. This is down from just under 45.5% in May, according to Reuters. Both China and India have benefited from discounted prices of ~ 30% vs. Brent, which is a powerful inducement to buy. Asia accounts for more than half of Russia’s seaborne crude oil sales, according to Bloomberg data. Related Report  Commodity & Energy StrategyTighter Oil Markets On The Way Whether China and India can maintain these purchases depends on whether ships taking oil to them can get their cargoes insured. Both states have domestic insurance providers, and, in the case of the latter, long-standing trade relationships going back decades. Other Asian economies do not have such financial infrastructure. Still, this is a high concentration of sales to two buyers. In addition, press reports indicate China spent $347mm to secure tankers to conduct high-risk ship-to-ship (STS) transfers of Russian crude in the Atlantic Ocean.2 Similar STS transfers have been used to move ~ 1.2mm b/d of Iranian and Venezuelan crude oil, most of which ends up in China, according to Lloyds. Base Case Sees Markets Balance In our base case analysis, markets remain relatively balanced going into winter. On the supply side, we expect core OPEC 2.0 – the Kingdom of Saudi Arabia (KSA) and the United Arab Emirates (UAE) – to continue to provide crude to the markets subject to their spare-capacity constraints (Chart 2, top panel). KSA likely will be producing close to 11mm b/d by year-end – vs its current output of 10.6mm b/d output presently – and the UAE will be close to 3.5mm b/d, vs 3.1mm b/d at present. KSA’s max capacity is 12mm b/d, while the UAE’s is 4mm b/d; both will want to maintain spare capacity to offset unexpected exogenous supply shocks next year. These two states account for most of the spare capacity in the world (Chart 3). The rest of OPEC 2.0 will continue to struggle to maintain its production, which makes the core producers’ spare capacity critically important (Chart 2, bottom panel). Chart 2Core OPEC 2.0 Will Increase Supply Chart 3Spare Capacity Concentrated In Core OPEC 2.0 Outside of OPEC 2.0, we are expecting the largest contribution to global supply will continue to come from US shale production (Chart 4). Shale-oil output in the top 5 US basins is expected to increase ~540K b/d this year, and next. This will take shale output to slighly above 7.5mm b/d and account for 76% of Lower 48 production in the States this year. Next year, we are expecting US Lower 48 production to rise 700K b/d, and for total US crude output to go to 12.8mm b/d, a new record. Chart 4US Remains Top Non-OPEC 2.0 Supplier This winter we are expecting an uptick in oil demand – particularly for distillates like gasoil and diesel in Europe, as EU firms switch from natural gas to oil on the margin. We expect this will add 800K b/d of demand over the winter months (November through March), which will lift our overall demand estimate 150k b/d this year, and 20K b/d next year – +2.19mm b/d vs +2.04mm b/d, and 1.82mm b/d vs. 1.80mm b/d next year. Chinese year-on-year oil demand growth remains negative. January-July 2022 demand was 15.24mm b/d vs 15.34mm b/d in 2021, continuing a string of y/y contractions. The two other major economic pillars of global oil demand – the US and Europe – show positive y/y growth of 800K b/d each over the same period. Global demand in 1H22 recovered to 98% of its pre-COVID-19 level – even with China’s negative y/y growth – while supply recovered to 96% of its pre-pandemic level, according to the International Energy Forum (IEF). Over most of the forecast period, we estimate global balances will continue to show the level of supply below that of demand, which will lead to continued physical deficits (Chart 5). Refined-product inventories increased by 34mm barrels in 1H22, while crude-oil stocks fell 23mm barrels. Global crude and product inventories are ~ 460mm barrels below their five-year average, which includes pandemic demand destruction, the IEF reported. We continue to expect inventories to remain below their 2010-14 average, which we prefer to track – it excludes the market-share wars of 2015-17 and that of 2020, and the pandemic’s effects on inventories (Chart 6). This will revive the backwardation in Brent and WTI prices, particularly if the loss of Russian barrels is larger than we expect this year and next. This could be dampened if the US resumes its SPR releases after they’ve run their course in October. Chart 5Global Market Balanced, But Slight Deficits Will Persist Chart 6OECD Inventories Below 5Y Average Investment Implications Our analysis indicates markets are mostly balanced going into winter (Table 1). That said, the balance of risks remains to the upside ahead of the EU’s embargoes on Russian crude and product imports, and the EU/UK/US insurance/reinsurance bans on providing cover for vessels carrying Russian material. This all is highly contingent on the extent to which the EU and its allies follow through on these punitive actions imposed on Russia in retaliation for its invasion of Ukraine. Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) To Dec23 The removal from the market of some 2mm b/d of Russian oil production due to the various EU embargoes – even if it is offset by the return of 1mm b/d of Iranian exports on the back of a deal with the US – will push crude oil prices higher and inventories lower (Chart 7).3  Chart 7Brent Price Expectation Unchanged, But Demand Shifts To Winter Given these views, we remain long the oil and gas producer XOP ETF, which is up 19.5% since we re-established it on July 5, and, at tonight’s close, will be re-establishing our COMT ETF, to take advantage of higher energy and commodity prices and increasing backwardation in oil markets as inventories draw.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Analyst Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Paula Struk Research Associate Commodity & Energy Strategy paula.struk@bcaresearch.com Commodities Round-Up Energy: Bullish US distillate inventories – diesel and heating oil mostly – were up less than 1% for the week ended 12 August 2022, according to the US EIA. US distillate inventories stood at 112mm barrels. This did nothing to reverse the deep drawdown in distillate inventories of 18.5% y/y, which, along with European stocks, refiners are attempting to rebuild going into the 2022-23 winter. We expect natgas-to-oil switching this winter to add 800k b/d of demand to the market over the Nov-Mar winter season. Most of this demand will be for distillates, in our view, given its dual use as a fuel for industrial applications and household space-heating. Distillate demand could be higher this winter, if a La Niña produces colder-than-normal temperatures. The US Climate Prediction Center gives the odds of such an outcome 60% going into the 2022-23 winter. This would lift ultra-low-sulfur diesel futures in the US and gasoil futures in Europe higher as inventories draw (Chart 8). Base Metals: Bullish Copper prices dropped on weaker-than-expected Chinese macroeconomic data for July, although the fall was bounded by the People’s Bank of China’s decision to cut interest rates. According to US CFTC data, copper trading volumes are lower than pre-pandemic levels, as hedge funds' net speculative positions turned negative beginning in May and have mostly remained in the red since then. Low trading volumes will result in copper prices being highly susceptible to macroeconomic events, especially those occurring in China. Precious Metals: Neutral Gold prices are facing difficulty overcoming market expectations of high interest rates for the rest of this year (Chart 9). The bearish influence of tightening monetary policy and a strong USD has the upper hand on the supportive effect of recession risks, inflation, and geopolitical uncertainty for gold prices. Recent strength in US stock markets - which historically is inversely correlated with gold prices - following better-than-expected earnings, also contributed to recent gold price weakness. Chart 8 Chart 9     Footnotes 1 Please see Oil: It Ain't Over Till It's Over, which we published 11 August 2022, for additional discussion. NB: We discuss the differences between our view and that of our Geopolitical Strategy service regarding a deal between the US and Iran, which returns 1mm b/d of crude oil exports to the market. We give 60% odds to such a deal, while our colleagues at the GPS service assign a 40% probability to it. In our base case modeling presented herein, we expect these barrels to return to the market by 2Q23, perhaps sooner. 2 Please see Anonymous Chinese shipowner spends $376m on tankers for Russian STS hub published by Lloyd’s List 9 August 2022. The report notes, “All the ships are aged 15 years or older, precluding them from chartering by most oil majors, as well being unable to secure conventional financing, suggesting the beneficial owner is cash rich. The high seas logistics network offers scant regulatory and technical oversight as crude cargoes loaded on aframax tankers from Baltic Russian ports are transferred to VLCCs mid-Atlantic for onward shipment to China. One cargo has been tracked to India.“ 3 Please see Oil: It Ain't Over Till It's Over, which we published 11 August 2022, for additional discussion. NB: We discuss the differences between our view and that of our Geopolitical Strategy service regarding a deal between the US and Iran, which returns 1mm b/d of crude oil exports to the market. We give 60% odds to such a deal, while our colleagues at the GPS service assign a 40% probability to it. In our base case modeling presented herein, we expect these barrels to return to the market by 2Q23, perhaps sooner.   Investment Views and Themes Strategic Recommendations Trades Closed in 2022

特別レポート

エグゼクティブ・サマリー 第4次台湾海峡危機が現実化していることを受けて、世界の大国間での大規模な戦争の確率は上昇しました。 当社のディシジョンツリーは確率を約20%と示唆しており、これはロシアのウクライナ戦争だけを起点に想定した水準の2倍に相当します。世界は五発リボルバーで「ロシアンルーレット」をしている状態です。 今後の基本見解としては、米中の国内政治イベントが今秋に一段落した後、台湾緊張は横ばい（悪化はしないが改善もしない）になると見ています。 しかし、もし中国が第20回党大会後に緊張をエスカレートさせれば、侵攻の確率は大幅に上昇します。 台湾で紛争が発生した場合、ロシアが欧州でさらに攻勢的になる確率が高まります。 イランは核兵器の追求を強く進める可能性が高いです。   2022年下半期にポジティブな触媒は多くない 五連発拳銃によるルーレット 五連発拳銃によるルーレット タクティカル推奨開始日リターン 米国10年国債ロング2022-04-141.3% グローバルのディフェンシブ／サイクリック株式ロング2022-01-2013.8% 結論：投資家は少なくとも中国の党大会と米国の中間選挙が今秋に終わるまでは防御的なポジションを維持すべきです。来年の地政学的リスクは中国の台湾海峡での行動次第です。 特集   チャート 1 第三次世界大戦をめぐる臆測が高まる 五発のリボルバーを使ったルーレット 五発のリボルバーを使ったルーレット 世界の出来事に注意を払う悲観論者たちは、近年第三次世界大戦が勃発するリスクを懸念するようになりました。用語の検索は2019年以降増えていますが、懸念の理由は特定の危機事象というよりもむしろグローバルな多極化という基調にあります（チャート 1）。1 米中、あるいは米露間での大規模な戦争の確率はどのくらいでしょうか。どのように算出できるでしょうか。本レポートでは一連の「ディシジョンツリー」を提示し、各シナリオと確率を形式化して示します。 もしWWIIIを米国がロシアあるいは中国、または両方と直接交戦する戦争と定義するなら、今後数年以内にWWIIIが勃発する確率は20%に達すると計算されます！ これは非常に高い確率ですが、歴史はこうした確率が非現実的でないことを示しており、投資家は油断してはなりません。政治学者グレアム・アリソンは長期的に見た米中戦争の確率は約75%であると歴史的類推に基づいて示しています。 要点は、各国がこのWWIIIリスクを直視し、拒否しない限り世界の政治環境は改善しないということです。最もあり得るのは、WWIIIおよびそれがもたらす核戦争のリスクが最終的な制約となり、各国がそれを認識して行動を改めるケースですが、現在の大国の振る舞いはまだ制約を認識しておらず、短期的には瀬戸際政策を続ける意向が窺えます。 中国による台湾侵攻の確率 まず問いは、中国が台湾に侵攻するかどうかです。2021年4月に当社は第4次台湾海峡危機が12～24か月以内に発生すると予測しましたが、全面戦争には発展しないと見ていました。この見方が今試されています。 図表 1では、中国の台湾に対する政策選択肢をマッピングし、それぞれに確率を割り当てるディシジョンツリーを示します。 図表 1 第4次台湾海峡危機に関するディシジョンツリー（次の24か月） 五連発の拳銃によるルーレット 五連発の拳銃によるルーレット   中国は台湾を侵攻する能力を獲得しましたが、特に核三本柱（トライアド）のさらなる進展がない限り、失敗の確率は依然として高いです。したがって、即時に侵攻のために動員をかける確率は20%と見積もります。 明らかに、中国が侵攻を計画しているという具体的な兆候があれば真剣に受け止めるべきです。 2021年にウクライナ周辺でのロシアの軍事増強を投資家やメディアが軽視したことは損失を招きました。 同時に、米中は台湾海峡の現状を試しているだけであり、現状は今回のエピソード後に強化される可能性が高いという見方もあります。結局のところ、今回の危機は第4次台湾海峡危機であり、過去の危機はいずれも戦争には至りませんでした。 バイデン大統領と習近平が、今秋に予定される重要な国内政治イベントを前にそれぞれの力を誇示しているだけなら、両者は既に目的を達成しています。少なくとも今後数年間にわたっては、これ以上の軍事的見せつけは不要です。 我々は、過去一週間の緊張が残るが現状が強化されるシナリオに40%の確率を割り当てます。 その場合、台湾海峡の構造的問題は2024年の米国と台湾の大統領選挙の後、つまりこの図表の時間枠の外で再燃するでしょう。 残念ながら我々は長期的には悲観的であり、台湾での戦争の確率は高いと考えています。 そのため、我々は今後2年間で状況が悪化するシナリオにも同じく40%の確率を割り当てます。 もし中国が党大会後に演習や制裁を拡大するなら、習指導部が単なる国内向けパフォーマンスではないことが明らかになります。 同様に、もしバイデン政権が中間選挙後も対中ハイテク輸出管理の強化を推し進め、同盟国やパートナーにも同様の対応を求め続けるなら、米国は中国が何らかの攻勢作戦を準備していると暗に判断していることになります。その場合、侵攻の危険性は20%から40%に上昇します。 それでも、米中の危機外交が2023-24年に全面戦争を防ぐという見方は依然として妥当ですが、誤算のリスクは非常に高まります。 このディシジョンツリーの最後の要素は、中国が第二次世界大戦で見られたような従来型の上陸侵攻ではなく、「グレーゾーン戦術」やハイブリッド戦を好むという前提です。理由は複数あります。 第一に、上陸侵攻は最も困難な軍事作戦です。第二に、中国軍は未熟である一方、米国と同盟国は守備を固めています。第三に、ハイブリッド戦は米国の同盟国間に対応の分裂を生みます。第四に、ここ14年でロシアはハイブリッド戦が機能することを何度も示してきました。それは戦略的便益を最大化し、コストを最小化する手段です。 西側が小規模な侵攻にどう反応するかは世界が知っている：経済制裁だ。しかし大規模な侵攻にどう反応するかはまだ分かりません。したがって中国は小さく噛み切るインセンティブを持ちます。 とはいえ台湾の場合、こうした戦術が持続可能でない可能性もあります。当社の台湾に関するディシジョンツリーは、ハイブリッド戦や「代理戦争」が大規模戦争に進展する可能性を完全には織り込んでいません。しかしその可能性は実際には高いのです。したがって我々は米中の大規模戦争のリスクを過小評価しているわけではありません。 結論： 今後2年間で、台湾を巡る米中の代理戦争の主観的確率は約32%、直接的な米中戦争の確率は約4%です。 真の試練は習近平が今秋の党大会で権力を固めた後に訪れます。 我々は習氏が経済の再起動に注力すると予想します したがって我々は中国と台湾を除く新興アジアの市場を引き続き推奨します。 ロシアとNATOの戦争の確率 第二の問いは、ウクライナの戦争が西側とのより広範な戦争に変貌するかどうかです。ウクライナでは既に戦争が継続しているため、ロシアと西側の大規模戦争の確率は中国の場合よりも高くなります。一方、台湾海峡の緊張は現時点ではまだ虚勢の段階にすぎません。 投資家のベースケースとしては、ウクライナ戦争はウクライナ内に限定されると考えるべきです。欧州諸国はドンバスのためだけにロシアと壊滅的な戦いを望んでいません。しかし戦時には物事がしばしば誤ることがあります。 重要な問いは、ロシアがNATO加盟国を攻撃するかどうかです。そうなれば同盟条約の第5条が発動され、「欧州または北米における一つ以上の（同盟）加盟国に対する武力攻撃は、すべての加盟国に対する攻撃と見なされる」ことになり、必要に応じて安全回復のために武力行使が正当化されます。 ロシアのウクライナ侵攻以降、バイデン大統領は繰り返し米国は「NATO領土の一インチたりとも防衛する」と述べており、これは政策の変更ではなく米国のレッドラインであり極めて高い可能性で防衛されるでしょう。したがってこれはロシアにとって重大な制約です。 図表 2ではロシアの選択肢をマッピングし、確率を割り当てます。 図表 2 ロシア・ウクライナ戦争に関するディシジョンツリー（次の24か月） 五発のリボルバーを使ったルーレット 五発のリボルバーを使ったルーレット   我々はロシアがドンバス地域とクリミアへの陸路を確保し、勝利を宣言する確率を55%と見ています。ロシアは征服地を何らかの外交合意、つまり停戦という形で正当化しようと動き始めるでしょう。これが我々の2023年のベースケースです。 ロシアが既に外交に向けた動きを始めている証拠があります。2 理由はロシア経済が打撃を受け、世界のコモディティ価格が下落し、人的・物的資源が消耗しているからです。プーチン大統領はドニエプル川河口など、侵攻した地域を支配している限り、ウクライナを弱体化させるという目的は大部分達成したと見なすでしょう。 プーチンは征服地を固め、経済と社会を立て直す必要があります。早ければ早いほどロシアにとって有利であり、欧州がコンセンサスを形成して将来的に天然ガスの全面禁輸を実施するのを防げます。 しかしプーチンの野心が彼を破滅に導くリスクもあります。 我々は侵攻が南西ウクライナ（戦略的港湾都市オデッサを含む）やモルドバ東部に拡大する確率を35%と見積もります。モルドバでは親ロシア派が分離統治するトランスニストリア地域にロシア軍が駐留しています。 この新たなキャンペーンはウクライナを完全に内陸化し、モルドバを無力化し、ロシアにより大きな海上アクセスを与えるでしょう。しかしそれはEUを結束させ、天然ガス禁輸を誘発し、ロシアを弱体化させて絶望的な状況に追い込む可能性もあります。報復に出れば、広範な戦争につながることも考えられます。 フィンランドやスウェーデンがNATO加盟を試みたことでプーチンが攻撃する確率は7%にすぎないと見ます。スターリンはフィンランドに失敗し、プーチンの軍はキエフすら征服できませんでした。英国はこれらの国の支援を約束しており、攻撃はNATOとの戦争を引き起こす公算が大きいでしょう。フィンランド攻撃の決断はロシアがNATOがそこに基地を置く計画を立てていると本当に信じた場合にのみ生じるでしょう。つまりそれがロシアの宣言したレッドラインです。 バルト三国に対するロシアの攻撃は、それらが既にNATOに加盟しているため可能性は低いです。ただしプーチンが絶望的になれば起こり得るというリスクはあります。 我々はバルト侵攻のリスクを3%と見積もります。 要するに、ロシアが欧州に対するエネルギーの締め付けを停戦交渉で有利な合意を引き出すためではなく侵攻の拡大に使うなら、より広範な戦争の確率は上昇します。 結論： 結果として、今後24か月での鎮静化の確率は55%、小規模なエスカレーション（例：オデッサ、モルドバ）は35%、NATO加盟国を巻き込みNATOとロシアの戦争に発展する大規模なエスカレーションは10%です。 戦術的には、もし世界経済が回復しロシアが軍事作戦を中止して停戦交渉に舵を切る明確な転換を示すなら、先進国の欧州通貨および資産を買うべきです。景気循環的には、欧州資産で持続的な強気市場が実現するには米露間のより深い理解が必要です。 米国・イスラエルによるイラン攻撃の確率 今年起きている第三の地政学的危機は、バイデン大統領とアリー・ハメネイ師が2015年の米国・イラン核合意に再加盟することで当面先送りになる可能性があります。しかし我々は懐疑的です。 バイデン政権は2015年の核合意に再加盟して、イランの原油を日量約100万バレル市場に戻し、中間選挙前にガソリン価格を下げたいと考えています。米国のグランドストラテジーはまたイランと関与して中東を安定化させ、米国がアジアへ軸足を移せるようにしたいと考えています。 EUはイラン資源への需要がより大きく、イランの核獶取得を防ぎたいので合意を提案しています。ロシアと中国も対米制裁解除とイランとの貿易を望むため支持的ですし、必ずしもイランに核が持たれることを望んでいるわけではありません。 ただし一つ問題があります：イランは体制の長期的生存を確保するために核兵器を必要としている。 問題はハメネイが再び米国との合意を承認するかどうかです。最初の合意は彼の体制に大きな代償をもたらして裏切られました。近い将来ハメネイに代わって権力を握ることを望むエブラヒム・ライシ大統領は、自らのキャリアと個人の安全を2024年の大統領選の共和党勝利に賭けることには強く反対するでしょう。 イランは既に核ブレイクアウト能力を達成しています—核装置を構築できるだけの60%濃縮ウランを保有している—そして最終的に核抑止力を獲得しようとしない理由が不明です。特に将来的に米国やその同盟国からの軍事攻撃から体制を守る必要が生じる可能性があるためです。 ただし当社の確信度は中程度です。バイデン大統領は制裁解除を望んでおり一方的にそれを行うことができるからです。バイデン政権はいまだ合意を成立させるための予備的措置を講じていませんが、それは変わる可能性があります。3 短期的なつなぎ合意には好循環的な理屈があります。 BCAのコモディティ＆エネルギー・ストラテジスト、ボブ・ライアンによれば、サウジアラビアとUAEの間の予備生産余力は合わせて約150万バレルに過ぎません。EUの石油禁輸と西側諸国の対ロシア制裁は約200万バレル／日を市場から押し出すため、OPECの余力の大部分を吸収します。したがってバイデン政権はイランが市場にもたらし得る100万バレルを必要としています。 我々はイランが制裁解除を認める合意に署名し、バイデンに制裁解除を可能にする可能性を否定できません。それは彼らの経済に利益をもたらします。彼らは核査察を許容しつつ、密かに弾頭や弾道ミサイル開発に注力を移すかもしれません。イランは不可逆的に核計画を放棄するわけではなく、時間稼ぎに長けています。 それでもイランの国内政治は合意を支持しておらず、米国が提供できる信頼できる安全保障の保証がなければ、イランのグランドストラテジーは合意を支持しません。米国はその外交政策の一貫性の欠如からそのような保証を提供できないのです。米国のグランドストラテジーは合意が検証可能であれば支持しますが、イランが合意を口実に爆弾を追求するようなケースは容認しません。 イランは3年間の最大制裁、パンデミック、世界的混乱を経ても屈服していません。そしてロシアと中国が西側に攻勢をかけるようになったことで、戦略的利益を引き出す見通しがより大きくなったとイランは見ています。 モスクワと北京は対ワシントンの共通の不満のため戦略的パートナーになり得ます。一方で米国はルーハニ政権を裏切ったのと同じようにライシ政権を裏切ることも容易であり、その結果として経済は再び翻弄され、最高指導者と政治体制は国民から二重に愚か者と見なされるでしょう。 図表 3はイランの選択肢を整理しています。 図表 3 イラン核危機に関するディシジョンツリー（次の24か月） 五連発拳銃でのルーレット 五連発拳銃でのルーレット   交渉が決裂した場合（50%）、イランは米国とイスラエルが攻撃する前に核兵器確保へ向けて突進するでしょう。 米国とイランが合意に達した場合（40%）、イランは2024年の米国選挙まで合意の条件に従う可能性があり、当面は投資家の懸念材料が除かれます。しかし長期的に核抑止力を得ようとする利害は変わらず、2024年以降に紛争が再燃するでしょう。 協議が決着せず継続する場合（10%）、イランは合意の制約なしに核計画を漸進的に進めるでしょう（ただし突発的な突進を必ずしも必要としないかもしれません）。 要するに、ロシアと中国はイランが核計画を凍結してもイランを必要としますが、米国とイスラエルはイランを抑止するために勢力均衡のアブラハム同盟を形成するでしょう—たとえイランが核計画を凍結してもです。 結論： 投資家は短期的なつなぎの米国・イラン核合意に40%の確率を割り当てるべきです。原油価格の下落は一時的なものにとどまるでしょう。長期的な供給拡大は、米国がイランに不可逆的に核計画を停止させるのに十分な安全保障保証を提供できないため期待できません。 第三次世界大戦の確率 ここからが難しい部分で、これら3つの地政学的危機を合わせて考えます。以下では単純化しすぎていますが、異なるプレーヤーとその選択肢について我々の考えを形式化するのが目的です。 図表 4は中国／台湾紛争に関する結論から出発し、その結果としてロシアのより広範な戦争の確率を調整し、イランが核兵器追求に極めて積極的であるという見方を加えたものです。時間枠は再び2年です。 図表 4 第三次世界大戦に関するディシジョンツリー（次の24か月） 五発の銃を使ったルーレット 五発の銃を使ったルーレット   WWIIIとは異なる紛争シナリオとしては「限定戦争」があり—これは米国が関与しない、あるいは間接的にしか関与しないハイブリッド戦や代理戦争を指す危険な概念です。あるいはロシアと中国を巻き込まないイランとの紛争である可能性もあります。 我々は中国から議論を始めます。なぜなら中国は現代で最も有能で野心的なグローバルパワーだからです。中国の戦略的台頭は世界秩序を揺るがし米国に挑戦しています。また今年のいくつかの証拠から、ロシアは戦争をウクライナ外に拡大する意図を持っていない可能性が示唆されていることも理由です。 中国が台湾に対してさらなる攻撃的行動を取れば、ロシアがより大きなリスクを取るユニークな機会が生まれます。そうでない場合、WWIIIの確率は2年間で急落します。これが我々のベースケースです。 しかし中国が台湾を攻撃し米国が台湾を防衛する場合、我々はロシアがバルト三国に侵攻する確率が高まると見ています。もし中国がハイブリッド攻撃を行い米国が台湾を間接的にしか支援しないなら、ロシアの攻勢の確率はわずかにしか上がりません。 結果として、WWIII（米国がロシアまたは中国、あるいは両者と直接戦う戦争）の確率は20%になります。こうした戦争が限定的に留まるかどうかは議論の余地があります。1945年以降の戦争ゲームは、主要核保有国間の戦争はエスカレートしやすいことを示しています。しかし核兵器は相互確証破壊という究極の制約をもたらします。核エスカレーションのリスクがあるため、我々はディシジョンツリーにおけるWWIIIの確率を下方に丸めています。 より確からしい59%の「限定戦争」シナリオは一見ポジティブな結果のように見えるかもしれませんが、そこには今日の水準からの地政学的緊張の大幅な上昇、例えば中国の台湾に対するハイブリッド戦などが含まれます。 結論： この試算ではWWIIIの確率は最大20%に達し得ます。これは我々のロシアに関するディシジョンツリーの水準の倍であり、当社の台湾危機の予測が現実化したことを考慮すると妥当です。 重要な要因は、今秋の党大会後に北京が台湾への圧力をさらにエスカレートさせるかどうかです。それが危険な連鎖反応を引き起こす可能性があります。 世界経済と金融市場は地政学的リスクからの下振れリスクを依然として抱えていますが、ロシアが停戦に向かい、中国が台湾への行動を遅らせて経済再起動に集中する場合、2023年には改善が見られる可能性があります。 投資の示唆 今年初めにロシアがウクライナに侵攻した際、当社の同僚であるチーフ・グローバル・ストラテジストのピーター・ベレジンは核による破滅の確率を10%と主張しました。 少なくともこれはロシアとNATOが衝突する確率として合理的な数値です。 今や予想された台湾危機が現実になりました。我々は主要な戦争の確率が20%へと倍増したと推定します。 逆に言えばより良い結果が起こる確率は80%です。分析的には、我々は依然としてロシアが限定的な目的—ウクライナを繁栄や軍事的に強大にさせないよう弱体化する—を追求していると見ており、中国も限定的な目的—台湾を国家たる存在としてではなく従属へと向かわせることで威嚇する—を追求していると見ています。 これらの目的が変わらない限り、我々はまだ第三次世界大戦からは遠いと考えます。 世界は不活化されたウクライナと従属した台湾と共存できます。 しかし否定できないのは、2008年のグローバル金融危機以降の世界情勢の軌跡が第二次世界大戦前の道筋と不快なほど似ているということです：金融危機、経済後退、デフレ、国内不安、通貨切り下げ、貿易保護主義、債務の貨幣化、軍備増強、インフレ、そして侵略戦争。ルーレットがゲームなら、世界戦争の確率は6分の1、すなわち17%であり、我々のディシジョンツリーの20%という結果に近い数値です。 我々が仮に大げさであるとしても、WWIIIの確率が20%に達すると論理的に主張できること自体が、投資家が現在のウクライナと台湾をめぐる緊張が低下するまで大きなリスクを取るのを待つべきであることを示唆しています。 簡単なチェックリストを見ると、グローバルマクロと地政学の文脈は陰鬱です（表 1）。チェックリストの改善が見られるまでより楽観的になるのは控えるべきです。 表 1 2022年下半期にポジティブな触媒は多くない 五発の拳銃を使ったルーレット 五発の拳銃を使ったルーレット     チャート 2 2022年下半期は防御的ポジションを維持 2022年下半期は防御的なポジションを維持する 2022年下半期は防御的なポジションを維持する 具体的には、投資家はロシアがNATOに拡大しないこと、そして中国が当面台湾を侵攻しないことに合理的な安心感を持つ必要があります。 これはワシントンとモスクワ、ワシントンと北京の間で紛争を回避する新たな外交的理解を要求します。 そのような理解は危機の中でしか築かれません。関連する危機は進行中ですがまだ完了していません。 通常の解決策である外交を通じて戦争リスクが払拭されるまで、グローバル株式にはさらに下振れリスクがある可能性が高いです。 世界システムの具体的かつ信頼できる改善が見られるまで、リスク資産に対して一般的なオーバーウェイト姿勢を取るのは控えましょう。株より政府債券を重視し、グローバル株より米国株、景気敏感セクターよりディフェンシブ・セクターを好み、中国・台湾の通貨と資産は評価を下げることを推奨します（チャート 2）。     マット・ガートケン チーフ・ジオポリティカル・ストラテジストmattg@bcaresearch.com  脚注 1      記：Graham Allison、Destined For War: Can America and China Escape Thucydides’s Trap?（New York: Houghton Miffin Harcourt, 2017）。 2     例えば、オデッサからの穀物輸送に関するトルコ仲介の合意、2015年イラン核合意への再加盟を支持する外交的動き、ヘルソンのような征服地での住民投票、軍縮交渉での影響力強化の試みなどです。欧州のエネルギーを断つことは最終的に欧州を停戦に有利な条件で妥協させるための圧力手段です。 3     イランは依然として余計な要求を出しています—最近ではIAEAがイランの未公表の核施設で発見された特定の人工ウラン粒子の出所を調査している件を取り下げるよう要求しました。IAEAはこの調査を取り下げておらず、取り下げればIAEAの信頼性が損なわれます。一方でバイデンは制裁を強化しており、制裁解除はイランの主要な要求です。バイデンはイラン革命防衛隊やイQods部隊をテロ指定から外していません。これらのハードルは決定的ではありませんが、我々の見方を変える前に何らかの進展を見るべきだと考えます。 戦略テーマ オープン・タクティカル・ポジション（0～6か月） オープン・サイクリック推奨（6～18か月） 地域別地政学リスクマトリックス 「打率」：地政学ストラテジーの成果（）

特別レポート

Executive Summary Iron Ore & Steel Prices: Facing Downward Pressure Global iron ore and steel supply is likely to grow faster than demand over the next six months. As a result, the prices of both metals will likely fall. Chinese steel output will likely rebound moderately in the absence of government-mandated steel production cutbacks. In the meantime, mainland steel demand will continue to contract because of its crumbling property sector. Global steel output excluding China will contract over the next six months on the back of weakening industrial demand for steel. Even though Chinese iron ore consumption may rise moderately over the next six months, its imports will not improve much because of robust growth in domestic iron ore production. Furthermore, global iron ore demand excluding China will decline as steel demand and output contract. In the intervening six months, global iron ore production growth will rise. This will lead to an oversupplied iron ore market.  Bottom Line: Both iron ore and steel prices will likely deflate over the next several months. Therefore, Chinese steel share prices as well as global mining and steel stocks have more downside.   China’s demand for iron ore and steel are key to their respective price outlooks because these metals account for about 70% of global iron ore imports and over 50% of global steel consumption. Considerable reduction in Chinese steel output (hence, demand for iron ore) and rising domestic iron ore supply have resulted in a contraction in Chinese iron ore imports since last June. In the meantime, domestic steel demand weakened sharply, primarily because of plunging property construction. The upshot has been lower domestic steel prices (Chart 1). This report evaluates the direction of iron ore and steel prices over the next six months. Chart 1Crumbling Property Sector: Lower Steel Demand Ahead Chart 2Iron Ore & Steel Prices: Facing Downward Pressure We expect Chinese steel output to rise in the absence of government-mandated production cuts and on positive profit margins. This will lift Chinese iron ore imports. In the meantime, Chinese steel demand will likely continue to contract. Thus, steel prices will continue falling over the next several months (Chart 2, top panel). For iron ore, an increase in Chinese imports will not be enough to offset contracting global demand. As a result, the price of iron ore will face downward pressure over the coming months (Chart 2, bottom panel). From The Chinese Steel Market… The Chinese steel market may experience an increasing oversupply over the next six months. Chinese Steel Supply Chinese steel production is likely to rise moderately in the next six months.  First, there are no government-mandated cuts in steel production currently in place. Chart 3Mandated Steel Output Cuts In 2021: Unlikely Repeat In 2022H2 Last June, Chinese authorities ordered steel mills to cut output from record levels in a bid to restrain carbon emissions. This resulted in a 15% year-on-year drop in Chinese crude steel1 output and a 10% year-on-year decline in Chinese steel products production during 2021H2 (Chart 3). In 2022Q1, to ensure smog-free skies in February as China hosted the 2022 Winter Olympic Games, some steel producers were again ordered to cut their production. As a result, the year-on-year decline of Chinese steel output and steel product output for 2022Q1 were at 10% and 5%, respectively. In 2022Q2, however, the picture is more of a mixed bad. While many small firms increased volumes, medium and large sized steel producers voluntarily chose to reduce their output. As a result, China’s steel output is remains in contraction. Further, tightness in electricity supply over the summer curbed any potential recovery in steel output. Over the next six months, we expect decreasing voluntary cuts and easing electricity supply will lift steel output moderately. Chart 4Steelmakers' Profit Margins: Low, Albeit Still Positive Second, overall profit margins for Chinese steel producers are still positive, albeit at a low level (Chart 4). Even at a very low profit margin, steel producers in China still tend to produce steel as much as they can to cover their very large fixed costs. In other words, if they do not produce, they will experience greater losses.  In addition, given deteriorating employment conditions in the broader economy, maintaining employment has become a major focus of local governments. The latter will guide state-owned enterprises (SOEs) – many steel mills are SOEs or government-affiliated – to raise output and employment. For now, the government has simply asked steel producers to cut their production voluntarily, rather than mandating cuts as authorities did last year and earlier this year. In brief, in the absence of government-mandated steel output reduction, some producers will opt to increase their output to cover their fixed costs and maintain/increase employment. Will the Chinese government demand mandated cuts again later this year? We believe the odds are low. Last year, the mandated cuts were the result of more aggressive emissions reduction targets, with a deadline at the end of 2025 for the Chinese steel sector. In February of this year, the authorities extended this deadline to 2030 to grant its steel sector the ability to reach peak emissions. This will allow a gradual output reduction instead of a sharp reduction in mills with high-emission steel-producing capacity. With such a deadline extension already in place, the government is unlikely to implement mandated steel output cuts again. Chinese Steel Demand Chinese steel consumption will likely continue to contract over the next six months. Chart 5 shows that 58% of Chinese steel consumption is from building and construction, which mainly comprises the property sector and the infrastructure sector. Based on our estimate, Chinese steel demand will decline about 3.8% over the next six months, mainly dragged down by the shattered property market (Table 1). Chart 5Chinese Steel Consumption Composition Table 1Chinese Steel Demand Growth Estimates Chart 6Property Market is in a Crisis The property sector is the largest steel consumer, accounting for about 35% of Chinese steel consumption. This sector is going through a crisis, and there are no signs of improvement yet. Property sales, new construction, and completion are all in a deep and unprecedented contraction (Chart 6, panels 1, 2, and 3). Even the commodity building floor space under construction entered contraction for the first time in at least the past two decades (Chart 6, bottom panel). Both central and local governments have implemented policies to revive the property sector since late last year. Following a wave of mortgage boycotts, the July 28 Central Politburo meeting demanded local governments to ensure those sold-but-unfinished housing projects to be completed. However, due to the extreme shortage of funding faced by real estate developers and the fragmented nature of this industry in China, it will take time to get the current property sector crisis resolved. Nonetheless, we expect supportive policies will work to some extent. We expect the year-on-year contraction in property construction to narrow to 10% over the next six months from about 13% in the past six months. Chart 7Infrastructure Sector: The Main Supportive Force for Chinese Steel Demand The infrastructure sector is another major source for Chinese steel demand (Chart 7). The sector contributes about 23% of Chinese steel consumption. Although the traditional infrastructure investment shows a solid 10% growth, we only assume 7% of growth in the sector’s steel demand. This is because, within the traditional infrastructure sector, two heavy steel consuming subsectors –railway and highway constructions – will register slower growth in their respective investments than overall infrastructure. Chart 8Steel Demand In the Machinery Sector: Likely to Remain In Contraction The 2016-2019 Boom: Only Sales Excavators And Cranes Hit A New High... Machinery production, the third largest steel consuming sector, will remain in contraction because of the depressed property market. Sales of major construction equipment – excavators, loaders, and cranes – have declined 36%, 23%, and 50% year-on-year in 2022H1 (Chart 8). With continuing weakness in the property market, we expect steel demand from machinery producers to be in a similar contraction (10%) over the next six months. Autos and electric appliances together account for about 7.3% of Chinese steel consumption. Weekly data shows Chinese auto sales are in a recovery phase (Chart 9). We expect the sector’s steel use to increase by 8% year-on-year over the next six months based on our projections from our research on the auto industry. Affected by the faltering domestic property market, the outlook for electric appliances is also dismal. The output of air conditioners, freezers, refrigerators, and washing machines is contracting (Chart 10). The expected contraction in global demand for consumer goods will ensure a continuous drop in their production in China, the largest world producer of white goods. We expect these sectors' steel consumption growth to improve from a 9% contraction in 2022H1 to a 5% contraction over the next six months. Chart 9Steel Demand From Auto Sales is Recovering Chart 10Steel Demand by Electric Appliances: Smaller Contraction Ahead Chart 11Steel Demand in Other Sectors: Will Likely Stay in Contraction Other sectors that consume steel include many industrial goods, such as civil steel ships and containers. The shipping industry has boomed during the past two years because of a global increase in goods demand. This also significantly increased demand for metal containers, and to a lesser extent, civil steel ships between 2020 and 2021 (Chart 11). As global trade volumes contract over the next six months, we expect steel consumption in these other sectors to contract by 3% over the same period. What about external demand for Chinese steel? Chinese steel products exports, which account for about 5% of the country’s steel products output, will grow moderately in the next six months. Historically, the Chinese government had provided a VAT rebate of around 13% to encourage steel exports. Last year, it removed such export tax rebates on various steel products in a bid to slow domestic carbon emissions. Chart 12Chinese Steel Exports: Moderate Growth Ahead However, this has not considerably reduced Chinese steel exports. Chinese exports of steel products only had a year-on-year contraction from January to April 2022, largely because of COVID-related shutdowns, and then experienced considerable growth during May-July of the same year (Chart 12). At the same time, Chinese imports of steel products have been contracting since last May. This pattern shows the strong global competitiveness of Chinese steel products. We expect moderate growth in Chinese steel products exports over the next six months, which will be much lower than last year’s growth. In 2021, Chinese steel products exports surged by 25% year-on-year, as steel exporters rushed to export their products to take advantage of the rebates before its removal. Bottom Line: Chinese steel supply is likely to exceed demand over the next six months. This will result in an oversupplied steel market in China, exerting downward pressure on steel prices. …To The Global Iron Ore Market Chart 13Chinese Steel Production: Largely Determines the Country's Iron Ore Imports Iron ore is mainly used in the steel-making process. Limited iron ore supplies within China mean that about 80% of the country’s iron ore demand are satisfied by imports. As a result, variations in Chinese steel production largely determine swings in Chinese iron ore imports (Chart 13). Based on our expectations of the Chinese steel market, we can provide our supply-demand analysis for the global iron ore market. Global Iron Ore Demand While rebounding Chinese steel output will lift the nation’s iron ore consumption, iron ore demand from the rest of the world will shrink materially. Net-net, global iron ore demand will weaken, albeit only marginally over the next six months. Steel production is declining in the world outside China. We expect such contraction will continue into early 2023, as the pandemic-triggered overspending on goods ex-autos reverses (Chart 14). In addition, in Europe, energy rationing and sky-high energy prices will likely lead to defunct mills as a response to reducing their output; hence, their iron ore consumption will tank. Given that Europe accounts for about 10% of world steel production and nearly 50% of its steel production is using electric furnaces,2 this will reduce global iron ore demand. Last year, global steel production excluding China increased by 13% year-on-year, the highest growth since 2011 (Chart 15). This is much higher than the average 2% growth during 2017-2019, reflecting the overconsumption of goods by advanced economies in 2021. Indeed, steel production has already declined for four consecutive months. We expect a year-on-year contraction of about 5% global steel production in the world excluding China over the next six months. Chart 14The World Outside China: Steel Output Will Continue Declining Chart 15Falling DM PMI Signals Weaker Steel Output in the World Outside China Scrap steel is one substitute for iron ore in the steel-making process, but, this time, there will be limited replacement from scrap steel in China. Tight supply of scrap steel and relatively high scrap steel prices will make iron ore more appealing than scrap steel as feedstock for Chinese steel producers over the next several months. Scrap prices are currently high relative to both steel product prices and imported iron ore prices (Chart 16). Chart 16Iron Ore Substitute in China: Limited Scrap Steel Demand in 2022H2 Chart 17China: Domestic Iron Ore Output is Rising Global Iron Ore Supply Global iron ore supply will rise slightly over the next six months. Chinese iron ore output is set to continue increasing as well (Chart 17, top panel). The authorities plan to boost domestic iron ore output by 6.5% per year until 2025. Profit margins for Chinese producers are currently at a multi-year high (Chart 17, bottom panel). This will encourage domestic iron ore production over the next six months.  Currencies in global major iron ore producing countries (Brazil, Australia and South Africa) have depreciated considerably. As a result, iron ore prices in these countries in local currency terms are currently still elevated. This will incentivize more iron ore production and exports by producers in these countries. Bottom Line: Global iron ore supply will increase slightly, while demand will contract slightly over the next six months. This will be negative for iron ore prices. Investment Implications Chart 18Global Mining Stocks and Steelmaker Stock Prices: More Downside Ahead Avoid Global Steel And Mining Stocks For Now Both iron ore and steel prices will likely deflate over the next six months. Hence, global mining stocks and steelmakers stock prices will experience more downside in the coming months (Chart 18). Global ex-China steel producers have benefited from strong steel demand in DM and from surging steel prices (Chart 15 above). As we expect that DM demand for consumer goods will contract over the next six months, steel prices will drop, weighing on global steelmakers’ share prices.  Concerning equity valuations, global mining and steel stocks trade at very low trailing P/E ratios. However, for highly cyclical stocks, such a low trailing P/E ratio is often a sign of peak profits. At peaks of cycles, share prices drop first, while EPS remains elevated, as it is a backward-looking variable. In fact, more often than not, buying these stocks when the P/E ratio is very high and selling them when the P/E ratio is very low has been a very profitable strategy. In short, a low P/E ratio for mining share prices and steel producers is not a reason to be long these stocks. The direction of both the global industrial cycle and steel and iron ore prices is what matters. On both counts, the outlook remains downbeat for now.   Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com     Footnotes 1     According to the World Steel Association, crude steel is defined as steel in its first solid (or usable) form, including ingots, semi-finished products (billets, blooms, slabs), and liquid steel for castings. 2     The electric furnace is using electricity and scrap steel to produce crude steel. As Europe is facing energy constraint, this will likely affect European steel output greatly. Strategic Themes Cyclical Recommendations

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