Inflation/Deflation

Highlights In this Weekly Report, we present our semi-annual chartbook of the BCA Central Bank Monitors. All of our country Monitors are now forecasting monetary policy on hold, apart from Australia and New Zealand where looser policy is warranted (Chart of the Week). However, with early leading indicators now flagging a trough in global growth, and with labor markets mostly tight, the Monitors may not signal a need for incremental easing since inflationary pressures have not decelerated much. Given how far global bond yields have fallen in response to the weaker growth backdrop over the past year, any sign of the Monitors finding a floor would herald a turnaround in overbought global government bond markets – most notably in the U.S. and core Europe, where a below-benchmark strategic duration stance is most appropriate. Feature Chart of the WeekA Synchronized Pullback In The BCA Central Bank Monitors An Overview Of The BCA Central Bank Monitors Chart 2Bond Yields Have Fully Adjusted To Our CB Monitors The BCA Central Bank Monitors are composite indicators designed to measure the cyclical growth and inflation pressures that can influence future monetary policy decisions. The economic data series used to construct the Monitors are not the same for every country, but the list of indicators generally measure the same things (i.e. manufacturing cycles, domestic demand strength, commodity prices, labor market conditions, exchange rates, etc). The data series are standardized and combined to form the Monitors. Readings above the zero line for each Monitor indicate pressures for central banks to raise interest rates, and vice versa. Through the nexus between growth, inflation, and market expectations of future interest rate changes, the Monitors do exhibit broad correlations to government bond yields in the Developed Markets (Chart 2). Our current recommended country allocations for global government bonds reflect the trends seen in the Central Bank Monitors, even as they have all shifted lower. We are favoring countries where the Monitors are falling (Australia, the U.K., Japan, New Zealand and Canada) relative to regions where the Monitors appear to be stabilizing (the U.S., core Europe). In each BCA Central Bank Monitor Chartbook, we include a new chart for each country that we have not shown previously. In this edition, we show the components of the Monitors, grouped into those focusing on economic growth and inflation, plotted against money market yields curves (the spread between 1-year government bond yields and central bank policy rates, to measure expected changes in interest rates). Fed Monitor: No Rate Cuts Needed Our Fed Monitor has drifted lower over the past several months and now sits just above the zero line (Chart 3A). That indicates no pressure to hike interest rates, which is consistent with the Fed’s recent dovish turn. Yet the Monitor is also not yet in the “easier money required” zone that would suggest a need for the Fed to lower the funds rate - even though that is an outcome now discounted in the U.S. yield curve. Markets have gotten ahead of themselves with the expectation of Fed rate cuts. Markets have gotten ahead of themselves with the expectation of Fed rate cuts. Yes, the U.S. has finally seen some negative impact from slower global growth and the late-2018 tightening of U.S. financial conditions. However, those factors are now starting to become less negative for growth – most notably the across-the-board rally in equity and credit markets in Q1 that has eased financial conditions. There is little danger of a shift to a sustained period of below-trend growth (i.e. less than 2%) in 2019 that would free up spare capacity, and ease inflation pressures, in the U.S. economy (Chart 3B).   Chart 3AU.S. Treasury Rally Looks Overdone Chart 3BA Big Pullback In U.S. Inflation Is Unlikely Among the three sub-components of the Fed Monitor (growth, inflation and financial conditions), all are close to the zero lines (Chart 3C), suggesting that the current neutral signal from the Monitor is broad-based. The rally in the U.S. Treasury market now looks stretched, however, with the 10-year yield now lower than levels of a year ago – an outcome that, in that past, has usually coincided with the Fed Monitor falling well below zero (Chart 3D). A below-benchmark duration stance in the U.S. is appropriate, as the risk/reward profile favors higher Treasury yields from current depressed levels. Chart 3CFed Monitor Components All Near Zero, Validating Current Fed Pause Chart 3DU.S. Treasury Rally Looks Overdone BoE Monitor: The Window For A Rate Hike Has Closed Our Bank of England (BoE) Monitor, which had been in the “tighter money required” zone between 2016-18, has fallen back to the zero line (Chart 4A). The obvious culprit is the ongoing Brexit uncertainty, which has damaged confidence among both businesses and consumers. Overall economic growth has held in better than expected given the Brexit noise – for example, the manufacturing PMI now sits at 55.1, comfortably above the boom/bust 50 threshold. Yet leading economic indicators continue to deteriorate and growth is likely to remain under downward pressure in the coming months. Despite estimates showing a lack of spare capacity in the U.K. economy (a closed output gap, an unemployment rate well below NAIRU), both headline and core inflation have fallen back to the BoE’s 2% target (Chart 4B). The central bank has changed its policy bias as a result, with even the more hawkish members of the Monetary Policy Committee signaling that there is no longer any pressing need for rate hikes.   Chart 4AU.K.: BoE Monitor Chart 4BU.K. Inflation Back To BoE Target When looking at the split between the growth and inflation components of our BoE Monitor, it is clear that the former has triggered the large fall in the Monitor (Chart 4C). Yet even the inflation component has fallen below the zero line. With no pressure from any corner to alter monetary policy, the BoE can continue to sit on its hands and wait for some clarity to develop on the Brexit front. Chart 4CHit To U.K. Economy From Brexit Uncertainty Keeping BoE On Hold We continue to recommend overweighting U.K. Gilts within global government bond portfolios, given the weakening trend in U.K. leading economic indicators and persistent Brexit uncertainty (Chart 4D). Chart 4DA Deeper U.K. Growth Slowdown Needed To Drive Down Gilt Yields ECB Monitor: Bund Yields Have Fallen Too Far Our European Central Bank (ECB) Monitor is slightly below the zero line, signaling no real need for any change to euro area monetary policy (Chart 5A). The sharp slowing of economic growth last year, driven primarily by plunging exports, is the main reason why the Monitor has stayed subdued. Despite the weaker growth momentum, however, there remains far less spare capacity in the euro area economy than at any time since before the 2009 global recession (Chart 5B). Chart 5AEuro Area: ECB Monitor Chart 5BEuro Area Inflation More Stable At Full Employment   Nonetheless, the ECB has already back-pedaled on policy normalization announced last December. The central bank announced a new program of cheap funding for euro area banks (TLTRO3) to begin this September, replacing the expiring loans from the previous funding program. The backdrop is turning less bullish for core European bond markets, where yields have fallen much further than justified by our ECB Monitor. There are some tentative signs that euro area growth may be stabilizing, such as increases in the expectations component of the ZEW and IFO surveys. If this is the beginning of a true cyclical turnaround, then the downward pressure on our ECB Monitor from a weak economy will soon reverse (Chart 5C). Chart 5COffsetting Growth & Inflation Components In The ECB Monitor The ECB is now signaling that it will keep policy rates unchanged until the end of the year, on top of the new TLTRO. In addition, faster global growth in the latter half of 2019 will provide a boost to the euro area economy via the export channel. The backdrop is turning less bullish for core European bond markets, where yields have fallen much further than justified by our ECB Monitor (Chart 5D). We recommend only a neutral allocation to core European government bonds, but our next move is likely a downgrade. Chart 5DBund Rally Looks Stretched Versus ECB Monitor BoJ Monitor: No Inflation, No Change In Policy Our Bank of Japan (BoJ) Monitor has drifted back to the zero line after a brief cyclical stay in the “tighter money required” zone in 2017/18 (Chart 6A). Such is life in Japan, where even an unemployment rate of 2.3% – the lowest in decades – cannot generate inflation outcomes anywhere close to the BoJ’s 2% target (Chart 6B). Chart 6AJapan: BoJ Monitor Chart 6BNo Spare Capacity In Japan, But Still No Inflation The slowing of global trade activity and weakness in Chinese economic growth has hit the export-sensitive Japanese economy hard. Industrial production is now contracting, export volumes fell –6.8% year-over-year in January, and the widely-followed Tankan survey showed the biggest quarterly drop in business confidence among manufacturers in Q1/2019 since 2011. Household confidence has also taken a hit and retail sales growth has stagnated. Against such a weak economic backdrop, the soft growth component of our BoJ Monitor is fully offsetting the relative strength of the inflation component (Chart 6C). The latter is mostly related to the tightness of Japan’s labor market, which has pushed nominal wage inflation to 3.0% - the fastest pace since 1990. Core inflation at 0.4% has not followed suit, however. Chart 6CStill Not Enough Growth To Justify Any Reduction in BoJ Accommodation We continue to recommend an overweight stance on JGBs, based on our view that the BoJ will maintain hyper-easy monetary policy settings – especially compared to the rest of the developed markets – until there is much higher realized core inflation in Japan. There is no chance of the BoJ moving any part of the Japanese yield curve it effectively controls (all interest rates with maturity of 10 years of less) until both growth and inflation move durably higher (Chart 6D). Chart 6DNo Pressure On JGB Yields To Rise BoC Monitor: Neutral Across The Board Our Bank of Canada (BoC) Monitor has fallen sharply since mid-2018 and now sits right at the zero line, suggesting no pressure to change monetary policy (Chart 7A). The main cause is weakness in the Canadian economy, which has responded negatively to the combination of previous BoC rate hikes, diminished business confidence and slower global growth. The central bank was surprised by how rapidly the Canadian economy lost momentum at the end of last year, when real GDP expanded an anemic 0.4% annualized pace in Q4/2018. That prompted the BoC to signal a halt to the rate hikes, even with core inflation measures hovering close to the midpoint of the BoC’s 1-3% target band (Chart 7B). Chart 7ACanada: BoC Monitor Chart 7BIs Economic Slack Underestimated In Canada? Canadian money markets now discount -20bps of rate cuts over the next year. In the past, market pricing of BoC rate expectations has tended to be more correlated to the inflation component of our BoC Monitor (Chart 7C). The latest downturn in the Monitor, however, has been driven by declines in both the growth and inflation components. The BoC’s dovish turn is validated by broad-based weakness in the Canadian data. Chart 7CBoC Monitor Components Both Consistent With No Change In Interest Rates We closed our long-standing underweight recommended allocation for Canadian government bonds on March 19.1 We are now at neutral weight, although we may shift to an overweight stance if the coming rebound in global growth that we expect does not carry over into the Canadian economy and trigger some stabilization in our BoC Monitor (Chart 7D). The BoC’s dovish turn is validated by broad-based weakness in the Canadian data. Chart 7DCanadian Yields Will Not Rise Again Without A Rebound In Growth RBA Monitor: More Pressure To Cut Rates The Reserve Bank of Australia (RBA) Monitor has been below the zero line since September 2018, indicating a need for easier monetary policy (Chart 8A). A slumping economy has been weighed down by sluggish consumption, weak exports and falling house prices in the major cities. Combined with inflation stubbornly below the 2-3% RBA target band, this has driven Australian bond yields to new lows. -41bps of RBA rate cuts over the next year are now discounted in the Australian OIS curve. Delivering on those rate cut expectations, however, will likely require some weakening of the labor market (Chart 8B). Chart 8AAustralia: RBA Monitor Chart 8BAustralia: RBA Monitor As depicted in Chart 8C, both the growth and inflation components of our RBA Monitor have fallen below the zero line. Over the past quarter-century, when both components of the RBA Monitor were as far below zero as they are now, shorter-dated bond yields have ended up falling below the Cash Rate as markets move to price in an easing cycle. That 1-year/Cash Rate spread has not yet gone negative, suggesting there is more room for the entire Australian government yield curve to be dragged lower by the front-end if the economy does not soon improve. Chart 8CSoft Inflation Is Why Our RBA Monitor Is Calling For Cuts The positive correlation between the RBA Monitor and changes in the 10-year Australian government bond yield suggests that downward pressure on yields will persist until economic growth or inflation begins to revive. The positive correlation between the RBA Monitor and changes in the 10-year Australian government bond yield suggests that downward pressure on yields will persist until economic growth or inflation begins to revive (Chart 8D). With Australia’s leading economic indicator still decelerating, and with any boost to exports not likely until later this year, we continue to recommend an overweight stance on Australian government bonds. Chart 8DStay Long Australian Bonds RBNZ Monitor: Setting Up For A Rate Cut Our Reserve Bank of New Zealand (RBNZ) monitor has been below the zero line since September 2018, indicating that easier monetary policy is required. (Chart 9A). The central bank made a significant dovish shift in its forward guidance at the March meeting, noting that the balance of risks for the New Zealand (NZ) economy was now tilted to the downside and the next move is more likely to be a rate cut. That dovish turn is consistent with the underwhelming performance of NZ inflation (Chart 9B). The RBNZ does not expect inflation to hit 2% until the end of 2020, even with the unemployment rate at a ten-year low of 4.3% and wages growing at a 2.9% annual rate. Chart 9ANew Zealand: RBNZ Monitor Chart 9BNZ Inflation Has Struggled To Breach 2% Over the past two decades, market pricing of RBNZ rate moves has been more correlated to the growth component of our RBNZ Monitor. In the years since the Global Financial Crisis, however, the growth and inflation components have been highly correlated to each other and to expectations for interest rates (Chart 9C). With markets now discounting -45bps of rate cuts over the next year, the NZ yield curve appears appropriately priced relative to our RBNZ Monitor. Chart 9CBoth Inflation & Growth Components Of The RBNZ Monitor Signaling Rate Cuts We have maintained a bullish recommendation on NZ government bonds versus both U.S. Treasuries and German Bunds since mid-2017, and we see no reason to close this highly profitable position, even if the RBNZ fails to fully deliver on discounted rate cuts. Both Treasuries and Bunds look overvalued amid signs of U.S. and European growth stabilizing, while the deterioration in our RBNZ Monitor suggests NZ yields have far less upside (Chart 9D). Chart 9DStay Long New Zealand Government Bonds Riksbank Monitor: Rate Hikes Delayed, Rate Cuts Unlikely Our Riksbank Monitor is currently slightly below zero and market is now priced for -17bps of rate cuts over next year (Chart 10A). The market has judged that the recent bout of weaker Swedish economic data has effectively derailed the Riksbank’s plans to hike rates in the second half of 2019. However, given the dearth of spare capacity in the Swedish economy (Chart 10B), and with the policy rate still negative, rate cuts are unlikely to be delivered. At best, the central bank can delay rate hikes if growth continues to disappoint, which also supports easier monetary conditions via a weaker exchange rate (the krona is down -4.7% year-to-date). Chart 10ASweden: Riksbank Monitor Chart 10BSweden Inflation Cooling Off A Bit The Riksbank stated in its February Monetary Policy Report that low Swedish productivity growth is leading to cost pressures through higher unit labor costs. It also forecasts that faster wage growth over the next year will help keep inflation near the 2% Riksbank target. The implication is that it will take much weaker growth, and higher unemployment, before the central bank will completely abandon its quest to normalize Swedish interest rates. The relationship between the growth/inflation components of our Riksbank Monitor and the market’s interest rate expectations has been weak since the central bank cut rates below zero and introduced quantitative easing in late 2014 (Chart 10C). Prior to that, however, it was the growth component that was more correlated to short-term interest rate expectations. On that note, the rebound in global growth that we are expecting will help support the Swedish economy, which is highly geared to global economic activity, and put a floor under Swedish bond yields (Chart 10D). Chart 10CRiksbank Can Stay On Hold Chart 10DNo Pressure For Higher Sweden Bond Yields Robert Robis, CFA, Chief Fixed Income Strategist rrobis@bcaresearch.com Ray Park, CFA, Research Analyst ray@bcaresearch.com Footnotes 1 Please see Global Fixed Income Weekly Report “March Calmness,” published March 19, 2019. Available at gfis.bcaresearch.com. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

ハイライト グローバル株式およびその他のリスク資産は、今後数週間はボラティリティ高止まりの横ばい推移となり、その後一連の出だし失敗を経て世界成長がようやく加速するにつれて年末までは徐々に上昇するだろう。 私たちは現在、フェドが以前想定していたよりも遅いペースで利上げを行うと見ているが、最終的にはインフレを抑えるために利上げを急がざるを得なくなるだろうと考えている。 フェドファンド金利はおそらく2021年に4％で頭打ちとなり、市場が現在織り込んでいるよりも四半期ごとに0.25ポイントの利上げが合計9回多く示唆される。 12か月の投資期間では、投資家はグローバル株式をオーバーウェイトし、国債をアンダーウェイトし、現金配分は中立を維持すべきである。 ドルは第2四半期にピークを迎え、その後年末までおよび2020年にかけて弱含みとなり、来年遅い時期に再び強含み始めるだろう。 投資家は今後数週間、新興国（EM）および欧州株を一時的に格上げする準備をすると同時に、景気循環型の株式セクターへのエクスポージャーを増やすべきである。 工業用金属と原油は年の経過とともに強含みとなるだろう。金は押し目で買うべきである。 投資家は2020年末にポートフォリオのリスク低減を開始し、2021年の景気後退に備えるべきである。 チャート 001   特集 また始まるのか？ 昨年6月によりディフェンシブになった後、私たちは12月のFOMC後の急落を受けて株式に対して強気に転じた。株式が反発を続けるにつれて、私たちは楽観を和らげた。3月初めに私たちは「年初から上昇してきた世界の株式は、投資家が慌てていわゆるグリーンシュートの出現を待つため、今後6～8週間で『デッドゾーン』に入る可能性が高い」と書いた。1 先週金曜日に発表された期待外れの欧州PMIデータは、グリーンシュート論に一部止めを刺した格好だ。ドイツの製造業PMIは6年ぶりの低水準に落ち込み、新規受注の構成要素はグレート・リセッション以来の弱い水準を示した。これを受けてドイツの10年国債利回りは2016年以来初めてマイナス圏に入り、米10年国債利回りも15か月ぶりの低水準まで下落し、3か月/10年のカーブが逆イールド化した。歴史的に見て、逆イールドは米国の景気後退を予測する信頼できる指標であった（チャート1）。 チャート1イールドカーブの逆転、景気後退、およびタームプレミアム イールドカーブの逆転、景気後退、そしてタームプレミアム イールドカーブの逆転、景気後退、そしてタームプレミアム トランプ大統領がテレビ評論家のスティーブン・ムーアをフェドの理事に任命する決定を下したことも事態を好転させなかった。供給側（サプライサイド）の「経済学者」ラリー・クドローの推薦を受けたムーアは、2007年の住宅市場の懸念を軽視したこと、2010年にQEがハイパーインフレを引き起こすと的確に予測したことで知られ、トランプ減税が財政赤字を小さくするだろうと信じている点でも有名だ。 世界成長は年の後半に加速するだろう これらの憂慮すべき展開を踏まえ、景気とリスク資産に対して再び景気循環的に弱気に転じるべき時だろうか。私たちはそうは考えない。今後数週間は株式にとって厳しい局面があり得る――これは私たちのマクロクオンツ・モデルが現在示しているリスクだ――が、一連の出だし失敗を経て世界成長がようやく加速するにつれてセンチメントは改善するはずだ。実際、すでにいくつかの前向きな兆候が見えている：上昇している先行指標を持つ国の比率を追跡する当社のグローバル先行経済指標の拡散指数は上昇しており（チャート2）、グローバルLEIを先行している。サービス業のPMIも概ね改善しており、世界成長の弱さは主に貿易と製造業に集中していることを示唆している。さらに貿易面でも、バルチック・ドライ指数や世界のコンテナ船の活動を示す週次のHarpex海運指数といったいくつかの先行指標が安値から反発している。 我々はイールドカーブのシグナルを過小評価すべきだと考える。現在それはマイナスのタームプレミアムによって深刻に歪められているからだ。もし米10年のタームプレミアムが2004年の水準に戻っていれば、3か月/10年のスロープは200ベーシスポイント以上急勾配になり、この問題について誰も話題にしないだろう。実際、今日のタームプレミアムを考慮すれば、1995年にはほぼ確実にカーブは逆転していただろう。当時株式を手放した者は歴史上最も偉大なブルマーケットの一つを逃したことになる。 また、米10年利回りの一部低下はポジティブな展開を反映していることは言うまでもない：フェドがよりハト派に転じたのだ。10年/30年部分のイールドカーブを見れば、実際にはスティープ化している。これは市場がフェドの行動をリフレーション的であると見なしている兆候である。 逆イールドカーブが経済活動を鈍化させる明確な因果メカニズムはないが、イールドカーブの逆転が投資家を怯ませ、それによって金融環境のタイト化を招くという自己成就的予言になる可能性はある（チャート3）。このような「ドゥームループ」は概念的には可能だが、今年初めに我々が議論したように、現在の環境で発生する可能性は低い。2いずれにせよ、金融環境は年初以来緩和している。これは今後数か月の成長を押し上げるはずだ。   チャート2世界成長は##br##安定し始めている可能性がある 世界の成長は安定し始めている可能性がある 世界の成長は安定し始めている可能性がある チャート3年初来の金融環境の緩和は世界成長にとって好材料 年初以来の金融環境の緩和は世界経済の成長にとって好材料だ 年初以来の金融環境の緩和は世界経済の成長にとって好材料だ 中国のクレジット成長は上昇へ 世界成長は中国経済の減速に足を引っ張られてきた。昨年のデレバレッジ化キャンペーンは投資支出の大幅な減速を招き、これは世界中の資本財メーカーやコモディティ生産者に悪影響を及ぼした（チャート4）。 歴史的に見て、クレジット成長が名目GDP成長に近づくとき、中国は金融部門への締め付けを緩めてきた（チャート5）。おそらく我々はそのポイントに達したようだ。季節調整で歪んだ弱い2月の数値にもかかわらず、クレジット成長はついに前年比で加速している。 チャート4中国：デレバレッジ化キャンペーンは投資支出に悪影響を与えた 中国：デレバレッジ化の取り組みは投資支出に悪影響を及ぼした 中国：デレバレッジ化の取り組みは投資支出に悪影響を及ぼした チャート5歴史的に、中国はクレジット成長が名目GDP成長に接近するとデレバレッジを縮小してきた 歴史的に見ると、信用の伸びが名目GDP成長率に近づくと、中国はデレバレッジの取り組みを縮小してきた。 歴史的に見ると、信用の伸びが名目GDP成長率に近づくと、中国はデレバレッジの取り組みを縮小してきた。 我々は中国のクレジット成長が過去の再レバレッジ局面ほど大きく上昇するとは予想していない。だが、これは経済の状態がより良くなっているためであり、現状からの債務増加に内在的な制約があるためではない。 中国の高い貯蓄率は、ターム名目GDP成長率よりも金利を大きく下回る水準に保ってきた。これは債務持続可能性の主要な決定要因である（チャート6）。3中央政府が現在のように大部分の地方債務と企業債務に対して暗黙の保証を維持している限り、デフォルトリスクは最小限にとどまるだろう。いずれにせよ、総債務がGDP比240％に達していることを考えれば、クレジット成長が1パーセンテージポイント上昇するだけで、GDPの2.4％に相当する大きなクレジット刺激が生じることになる。 中国のクレジットインパルスは輸入を約6～9か月先行する（チャート7）。これは年の後半における世界貿易にとって良い兆候である。 チャート6中国の高い貯蓄率は金利をトレンドの名目GDP成長率を大きく下回る水準に保ってきた 中国の高い貯蓄率が金利をトレンドの名目GDP成長率を大幅に下回る水準に抑えている 中国の高い貯蓄率が金利をトレンドの名目GDP成長率を大幅に下回る水準に抑えている チャート7中国のリフレーション的刺激は世界貿易に恩恵をもたらすだろう グローバル・トレードは中国のリフレーション的な刺激から恩恵を受けるだろう グローバル・トレードは中国のリフレーション的な刺激から恩恵を受けるだろう   貿易戦争の一服か？ 貿易戦争の緊張緩和は事態を改善するだろう。自称「名交渉人」であるドナルド・トランプは、来年の大統領選挙前に中国との合意をまとめる必要があり、同時にその合意が米国にとって有利な条件で成立したと有権者に納得させなければならない。 任期序盤に中国と合意に達することは、双方向の貿易赤字を減らせなかった場合にはリスクがあった――米国の財政政策が景気循環的であることを考えればそれは全くあり得る結果だ。しかし現時点では、トランプは中国と素晴らしい取引をまとめたと自慢でき、かつその成果が実現するのは再選後であると有権者に安心させることができる。したがって、トランプが合意の締結を目指す可能性は高まっている。 中国側は可能な限り大きな交渉力を確保したがっている。これは、自国経済が双方の利益にならない貿易協定を突っぱねても、その影響を十分に吸収できるほど強いと説得力を持って示せることを意味する。クレジットサイクルが中国成長の支配的な原動力であるため、これはデレバレッジ化キャンペーンを一時的に後回しにすることを必要とする。世界成長の加速と強い国内需要は欧州に恩恵をもたらす 中国の成長加速は今年後半に欧州の輸出セクターを助けるだろう。中国のCaixin購買担当者指数（PMI）の輸出コンポーネントは底値から上昇している。これはユーロ圏のPMIを約三か月先行している。一方で、ユーロ圏の国内需要はより緩和的な財政政策と低下する債券利回りの恩恵を受けるだろう。 イタリアにとっては債券利回りの低下が特に有益だ。昨年三月にポピュリスト政権が選出された後の利回り急騰と企業信頼感の喪失は景気後退に突入させた（チャート 8）。現在、10年物BTP利回りが高値から100ベーシスポイント以上低下しているため、イタリア経済は回復し始めるはずだ。 国内成長が加速しても欧州中央銀行は今年利上げを行わないだろうが、市場はおそらく2020年以降に数回の利上げを織り込むだろう。これによりコア欧州債券市場の利回り曲線がわずかに再スティープ化し、長らく苦しんでいる銀行の収益にはプラスに働くはずだ。 ブレグジットは依然として懸念材料だ。この継続する物語は滑稽な段階に達しており、1) 英国はEU離脱に投票したが、2) 議会はブリュッセルと満足のいく合意に達しない限りEUに留まることに投票し、しかも3) 提示されていた唯一の合意案を拒否した。多くの英国有権者がもはやブレグジットを望んでいないことを考えると（チャート 9）、我々は政府がいわゆる先送りを続け、二度目の国民投票が発表されるか「ソフト・ブレグジット」合意が策定されるまでその問題を先送りにするだろうと考えている。いずれの結果も市場には歓迎されるだろう。 チャート 8イタリアの債券利回りはもはや逆風ではない イタリア国債利回りはもはや逆風ではない イタリア国債利回りはもはや逆風ではない チャート 9英国：やり直しとなれば残留側が勝つ可能性が高い 英国：やり直しが行われれば、残留派が勝つ可能性が高い 英国：やり直しが行われれば、残留派が勝つ可能性が高い   フェッドはどうするか？ チャート10 昨年の「クリスマス暴落」はフェッドの反応関数を明らかによりハト派の方向へと変えた。今後数か月でジェローム・パウエルが利上げを行うとは予想していないが、世界成長の再加速は12月にフェッドを再び引き締めに向かわせる可能性が高い。フェッドは2020年に四半期に一度の利上げを継続し、インフレ上昇に対応して2021年には引き締めペースを加速させるだろう。 総じて、我々はこのサイクルの終わりまでにフェデラルファンド金利が約4%に上昇すると見ている。これは市場が現在織り込んでいる水準よりも四半期ごとの25ベーシスポイントの利上げが九回多いことを意味する（チャート 10）。我々はフェデラルファンド先物のショートポジションで損切りになったが、顧客には2021年6月限フェデラルファンド先物または同等の手段をショートすることを推奨する。 米国経済：再び好調 基本的に米国経済は堅固な基盤にあり、より高い金利にも耐えられる。10年前とは異なり、住宅市場は良好な状態にある（チャート 11）。持ち家空室率は記録的な低水準近辺にある。フィコ・スコアを見る限り、住宅ローンの貸出の質は依然として高い。労働市場も堅調で、求人件数は二月に再び過去最高を記録した（チャート 12）。健全な住宅市場と労働市場の組み合わせは消費者にとって不可避的に良い。 チャート 11米国の住宅の基礎条件は堅調 米国の住宅ファンダメンタルズは堅調だ 米国の住宅ファンダメンタルズは堅調だ チャート 12米国の労働市場は堅調である 米国の労働市場は堅調だ 米国の労働市場は堅調だ チャート13 個人貯蓄率は現在7.6%にあり、家計の純資産対可処分所得比率から期待される水準よりもかなり高い（チャート 13）。貯蓄率の低下は消費支出が所得よりも速く増加することを可能にするだろう。後者は賃金上昇によって支えられているため、これは消費にとって強気材料となる。 設備投資意向は過去数か月で低下したが、歴史的基準から見ると依然として高い水準にある（チャート 14）。実質非住宅資本ストックは回復開始以来平均でわずか1.7%しか成長しておらず、リセッション前の期間の3%から低下している（チャート 15）。生産性成長の景気循環的な上振れ、上昇する労働コスト、低い余剰生産能力の水準は、企業が新しい工場や設備に投資する動機付けとなるはずだ。 チャート 14設備投資意向は軟化したが、依然として高水準にある 設備投資の意向は軟化したが、依然として高水準にある 設備投資の意向は軟化したが、依然として高水準にある チャート 15米国の設備投資余地はまだある 米国への資本投資にはさらなる余地がある 米国への資本投資にはさらなる余地がある   企業債務：どれほどのリスクか？ チャート 16米国の企業債務は世界基準で極端ではない 米国の企業債務は世界基準では極端ではない 米国の企業債務は世界基準では極端ではない 近年、企業債務水準は大幅に増加し、契約条項の緩いローンの増加に見られるように引受基準は悪化した。それでも状況は深刻とは程遠い。 他国と比べると、米国の企業債務はかなり低い（チャート 16）。フランスの企業債務はGDP比で143%に達し、米国の2倍である。これはフランスの企業セクターがすべて順調であることを示すわけではないが、事実としてフランスは企業債務の危機に見舞われていない。これは米国が差し迫った危機に瀕していないことのシグナルにもなる。 現金を差し引くと、米国の企業債務のGDP比は1989年と同じ水準にあり、その年のフェデラルファンド金利はほぼ9%であった。法人ネット負債対EBITDの比率は比較的低いままである。利子負担能力比率は歴史平均を上回っている。加えて、過去数年で企業資産もかなり速く増加しており、企業の債務対資産比率は概ね安定している（チャート 17）。 企業部門の金融収支－－企業の収入と支出の差－－は依然としてGDPの1%でプラス圏にある。過去50年のすべての景気後退は企業部門の金融収支が赤字になったときに始まっている（チャート 18）。 チャート 17米国の企業債務：どのくらい高いか？ 米国の企業債務：どこまで高くなる？ 米国の企業債務：どこまで高くなる？ チャート 18企業部門の金融収支は依然として黒字 企業部門の金融収支は依然として黒字 企業部門の金融収支は依然として黒字 住宅ローンのようにレバレッジドな機関が多く保有する債務とは異なり、ほとんどの企業債務は年金基金、保険会社、ミューチュアル・ファンド、イーティーエフのような非レバレッジのプレイヤーによって保有されている。銀行貸出は非金融企業部門債務のわずか18%を占め、1980年の40%から低下している（チャート 19）。銀行が保有するレバレッジド・ローンのシェアは10年前の約25%から現在は10%未満に低下している。さらに、今日の銀行は過去よりもはるかに高品質の自己資本を多く保有している（チャート 20）。これにより企業債務は経済にとってシステミックに重要である度合いが低くなっている。   チャート 19銀行は企業セクターへのエクスポージャーを削減した 銀行は企業向けのエクスポージャーを縮小した 銀行は企業向けのエクスポージャーを縮小した チャート 20米国の銀行は十分な自己資本を保有している 米国の銀行は健全な資本水準にある 米国の銀行は健全な資本水準にある 我々が12月にリスク資産に対してより強気になった理由の一つは、株式が急落し企業スプレッドが拡大したにもかかわらず金融ストレス指数に大きな追随がなかったためである。例えば、悪名高いテッド・スプレッドはほとんど動かなかった（チャート 21）。 チャート 21テッド・スプレッドは落ち着いており、深刻な金融ストレスの兆候は示していない TEDスプレッドは良好に推移しており、金融ストレスの重大な兆候は見られない TEDスプレッドは良好に推移しており、金融ストレスの重大な兆候は見られない みんなラリーに同意している 米国経済に大きな不均衡がないことを踏まえると、投資家はなぜフェッドが実際にはさらに利上げできないと考えているのだろうか。フェデラルファンド金利の実質ベースはかろうじてゼロを上回っているにすぎないのに。答えは、投資家がラリー・サマーズの世俗的停滞（セキュラー・スタグネーション）論を受け入れているように見えることである。これは中立金利が過去に比べて今日ははるかに低いという仮説である。 我々はこの理論にいくぶんの同情を持っているが、これは生産性や人口動態といった長期的な金利決定要因に関する理論であることを忘れてはならない。この理論は景気循環的な金利のドライバー、すなわち余剰生産能力の量、財政政策のスタンス、信用の成長、賃金動向などについてはほとんど何も語っていない。 今十年初め、我々がまだ債券に非常に強気であったときには、経済は極めて低い金利を必要としているともっともらしく主張できた：産出ギャップは依然として大きく、デレバレッジのサイクルは始まったばかりであり、住宅と株価は下押しされ、賃金上昇は乏しく、大不況の間の短い景気刺激のバーストの後に財政政策は制約的になっていた。中立からはほど遠いか？ 上述のすべての要因は、過去数年の間に完全にまたは部分的に方向を転じている。財政政策を一例として挙げると、IMFは米国の構造的財政赤字が2014–15年にGDPの平均で3.3%だったと推計している。2019–20年にはIMFは赤字がGDPの平均で5.6%になると見込んでいる。 より緩和的な財政政策はどの程度まで米国の中立金利を押し上げたのだろうか。保守的に仮定して、追加の1ドルの財政刺激が総需要を1ドル押し上げるとしよう。この場合、財政政策は過去5年間で総需要に対してGDP比で2.3%を上乗せしたことになる。総需要が1パーセンテージポイント増加すると中立金利が1%上昇すると仮定すると（これはイエレン元FRB議長が支持したテイラールールの仕様と一致する）、財政政策だけで中立金利を2パーセントポイント以上押し上げたことになる。 上の議論は、長期的な構造要因が中立金利を下押ししているとしても、景気循環的な要因が中立金利をかなり押し上げた可能性があることを示唆している。FRBは今後1〜2年の経済にとって適切な水準を見据えて金利を設定するはずなので、金利が過度に低い状態が長く続くことになりかねない。これにより経済は過熱し、最終的にはインフレが急上昇するだろう。 インフレの脅威 良いニュースは、我々のお気に入りの指標のいずれも大規模な差し迫ったインフレ上昇を示していないことだ（チャート22）。関税が高まっているにもかかわらず、消費者向け輸入物価のインフレ率は鈍化している。コア中間財の生産者物価インフレ率は減速している。ISMや地域連銀の調査における支払価格項目は急落している。インフレ・サプライズ指数は反転して低下している。調査ベースおよび市場ベースのインフレ期待はともに昨夏より低いままである。これらの動きに沿って、BCAの独自のパイプライン・インフレ指標は2年半ぶりの低水準に下落している。 賃金上昇は加速しているが、生産性の伸びの方がさらに大きくなっている。その結果、単位労働コストのインフレ率は昨年中頃から低下している。単位労働コストはコアCPIの約12か月先行指標である（チャート23）。これは少なくとも来年下半期までは消費者物価のインフレ率が不快なほど高い水準に達する可能性は低いことを示唆している。 Chart 22米国における差し迫った大規模インフレ上昇の兆候は見られない 米国で差し迫った大規模なインフレーションの急騰の兆候は見られない... 米国で差し迫った大規模なインフレーションの急騰の兆候は見られない... Chart 23単位労働コストの減速は当面インフレ圧力を和らげる ...そして、単位労働コストの減速は当面の間、インフレ圧力を和らげるだろう ...そして、単位労働コストの減速は当面の間、インフレ圧力を和らげるだろう その時点では、インフレが上昇に転じるリスクが高い。これによりFRBは2021年初めに急激な利上げを開始せざるを得なくなり、ドルが上昇し株式やスプレッド・プロダクトが売られる可能性がある。結果として金融状況が引き締まり、2021年中～後半に米国と世界の景気が後退に陥る恐れが高い。   当面はグローバル株式に強気を維持し、来年後半に防御的姿勢へ転換 Chart 24アナリスト予想はかなり控えめである アナリストの予想はかなり控えめだ アナリストの予想はかなり控えめだ 上で述べた二段階のFRBによる引き締めサイクル――12月に始まり2020年にかけて徐々に利上げを行い、その後インフレ上昇に反応してより積極的な利上げに移行する――が今後数年間の投資見解を形作る。本刊行物の冒頭にある主要金融市場予測チャートは、主要資産クラスが向かう先の大まかなスケッチを示している。 株式や他のリスク資産は、FRBが年内にさらに利上げを示唆して市場の準備を始める時期の前後でボラティリティが高まるものの、最初の段階の利上げを織り込むことができるだろうと我々は考えている。昨年9月とは異なり、利益見通しはより保守的だ。ボトムアップの推計では、2019年に米国で1株当たり利益（EPS）が3.9%上昇し、世界のその他地域で5.4%上昇する見通しである（チャート24）。成長の加速、金融環境の緩和、継続的な自社株買いの組合せは、これらの数値に上振れ余地を示唆している。 さらに重要な点は、9月とは異なり、FRBは経済が良好に推移している場合にのみ利上げを開始するだろうということである。パウエルは米国経済が減速し始めたちょうどその時に「金利は中立からは遠い」と述べてしまい、誤りを犯した。もしその発言が米国の成長がまだ加速している時点で出ていたなら、投資家はおそらくそれを無視しただろう。 ジェローム・パウエルは同じ過ちを繰り返さないだろう。代わりに別の誤りを犯す可能性がある：経済を過熱させ、FRBが明らかに後手に回り、追いつくために慌てて利上げを行わざるを得ない状況にしてしまうことである。その結果生じるスタグフレーション的な環境――労働力不足により成長が鈍化しつつインフレが上向く状況――は株式や他のリスク資産にとって有毒となるだろう。 タイミングを正確にするのは難しいが、我々は投資家に対して今後12〜18か月は控えめにリスク志向を維持することを推奨する。ただし、FRBが利上げのペースを加速する前の来年後半には株式とスプレッド・プロダクトへのエクスポージャーを削減すべきだ。 国際株式を一時的に格上げする準備をする 米国株式市場は他の市場と比べて「ロー・ベータ」になりがちである。もし今年後半に世界成長が加速するなら、国際株式は米国株式をアウトパフォームするだろう。我々はEEMイーティーエフのプットを1月3日に売却して104%の利益を得ており、現在は新興国株式を純粋にロングすることを推奨している。世界成長の回復を示すさらなる確証が得られ次第、為替ヘッジなしの条件で新興国株式と欧州株式の両方をオーバーウェイトへ格上げすることを数週間以内に検討する予定だ。 日本株については判断が分かれるところだ。強い世界成長は日本の多国籍企業に恩恵をもたらすが、国内市場に重心を置く企業は政府が10月に消費税を引き上げるなら打撃を受ける可能性がある。当面は日本株の格上げは見送るつもりだ。 グローバルなセクターレベルでは、我々は今年初めにディフェンシブ寄りの配分を縮小した（昨夏により慎重になっていた後で）。投資家にはエネルギーとインダストリアル（工業）をオーバーウェイトすることを推奨する。金融とマテリアル（素材）にも好感を抱き始めている。前者は今年後半のイールドカーブのスティープ化やクレジット成長の加速から恩恵を受けるだろう。後者はより堅調な中国経済から利益を得るだろう。ヘルスケア、情報技術、コミュニケーション・サービスは中立配分を維持する。不動産と公益事業は債券利回りが上昇し始めるとどちらも傷を負う。生活必需品のような古典的なディフェンシブ・セクターもアンダーパフォームするだろう。  世界の債券利回りは上昇しそうだ 世界の債券利回りは、成長が上振れサプライズを起こすにつれて今後12〜18か月で上昇する可能性が高い。インフレが加速するにつれて利回りは2021年前半に向けてさらに上昇し続けるだろう。 過去のリスクオフ局面とは異なり、次の景気後退に向かう過程で米国債が大きなセーフヘイブンの役割を果たすとは限らない。上述の通り、今日債券利回りがこれほど低い理由の一つはターム・プレミアムが非常に低下していることだ。FRBの債券買入の累積効果がターム・プレミアムを押し下げている可能性は高いが、より大きな影響は投資家が米国債をさまざまなマクロリスクに対する保険として見なしていることに由来している。投資家は、経済が景気後退に陥ると株価は下落し、住宅市場は悪化し、賃金上昇は鈍化し、雇用見通しは悪化するが、少なくとも債券ポートフォリオの価値は上がるだろうと考えることに慣れているのだ。 この考え方の問題は、それが有効なのはFRBが成長の強まりに対して利上げを行う場合だけだという点だ。もしFRBがインフレが手に負えなくなっていることに反応して利上げを行うなら、米国債利回りは上昇する一方で株式は下落する可能性がある。これは実際、1960年代後半から2000年代初頭にかけては常態だった（チャート25）。 Chart 25米国債利回りが上昇する一方で株式が下落する可能性 米国債利回りは上昇する一方で、株価は下落する可能性がある 米国債利回りは上昇する一方で、株価は下落する可能性がある もし米国債がセーフヘイブンの地位を失えば、ターム・プレミアムは上昇するだろう。利回り上昇が株式市場を弱め、投資家が株式と債券の両方から現金へと一斉に逃げることで、さらなる利回り上昇と株価下落を招くという悪循環が生じる可能性がある。 投資家は今後12か月間、米国債に対してはやや短めのデュレーション・スタンスを維持し、その後インフレが表面化し始める2020年中頃にはデュレーションを最大限アンダーウェイトにするべきだ。デュレーションをロングする（長めの債を保有する）判断が合理的になるのは、FRBが金利を制約的な水準まで引き上げ、経済が景気後退に入った場合だけである。それが起こるのは2021年下半期まで見込まれない。 地域別には、今後12か月間で米国債に対して欧州、カナダ、オーストラリア、ニュージーランド、特に日本の国債を好む。米国経済が最も過熱するリスクにさらされているからだ。通貨ヘッジありの観点では、10年物米国債利回りは世界の主要国の中で低い部類に入る（表1）。例えば日本の10年国債は通貨ヘッジありの条件で2.72%を提供し、ドイツ国債は2.94%を示している。 Table 1先進国の債券市場 2019年第2四半期 ストラテジー見通し：デッドゾーンからエンドゾーンへ 2019年第2四半期 ストラテジー見通し：デッドゾーンからエンドゾーンへ  米ドル：ソフト・パッチへ向かう 米ドルの見通しを測るのはやや厄介だ。米連邦準備制度理事会（Fed）は今後12か月間で段階的に利上げを行うにせよ、市場が織り込んでいる水準よりは高い利上げを行う見込みだ。他の大半の中央銀行がまだ様子見の姿勢を続けているため、短期金利差は米ドルに有利に動く可能性が高い。それでも、日本を除けば、世界的な成長が強まると投資家は2020年以降の他の先進国での追加利上げを織り込む可能性が高い。その結果、長期の利回り差は短期の利回り差ほど拡大しないかもしれない。 おそらくそれ以上に重要なのは、米ドルはカウンターサイクリカル、つまり世界成長の動きと逆方向に動く通貨であるという点だ（Chart 26）。この逆循環性は、米国経済が世界の他地域と比べて製造業よりもサービス業により重点を置いていることに起因する（Chart 27）。したがって、世界成長が加速すると、資本は米国から世界の他地域へ流れる傾向が強まり、外貨需要が増え、ドル需要は減少することになる。 Chart 26ドルは逆循環通貨である ドルは景気循環に逆行する通貨である ドルは景気循環に逆行する通貨である Chart 27米国はグローバル成長に対する低ベータの投資対象である 米国はグローバル成長に対する低ベータの投資先 米国はグローバル成長に対する低ベータの投資先 もし世界成長が今年後半に持ち直すなら、ドルは第2四半期にピークを付け、その後2019年末から2020年にかけて弱含む可能性が高い。ドルの動きは、2017年の経過と似た経路をたどるかもしれない。2017年はFedが4回利上げした年だが、貿易加重換算の広義ドルはそれでも7％弱含んだ。 Chart 28円はリスクオフ通貨である 円はリスクオフ通貨だ 円はリスクオフ通貨だ 2017年と同様に、ユーロは今年後半に米ドルに対して上昇するだろうし、多くの新興国通貨やコモディティ通貨も同様に上昇するだろう。ただし、2017年に多くの通貨がドルに対して上昇したのに日本円がその動きに参加しなかったのと同じように、円は米ドルに対してあまり勢いよく上昇するのは難しいだろう。 円は“リスクオフ”通貨であり、したがって世界のリスク資産が上昇すると円は弱まる傾向がある（Chart 28）。さらに、もし今年後半に世界の国債利回りが日本国債（JGB）利回りに対して上昇するならば、円は打撃を受けるだろう。特に、財政政策の引き締まりを受けて日銀がイールドカーブ・コントロールの運用を長引かせざるを得ない場合はその傾向が強まる。123を下回る場面ではEUR/JPYをロングするつもりだ。 一旦弱含んだ後、米ドルは来年末に再び上昇する 米国経済が2020年に供給面の制約にますます直面するにつれ、成長は鈍化し、インフレは加速するだろう。Fedはインフレの上昇以上の速さで利上げを行って応じる。結果として実質金利が上昇し、ドルに上方圧力がかかるだろう。 このスタグフレーション的な環境では、株式は急落し、クレジットスプレッドは拡大する。米国の金融環境の引き締まりは世界中に波及し、世界成長はそれがなかった場合よりも一層減速するだろう。これがさらにドルを加速させる。米ドルがピークを付けるのは、Fedが2021年末に利下げを開始した時点のみである。 コモディティ：より強気に 今年後半のドルの弱含みと、中国の回復に牽引された世界成長の強化はコモディティにとって追い風となる。BCAのコモディティ・ストラテジストは、現行水準で銅のロングを推奨する。また、原油に対する強気のバイアスも維持している。ブレントは今年平均75ドル/バレル、2020年は80ドル/バレルになると見込んでいる。米国のシェール生産の増加は、深海の輸出施設整備の遅延によって相殺され、供給は比較的タイトに保たれるだろう。 過去のレポートでは、インフレヘッジとして金を購入することの有用性を論じてきた。ただし、我々はドル強気見解のためにそれを実行に移すのを控えてきた。今やドルが今後数か月でピークを付けると見ているため、1275ドル/オンスを下回る場面があれば金を買いたい。   Peter Berezin, チーフ・グローバル・ストラテジスト グローバル・インベストメント・ストラテジー peterb@bcaresearch.com 脚注 1      Please see Global Investment Strategy Weekly Report, “グレツキーのドクトリン,” dated March 1, 2019. 2      Please see Global Investment Strategy Weekly Report, “FCIドゥーム・ループの可能性は低い,” dated January 4, 2019. 3      Please see Global Investment Strategy Weekly Report, “本当に世界には政府債務が多すぎるのか？” dated February 22, 2019. ストラテジー & マーケット動向 マクロクォント・モデルと現在の主観的スコア チャート29 タクティカル・トレード ストラテジー推奨 クローズド・トレード

Highlights Duration: None of the economic indicators that have reliably signaled peak interest rates in prior cycles are sending a signal at the moment. This leads to the inevitable conclusion that further Fed rate hikes are likely at some point before the end of the cycle. With the Fed now projecting an essentially flat path for interest rates, the next surprise from the Federal Reserve will probably be a hawkish one. Fed: The Fed is currently waging a war on two fronts. It wants to keep interest rates low enough to send inflation expectations higher, back to levels consistent with its 2% target. But it also wants to avoid excessively easy financial conditions that could threaten the sustainability of the economic recovery. We expect that easier financial conditions will cause the Fed to shift back toward a tightening bias near the end of this year. Yield Curve: Inversion of the 3-month/10-year Treasury slope is cause for concern, if it persists. But we expect it to reverse in the coming months as global growth recovers and the Fed remains accommodative. Eventually, after financial conditions have eased sufficiently, the Fed’s next move will be a hawkish surprise. Investors can profit from this move by entering positive carry yield curve trades: short the 5-year or 7-year bullet and go long a duration-matched barbell. Feature The Last Dovish Surprise Or The Beginning Of The End? Treasury yields moved sharply lower following last week’s Fed meeting, as FOMC participants made larger-than-anticipated downward revisions to their interest rate projections. As of last December, 11 out of 17 Fed members expected to lift rates at least twice in 2019. Now, 11 out of 17 expect to keep rates flat (Chart 1). Chart 1Fed Sees No Hikes This Year Judging from the bond market’s reaction, the Fed clearly managed to deliver a dovish surprise at last week’s meeting. Now, the relevant question for investors becomes whether that dovish surprise can be repeated. With the Fed signaling an essentially flat path for interest rates, a dovish surprise from these levels would involve the suggestion of rate cuts. History tells us that rate cuts are only likely to occur if the economy is headed into recession, an event that still seems relatively far off. As such, we expect that the next surprise from the Fed will be a hawkish one, and that the next large move in Treasury yields will be higher. Our conviction that the economy is not yet close to recession comes from our analysis of economic markers that have reliably signaled peak interest rates in past cycles.1 For example, one such marker is when year-over-year nominal GDP growth falls below the 10-year Treasury yield (Chart 2). At present, year-over-year nominal GDP growth is running at 5.3%. That growth rate is bound to slow during the next few quarters, but it would need to slow a lot before it falls below the current 10-year Treasury yield of 2.40%. Chart 2GDP Growth Suggests That Monetary Policy Remains Accommodative The New York Fed’s GDP Nowcast projects that real GDP growth will be 1.29% in the first quarter. Incorporating 2% inflation, that is roughly 3.3% in nominal terms. If Q1 turns out to be the trough in growth for the year, it suggests that interest rates still have considerable room to rise before the economic recovery ends. Second, we have observed that peak interest rates tend to coincide with material declines in the 12-month moving averages of single-family housing starts and new home sales. While the housing data weakened somewhat in 2018, the data have rebounded sharply since mortgage rates fell near the end of last year. Housing starts have already jumped back above their 12-month moving average, as has the weekly Mortgage Application Purchase index (Chart 3). Chart 3Housing & Employment Support Higher Rates Finally, we have noted that peak interest rates tend to coincide with an uptrend in initial jobless claims. Much like with housing, the initial claims data sent a warning near the end of last year. But that tentative increase in claims has already reversed course (Chart 3, bottom panel). None of those historically reliable indicators suggest that we have reached peak interest rates for the cycle.  We will continue to keep a close eye on nominal GDP growth, the housing data and initial jobless claims. But all in all, none of those historically reliable indicators suggest that we have reached peak interest rates for the cycle. This leads to the inevitable conclusion that further Fed rate hikes are likely at some point and that the next surprise from the Federal Reserve will probably be a hawkish one. Given this skewed risk/reward trade-off, we recommend that investors maintain below-benchmark duration in U.S. bond portfolios on the view that the next large move in Treasury yields will be higher. The difficult part is timing when that move will occur. In the remainder of this report we provide some thoughts on how to think about that timing, and also some trade ideas that should be profitable in the meantime. The New Battleground: Inflation Expectations Vs. Financial Conditions Recent remarks from Fed Chairman Jerome Powell and other FOMC participants have made it clear that an important rationale for the Fed’s pause is a desire to re-anchor inflation expectations at a level closer to the Fed’s target. For example, here is Chairman Powell from last week’s press conference: So, if inflation expectations are below two percent, they’re always going to be pulling inflation down, and we’re going to be paddling upstream and trying to, you know, keep inflation at two percent … And here is what the Chairman said about inflation expectations in his recent congressional testimony: In our thinking, inflation expectations are now the most important driver of actual inflation. With that in mind, consider that long-maturity TIPS breakeven inflation rates have been below “well anchored” levels for pretty much the entire post-crisis period, as have long-term inflation expectations from the University of Michigan Consumer survey (Chart 4). Chart 4The Fed Wants Higher Inflation Expectations The Fed has clearly made the re-anchoring of inflation expectations a priority, meaning that we should monitor TIPS breakeven inflation rates and survey measures of inflation expectations to assess when rate hikes might re-start. However, we don’t think that higher inflation expectations are absolutely necessary before the Fed resumes hiking. Consider what Fed officials were saying as recently as December: Governor Lael Brainard on December 7, 2018:2 The last several times resource utilization approached levels similar to today, signs of overheating showed up in financial-sector imbalances rather than in accelerating inflation. Chairman Powell on June 20, 2018:3 Indeed, the fact that the two most recent U.S. recessions stemmed principally from financial imbalances, not high inflation, highlights the importance of closely monitoring financial conditions.   In other words, until recently the Fed seemed more concerned with financial conditions than with inflation expectations. What changed? Quite simply, financial markets sold off and financial conditions no longer appear excessively easy (Chart 5). Chart 5The Fed Doesn’t Want An Asset Bubble The Financial Conditions component of our Fed Monitor remains “easier” than its historical average, but shows that conditions have tightened significantly since last October (Chart 5, top panel). Junk spreads have widened since last October (Chart 5, panel 2), as has the excess corporate bond risk premium after accounting for expected default risk (Chart 5, panel 3). 4 The S&P 500’s 12-month forward Price/Earnings ratio is down to 16.5, from 17 last October and a 2018 peak of 18.8 (Chart 5, bottom panel). If financial markets rally during the next few months, then it is quite possible that financial conditions will once again force the Fed’s hand. In essence, financial asset valuations appear somewhat reasonable and are not an immediate cause for concern. This means that the Fed can turn its attention toward trying to drive inflation expectations higher. However, if financial markets rally during the next few months, then it is quite possible that financial conditions will once again force the Fed’s hand. The Outlook For Financial Conditions & Global Growth The Fed’s dovish policy shift should support a rally in risk assets in the coming months, though such a rally may also require evidence of improvement in global growth. Right now that evidence is scant. March Flash PMIs for the U.S. and Eurozone both fell last week, while Japan’s stayed flat below the 50 boom/bust line. This means that the Global Manufacturing PMI’s downtrend will almost certainly continue when the final March data are released next week (Chart 6). Chart 6Global Growth Is Weak ... However, while the coincident PMI data continue to soften, we have recently noticed some green shoots in leading global growth indicators (Chart 7). Chart 7... But Leading Indicators Are Improving First, our Global Leading Economic Indicator (LEI) Diffusion Index has moved above 50%, meaning that a majority of countries are seeing improvement in their LEIs for the first time since early 2018 (Chart 7, top panel). Second, our China Investment Strategy service’s Li Keqiang Leading Indicator – a composite of six indicators of Chinese money and credit growth – has stabilized. While a 2016-style surge in credit growth is unlikely, even a stabilization in this leading indicator will help prop up global growth in 2019 (Chart 7, panel 2). We do not think that 3-month/10-year curve inversion will last very long.  Finally, the CRB Raw Industrials index has rebounded smartly during the past few weeks, and is now threatening to break above its 200-day moving average (Chart 7, bottom panel). Investment Implications The Fed is currently waging a war on two fronts. It wants to keep interest rates low enough to send inflation expectations higher, back to levels consistent with its 2% target. But it also wants to avoid excessively easy financial conditions that could threaten the sustainability of the economic recovery. Asset prices are not extended at the moment, so the Fed can maintain an accommodative policy focused on driving inflation expectations higher. However, at some point the combination of accommodative policy and improving global growth will cause the Fed’s attention to turn back toward financial conditions. That will put rate hikes back on the table and send Treasury yields higher. Timing when that shift will occur is difficult, which is why we recommend that investors enter positive carry yield curve trades to boost returns while we await a hawkish surprise from the Fed later this year (see next section). What The Yield Curve Is Telling Us The Fed’s dovish surprise sent Treasury yields lower last week and also led to significant changes in the shape of the yield curve. In particular, investors have focused on the fact that the 10-year yield is now below the 3-month T-bill rate. That focus is not surprising, given that curve inversion has been a reliable leading indicator of recession in past cycles. We use the 2-year/10-year and 3-year/10-year slopes in our research into the phases of the cycle (Chart 8), and while both of those slopes remain positive – consistent with a “Phase 2” environment – we will keep a close eye on the 3-month/10-year slope in the coming weeks.5 Historically, inversion of the different curve segments has occurred at around the same time. Chart 8Still In Phase 2 Given that the Fed has already signaled a much more dovish policy stance and that global growth is likely to improve later this year, we do not think that 3-month/10-year curve inversion will last very long. However, if we are wrong and the 2-year/10-year and 3-year/10-year slopes are eventually pulled down into negative territory, then we may have to re-visit some of our asset allocation positions. But for now, we find the 5-year and 7-year maturities to be the most interesting points on the yield curve (Chart 9). In fact, the 5-year and 7-year yields are so low that investors can earn more yield by entering duration-matched barbells consisting of the long and short ends of the curve. For example, the 5-year Treasury note offers a lower yield than a duration-matched barbell consisting of the 2-year and 10-year notes. Similarly, the 7-year note offers less yield than a duration-matched barbell consisting of the 2-year note and 30-year bond (Chart 10). Chart 10Barbells Are Positive Carry Further, we have also observed that the 5-year and 7-year yields are most sensitive to changes in 12-month rate hike expectations. Chart 11 shows that when our 12-month discounter rises, the yield curve tends to steepen out to the 7-year maturity, and flatten thereafter. This means that the 5-year and 7-year yields have the most upside when rate hikes are eventually priced back into the curve. Chart 11Yield Curve Correlations Taken together, positive carry in the barbells and the sensitivity of 5-year and 7-year yields to 12-month rate expectations mean that investors should enter short positions in the 5-year or 7-year notes today, offset by long positions in duration-matched barbells (eg. the 2/10 or 2/30). These trades will earn significant capital gains when the Fed ultimately delivers a hawkish surprise, sending the 5-year and 7-year yields higher, and will also earn positive carry in the meantime, while we wait for financial conditions to ease enough to shift the Fed’s reaction function. We have also observed that the 5-year and 7-year yields are most sensitive to changes in 12-month rate hike expectations. These long barbell / short 5-year or 7-year bullet positions will only lose money if the market prices-in further rate cuts going forward. With the market already priced for 32 bps of cuts during the next 12 months, a further decline would be consistent with economic recession. This remains the least likely scenario. Bottom Line: Inversion of the 3-month/10-year Treasury slope is cause for concern, if it persists. But we expect it to reverse in the coming months as global growth recovers and the Fed remains accommodative. Eventually, after financial conditions have eased sufficiently, the Fed’s next move will be a hawkish surprise. Investors can profit from this move by entering positive carry yield curve trades: short the 5-year or 7-year bullet and go long a duration-matched barbell.   Ryan Swift,  U.S. Bond Strategist rswift@bcaresearch.com Footnotes 1 Please see U.S. Bond Strategy Weekly Report, “Running Room,” dated January 29, 2019, available at usbs.bcaresearch.com 2 https://www.federalreserve.gov/newsevents/speech/brainard20181207a.htm 3  https://www.federalreserve.gov/newsevents/speech/powell20180620a.htm 4 The Gilchrist and Zakrajsek (GZ) Excess Bond Premium is a measure of the excess spread available in a sample of nonfinancial corporate bonds, after removing a bottom-up estimate of expected default losses for each security. Default losses are estimated based on the Merton Default model, using each firm’s market value of equity and face value of debt. https://www.federalreserve.gov/econresdata/notes/feds-notes/2016/files/… 5 Our research into the different phases of the cycle based on the slope of the yield curve can be found in U.S. Bond Strategy Special Report, “2019 Key Views: Implications For U.S. Fixed Income,” dated December 18, 2018, available at usbs.bcaresearch.com Fixed Income Sector Performance Recommended Portfolio Specification

Highlights Dovish Central Banks: Central bankers have successfully talked down bond yields, in an effort to prevent an even deeper pullback in global growth. Government bonds now look overvalued relative to likely outcomes on growth and inflation over the next year. A moderate below-benchmark medium-term duration exposure is warranted on a risk/reward basis, as the next large yield move from current levels is more likely up than down. U.S. Treasuries: The Fed is now signaling no more rate hikes for the rest of 2019, but this newly dovish language merely brings their own interest rate forecasts closer to current market pricing. Lower bond yields and easier financial conditions will help underwrite a recovery in U.S. growth, just as a stabilization of the global economy is starting to materialize. The current downturn in Treasury yields, which is looking technically stretched, should soon begin to bottom out. Feature Another Panic Hits Global Bond Markets The message from central banks to the financial markets is now very loud and clear – global monetary policy is firmly on hold for at least the rest of 2019. Fears over slowing global growth, persistent geopolitical uncertainty and underwhelming inflation have put policymakers on a more cautious footing. The messaging from central banks has become highly synchronized, with even the same buzz words (“patience”, “uncertainty”, “data dependent”) being bandied about in speeches and policy statements. Bond yields have responded to the dovish forward guidance in recent weeks from the Fed, the European Central Bank, the Bank of England, the Bank of Japan and others. Our “Major Countries” measure of 10-year government bond yields in the largest developed economies has fallen to 1.3%, the lowest level since May 2017. The 10-year U.S. Treasury yield now sits at 2.40%, below the fed funds rate and triggering investor angst over the traditionally negative economic message of an inverted yield curve. Global equity markets, however, seem less concerned. The MSCI World Equity Index is only 5% from the 2018 highs after rallying 16% so far from the late 2018 low. This gap between robust equity prices and depressed bond yields is unusual, but not unprecedented. Similar divergences have occurred as recently as 2016 and 2017 (Chart of the Week). During those episodes, central banks responded to uncertainty (the July 2016 Brexit vote followed by currency volatility in China) or sluggish inflation readings (the unexpected 2017 dip in U.S. core inflation) by shifting to an easier monetary stance. This was largely done through delayed interest rate hikes or more dovish forward guidance, with the result being lower bond yields, diminished market volatility and easier financial conditions. Better global growth and more stable inflation expectations soon followed. Chart of the WeekWill Bonds Lose This Battle Once Again? With tentative signs emerging that global growth momentum is bottoming out, the next major move in global bond yields is likely up. Those prior gaps between low bond yields and high stock prices were eventually resolved through higher yields – an outcome that we think will be repeated in the current episode. Already, bond markets have aggressively repriced expectations of future monetary policy with even some rate cuts now discounted in the U.S., Canada and Australia. With tentative signs emerging that global growth momentum will soon bottom out and recover in the latter half of 2019 (Chart 2), the next major move in global bond yields is likely up, not down. Chart 2Global Bond Yields Are Too Pessimistically Priced The decline in yields over the past few months has obviously challenged our recommended strategic below-benchmark global duration stance. The two primary factors that drive our medium-term duration calls on any country can be summed up by the following questions: Do we expect greater or fewer rate hikes than are discounted in money market curves? Do we expect bond yields to rise above or below the current pricing in forward yield curves? In aggregate, we do not expect the major central banks to deliver more monetary easing than is currently priced according to our 12-month discounters, although we think that is most likely in the U.S. where the market is pricing in -21bps of cuts over the next year. Also, the 12-month-ahead forwards for 10-year bond yields in the U.S. (2.51%), Canada (1.69%), Germany (0.13%), Japan (0.02%), U.K. (1.16%) and Australia (1.82%) are not particularly high. Although, once again, we have the greatest confidence that those yield levels will be surpassed in the U.S. The timetable to generate a positive payoff by positioning for higher yields has been stretched out by the renewed dovishness of central banks. By switching their focus from tight labor markets and accelerating wage growth to slowing economies and softening inflation expectations, policymakers are creating a backdrop of lower volatility and more market-friendly stock/bond correlations (Chart 3). Chart 3Stock/Bond Yield Correlation Negative Once Again The goal is to underwrite additional rallies in risk assets to ease financial conditions and stimulate economic activity. This will eventually sow the seeds for a return to a more hawkish bias, but the timing of that switch is uncertain and will most likely coincide with some evidence of faster Chinese economic growth and an end to the downturn in global trade activity – an outcome that is unlikely to occur until the latter half of 2019. Bottom Line: Central bankers have successfully talked down bond yields, in an effort to prevent an even deeper pullback in global growth. Government bonds now look overvalued relative to likely outcomes on growth and inflation over the next year. A moderate below-benchmark medium-term duration exposure is warranted on a risk/reward basis, as the next large yield move from current levels is more likely up than down. The Fed’s more dovish forward guidance only brought the Fed’s rate forecasts down closer to current market pricing. U.S. Treasury Yields Should Soon Bottom Out U.S. Treasury yields moved sharply lower following last week’s Fed meeting, as the FOMC delivered a dovish surprise with its new set of interest rate projections. As of last December, 11 out of 17 Fed members expected to lift rates at least twice in 2019. Now, 11 out of 17 expect to keep rates flat. This was enough to lower the median “dot” by 50bps for 2019, essentially forecasting an unchanged funds rate this year with only one hike expected in 2020. While these are significant dovish changes to the Fed’s forward guidance, it only brought the Fed’s forecasts down to current market pricing on interest rate expectations (Chart 4). Yet bond yields fell sharply in response, tipping the Treasury curve into inversion. The cautious language from Fed Chairman Powell in the post-meeting press conference, which included a reference to Japan-style deflation risks as a threat if the Fed ignored the message from below-target U.S. inflation expectations, likely helped fuel the bullishness of Treasury market participants. Chart 4Fed Is Just Catching Up To Market Pricing It seems clear that the arguments of the more dovish members of the FOMC (John Williams, Richard Clarida, James Bullard, Neil Kashkari) have won over the more pragmatic members of the committee, including Jay Powell. Yet our own Fed Monitor is still not suggesting that rate cuts are necessary (Chart 5), although the growth component of the Monitor is tracking the last downturn seen in 2014/15. More importantly, the inflation elements of the Monitor are not pointing to a need for easier policy, while financial conditions are still in the “tighter money required” zone. Chart 5Markets Pricing In Fed Easing That Is Not Required The Fed is likely to ignore the risks to financial stability stemming from the new dovish slant to its monetary policy, as financial conditions have not yet fully unwound the tightening seen in the risk asset selloff in late 2018. Does that mean that the Fed wants to see U.S. equities hit new highs and U.S. corporate credit spreads return to previous lows? If that means a deeper U.S. economic slowdown can be avoided, the answer is most likely “yes”. They can always return to targeting overvalued asset markets if and when the U.S. and global economy is on more stable footing. In terms of the U.S. economic outlook, we think the current concerns over the recession risks stemming from an inverted Treasury curve are overstated. In a Special Report we published last July, we looked at the relationship between monetary policy, yield curves and economic growth and came to the following conclusions:1 Curve inversion, on a sustained basis, occurs when the Fed lifts the real (inflation-adjusted) funds rate above the neutral rate of interest, “r-star” (Chart 6); Chart 6Too Soon For Sustained U.S. Treasury Curve Inversion Once the Treasury yield curve does invert on a sustained basis, a recession starts seventeen months later, on average; Curve inversion, on a sustained basis, occurs when the Fed lifts the real funds rate above the neutral rate of interest, “r-star” At the moment, the Fed has paused its rate hiking cycle with a real funds rate that is just shy of the Williams-Laubach estimate of r-star, which is 0.5%. Considering that the “Williams” in “Williams-Laubach” is the current president of the New York Fed and Number Two on the FOMC, we should not be surprised that the Fed chose to pause now! The more important point is that it seems too early to look for a classic late-cycle Treasury curve inversion with the Fed on hold – unless, of course, U.S. inflation falls and pushes the real fed funds rate above r-star. That would require a much sharper slowing of U.S. growth to a below-potential pace that is not indicated by current data. Reliable cyclical indicators like the ISM Manufacturing index have fallen from the heady 2018 peaks, but remain at levels consistent at least trend U.S. economic growth (Chart 7). Additionally, the Conference Board’s leading economic indicator, as well as our own models for U.S. employment and capital spending growth, are suggesting that only some cooling of U.S. growth should be expected in the next few quarters (Chart 8), but not to a below-potential pace (i.e. significantly less than 2%). Chart 7UST Yields Should Soon Stabilize Chart 8A Big U.S. Slowdown In 2019 Is Unlikely So how much lower can Treasury yields go in this current rally? Looking at the individual valuation components of yields, the answer is “not much”. The real component of Treasury yields has already fallen sharply since the 2018 peak, and is now approaching 2017 resistance levels. At the same time, 10-year inflation expectations are drifting higher and are now around 25bps below the highs seen in 2018 (Chart 9). At best, we can see real yields and inflation expectations fully offsetting each other and keeping yields unchanged. The more likely outcome, however, is that inflation expectations continue to move higher while real yields stabilize as the U.S. economy moves away from the Q1 growth slowdown, meaning that we are close to the floor in yields now. Chart 9Inflation Expectations Will Lead UST Yields Higher How much lower can Treasury yields go in this current rally? Looking at the individual valuation components of yields, the answer is “not much”. The current downturn in Treasury yields is already looking stretched from a technical perspective (Chart 10). The 26-week total return of the Bloomberg Barclays U.S. Treasury index is now approaching the highs seen during all previous Treasury rallies since the Fed ended its QE program in 2014. The same signal comes from the size of the deviation of the 10-year Treasury yield below its 200-day moving average. Duration positioning is quite long, as well, according to the J.P. Morgan client survey. Chart 10UST Rally Looking Stretched In The Near-Term Not all the technical indicators are as stretched, as the Market Vane Treasury sentiment survey remains depressed and net speculative positioning on 10-year Treasury futures is only neutral (after a very large short position was covered). On balance, however, the indicators suggest that the current Treasury rally is looking over-extended. One other factor to consider is global growth. Much of the current decline in Treasury yields is a result of the prolonged weakness in non-U.S. growth that has pulled down all global bond yields. Yet according to the latest readings from cyclical indicators like the ZEW survey, expectations of future economic growth are now bottoming out, even as current growth continues to slow (Chart 11). This bodes well for a potential bottoming of global growth momentum that could put a floor underneath bond yields. Chart 11Early Signs Of Growth Stabilization? One final note – any signs of stabilization of European growth could also help global bond yields find a floor. Not only are the ZEW surveys in Europe starting to bottom out, the widely-followed German IFO survey is also starting to show modest improvement. If these trends continue, that would help end the drag on global yields from weakening European growth which has pulled German Bunds back to the 0% level (Chart 12). Chart 12Bunds & JGBs Have Been A Drag On Global Yields Any signs of stabilization in European growth could also help global bond yields find a floor. Bottom Line: The Fed is now signaling no more rate hikes for the rest of 2019, but this newly dovish language merely brings their own interest rate forecasts closer to current market pricing. Lower bond yields and easier financial conditions will help underwrite a recovery in U.S. growth, just as a stabilization of the global economy is starting to materialize. The current downturn in Treasury yields, which is looking technically stretched, should soon begin to bottom out. Robert Robis, CFA, Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1 Please see BCA Global Fixed Income Strategy/U.S. Bond Strategy Special Report, “Three Frequently Asked Questions About Global Yield Curves”, dated July 31st, 2018, available at gfis.bcaresearch.com and usbs.bcaresearch.com. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Highlights Portfolio Strategy Corporate sector selling price inflation is nil while leading wage inflation indicators signal additional labor cost increases in the coming months. The risk is that profit margins have already peaked for the cycle. We reiterate our tactically cautious overall equity market view. Galloping higher private and public sector software outlays, a structurally enticing software demand backdrop and ongoing industry M&A all signal that it still pays to be bullish software stocks Recent Changes Last Thursday we downgraded the S&P railroads index to underweight. Also last Thursday we trimmed the S&P air freight & logistics index to neutral. Table 1 Feature The SPX stalled last week, digesting the now-complete Fed pivot. Our sense is that the Fed’s dovish turn is now fully reflected in equities. Importantly, the longer and wider the dichotomy between stocks and bonds gets, the more painful the ramifications from the eventual snap will be, likely with equities yielding to the bond market (Chart 1). As we first posited on March 4, short-term equity market caution is still warranted.1 Chart 1Time To Get Back Together While the Fed meeting and sharp decline in Treasury yields dominated headlines last week, it was the NFIB’s latest release that really caught our attention. Importantly, it revealed that taxes and big government are no longer the biggest problems facing small and medium business owners, but labor is: “Twenty-two percent of owners cited the difficulty of finding qualified workers as their Single Most Important Business Problem, only 3 points below the record high. Ten percent of owners find labor costs as their biggest problem, a record high for the 45-year survey.”2 Historically, such extreme tightness in the SME labor market is a precursor of a yield curve inversion (NFIB cost of labor shown inverted, Chart 2). The link is clearer if we show this same NFIB series with the Labor Department’s average hourly earnings monthly release that is currently running at a 3.4%/annum clip (Chart 3). In other words, a tight labor market is conducive to corporations bidding up the price of labor which in turn causes the Fed to raise interest rates, eventually inverting the yield curve. Chart 2Cycle Is Long In The Tooth Chart 3Wage Growth... This macro backdrop is slightly unnerving and our biggest concern is the S&P 500’s profit margins (Chart 4). Q3/2018 marked the all-time peak in SPX quarterly margins according to Standard & Poor’s,3 and in Q4/2018 margins have deflated from a high mark of 12.13% to 10.11%, or a 16.7% q/q drop. Chart 4...Denting Margins Undoubtedly, last year’s fiscal easing-induced all-time highs in SPX margins is unsustainable, and a tight labor market is a warning shot. Using the same NFIB series on cost of labor being the most important problem SMEs face and subtracting it from our corporate pricing power proxy, we constructed an equity market margin proxy, shown as a Z-score in Chart 5. Historically, the y/y change in SPX profit margins move in lockstep with our margin proxy and the current message is grim (Chart 5). Chart 5Margin Trouble Ahead Before getting too bearish though, we want to make three salient points: First, while the NFIB survey’s labor related indicators are disconcerting, unit labor costs – the best measure of wage growth – remain muted as productivity growth has ramped up recently. Second, using empirical evidence dating back to the 1960s, the ultimate SPX profit margin mean reversion occurs during recessions, when EPS suffer a major setback. The implication is that margins can move sideways or grind lower in the coming year. As a reminder, BCA’s review remains that the U.S. will avoid recession in the next 12 months. Third, the most important yield curve slope, the 10/2, has not yet inverted, and even when it does invert, investors will have time to start positioning defensively; we have shown in recent research that the S&P peaks after the yield curve inverts.4 On a related note, we use this opportunity to update our corporate pricing power proxy, and Table 2 summarizes the sectorial results. Table 2Industry Group Pricing Power Corporate sector selling price inflation has ground to a halt at a time when wage inflation is rearing its ugly head. Worrisomely, our pricing power diffusion index’s breadth sunk below the 50% line, whereas our wage growth diffusion index spiked higher; 70% of the 44 industries we track are struggling with rising wages (second & third panels, Chart 6). Taken together, there is evidence that broad-based profit margin pressures are escalating, the mirror image of what our gauges were signaling in our last update late-last year.5 Chart 6Margins Have Likely Peaked Digging beneath the surface of our corporate pricing power proxy is revealing. As a reminder, we calculate industry group pricing power from the relevant CPI, PPI, PCE and commodity growth rates for each of the 60 industry groups we track. Table 2 also highlights shorter term pricing power trends and each industry's spread to overall inflation. 57% of the industries we cover are lifting selling prices, but only 27% are raising prices at a faster clip than overall inflation. Both figures are lower than our early-November report. Outright deflating sectors increased by eight to twenty four since our last update, fifteen of which are deflating at 1%/annum pace or lower. One third of the industries we cover are experiencing a downtrend in selling price inflation, representing a 43% increase since our most recent report (Table 2). Deep cyclicals/commodity-related industries (ex-oil) continue to dominate the top ranks, occupying the top six slots (Table 2). Despite the ongoing global manufacturing deceleration and still unresolved U.S./China trade tussle, the commodity complex's ability to increase prices remains resilient. On the flip side, energy-related industries occupy the bottom of the ranks as WTI crude oil is still 22% lower than the most recent peak in October 2018. In sum, business sector selling price inflation is nil while leading wage inflation indicators signal additional labor cost increases in the coming months. The risk is that profit margins have already peaked for the cycle. We reiterate our tactically cautious overall equity market view. This week we update a high-conviction overweight tech subgroup and recap our transportation subsurface moves from last Thursday. Buy The Software Breakout Software stocks are on fire and leading profit indicators suggest that more gains are in store in the coming months. Last week, we published a table ranking all the sectors and subsectors by 12-month forward profit growth estimates (please refer to Table 2 from the March 18 Weekly Report). While the broad tech sector is on an even keel with the SPX, software EPS are racing at twice the speed of the broad market, roughly 14%. Keep in mind, when growth gets scarce, investors flock to industries with accelerating profit prospects. The software profit juggernaut is intact and we reiterate our high-conviction overweight recommendation. Sustained capital outlays on software are a key driver of industry profits (bottom panel, Chart 7). In an otherwise muted Q4 GDP release, rising non-residential fixed investment in general and surging investment in software in particular suggest that our bullish software capex thesis is alive and kicking (middle panel, Chart 7). Chart 7Software On A Tear The move to cloud computing and SaaS, the proliferation of AI, machine learning and augmented reality are not fads but enjoy a secular growth profile, and signal that capital outlays on software are also in a structural uptrend. Not only private sector software capex is near all-time highs as a share of total outlays, but also government investment in software is reaccelerating at the fastest pace since the tech bubble. When productivity gains are anemic, both the business and government sectors resort to software upgrades in order to boost productivity. Cyber security is another more recent source of software related demand as governments are taking such risks extremely seriously the world over (second panel, Chart 8). Chart 8Earnings Led Advance Meanwhile, fear of missing out has rekindled industry M&A and both the dollar amount and number of deals are sky high, with acquirers bidding up premia to the stratosphere (Chart 9). This supply reduction is bullish for industry pricing power. Chart 9M&A Frenzy Granted the M&A frenzy has pushed relative valuations on the expensive side especially on a forward P/E basis, but on EV/EBITDA software stocks are trading below the historical mean and still significantly lower than the late-1990s peak valuation (bottom panel, Chart 8). If our bullish software profit thesis continues to pan out, then software stocks will grow into their pricey valuations. Finally, shareholder friendly activities are ongoing in this key tech subsector and buybacks in particular provide an added layer of artificial EPS growth (bottom panel, Chart 9). Adding it up, galloping higher private and public sector software outlays, a structurally enticing software demand backdrop and ongoing industry M&A, all signal that it still pays to be bullish software stocks. Bottom Line: Buy the software breakout. The S&P software index remains a high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5SOFT – MSFT, ORCL, ADBE, CRM, INTU, ADSK, RHT, CDNS, SNPS, ANSS, SYMC, CTXS, FTNT. Tweaking Transport Subgroup Positioning The S&P transports index’s recovery rally has stalled recently and is a cause for concern for the overall market. In more detail, the recent gulf between relative share prices and the SPX has widened and warns that the overall market is at a risk of suffering a pullback (Chart 10). Chart 10Engine Trouble Thus on Thursday last week, we made two subsurface transport changes, downgrading a subgroup to underweight that commands lofty valuations at a time when leading profit indicators are flashing red, and also downgrading to neutral a globally exposed transport sub-index. Get Off The Rails In our downgrade of the S&P railroads index late last year to a benchmark allocation, we highlighted that two of our key industry Indicators, the Railroad Indicator and our Rail Shipment Diffusion Indicator, had turned negative.6 These indicators have continued to deteriorate, including total rail shipments which have now started to contract for the first time since the 2015-16 manufacturing recession (third panel, Chart 11). Intermodal shipments in particular have nosedived, likely a result of weak retail sales, as we highlighted earlier this month.7 Chart 11Downgrade Rails To... This contraction would be far less concerning were it not for the rapid degradation of industry balance sheets as firms have sought to increase relatively cheap leverage in order to retire equity. Railroads are now significantly more indebted than the broad market which itself has not shown an aversion to adding leverage (bottom panel, Chart 11). Such a change in railroad capital structure has kept EPS growth rates artificially high while simultaneously adding an extra measure of equity risk premium that does not yet appear fully reflected in relative share prices. Moreover, when we downgraded the S&P railroads index to neutral last year, deteriorating Indicators were offset by exceptionally healthy pricing power.8 After a multi-year expansion, selling price inflation has now rolled over (second panel, Chart 12), taking away the remaining pillar supporting a neutral view which compelled us to move to an underweight allocation last week. Chart 12...Underweight Pricing power is one of the key determinants in our earnings model that, when combined with the previously noted contracting volumes, is indicating the end to the industry’s above-trend earnings growth is nigh (third panel, Chart 12). With relative earnings growth slowing and rising leverage adding incremental risk, the S&P railroads index’s premium valuation multiple looks increasingly dicey (bottom panel, Chart 12). Bottom Line: Broad based declines in traffic volumes, falling pricing power and high leverage suggest that earnings will underwhelm. Accordingly, last Thursday we moved to an underweight recommendation on the S&P railroads index as we expect a de-rating phase to materialize. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, CSX, NSC, KSU. Air Freight Had Its Wings Clipped We have been offside on the high-conviction overweight call on the S&P air freight & logistics index and the recent FedEx warning suggests that profits will come under pressure for this index for the rest of the year and will trail the SPX. As such, we trimmed exposure to neutral late-last week and removed it from the high-conviction overweight list for a loss of 14%. Chart 13 shows that all the profit drivers we had identified in early December last year have taken a sharp turn for the worse. Energy costs are no longer in deflation as oil prices have jumped from $42/bbl to near $60/bbl. Not only is global growth still decelerating, but also U.S. growth is in a softpatch: the manufacturing shipments-to-inventory ratio is on the verge of contraction, warning that delivery services’ selling prices are in for a turbulent ride (second panel, Chart 13). In addition, definitive news of Amazon becoming a formidable competitor in courier delivery services is structurally negative for the industry. Chart 13Air Freight: Move To The Sidelines Nevertheless, we refrain from turning outright bearish as air freight stocks are technically oversold and valuations are trading at the steepest discount to the broad market since mid-2002. Bottom Line: Last Thursday we downgraded the S&P air freight & logistics index to neutral and also removed it from the high-conviction overweight list. The ticker symbols for the stocks in this index are: BLBG: S5AIRF - UPS, FDX, CHRW, EXPD.   Anastasios Avgeriou, U.S. Equity Strategist anastasios@bcaresearch.com     Footnotes 1 Please see BCA U.S. Equity Strategy Weekly Report, “The Good, The Bad And The Ugly” dated March 4, 2019, available at uses.bcaresearch.com. 2https://www.nfib.com/assets/jobs0219hwwd.pdf 3https://ca.spindices.com/documents/additional-material/sp-500-eps-est.xlsx?force_download=true 4 Please see BCA U.S. Equity Strategy Weekly Report, “Signal Vs. Noise” dated December 17, 2018, available at uses.bcaresearch.com. 5 Please see BCA U.S. Equity Strategy Weekly Report, “Recuperating” dated November 5, 2018, available at uses.bcaresearch.com. 6 Please see BCA U.S. Equity Strategy Weekly Report, “Critical Reset“, dated October 29, 2018, available at uses.bcaresearch.com. 7 Please see BCA U.S. Equity Strategy Weekly Report, “The Good, The Bad And The Ugly“, dated March 4, 2019, available at uses.bcaresearch.com. 8 Please see BCA U.S. Equity Strategy Weekly Report, “Critical Reset“, dated October 29, 2018, available at uses.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor value over growth Favor large over small caps

Highlights The FOMC managed to surprise investors at its March meeting after all, … : Everyone knew the Fed wasn’t going to hike rates last Wednesday, but the scope of the downward revision in the median dots was unexpected. … as it turns out that the median FOMC participant sees the pause as a lengthy hiatus: Not only does the median voter expect no rate hikes this year, s/he only expects one more in the entire tightening cycle. Rate-hike expectations have dwindled from three to a lonely one. The motivation for the Fed’s pivot is hardly crystal clear, … : The Fed may have turned more dovish because it fears the U.S. is losing momentum or that key major economies may be on the verge of a recession, it succumbed to pressure from the White House or financial markets, and/or it fears being unable to counter the next downturn. … but it looks to us like it has simply decided it can no longer stomach too-low inflation expectations: The zero lower bound will likely come into play when the next recession arrives, and higher inflation expectations will increase the Fed’s maneuverability by giving it the scope to reduce real rates more easily. Feature Wednesday’s FOMC meeting formalized the Fed’s turn to “patient” monetary policy. The dots revealed that the median FOMC participant’s estimates of the appropriate fed funds rate at year-end 2019 and 2020 are now 50 basis points lower than they were at the December meeting. At that meeting, the median participant expected the fed funds rate would be 2⅞% at the end of 2019, and 3⅛% at the end of 2020; the median participant now sees 2⅜% at the end of this year, the midpoint of the current 2.25 – 2.5% range, with a final hike to 2⅝% sometime in 2020. Uber-dovish St. Louis Fed President Bullard crowed in early January that the committee was starting to see things his way, and it seems that he was right. While presumably only Minneapolis President Kashkari voted with Bullard for no 2019 hikes in December, nine more participants came over to his side in the ensuing three months. The shift on the FOMC can be boiled down as follows: in December, two voters called for no hikes in 2019, and eleven called for a minimum of two hikes; in March, eleven voters called for no hikes, and two called for just two (Chart 1). The migration of nine out of seventeen voters from two or three hikes to zero hikes lopped 50 basis points off the FOMC’s median year-end projections through 2021, and has pushed our equilibrium fed funds rate model even further away from the consensus. What happened, and what does it mean for our S&P 500, Treasury and spread-product views? What Made The Fed More Patient? Our real-time view of the Fed’s turn to patience in early January was that it was a logical response to the sharp, sudden tightening of financial conditions imposed by the fourth-quarter sell-off in stocks and corporate bonds (Chart 2). We didn’t create a regression model to try to put a precise number on what the tightening in financial conditions meant, but it seemed fair to assume that it equated to at least one 25-basis-point hike in the fed funds rate. If that was as conservative an estimate as we thought, the Fed’s only rational course was to step aside, given that the financial markets had already done a quarter or two of its work for it. Chart 2Markets Tightened For The Fed In 4Q Slowing momentum in the rest of the world offered another reason for backing off. Chinese deceleration that began with domestic policymakers’ deleveraging drive has been exacerbated by the ongoing trade spat with the U.S. (Chart 3). Chinese imports are the most direct channel by which China impacts the rest of the world, and global trade has slid as China has decelerated (Chart 4). The first contraction in global export volumes since the global manufacturing slump in early 2016 has dragged on Europe, which took its 2018 cue from a soft China, rather than a robust U.S. Chart 3Deleveraging Started China's Slump ... Chart 4... Which Was Felt Around The World Within the U.S., ongoing data releases have fostered the notion that the Fed can well afford to be patient. Despite booming payroll expansion in December and January, which created 538,000 net new jobs, the unemployment rate ticked up to 4% from 3.7%.1 The data raised the possibility that there may be more labor market slack than previously estimated. Headline inflation is hardly alarming, though core measures that back out oil’s drag are hanging around the Fed’s 2% target (Chart 5). Chart 5Core Inflation Is Near Target, But Oil Has Weighed On Headline Inflation Is The Phillips Curve Dead? Is it possible that the Fed could turn away from rate hikes when the unemployment rate is a tenth of a point above its lowest level since 1969? Does the Fed really think the Phillips Curve is so flat that even 50-year lows in unemployment aren’t going to boost wages? Has it abandoned the idea that inflation and the unemployment rate are inversely related once the economy reaches full employment? We don’t think so; as we argued in our recent Special Report on the Phillips Curve,2 we are convinced that the Fed’s belief in the relationship between unemployment and inflation remains intact. Every mainstream macroeconomic inflation model incorporates an inverse relationship with the unemployment rate. We fully accept that the Phillips Curve is kinked, and that the point where it inflects is dependent on estimates of the unobservable natural rate of unemployment (NAIRU), but the economics profession has no widely accepted model that does not take as given the notion that sub-NAIRU unemployment is inflationary. Until the profession develops an alternative framework that achieves wide acceptance, the Phillips Curve will continue to be a keystone element of central bank policy. The path from higher wages to higher consumer prices may be indirect and uncertain, but the link between the unemployment gap and annual wage gains is alive and well, even in the post-Volcker, low-inflation era (Chart 6). Chart 6Wages Rise When Workers Are Hard To Find What Might The Fed See That We Don’t? We have been, and remain, constructive on the U.S. economy. The delayed December retail sales release was lousy, and the uninspiring advance January figure led the Atlanta Fed to knock nearly 40 basis points off of its estimate of consumption’s contribution to first-quarter GDP, but it seems incompatible with a roaring job market, rising wages, and an elevated household savings rate. First-quarter growth projects to be sickly, but it has been for the last few years, and the Atlanta Fed’s GDP Now model projects that real final domestic demand grew by 1.3%, in spite of the government shutdown. The FOMC seemed to err on the side of caution in trimming its growth estimates by 20 and 10 basis points (“bps”) for 2019 and 2020, respectively, and revising its unemployment rate projections 20 bps higher for both years. The global economy has surely slowed; ex-the U.S., its biggest constituents decelerated for nearly all of 2018, as Chair Powell noted. He also noted, however, that Chinese policy makers have taken several steps to support activity. That will help the rest of the world, including Europe, as an accelerating fiscal and credit impulse boosts Chinese imports (Chart 7). Brexit remains a risk the Fed would be irresponsible not to plan for, but given that a do-over referendum would probably lead to the U.K. remaining in the E.U. (Chart 8), it is a risk that may well not come to pass. Chart 7Chinese Policymakers Want To Boost Growth Chart 8Let's Call The Whole Thing Off We do not think that the Fed changed course based on White House pressure. As we have noted before, White House-Fed conflict is nothing new, and while the Arthur Burns-led Fed knuckled under during Nixon’s re-election campaign, pressure from the Johnson, Reagan and G.H.W. Bush Administrations all came to naught. We also do not think that the Fed took its cue from investors, even if its 2019 policy rate outlook now closely resembles the money market’s (Chart 9). If it is wary of inverting the yield curve, however, it may want to see long yields rise before it hikes again.3 Chart 9Seeing It The Markets' Way (At Least For 2019) Don’t Fence Me In Q: [B]elow-target inflation is a … phenomenon … across advanced economies, and I’d … like to … hear your thoughts about what kind of challenges that poses to policy makers like yourself and the global economy in general. Chair Powell: It’s a major challenge. It’s one of the major challenges of our time, really, to have … downward pressure on inflation[.] It gives central banks less room … to respond to downturns[.] [I]f inflation expectations are below two percent, they’re always going to be pulling inflation down, and we’re going to be paddling upstream and trying to … keep inflation at two percent, which gives us some room to cut, … when it’s time to cut rates when the economy weakens. … It’s … one of the things we’re looking into as part of our strategic monetary policy review this year. The proximity to the zero lower bound calls for more creative thinking about ways we can … uphold the credibility of our inflation target, and … we’re open-minded about ways we can do that. Our best guess is that the Fed has become frustrated by moribund inflation expectations ten years into a recovery. Now that it sees the potential for a recession in the not-so-distant future, it would prefer not to have to confront it with the zero lower interest-rate bound tying one hand behind its back. It would be reasonable if it would also prefer not to have to rely too heavily on asset purchases, given all the headaches that even a modest shrinking of the balance sheet has occasioned. The Fed’s ongoing monetary policy review may therefore turn out to be more than an academic exercise. It might be awfully nice to have strategies aiming to reverse past misses of the inflation objective in place before the next recession arrives. Those strategies would provide the Fed with more flexibility to reduce real interest rates via moves in the fed funds rate. Powell discussed the potential appeal of these sorts of strategies at Stanford University just a week and a half before the FOMC meeting,4 and despite all the times they’ve been bandied about, they just might come to something this time around. Investment Implications The Fed has made a significant pivot since October’s “long way from neutral,” and December’s post-FOMC press conference, when the chair seemed to be disconnected from the markets’ agita. We don’t think a 2019 rate hike is completely out of the question, but there is no doubt that the Fed’s reaction function has changed. We don’t yet see a reason to revise our terminal rate estimate down from 3.25%-3.5%, even if it’s evident that it will take a good bit longer for the Fed to get there than we initially expected. It seems to be more willing to let inflation get ahead of it – it may end up actively encouraging inflation to do so – before it completes its meandering journey to the terminal rate. Allowing the economy to run a little hotter should be equity-friendly. It’s hard to get earnings contraction without a recession, and recessions don’t occur when monetary policy is accommodative. If the Fed requires more evidence of improvement before it resumes hiking rates, the economy and corporate earnings should be able to build up more momentum than they otherwise would. The Fed’s newfound patience should also be spread-product-friendly, as borrowers become better credits as an expansion rolls along. The Treasury outlook is more nuanced. Yields fell as the Fed committed to remaining on hold for longer, but the Fed now seems to have exhausted its capacity for dovish surprises. Short of a recession or near-recession, it’s hard to see how yields can go much lower. Given markets’ seeming conviction that inflation is as dead as a doornail, however, Treasury bond yields may do no more than drift higher at the margin until the Fed’s efforts to put a floor underneath inflation expectations begin to bear some fruit. We still think risk-friendly positioning makes sense, and we reiterate our equity and spread-product overweights, our Treasuries underweight, and our below-benchmark-duration recommendation. Doug Peta, CFA Chief U.S. Investment Strategist dougp@bcaresearch.com   Footnotes 1 At the other end of the spectrum, the unemployment rate fell two ticks in February, to 3.8%, despite a meager net increase of 20,000 jobs. Short-term disconnects can be explained by the fact that the unemployment rate (household) and net payrolls additions (business establishments) are calculated from separate surveys, but no one knows exactly how many people who aren’t working are available to work when they decide the time is ripe. 2 Please see the February 26, 2019 U.S. Investment Strategy Special Report, “The Phillips Curve: Science Or Superstition?” Available at usis.bcaresearch.com. 3 The Fed may not care a whit about the yield curve, but may simply want to hold its fire until it is convinced that the economy requires less accommodation so as not to overheat, which would get it to the same place: not hiking until long yields begin to price in the potential for overheating. 4 Please see the March 18, 2019 U.S. Investment Strategy Weekly Report, “Kinder, Gentler Central Banking.” Available at usis.bcaresearch.com.

特別レポート

Highlights Many on the left have embraced Modern Monetary Theory because it seemingly provides a politically expedient way to increase social welfare spending without raising taxes. Money-financed budget deficits can be justified when an economy is stuck in a liquidity trap, but can be extremely inflationary once full employment is reached. Investors should regard MMT as simply an extreme example of the increasingly permissive attitude that policymakers are adopting towards inflation and larger budget deficits. The path to high rates is lined with low rates, meaning that an extended period of accommodative monetary policy is usually necessary to stoke inflation. Investors should maintain a bullish bias towards global equities for now, but be prepared to turn bearish late next year as inflation begins to accelerate in the United States. An earlier turn to a more defensive posture on stocks may be necessary if Bernie Sanders, or some other far-left candidate, emerges as the likely victor in the next presidential election. Feature Print Some Money And Feel The Bern You know that an economic theory has reached the big leagues of policy debate when the Fed Chair is asked about it during his congressional testimony. This is exactly what happened on February 26, 2019, when Senator David Perdue questioned Jay Powell about his views on Modern Monetary Theory, or simply MMT as it is often called. Rather ironically given its name, MMT plays down the influence of monetary policy over the economy. Its adherents argue that Congress, and not the Fed, should be responsible for maintaining full employment. MMT proponents abhor the idea of a “balanced budget.” They contend that worries about sovereign debt levels are overblown. The U.S. government can always print money to finance itself. Fiscal deficits matter, but only to the extent that excessive deficits can cause inflation. The theory’s backers are a bit cagey about exactly how much inflation they are willing to tolerate or what they would do if, as in the 1970s, inflation and unemployment both rose together. Whether one thinks MMT is crackpot economics is not the point. What matters is that its supporters are growing in number. They include Stephanie Kelton, Bernie Sanders’ former economic advisor, and one of the speakers at BCA’s forthcoming annual New York Investment Conference. In my personal opinion, Sanders stands a very good chance of winning the 2020 presidential election. This makes MMT about as market-relevant as anything out there. In the following Q&A, we discuss the details of MMT and what it means for investors: Q: How does Modern Monetary Theory differ from standard Keynesian economics? A: MMT is almost indistinguishable from Keynesian economics when an economy is stuck in a liquidity trap, an environment where even interest rates of zero are not enough to revive demand. What really separates the two schools of thought is that MMT proponents tend to see liquidity trap conditions as the normal state of affairs, whereas most Keynesians see them as the exception to the rule. Q: Who’s right? The Keynesians or the MMTers? A: That remains to be seen. Near-zero rates have been the norm for most of the last decade, and much longer in Japan. This is a key reason why MMT has grown in popularity. The future may be different, however. Output gaps are shrinking and some of the structural forces which have held down rates over the last decade may fade. For example, the ratio of workers-to-consumers has peaked around the world, which may result in a decline in global savings (Chart 1). This could push up interest rates. Chart 1The Worker-To-Consumer Ratio Has Peaked Globally Q: Does the tendency of MMT backers to see the world as chronically ensnarled in a liquidity trap explain why they seem to consistently argue for bigger budget deficits? A: It does. If an economy needs negative interest rates to reach full employment, but actual rates are constrained by the zero-lower bound, anything which incrementally adds to aggregate demand will not result in higher rates. This means that increased government spending will not crowd out private investment – indeed, quite to the contrary, bigger budget deficits will “crowd in” private spending by boosting employment. The standard MMT prescription is to run a budget deficit that is large enough, but no larger, to maintain full employment. In effect, this means taking any excess private-sector savings – that is, savings which cannot be transformed into private investment or exported abroad via a current account surplus – and having the government absorb them with its own dissavings. Q: So MMT supporters are assuming that the government is competent and agile enough to tighten and loosen fiscal policy at exactly the right time? Good luck with that. A: Yes, that is a common problem with most left-wing theories: They assume that the government should not be trusted with anything unless it is run by fellow leftists, in which case it should be trusted with everything. To make the fiscal response timelier, MMT supporters have proposed creating a government job guarantee. The basic idea is that the government would hire more workers when the private sector is hunkering down, while shedding workers when the private sector is expanding. In theory, automatic fiscal stabilizers of this sort could help dampen the business cycle. The consensus among MMT backers in the U.S. is that a $15 wage would be high enough to offer a tolerable standard of living without enticing many people to opt for government work when suitable private-sector employment is available. MMT supporters are assuming that the government is competent and agile enough to tighten and loosen fiscal policy at exactly the right time. Unfortunately, as is often the case with such ideas, the devil is in the details. For example, does the $15 wage include potentially generous government benefits? What will the government do if someone shows up for work but decides to just loaf around? What about low-skilled workers who would be more productive in the private sector but are instead diverted into government make-work projects? Inquiring minds want to know. Q: And the price tag could be huge! Wouldn’t an extended period of large budget deficits – even if justified by economic circumstances – cause debt levels to spiral out of control? A: A prolonged period of large budget deficits would most certainly lead to a significant increase in the government debt burden. However, if the interest rate on government borrowing is lower than the growth rate of the economy, as MMT supporters tend to assume, the debt-to-GDP ratio will eventually stabilize.1 In such a setting, the government could just roll over the existing stock of debt indefinitely, while issuing enough new debt to cover interest payments. No additional taxes would be necessary. Chart 2 shows this point analytically. Right now, projected GDP growth is higher than 10-year government borrowing rates for most countries (Chart 3). That’s the good news. The bad news is that there is no guarantee that this will remain the case indefinitely. If interest rates ever rose above GDP growth for an extended period of time, debt dynamics would quickly become unsustainable. MMTers argue that the government can borrow at any rate it wants because they see the currency as a public monopoly.  Q: Isn’t it crazy to assume that interest rates will always stay below GDP growth? A: Not according to MMTers. They argue that the government can borrow at any rate it wants. This is because they see the currency as a public monopoly. As long as a government is able to issue its own currency, it can create money to pay for whatever it purchases, and by definition, money pays no interest. This means that the interest rate can always be held below the growth rate of the economy. The only reason policymakers may wish to raise interest rates is if inflation is getting out of hand. However, even then, most MMT adherents would prefer that the government tighten fiscal policy either by hiking taxes on the rich or cutting spending programs they don’t like (the military is usually high on their list). Raising rates is widely seen by MMT supporters as simply providing a handout to bondholders. Q: It sounds like MMT basically cuts the Fed and other central banks out of the loop. A: That’s right. MMTers contend that monetary policy has little impact on the economy. In fact, many MMT advocates believe that higher rates raise aggregate demand by putting more income into bondholders’ pockets. It’s a very odd argument. Yes, corporate investment tends to respond more to animal spirits than to changes in interest rates. However, there is little doubt that rates affect housing, the currency, and asset prices (and all three, in turn, affect animal spirits). It is almost as if the 1982 recession – an episode where the Volcker Fed took interest rates to 19% – never happened. Q: An odd argument, but perhaps not a surprising one? A: That’s where the “Magic Money Tree” moniker comes in. When an economy is suffering from high unemployment, there really is a free lunch: Putting more people to work can increase someone’s spending without decreasing someone else’s. However, when an economy is at full employment, scarcity becomes relevant again. If a government wants to spend more, it has to convince the private sector to spend less, which it normally does by raising interest rates. MMTers like to throw out the old chestnut about how budget deficits endow the private sector with financial assets such as cash or government bonds. But if additional government spending leads to higher inflation, an increase in the volume of financial assets will simply result in the erosion of the value of existing financial assets. There may be times when more government spending is beneficial even in a full-employment economy, such as funding for basic scientific research or public infrastructure. However, there may also be times when increased government spending is wasteful and comes at the expense of valuable private-sector investment. MMT does not distinguish between the two cases because its adherents seem to deny that any such trade-off exists. Q: It sounds like MMTers want to have their cake and eat it too. A: Exactly. The political appeal of MMT is that it seemingly promises European-style welfare spending without Europe’s level of taxes. Just print more money! Let us ignore the fact that the Fed actually pays interest on bank reserves. Under the current rules, increasing the monetary base would not be costless for the government if that money ended up back at the Fed in the form of excess reserves, as it surely would. The bigger problem is that a large increase in government spending, which is not matched by much higher taxes, will quickly cause the economy to overheat. At that point, policymakers would either need to rapidly tighten fiscal policy, aggressively hike interest rates, or face hyperinflation and a plunging currency. Q: That seems like an obvious point. Why don’t MMTers see it? A: It gets back to what we discussed at the outset – MMTers regard the world as being chronically stuck in a liquidity trap. The prevailing view among MMTers is that there is still a lot of spare capacity globally, including in the United States, where the unemployment rate has fallen below official estimates of NAIRU (the Non-Accelerating Inflation Rate of Unemployment). MMT supporters tend to be skeptical of these NAIRU estimates, believing them to be biased upwards. MMTers see the world as being chronically stuck in a liquidity trap. The prevailing view among MMTers is that there is still a lot of spare capacity in the world. To be fair, the methodology used by the OECD and many other statistical agencies to calculate the full employment rate, which effectively just smooths out past values of the actual unemployment rate, has probably understated the degree of labor market slack in a few countries (Chart 4). Chart 4AThe Unemployment Rate Versus NAIRU (I) Chart 4BThe Unemployment Rate Versus NAIRU (II) That said, we doubt that NAIRU is overstated in the United States. Both the Fed and the OECD peg NAIRU at 4.3%, slightly below the CBO’s estimate of 4.6%. As it is, the current CBO estimate is nearly one percentage point below the post-1960 average (Chart 5). Back in the 1960s and 1970s, most economists thought NAIRU was lower than it actually turned out to be (Chart 6). This caused the Fed to keep rates below where they should have been. Chart 5U.S. NAIRU Is Estimated To Be The Lowest On Record Chart 6The Fed Continuously Overstated The Magnitude Of Economic Slack In The 1970s Q: Let’s bring this back to market strategy. What does the increasing popularity of MMT mean for investors? A: Investors should regard MMT as simply an extreme example of the increasingly permissive attitude that policymakers are adopting towards inflation. The idea that central banks should raise rates preemptively to avoid overheating is slowly giving way to the belief that they should wait to see the “whites of inflation’s eyes” before tightening monetary policy. Meanwhile, on the fiscal side, austerity is out, and big deficits are in. None of this should be all that surprising. Attitudes towards inflation move in generational cycles. The generation that grew up during the 1930s was highly sensitized towards deflation risk. As a result, policymakers focused on increasing employment, even at the expense of higher inflation. In contrast, the generation that came of age in the 1970s favored policies that clamped down on inflation. For today’s generation, the stagflation of the seventies is a distant memory. “Maximum employment” is the name of the game again. It often takes several years for an overheated economy to produce inflation. This is particularly true when the Phillips curve is quite flat, as appears to be the case today. To the extent that the Fed raises rates over the next 12 months, it will be in response to better-than-expected growth. The stock market should be able to do well in that environment. However, as we get into late-2020 or early-2021, inflation may begin to move materially higher, forcing the Fed to crank up the pace of rate hikes. At that point, equity prices will drop and a maximum short duration stance towards government bonds will be warranted. Q: Just in time for Bernie Sanders’ inauguration! You predicted Trump would win, but Crazy Bernie? Come on, seriously? A: My guess is that Trump was the only Republican candidate who could have beaten Hillary Clinton in 2016, while Clinton was the only Democratic candidate who could have lost to Trump. Had it been Bernie versus Trump, Trump would have lost. Given how close the election turned out to be, Sanders would have probably prevailed.   This is not just idle speculation. During the tail end of the 2016 primary season, head-to-head polls showed Sanders leading Trump by about 10 points, compared to a 3-point lead for Clinton (Chart 7). The final results would have been more favorable for Trump, but given how close the election turned out to be, Sanders would have probably prevailed. A strong economy will help Trump this time around. However, demographic trends continue to move against Republicans. Trump also made a strategic mistake during his first two years in office by focusing on Republican pet issues like corporate tax cuts and gutting Obamacare, rather than securing funding for the border wall, which was his signature campaign promise. For its part, the Democrat establishment will try to stymie Sanders again, but having recently watered down the “superdelegate” rules, it will be in a much weaker position to do so than last time. Q: Yikes, President Bernie doesn’t sound good for stocks! A: In our client conversations on “tail risks” facing the markets, Bernie Sanders almost never comes up. Admittedly, a lot can change in the next 12 months, including the possibility that Joe Biden will enter the race. Biden is more moderate than Sanders and has broad-based appeal. This means that it is still too early to make any significant changes to portfolio strategy. However, if Bernie Sanders, or some other far-left candidate, begins to do well in the polls, markets may start to get antsy later this year.     Peter Berezin Chief Global Investment Strategist peterb@bcaresearch.com       1      Please see Global Investment Strategy Weekly Report, “Is There Really Too Much Government Debt In The World?” dated February 22, 2019.     Strategy & Market Trends MacroQuant Model And Current Subjective Scores Tactical Trades Strategic Recommendations Closed Trades