Monetary

Highlights Duration: Economic fundamentals indicate that U.S. TIPS breakeven inflation rates have further cyclical upside and this will drive nominal bond yields higher on a 6-12 month horizon. In the near term, however, positioning data suggest that the uptrend in U.S. bond yields is due for a pause. Maintain a below-benchmark duration stance. Oil & U.S. Bonds: The cost of inflation compensation is an important driver of U.S. bond yields and the oil price is an important driver of the cost of inflation compensation. This will continue to be true until long-maturity TIPS breakeven inflation rates settle into a range between 2.4% and 2.5%. At that point the oil price will become a less important driver of U.S. bond yields. Australia: Maintain an overweight position in Australian government debt. Economic data are still mixed and the RBA will stay on hold for the foreseeable future. Against a backdrop of Fed rate hikes, Australian debt should outperform. Feature Chart of the WeekHigher Yields, Driven By Inflation There was certainly no shortage of possible catalysts for last week's bond rout (Chart of the Week). The Bank of Japan (BoJ) reduced its buying of long-dated JGBs, there was a rumor that China plans to slow or stop its purchases of U.S. Treasury debt, and U.S. inflation expectations started to ramp back up - driven by a combination of higher oil prices and a strong December core CPI print. But of all these factors we think it is only the third that merits much attention. Once the BoJ started targeting the level of the yield curve in September 2016, its quantity targets became irrelevant. A reduction in the pace of BoJ buying only matters if it foreshadows a shift to a higher yield curve target. Our foreign exchange strategists don't think such a move is likely in the next 12-18 months.1 China, for its part, still has a highly managed currency and now that capital is no longer flowing out of the country it will start to rebuild its foreign exchange reserves. Given that the U.S. Treasury market remains the world's most liquid, it is hard to see how China can avoid having to park much of its excess foreign capital in the United States (Chart 2). The compensation for 10-year U.S. inflation protection broke above 2% last week, after having been as low as 1.66% as recently as last June. This 34 basis point increase in inflation compensation coincided with a 36 basis point increase in the nominal U.S. 10-year yield and a Brent crude oil price that rose from $45 per barrel last June to $70 per barrel as of last Friday. We think these correlations will continue to be the most important factors driving bond yields during the next 6-12 months, and the bulk of this report is dedicated to disentangling the linkages between oil prices, inflation, inflation expectations and nominal bond yields. But first we reiterate our cyclical investment stance. Last week's U.S. CPI report provided further evidence that U.S. core inflation is in the process of bottoming-out (Chart 3). The 10-year U.S. TIPS breakeven inflation rate will settle into a range between 2.4% and 2.5% by the time that core inflation returns to the Fed's target. By that time the nominal 10-year yield will be in a range between 2.8% and 3.25%. Likewise, our energy strategists anticipate that an ongoing steady decline in commercial inventories will keep crude prices well supported on a 6-12 month horizon. Chart 2China's Forex Reserves Are Rising Chart 3U.S. Inflation Turns The Corner However, on a shorter time horizon (3 months or less), recent shifts in speculative positioning signal that the uptrends in bond yields and the oil price might be due for a pause (Chart 4). After having been solidly "net long" since the middle of last year, net speculative positions in the 10-year U.S. Treasury futures contract have just dipped into "net short" territory. Historically, net speculative positions have been a decent indicator of 3-month changes in the 10-year U.S. Treasury yield, and at current levels they signal that the 10-year yield could decline modestly during the next three months (Chart 5). Similarly, speculators in the oil futures market are now more "net long" than at any time since last February. While this positioning indicator does not work quite as well for the oil market as for the Treasury market, net longs at more than 20% of open interest (most recent reading is 26%) have more often than not been met with 3-month price declines since 2010 (Chart 6). Chart 4Net Speculative Positioning##BR##For Oil And Bonds Chart 5Net Speculative Positions &##BR##10-Year Treasury Yield (2010 - Present) Chart 6Net Speculative Positions &##BR##WTI Oil Price (2010 - Present) Bottom Line: The outlook for U.S. inflation suggests that TIPS breakeven rates have further cyclical upside and this will drive nominal bond yields higher. However, positioning data in both bond and oil markets suggest that the recent run-up in yields might be due for a near-term pause. Maintain a below-benchmark duration stance on a 6-12 month horizon. Oil, TIPS, Inflation And U.S. Bond Yields: Sorting Out The Mess During the post-financial crisis period two relationships have been both (i) incredibly robust and (ii) unlike relationships observed in prior periods. They are: The cost of inflation protection has been an unusually important determinant of nominal U.S. bond yields. The oil price has shown a very strong correlation with the cost of inflation protection. Both relationships can be explained by the Federal Reserve's asymmetric ability to control inflation. We consider each relationship in turn. The Importance Of Inflation Chart 7TIPS Beta Declines When##BR##Breakevens Are Low A common rule of thumb is to estimate the TIPS beta - the proportion of movement in U.S. nominal bond yields that is explained by movement in TIPS (real) yields - at around 0.8. In other words, this assumes that 80% of the movement in nominal bond yields is explained by the real component. However, we observe that since the financial crisis the 10-year TIPS beta has been a much lower 0.68, and at times it has been closer to 0.5 on a 12-month rolling basis (Chart 7). We also observe that the TIPS beta tends to be lower when TIPS breakeven inflation rates are un-anchored to the downside. There is a very good reason for this. The reason is that the Fed's ability to influence inflation is asymmetric. The Fed has a strong track record of successfully tightening to bring inflation down, but has been less successful at easing to drive it up. This asymmetric ability to influence prices is due in no small part to the zero-lower bound on interest rates. Because the Fed's ability to ease policy is constrained while its ability to tighten is not, bond market participants may at times question the Fed's ability to ease and revise their inflation expectations lower. It is also during these periods that inflation expectations become more volatile and a more important determinant of nominal bond yields. This is because they are increasingly driven by the swings in the economic data and less by the Fed's policy bias. The Importance Of Oil This is where the oil price comes in. Oil and other commodities are crucial inputs to the production process. As such, not only do these prices rise in response to stronger aggregate demand, but higher prices also signal mounting cost-push inflationary pressures. But despite this obvious truth, there is not always a strong correlation between oil prices and inflation expectations. This is because the Fed's reaction function influences the relationship. Consider the pre-crisis (2004-2008) period. Long-maturity TIPS breakeven inflation rates stayed range-bound between 2.4% and 2.5% even as the oil price increased dramatically (Chart 8). Since investors perceived that the Fed would simply tighten policy to tamp out any inflationary pressures that might arise, there was no desire to demand greater compensation for inflation. However, this logic does not work in reverse. When commodity prices fell in 2014, inflation expectations declined alongside. In fact we observe that the correlations between long-maturity TIPS breakeven inflation rates and both oil and commodity prices have been much stronger in the post-crisis period, when inflation expectations have been un-anchored (Table 1). Chart 8The Unstable Correlation: Breakevens & Oil Table 1Correlations Between TIPS Breakeven Inflation & Commodities Investment Conclusions The Fed's asymmetric reaction function leads to two crucial investment conclusions. First, long-maturity inflation expectations (as measured by the U.S. TIPS breakeven inflation rate) can fall when deflationary pressures mount, but their upside is capped in the 2.4% to 2.5% range. This is because the market has no reason to question the Fed's ability to lower inflation by lifting rates. The upside limit of 2.4% to 2.5% will remain in place unless the Fed changes its inflation target. A change to the inflation target that allows for higher inflation is an idea that is quickly gaining traction among policymakers, but is unlikely to be implemented this year. Second, when long-maturity inflation expectations are below their 2.4% to 2.5% upper-bound they become both (i) a more important driver of nominal yields - as evidenced by the lower TIPS beta - and (ii) more sensitive to swings in commodity prices. For this reason, the oil price will continue to be an important driver of inflation expectations and nominal U.S. bond yields for the next few months, but will decrease in importance as TIPS breakevens move back to their 2.4% to 2.5% range. Once inflation expectations are re-anchored, nominal bond yields will once again be predominantly driven by the real component and swings in the price of oil will be less important for bond markets. The dynamics described above are not merely theoretical. Consider the evidence from five developed countries presented in Charts 9 & 10. Chart 9 shows that the oil price is tightly correlated with inflation expectations in the U.S., Eurozone and Japan, but also that inflation expectations in the U.K. and Australia did not respond to the recent increase in oil prices. The reason is that core inflation in the U.K. and Australia is already relatively close to the central bank's target (Chart 10). It is only where core inflation is far below target (in the U.S., Eurozone and Japan) that the oil price remains an important driver of bond yields. Chart 9Oil & Inflation Expectations Highly Correlated... Chart 10...But Only When Inflation Is Low The U.K. in particular presents an interesting case study. U.K. core inflation was quite far below target throughout 2015 and 2016, and during this time period U.K. inflation expectations were tightly linked with the oil price. It is only in the past few months that U.K. core inflation has moved back above target, and not surprisingly the correlation between the U.K. 10-year CPI swap rate and the price of oil has started to break down. Bottom Line: At present, the cost of inflation compensation is an important driver of U.S. bond yields and the oil price is an important driver of the cost of inflation compensation. Both of these dynamics will continue to be true for the next few months, but will decline in importance as TIPS breakeven inflation rates rise. When long-maturity TIPS breakeven inflation rates settle into a range between 2.4% and 2.5%, then the oil price will become a less important driver of U.S. bond yields. Australia: Too Soon To Expect A Hike Chart 11Australia: A Solid Rebound In Growth... Over the last quarter much of the economic data from Australia have improved. Real GDP growth rebounded sharply to 2.8% YoY in Q3 from 1.9% the previous quarter (Chart 11). Iron ore prices have been rising since mid-October. Employment growth is robust and the unemployment rate is well below its estimated natural level. This begs the question - with so much going right is it time for the Reserve Bank of Australia (RBA) to lift rates? Our answer is an emphatic "no." First, most data improvements have been relatively minor and the overall economic picture remains mixed. As we mentioned in our recent Special Report,2 the RBA is stuck between conflicting forces. Booming house prices and rising household indebtedness on the one hand, and an economy still working off excess capacity on the other. Nevertheless, our expectation is that the RBA will allow the economy to recover further for the following reasons: Consumer health is fragile. Policymakers left cash rates unchanged at the last monetary policy meeting in December, and Governor Philip Lowe expressed concerns about household consumption. Consumption is a significant driver of economic growth and the combination of declining savings, elevated debt levels and weak income growth is worrisome (Chart 12). Since then, real income growth has dipped back into positive territory, but only barely so. Meanwhile, house prices are still surging, despite macro-prudential measures aimed at tightening lending standards, thereby supporting consumer spending through the wealth effect. Given an extreme household debt to income ratio, consumption would be very vulnerable if the RBA were to curb house price gains by raising rates. Labors markets have plenty of slack. The unemployment rate has fallen to a four year low and other labor market statistics show a broad-based improvement over the last quarter. However, the unemployment rate is still significantly higher than it was in the previous cycle and other improvements in the labor market have also occurred from extremely weak levels. In 2017Q1, the underemployment rate and part-time workers as a percentage of total workers both reached all-time highs. Those numbers have dipped slightly in Q3, with underemployment falling to 8.3% and part-time workers as a percentage of total declining to 31.7%, but those elevated levels suggest there still needs to be significant improvement before spare capacity is worked off and real wage growth starts to move higher (Chart 13). Chart 12...But Consumers Can't Afford A Rate Hike Chart 13Still Plenty Of Slack In Australian Labor Markets Inflation is still too low. Headline and core inflation readings came in at 1.8% and 1.9% respectively in Q3 (Chart 14). While headline slowed, core inflation recovered over the last quarter. Tradeable goods inflation collapsed into negative territory at -0.9%, as a result of currency strength and increased competition among retailers. Going forward, we expect consumer price growth to be muted given the lack of inflationary pressures. The output gap is wide, despite rebounding growth, and the IMF forecasts that it will be years before the Australian economy reaches capacity. The trade-weighted Aussie dollar index has risen almost 5% since it bottomed in early December, while the AUD/USD has broken above its 40-week moving average. Continued currency strength would exert even further deflationary pressure. As stated above, the labor market also requires significant improvement to work off excess capacity. All of these factors caused the RBA to dial back its inflation forecast in the November statement. It now expects that inflation will remain quite flat for the next two years, only touching the lower-end of its 2%-3% target range at the end of 2019. Consequently, inflation will not be forcing the RBA's hand in the foreseeable future. One of our key themes for 2018 is that global growth will be less synchronized. Central banks will therefore employ diverging monetary policies, presenting cross-country bond market investment opportunities. As such, we recently shifted to a slight overweight position in Australian debt within our model portfolio, arguing that it would outperform global government bond benchmarks during a year expected to be driven by Fed tightening and ECB/BoJ tapering concerns. Historically, relative yield moves have closely tracked relative shifts in monetary policy (Chart 15). In the U.S., above-trend growth, a tight labor market and the continued recovery in inflation will force the Fed to become more aggressive. If the RBA stays inactive as we expect, then this gap should continue to move in favor of Australian debt. Additionally, there is still a modest yield pickup in Australian debt relative to the global index and as we expect global bond yields to rise, low-beta Australian government bonds should offer considerable protection. Chart 14Australia: Lacking Inflationary Pressures Chart 15Australian Relative Yields Track Relative Policy This also leads us to continue holding our tactical Long Dec 2018 Australian Bank Bill futures trade from last October. We initially entered into this trade as a more focused way of expressing that the RBA will stay on hold. The trade is currently 6 bps in the money and with markets still pricing about 30 bps of rate hikes during the next 12 months, there is plenty of room for further profit as market expectations are revised down. Bottom Line: Maintain an overweight position in Australian government debt. Economic data are still mixed and the RBA will stay on hold for the foreseeable future. Against a backdrop of Fed rate hikes, Australian debt should outperform. Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com Patrick Trinh, Associate Editor Patrick@bcaresearch.com 1 Please see BCA's Foreign Exchange Strategy Weekly Report, "Yen: QQE Is Dead! Long Live YCC!", dated January 12, 2018, available at fes.bcaresearch.com. 2 Please see BCA's Global Fixed Income Strategy Special Report, "Australia: Stuck Between A Rock And A Hard Place", dated July 25, 2017, 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

Highlights Duration: Economic fundamentals indicate that TIPS breakeven inflation rates have further cyclical upside and this will drive nominal bond yields higher on a 6-12 month horizon. In the near term, however, positioning data suggest that the uptrend in bond yields is due for a pause. Maintain a below-benchmark duration stance. Oil & Bonds: The cost of inflation compensation is an important driver of bond yields and the oil price is an important driver of the cost of inflation compensation. This will continue to be true until long-maturity TIPS breakeven inflation rates settle into a range between 2.4% and 2.5%. At that point the oil price will become a less important driver of yields. Fed: The Fed will start actively discussing alternative monetary policy frameworks in 2018. While we think the Fed will eventually adopt a policy framework that tolerates higher inflation, this shift probably won't occur this year. Feature There was certainly no shortage of possible catalysts for last week's bond rout (Chart 1). The Bank of Japan (BoJ) reduced its buying of long-dated JGBs, there was a rumor that China plans to slow or stop its purchases of U.S. Treasury debt, and U.S. inflation expectations started to ramp back up - driven by a combination of higher oil prices and a strong December core CPI print. But of all these factors we think it is only the third that merits much attention. Once the BoJ started targeting the level of the yield curve in September 2016 its quantity targets became irrelevant. A reduction in the pace of BoJ buying only matters if it foreshadows a shift to a higher yield curve target. Our foreign exchange strategists don't think such a move is likely in the next 12-18 months.1 China, for its part, still has a highly managed currency and now that capital is no longer flowing out of the country it will start to rebuild its foreign exchange reserves. Given that the U.S. Treasury market remains the world's most liquid, it is hard to see how China can avoid having to park much of its excess foreign capital in the United States (Chart 2). Chart 1Higher Yields, Driven By Inflation Chart 2China's Forex Reserves Are Rising The compensation for 10-year U.S. inflation protection broke above 2% last week, after having been as low as 1.66% as recently as last June. This 34 basis point increase in inflation compensation coincided with a 36 basis point increase in the nominal 10-year yield and a Brent crude oil price that rose from $45 per barrel last June to $70 per barrel as of last Friday. We think these correlations will continue to be the most important factors driving bond yields during the next 6-12 months, and the bulk of this report is dedicated to disentangling the linkages between oil prices, inflation, inflation expectations and nominal bond yields. But first we reiterate our cyclical investment stance. Last week's CPI report provided further evidence that core inflation is in the process of bottoming-out (Chart 3). The 10-year TIPS breakeven inflation rate will settle into a range between 2.4% and 2.5% by the time that core inflation returns to the Fed's target. By that time the nominal 10-year yield will be in a range between 2.8% and 3.25%. Likewise, our energy strategists anticipate that an ongoing steady decline in commercial inventories will keep crude prices well supported on a 6-12 month horizon. Chart 3U.S. Inflation Turns The Corner Chart 4Net Speculative Positioning For Oil And Bonds However, on a shorter time horizon (3 months or less), recent shifts in speculative positioning signal that the uptrends in bond yields and the oil price might be due for a pause (Chart 4). After having been solidly "net long" since the middle of last year, net speculative positions in the 10-year U.S. Treasury futures contract have just dipped into "net short" territory. Historically, net speculative positions have been a decent indicator of 3-month changes in the 10-year U.S. Treasury yield, and at current levels they signal that the 10-year yield could decline modestly during the next three months (Chart 5). Similarly, speculators in the oil futures market are now more "net long" than at any time since last February. While this positioning indicator does not work quite as well for the oil market as for the Treasury market, net longs at more than 20% of open interest (most recent reading is 26%) have more often than not been met with 3-month price declines since 2010 (Chart 6). Chart 5Net Speculative Positions & 10-Year Treasury Yield Chart 6Net Speculative Positions & WTI Oil Price Bottom Line: The outlook for U.S. inflation suggests that TIPS breakeven rates have further cyclical upside and this will drive nominal bond yields higher. However, positioning data in both bond and oil markets suggest that the recent run-up in yields might be due for a near-term pause. Maintain a below-benchmark duration stance on a 6-12 month horizon. Oil, TIPS, Inflation And Bond Yields: Sorting Out The Mess During the post-financial crisis period two relationships have been both (i) incredibly robust and (ii) unlike relationships observed in prior periods. They are: The cost of inflation protection has been an unusually important determinant of nominal U.S. bond yields The oil price has shown a very strong correlation with the cost of inflation protection Both relationships can be explained by the Federal Reserve's asymmetric ability to control inflation. We consider each relationship in turn. The Importance Of Inflation Chart 7TIPS Beta Declines When ##br##Breakevens Are Low A common rule of thumb is to estimate the TIPS beta - the proportion of movement in U.S. nominal bond yields that is explained by movement in TIPS (real) yields - at around 0.8. In other words, this assumes that 80% of the movement in nominal bond yields is explained by the real component. However, we observe that since the financial crisis the 10-year TIPS beta has been a much lower 0.68, and at times it has been closer to 0.5 on a 12-month rolling basis (Chart 7). We also observe that the TIPS beta tends to be lower when TIPS breakeven inflation rates are un-anchored to the downside. There is a very good reason for this. The reason is that the Fed's ability to influence inflation is asymmetric. The Fed has a strong track record of successfully tightening to bring inflation down, but has been less successful at easing to drive it up. This asymmetric ability to influence prices is due in no small part to the zero-lower bound on interest rates. Because the Fed's ability to cut rates is constrained by the zero-bound while its ability to lift rates is not, bond market participants may at times question the Fed's ability to ease and revise their inflation expectations lower. It is also during these periods that inflation expectations become more volatile and a more important determinant of nominal bond yields. This is because they are increasingly driven by the swings in the economic data and less by the Fed's policy bias. The Importance Of Oil This is where the oil price comes in. Oil and other commodities are crucial inputs to the production process. As such, not only do these prices rise in response to stronger aggregate demand, but higher prices also signal mounting cost-push inflationary pressures. But despite this obvious truth, there is not always a strong correlation between oil prices and inflation expectations. This is because the Fed's reaction function influences the relationship. Consider the pre-crisis (2004-2008) period. Long-maturity TIPS breakeven inflation rates stayed range-bound between 2.4% and 2.5% even as the oil price increased dramatically (Chart 8). Since investors perceived that the Fed would simply tighten policy to tamp out any inflationary pressures that might arise, there was no desire to demand greater compensation for inflation. However, this logic does not work in reverse. When commodity prices fell in 2014, inflation expectations declined alongside. In fact we observe that the correlations between long-maturity TIPS breakeven inflation rates and both oil and commodity prices have been much stronger in the post-crisis period, when inflation expectations have been un-anchored (Table 1). Chart 8The Unstable Correlation Breakevens & Oil Table 1Correlations Between TIPS Breakeven Inflation And Commodities Investment Conclusions The Fed's asymmetric reaction function leads to two crucial investment conclusions. First, long-maturity inflation expectations (as measured by the TIPS breakeven inflation rate) can fall when deflationary pressures mount, but their upside is capped in the 2.4% to 2.5% range. This is because the market has no reason to question the Fed's ability to lower inflation by lifting rates. The upside limit of 2.4% to 2.5% will remain in place unless the Fed changes its inflation target. A change to the inflation target that allows for higher inflation is an idea that is quickly gaining traction among policymakers, but is unlikely to be implemented this year (see section titled "The Fed In 2018: Contemplating A Major Change" below). Second, when long-maturity inflation expectations are below their 2.4% to 2.5% upper-bound they become both (i) a more important driver of nominal yields - as evidenced by the lower TIPS beta - and (ii) more sensitive to swings in commodity prices. For this reason, the oil price will continue to be an important driver of inflation expectations and nominal bond yields for the next few months, but will decrease in importance as TIPS breakevens move back to their 2.4% to 2.5% range. Once inflation expectations are re-anchored, nominal bond yields will once again be predominantly driven by the real component and swings in the price of oil will be less important for bond markets. The dynamics described above are not merely theoretical. Consider the evidence from five developed countries presented in Charts 9 & 10. Chart 9 shows that the oil price is tightly correlated with inflation expectations in the U.S., Eurozone and Japan, but also that inflation expectations in the U.K. and Australia did not respond to the recent increase in oil prices. The reason is that core inflation in the U.K. and Australia is already relatively close to the central bank's target (Chart 10). It is only where core inflation is far below target (in the U.S., Eurozone and Japan) that the oil price remains an important driver of bond yields. Chart 9Oil & Inflation Expectations Highly Correlated... Chart 10...But Only When Inflation Is Low The U.K. in particular presents an interesting case study. U.K. core inflation was quite far below target throughout 2015 and 2016, and during this time period U.K. inflation expectations were tightly linked with the oil price. It is only in the past few months that U.K. core inflation has moved back above target, and not surprisingly the correlation between the U.K. 10-year CPI swap rate and the price of oil has started to break down. Bottom Line: At present, the cost of inflation compensation is an important driver of bond yields and the oil price is an important driver of the cost of inflation compensation. Both of these dynamics will continue to be true for the next few months, but will decline in importance as TIPS breakeven inflation rates rise. When long-maturity TIPS breakeven inflation rates settle into a range between 2.4% and 2.5%, then the oil price will become a less important driver of bond yields. The Fed In 2018: Contemplating A Major Change? As was alluded to in the prior section, the biggest potential change for bond markets in 2018 would be if the Fed changed its monetary policy framework to one that tolerated higher levels of inflation. For example, let's imagine that the Fed suddenly lifted its inflation target from 2% to 3%. This would likewise shift the upper-bound range for long-maturity TIPS breakeven inflation rates to approximately 3.4% to 3.5%. It would mean that nominal bond yields have further upside over the course of the cycle, and also that oil and commodity prices would play an important role in bond markets for much longer. It would also lengthen the period where spread product can outperform Treasuries since the Fed would not be so quick to choke off the recovery. We still think it is unlikely that such a change will be implemented this year, but recent weeks have seen a marked increase in the number of Fed policymakers either advocating for a different policy framework or saying that the Fed should start researching alternative frameworks. What's crucial to remember is that the reason policymakers are unsatisfied with the current 2% inflation target is that it brings the zero-lower bound on interest rates into play too often. So any potential change in policy framework would be to one that tolerates higher inflation rates. Bernanke's Idea Chart 11The Implications Of A Price Level Target One potential new policy approach was put forward by ex-Fed Chairman Ben Bernanke in a recent blog post.2 Bernanke made the case for "Temporary Price Level Targeting", a policy where the Fed continues to use a 2% inflation target when the fed funds rate is sufficiently far from zero, but then switches to a price-level target when the fed funds rate is close to the zero bound. In his own words, the strategy would be communicated as follows: The Committee therefore agrees that, in future situations in which the funds rate is at or near zero, a necessary condition for raising the funds rate will be that average inflation since the date at which the federal funds rate first hit zero be at least 2 percent. Chart 11 provides an illustration of this example. Under the current framework the Fed targets 2% PCE inflation and forecasts that it will achieve this target sometime in 2019. In Bernanke's proposed framework the Fed would not target 2% inflation, but rather a price level that is consistent with 2% trend growth in prices since the zero-lower bound was hit in December 2008. In order to achieve this goal by the end of 2019 the Fed would need to tolerate a significant overshoot of inflation during the next two years (bottom panel). Who's On Board? The Appendix to this report is a list of all Fed Governors and Regional Fed Presidents. It also shows our own assessment of each committee member's policy bias. We noted from the most recent Summary of Economic Projections that 6 FOMC participants expect three rate hikes in 2018, 6 expect fewer than three rate hikes and 4 expect more than three hikes. From recent speeches we attempted to discern which member owns which forecast and then we attributed a "dovish" policy bias to those with a forecast for fewer than three hikes, a "neutral" bias to those expecting three hikes, and a "hawkish" bias to those expecting more than three hikes. We also show which FOMC participants are voters in 2018, although we do not think that distinction carries much practical importance. The Committee tends to arrive at decisions by consensus anyways, and all participants voice their opinions at every meeting whether or not it is their turn to vote. But it is the "notes" column of the Appendix that is most striking. There we highlighted all the FOMC participants who have recently made comments regarding the exploration of alternative policy frameworks. A general consensus seems to be forming that alternative frameworks should be studied this year, and a few policymakers (San Francisco Fed President John Williams, in particular) have strongly made the case that the Fed should switch to some sort of price level targeting regime. The Appendix also identifies the biggest source of uncertainty for the Fed this year. Namely that there are four vacant Governor positions that need to be filled. The New York Fed will also need a new President when William Dudley retires later this year. Who is nominated to fill those vacant positions will go a long way toward determining how aggressively the Fed pursues alternative policy frameworks. Bottom Line: The Fed will start actively discussing alternative monetary policy frameworks in 2018. While we think the Fed will eventually adopt a policy framework that tolerates higher inflation, this shift probably won't occur this year. Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com 1 Please see Foreign Exchange Strategy Weekly Report, "Yen: QQE Is Dead! Long Live YCC!", dated January 12, 2018, available at fes.bcaresearch.com 2 https://www.brookings.edu/blog/ben-bernanke/2017/10/12/temporary-price-level-targeting-an-alternative-framework-for-monetary-policy/ Appendix Table 2Composition Of The FOMC Fixed Income Sector Performance Recommended Portfolio Specification

ハイライト コンセンサスは2017年第4四半期の1株当たり利益（EPS）が前年同期比で12%の増加、2018年は14%を見込んでいる。税制改正法案が2018年の営業環境に与える影響は、2017年第4四半期の決算を議論する際に企業経営陣や投資家の注目点となるだろう。 12月の小売売上高とコアCPIの数値は、FRBの3月利上げの理論を後押ししている。 我々は来たる2月のFOMC議長交代は円滑に進むと予想しており、それは金融政策の段階的正常化を確実にするだろう。ただし、連邦準備制度理事会（FRB）の空席、タカ派/ハト派のシフトおよび反対票は懸念事項である。 特集 米国株式は先週も上昇を続け、投資家は世界成長と2018年のS&P 500収益に対する期待を切り上げた。本レポートの次節では2017年第4四半期の決算シーズンのプレビューを提供する。12月のコアCPIが前年比で予想より強い1.8%上昇したことから、インフレの気配も見られた。多くのFRB関係者の発言が相次いだが、市場の見方──次回の利上げは3月会合で行われる──を変えるほどではなかった。今週のレポートの最終節ではFOMCの構成について論じる。10年物米国債利回りは約10ベーシスポイント上昇し、週末は2.56%で終えた。BCAの米国ボンド・ストラテジストは10年物の公正価値を2.94%と見積もっている。1 さらに、2年物米国債利回りは先週金曜日に2008年以来初めて2%に到達した。 S&P 500の業績：2017年第4四半期 コンセンサスは2017年第4四半期のEPSが2016年第4四半期比で12%増加、2018年は15%増を見込んでいる。エネルギー、資本財・素材、そしてテクノロジー株が収益成長を牽引する一方、通信および不動産セクターの収益は伸び悩むだろう。エネルギーセクターを除くと、コンセンサスは2017年第4四半期のEPSが前年比で10%上昇すると見ている。 過去四半期と2018年に関する楽観的な利益見通しは、原油価格の回復を反映しており、原油高は2017年第4四半期のエネルギーセクターEPSを印象的な138%押し上げると予想される（チャート1）。エネルギー関連の設備投資とS&P 500全体の収益は密接に関連している（チャート1、パネル2）。世界成長環境の改善と抑制された労働コストは、2017年第4四半期および2018年初めに利益率のカウンタ―サイクリカルな上昇を引き続き促した。さらに、昨年末に成立したTax Cut and Jobs Act of 2017の直接的効果は、2018年の米国実質GDP成長率を0.2〜0.3ポイント押し上げる可能性が高い。ハリケーン復興支出と連邦裁量的支出の上限引き上げに関する議会の合意が得られれば、今年の成長率にさらに0.2ポイント程度上乗せされる可能性がある。しかし、税制変更や即時の資本償却が企業部門のセンチメントをさらに高め、投資支出を前倒しさせる能力に大きく依存する。 税制改正法案が2018年の営業環境に与える影響は、2017年第4四半期の決算を議論する際に企業経営陣や投資家の関心事となるだろう。具体的には、企業が低い税率の恩恵や海外からの資金還流を通じて現金をどのように活用するかが前面に出るだろう。チャート2は2017年第3四半期までのデータで、株式買戻しと配当が過去の景気循環をやや上回る一方、設備投資はほぼ平均的であったことを示している。BCAはこのミックスを引き続き注視する。欧州と新興市場（EM）での経済状況の改善、米ドル、マージンの持続可能性、そしてハリケーン・ハーベイやイルマの影響は、決算説明会で厳しく検証されるだろう。 Chart 1 S&P 500 Sensitive To Oil Prices##BR##And Oil Driven Capex S&P 500は原油価格および原油主導の設備投資に敏感 S&P 500は原油価格および原油主導の設備投資に敏感 Chart 2 Comparison Of Corporate Outlays##BR##Across Four Economic Expansion Phases 円滑な移行？ 円滑な移行？ アナリストはまた、金利上昇とイールドカーブの形状にも注目するだろう。1月12日に10年物米国債利回りは3月以来の高水準となる2.56%に達した。さらに、2017年第4四半期の10年物利回りは第3四半期比で16ベーシスポイント高く、2016年第4四半期比では26ベーシスポイント高かった。BCAは2年物と10年物のイールドカーブが今後6か月で急勾配化（steepen）し、その後年後半にフラット化すると予想している。カーブと上昇する金利はS&P 500の金融セクターに追い風を与える。BCAのU.S. エクイティ・ストラテジーチームは2017年5月以来、金融セクターをオーバーウェイトで継続している。2 いつものように、2018年第1四半期以降のトレンドに関する経営陣のガイダンスは、実際の第4四半期結果よりも重要である（チャート3）。投資家は経営陣の過度な楽観に警戒すべきだ。というのも収益成長の予想は時間とともに下方修正されることが多いからである。 2017年第4四半期も2017年前3四半期と同様に、海外売上が高い企業は欧州、日本および新興市場での成長改善の恩恵を受けるはずだ。チャート4は高いISM数値が2018年の収益と売上にとって好ましい背景を提供していることを示している。さらに、チャート5はS&P 500の売上の代替指標である鉱工業生産（IP）が2018年に加速し企業収益を押し上げる態勢にあることを示している。今年および来年の世界GDP成長予測は着実に上向いており、過去に予想が容赦なく下方修正され続けた年とは対照的である（チャート6）。 Chart 3 2018 Estimates Turned Higher After Tax Law Passed; '19 Likely To Move Lower 税制改正法が可決された後、2018年の見積もりは上方に転じた；2019年は下方に動く可能性が高い。 税制改正法が可決された後、2018年の見積もりは上方に転じた；2019年は下方に動く可能性が高い。 Chart 4 Favorable Macro Backdrop For Earnings And Sales 利益および売上高にとって好ましいマクロ環境 利益および売上高にとって好ましいマクロ環境 加えて、BCAのU.S. エクイティ・ストラテジーサービスは3、2015年の谷の後、売上高のポジティブな改定数が収益のポジティブ改定数を着実に上回っていることを指摘している。これは実際の収益成長が売上成長を大きく上回っているにもかかわらず起きている現象である。最近の売上高に対する非常にポジティブな改定の一因として、企業が税制改革の最大の恩恵を受けるために一部の利益を2017年から2018年に移している可能性が考えられる。 Chart 5 ISM Components Suggest IP##BR##Poised To Accelerate ISMの構成要素は鉱工業生産（IP）の加速を示唆 ISMの構成要素は鉱工業生産（IP）の加速を示唆 Chart 6 Global Growth Estimates##BR##Still Accelerating 世界の成長見通しはなお加速している 世界の成長見通しはなお加速している 米ドルは最近数四半期ではEPSに対して小幅な悪影響にとどまってきたが、第4四半期はややプラスに転じる見込みだ。米ドルは広範な通貨バスケットに対して1年前より3%下落している。さらに、最新のベージュブック（11月29日）では「強いドル」に関する言及が1年前と比べて8件減少した。これは強い通貨がここ数か月で経営陣の主要な懸念事項として薄れてきたことを示している（チャート7）。 それでもBCAの見解は、米ドルは今後12か月で5%上昇するとしている。ドル高はEPS成長を概ね1〜2ポイント押し下げるが、その大部分はラグのため来年に生じるだろう。単独でのドル上昇は株式市場にとって大きな逆風にはならないはずだ。実際にドルが上昇するのは、米国の堅調な経済成長と企業の売上拡大という文脈においてのみである。米国におけるインフラ投資パッケージの立法進展や米国の企業設備投資の改善は、ドルの見通しを高めるだろう。 昨秋の大規模ハリケーンが第4四半期の決算に与える影響は、S&P 500およびほとんどのセクターにとって限定的だろう。天候に敏感な複数の産業（保険、航空、化学、精製、レジャー等）は第3四半期の結果に大きな混乱を受けた。これらの産業は第4四半期にいくばくかの反動増が見られる可能性が高い。 投資家は2017年第4四半期にマージンが6四半期連続で改善することに懐疑的だ。BCAの見解では、我々はマージンにとって一時的な「甘いスポット」にあり、これは今後数四半期続くはずだが、賃金上昇圧力が表面化するにつれてその後はマージンの長期的な平均回帰が再開するだろう。 結論として、我々は2017年第4四半期および2018年初頭にかけて収益環境は株価を下支えすると予想する。その先では、EPS成長は2018年後半に減速を始め、2019年に入ると株価にとってより逆風となるだろう（チャート8）。株式を債券に対してオーバーウェイトのまま維持せよ。 Chart 7 The Dollar Should Not Be##BR##A Factor In Q4 Earnings Season 第4四半期の決算シーズンにおいて、ドルは要因とならないはずだ 第4四半期の決算シーズンにおいて、ドルは要因とならないはずだ Chart 8 Strong S&P Growth Ahead,##BR##Will Start To Slow Soon S&Pは今後強い成長が見込まれるが、まもなく減速し始めるだろう S&Pは今後強い成長が見込まれるが、まもなく減速し始めるだろう FRB議長交代：順風満帆か？ Chart 9 December's CPI Data Will Be Met##BR##With A Sigh Of Relief From The Fed 12月のCPIデータはFRBに安堵のため息をもたらすだろう 12月のCPIデータはFRBに安堵のため息をもたらすだろう 11月の月次で0.1%と期待外れだった伸びの後、12月のコアCPIは月次で0.3%の反発を示した（チャート9）。歓迎すべきニュースだが、いくつか留意点がある。第一に、伸びは住宅と医療ケアの2つのサブコンポーネントに集中していた。住宅はコアCPIの40%以上を占め、我々のモデルは今後の緩和を示唆している。第二に、コアサービス（住居と医療を除く）インフレは依然として2%未満と弱く、コア財の価格はなおデフレ傾向にある。第三に、年率のコアインフレ率はわずか1.8%である。コアCPIの2.4〜2.5%はコアPCEデフレーターに対するFRBの2%目標と整合的である。 12月の小売売上高のリポートは、2018年末時点での景気の明るいトーンを補強した。アトランタ連銀のGDPNowによる2017年第4四半期の推定は1月12日時点で3.3%と、1月5日の2.7%から上方修正された。 米国のインフレは年末までに徐々に目標に戻るはずである。米国のフィクスト・インカム・ポートフォリオでは、投資家はベンチマークを下回るデュレーションを維持し、名目国債に対してTIPSをオーバーウェイトにすべきだ。インフレ・ブレークイーブンの上昇はイールドカーブをスティーピングさせるバイアスも生むだろう。コアCPIの反発は確かに心強いが、FRBがインフレが本当に目標に向かっていると一層自信を持つには、さらに確かな数値が必要だ。3月のFOMC会合までにあと2件のCPI公表があるため、FRBはその時までに利上げを決断するための証拠を得るかもしれない。 我々は来たる2月のFOMC議長就任に関して、パウエル氏への移行は円滑に進むと予想しており、それにより金融政策の段階的正常化が確実となるだろう。パウエル氏はFF金利を推定の終点である2.75%に徐々に近づける過程で波風を立てたくないはずだ。4 我々がFOMC指導部の移行が円滑に行われると断言する理由はいくつかある： FRB議長の前例：過去のFOMC指導部交代において、平均すると金融政策の軌道は約13か月間継続してから方向転換した（チャート10）。例えば、グリーンスパン退任（2006年2月）の後、バーナンキ前議長はさらに4回の利上げを続け、引き締めサイクルは2006年6月にピークに達した。イエレン前議長は2014年初めにバーナンキが去った後、ほぼ2年間ゼロ金利政策（ZIRP）を維持した。グリーンスパン議長はボルカーが始めた引き締めの軌道を維持したが、1987年の株式市場クラッシュ後にクレジットクランチを回避するため一時的に中断した。その後グリーンスパン議長は1年以上にわたり利上げを再開した。コンフォーミングな中道派として知られるパウエル議長も先人の流れに従うだろう。米国の金融政策は、世界成長に対する予期せぬショックやインフレの想定外の軌道の逸脱がない限り、イエレン前議長の政策から大きく変わらないだろう。 Chart 10 Fed Chair Precedents: Continuous Monetary Policy Path FRB議長の先例：継続的な金融政策の道筋 FRB議長の先例：継続的な金融政策の道筋 FOMCの構成変化：地域連銀総裁のローテーションに伴い、毎年FOMCの投票メンバーは異なる顔ぶれになる。今年は複数の地域総裁の退任と理事会の空席で不確実性が高まっている。2018年の投票FOMCメンバーの構成は2017年に比べややタカ寄りになるだろう（チャート11）。金融政策の連続性と有効性は、先物市場で既に織り込まれている今後の追加利上げ（少なくとも2回）や2018年に期待されるさらに3回の利上げ見込みによりさらに促進されるだろう。ミネアポリス連銀総裁カシュカリとシカゴ連銀総裁エバンスは今年、投票権のないメンバーとして退任する。カシュカリは最もハト派と見なされ、2020年に投票権を持つメンバーとして戻る予定であり、エバンスは2019年に復帰するだろう。 Chart 11 Composition Of Voting FOMC Members 2017 Vs. 2018 円滑な移行？ 円滑な移行？ 対照的に、クリーブランドのメスター、サンフランシスコのウィリアムズ、リッチモンドのバーキンの到着は政策をややタイト寄りに傾ける。最も重要なのは、ニューヨーク連銀のダドリー（中道派）がイエレンの任期が来月満了してから約5か月後に退任することである。オバマ政権時代に任命された理事のレール・ブレイナードは、現存する2人のハト派のうち最もハト派の投票者として残るだろう。FOMCのタカ派寄りの傾向はもはや認識の問題ではなく現実のものになる。トランプ大統領によるマーウィン・グッドフレンドの理事指名は中立化に向けた動きを促すはずだ（グッドフレンドは必ずしも明確なタカ派ではなく、デフレ対策にも慎重である）とともに、2018年に少なくとも4人の理事でFRBが運営されることを確実にするだろう。グッドフレンドの承認が成功すれば、副議長と残る2名の理事の合計3つの空席だけが残ることになる。限界的には、2018年のFOMC投票メンバーは若干タカ派寄りに傾くが、歴史は新議長が急激な政策転換よりも段階的な移行を好むことを示唆している。 FRBの空席：理事会の3つの未埋めの空席は、来月のイエレンからパウエルへの円滑な指導権移行を妨げるべきではない。近年、FRBの空席の継続期間は過去の年と比べて長くなっている。超党派政策センターの最近の報告によれば5、長期にわたる空席は13の独立金融規制機関の中でFRBに最も顕著に見られる。1986年以降のFRBの空席率67%は、1947年〜1986年の21%を大きく上回っている（チャート12）。同センターはまた、2000年1月1日以降、連邦準備理事会に少なくとも1つの空席がある期間が80%以上であったと計算しており、「満員のFRB理事会はかつての空席ほど珍しい」という点を強調している。FOMCは1947年〜1986年の間は大部分（79%）で満員であったが、過去30年ではその割合は3分の1（33%）に過ぎなかった（チャート13）。したがって、FOMC構成の構造的変化でさえ、2015年12月のゼロ金利政策からの離陸（2006年6月以来の初の利上げ）や昨年9月のFRBバランスシート正常化の開始を妨げることはなかった。投資家への示唆は、FOMCはかなり前から高い空席率の下で運営しており、そのような状況に慣れているため、空席は今年のFRBの政策軌道やイエレンからパウエルへの移行において大きな役割を果たすべきではないということである。 Chart 12 Vacancies Are Now The Norm スムーズな移行？ スムーズな移行？ Chart 13 More Than One Vacancy Is Not Uncommon Too スムーズな移行ですか？ スムーズな移行ですか？ FOMCにおける反対意見：FRB理事会の定員未満であっても、2005年以降理事による反対はなかった（チャート14）。我々は過去のサイクルと同程度の頻度の反対があると予想している。2017年の4件の反対はいずれも地域連銀総裁によるものであった。イエレン議長は理事会のメンバー時代にも、サンフランシスコ連銀総裁時代にも意見の不一致を表明したことはない。注目すべきは、パウエル次期議長は2012年に理事会に加わって以来、反対票を投じたことがないことである。さらに、理事会メンバーによる反対表明は通常より緩和的な政策を求めるものであった（78%が緩和志向で、28%が引き締め志向）。例えば、2015年秋のサイクル最初の利上げ前に、2人のハト派のFRB理事がイエレン議長に反対した。ブレイナード理事とタルーロ理事は、インフレが依然として低すぎると考え、利上げを2016年に先送りすべきだと主張した。彼らは先行きリスクが下振れ要因として残るため、早まって行動するより「待って様子を見る」方がリスクが低いと考えた。この意見の相違の一因は、市場ベースのインフレ期待に関する見解の相違にあった。原油価格と密接に関連して、市場ベースの長期インフレ期待は低下していた。同様に2017年にはミネアポリス連銀総裁カシュカリとシカゴ連銀総裁エバンスが懸念を示して意見を異にした。彼らは、低インフレの持続がFOMCが述べたような純粋に「一時的な要因」によるものとは限らないと主張した。 Chart 14 Dissent By Reserve Bank Presidents And Fed Governors スムーズな移行？ スムーズな移行？ 結論：2018年にFRB政策に最も重大な影響を与えるのは、FRBの構成ではなく経済とインフレの軌跡だ。2017年12月のFOMC会合ではインフレや名目GDPターゲティングの採用を検討する支持が一部にあったが、FRBは現行の政策にコミットし続けるだろう。一方、パウエル新議長は前任者と同様に利上げに対して段階的なアプローチを維持する可能性が高いが、FOMC投票メンバーの構成はわずかにタカ寄りである。2018年初めの理事会の空席はリスクではあるが、過去の空席が劇的な政策変更を引き起こしたことはない。BCAは今年3〜4回の利上げを予想しているが、ポートフォリオのリスクを軽減するにはまだ時期尚早である。株式を債券に対してオーバーウェイトで維持せよ。 John Canally, CFA, シニア・バイス・プレジデント 米国インベストメント・ストラテジー johnc@bcaresearch.com Jizel Georges, シニア・アナリスト jizelg@bcaresearch.com 1 BCAリサーチのU.S. ボンド・ストラテジー ウィークリー・レポート「January Effect」、2018年1月9日掲載を参照のこと。usbs.bcaresearch.comで入手可能。 2 BCAリサーチのU.S. エクイティ・ストラテジー ウィークリー・レポート「Girding For A Breakout」、2017年5月1日掲載を参照のこと。uses.bcaresearch.comで入手可能。 3 BCAリサーチのU.S. エクイティ・ストラテジー インサイト「What's Up With SPX Revenue Vs. Profit Revisions」、2018年1月12日掲載を参照のこと。uses.bcaresearch.comで入手可能。 4 https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20171213.pdf 5 "Financial Regulators Struggling With Longer Vacancies At The Top", Schardin, Justin and Sheth, Ashmi, Bipartisan Policy Center, March 2017.

ハイライト 日本経済は好調です。これにより日銀はQQE（量的・質的金融緩和）プログラムから段階的に離脱することが可能になっています。 しかし、インフレが金融環境の直接的な関数であり続けるため、YCC（イールドカーブ・コントロール）プログラムは当面維持されるでしょう。 円のポジショニングとバリュエーションがこれほど歪んでいるため、特にユーロに対して円のリレーが生じる可能性があります。EUR/JPYをショートします。 米連邦準備制度と同様に、カナダ銀行（BoC）も今年に3回利上げするでしょう。しかし、市場はすでにカナダの利上げを米国よりも多く織り込んでいます。USD/CADはニュートラルを維持します。ただし、CADはNOKに対して下落圧力を受けるでしょう。CAD/NOKをショートします。 特集 チャート I-1 JPY 対 債券：決別 JPY対債券：決別 JPY対債券：決別 ここ数か月、USD/JPYに興味深い変化が起きました。米国の国債利回りから切り離され始めたのです（チャート I-1）。大部分は、2017年にドル指数が10%下落したことに起因するドル自身の弱さが反映されています。しかし昨年のドルの弱さにもかかわらず、9月7日以降は実質的に横ばいでした。円が債券利回りから切り離されたもう一つの要因は、欧州中央銀行（ECB）が独自の資産購入プログラムの終了を発表したことで、次に購入縮小の対象になるのは日銀だと見なされたことです。 1月8日、日銀はその方向に動き始め、長期JGBの買入れを縮小し始めました。その日以降、世界の債券は売られ、円も勢いを取り戻しました。我々は円のベア相場が終わったとは考えていませんが、ユーロに対してプレイ可能なリレーが生じる可能性が高いと見ています。 太陽は昇る 日銀が一部の金融刺激を取り除きたいと考えるのは正当です。日本経済は全てのシリンダーで稼働しており、改善は幅広く見られます。 資産価格の上昇と23年ぶりの低水準の失業率に支えられた消費者信頼感は過去最高水準に達しています（チャート I-2）。これは実質家計支出を引き続き支え、2015年から2017年初めまでの持続的な縮小の後、現在はほぼ年率2%のペースで成長しています。 家計支出を支えるもう一つの要因は賃金面です。契約賃金はすでに2006年以来の最速ペースで伸びており、残業代を除く賃金は1998年以来見られなかったペースで拡大しています（チャート I-3）。さらに、求人倍率は1974年以来の高水準にあります。これにより、安倍晋三首相が企業と賃上げを巡って繰り広げている圧力が実を結び、今春の賃金交渉で加速的な上昇が生じる可能性が高まります。 チャート I-2 日本の家計は意気軒昂 消費者信頼感調査 日本の世帯は活気にあふれている 消費者信頼感調査 日本の世帯は活気にあふれている チャート I-3 賃金成長が加速 賃金の伸びが加速している 賃金の伸びが加速している 企業の信頼感も急上昇しています。日本の製造業PMIは日本基準で高い水準にあり、現在54であり、中小企業の信頼感は工業生産の加速を示唆しています（チャート I-4）。 金融市場もこの状況を裏付けています。日経平均の急騰が投資家の注目を集めていますが、さらに印象的なのは小型株の強さで、2015年以降大型株を17%アウトパフォームしています（チャート I-5）。この動きは信用成長の回復と一致しており、通常は堅調な成長見通しと関連します。 我々の系列誌であるザ・バンク・クレジット・アナリストが開発したGDPモデルは、これらの諸現象を要約しており、日本の実質GDP成長率は2018年前半に年率3%に達する可能性があると予測しています（チャート I-6）。したがって、日本経済はさらに勢いを増すと見られます。 チャート I-4 日本企業も好況感を実感##br##している 日本企業も好調を実感している 日本企業も好調を実感している チャート I-5 小型株は明るい見通しを示唆##br##している スモールキャップは明るい見通しを示す スモールキャップは明るい見通しを示す チャート I-6 日本の成長は##br##勢いを持っている 日本の成長に勢いがある 日本の成長に勢いがある では、こうした改善を支えている要因は何でしょうか。 第一に、日本の財政の流れが変わりました。2012年から2016年にかけて財政政策は日本の経済活動に年間平均0.6%分のブレーキをかけていました。しかし2017年には財政政策は緩和に転じ、GDPに0.2%の押し上げをもたらしました。 第二に、日本は新興市場（EM）成長の回復から大きな恩恵を受けています。IMFによれば、新興市場の成長が1%ショックした場合、日本の成長に与える影響は50ベーシスポイントであり、これは米国への同じショックのほぼ5倍に相当します。これは日本の輸出の43%が新興市場向けであるためです。 第三に、新興市場の活動が日本に与える影響は、円の逆循環的な性質によって増幅されます。世界および新興市場の成長がより力強くなると円は弱含み、これが日本の金融環境を緩和します。この現象は昨年顕著に表れ、過去16か月で金融環境は1標準偏差分緩和しました。 これらの動きが成長改善と日銀のトーンの変化の土台を築いたのです。 結論： 日本は非常に好調です。消費者と企業の期待は高く、支出は増加しており、GDPはさらに加速する見込みです。財政引き締めの緩和、強い新興市場、そして金融環境の緩和がこれらの改善を支えています。日銀はこれに注目しています。 日銀はどこまで踏み込めるか？ 日銀はここ数か月、政策変更に動きたがっていました。2017年11月、日銀総裁の黒田氏は「リバーサル・レート」という概念について言及していました。リバーサル・レートとは、金利をそれ以下に下げると追加の利下げが経済活動にとって収縮的になる金利水準を指します。これは、その水準を下回ると金利の低下が銀行の金利マージンを損ない、商業銀行が民間部門への貸し出しを抑制し始めるためです。 日銀がリバーサル・レートについて声を大きくしていた理由は、このレートが商業銀行のバランスシートに保有される証券の量と逆相関関係にあるからです。商業銀行が政府債を多く保有している場合、金利が非常に低い水準に下がるとこれらの証券の評価額が上昇し、低い金利マージンの悪影響を相殺します。日本の問題は、日銀が政府の発行額より多くのJGBを吸い上げたため、銀行の保有残高が急速に減少していたことです（チャート I-7）。これはリバーサル・レートの上昇を意味し、日銀の政策運営がやや制約されていることを示していました。 12月にインフレが上振れサプライズを起こしたとき、金融市場は激しく反応しました。日本の名目利回りはあまり動きませんでしたが、日本のインフレ期待が急上昇し、それが日本の実質金利の急落を促しました（チャート I-8）。これは日本の金融環境を事実上緩和させ、日銀が資産購入を調整するための絶好の口実を作りました：債券購入の微調整による負の影響は緩和され、日銀の見解ではリバーサル・レートの低下により金融環境の制御を失うことはないと考えられたのです。 このような政策行動とレトリックの変化にもかかわらず、我々はまだイールドカーブ・コントロール（YCC）プログラムの終わりを予想していません。食料とエネルギーを除くインフレはわずか0.3%にとどまり、日銀の2%目標や1%ですら大きく下回っています。1%台は緩和をより現実的に解除するレベルでしょう。 さらに、日銀はやや板挟みの状況にあります。確かに経済は大きく改善していますが、これはインフレ動向を十分に説明するものではありません。日本の設備稼働率は日本のコアインフレ変動のわずか3%しか説明しておらず、世界の稼働率は10%にとどまります。むしろ日本のインフレを説明する最良の要因は金融環境（FCIs）でした。他のどの国でも金融環境がこれほどまでにインフレ動向を説明することはありません。最近の日本のインフレの動きは、2010年以来の日本の金融環境の変化と完全に整合しています。この関係に基づくと、食料とエネルギーを除くCPIは2018年6月に0.7%でピークに達する可能性が高いです（チャート I-9）。 チャート I-7 QQEのために##br##リバーサル・レートは低下している 日本のリバーサル・レートはQQEのために低下している 日本のリバーサル・レートはQQEのために低下している チャート I-8 インフレ期待の急上昇 インフレ期待の急上昇 インフレ期待の急上昇 チャート I-9 金融環境の緩和で##br##インフレは上昇している 金融環境が緩和されたため、インフレが加速している 金融環境が緩和されたため、インフレが加速している しかし、日銀が緩和をあまりに速く取り除けば、円は上昇し金融環境は急激に引き締まります。おそらくインフレは大幅に弱まり、当初の利上げ理由が無効化されるでしょう。これらの力学は少なくとも今後12～18か月はYCCが継続されることを示唆しています。 結論：日銀は間もなくQQEプログラムを完全に廃止するでしょう。しかし、これはイールドカーブ・コントロールの解除を意味するものではありません。これは日本のインフレが日銀の目標から極めてかけ離れていることと、日本のインフレ率が金融環境に非常に敏感であることの両方によります。したがって、よりタイトな政策による市場の反応としての強い円が金融環境を引き締めれば、インフレは崩壊し、引き締めの必要性自体がなくなってしまうのです。 投資への示唆 USD/JPYは割高で、購買力平価が示す公正価値より16%高く取引されています。さらに、円はGDP比4%の好ましい経常黒字に支えられています。加えて、グローバル投資家はデュレーションをアンダーウェイトしてきました。こうした現象は円にとってネガティブになる傾向があります。投資家が現在のようにデュレーションを大幅にアンダーウェイトしている場合、円がリレーする可能性が高まります（チャート I-10）。 確かに2014年にも投資家は現在と同様に債券にネガティブでしたが、USD/JPYは下落しました。これは当時、日銀が資産購入プログラムの拡大を発表したためです。今日は日銀がQQEを放棄する方向に動いており、これはショートカバーを伴うリレーを誘発する可能性が高いです。 では、投資家は円に対してどの通貨を売るべきでしょうか。我々はユーロが米ドルに代わる興味深い選択肢であると考えます。 現在、EUR/JPYは極めて割高です。長期的には、購買力平価ベースでEUR/JPYは通常のレンジから大きく外れて取引されています（チャート I-11）。さらに、金利差やリスクアペタイトを織り込む指標ではUSD/JPYはやや割高ですが、同様の比較でEUR/USDは非常に高値圏にあります。つまり、短期的なバリュエーションの観点からEUR/JPYは非常に需要が高い水準で取引されていることになります（チャート I-12）。したがって、戦術的にはこのクロスをショートするタイミングが徐々に整いつつあります。 チャート I-10 デュレーションのポジショニングは##br##円に上昇リスクを示唆 デュレーションのポジショニングは円の上方リスクを示している デュレーションのポジショニングは円の上方リスクを示している チャート I-11 EUR/JPYは割高 EUR/JPYは割高です EUR/JPYは割高です チャート I-12 EUR/JPYに対する戦術的リスク EUR/JPY向けタクティカル・リスク EUR/JPY向けタクティカル・リスク . EUR/JPYをショートすることを支持する追加の理由として、相対的な金融環境があります。ユーロ圏の金融環境は日本に対して米国よりもはるかに引き締まっています（チャート I-13）。その結果、セクターの偏りを調整しても、欧州株は現在日本株に対して米国株よりも大きくアンダーパフォームしています。これは、日本の相対的な経済見通しが米国と比較するよりもユーロ圏と比較した場合により明るいことを示しています。つまり、円は米ドルよりもユーロに対してより大きく上昇する余地があるということです。 最後に、ユーロと円の間のポジショニングも極めて偏っています。チャート I-14 が示すように、投機筋が同時にユーロをロングし円をショートしているとき、EUR/JPYはその後に調整を経験する傾向があります。 チャート I-13 ユーロ圏の金融環境は##br##米国よりも大きく引き締まった ユーロ圏の金融環境指数は米国のそれよりも一層引き締まった ユーロ圏の金融環境指数は米国のそれよりも一層引き締まった チャート I-14 ユーロの##br##偏ったポジショニング EURにおける偏ったポジショニング EURにおける偏ったポジショニング 以上の要因は円の大きなリレーの可能性を示唆しますが、このリレーの持続力は限定的である可能性が高いです。日銀が放棄しようとしているQQEは、ここ数か月にわたって半ばしか実施されておらず、債券買入れは8兆円の目標を大きく下回っていました。 日銀は当面YCCの維持にコミットしています。このプログラムを放棄して初めて円に対する持続的なサポートが生まれます。それまでは、どのような円のリレーも金融環境を引き締めインフレを傷つけるため、円高は「レンタル」するもの（短期的に借りるベット）であり、保有するものではありません。日本の最終的な政策金利が上昇できる余地はまだ小さいのです。 結論：QQEの放棄は円高を引き起こす可能性が高いです。そのリレーは、評価、ポジショニング、金融環境が欧州通貨と比べて特に悪化しているため、ユーロに対して最も顕著になるでしょう。明確に言えば、円高は反動的な動きとなる可能性が高く、強い円は日本に深刻なデフレ圧力を与えるため、日銀のYCCプログラムは堅く維持されるでしょう。我々はEUR/JPYを133.79でショートしています。 CAD：BoCとNAFTAの狭間に チャート I-15 カナダは賃金上昇を経験する見込み Canada:##br## インフレ環境が出現 カナダの賃金は上昇する見込み カナダ：インフレ圧力が高まり始めている カナダの賃金は上昇する見込み カナダ：インフレ圧力が高まり始めている カナダ銀行（BoC）は来週会合を開き、今月政策金利を引き上げる確率が高まっています。カナダ経済も国内部門主導で非常に堅調です。実質消費支出は約10年ぶりの速さで伸び、失業率は40年ぶりの低水準にあり、設備投資は2014年から2016年の原油価格暴落で打撃を受けた後回復しています。 この背景により、カナダ経済は既に自国のキャパシティ制約に達しつつあります。BoCはカナダの産出ギャップが閉じたと見積もっています。さらに、最近のビジネス・アウトルック調査はこのメッセージを裏付けています：記録的な割合のカナダ企業がキャパシティ制約のため需要に応えられないと述べており、人手不足の数と深刻度の増加は労働市場の逼迫を示しています（チャート I-15）。逼迫したキャパシティと賃金上昇は、すでに可視化されているコアインフレの回復を支えるでしょう。現在コアインフレはすでに1.8%に達しています。 その結果、我々はBoCが今年はFRBと同程度に利上げするだろうと見ています。しかし、この展開がCADに与える影響は限定的かもしれません。投資家は今後12か月でカナダの利上げを米国より多く織り込んでおり、それぞれ82ベーシスポイント対60ベーシスポイントとなっています。さらに、投機筋は再びルーニー（カナダドル）を大幅にロングしており、強い経済指標が実際にCADをさらに押し上げるためのハードルは高いままです。 さらに、NAFTAはカナダにとって依然大きなリスクです。当社のチーフ・ジオポリティカル・ストラテジスト、マルコ・パピッチが11月のスペシャル・レポートで述べたように、トランプ大統領はNAFTAの破棄に関してほとんど制約がない権限を持っています（表 I-1）。1 もしNAFTAが崩壊すれば、カナダは最終的に依然として優遇措置のあるカナダ・米国自由貿易協定に戻る可能性が高いでしょう。したがって、カナダと米国間の貿易への影響は一時的である可能性が高いです。しかし、痛みの大部分はカナダの設備投資に及ぶはずです。NAFTA解消に伴う高い不確実性は企業にカナダでの拡張計画を放棄させ、北米の生産能力を直接米国で拡大させるよう促し、サプライチェーンにおける規制リスクを回避するでしょう。これによりカナダの将来の成長プロファイルは抑制されます。 表 I-1 トランプは貿易に関してほとんど制約を受けない 円：QQEは終わった！YCC万歳！ 円：QQEは終わった！YCC万歳！ 石油がCADの穴埋めをする可能性は低いです。ブレントがほぼ70米ドル/バレルに達した時点で、当社のコモディティ＆エネルギー戦略担当の目標に到達しました。OPEC 2.0は価格がさらに大幅に上昇することを容認しないでしょう。なぜならそれはシェール生産者に能力拡大のインセンティブを与え、2014年前の供給過剰のダイナミクスを再生してしまうからです。さらに、カナダにとって最も関連性の高い指標であるウエスト・カナダ・セレクト（WCS）はWTIやブレントに対して大きくディスカウントされたままです。これはアルバータ州外に油を輸送するパイプライン容量が不足しているためで、カナダは自国の石油に溺れている状況です。この状況はすぐには変わりません。 チャート I-16 CAD/NOKは伸び過ぎている CAD/NOKは行き過ぎている CAD/NOKは行き過ぎている これらを踏まえ、我々は12か月ベースでUSD/CADを中立と見ていますが、今後数週間で1.29への戻りは起こり得ると考えます。しかし、カナダ産原油がディスカウントで取引されている一方で、CADはG10のもう一つのペトロ通貨であるNOKよりも良好に推移しています。これは、CADのリスクを織り込むよりクリーンな方法としてCAD/NOKのショートが考えられることを示唆しています。 第一に、カナダドルは現在ノルウェークローネに対して非常に割高で、購買力平価比で11%高く取引されています（チャート I-16）。生産性やコモディティ価格のような他の要因で調整しても、CADは1994年以来の最大のNOKに対するプレミアムで取引されています。これはCAD/NOKにとってリスクを示します。ルーニーは貿易政策リスクにさらされている一方、ノッキー（NOK）はそうではありません。 第二に、国際収支の面はNOKにとって非常に有利です。ノルウェーは経常収支黒字がGDP比で5.5%であるのに対し、カナダは2.8%の赤字です。さらに、ノルウェーはGDP比210%のネット国際投資ポジション（NIIP）を有しており、G10で最大です。強いNIIPは実効実質為替レートの上昇と関連します。 第三に、カナダ経済の勢いは投資家によく知られているため、投資家がCADをこれほどロングし、BoCから多数の利上げを期待している理由となっていますが、ノルウェーの良好な側面は見過ごされています。ノルウェーの先行指標は依然上昇しており、産業生産と実質GDP成長は加速しています。 第四に、ノルゲス銀行はNOKの弱さに反応しています。12月の会合で同行はトーンを調整し、NOKはノルウェー中央銀行の目から見ると金融環境を過度に緩和していると述べました。これはノルウェーから期待される25ベーシスポイントの利上げが過小評価されている可能性を示唆します。また、カナダとノルウェーの間で期待される12か月の利上げ差が現在約60ベーシスポイントと異常に開いていることが正常化する可能性も示しています。 最後に、CAD/NOKは長期的および短期的なヒストリカルレンジの上限に向かって取引されています。CADのポジショニングはロング側にかなり偏っていますが、ノルウェークローネは投機筋によりショートされています（ノルゲス銀行のデータ）。したがって、NAFTAの不確実性、BoCの見通しが既に織り込まれていること、WCSとブレントのディスカウントが縮小する可能性が低いことを考えると、リスクはCAD/NOKの下落方向に偏っています。 結論: カナダ経済は好況です。これはBoCがFRBに歩調を合わせ、今年少なくとも3回は利上げすることを意味します。しかし、市場はすでに米国よりもカナダの利上げを多く織り込んでいます。さらに、原油価格の上方余地は限られており、WCSベンチマークは引き続きブレントに対して大幅なディスカウントで取引されるでしょう。したがって、USD/CADは上値余地が限定的である一方、下値も限定的です。しかし、CAD/NOKは現在水準から多くの下落リスクを抱えています。我々は今週このクロスをショートし、エントリーポイントを6.398に設定します。 マチュー・サヴァリー, 副社長 外国為替ストラテジー mathieu@bcaresearch.com 1 BCAのグローバル・インベストメント・ストラテジー スペシャル・レポート「NAFTA - Populism Vs. Pluto-Populism」（2017年11月10日付）を参照ください。gis.bcaresearch.comで入手可能です。 通貨 米ドル チャート II-1 USD テクニカル 1 米ドルのテクニカル 1 米ドルのテクニカル 1 チャート II-2 USD テクニカル 2 米ドル テクニカル 2 米ドル テクニカル 2 米国の最近のデータは混在しています： 非農業部門雇用者数は下振れし、148千人となりました。 さらに、労働参加率は下振れし、62.7%となりました。 ISM非製造業PMIも予想を下回り、55.9となりました。 しかし、消費者信用の変化は予想を上回り、279.5億ドルとなりました。 週の始め、ドルは強含みで始まりましたが、やがて収束しました。背景には比較的タカ派的なECB議事録や日本の政策調整があります。総じて、市場がフェドのドットプロットを織り込み続けるため、ドルに上昇圧力がかかると予想しています。 レポートリンク： A Cold Snap Doesn't Make A Winter - 2018年1月5日 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - 2017年12月15日 ユーロ チャート II-3 EUR テクニカル 1 EUR テクニカル指標 1 EUR テクニカル指標 1 チャート II-4 EUR テクニカル 2 EUR テクニカル指標 2 EUR テクニカル指標 2 ユーロ圏の最近のデータは良好でした： コアインフレは予想を上回り、1.1%となりました。 さらに、経済センチメント指標も予想を上回り、116となりました。 小売売上高の前年比成長も上振れし、2.8%となりました。 最後に、失業率は8.8%から8.7%に低下しました。 ポジティブなデータにもかかわらずユーロは今週下落しました。ユーロは週初は弱含みでしたが、その後ECBのタカ派的議事録を受けて急騰しました。これは米国での利上げ期待の高まりによるものです。総じて、日銀が超ハト派政策を後退させる余地はECBよりも大きいため、EUR/JPYは下押しされると予想します。 レポートリンク： A Cold Snap Doesn't Make A Winter - 2018年1月5日 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 The Xs And The Currency Market - 2017年11月24日 円 チャート II-5 JPY テクニカル 1 JPY テクニカル 1 JPY テクニカル 1 チャート II-6 JPY テクニカル 2 JPY テクニカル分析 2 JPY テクニカル分析 2 日本の最近のデータは混在しています： 現金給与の前年比成長は予想を上回り、0.9%となりました。10月からも増加しています。 しかし消費者信頼感は下振れし、44.7となり前月から低下しました。 今週、円は急上昇しており、USD/JPYは1.7%下落しました。これは日銀が長期債の買入れを減らす意向を示したためです。市場はこれを日銀が超ハト派の金融政策からの出口に動き始めるシグナルと解釈しました。これらの動きは、特にユーロに対して円に上昇圧力を与え続けるでしょう。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 Riding The Wave: Momentum Strategies In Foreign Exchange Markets - 2017年12月8日 The Xs And The Currency Market - 2017年11月24日 英ポンド チャート II-7 GBP テクニカル 1 GBPのテクニカルズ 1 GBPのテクニカルズ 1 チャート II-8 GBP テクニカル 2 GBP テクニカル分析 2 GBP テクニカル分析 2 英国の最近のデータは混在しています： 鉱工業生産の前年比成長は予想を上回り、2.5%となりました。 さらに、製造業生産の前年比成長も上振れし、3.5%となりました。 しかし、Halifaxの住宅価格の前年比は予想を下回り、2.7%となり、月次では0.6%の下落となりました。 今週ポンドは対ドルで横ばい、一方で対ユーロでは約1%下落しました。総じて、イングランド銀行（BoE）は大幅な利上げ余地が限られています。さらに、利上げとポンド高の結果としてインフレは緩和し始めるはずで、これがポンドに下押し圧力をかけるでしょう。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 The Xs And The Currency Market - 2017年11月24日 Reverse Alchemy: How To Transform Gold Into Lead - 2017年11月3日 豪ドル チャート II-9 AUD テクニカル 1 AUDのテクニカル分析 1 AUDのテクニカル分析 1 チャート II-10 AUD テクニカル 2 AUD テクニカルズ 2 AUD テクニカルズ 2 オーストラリアの最近のデータは混在しています： 建築許可の前年比成長は予想を上回り、17.2%となりました。 しかし、11月の貿易収支は予想を下回り、-6.28億となりました。前月の-3.02億から悪化しています。 AUD/USDは今週横ばいでしたが、AUD/NZDは約1%下落しました。世界経済の成長は依然強いものの、韓国や台湾の輸出成長などの主要指標は減速に転じています。さらに、中国のマネーサプライ成長は減少を続けています。これらは中国の工業活動の一時的な減速を示唆しており、AUD/USDの弱含みにつながるでしょう。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 The Xs And The Currency Market - 2017年11月24日 通貨ヘッジ：動的か静的か？ - グローバル投資家のための実践ガイド - 2017年9月29日 ニュージーランド・ドル チャート II-11 NZD テクニカル 1 NZDテクニカル 1 NZDテクニカル 1 チャート II-12 NZD テクニカル 2 NZドルのテクニカル指標 2 NZドルのテクニカル指標 2 キウイは年初来でほぼ5%上昇しており、世界成長が堅調に推移していることを反映しています。総じて、NZDは今年AUDをアウトパフォームすると予想します。ニュージーランドは金融環境の引き締まりに対してオーストラリアよりも感応度が低いためです。しかし長期的には、上昇余地は限定的です。新しいポピュリスト政権は移民抑制と、RBNZに複数目標（デュアル・マンダテ）を課すことを公約しており、これらはニュージーランドの中立金利を押し下げ、キウイに下押し圧力をかけるでしょう。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 The Xs And The Currency Market - 2017年11月24日 Reverse Alchemy: How To Transform Gold Into Lead - 2017年11月3日 カナダドル チャート II-13 CAD テクニカル 1 CADのテクニカル 1 CADのテクニカル 1 チャート II-14 CAD テクニカル 2 CADのテクニカル指標 2 CADのテクニカル指標 2 カナダの最近のデータは概ね良好でした： 失業率は5.9%から5.7%へと改善し、ポジティブなサプライズとなりました。 さらに、雇用者数の純増も予想を上回り、78.6千人となりました。 住宅着工件数の年間成長も予想を上回り、217千戸となりました。 しかし、Ivey購買担当者指数は予想を下回り、60.4となりました。 USD/CADは火曜日、トランプがNAFTAから撤退するとの報道を受けて急騰しました。総じて、カナダドルの上値余地は限定的であると考えています。市場はすでにカナダの利上げを米国より多く織り込んでいるためです。この弱さはCAD/NOKのショートで利用できる可能性があります。複数の指標でこのクロスは大きく過大評価されています。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 The Xs And The Currency Market - 2017年11月24日 Market Update - 2017年10月27日 スイスフラン チャート II-15 CHF テクニカル 1 CHF テクニカル 1 CHF テクニカル 1 チャート II-16 CHF テクニカル 2 CHF テクニカル指標 2 CHF テクニカル指標 2 スイスの最近のデータは良好でした： ヘッドラインインフレは予想通り0.8%でした。一方で月次のインフレは上振れし、0%となりました。 失業率も非常に低い水準で予想通り3%でした。 最後に、小売売上高の前年比成長は前月の2.6%に対し-0.2%と大きく上振れしました。 EUR/CHFは先週から比較的横ばいです。総じて、フランの上昇余地は限定的だと見ています。SNBは対外為替市場で積極的に介入を続けるでしょう。SNBが政策を変更するためには、スイスのインフレが相当期間高水準で推移する必要があります。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 The Xs And The Currency Market - 2017年11月24日 長期フェアバリューモデルの更新 - 2017年9月15日 ノルウェー・クローネ チャート II-17 NOK テクニカル 1 NOK テクニカル指標 1 NOK テクニカル指標 1 チャート II-18 NOK テクニカル 2 NOK テクニカル 2 NOK テクニカル 2 ノルウェーの最近のデータは混在しています： ヘッドラインインフレは予想を上回り、1.6%となりました。 さらに、コアインフレも上振れし、1.4%となりました。 しかし製造業の生産成長は予想を下回り、0.3%となりました。 USD/NOKは原油価格が70ドル近辺に迫る中、約0.7%下落しています。それでも、USD/NOKの上値余地はここから限定的だと考えています。市場はフェドのさらなる利上げを織り込み始めるでしょう。それでも、より強い原油を見込む投資家はEUR/NOKをショートすることを検討できるでしょう。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - 2017年12月15日 The Xs And The Currency Market - 2017年11月24日 スウェーデン・クローナ チャート II-19 SEK テクニカル 1 SEK テクニカルズ 1 SEK テクニカルズ 1 チャート II-20 SEK テクニカル 2 SEKのテクニカル分析 2 SEKのテクニカル分析 2 2017年末に急落した後、USD/SEKは今年に入って比較的横ばいです。総じて、イングヴェス総裁は依然として非常にハト派ですが、最新の議事録では金融政策の変更が近づいていることを認めました。一方、副総裁のヤンソンは資産購入を継続することを支持しつつも、レポ金利を据え置くことは「受け入れがたい」と述べました。金融環境の引き締まりによるユーロ圏の減速を見込む投資家はEUR/SEKをショートすることを検討できます。 レポートリンク： 10 Charts To Digest With The Holiday Trimmings - 2017年12月22日 Canaries In The Coal Mine Alert 2: More On EM Carry Trades And Global Growth - 2017年12月15日 The Xs And The Currency Market - 2017年11月24日 トレード & 予測 予測サマリー コア・ポートフォリオ 戦術的トレード クローズド・トレード

Highlights U.S. Treasuries: U.S. Treasury yields are too low relative to the strength of global economic growth and the rising trend in U.S. inflation expectations. Maintain below-benchmark duration exposure in the U.S., stay underweight Treasuries versus global bond benchmarks, and continue to favor TIPS over nominals. Canada: The Canadian economic data is moving from strength to strength, and now price and wage inflation data is moving higher. The Bank of Canada will hike rates next week with additional increases likely in 2018. Remain underweight Canadian government bonds and stay long inflation protection (both through linkers and CPI swaps). 2017 Model Portfolio Performance Wrap-Up: We closed the books on the first full calendar year of our model bond portfolio with a total return of 3.75%. This was a small -13bps of underperformance versus our custom benchmark, coming entirely from underweight positions on longer-dated developed market government bonds that offset the asset allocation gains from overweights to corporate debt. Feature Chart of the WeekGlobal Bond Yields Are Too Low 2018 has started much as 2017 ended, with growth-sensitive assets rallying alongside robust economic data. Most major global equity markets are already up 2-3% after the first week of the year, with the U.S. NASDAQ, Japanese Nikkei and Italian MIB indices advancing over 4%. Global credit markets are also off to a strong start, with spreads for U.S. High-Yield corporate debt and EM hard currency corporate debt tighter by -17bps and -8bps, respectively. Even commodity markets have joined the party, with the benchmark Brent oil price hitting the highest level in nearly three years. The pro-growth, pro-risk backdrop is keeping upward pressure on global government bond yields. This is occurring primarily through the inflation expectations component of yields, which are rising in all developed economies (even Japan). Real yields, which are not rising despite the strength of the broad-based global growth upturn (Chart of the Week), have been drifting lower, providing some offset to rising inflation expectations. The primary trend for global yields remains upward, however - especially if growth remains solid and inflation expectations continue to push higher, giving central banks like the U.S. Federal Reserve the confidence to continue hiking interest rates. We continue to favor below-benchmark duration exposure, and overweight corporate bond allocations versus government debt, for global fixed income investors over the next 6-9 months. U.S. Treasuries: Still More Reasons To Sell Than Buy U.S. Treasury market participants have a lot to things to be nervous about at the moment. Likely future Fed rate hikes, the weakening U.S. dollar, rising oil prices, ongoing U.S. labor market strength, persistently booming economic growth, the never-ending equity bull market, the potential impact of the Trump fiscal stimulus, the Fed starting its balance sheet runoff - all factors that should force bond investors to expect yields to rise. Yet longer-dated Treasury yields continue to trade too low relative to the bond-bearish fundamentals. The current benchmark 10-year Treasury yield at 2.48% remains well below the fair value from our 2-factor regression model, which is now up to 2.94% (Chart 2). That valuation gap of 46bps is close to the widest levels seen in July 2016 and September 2017, which were both episodes that proved to be excellent entry points for bearish Treasury positions. The two inputs into our Treasury yield model are the global manufacturing PMI and bullish sentiment towards the U.S. dollar (USD). The PMI is included as an indicator of global growth and currently sits at 54.5 - the highest level in nearly seven years - led by strong readings in almost every major economy (Chart 3). This has been the primary driver of the fair value for the 10-year Treasury yield since global growth bottomed out and began to accelerate in mid-2016. Chart 210-Year Treasuries Are##BR##Overvalued On Our Model Chart 3Global Growth##BR##Is Booming Sentiment towards the USD is the second input to our Treasury model. It is included as a weakening greenback represents an easing of monetary conditions that could trigger a need for more Fed rate hikes that can push the Treasury curve higher from the short-end (and vice versa for a rallying USD). At the same time, a depreciating USD can drive U.S. inflation higher through higher costs of imported goods & services, which can raise bond yields through higher inflation expectations or greater Fed tightening expectations (again, the opposite holds true for a strengthening USD). Right now, both the strong PMI and weak sentiment towards the dollar are boosting the fair value of the 10-year Treasury yield. The fall in value of the greenback is particularly unusual, as it is flying in the face of widening interest rate differentials between the U.S. and the rest of the world (Chart 4, top panel). This is clearly a function of the fact that global growth is rapidly improving - especially in Europe - but very few central banks have yet to respond to that growth with interest rate hikes that match what the Fed has been delivering. So while actual interest rate differentials remain USD-supportive, expectations of some eventual tighter monetary policy outside the U.S. that could narrow those interest rate gaps are triggering speculative inflows into non-USD currencies. With the trade-weighted USD now 5% below levels of a year ago, this should lead to higher headline inflation in the U.S. in the next few months (middle panel). Combined with the continued strength in global oil prices, that means that the two biggest factors that weighed on realized U.S. inflation- the USD rally and oil price collapse of 2014/15 - are now both acting to boost inflation expectations (bottom panel). Throw in the growing body of evidence that a tight U.S. labor market that is putting gentle upward pressure on wage growth, and U.S. inflation expectations - which still remain 40-50bps below levels consistent with the Fed's inflation target - should continue to move higher in the next six months. Rising longer-term inflation expectations would typically result in bear-steepening pressures on the Treasury yield curve. That is not happening at the moment, however, with the 2-year/10-year Treasury curve still at a relatively flat 53bps at the time this report went to press. The flatness of the Treasury curve has worried investors, and even some Fed officials, given the well-known leading relationship between the yield curve and U.S. economic growth. It is too early to draw any conclusions between the shape of the curve and future U.S. economic growth, however, for several reasons: As mentioned above, inflation expectations are still well below levels consistent with the Fed's 2% inflation target on the PCE deflator (which translates to 2.5% on the CPI index used to price TIPS and CPI swaps). Both the European Central Bank (ECB) and Bank of Japan (BoJ) are still buying bonds through their asset purchase programs, although at a slower pace than previous years. This continues to depress local bond yields in Europe and Japan with spillover effects into the U.S. Treasury market - even as the Fed begins the slow runoff of Treasuries from its massive balance sheet. Data on mutual fund and ETF flows shows that there has been significant and sustained buying of bond funds by U.S. retail investors over the past couple of months. There has also been net selling of equity funds, however, suggesting that U.S. retail investors are rebalancing as the equity markets surge higher. Investor positioning in the U.S. Treasury market is very short at the moment, with the J.P. Morgan survey of "active" bond manager duration exposure at an all-time low and the net positioning on Treasury futures now slightly favoring shorts (Chart 5). It makes little sense to interpret a flattening Treasury curve as a signal that the bond market believes that the Fed was making a policy mistake if professional bond investors were running massive duration underweight positions that would benefit if bond yields rise. Chart 4Upside Pressure On U.S. Inflation##BR##From Oil & The USD Chart 5Big Duration Underweight##BR##Among U.S. Bond Managers All these factors muddy the economic signal provided by the Treasury curve at the moment. Nonetheless, we remain of the view that the Fed would not continue on its rate hiking path without U.S. inflation expectations moving sustainably back to levels consistent with the Fed's inflation target. In other words, the Treasury curve must bearishly steepen first through rising inflation expectations before bearishly flattening later through actual Fed rate hikes. The latter will dampen future U.S. growth expectations and eventually result in a cyclical peak in longer-dated Treasury yields, but from levels closer to 3% on the 10-year after inflation expectations "fully" normalize. Bottom Line: U.S. Treasury yields are too low relative to the strength of global economic growth and the rising trend in inflation expectations. Maintain below-benchmark duration exposure in the U.S., stay underweight Treasuries versus global bond benchmarks, and continue to favor TIPS over nominals. The Bank Of Canada Keeps On Playing Catch-Up The Canadian economic story continues to be the best within the developed world. The year-over-year growth rate for real GDP accelerated to over 3% late last year, primarily on the back of robust consumer spending (Chart 6). Even the lagging parts of the economy, like business investment and government spending, began to perk up last year. The momentum remained powerful at the end of 2017, with the unemployment rate in December hitting a 40-year low. The economic boom forced the Bank of Canada (BoC) to begin lifting interest rates last year, with two 25bp hikes occurring in July and September that unwound the easing from 2015. The rapid pace of growth has absorbed spare capacity much faster than the BoC originally projected. More hikes will be required if the current pace of growth is maintained, particularly with the BoC estimating that the neutral policy rate is around 3% and the current Overnight Rate is only at 1%. The Canadian consumer has been enjoying a powerful shopping spree. Real consumer spending growth is at 4% on a year-over-year basis - the highest level since early 2008 (Chart 7). This is led by a powerful surge in spending on consumer durables, where annual growth has surged to 10% (middle panel). Consumer confidence is booming and Canadian workers are enjoying the fastest pace of income growth since 2014 (bottom panel). Chart 6Robust Canadian Growth,##BR##Led By The Consumer Chart 7Canadian Consumers Are##BR##Confidently Spending Surprisingly, the powerful surge in consumer spending has occurred alongside some cooling of the overheated Canadian housing market. The growth rates of existing home sales and prices have both decelerated massively from the pace of the boom years in 2012-16 (Chart 8). The performance of house prices in the three biggest Canadian cities is now a mixed bag, with Vancouver prices reaccelerating, prices in Toronto decelerating and prices in Montreal growing only modestly (middle panel). Regulatory actions to limit the speculative buying of Canadian real estate by foreigners has helped dampen the surge in house prices in some markets. Although the bigger macro-prudential measures designed to tighten mortgage finance rules and reduce the amount of leverage in Canadian housing transactions has likely had a bigger effect. Canadian banks must now conduct stress tests to check if borrowers are able to pay off their mortgages if Canadian interest rates continue to rise. This represents a reduction in the marginal supply of riskier mortgage lending that will help restrain house price inflation in Canada's major cities. In addition, the supply of Canadian homes is growing with new home-building activity, both for single and multiple units, having picked up and overall residential investment growth now up nearly 5% on a year-over-year basis (bottom panel). With signs that the Canadian housing market has stopped rapidly inflating, the BoC can focus its interest rate policy on domestic growth and inflation considerations without worrying about pricking the housing bubble. On that front, the latest edition of the BoC's Business Outlook Survey, released yesterday, provided plenty of reasons to tighten monetary policy further. The overall survey indicator surged back to the peak seen last summer just before the BoC delivered its first rate hike (Chart 9). Capital spending intentions also rebounded back to the 2017 peaks, which bodes well for future gains in investment spending (second panel). Chart 8Canadian Housing Looking##BR##A Bit Less Frothy Chart 9BoC Business Outlook Survey Signaling##BR##Tightening Capacity Constraints The most interesting parts of the Business Outlook Survey were the capacity utilization measures. A greater share of companies were reporting labor shortages (third panel), with the highest percentage of firms reported difficulties in meeting unexpected increases in demand since 2007 (bottom panel). This suggests that the recent surge in employment, wage growth and price inflation are all sustainable. Headline and core CPI inflation are up to 2.1% and 1.8%, respectively, as of November. This is around the midpoint of the BoC's 1-3% target range (Chart 10). The Bank of Canada forecasts that CPI inflation will continue to rise and remain near 2% target in 2018, but all the risks are to the upside. The unemployment rate is now down to 5.7%, the lowest level since 1976 and well below the OECD's estimate of the NAIRU level at 6.5%. Average hourly earnings growth has surged in response, rising to just under 3% on a year-over-year basis since the trough in early 2017. The Phillips Curve appears to be alive and well in Canada. Canadian interest rate markets have already responded aggressively to the stronger growth and inflation data. Our interest rate discounters now show that the money markets are now expecting 61bps of BoC rate hikes over the next six months and 91bps over the next twelve months (Chart 11). With a 25bp hike at next week's BoC meeting now priced with almost full certainty, the current market pricing suggests at least one more hike will happen by June and nearly three more hikes by year-end. That would be even more hikes than we expect from the Fed in 2018, which is important for the Canadian dollar (CAD). The CAD has appreciated 16% since it bottomed out in early 2016, occurring alongside the rise in global oil prices over the same period (second panel). The price of Canada's Western Select grade of crude oil has lagged the move in other oil benchmarks massively over the past several months, due to a lack of pipeline capacity getting oil out of Alberta that has created a supply glut. This may limit the degree to which additional gains in global energy prices benefit the Canadian dollar from a terms-of-trade perspective. This will not prevent the BoC from delivering additional rate hikes, however - especially if that merely matches the 75bps of Fed rate hikes that the FOMC is projecting, and which we expect, over the rest of the year. In terms of investment strategy, the combination of robust Canadian economic growth and rising inflation pressures leads us to continue recommending an underweight stance on Canadian government bonds, as we have maintained since July 11, 2017. This week, we are introducing two new tactical trades that should benefit as Canadian inflation moves higher and the BoC tightens more aggressively in response (Chart 12): Chart 10The Canadian Phillips Curve Is Not Dead Chart 11The Market Now Expects A Lot From The BoC Chart 12Two New Tactical Trades In Canada Short the June 2018 Canada Bankers' Acceptance futures contact vs. the December 2018 contract (middle panel). The market is now discounting the likely maximum amount of tightening that the BoC can deliver by year-end, while there are only little more than two hikes priced by June. Assuming that the BoC hikes next week, that means that there is only one more hike expected by June. With three more BoC meetings scheduled between next week and June, that provides plenty of opportunities for hawkish surprises from the BoC before then. In other words, this trade is a way to play for the BoC being forced to front-load more rate hikes into the first half of 2018 versus the latter half. Long 10yr inflation expectations through linkers versus nominal government bonds, or using CPI swaps (bottom panel). Given the pickup in domestic inflation pressures currently underway, plus the rise in global inflation coming from the surge in commodity prices, there is room for Canadian market-based inflation expectations to rise from the current level of 1.7%. Bottom Line: The Canadian economic data is moving from strength to strength, and now price and wage inflation data is moving higher. The Bank of Canada will likely hike rates next week with additional increases likely in 2018. Remain underweight Canadian government bonds. 2017 GFIS Model Bond Portfolio Performance: A Brief Review The turn of the year marked the end of the first full calendar year for the Global Fixed Income Strategy (GFIS) model bond portfolio. This now allows us to report the performance of the portfolio on the same basis as our clients. In the future, we will publish quarterly reviews of the portfolio returns after the end of each quarter in a calendar year (in April, July, October and January). The GFIS model portfolio returned 3.45% in 2017. This underperformed our custom performance benchmark (a blend of the Barclays Global Aggregate Index with global high-yield corporate debt) by -13bps (Chart 13). That underperformance can be entirely attributed to our government bond duration allocations, which lagged the benchmark by -46bps. Our recommended credit positions were a positive contributor, generating 33bps of outperformance primarily through overweights to U.S. Investment Grade and High-Yield corporate bonds. The detailed breakdown of the 2017 returns is presented in Table 1. In terms of the government bond portion of the portfolio, the underperformance can be isolated completely to the longest maturity bucket (10+ years). The combined performance of that bucket for all countries lagged that of the benchmark by -52bps. Given our expectation that global yield curves would bear-steepen in the latter half of 2017, it is no surprise that the bulk of our underperformance came by having too little exposure at the long-end. Also, having too much exposure in Japanese government bonds offering no yield also represented a major drag on the income component of the model portfolio's returns (Chart 14). Chart 13GFIS Model Bond Portfolio##BR##2017 Return Breakdown Table 1GFIS Model Bond Portfolio##BR##2017 Return Breakdown In terms of our credit allocations, favoring U.S. corporate exposure vs. non-U.S. corporates was the right call, generally speaking (Chart 15). However, we did not have enough portfolio weight in that trade to offset the drag on the overall yield from the Japan government bond overweight. Chart 14GFIS Model Portfolio Government Bond Performance Attribution By Country Chart 15GFIS Model Portfolio Spread Product Performance Attribution Looking ahead, the new model bond portfolio allocation for 2018 that we discussed in our final report of 2017 should offer a better chance of outperforming the benchmark.1 Specifically, we dialed down the Japan overweight, increased the U.S. Investment Grade corporate bond overweight, and reduced the curve steepening exposure in Euro Area governments. This not only boosted the overall yield of the portfolio, but also moderated the overall portfolio duration underweight. This portfolio will do well in the first half of 2018 if our base case of an inflation-driven rise in global government bond yields, led primarily by the U.S. where corporate debt is also expected to outperform Treasuries, comes to fruition. Bottom Line: We closed the books on the first full calendar year of our model bond portfolio with a total return of 3.75%. This was a small -13bps underperformance of versus our custom benchmark, coming entirely from underweight positions on longer-dated developed market government bonds that offset the asset allocation gains from overweights to corporate debt. Robert Robis, Senior Vice President Global Fixed Income Strategy rrobis@bcaresearch.com Ray Park, Research Analyst ray@bcaresearch.com 1 Please see BCA Global Fixed Income Strategy Weekly Report, "Our Model Bond Allocation In 2018: A Tale Of Two Halves", dated December 19th 2017, 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

Highlights Upbeat economic reports for December set the stage for a solid 2018. The FOMC minutes acknowledged the flatter curve and only a minority of members discounted the signal from the curve. A majority thought that a tighter labor market would lead to higher inflation. The Citi Economic Surprise Index is peaking, but risk assets should hold up as the Index rolls over. Feature The first week of 2018 brought more good news for risk assets. U.S. stocks beat bonds, oil prices rose, and credit spreads narrowed amid a solid set of economic data. Several high-profile U.S. companies announced share buybacks, and/or one-time bonuses or wage increases linked to the tax cut plan passed by Congress at the end of 2017. Moreover, there were hints of further economic stimulus as lawmakers from both sides of the aisle discussed relaxing the sequester rules that would lift federal spending this year. Markets shrugged off a fresh round of saber rattling between the U.S. and North Korea. Gold prices nudged higher and the U.S. dollar fell despite the upbeat economic news. December's reports on manufacturing and service sector ISM, vehicle sales and the labor market, along with November's numbers on construction spending, trade and factory orders, all lifted estimates for Q4 GDP and boosted the prospects for corporate earnings in Q4 2017 and beyond. Chart 1 shows that the elevated ISM figures provide a favorable backdrop for earnings and sales in 2018. Moreover, Chart 2 indicates that IP, a proxy for S&P 500 sales, is poised to advance in 2018 and provide a lift to corporate profits. We will preview the S&P 500's Q4 2017 earnings reports in next week's U.S. Investment Strategy. Chart 1Favorable Macro Backdrop For Earnings And Sales Chart 2ISM Components Suggest IP Poised To Accelerate The Atlanta Fed GDP Now estimate stood at 2.7% on January 5, while the New York Fed's Nowcast for Q4 GDP was a healthy 4% (Chart 3). Both soundings are well above the FOMC's assessment of the economy's long-term potential growth rate (1.8%) and puts GDP growth in 2017 above the Fed's forecast. The implication is that the output gap pushed deeper into positive territory as 2017 ended, setting the stage for higher inflation in 2018. The December 2017 jobs report, released last Friday, January 5, does not change BCA's outlook for the U.S. economy or the Fed. The U.S. economy added a lower than expected 148,000 new jobs in December, which left the unemployment rate unchanged at 4.1%. Despite the softer than anticipated data, the 3-month average of payrolls growth is still a very healthy 204,000. The monthly increase in wages quickened to 0.3% m/m in December, up from 0.1% m/m last month. However, annual wage inflation remains modest at just 2.5% (Chart 4). Chart 3U.S. Economic Growth Well##BR##Ahead Of Potential In Q4 Chart 4Labor Market Still Tightening Despite##BR##Soft December Report The indications for Q4 GDP growth are solid. Aggregate hours worked rose 2.5% at an annualized rate in Q4 2017. Assuming modest growth in productivity, the payrolls data are consistent with over 3% GDP growth in Q4. There is nothing in the December payroll data to suggest that the underlying trajectory in the U.S. economy has changed. The economy continues to grow above trend. Wage gains are modest at the moment, but should accelerate as the labor market keeps tightening with above-trend GDP growth. This upbeat economic outlook is also supported the December 2017 non-manufacturing ISM survey, also released last Friday. While the overall index fell from 57.4 to 55.9, it is still consistent with solid GDP growth. Moreover, the employment index rose from 55.3 to 56.3, which signals firm job gains, and the prices paid index held steady at a fairly elevated level of 60.8. Bottom Line: It's been solid start to 2018 and it's steady as she goes for the U.S. economy and the Fed. FOMC Minutes: A Rubric BCA's U.S. Bond Strategy service expects that the 2/10 yield curve will languish between 0 and 50 bps in 2018. The curve will steepen from 51 bps at the end of 2017 through mid-year 2018, and then flatten into year-end (Chart 5). Which asset classes would benefit if our curve call is accurate? BCA's "The Bucket List"1 explains our view of the curve in 2018 and details the past performance of various U.S. assets in differing yield curve environments. Chart 5A Flat Yield Curve Is OK For Most Risk Assets BCA expects that the yield curve will first steepen in 2018, then become flatter, ultimately spending most of the year between 0 and 50 bps. A flat curve is the ideal environment for the S&P 500 and the stock-to-bond ratio. However, small cap stocks struggle when the curve is flat; BCA's view is that small caps will outperform large caps in 2018. A flat yield curve raises the risk of a sell-off in high yield, but provides a favorable grounding for oil, which is in line with BCA's fundamental view. BCA expects EPS growth will be positive this year; earnings growth is higher 75% of the time when the curve is flat. The yield curve's slope was a focus of debate at the FOMC's December 12-13, 2017 meeting. Participants cited several reasons for the flat curve2: recent increases in the target range for the federal funds rate; reductions in investors' estimates of the longer-run, neutral real interest rate; lower longer-term inflation expectations; lower term premiums Fed economists recently updated their quantitative assessments of the FOMC's minutes. The note provides a guide (Table 1 in the Fed paper3 and Tables 1 and 2 below) to the number of quantitative descriptors in the minutes (one, a couple, a few, etc.). We use this rubric to assess the committee's latest views on the yield curve and inflation. Table 1FOMC Assessment Of The Yield Curve Table 2FOMC Assessment Of Inflation In short, the FOMC acknowledged the flatter curve and only a minority of members discounted the signal from the curve. Moreover, a majority thought that a tighter labor market would lead to higher inflation. Only one participant held the view that secular trends were muting inflation. Bottom Line: BCA expects the Fed to deliver 3 to 4 rate hikes in 2018, which is still not fully priced in by the market. Investors should maintain below-benchmark duration in fixed income portfolios. Asset allocators should remain overweight stocks versus bonds. Growth is strong and the yield curve is not inverted yet. Therefore, it is still early to de-risk portfolios. Is Economic Surprise Peaking? The Citigroup (Citi) Economic Surprise Index is elevated relative to its recent history, but it may have further to run. Economic prospects were cheery following the 2016 presidential election and the economic data exceeded those lofty projections, aided by a warmer than usual winter. However, the temperate conditions borrowed activity from the spring, which was cooler and wetter than normal, and the combination of lofty expectations and seasonal distortions sent the Citi Economic Surprise Index spiraling lower through mid-year 2017. Since its bottom in June 2017 at -78.6%, the index climbed for 135 days before its peak in late December 2017 (Chart 6, panel 1). On average since 2010, the Citi Index moved from trough-to-peak in 96 days, which means the recent run-up was much longer than usual. However, that phenomenon may have been due to the raised economic expectations and variable weather patterns at the start of 2017. Chart 6Economic Surprise Index Has Surged, But Expectations Remain Muted At 80.7%, the Index has been above zero for 68 days (Chart 6, panel 1). It typically takes 46 days for it to climb from zero to its zenith. Table 3 shows the performance of financial markets and other assets after the Index moves from zero to the peak. The most recent episode (October through December 2017) matched historical averages across most asset classes, although the underperformance of small caps versus large ran counter to the past as the Surprise Index climbed from zero. Table 3Risk Assets Perform Well As Surprise Index Climbs Since 2010, the Index has stayed above 40 for an average of 51 days (Chart 6, panel 1). The Index has been over 40 since November 16, 2017, or 35 days. This suggests that it can remain elevated for another month or so before it again moves lower. However, the Index is mean reverting and investors wonder what will happen to risk assets after economic surprise rolls over. Table 4 and Chart 7 shows the performance of key financial markets and commodities when the Citi Index returned to zero from 40-plus. There have been six such intervals since 2010. On average, gold and oil perform well as the surprise index dips to zero. Stocks and credit outperform Treasuries during these episodes, and small caps beat large caps. Rising economic surprise (Table 3) is a more favorable environment for stocks, credit and oil than when the surprise index is rolling over. However, the performance of gold and small caps is better after the Citi Surprise Index peaks (Table 4). Table 4Risk Assets Hold Up When Citi Surprise Index Rolls Over Chart 7U.S. Assets As Economic Surprise Rolls Over Nonetheless, muted economic expectations will limit the downside in the Index in the coming months. Panel 3 of Chart 6 shows that the outlook for both hard and soft economic data remained muted through the end of November 2017, especially when compared with the significant improvement in economic prospects in late 2016 and early 2017. Bottom Line: Risk assets outperformed as the Citi Economic Surprise Index climbed in the second half of 2017. The Index can stay near recent peaks for several more months thanks to subdued economic forecasts, but it will roll over eventually. However, the elevated level of the Index suggests that there are near-term risks for equities and credit because a lot of good economic news is already priced in. Still, we recommend that investors ride out the volatility given our view that stocks will outperform bonds in the next 6-12 months. John Canally, CFA, Senior Vice President U.S. Investment Strategy johnc@bcaresearch.com 1 Please see BCA Research's U.S. Investment Strategy Weekly Report "The Bucket List", published December 18, 2017. Available at usis.bcaresearch.com. 2 https://www.federalreserve.gov/monetarypolicy/fomcminutes20171213.htm 3 https://www.federalreserve.gov/econres/notes/feds-notes/the-fomc-meeting-minutes-an-update-of-counting-words-20170803.htm

Highlights A "decision tree" for the allocation to Chinese stocks highlights several key questions for investors over the coming year. The equity allocation decision hinges on the condition of the global economy, the stance of monetary policy, the pace of structural reforms, and the character of the ongoing economic slowdown. Despite several identifiable risks, our "decision tree" suggests that investors should be overweight Chinese vs global stocks. Feature Unlike in past years, BCA's China Investment Strategy service published its 2018 themes report in December, as an addendum to BCA's special year end Outlook report.1 Our final report for 2017 echoed our key themes by recapping some of the most important developments in China last year, as well as their longer-term implications.2 These reports outline our framework for evaluating China's economy in 2018, and will serve as an important reference point over the coming months relating to the pace of China's economic slowdown, policymakers' actions and priorities, and investor attitudes toward Chinese assets. In today's brief report, we begin the New Year by walking through the Chinese equity "decision tree" that flows from the framework that we detailed in our themes piece noted above (Chart 1). The chart presents a set of questions that should be answered over the coming 6-12 months in order to decide on the ideal allocation to Chinese equities within a global portfolio. We elaborate on the decision tree below. Chart 1The Chinese Equity "Decision Tree" Is The Global Economy Slowing Significantly?: Developments in China need to be considered within a global context. We have noted in previous reports that a synchronized global economic slowdown was a key factor behind China's economic slowdown in 2015.3 If global growth were to slow significantly this year, it would bode poorly for the relative performance of Chinese stocks. Next week's report will discuss the evolution of the alpha and beta characteristics of China's investable stock market; while our research is still ongoing, the evidence suggests that Chinese equities in US$ terms have become a high-beta market that would likely suffer in relative terms if the global equity market stumbles. Chart 1 highlights that the appropriate allocation to Chinese equities vs global stocks is underweight if the answer to this first question is yes, with the upgrade/downgrade bias determined simply by whether there has been an appropriate response from Chinese and global policymakers. Is Significant Further Monetary Policy Tightening Likely?: Overly tight monetary policy was the second ingredient that contributed to the 2015 slowdown. Monetary conditions tightened somewhat in the first half of 2017 (Chart 2), but the overall stance is not restrictive. Taken alone, hawkish rhetoric from the PBOC would imply that significant further tightening is imminent. However our sense is that the bark of monetary authorities will be worse than their bite over the coming months, especially since growth momentum and house price appreciation has already peaked. Is The Pace Of Renewed Structural Reforms Likely To Be Aggressive?: October's Party Congress heralded stepped-up reform efforts in 2018 and beyond, which we have highlighted is a risk to a constructive stance towards Chinese stocks. While the "status quo" scenario of no significant reforms is highly unlikely, the intensity of reforms pursued over the coming year will have to be closely monitored by policymakers to avoid a repeat of the 2015 experience. Even if policymakers feel that their threshold for pain will be higher in 2018 than has previously been the case, they are very likely to avoid a significant slowdown as it would raise the risk of returning to the exact set policies that they are trying to turn away from. In other words, an intense pace of reform would risk turning a "two steps forward, one back" situation into a full-blown retreat from structural reform momentum. For now, our China Reform Monitor continues to suggest that reform intensity will be consistent with a rising equity market (Chart 3). Chart 2Chinese Monetary Conditions ##br##Have Tightened Chart 3Investors Don't Believe That Reforms##br## Will Upset The Apple Cart Is The Existing Slowdown In China's Growth Momentum Metastasizing? Our view of China's significant growth slowdown in 2015 suggests that the end of the recent economic "mini-cycle" is likely to be benign and controlled, absent a policy mistake or a major global shock. However, it is possible that the lagged effect of a deceleration in export growth and tighter monetary policy, both of which have already occurred, could cause a broader or deeper slowdown in economic growth beyond what we have already observed. In order to gauge this risk, we tested a wide range of commonly-watched macro data series for signs that they reliably lead economic activity in China,4 using the Li Keqiang index as our proxy for the business cycle. We concluded that measures of money & credit are among the most important predictors, and presented a composite leading indicator of the Li Keqiang index based on six series that passed our test criteria (Chart 4). For now, our indicator suggests that the Chinese economy will continue to slow over the coming months, but that the pace and magnitude of the decline will be benign and controlled. The first question in our decision tree is the easiest to answer: The highly synchronized nature of global economic growth suggests that a significant slowdown is not imminent, even if the pace of growth becomes narrower or slows modestly (Chart 5). While our decision tree highlights that answering "yes" to any of the last three questions means that investors should have a negative bias towards Chinese investable stocks (and should downgrade them in response to a technical breakdown), these questions are still addressing risks rather than probable events. This supports our current recommendation of being overweight Chinese investable equities with a positive bias. Chart 4The Chinese Economy##br## Will Gradually Slow Chart 5No Sign Of A Significant ##br##Global Economic Slowdown As a final point, some investors and market participants have noted that investable Chinese stocks experienced a non-trivial selloff at the end of 2017, with some questioning whether it is a harbinger of a more pronounced economic slowdown. Our answer is no, for two reasons. First, there is some evidence to suggest that the selloff was technical in nature, as the sectors that had experienced the largest gains prior to the selloff also experienced the largest declines (Chart 6). Second, the timing of the relative selloff in Chinese stocks coincided exactly with a relative selloff in the global tech sector (Chart 7), which is strongly indicative of a common, global, factor. But given the underlying strength in the global economy, we regard this event as idiosyncratic and do not view it as a threat to the relative performance of Chinese vs global stocks over the coming year. Chart 6The Late-Year Selloff Was Partially ##br##Driven By Technical Conditions Chart 7Global Tech Also Drove The Selloff##br## In Chinese Relative Performance Bottom Line: While there are several identifiable risks that need to be monitored in 2018, for now our "decision tree" for the relative allocation to Chinese equities suggests that investors should be overweight within a global equity portfolio. Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com 1 Please see BCA Special Report, "2018 Outlook - Policy And The Markets: On A Collision Course," dated November 20, 2017, and Weekly Report, "Three Themes For China In The Coming Year", dated December 7, 2017, available at cis.bcaresearch.com. 2 Please see China Investment Strategy Weekly Report, "Legacies Of 2017", dated December 21, 2017, available at cis.bcaresearch.com. 3 Please see China Investment Strategy Weekly Report, "Tracking The End Of China's Mini-Cycle", dated October 12, 2017, and "China's Economy - 2015 vs Today (Part 1): Trade", dated October 26, 2017, available at cis.bcaresearch.com. 4 Please see China Investment Strategy Special Report, "The Data Lab: Testing The Predictability Of China's Business Cycle", dated November 30, 2017, available at cis.bcaresearch.com. Cyclical Investment Stance Equity Sector Recommendations

Highlights Before re-capping the performance of our recommendations last year - up 77%, led by oil calls, which posted an average gain of 111% - we take a look at what the re-emergence of financial and monetary factors will mean for commodities this year. Fundamentals - supply, demand, inventories - drove the evolution of industrial commodity prices over the past two years, and will remain supportive for oil and, to a lesser degree, base metals in 1H18. Thereafter, in 2H18, we believe financial and monetary variables will begin to re-assert their importance in the evolution of commodity prices. Forecasting commodity prices becomes more difficult, as a result, as it is not clear the Fed or other systematically important central banks, understand what is driving their principal policy variables - particularly inflation - or how they are evolving. Despite these central-bank uncertainties, we remain long broad commodity exposure via the S&P GSCI (up 6.4% since it was recommended in Dec/17), long call spreads in Brent and WTI across 2018 deliveries (up 78%); and long gold (up 6.7%). 2018 Weightings Energy: Overweight. WTI and Brent crude oil forward curves will become more backwardated as the combination of OPEC 2.0 production discipline and continued strength in demand draws inventories lower. This will boost S&P GSCI returns.1 Base Metals: Neutral. Base metals will continue to be supported through 1Q18 by China's environmental reforms, which are reducing supply in the face of continued strength in global demand. Strong demand ex-China will offset weaker Chinese growth, supporting metals prices. Precious Metals: Neutral. While we expect four rate hikes by the Fed this year, we are wary of policy errors at systemically important central banks, which makes forecasting monetary policy highly uncertain. We remain long gold as a portfolio hedge. Ags/Softs: Underweight. Still-high supplies outside the corn market; policy uncertainty re NAFTA; and uncertainty over Fed policy likely keep grain prices weak. A stronger USD would weaken demand for U.S.-sourced grains and softs. Feature Chart of the WeekFundamentals Continue To##BR##Support Commodities That was quick! Oil prices are closely hewing to fundamentals as the year opens. We revised our Brent forecast to $67/bbl in early December (up from a $65/bbl forecast in mid-October 2017), based on our fundamental assessment of the market - supply, demand and inventories - and, voilà, contracts for Mar/18 delivery got there by the end of 2017. Our $63/bbl forecast for WTI is still ~ $2.50/bbl from being realized, but we continue to expect this gap to close. At the moment, fundamentals for industrial commodities - oil and, to a slightly lesser extent, base metals - will support firmer prices in 1H18 (Chart of the Week). For oil, this will be an extension of the fundamental realignment initiated by OPEC 2.0 at the end of 2016. The producer coalition agreed to remove ~ 1.1mm b/d from the market, which, along with another 300k to 400k barrels of natural declines, tightened the supply side considerably. On the demand side, the synchronized global economic upturn that powered consumption up by 1.65mm b/d last year, by our estimation, will push demand higher by 1.67mm b/d this year. Supply-side adjustments in base metals, particularly copper, where strikes and natural disasters combined to tighten markets, will be augmented by the ongoing environmental reforms in China (Chart 2). These supply-side effects in industrial commodities occurred against a backdrop of stronger-than-expected economic growth worldwide last year - the first such upturn since the Global Financial Crisis (GFC) in 2008 (Chart 3). Chart 2Fundamentals Supported Metals Chart 3Global Upturn Powers Commodity Demand We expect this to continue. Part of the recovery in aggregate demand worldwide can be attributed to the massive monetary stimulus by systematically important central banks - led by the Fed, the ECB and BoJ. Lower energy prices last year, which acted like a tax cut, put more discretionary income in consumers' hands and also boosted aggregate demand.2 Monetary Policy Will Re-Assert Itself Chart 4The USD Will Re-Emerge As A##BR##Driver Of Commodity Prices The influence of monetary policy - chiefly how the Fed's actions affect the USD - has been de minimis over the past two years relative to fundamentals, which have driven price formation in industrial commodities (Chart 4). While the Fed raised its policy rate 3 times last year, monetary conditions remained relatively loose in the U.S., which was supportive of commodity prices. Looser monetary conditions kept the USD better offered than other major currencies in 4Q17, which allowed gold prices to recover late in the year. A weaker USD also supported grain markets, which also have staged a somewhat subdued recovery following a mid-2017 sell-off. For at least 1H18, we see commodities generally continuing to be supported by strong fundamentals and relatively accommodative monetary policy globally, even with the Fed lifting its policy rate as many as four times this year, per our House view. Inflation Pressures Could Start Building By 2H18, inflationary pressures could start to build: In the U.S., tax cuts coupled with fiscal stimulus from the federal government in the form of disaster relief and higher discretionary spending - could add ~ 0.5% to GDP growth this year, based on calculations by BCA's Global Investment Strategy team (Chart 5).3 This should, all else equal, increase demand for labor and push the U.S. unemployment rate lower, lifting wages, inflation and inflation expectations in turn (Chart 6). At least that's how it's supposed to work. Our colleagues in BCA Research's U.S. Bond Strategy note, the "dichotomy between stronger growth and a tight labor market on the one hand and low inflation on the other gets to the heart of the first big challenge that incoming Fed Chairman Jay Powell will face next year. Specifically, how much faith should the Fed have in its framework for forecasting inflation? Chart 5U.S. Inflation Is Ticking Higher Chart 6Still Waiting On The Phillips Curve "... Janet Yellen's Phillips Curve model of core inflation does not explain this year's decline.1 It also shows that inflation is close to 0.5% below fair value, almost the largest deviation since 1995."4 We're inclined to agree with former Fed Chair Ben Bernanke on this. In 2016, he noted that, given the years-long stretch of errors in forecasting key economic variables - output, unemployment and the Fed funds rate - "Fed-watchers should probably focus on incoming data and count a bit less on Fed policymakers for guidance."5 This is a mixed blessing (or curse) for commodity markets: Increased economic activity raises demand for commodities, so at least in 1H18, and most likely for the second half as well, commodity demand will remain well supported globally. If we do get higher inflation, the Fed likely would feel it could lean into its rate-normalization with greater vigor, and start guiding to more frequent or bigger rate hikes. If we don't see higher inflation - if, as Chicago Fed President Charles Evans fears, inflation expectations have been marked down in a meaningful way - and the Fed cannot justify further rate hikes, we could see the real side of the global economy take another leg higher, lifting commodity demand in the process.6 This is the big issue for the coming year. We cannot say at this point how it plays out, which is why we recommend commodity investors remain in tactical mode, as we did a year ago. Recapping 2017's Recommendations Our trade recommendations were up an average of 77% last year, led by a 111% gain in our oil calls. This was a touch better than the 95% average gain we posted on our oil recommendations in 2016 (Table 1). Table 1Average Quarterly Returns 2017 Without a doubt, most of our recommendations were in the oil markets, as the accompanying tables show, and we maintained an exposure of one sort or another in oil throughout the year (Table 2). Table 2Trades Closed In 2017 The big drivers of our view in oil markets were fundamentals: On the supply side, we maintained the view OPEC 2.0 would not waver in its commitment to draining global storage levels, particularly in the OECD commercial inventories via supply reductions. On the demand side, by mid-2017, it became apparent to us the big data providers - the U.S. EIA and the IEA in Paris - and most of the sell-side analysts were underestimating demand. Information flows during 1H17 were often contradictory, which injected enormous volatility in crude-oil spread markets - particularly the calendar spreads trading markets employ to take a view on the shape of the forward curve (e.g., long a near-term futures contract like Dec/17 Brent, vs. short a deferred delivery contract like Dec/18). This intense volatility drove us toward the relative safety of call-option spreads in 2H17, where the risk of loss is limited to the net premium paid for the call spread. As we did last year, we constructed an information ratio (IR) to determine whether the additional volatility produced by our recommendations was adequately compensated for by the returns (simple percent changes of the opening level for a recommendation vs. the closing level). Our IR uses the S&P GSCI as a benchmark, given it has a relatively high weight in energy-related exposures. Our ratio looks at the average excess return of the active portfolio against this benchmark. This average excess return is divided by its standard deviation (also referred to as the tracking error volatility) in order to generate a risk-adjusted metric to measure returns on our recommendations relative to the risk we took to generate them. BCA's IR thus is calculated as: The higher the IR, the better the risk-adjusted relative performance of the portfolio. Three elements can explain a high IR: High returns in the portfolio; low returns in the benchmark, or low tracking error volatility. Hence, this measure provides a numeric value to analyze the risk-reward trade-off; it tells us whether or not the risk assumed in our trades was compensated for by larger returns. Viewing our energy recommendations as a portfolio over the course of 2017, our average return was 111%, while the GSCI return was 5.8%. The tracking error volatility was 112%.7 Using these inputs, the IR of our recommendations was 0.94. While not as stellar as our 2016 IR of 1.47, this risk-adjusted return is still stout, and indicates the consistent positive excess returns of our portfolio relative to passive GSCI exposure compensated for the high volatility of those returns. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com Hugo Bélanger, Research Analyst HugoB@bcaresearch.com 1 OPEC 2.0 is the name we've given the OPEC + non-OPEC producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia. 2 For a summary of our 2018 outlooks, please see BCA Research's Commodity & Energy Strategy Weekly Report "Oil Fundamentals Remain Bullish Heading Into 2018," published on December 21, 2017, and "Opposing Forces: Stay Neutral Metals In 2018" in the same issue. It is available at ces.bcaresearch.com. 3 Please see BCA Research's Global Investment Strategy Weekly Report, "Don't Fear A Flatter Yield Curve," published December 22, 2017. It is available at gis.bcaresearch.com. 4 Please see BCA Research's U.S. Bond Strategy Weekly Report, "Ill Placed Trust?," published December 19, 2017. It is available at usbs.bcaresearch.com. 5 Please see "The Fed's shifting perspective on the economy and its implications for monetary policy," by Ben S. Bernanke, published by the Brookings Institution on its website August 8, 2016. 6 Please see "All Talk, Few Answers From FOMC for Yellen's Long Inflation Miss," published by bloomberg.com on January 3, 2018. 7 Note: In order to find the standard deviation of the portfolio's excess returns (tracking error volatility), we averaged the daily percentage change in each trade's underlying assets. Any given trade only weighed in the daily average return if it was open during that day of the year. We are not accounting for the type of trades (spreads, pairs or single trades), we only track the underlying asset returns. From these daily average returns we subtracted the daily return of the preferred benchmark to obtain the daily excess return. Using this, we computed an historical standard deviation (based on 20-day periods) for every day during which a trade was open in our portfolio (we had 224 days with at least one energy trade opened). Lastly, we annualized this standard deviation to obtain our tracking-error volatility. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2017

Highlights Global bourses celebrated solid earnings growth and the passage of U.S. tax cuts heading into year-end. The direct effect of the tax cuts will likely boost U.S. real GDP growth in 2018 by 0.2 to 0.3 percentage points. It could be more, depending on the impact on animal spirits in the business sector and any fresh infrastructure spending. The good news on global growth continue to roll in. Real GDP growth is accelerating in the major advanced economies, driven in part by a surge in capital spending. Nonetheless, record low volatility and a flat yield curve in the U.S. highlight our major theme for 2018; policy is on a collision course with risk assets because output gaps are closing and monetary policy is moving away from "pedal to the metal" stimulus. We expect inflation to finally begin moving higher in the U.S. and some of the other advanced economies. This will challenge the consensus view that "inflation is dead forever", and that central banks will respond quickly to any turbulence in financial markets with an easier policy stance. The S&P 500 would suffer only a 3-5% correction if the VIX were to simply mean-revert. But the pain would likely be more intense if there is a complete unwinding of 'low-vol' trading strategies. We will be watching inflation expectations and our S&P Scorecard for signs to de-risk. Government yield curves should bear steepen, before flattening again later in 2018. Stay below benchmark in duration for now and favor bonds in Japan, Italy, the U.K. and Australia versus the U.S. and Canada (currency hedged). Interest rate differentials in the first half of the year should modestly benefit the U.S. dollar versus the other major currencies. Investors should remain exposed to oil and related assets, and bet on rising inflation expectations in the major bond markets. The intensity of forthcoming Chinese reforms will have to be monitored carefully for signs they have reached an economic 'pain threshold'. We do not view China as a risk to DM risk assets, but even a soft landing scenario could be painful for base metals and the EM complex. Bitcoin is not a systemic threat to global financial markets. Feature Chart I-1Policy Collision Course? Global bourses celebrated solid earnings growth and the passage of U.S. tax cuts heading into year-end. Ominously, though, a flatter U.S. yield curve and extraordinarily low measures of volatility hover like dark clouds over the equity bull market (Chart I-1). The flatter curve could be a sign that the Fed is at risk of tightening too far, which seems incompatible with depressed asset market volatility. This combination underscores the major theme of the BCA Outlook 2018 that was sent to clients in November; policy is on a collision course with risk assets because output gaps are closing and monetary policy is moving away from "pedal to the metal" stimulus. Analysts are debating how much of the decline in volatility is due to technical factors and how much can be pinned on the macro backdrop. For us, they are two sides of the same coin. Betting that volatility will remain depressed has reportedly become a yield play, via technical trading strategies and ETFs. Trading models encourage more risk taking as volatility declines, such that lower volatility enters a self-reinforcing feedback loop. The danger is that this virtuous circle turns vicious. On the macro front, many investors appear to believe that the structure of the advanced economies has changed in a fundamental and permanent way. Deflationary forces, such as Uber, Amazon and robotics are so strong that inflation cannot rise even if labor becomes very scarce. If true, this implies that central banks will proceed slowly in tightening, and that the peak in rates is not far away. Moreover, below-target inflation allows central banks to respond to any economic weakness or unwanted tightening in financial conditions by adopting a more accommodative policy stance. In other words, investors appear to believe in the "Fed Put". Implied volatility is a mean-reverting series. It can remain at depressed levels for extended periods, especially when global growth is robust and synchronized. Nonetheless, we believe that the "outdated Phillips curve" and the "Fed Put" consensus views will be challenged later in 2018, leading to an unwinding of low-vol yield plays. For now, though, it is too early to scale back on risk assets. Global Growth Shifts Up A Gear... The good news on global growth continue to roll in. Easy financial conditions and the end of fiscal austerity provide a supportive growth backdrop. A measure of fiscal thrust for the G20 advanced economies shifted from a headwind to a slight tailwind in 2016 (Chart I-2). Our short-term models for real GDP growth in the major countries continue to rise, in line with extremely elevated purchasing managers' survey data (Chart I-3). The major exception is the U.K., where our GDP growth model is rolling over as the Brexit negotiations take a toll. Chart I-2Fiscal Austerity Is Over Chart I-3GDP Growth Models Are Upbeat Much of the acceleration in our GDP models is driven by the capital spending components. Animal spirits appear to be taking off and it is a theme across most of the advanced economies. G3 capital goods orders pulled back a bit in late 2017, but this is more likely due to noise in the data than to a peak in the capex cycle (Chart I-4). Industrial production, the PMI diffusion index and advanced-economy capital goods imports confirm strong underlying momentum in investment spending. Chart I-4Capital Spending Helping To Drive Growth In the U.S., tax cuts will give business outlays and overall U.S. GDP growth a modest lift in 2018. The House and Senate hammered out a compromise on tax cuts that is similar to the original Senate version. The new legislation will cut individual taxes by about $680 billion over ten years, trim small business taxes by just under $400 billion, and reduce corporate taxes by roughly the same amount (including the offsetting tax on currently untaxed foreign profits). The direct effect of the tax cuts will likely boost U.S. real GDP growth in 2018 by 0.2 to 0.3 percentage points. However, much depends on the ability that the tax changes and immediate capital expensing to further lift animal spirits in the business sector and bring forward investment spending. Any infrastructure program would also augment the fiscal stimulus. The total impact is difficult to estimate given the lack of details, but it is clearly growth-positive. ...But The U.S. Yield Curve Flattens... Bond investors are unimpressed so far with the upbeat global economic data. It appears that long-term yields are almost impervious as long as inflation is stuck at low levels. In the U.S., a rising 2-year yield and a range-trading 10-year yield have resulted in a substantial flattening of the 2/10 yield slope (although some of the flattening has unwound as we go to press). Investors view a flattening yield curve with trepidation because it smells of a Fed policy mistake. It appears that the bond market is discounting that the Fed can only deliver another few rate hikes before the economy starts to struggle, at which point inflation will still be below target according to market expectations. We would not be as dismissive of an inverted yield curve as Fed Chair Yellen was during her December press conference. There are indeed reasons for the curve to be structurally flatter today than in the past, suggesting that it will invert more easily. Nonetheless, the fact that the yield curve has called all of the last seven recessions is impressive (with one false positive). The good news is that, in the seven episodes in which the curve correctly called a recession, the signal was confirmed by warning signs from our Global Leading Economic Indicator and our monetary conditions index. At the moment, these confirming indicators are not even flashing yellow.1 Our fixed-income strategists believe that the curve is more likely to steepen than invert over the next six months. If inflation edges higher as we expect, then long-term yields will finally break out to the upside and the curve will steepen until the Fed's tightening cycle is further advanced. If we are wrong and inflation remains stuck near current levels or declines, then the FOMC will have to revise the 'dot plot' lower and the curve will bull-steepen. In other words, we do not think the FOMC will make a policy mistake by sticking to the dot plot if inflation remains quiescent. Rising inflation is a larger risk for stocks and bonds than a policy mistake. A clear uptrend in inflation would shake investors' confidence in the "Fed Put" and thereby trigger an unwinding of the low-vol investment strategies. A sharp selloff at the long end of the curve in the major markets would send a chill through the investment world because it would suggest that the Phillips curve is not dead, and that central banks might have fallen behind the curve. ...As Inflation Languishes For now there is little evidence of building inflation pressure in either the CPI or the Fed's preferred measure, the core PCE price index. The latter edged up a little in October to 1.4% year-over-year, but the November core CPI rate slipped slightly to 1.7%. For perspective, core CPI inflation of 2.4-2.5% is consistent with the Fed's 2% target for the core PCE index. The Fed has made no progress in returning inflation to target since the FOMC started the tightening cycle. A risk to our view is that the expected inflation upturn takes longer to materialize. The annual core CPI inflation rate fell from 2.3 in January 2017 to 1.7 in November, a total decline of 0.55 percentage points. The drop was mostly accounted for by negative contributions from rent of shelter (-0.31), medical care services (-0.13) and wireless telephone services (-0.1). These categories are not closely related to the amount of slack in the economy, and thus might continue to depress the headline inflation rate in the coming months even as the labor market tightens further. Recent regulatory changes, for example, suggest that there is more downside potential in health care services inflation. We have highlighted in past research that it is not unusual for inflation to respond to a tight labor market with an extended lag, especially at the end of extremely long expansion phases. Chart I-5 updates the four indicators that heralded inflection points in inflation at the end of the 1980s and 1990s. All four leading inflation indicators are on the rise, as is the New York Fed's Underlying Inflation Indicator (not shown). Importantly, economic slack is disappearing at the global level. The OECD as a group will be operating above potential in 2018 for the first time since the Great Recession (Chart I-6). Finally, oil prices have further upside potential. Higher energy prices will add to headline inflation and boost inflation expectations in the U.S. and the other major economies. Chart I-5U.S. Inflation: Indicators Point Up Chart I-6Vanishing Economic Slack The bottom line is that we are sticking with the view that U.S. inflation will grind higher in the coming months, allowing the FOMC to deliver the three rate hikes implied by the 'dot plot' for 2018. In December, the FOMC revised up its economic growth forecast to 2.5% in 2018, up from 2.1%. The projections for 2019 and 2020 were also revised higher. Growth is seen remaining above the 1.8% trend rate for the next three years. The FOMC expects that the jobless rate will dip to 3.9% in 2018 and 2019, before ticking up to 4.0% in 2020. With the estimate for long-run unemployment unchanged at 4.6%, this means that the labor market is expected to shift even further into 'excess demand' territory. If anything, these forecasts look too conservative. It is unreasonable to expect the unemployment rate to stabilize in 2019 and tick up in 2020 if the economy is growing above-trend. This forecast highlights the risk that the FOMC will suddenly feel 'behind the curve' if inflation re-bounds more quickly than expected, at a time when the labor market is so deep in 'excess demand' territory. The consensus among investors would also be caught off guard in this scenario, resulting in a rise in bond volatility from rock-bottom levels. How Vulnerable Are Stocks? How large a correction in risk assets should we expect? One way to gauge this risk is to estimate the historical 'beta' of risk asset prices to mean-reversions in the VIX. The VIX is currently a long way below its median. Major spikes to well above the median are associated with recessions and/or financial crises. However, as a starting point, we are interested in the downside potential for risk asset prices if the VIX simply moves back to the median. Table I-1 presents data corresponding to periods since 1990 when the VIX mean-reverted from a low level over a short period of time. We chose periods in which the VIX surged at least to its median level (17.2) from a starting point that was below 13. The choice of 13 as the lower threshold is arbitrary, but this level filters out insignificant noise in the data and still provides a reasonable number of episodes to analyze.2 Table I-1Episodes Of VIX 'Mean Reversion' The episodes are presented in ascending order with respect to the starting point for the 12-month forward P/E ratio. This was done to see whether the valuation starting point matters for the size of the equity correction. The "VIX Beta" column shows the ratio of the percent decline in the S&P 500 to the change in the VIX. The average beta over the 15 episodes suggests that stocks fall by almost a half of a percent for every one percent increase in the VIX. Today, the VIX would have to rise by about 7½% to reach the median value, implying that the S&P 500 would correct by roughly 3½%. Investment- and speculative-grade corporate bonds would underperform Treasurys by 22 and 46 basis points, respectively, in this scenario. Interestingly, the equity market reaction to a given jump in the VIX does not appear to intensify when stocks are expensive heading into the shock. The implication is that a shock that simply returns the VIX to "normal" would not be devastating for risk assets. The shock would have to be worse. Chart I-7Market Reaction To 1994 Fed Shock The episodes of VIX "mean reversion" shown in Table I-1 are a mixture of those caused by financial crises and by monetary tightening (and sometimes both). The U.S. 1994 bond market blood bath is a good example of a pure monetary policy shock. It was partly responsible for the "tequila crisis", but that did not occur until late that year. Chart I-7 highlights that the U.S. equity market reacted more violently to Fed rate hikes in 1994 than the average VIX beta would suggest. The VIX jumped by about 14% early in the year, coinciding with a 9% correction in the S&P 500. Investors had misread the Fed's intension in late 1993, expecting little in the way of rate hikes over the subsequent year. A dramatic re-rating of the Fed outlook caused a violent bond selloff that unnerved equity investors. We are not expecting a replay of the 1994 bond market turmoil because the Fed is far more transparent today. Nonetheless, the equity correction could be quite painful to the extent that the VIX overshoots the median as the large volume of low-volatility trades are unwound. A 10% equity correction in the U.S. this year would not be a surprise given the late stage of the bull market and current market positioning. Yield Curves To Bear Steepen Upward pressure on inflation, bond yields and volatility will not only come from the U.S. We expect inflation to edge higher in the Eurozone, Canada, and even Japan, given tight labor markets and diminished levels of global spare capacity. The European economy has been a star performer this year and this should continue through 2018. Even the periphery countries are participating. The key driving factors include the end of the fiscal squeeze in the periphery and the recapitalization of troubled banks. The latter has opened the door to bank lending, the weakness of which has been a major growth headwind in this expansion. Taken at face value, recent survey data are consistent with about 3% GDP growth (Chart I-3). We would dis-count that a bit, but even continued 2.0-2.5% GDP growth in the euro area would compare well to the 1% potential growth rate. This means that the output gap is shrinking and the labor market will continue tightening. Despite impressive economic momentum, the ECB is sticking to the policy path it laid out in October. Starting in January, asset purchases will continue at a reduced rate of €30bn per month until September 2018 or beyond. Meanwhile, interest rates will remain steady "for an extended period of time, and well past the horizon of the net asset purchases." If asset purchases come to an end next September, then the first rate hike may not come until 2019 Q1 at the earliest. Thus, rate hikes are a long way off, but the deceleration of growth in the Eurozone monetary base will likely place upward pressure on the long end of the bund curve (shown inverted in Chart I-8). Chart I-8ECB Tapering Will Be Bond-Bearish Canada is another economy with ultra-low interest rates and rapidly diminishing labor market slack. The Bank of Canada will be forced to follow the Fed in hiking rates in the coming quarters. In Japan, strong PMI and capital goods orders are hopeful signs that domestic capital spending is picking up, consistent with our upbeat real GDP model (Chart I-3). Recent data on industrial production and retail sales were weak, but this was likely due to heavy storm activity; we expect those readings to bounce back. Nonetheless, it is still not clear that the Japanese economy has moved away from a complete dependency on the global growth engine. We would like to see stronger wage gains to signal that the economy is finally transitioning to a more self-reinforcing stage. It is hopeful that various measures of core inflation are slightly positive, but this is tentative at best. That said, the BoJ may be forced to alter its current "yield curve control" strategy by modestly lifting the target on longer-term JGB yields later in 2018, in response to pressures from robust growth and rising global bond yields. Thus, the pressure for higher bond yields should rotate away from the U.S. in the latter half of 2018 towards Europe, Canada and possibly Japan. This could eventually see the U.S. dollar head lower, but we still foresee a window in the first half of 2018 in which the dollar will appreciate on the back of widening interest rate differentials. We are less bullish than we were in mid-2017, expecting only about a 5% dollar appreciation. China: Long-Term Gain Or Short-Term Pain? The Chinese cyclical outlook remains a key risk to our upbeat view on risk assets. Significant structural reforms are on the way, now that President Xi has amassed significant political support for his reform agenda. These include deleveraging in the financial sector, a more intense anti-corruption campaign focused on the shadow-banking sector, and an ongoing restructuring in the industrial sector. The reforms will likely be positive for long-term growth, but only to the extent that they are accompanied by economic reforms. This month's Special Report, beginning on page 19, highlights that 2018 will be pivotal for China's long-term investment outlook. In the short term, reforms could be a net negative for growth depending on how deftly the authorities handle the monetary and fiscal policy dials. We witnessed this tension between growth and reform in the early years of President Xi's term, when the drive to curtail excessive credit growth and overcapacity caused an abrupt slowdown in 2015. Managing the tradeoff means that China's economy will evolve in a series of growth mini cycles. China is in the down-phase of a mini cycle at the moment, as highlighted by the Li Keqiang Index (LKI; Chart I-9). The LKI is a good proxy for the business cycle. BCA's China Strategy service recently combined the data with the best leading properties for the LKI into a single indicator.3 This indicator suggests that the LKI will end up retracing about 50% of its late 2015 to early 2017 rise before the current slowdown is complete. The good news is that broad money growth, which is a part of the LKI leading indicator, has re-accelerated in recent months. This suggests that the current economic slowdown phase will not be protracted, consistent with our 'soft landing' view. The intensity of forthcoming reforms will have to be monitored carefully for signs they have reached an economic pain threshold. We will be watching our LKI leading indicator and a basket of relevant equity sectors for warning signs. We do not view China as a risk to DM risk assets, but even a soft landing scenario could be painful for base metals and the EM complex (Chart I-10). Chart I-9China: Where Is The Bottom? Chart I-10Metals At Risk Of China Soft Landing Equity Country Allocation For now we continue to recommend overweight positions in stocks versus bonds and cash within balanced portfolios. We also still prefer Japanese stocks to the U.S., reflecting our expectation for rising bond yields in the latter and an earnings outlook that favors the former. Chart I-11 updates our earnings-per-share growth forecast for the U.S., Japan and the Eurozone. We expect U.S. EPS growth to decelerate more quickly in 2018 than in Japan, since the U.S. is further ahead in the earning cycle and is more exposed to wage and margin pressure. European earnings growth will also be solid in 2018, but this year's euro appreciation will be a headwind for Q4 2017 and Q1 2018 earnings. European and Japanese stocks are also a little on the cheap side versus the U.S., although not by enough to justify overweight positions on valuation grounds alone. We have extended our valuation work to a broader range of countries, shown in Chart I-12. All are expressed relative to the U.S. market. These metric exclude the Financials sector, and adjust for both differing sector weights and structural shifts in relative valuation. Mexico is the only one that is more than one standard deviation cheap relative to the U.S. Nonetheless, our EM team is reluctant to recommend this market given uncertainty regarding the NAFTA negotiations. Russia is not as cheap, but is in the early stages of recovery. Our EM team is overweight. Chart I-11Top-Down EPS Projection Chart I-12Valuation Ranking Of Nonfinancial Equity Markets Relative To The U.S. A Note On Bitcoin Finally, we have received a lot of client questions regarding bitcoin. The incredible surge in the price of the cryptocurrency dwarfs previous asset price bubbles by a wide margin (Chart I-13). As is usually the case with bubble, supporters argue that "this time is different." We doubt it. Chart I-13Bitcoin Bubble Dwarfs All The Rest BCA's Technology Sector Strategy weighed into this debate in a recent Special Report.4 In theory, blockchain technology, including cyber currencies, can be used as a highly secure, low cost, means of transfer value from one person to the next without an intermediary. However, the report highlights that bitcoin is highly subject to fraud and manipulation because it is unregulated. Liquidity and accurate market quotes are questionable on the "fly by night" exchanges. Its use as a medium of exchange is very limited, and governments are bound to regulate it because cryptocurrencies are a tool for money laundering, tax evasion and other criminal activities. Another fact to keep in mind is that, although the supply of new bitcoins is restricted, the creation of other cryptocurrencies is unlimited. Would the bursting of the bitcoin bubble represent a risk to the economy? The market cap of all cryptocurrencies is estimated to be roughly US$400 billion (US$250 billion for bitcoin alone). This is tiny compared to global GDP or the market cap of the main asset classes such as stocks and bonds. The amount of leverage associated with bitcoin is unknown, but it is hard to see that it would be large enough to generate a significant wealth effect on spending and/or a marked impact on overall credit conditions. The links to other financial markets appear limited. Investment Conclusions Our recommended asset allocation is "steady as she goes" as we move into 2018. The policy and corporate earnings backdrop will remain supportive of risk assets at least for the first half of the year. In the U.S., the recently passed tax reform package will boost after-tax corporate cash flows by roughly 3-5%. Cyclical stocks should outperform defensives in the near term. Nonetheless, we expect 2018 to be a transition year. Stretched valuations and extremely low volatility imply that risk assets are vulnerable to the consensus macro view that central banks will not be able to reach their inflation targets even in the long term. The consensus could be in for a rude awakening. We expect equity markets to begin discounting the next U.S. recession sometime in early 2019, but markets will be vulnerable in 2018 to a bond bear phase and escalating uncertainty regarding the economic outlook. If risk assets have indeed entered the late innings, then we must watch closely for signs to de-risk. One item to watch is the 10-year U.S. CPI swap rate; a shift above 2.3% would be consistent with the Fed's 2% target for the PCE measure of inflation. This would be a signal that the FOMC will have to step-up the pace of rate hikes and aggressively slow economic growth. We will also use our S&P Scorecard Indicator to help time the exit from our overweight equity position (Chart I-14). The Scorecard is based on seven indicators that have a good track record of heralding equity bear markets.5 These include measures of monetary conditions, financial conditions, value, momentum, and economic activity. The more of these indicators in "bullish" territory, the higher the score. Currently, four of the indicators are flashing a bullish signal (financial conditions, U.S. unemployment claims, ISM new orders minus inventories, and momentum). We demonstrated in previous research that a Scorecard reading of three or above was historically associated with positive equity total returns in the subsequent months. A drop below three this year would signal the time to de-risk. Our thoughts on the risks facing equities carry over to the corporate bonds space. Our Global Fixed Income Strategy service notes that uncertainty about future growth has the potential to increase interest rate volatility that can also push corporate credit spreads wider (Chart I-15).6 Elevated leverage in the corporate sector adds to the risk of a re-rating of implied volatility. For now, however, investors should continue to favor corporate bonds relative to governments for the (albeit modest) yield pickup. Chart I-14Watch Our Scorecard To Time The Exit Chart I-15Higher Uncertainty & ##br##Vol To Hit Corporate Bonds Overall bond portfolio duration should be kept short of benchmark. We may recommend taking profits and switching to benchmark duration after global yields have increased and are beginning to negatively affect risk assets. While yields are rising, investors should favor bonds in Japan, Italy, the U.K. and Australia within fixed-income portfolios (on a currency-hedged basis). Underweight the U.S. and Canada. German and French bonds should be close to benchmark. Yield curves should steepen, before flattening later in the year. Interest rate differentials in the first half of the year should modestly benefit the U.S. dollar versus the other major currencies. Finally, investors should remain exposed to oil and related assets, and bet on rising inflation expectations in the major bond markets. Mark McClellan Senior Vice President The Bank Credit Analyst December 28, 2017 Next Report: January 25, 2018 1 Please see BCA Global ETF Strategy service, "A Guide to Spotting And Weathering Bear Markets," August 16, 2017, available at etf.bcaresearch.com 2 Note that we are not saying that a rise in the VIX "causes" stocks to correct. Rather, we are assuming that a shock occurs that causes stocks to correct and the VIX to rise simultaneously. 3 Please see China Investment Strategy Special Report, "The Data Lab: Testing The Predictability Of China's Business Cycle," November 30, 2017, available at cis.bcaresearch.com 4 Please see BCA Technology Sector Strategy Special Report, "Cyber Currencies: Actual Currencies Or Just Speculative Assets?" December 12, 2017, available at tech.bcaresearch.com 5 Market Timing: Holy Grail Or Fool's Gold? The Bank Credit Analyst, May 26, 2016. 6 Please see BCA Global Fixed Income Strategy service, "Our Model Bond Portfolio Allocation In 2018: A Tail Of Two Halves," December 19, 2017, available at gfis.bcaresearch.com II. A Long View Of China 2018 is a pivotal year for China, as it will set the trajectory for President Xi Jinping's second term ... and he may not step down in 2022. Poverty, inequality, and middle-class angst are structural and persistent threats to China's political stability. The new wave of the anti-corruption campaign is part of Xi's attempt to improve governance and mitigate political risks. Yet without institutional checks and balances, Xi's governance agenda will fail. Without pro-market reforms, investors will face a China that is both more authoritarian and less productive. Hearts rectified, persons were cultivated; persons cultivated, families were regulated; families regulated, states were rightly governed; states rightly governed, the whole world was made tranquil and happy. - Confucius, The Great Learning Comparisons of modern Chinese politics with Confucian notions of political order have become cliché. Nevertheless, there is a distinctly Confucian element to Chinese President Xi Jinping's strategy. Xi's sweeping anti-corruption campaign, which will enter "phase two" in 2018, is essentially an attempt to rectify the hearts and regulate the families of Communist Party officials and civil servants. The same could be said for his use of censorship and strict ideological controls to ensure that the general public remains in line with the regime. Yet Xi is also using positive measures - like pollution curbs, social welfare, and other reforms - to win over hearts and minds. His purpose is ultimately the preservation of the Chinese state - namely, the prevention of a Soviet-style collapse. Only if the regime is stable at home can Xi hope to enhance the state's international security and erode American hegemony in East Asia. This would, from Beijing's vantage, make the whole world more tranquil and happy. Thus, for investors seeking a better understanding of China in the long run, it is necessary to look at what is happening to its governance as well as to its macroeconomic fundamentals and foreign relations.1 China's greatest vulnerability over the long run is its political system. Because Xi Jinping's willingness to relinquish power is now uncertain, his governance and reform agenda in his second term will have an outsized impact on China's long-run investment outlook. The Danger From Within From 1978-2008, the Communist Party's legitimacy rested on its ability to deliver rising incomes. Since the Great Recession, however, China has entered a "New Normal" of declining potential GDP growth as the society ages and productivity growth converges toward the emerging market average (Chart II-1). In this context, Chinese policymakers are deathly afraid of getting caught in the "middle income trap," a loose concept used to explain why some middle-income economies get bogged down in slower growth rates that prevent them from reaching high-income status (Chart II-2).2 Chart II-1The New Normal Chart II-2Will China Get Caught In The Middle-Income Trap? Such a negative economic outcome would likely prompt a wave of popular discontent, which, in turn, could eventually jeopardize Communist Party rule. The quid pro quo between the Chinese government and its population is that the former delivers rising incomes in exchange for the latter's compliance with authoritarian rule. The party is not blind to the fate of other authoritarian states whose growth trajectory stalled. The threat of popular unrest in China may seem remote today. The Communist Party is rallying around its leader, Xi Jinping; the economy rebounded from the turmoil of 2015 and its cyclical slowdown in recent months is so far benign; consumer sentiment is extremely buoyant; and the global economic backdrop is bright (Chart II-3). Yet these positive political and economic developments are cyclical, whereas the underlying political risks are structural and persistent. China has made massive gains in lifting its population out of poverty, but it is still home to 559 million people, around 40% of the population, living on less than $6 per day, the living standard of Uzbekistan. It will be harder to continue improving these workers' quality of life as trend growth slows and the prospects for export-oriented manufacturing dry up. This is why the Xi administration has recently renewed its attention to poverty alleviation. The government is on target in lifting rural incomes, but behind target in lifting urban incomes, and urban-dwellers are now the majority of the nation (Chart II-4). The plight of China's 200-250 million urban migrants, in particular, poses the risk of social discontent. Chart II-3China's Slowdown So Far Benign Chart II-4Urban Income Targets At Risk Moreover, while China knows how to alleviate poverty, it has less experiencing coping with the greatest threat to the regime: the rapid growth of the middle class, with its high expectations, demands for meritocracy and social mobility, and potential for unrest if those expectations are spoiled (Chart II-5). Democracy is not necessarily a condition for reaching high-income status, but all of Asia's high-income countries are democracies. A higher level of wealth encourages household autonomy vis-à-vis the state. Today, China has reached the $8,000 GDP per capita range that often accompanies the overthrow of authoritarian regimes.3 The Chinese are above the level of income at which the Taiwanese replaced their military dictatorship in 1987; China's poorest provinces are now above South Korea's level in that same year, when it too cast off the yoke of authoritarianism (Chart II-6). Chart II-5The Communist Party's Greatest Challenge Chart II-6China's Development Beyond Point At Which Taiwan And Korea Overthrew Dictatorship This is not an argument for democracy in China. We are agnostic about whether China will become democratic in our lifetime. We are making a far more humble point: that political risk will mount as wealth is accumulated by the country's growing middle class. Several emerging markets - including Thailand, Malaysia, Turkey and Brazil - have witnessed substantial political tumult after their middle class reached half of the population and stalled (Chart II-7). China is approaching this point and will eventually face similar challenges. Chart II-7Middle Class Growth Troubles Other EMs The comparison reveals that an inflection point exists for a society where the country's political establishment faces difficulties in negotiating the growing demands of a wealthier population. As political scientists have shown empirically, the very norms of society evolve as wealth erodes the pull of Malthusian and traditional cultural variables.4 Political transformation can follow this process, often quite unexpectedly and radically.5 Clearly the Chinese public shows no sign of large-scale, revolutionary sentiment at the moment. And political opposition does not necessarily result in regime change. Nevertheless, it is empirically false that the Chinese people are naturally opposed to democracy or representative government. After all, Sun Yat Sen founded a Republic of China in 1912, well before many western democratic transformations! And more to the point, the best survey evidence shows that the Chinese are culturally most similar to their East Asian neighbors (as well as, surprisingly, the Baltic and eastern European states): this is not a neighborhood that inherently eschews democracy. Remarkably, recent surveys suggest that China's millennial generation, while not wildly enthusiastic about democracy, is nevertheless more enthusiastic than its peers in the western world's liberal democracies (Chart II-8)! Chart II-8Chinese People Not Less Fond Of Democracy Than Others China is also home to one of the most reliable predictors of political change: inequality. China's economic boom is coincident with the rise of extreme inequalities in income, wealth, region, and social status. True, judging by average household wealth, everyone appears to be a winner; but the average is misleading because it is pulled upward by very high net worth individuals - and China has created 528 billionaires in the past decade alone. A better measure is the mean-to-median wealth ratio, as it demonstrates the gap that opens up between the average and the typical household. As Chart II-9 demonstrates, China is witnessing a sharp increase in inequality relative to its neighbors and peers. More standard measures of inequality, such as the Gini coefficient, also show very high readings in China. And this trend has combined with social immobility: China has a very high degree of generational earnings elasticity, which is a measure of the responsiveness of one's income to one's parent's income. If elasticity is high, then social outcomes are largely predetermined by family and social mobility is low. On this measure, China is an extreme outlier - comparable to the U.S. and the U.K., which, while very different economies, have suffered recent political shocks as a result of this very predicament (Chart II-10). Chart II-9Inequality: A Severe Problem In China Chart II-10China An Outlier In Inequality And Social Immobility "China does not have voters" unlike the U.S. and U.K., is the instant reply. Yet that statement entails that China has no pressure valve for releasing pent-up frustrations. Any political shock may be more, not less, destabilizing. In the U.S. and the U.K., voters could release their frustrations by electing an anti-establishment president or abrogating a trade relationship with Europe. In China, the only option may be to demand an "exit" from the political system altogether. Note that there is already substantial evidence of social unrest in China over the past decade. From 2003 to 2007, China faced a worrisome increase in "mass incidents," at which point the National Bureau of Statistics stopped keeping track. The longer data on "public incidents" suggests that the level of unrest remains elevated, despite improvements under the Xi administration (Chart II-11). Broader measures tell a similar story of a country facing severe tensions under the surface. For instance, China's public security spending outstrips its national defense spending (Chart II-12). Chart II-11Chinese Social Unrest Is Real Chart II-12China Spends More On ##br##Domestic Security Than Defense In essence, Chinese political risk is understated. This conclusion may seem counterintuitive, given Xi's remarkable consolidation of power. But is ultimately structural factors, not individual leaders, that will carry the day. The Communist Party is in a good position now, but its leaders are all-too-aware of the volcanic frustrations that could be unleashed should they fail to deliver the "China Dream." This is why so much depends upon Xi's policy agenda in the second half of his term. To that question we will now turn. Bottom Line: The Communist Party is at a cyclical high point of above-trend economic growth and political consolidation under a strongman leader. However, political risk is understated: poverty, inequality, and middle-class angst are structural and persistent and the long-term potential growth rate is slowing. If we assume that China is not unique in its historical trajectory, then we can conclude that it is approaching one of the most politically volatile periods in its development. Chart II-13Xi's Anti-Corruption Campaign The Governance And Reform Agenda Since coming to office in 2012-13, President Xi has spearheaded an extraordinary anti-corruption campaign and purge of the Communist Party (Chart II-13). The campaign has understandably drawn comparisons to Chairman Mao Zedong's Cultural Revolution (1966-76). Yet these are not entirely fair, as Xi has tried to improve governance as well as eradicate his enemies. As Xi prepares for his "re-election" in March 2018, he has declared that he will expand the anti-corruption campaign further in his second term in office: details are scant, but the gist is that the campaign will branch out from the ruling party to the entire state bureaucracy, on a permanent basis, in the form of a new National Supervision Commission.6 There are three ways in which this agenda could prove positive for China's long-term outlook. First, the regime clearly hopes to convince the public that it is addressing the most burning social grievances. Corruption persistently ranks at the top of the list, insofar as public opinion can be known (Chart II-14). Public opinion is hard to measure, but it is clear that consumer sentiment is soaring in the wake of the October party congress (see Chart II-3 above). It is also worth noting that the Chinese public's optimism perked up in Xi's first year in office, when the policy agenda on offer was substantially the same and the economy had just experienced a sharp drop in growth rates (Chart II-15). Reassuring the public over corruption will improve trust in the regime. Second, the anti-corruption campaign feeds into Xi's broader economic reform agenda. Productivity growth is harder to generate as a country's industrialization process matures. With the bulk of the big increases in labor, capital, and land supply now complete in China, the need to improve total factor productivity becomes more pressing (Chart II-16). Unlike the early stages of growth, this requires reaching the hard-to-get economic conditions, such as property rights, human capital, financial deepening, entrepreneurship, innovation, education, technology, and social welfare. Chart II-14Chinese Public Grievances Chart II-15Anti-Corruption Is Popular Chart II-16Productivity Requires Institutional Change On this count, the Xi administration's anti-corruption campaign has been a net positive. The most widely accepted corruption indicators suggest that it has made a notable improvement to the country's governance. Yet the country remains far below its competitors in the absolute rankings, notably its most similar neighbor Taiwan (Chart II-17 A&B). The institutionalization of the campaign could thus further improve the institutional framework and business environment. Chart II-17AAnti-Corruption Campaign Is A Plus... Chart II-17B...But There's A Long Way To Go Third, the anti-corruption campaign can serve as a central government tool in enforcing other economic reforms. Pro-productivity reforms are harder to execute in the context of slowing growth because political resistance increases among established actors fighting to preserve their existing advantages. If the ruling party is to break through these vested interests, it needs a powerful set of tools. Recently, the central government in Beijing has been able to implement policy more effectively on the local level by paving the way through corruption probes that remove personnel and sharpen compliance. Case in point: the use of anti-corruption officials this year gave teeth to environmental inspection teams tasked with trimming overcapacity in the industrial sector (Chart II-18). And there are already clear signs that this method will be replicated as financial regulators tackle the shadow banking sector.7 Chart II-18Reforms Cut Steel Capacity, ##br##Reduced Need For Scrap These last examples - financial and environmental regulatory tightening - are policy priorities in 2018. The coercive aspect of the corruption probes should ensure that they are more effective than they would otherwise be. And reining in asset bubbles and reducing pollution are clear long-term positives for the regime. Ideally, then, Xi's anti-corruption campaign will deliver three substantial improvements to China's long-term outlook: greater public trust in the government, higher total factor productivity, and reduced systemic risks. The administration hopes that it can mitigate its governance deficit while improving economic sustainability. In this way it can buy both public support and precious time to continue adjusting to the new normal. The danger is that these policies will combine to increase downside risks to growth in the short term.8 Bottom Line: Xi's anti-corruption campaign is being expanded and institutionalized to cover the entire Chinese administrative state. This is a consequential campaign that will take up a large part of Xi's second term. It is the administration's major attempt to mitigate the socio-political challenges that await China as it rises up the income ladder. Absolute Power Corrupts Absolutely? The problem, however, is that Xi may merely use the anti-corruption campaign to accrue more power into his hands. As is clear from the above, Xi's governance agenda is far from impartial and professional. The anti-corruption campaign is being used not only to punish corrupt officials but also to achieve various other goals. Xi has even publicly linked the campaign to the downfall of his political rivals.9 In essence, the campaign highlights the core contradiction of the Xi administration: can Xi genuinely improve China's governance by means of the centralization and personalization of power? Chart II-19China's Governance Still Falls Far Behind Over the long haul, the fundamental problem is the absence of checks and balances, i.e. accountability, from Xi's agenda. For instance, the National Supervision Commission will be granted immense powers to investigate and punish malefactors within the state - but who will inspect the inspectors? Xi's other governance reforms suffer the same problem. His attempt to create "rule of law" is lacking the critical ingredients of judicial independence and oversight. The courts are not likely to be able to bring cases against the party, central government, or powerful state-owned firms, and they will not be able to repeal government decisions. Thus, as many commentators have noted, Xi's notion of rule of law is more accurately described as "rule by law": the reformed legal system will in all probability remain an instrument in the hands of the Communist Party. Likewise, Xi's attempt to grant the People's Bank of China greater powers of oversight in order to combat systemic financial risk suffers from the fact that the central bank is not independent, and will remain subordinate to the State Council, and hence to the Politburo Standing Committee. This is not even to mention the lamentable fact that Xi's campaign for better governance has so far coincided with extensive repression of civil society, which does not mesh well with the desire to improve human capital and innovation.10 Thus it is of immense importance whether Xi sets up relatively durable anti-corruption, legal, and financial institutions that will maintain their legitimate functions beyond his term and political purposes. Otherwise, his actions will simply illustrate why China's governance indicators lag so far behind its peers in absolute terms. Corruption perceptions may improve further, but there will be virtually no progress in areas like "voice and accountability," "political stability and absence of violence," "rule of law," and "regulatory quality," each of which touches on the Communist Party's weak spots in various ways (Chart II-19). Analysis of the Communist Party's shifting leadership characteristics reinforces a pessimistic view of the long run if Xi misses his current opportunity.11 The party's top leadership increasingly consists of career politicians from the poor, heavily populated interior provinces - i.e. the home base of the party. Their educational backgrounds are less scientific, i.e. more susceptible to party ideology. (Indeed, Xi Jinping's top young protégé, Chen Miner, is a propaganda chief.) And their work experience largely consists of ruling China's provinces, where they earned their spurs by crushing rebellions and redistributing funds to placate various interest groups (Chart II-20). While one should be careful in drawing conclusions from such general statistics, the contrast with the leadership that oversaw China's boldest reforms in the 1990s is plain. Chart II-20China's Leaders Becoming More 'Communist' Over Time Bottom Line: Xi's reform agenda is contradictory in its attempt to create better governance through centralizing and personalizing power. Unless he creates checks and balances in his reform of China's institutions, he is likely to fall short of long-lasting improvements. The character profiles of China's political elite do not suggest that the party will become more likely to pursue pro-market reforms in Xi's wake. Xi Jinping's Choice Xi is the pivotal player because of his rare consolidation of power, and 2018 is the pivotal year. It is pivotal because it will establish the policy trajectory of Xi's second term - which may or may not extend into additional terms after 2022. So far, the world has gained a few key takeaways from Xi's policy blueprint, which he delivered at the nineteenth National Party Congress on October 18: Xi has consolidated power: He and his faction reign supreme both within the Communist Party and the broader Chinese state; Xi's policy agenda is broadly continuous: Xi's speech built on his administration's stated aims in the first five years as well as the inherited long-term aims of previous administrations; China is coming out of its shell: In the international realm, Xi sees China "moving closer to center stage and making greater contributions to mankind"; The 2022 succession is in doubt: Xi refrained from promoting a successor to the Politburo Standing Committee, the unwritten norm since 1992. Markets have not reacted overly negatively to these developments (Chart II-21), as the latter do not pose an immediate threat to the global rally in risk assets. The reasons are several: Chart II-21Market Not Too Worried About ##br##Party Congress Outcomes Maoism is overrated: While the Communist Party constitution now treats Xi Jinping as the sole peer of the disastrous ruler Mao Zedong, the market does not buy the Maoist rhetoric. Instead, it sees policy continuity, yet with more effective central leadership, which is a plus. Reforms are making gradual progress: Xi is treading carefully, but is still publicly committed to a reform agenda of rebalancing China's economic model toward consumption and services, improving governance and productivity, and maintaining trade openness. Whatever the shortcomings of the first five years, this agenda is at least reformist in intention. China's tactic of "seeking progress while maintaining stability" is certainly more reassuring than "progress at any cost" or "no progress at all"! Trump and Xi are getting along so far: Xi's promises to move China toward center stage threaten to increase geopolitical tensions with the United States in the long run, yet markets are not overly alarmed. China is imposing sanctions on North Korea to help resolve the nuclear missile standoff, negotiating a "Code of Conduct" in the South China Sea, and promoting the Belt and Road Initiative (BRI), which will marginally add to global development and growth. Trump is hurling threatening words rather than concrete tariffs. 2022 is a long way away: Markets are unconcerned with Xi's decision not to put a clear successor on the Politburo Standing Committee, even though it implies that Xi will not step down at the end of his term in five years. Investors are implicitly approving Xi's strongman behavior while blissfully ignoring the implication that the peaceful transition of power in China could become less secure. Are investors right to be so sanguine? Cyclically, BCA's China Investment Strategy is overweight Chinese investible equities relative to EM and global stocks. Geopolitical Strategy also recommends that clients follow this view and overweight China relative to EM. Beyond this 6-12 month period, it depends on how Xi uses his political capital. If Xi is serious about governance and economic reform, then long-term investors should tolerate the other political risks, and the volatility of reforms, and overweight China within their EM portfolio. After all, China's two greatest pro-market reformers, Deng Xiaoping and Jiang Zemin, were also heavy-handed authoritarians who crushed domestic dissent, clashed with the United States from time to time, and hesitated to relinquish control to their successors. However, if Xi is not serious, then investors with a long time horizon should downgrade China/EM assets - as not only China but the world will have a serious problem on its hands. For Deng Xiaoping and Jiang Zemin always reaffirmed China's pro-market orientation and desire to integrate into the global economic order. If Xi turns his back on this orientation, while imprisoning his rivals for corruption, concentrating power exclusively in his own person, and contesting U.S. leadership in the Asia Pacific, then the long-run outlook for China and the region should darken rather quickly. Domestic institutions will decay and trade and foreign investment will suffer. How and when will investors know the difference? As mentioned, we think 2018 is critical. Xi is flush with political capital and has a positive global economic backdrop. If he does not frontload serious efforts this year then it will become harder to gain traction as time goes by.12 If he demurs, the Chinese political system will not afford another opportunity like this for years to come. The country will approach the 2020s with additional layers of bureaucracy loyal to Xi, but no significant macro adjustments to its governance or productivity. It is not clear how long China's growth rate is sustainable without pro-productivity reforms. It is also not clear that the world will wait five years before responding to a China that, without a new reform push, will appear unabashedly mercantilist, neo-communist, and revisionist. Bottom Line: The long-run investment outlook for China hinges on Xi Jinping's willingness to use his immense personal authority and concentration of power for the purposes of good governance and market-oriented economic reform. Without concrete progress, investors will have to decide whether they want to invest in a China that is becoming less economically vibrant as well as more authoritarian. We think this would be a bad bet. Matt Gertken Associate Vice President Geopolitical Strategy Marko Papic Senior Vice President Chief Geopolitical Strategist Geopolitical Strategy 1 Please see BCA Geopolitical Strategy Special Report, "Taking Stock Of China's Reforms," dated May 13, 2015, available at gps.bcaresearch.com. 2 Chinese policymakers are expressly concerned about the middle-income trap. Please see the World Bank and China's Development Research Center of the State Council, "China 2030: Building A Modern, Harmonious, And Creative Society," 2013, available at www.worldbank.org. Liu He, who is perhaps Xi Jinping's top economic adviser, had a hand in drafting this report and is now a member of the Politburo and shortlisted to take charge of the newly established Financial Stability and Development Commission at the People's Bank of China. 3 Please see Indermit S. Gill and Homi Kharas, "The Middle-Income Trap Turns Ten," World Bank, Policy Research Working Paper 7403 (August, 2015), available at www.worldbank.org 4 Please see Ronald Inglehart and Christian Welzel, Modernization, Cultural Change and Democracy: the Human Development Sequence (Cambridge: CUP, 2005). 5 For example, the collapse of the Soviet Union and the Arab Spring, as well as the downfall of communist regimes writ large, were completely unanticipated. 6 Specifically, Xi is creating a National Supervision Commission that will group a range of existing anti-graft watchdogs under its roof at the local, provincial, and central levels of administration, while coordinating with the Communist Party's top anti-graft watchdog. More details are likely to be revealed at the March legislative session, but what matters is that the initiative is a significant attempt to institutionalize the anti-corruption campaign. Please see BCA Geopolitical Strategy Special Report, "China's Party Congress Ends ... So What?" dated November 1, 2017, available at gps.bcaresearch.com. 7 China has recently drafted top anti-graft officials, such as Zhou Liang, from the powerful Central Discipline and Inspection Commission and placed them in the China Banking Regulatory Commission, which is in charge of overseeing banks. Authorities have already imposed fines in nearly 3,000 cases in 2017 affecting various kinds of banks, including state-owned banks. On the broader use of anti-corruption teams for economic policy, please see Barry Naughton, "The General Secretary's Extended Reach: Xi Jinping Combines Economics And Politics," China Leadership Monitor 54 (Fall 2017), available at www.hoover.org. 8 Please see BCA Geopolitical Strategy Special Report, "Three Questions For 2018," dated December 13, 2017, available at gps.bcaresearch.com. 9 Please see Gao Shan et al, "China's President Xi Jinping Hits Out at 'Political Conspiracies' in Keynote Speech," Radio Free Asia, January 3, 2017, available at www.rfa.org 10 Xi has cranked up the state's propaganda organs, censorship of the media, public surveillance, and broader ideological and security controls (including an aggressive push for "cyber-sovereignty") to warn the public that there is no alternative to Communist Party rule. This tendency has raised alarms among civil rights defenders, lawyers, NGOs, and the western world to the effect that China's governance is actually regressing despite nominal improvement in standard indicators. This is the opposite of Confucius's bottom-up notion of order. 11 Please see BCA Geopolitical Strategy Special Report, "China: Looking Beyond The Party Congress," dated July 19, 2017, available at gps.bcaresearch.com. 12 Xi faces politically sensitive deadlines in the 2020-22 period: the economic targets in the thirteenth Five Year Plan; the hundredth anniversary of the Communist Party in 2021; and Xi's possible retirement at the twentieth National Party Congress in 2022. At that point he will need to focus on demonstrating the Communist Party's all-around excellence and make careful preparations either to step down or cling to power. III. Indicators And Reference Charts Global equity indexes remained on a tear heading into year-end on the back of robust earnings growth in the major countries and U.S. tax cuts. There are some dark clouds hanging over this rally, as discussed in the Overview section. The technicals are stretched, but none of our fundamental indicators are warning of a market top. Implied equity volatility is very low, which can be interpreted in a contrary fashion. Investor sentiment is frothy and our Speculation Indicator is very elevated. Moreover, our equity valuation indicator has finally reached one standard deviation, which is our threshold of overvaluation. Valuation does not tell us anything about timing, but it does highlight the downside risks. Our monetary indicator also deteriorated a little more in December, although not by enough on its own to justify downgrading risk assets. On a positive note, earnings surprises and the net revisions ratio are not sending any warning signs for profit growth (although net revisions have edged lower recently). Moreover, our new Revealed Preference Indicator (RPI) continued on its bullish equity signal in November for the fifth consecutive month. The RPI combines the idea of market momentum with valuation and policy measures. It provides a powerful bullish signal if positive market momentum lines up with constructive signals from the policy and valuation measures. Conversely, if constructive market momentum is not supported by valuation and policy, investors should lean against the market trend. Our Willingness-to-Pay (WTP) indicators are also bullish on stocks in the U.S., Europe and Japan. These indicators track flows, and thus provide information on what investors are actually doing, as opposed to sentiment indexes that track how investors are feeling. The small dip in the Japanese WTP in December is a little worrying, but we need to see more weakness to confirm that flows no longer favor Japanese equities. In contrast, Europe's WTP rose sharply in December, suggesting that investors are allocating more to their European equity holdings. We are overweight both Europe and (especially) Japan relative to the U.S. (currency hedged). U.S. Treasury valuation is still very close to neutral, even following December's backup in yields. There is plenty of upside potential for yields before they hit "inexpensive" territory. Similarly, our technical bond indicator suggests that technical factors will not be headwind to a further bond selloff in 2018. Little has change for the dollar. The technicals are neutral. Value is expensive based on PPP, but less so by other valuation metrics. We see modest upside for the greenback in 2018. EQUITIES: Chart III-1U.S. Equity Indicators Chart III-2Willingness To Pay For Risk Chart III-3U.S. Equity Sentiment Indicators Chart III-4Revealed Preference Indicator Chart III-5U.S. Stock Market Valuation Chart III-6U.S. Earnings Chart III-7Global Stock Market And ##br##Earnings: Relative Performance Chart III-8Global Stock Market And ##br##Earnings: Relative Performance FIXED INCOME: Chart II-9U.S. Treasurys And Valuations Chart II-10U.S. Treasury Indicators Chart II-11Selected U.S. Bond Yields Chart II-1210-Year Treasury Yield ComponentsChart II-13U.S. Corporate Bonds And Health Monitor Chart II-14Global Bonds: Developed Markets Chart II-15Global Bonds: Emerging Markets CURRENCIES: Chart II-16U.S. Dollar And PPP Chart II-17U.S. Dollar And Indicator Chart II-18U.S. Dollar Fundamentals Chart II-19Japanese Yen Technicals Chart II-20Euro Technicals Chart II-21Euro/Yen Technicals Chart II-22Euro/Pound Technicals COMMODITIES: Chart II-23Broad Commodity Indicators Chart II-24Commodity Prices Chart II-25Commodity Prices Chart II-26Commodity Sentiment Chart II-27Speculative Positioning ECONOMY: Chart II-28U.S. And Global Macro Backdrop Chart II-29U.S. Macro Snapshot Chart II-30U.S. Growth Outlook Chart II-31U.S. Cyclical Spending Chart II-32U.S. Labor Market Chart II-33U.S. Consumption Chart II-34U.S. Housing Chart II-35U.S. Debt And Deleveraging Chart II-36U.S. Financial Conditions Chart II-37Global Economic Snapshot: Europe Chart II-38Global Economic Snapshot: China