Currencies

Highlights Recent data suggest central bankers remain behind the curve in boosting inflation expectations. Ergo, expect a dovish bias to persist over the next few months. Our thesis remains that global growth is in a volatile bottoming process. However, market focus could temporarily flip towards short term data weakness, which warrants taking out some insurance. Meanwhile, in an environment where volatility is low and falling, it also pays to have insurance in place. Rising net short positioning in the yen and Swiss franc is making them attractive from a contrarian standpoint. Maintain a limit-buy on CHF/NZD at 1.45. The path of least resistance for the dollar remains down. This is confirmed by incoming data that suggests the euro area economies have bottomed, which should boost the EUR/USD. The rising dollar shortage remains a key risk to our sanguine view. But the forces driving dollar liquidity lower are largely behind us. Feature Investors looking for more clarity on the global growth picture from the April data print have been left in a quandary. In the U.S., the headline first-quarter real GDP growth number of 3.2% was well above consensus but was boosted by volatile components such as inventories and net exports. Real final sales to domestic purchasers, a cleaner print for final demand, came in at 1.5%, the lowest increase since 2015. Assuming trend growth in the U.S. is around 2%, a view shared by the Federal Open Market Committee (FOMC), then the increase in first-quarter final sales was a big miss. Most importantly, the U.S. ISM manufacturing index fell to 52.8 in April, a drop that was broad-based across seven of the 10 components. Chart I-1At The Cusp Of A V-Shaped Recovery? At The Cusp Of A V-Shaped Recovery? At The Cusp Of A V-Shaped Recovery? Across the ocean, European growth was a tad stronger. Italy managed to nudge itself out of a technical recession, while Spanish year-on-year growth of 2.4% helped drive euro area GDP growth to the tune of 1.2%. The most volatile components of euro area growth tend to be investment and net exports. Should both pick up on the back of stronger external demand, then GDP could easily gravitate towards 1.5%-2%, pinning it well above potential. The German PMI is currently one of the weakest in the euro zone. But forward-looking indicators suggest we are at the cusp of a V-shaped bottom over the next month or so (Chart I-1). China remains the epicenter of any growth pickup and the headline PMI numbers were soft, with the official NBS manufacturing PMI falling to 50.1 from 50.5, and the private sector Caixin manufacturing PMI falling to 50.2 from 50.8. Still, the numbers remain above the critical 50 threshold level, and well beyond the 45-48 danger zone. Export growth numbers across southeast Asia remain weak, and after a brisk rise since the start of the year, many China plays including commodity prices, the yuan, emerging market stocks, and Asian currencies are all rolling over. The bearish view is that there are diminishing marginal returns to Chinese stimulus, and the authorities need to be more aggressive to turn the domestic economy around. The reality is that policy stimulus works with a lag, and we need about three to six months before we see the effects of the current policy shift. Southeast Asian exports track the Chinese credit impulse with a lag of six months, and there is little reason to believe this time should be different (Chart I-2). Chart I-2Global Trade Should Soon Bottom Global Trade Should Soon Bottom Global Trade Should Soon Bottom The broad message is that global growth likely bottomed in the first quarter. However, before evidence of this fully unfolds, markets are likely to be swayed by the ebbs and flows of higher-frequency data, making for a volatile bottoming process. We recommend maintaining a pro-cyclical bias, but taking out some insurance against a potential spike in volatility.  The Fed On Hold This week’s FOMC meeting focused on the lack of inflationary pressures in the U.S. but was largely a non-event for financial markets, aside from a spike in volatility. Nonetheless, there were three key takeaways. First, the dip in inflation appears to be “transitory,” driven by lower clothing prices and financial services fees. Second, Chair Powell made it clear that the Fed will only feel the need to ease policy if inflation runs “persistently” below target. Finally, the Fed’s interpretation of its “symmetric” inflation target is slowly shifting. Many FOMC members increasingly believe that the Fed should explicitly pursue an overshoot of its 2% inflation target to make up for past misses. Taken together, we expect the Fed to remain on hold for the time being, but to eventually start raising rates again as inflationary pressures pick up. Chart I-3Inflation Should Be Higher In The U.S. Versus The Euro Area Inflation Should Be Higher In The U.S. Versus The Euro Area Inflation Should Be Higher In The U.S. Versus The Euro Area The bigger picture is that in a very globalized world with fully flexible exchange rates, it is becoming more and more difficult for any one central bank to independently achieve its inflation objective. This is because, should inflation be on the rise and moving higher in one country, expectations of higher interest rates should lift its currency, which eventually tempers inflationary pressures, and vice versa. This is obviously a very simplistic view of the world economy, since other factors such as demographics, productivity, labor mobility, openness of the economy, and policy divergences among others, play important roles. However, it is remarkable that almost every developed market central bank has continued to attempt to boost inflation to the 2% level since the Global Financial Crisis, but very few have been able to achieve this independently. In a very globalized world with fully flexible exchange rates, it is becoming more and more difficult for any one central bank to independently achieve its inflation objective.  Take the case of Europe versus the U.S., two economies that could not be more different. Euro area imports constitute about 41% of GDP, while the number in the U.S. is only 15%, so tradeable prices matter a lot more for the former. Meanwhile, the demographic profile is worse in Europe, with the old-age dependency ratio at 32% in Europe versus 23% in the U.S. Finally, other measures of supply-side constraints such as labor market slack or capacity utilization suggest the euro area is well behind the U.S. on the path toward a closed output gap (Chart I-3). Despite this, since 2015, headline inflation in both the U.S. and euro area have moved tick-for-tick. Yes, policy divergences between the two countries have been very wide, either via the lens of quantitative easing or simply the differential in policy rates (Chart I-4). But the fact that the magnitude and direction of overall inflation has moved homogenously, begs the question of the ability of either central bank to influence overall prices. One explanation could be that variations in headline CPI are largely driven by volatile items that tend to be exogenous, while variations in core CPI tend to be mostly driven by endogenous factors. This is confirmed by most research that suggest there is a weak link between rising commodity prices and longer-term inflation.1 That said, over the shorter run, commodity price gyrations can dominate and be the main driver of inflation expectations (Chart I-5). Chart I-4U.S. And Euro Area Overall CPI Are Broadly Similar U.S. And Euro Area Overall CPI Are Broadly Similar U.S. And Euro Area Overall CPI Are Broadly Similar Chart I-5In The Short Term, Commodity Prices Matter For Inflation Expectations In The Short Term, Commodity Prices Matter For Inflation Expectations In The Short Term, Commodity Prices Matter For Inflation Expectations The bottom line is that muted inflationary pressures are a global phenomenon, and not centric to the U.S. This means that as a whole, global central banks are set to stay accommodative for the time being, which will be bullish for global growth (Chart I-6). This warrants maintaining a pro-cyclical stance but being extremely selective in what might be a volatile bottoming process. Chart I-6Global Monetary Policy Needs To Ease Further bca.fes_wr_2019_05_03_s1_c6 bca.fes_wr_2019_05_03_s1_c6 Maintain A Pro-Cyclical Stance With the S&P 500 breaking to all-time highs, crude oil prices up around 40% from their lows, and U.S. 10-year Treasury yields rolling over relative to the rest of the world, this has historically been fertile ground for high-beta currency trades. That said, the lack of more pronounced strength in pro-cyclical currencies like the Australian, New Zealand, and Canadian dollars suggest that caution prevails. Our bias is that currency markets continue to fight a tug-of-war between strong dollar fundamentals and fading tailwinds. Our portfolio consists mostly of trades along the crosses, but we have been cautiously adding to U.S. dollar short positions over the past few weeks: Long AUD/USD: Our limit-buy on the Aussie was triggered at 0.70. Data out of Australia are showing tentative signs of a bottom. Last week’s important jobs report showed that the economy continues to offer more employment than the consensus expects. Meanwhile, the credit growth data out of Australia this week suggests that macro-prudential policies continue to drive a wedge between owner-occupied and investor housing (Chart I-7). House prices in Australia are already deflating to the tune of around 6%. Once the cleansing process is through, we expect house price growth to eventually converge toward levels of credit and/or natural income growth. Moreover, the Australian dollar remains a commodity currency, and will benefit from rising terms-of-trade. Iron ore prices remain firm on the back of supply-related issues. Meanwhile, a rising mix of liquefied natural gas in the export basket will provide tailwinds as China continues to steer its economy away from coal. Finally, Chinese credit growth has been a key determinant of the re-rating of Australian equities. Ergo, a rising Chinese credit impulse will ignite Australian share prices, and by extension the Australian dollar (Chart I-8). Chart I-7Australian Credit Growth Converging To Steady State Australian Credit Growth Converging To Steady State Australian Credit Growth Converging To Steady State Chart I-8More Chinese Credit Will Help Australian Equities More Chinese Credit Will Help Australian Equities More Chinese Credit Will Help Australian Equities Long GBP/USD: Our buy-limit order on the British pound was triggered at 1.30 on March 29th. As we argued back then, the pound is sitting exactly where it was after the 2016 referendum results, but the odds of a hard Brexit have significantly fallen since then. On the domestic front, economic surprises in the U.K. relative to both the U.S. and euro area continue to soar. The reality is that the pound and U.K. gilt yields should be much higher – solely on the basis of hard incoming data. Employment growth has been holding up very well, wages are inflecting higher, and the average U.K. consumer appears in decent shape. Full-time employees continue to creep higher as a percentage of overall employment (Chart I-9). This view was echoed in yesterday’s Bank Of England (BoE) policy meeting, where the central bank raised its growth forecast while striking a more hawkish tone. Chart I-9U.K.: What Brexit? U.K.: What Brexit? U.K.: What Brexit? Chart I-10Sweden: Volatile Bottom Sweden: Volatile Bottom Sweden: Volatile Bottom   Long SEK/USD: The Swedish krona should be one of the first currencies to benefit from any bottoming in European growth (Chart I-10). The Swedish economy appears to have bottomed relative to that of the U.S., making the USD/SEK an attractive way to play USD downside. From a technical perspective, the cross is trading at its lowest level since the global financial crisis (Chart I-11). Economic surprises in the U.K. relative to both the U.S. and euro area continue to soar. The main appeal of the Swedish krona is that it is extremely cheap. Meanwhile, despite negative interest rates, Swedish household loan growth has been slowing as consumers are increasingly financing purchases through rising wages. This will alleviate the need for the Riksbank to maintain ultra-accommodative policy, despite its recent dovish shift. Buy Some Insurance Given current low levels of volatility and elevated equity market valuations, the dollar would have been a great insurance policy for any stock market correction. But with U.S. interest rates having risen significantly versus almost all G10 countries in recent years, the dollar has itself become the object of carry trades. This has also come with a good number of unhedged trades, as the rising exchange rate has lifted hedging costs.  Chart I-11How Much Lower Could The Swedish Krona Go? How Much Lower Could The Swedish Krona Go? How Much Lower Could The Swedish Krona Go? Chart I-12Buy Some##br## Insurance Buy Some Insurance Buy Some Insurance It will be difficult for the dollar to act as both a safe-haven and carry currency, because the forces that drive both move in opposite directions. As markets become volatile and some carry trades are unwound, unhedged trades will become victim to short-covering flows. Currencies such as the Japanese yen and the Swiss franc that could have been used to fund carry trades are ripe for reversals. This suggests at a minimum building some portfolio hedges. One such hedge is going long the CHF/NZD. This trade has a high negative carry, so we do not intend to hold it for longer than three months. But it should pay off handsomely on any rise in volatility (Chart I-12). Maintain a limit-buy at 1.45.   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Stephen G Cecchetti and Richhild Moessner, “Commodity Prices And Inflation Dynamics,” Bank Of International Settlements, Quarterly Review, (December 2008). Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the U.S. continue to moderate: Annualized Q1 GDP came in at 3.2% quarter-on-quarter, well above estimates. Personal income increased by 0.1% month-on-month in March, below the estimated 0.4%. On the other hand, personal spending increased by 0.9% month-on-month in March. PCE deflator and core PCE deflator fell to 1.5% and 1.6% year-on-year, respectively in March. Michigan consumer sentiment index slightly increased to 97.2 in April. Markit manufacturing PMI increased from 52.4 to 52.6 in April, while ISM manufacturing PMI fell to 52.8. Q1 nonfarm productivity increased by 3.6%, surprising to the upside. DXY index fell by 0.3% this week. On Wednesday, the Fed announced their decision to keep interest rates on hold at current levels, further suggesting that there is no strong case to move rates in either direction based on recent economic developments. Moreover, Fed chair Powell reiterated their strong commitment to the 2% inflation target. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 Beware Of Diminishing Marginal Returns- April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area are improving: Money supply (M3) in the euro area increased by 4.5% year-on-year in March. The sentiment in the euro area remains soft in April: economic sentiment indicator fell to 104; business climate fell to 0.42; industrial confidence fell to -4.1; consumer confidence was unchanged at -7.9. Q1 GDP came in at 1.2% year-on-year, surprising to the upside. Unemployment rate fell to 7.7% in March. Markit PMI increased to 47.9 in April. EUR/USD appreciated by 0.3% this week. European data keep grinding higher. Italian GDP moved back into positive territory in Q1. Spanish GDP also rebounded in Q1. Positive Chinese credit data suggests the euro will soon benefit from rising Chinese imports.  Report Links: Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been positive: The unemployment rate in March increased slightly to 2.5%; job-to-applicant ratio was unchanged at 1.63. Tokyo consumer price inflation increased to 1.4% year-on-year in March, the highest level since October 2018. Industrial production fell by 4.6% year-on-year in March. However, projections for April suggest a 2.7% month-on-month jump. Retail sales grew by 1% year-on-year in March, higher than expected. Housing starts grew by 10% year-on-year in March. This is the highest growth level since February 2017. USD/JPY fell by 0.2% this week. The Japanese government’s intention to raise sales tax this October could be a highly deflationary outcome. However, there is still an outside chance that the tax hike will be postponed. We continue to recommend yen as a safety hedge. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 A Trader’s Guide To The Yen - March 15, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the U.K. have been positive: U.K. mortgage loans in March increased to 40K.  Nationwide housing prices increased by 0.9% on a year-on-year basis in April. Markit manufacturing PMI came in above expectations at 53.1 in April, even though it fell; Markit construction PMI however increased to 50.5. Money supply (M4) increased by 2.2% year-on-year in March. GBP/USD increased by 1% this week. The Bank of England kept rates on hold at 0.75% this week. In the May inflation report, the BoE mentioned that U.K.’s economic outlook will depend significantly on the nature and timing of EU withdrawal, and the new trading agreement with EU in particular. But governor Carney struck a slightly hawkish tone, revising up GDP estimates and guiding the next policy move as a rate hike. Report Links: Not Out Of The Woods Yet - April 5, 2019 A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have shown tentative signs of recovery: Private sector credit growth fell to 3.9% year-on-year in March. However, this is heavily biased downwards by lending to home investors that has slowed to a crawl. The Australian Industry Group (AiG) manufacturing index increased to 54.8 in April. RBA commodity index increased by 14.4% year-on-year in April. AUD/USD fell by 0.4% this week. The data are starting to look brighter in Q2, suggesting that the economy might have bottomed in Q1. The Australian dollar is likely to grind higher, especially driven by rising terms of trade. Report Links: Beware Of Diminishing Marginal Returns- April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Into A Transition Phase - March 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand are mixed: ANZ activity outlook increased by 7.1% in April. ANZ business confidence in April improved to -37.5. On the labor market front in Q1, the employment change fell to 1.5% year-on-year; unemployment rate was unchanged at 4.2%, but participation rate fell to 70.4%; labor cost index fell to 2% year-on-year. Building permits contracted by 6.9% month-on-month in March. NZD/USD depreciated by 0.4% this week. The data from New Zealand continue to underperform its antipodean neighbor. We anticipate this trend will persist. Stay long AUD/NZD, currently 0.5% in the money. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada continue to underperform: GDP in February contracted by 0.1% on a month-on-month basis. Markit manufacturing PMI fell below 50 to 49.7 in April.  USD/CAD fell by 0.1% this week. During Tuesday’s speech, Governor Poloz acknowledged recent negative developments in the Canadian economy, and blamed it on the U.S.-led trade war, as well as the sharp decline in oil prices late last year. While a bottoming in the global growth could be a tailwind for the Canadian economy near-term, a Ricardian equivalence framework will suggest fiscal austerity over the next few years, will be a headwind for long-term CAD investors. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been negative: KOF leading indicator fell to 96.2 in April. Real retail sales contracted by 0.7% year-on-year in March. SVME PMI fell below 50 to 48.5 in April. USD/CHF fell by 0.1% this week. The reduced volatility worldwide could make the Swiss franc less attractive. Moreover, the relative outperformance of the euro area is a headwind for the franc. Our long EUR/CHF position is now 1% in the money. We intend to trade the franc purely as an insurance policy near-term. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway has been positive: Retail sales increased by 0.6% in March, in line with expectations. This was a marked improvement from the 1.2% drop in February. The unemployment rate held low at 3.8% USD/NOK increased by 1% this week. We expect the Norwegian krone to pick up based on the strong fundamentals and positive oil price outlook. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been mostly positive: Retail sales increased on a month-on-month basis by 0.5% in March, but fell to 1.9% on a yearly basis. Producer price index was unchanged at 6.3% year-on-year in March. Trade balance came in at a large surplus of 7 billion SEK in March. Manufacturing PMI fell to 50.9 in April, but notably, import orders and backlog orders rose.  USD/SEK increased by 0.4% this week. Despite the RiksBank’s dovish shift last week, we continue to favor our long SEK position. Our conviction is rooted in the fact that the Swedish krona is undervalued, and relative PMI trends favor Sweden vis-à-vis the U.S. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Indonesian financial assets have benefited from the Federal Reserve’s dovish turn and corresponding fall in U.S. bond yields (Chart I-1, top panel). Moreover, the market is cheering President Joko Widodo’s lead in the presidential vote tally. Yet investors are ignoring the budding weakness in industrial metals prices, which has historically been an important driver of Indonesia’s exchange rate (Chart I-1, middle panel). Going forward, the Indonesian currency, equities and local currency bonds all remain vulnerable: Falling global growth in general and Chinese imports in particular will intensify Indonesia’s exports contraction and worsen the country’s already wide current account deficit. In turn, the latter will induce currency depreciation, which will then lead to higher interbank rates (Chart I-2). Chart I-1Global Growth Matters For Indonesian Markets Global Growth Matters For Indonesian Markets Global Growth Matters For Indonesian Markets Chart I-2Falling Current Account Deficit = Higher Local Rates Falling Current Account Deficit = Higher Local Rates Falling Current Account Deficit = Higher Local Rates Upward pressure on local interbank rates will cause a slowdown in domestic private loan growth.   The Indonesian central bank – Bank Indonesia (BI) – has been attempting to lower interbank rates, which have been hovering above the central bank's policy rate (Chart I-3). To achieve this, the central bank has substantially increased excess reserves in the banking system (Chart I-4). It has done so by purchasing central bank certificates from commercial banks, conducting foreign exchange swaps and providing repo lending. Chart I-3A Sign Of Liquidity Strains A Sign Of Liquidity Strains A Sign Of Liquidity Strains Chart I-4Bank Indonesia Is Injecting Liquidity Bank Indonesia Is Injecting Liquidity Bank Indonesia Is Injecting Liquidity   Yet by expanding banking system liquidity so aggressively, BI risks renewed currency depreciation. Like any central bank in a country with an open capital account, BI cannot expect to have full control over the exchange rate while simultaneously targeting local interest rates. The Impossibly Trinity dilemma dictates that a central bank needs to choose between controlling the two. Therefore, if BI continues to inject local currency liquidity to cap or bring down interest rates (interbank rates), the resulting excess liquidity could encourage and facilitate speculation against the rupiah. Scratching below the surface, the recent strong outperformance of Indonesian equities has been entirely due to the surge in the country’s bank share prices (Chart I-5, top panel). Remarkably, the performance of Indonesian non-financial as well as small-cap stocks has been especially dismal (Chart I-5, middle and bottom panels). This is an upshot of poor profitability among Indonesia’s non-financial listed companies (Chart I-6). Chart I-5Indonesian Bank Stocks Are The Only Outperformers Indonesian Bank Stocks Are The Only Outperformers Indonesian Bank Stocks Are The Only Outperformers Chart I-6Falling Non-Financial Corporate Profitability Falling Non-Financial Corporate Profitability Falling Non-Financial Corporate Profitability Furthermore, deteriorating financial health of non-financial corporates, especially small companies, will lead to higher NPLs on banks’ books. Notably, Indonesian banks are more heavily exposed to businesses than to households. As NPLs rise anew, Indonesian commercial banks will need to lift their bad-loan provisioning levels, generating a major profit relapse (Chart I-7). Importantly, Indonesian commercial banks have been boosting their profits by reducing NPL provisions since early 2018. Reversing this will materially affect their earnings. Chart I-7Indonesian Bank Share Prices Are Vulnerable Indonesian Bank Share Prices Are Vulnerable Indonesian Bank Share Prices Are Vulnerable Additionally, bank stocks are vulnerable due to falling net interest income margins. Moreover, their share prices are overbought and not cheap. To be clear, we are not negative on Indonesia’s structural outlook. The above-mentioned alarms are more near-to-medium terms issues. Still, foreign ownership of local currency bonds and stocks – at 38% each – are high, and could be a major source of potential outflows if the rupiah depreciates. This would cause Indonesian stocks and local currency bonds to sell off severely. Bottom Line: The global growth slowdown/commodities downturn and the U.S. dollar upturn are not yet over. Consequently, foreign flows into EM will diminish, which will be particularly negative for Indonesian financial markets. We recommend investors continue underweighting Indonesian equities and avoid Indonesian local currency bonds for now. We continue to recommend a short position in the IDR versus USD. Ayman Kawtharani, Associate Editor ayman@bcaresearch.com

Highlights In Indonesia, investors are ignoring the weakness in global growth, which is an important driver of the country’s financial markets. The Indonesian currency, equities and local currency bonds all remain vulnerable. We continue to recommend underweighting Indonesian assets for now. In Turkey, additional adjustments in the exchange rate and interest rates are unavoidable. Stay put/underweight Turkish financial markets. In the UAE, the economy is set to improve marginally this year. We recommend overweighting UAE equities and corporate spreads within their respective EM portfolios. Feature Indonesia: The Currency And Bank Stocks Are At Risk  Indonesian financial assets have benefited from the Federal Reserve’s dovish turn and corresponding fall in U.S. bond yields (Chart I-1, top panel). Moreover, the market is cheering President Joko Widodo’s lead in the presidential vote tally. Yet investors are ignoring the budding weakness in industrial metals prices, which has historically been an important driver of Indonesia’s exchange rate (Chart I-1, middle panel). Going forward, the Indonesian currency, equities and local currency bonds all remain vulnerable: Falling global growth in general and Chinese imports in particular will intensify Indonesia’s exports contraction and worsen the country’s already wide current account deficit. In turn, the latter will induce currency depreciation, which will then lead to higher interbank rates (Chart I-2). Chart I-1Global Growth Matters For Indonesian Markets Global Growth Matters For Indonesian Markets Global Growth Matters For Indonesian Markets Chart I-2Falling Current Account Deficit = Higher Local Rates Falling Current Account Deficit = Higher Local Rates Falling Current Account Deficit = Higher Local Rates Upward pressure on local interbank rates will cause a slowdown in domestic private loan growth.   The Indonesian central bank – Bank Indonesia (BI) – has been attempting to lower interbank rates, which have been hovering above the central bank's policy rate (Chart I-3). To achieve this, the central bank has substantially increased excess reserves in the banking system (Chart I-4). It has done so by purchasing central bank certificates from commercial banks, conducting foreign exchange swaps and providing repo lending. Chart I-3A Sign Of Liquidity Strains A Sign Of Liquidity Strains A Sign Of Liquidity Strains Chart I-4Bank Indonesia Is Injecting Liquidity Bank Indonesia Is Injecting Liquidity Bank Indonesia Is Injecting Liquidity   Yet by expanding banking system liquidity so aggressively, BI risks renewed currency depreciation. Like any central bank in a country with an open capital account, BI cannot expect to have full control over the exchange rate while simultaneously targeting local interest rates. The Impossibly Trinity dilemma dictates that a central bank needs to choose between controlling the two. Yet investors are ignoring the budding weakness in industrial metals prices, which has historically been an important driver of Indonesia’s exchange rate. Therefore, if BI continues to inject local currency liquidity to cap or bring down interest rates (interbank rates), the resulting excess liquidity could encourage and facilitate speculation against the rupiah. Scratching below the surface, the recent strong outperformance of Indonesian equities has been entirely due to the surge in the country’s bank share prices (Chart I-5, top panel). Remarkably, the performance of Indonesian non-financial as well as small-cap stocks has been especially dismal (Chart I-5, middle and bottom panels). This is an upshot of poor profitability among Indonesia’s non-financial listed companies (Chart I-6). Chart I-5Indonesian Bank Stocks Are The Only Outperformers Indonesian Bank Stocks Are The Only Outperformers Indonesian Bank Stocks Are The Only Outperformers Chart I-6Falling Non-Financial Corporate Profitability Falling Non-Financial Corporate Profitability Falling Non-Financial Corporate Profitability Furthermore, deteriorating financial health of non-financial corporates, especially small companies, will lead to higher NPLs on banks’ books. Notably, Indonesian banks are more heavily exposed to businesses than to households. As NPLs rise anew, Indonesian commercial banks will need to lift their bad-loan provisioning levels, generating a major profit relapse (Chart I-7). Importantly, Indonesian commercial banks have been boosting their profits by reducing NPL provisions since early 2018. Reversing this will materially affect their earnings. Chart I-7Indonesian Bank Share Prices Are Vulnerable Indonesian Bank Share Prices Are Vulnerable Indonesian Bank Share Prices Are Vulnerable Additionally, bank stocks are vulnerable due to falling net interest income margins. Moreover, their share prices are overbought and not cheap. To be clear, we are not negative on Indonesia’s structural outlook. The above-mentioned alarms are more near-to-medium terms issues. Still, foreign ownership of local currency bonds and stocks – at 38% each – are high, and could be a major source of potential outflows if the rupiah depreciates. This would cause Indonesian stocks and local currency bonds to sell off severely. Bottom Line: The global growth slowdown/commodities downturn and the U.S. dollar upturn are not yet over. Consequently, foreign flows into EM will diminish, which will be particularly negative for Indonesian financial markets. We recommend investors continue underweighting Indonesian equities and avoid Indonesian local currency bonds for now. We continue to recommend a short position in the IDR versus USD. Ayman Kawtharani, Associate Editor ayman@bcaresearch.com Turkey’s Foreign Debt Bubble: The Worst Is Not Yet Behind Us Turkish financial assets, and the currency especially, will remain under selling pressure in the coming months. Additional adjustments in the exchange rate and interest rates - as well as in the real economy and current account balance - appear unavoidable. The key imbalance remains the gap between foreign debt obligations (FDOs) and the availability of foreign currency to meet these debt obligations. Turkey’s FDOs in 2019 are equivalent to $180 billion (Chart II-1). FDOs measure the sum of short-term claims, interest payments and amortization over the next 12 months. This consists of $15 billion in interest payments, $65 billion in debt amortization and $100 billion in maturing short-term (under one year) claims. In theory, these debt obligations can either be rolled over, or the nation should generate current account and capital account surpluses and use these surpluses to pay down FDOs. Even though the current account deficit is shrinking, it is still in a deficit of $18 billion. Net FDI inflows remain weak at US$10 billion. Hence, it appears that Turkey’s only options are either to roll over maturing foreign currency debt or to lure foreign investors into local currency assets and use the surplus in net portfolio inflows to meet these FDOs. The central bank’s foreign currency reserves excluding both commercial banks’ deposits at the Central Bank of Turkey and FX swaps now stand at $13 billion. However, due to a lack of credibility in the Turkish government’s macro policies - in addition to the ongoing deep economic recession and heightened financial market volatility - external creditors will be unwilling to roll over the debt. In fact, net portfolio flows into government debt and equities have tumbled for the same reason. Typically, when foreign funding dries up temporarily, a country can use its foreign exchange reserves to meet its FDOs. However, Turkey’s foreign exchange reserves have already plummeted to extremely low levels (Chart II-2). The central bank’s foreign currency reserves excluding both commercial banks’ deposits at the Central Bank of Turkey and FX swaps now stand at $13 billion. This is negligible compared with the $180 billion FDO figure due in 2019. Chart II-1Turkey: A Large Foreign Debt Servicing Burden Turkey: A Large Foreign Debt Servicing Burden Turkey: A Large Foreign Debt Servicing Burden Chart II-2Foreign Exchange Reserves Are Too Small Foreign Exchange Reserves Are Too Small Foreign Exchange Reserves Are Too Small   The recent plunge in the central bank’s net foreign exchange reserves excluding swaps (i.e. net international reserves) has put many pertinent metrics at record lows. In particular, net international reserves are at a precarious level relative to both total imports and external debt (Chart II-3). Finally, the net international reserves-to-broad money supply ratio has fallen to 7% (from 15% in 2014) despite the fact that the massive lira depreciation reduced the U.S. dollar measure of broad money supply (Chart II-4). Chart II-3FX Reserves Do Not Cover Imports Or External Debt FX Reserves Do Not Cover Imports Or External Debt FX Reserves Do Not Cover Imports Or External Debt Chart II-4Low Coverage Of Broad Money By International Reserves Low Coverage Of Broad Money By International Reserves Low Coverage Of Broad Money By International Reserves The currency will have to depreciate further and interest rates will have to move higher to shrink domestic demand/imports more. This is needed to generate a current account surplus that could be used to service FDOs, or that otherwise entices foreign creditors to be willing to roll over foreign debt or invest in Turkey. Finally, while the adjustment in the real economy is advanced, it is unlikely to be over, due to the large foreign debt bubble. Importantly, with large foreign and local currency debt obligations coming due for both companies and households - in addition to the deterioration in economic activity and higher interest rates - NPLs are bound to rise (Chart II-5). This is especially likely to occur because a lot of borrowing has been used in the property market both for construction and purchases. Notably, real estate volumes are shrinking, and prices are deflating in real terms (Chart II-6). Chart II-5NPLs Will Rise A Lot NPLs Will Rise A Lot NPLs Will Rise A Lot Chart II-6Turkey: Real Estate Is In Free Fall Turkey: Real Estate Is In Free Fall Turkey: Real Estate Is In Free Fall     Bottom Line: The macro adjustment in Turkey is not yet complete. The country still lacks foreign currency supply to service its enormous 2019 FDOs. Further currency depreciation and higher interest rates are required to depress domestic demand/imports and push the current account into surplus. Stay put / underweight Turkish financial markets. The authorities are becoming desperate, and the odds of capital control enforcement are not negligible. While such an outcome is not possible to forecast with any certainty or time frame, investors should consider this very real risk. Andrija Vesic, Research Analyst andrijav@bcaresearch.com Overweight UAE Equities And Corporate Bonds Over the next six to nine months, we believe both UAE equities and corporate spreads will outperform their respective emerging market (EM) benchmarks. The UAE economy is set to improve marginally this year (Chart III-1). It will benefit from expansionary fiscal policy, rising oil output, a buoyant tourism sector, a resilient banking sector and less of a drag from the real estate sector. First, sizable fiscal spending will lead to rising non-oil economic growth. The UAE’s federal budget spending for 2019 will increase by 17.3% from a year ago, much higher than the 5.5% year-on-year growth in 2018. Second, UAE oil output could increase by 15% later this year from current levels (Chart III-2). The U.S. announced on April 22 that all Iran sanction waivers will not be extended beyond the early-May expiration date. The U.S. administration also stated that it has secured pledges from Saudi Arabia and the UAE to increase their oil production in order to offset disrupted supply from Iran. Rising oil output will mitigate the negative impact of potentially lower oil prices on the UAE’s economy. Chart III-1Improving UAE Economy Improving UAE Economy Improving UAE Economy Chart III-2Rising Oil Output Rising Oil Output Rising Oil Output   Third, the outlook for the tourism sector is also positive. The number of tourists is set to rise as Expo 2020 approaches. The government is targeting 20 million visitors in 2020, 26% higher than last year’s levels. The UAE is building theme parks, museums, hotels and infrastructure to attract more tourists. The UAE economy is set to improve marginally this year. Fourth, the UAE’s banking sector will enjoy rising credit growth, robust profitability and improved asset quality this year. The banking system has been in consolidation mode since January 2016, with a 15% reduction in branches and a 14% drop in the number of employees. This has improved the banking sector’s profitability by cutting operating costs and increasing efficiency. The improving growth outlook will lift credit growth. The central bank’s most recent Credit Sentiment Survey suggests banks’ lending standards for both business and personal loans are loosening (Chart III-3). In addition, UAE banks enjoy large capital buffers. Despite rising non-performing loans (Chart III-4), UAE banks still reported a Tier-1 capital adequacy ratio of 17% as of December 2018. Chart III-3Credit Growth Is Likely To Increase Credit Growth Is Likely To Increase Credit Growth Is Likely To Increase Chart III-4Rising NPLs, But Still Large Capital Buffers Rising NPLs, But Still Large Capital Buffers Rising NPLs, But Still Large Capital Buffers   Lastly, the real estate markets in both Dubai and Abu Dhabi have suffered from oversupply (from both mushrooming supply and weaker demand) over the past several years. Property prices have already fallen over 20% in both Dubai and Abu Dhabi from their 2014 peaks (Chart III-5). Odds are high that the most dangerous phase of the property market downturn is behind us. Chart III-5Real Estate Adjustment Is Advanced Real Estate Adjustment Is Advanced Real Estate Adjustment Is Advanced In addition, the government’s efforts to attract people to stay in the country longer will somewhat offset the ongoing exodus of expatriates. Last May, the UAE introduced a new visa system that will allow investors, innovators and talented specialists in the medical, scientific, research and technical fields to stay in the country for up to 10 years. Overall, a potential bottom in property demand and restrained supply will likely make the real estate sector less of a drag on this bourse this year. Finally, the authorities are also more open to increasing the foreign ownership cap in the banking sector, albeit not up to 100%. For example, in early April, the largest UAE lender – First Abu Dhabi Bank – obtained regulatory approval to increase its foreign ownership limit to 40% from 25%. This has boosted foreign equity purchases and has supported the equity index. Bottom Line: We recommend an overweight position in UAE equities within an EM portfolio this year (Chart III-6). For fixed income investors, we recommend overweighting UAE corporate credit in an EM corporate credit portfolio. UAE corporate credit is a lower beta market and will outperform as EM corporate spreads widen (Chart III-7). Most UAE-dollar corporate bonds have been issued by banks. Banks in the UAE do not suffer from structural overhangs, and the cyclical downturn in the property market is well advanced. This is why they have been, and will remain, a lower beta sector within an EM corporate credit portfolio. Chart III-6Overweight UAE Equities Within An EM Portfolio Overweight UAE Equities Within An EM Portfolio Overweight UAE Equities Within An EM Portfolio Chart III-7UAE Corporate Credit Will Likely Outperform EM Benchmark UAE Corporate Credit Will Likely Outperform EM Benchmark UAE Corporate Credit Will Likely Outperform EM Benchmark   Ellen JingYuan He, Associate Vice President ellenj@bcaresearch.com Footnotes Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Highlights The March data brought the first signs of a stabilization in China’s “hard” economic data, albeit from a weak level. The April PMIs disappointed, but they remained in expansionary territory; this is in addition to a continued significant improvement in the trade-related subcomponents of the official survey. Chinese credit growth is unlikely to relapse over the coming year, despite recent investor concerns that Chinese policymakers may dial back their stimulus efforts. The pace of growth may moderate, but halting the uptrend in growth this year would constitute a major policy mistake that we do not expect. Chinese stocks may trend flat-to-down in the very near term as investors await a signed trade deal with the U.S. and further signs of a recovery in activity. Over the next 6-12 months, however, an overweight stance is warranted, barring a major relapse in our leading indicator. Feature Tables 1 and 2 on pages 2 and 3 highlight key developments in China’s economy and its financial markets over the past month. On the growth front, March’s data brought the very first (albeit modest) signs of stabilization in actual Chinese economic activity. While the April manufacturing PMIs released earlier this week disappointed, the trade related components of the official survey continued to improve meaningfully, which implies that an improvement in domestic demand is still early. This conclusion is not particularly surprising given that the first green shoots in the actual data are emerging from a depressed level of activity. Credit growth has only recently picked up, implying that actual activity will strengthen over the coming 6-12 months followed a signed trade deal and a continued (modest) uptrend in credit. Table 1China Macro Data Summary China Macro And Market Review China Macro And Market Review Table 2China Financial Market Performance Summary China Macro And Market Review China Macro And Market Review Within financial markets, the most significant recent development has been that Chinese stocks have sagged somewhat due to concerns that policymakers may meaningfully dial back their stimulus efforts over the coming year. In our view, recent statements from policymakers, as well as the fact that the recovery in activity is only now beginning, underscores that credit growth is unlikely to relapse over the coming year. It may not grow at the breakneck pace observed in the first quarter, but beyond the near-term jitters that this may introduce into the equity market, we do not see it as a threat to an overweight stance towards Chinese stocks over the coming 6-12 months. In reference to Tables 1 and 2, we provide below several detailed observations concerning developments in China’s macro and financial market data: Chart 1 highlights that March brought the first sign of a stabilization in actual Chinese economic activity. When measured on a smoothed basis, the Li Keqiang index itself weakened further in March, but total import growth moved sideways and nominal manufacturing output ticked higher. We noted in our last Macro & Market review that future changes in activity measures were now more likely to reflect actual changes in underlying economic circumstances given that the previously beneficial tariff front-running effect had probably washed out of the data. March’s data confirms this view, and underscores that activity will pickup in the second half of the year. Chart 1The First (Albeit Tentative) Sign Of Economic Stabilization The First (Albeit Tentative) Sign Of Economic Stabilization The First (Albeit Tentative) Sign Of Economic Stabilization Chart 2 shows that the uptrend in our leading indicator for Chinese economic activity is so far modest, but also that it is now at a 2-year high relative to its 12-month moving average. The indicator is being weighed-down by weak money growth (M2 and our definition of M3), even though monetary conditions remain easy and our measures of credit growth picked up sharply in Q1. We doubt that the trend in Chinese money and credit growth can sustainably decouple in a scenario where the latter is sustainably improving, as it would imply that all of the credit improvement was originating from non-bank financial institutions. As such, we expect money growth to catch up to credit growth in the coming months. The annual change in the PBOC’s pledged supplementary lending injection remained in negative territory in March, and both floor space started and sold decelerated modestly further. Construction and sales activity continue to diverge, with the latter still pointing to a further slowdown in the former. We will be updating our Chinese housing outlook in a Special Report next week. April’s Caixin and official manufacturing PMI disappointed, but this overshadowed a continued significant improvement in the new export orders and import components of the official PMI (Chart 3). In our view, this is consistent with a stabilization in the export outlook, but implies that Chinese domestically-oriented manufacturing activity is not yet booming. Nonetheless, a signed trade deal, improving importer/exporter sentiment, and an uptrend in credit growth still implies that activity will pick up meaningfully later in the year. Chart 2Our Leading Indicator Is Now Modestly Trending Higher Our Leading Indicator Is Now Modestly Trending Higher Our Leading Indicator Is Now Modestly Trending Higher Chart 3Trade-Related Components Of The Official PMI Continue To Rise Trade-Related Components Of The Official PMI Continue To Rise Trade-Related Components Of The Official PMI Continue To Rise   Over the past month, Taiwanese and domestic Chinese stocks have been the best performers within “Greater China”, relative to the MSCI Hong Kong index, the MSCI China index, and the Hang Seng China Enterprises index. The latter in particular has lagged other Chinese equity indexes since late-March (Chart 4), and may be due for a catch-up. Over the nearer-term, Chinese stocks, especially the domestic market, have sagged due to concerns that Chinese policymakers may meaningfully dial back their stimulus efforts over the coming year. We discussed this risk in our April 17thWeekly Report,1 and noted that while we expected credit growth to moderate somewhat, a more meaningful slowdown, particularly if coupled with signals from policymakers that a much slower pace of growth is desired, could pose a risk to our overweight equity stance. The April manufacturing PMIs disappointed, but the trade-related components of the official survey continued to improve meaningfully. In our view, recent statements from policymakers, particularly from PBOC Deputy Governor Liu Guoqiang,2 underscores that credit growth is unlikely to relapse over the coming year; it will simply not be growing at the breakneck pace observed in the first quarter. Beyond the near-term jitters that this may introduce into the equity market, we do not see it as a threat to an overweight stance towards Chinese stocks over the coming 6-12 months. Chart 5 highlights that Chinese consumer stocks have been the clear winners since the beginning of the year, particularly in the domestic market. Consumer stocks, including staples, sold off substantially in 2H2018 as investors responded to shockingly weak consumer spending data. Stimulus measures targeted to Chinese households, along with a meaningful improvement in some measures of consumer spending, has helped restore investor confidence in consumer stocks (which had previously been viewed as a bullish “no-brainer” structural trade). Chart 4Is An H-Share Catchup##br## Looming? Is An H-Share Catchup Looming? Is An H-Share Catchup Looming? Chart 5Chinese Consumer Stocks Have Been On Fire Chinese Consumer Stocks Have Been On Fire Chinese Consumer Stocks Have Been On Fire   The sharp rise in the 7-day interbank repo rate in April fed concerns among equity investors that Chinese policymakers might be in the process of paring back their stimulus efforts. However, as Chart 6 shows, China’s 7-day repo rate is extraordinarily volatile, and is affected by a variety of seasonal and technical factors. The chart shows that a 1-month moving average of the 7-day repo rate is broadly in line with the level that has prevailed over the past 9 months. In addition, the 3-month repo rate (which we have argued has been a more informative predictor of China’s monetary policy stance) remains well on the low end of its range over the past year. In short, despite investor concerns, Chinese interbank repo rates are not signaling a change in China’s monetary policy stance. Tighter monetary policy is not in the cards for this year. After having risen noticeably in late-March, Chinese onshore corporate bond spreads have fallen back to the low end of their trading range over the past 8 months. We continue to recommend that domestic investors hold a diversified portfolio of SOE corporate bonds, on the basis that actual bond defaults over the coming 6-12 months are likely to be materially lower than what investors are pricing in even though they are indeed likely to rise. Chart 7 shows that USD-HKD has eased somewhat over the past month from the top end of the band, and now trades closed at 7.845. This modest appreciation in HKD appears to have been catalyzed by a further reduction in the supply of interbank liquidity by the HKMA. While the appreciation in HKD is some modest good news for Hong Kong’s monetary authority, it remains reluctant to reduce liquidity in the system given how extremely weak loan growth is in Hong Kong. This implies that, barring a meaningful upturn in credit, a significant appreciation in HKD is not likely in the cards. Chart 6Interbank Repo Rates Are Not Trending Higher Interbank Repo Rates Are Not Trending Higher Interbank Repo Rates Are Not Trending Higher Chart 7A Modest Appreciation In HKD (Which Is Not Likely To Continue) A Modest Appreciation In HKD (Which Is Not Likely To Continue) A Modest Appreciation In HKD (Which Is Not Likely To Continue)   Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com Footnotes 1      Please see China Investment Strategy Weekly Report “In The Wake Of An Upgrade: An Investment Strategy Post-Mortem,” dated April 17, 2019, available at cis.bcaresearch.com 2      During a PBOC briefing on April 25, Deputy Governor Guoqiang noted that “no one can bear it if policy swings back and forth between tightening and loosening many times a year”. Cyclical Investment Stance Equity Sector Recommendations

Feature What Could Sour The Sweet Spot? This continues to look like a very benevolent environment for risk assets. Growth in the U.S. remains decent, with Q1 GDP growth beating expectations at 3.2% QoQ annualized (albeit somewhat distorted by rising inventories). Leading indicators point to U.S. GDP growth of around 2.5% for 2019. The rest of the world is showing the first “green shoots” of economic recovery. China continues to expand credit, and the effects of this are starting to stabilize growth in Europe, Japan, and the Emerging Markets (Chart 1). Recommended Allocation Monthly Portfolio Update Monthly Portfolio Update Chart 1China Reflation Helping Growth To Bottom China Reflation Helping Growth To Bottom China Reflation Helping Growth To Bottom At the same time, central banks everywhere have turned accommodative. Following the Fed’s dovish shift late last year, the market has priced in rate cuts by end-2019. The ECB is about to relaunch its TLTRO funding program, and is expected to keep rates in negative territory for at least another year (Chart 2) – though there are worries whether Mario Draghi’s successor as ECB president might be more hawkish. The Bank of Canada and Bank of Japan, among others, have recently reemphasized monetary caution. Chart 2No Rate Hikes Anywhere No Rate Hikes Anywhere No Rate Hikes Anywhere Chart 3Term Premium Keeping Down Yields Term Premium Keeping Down Yields Term Premium Keeping Down Yields This goes some way to explain the biggest puzzle in markets currently: why, despite global equities being less than 1% below a record high, long-term interest rates remain so low, with the 10-year U.S. Treasury yield at 2.5%, and yields in Germany and Japan hovering around zero. There are other explanations too. A decomposition of the U.S. 10-year yield shows that most of the downward pressure has come from a sharp drop in the term premium (Chart 3). This is partly because lousy growth in other developed economies, such as Germany and Japan, has pushed down yields in these countries and, given that spreads to the U.S. were at record highs, depressed U.S. rates too. It also reflects a lingering pessimism among investors who bought Treasuries at the end of last year to hedge against recession and who remain concerned about the economy. This is evidenced by continuing strong flows into bond funds in 2019 (Chart 4). A decomposition of the U.S. 10-year yield shows that most of the downward pressure has come from a sharp drop in the term premium. Chart 4Investors Buying Bonds, Not Equities Investors Buying Bonds, Not Equities Investors Buying Bonds, Not Equities Chart 5Why Has Inflation Fallen? Why Has Inflation Fallen? Why Has Inflation Fallen? A further explanation is the recent softness in inflation, with the Fed’s focus measure, core PCE inflation, slowing to an annual rate of only 0.7% over the past three months (Chart 5). This is probably mostly due to the economic slowdown late last year. But it may also have structural causes: the recent improvement in labor productivity can perhaps allow wages to rise without feeding through into consumer price inflation (Chart 6). Chart 6Maybe Because Of Better Productivity Maybe Because Of Better Productivity Maybe Because Of Better Productivity Chart 7Indicators Suggest Inflation Will Still Trend Up Indicators Suggest Inflation Will Still Trend Up Indicators Suggest Inflation Will Still Trend Up How is this all likely to pan out?  We think it improbable that inflation will stay low for long if growth is as robust as we expect. Leading indicators of inflation continue to suggest prices will trend higher (Chart 7). The Fed may not rush to raise rates (not least since, with the lower inflation recently, the Fed Funds Rate in real terms is now at neutral according to the Laubach-Williams model, Chart 8). But we also find it inconceivable that the Fed will cut rates, if growth remains strong, stocks continue to rise, and global risks recede. By the end of this year, it should be able to make a renewed case for a further hike. But even if it doesn’t do that – and permits either inflation to overheat for a while, or asset bubbles to form – these scenarios should be more conducive to equity outperformance, than bond outperformance. Global equities have already risen by 22% since last December’s low and may struggle to make rapid progress over the next few months. The key to further upside for stocks will be earnings: since analysts have cut EPS forecasts for S&P 500 companies for this year to only 4%, those expectations should not be hard to beat. In the Q1 earnings season, for instance, 79% of companies have so far come in ahead of the consensus EPS forecast. For global asset allocators, the key decision is always at the asset-class level. Will equities outperform bonds over the coming 12 months? Equities should have further upside if our macro scenario proves correct. On the other hand, we find it hard to imagine that global bond yields will not rise moderately if global growth recovers, the Fed refrains from cutting rates, inflation rises somewhat, and investors turn less wary of equities. We continue, therefore, to expect the stock-to-bond ratio (Chart 9) to rise further over the next 12 months. We think it improbable that inflation will stay low for long if growth is as robust as we expect. Chart 8Is Fed Now At Neutral? Is Fed Now At Neutral? Is Fed Now At Neutral? Chart 9Stock-To-Bond Ratio Can Rise Further Stock-To-Bond Ratio Can Rise Further Stock-To-Bond Ratio Can Rise Further   Chart 10Europe And EM Outperform Only Briefly Europe And EM Outperform Only Briefly Europe And EM Outperform Only Briefly Equities: We remain overweight global equities, but are reluctant to take higher beta country exposure until there is greater clarity on the bottoming out of ex-U.S. growth. Moreover, the structural headwinds that have prevented anything more than short-term outperformance for eurozone stocks (banking sector weakness) and Emerging Markets (excess debt and poor productivity) since 2010 remain powerful negative factors (Chart 10). Our moderately pro-cyclical sector recommendations (overweight energy and industrials) should hedge us against upside risk emanating from a strong rebound in Chinese imports. Fixed Income: Over the past few years, periods where equities have decoupled from bond yields have been resolved with bond yields playing catch-up (Chart 11). We expect the same to happen over the next few months, with global government bond yields rising moderately. The risk-on environment continues to be positive for credit. We prefer credit to government bonds within fixed income, but are only neutral within our overall recommended portfolio. U.S. high-yield bonds in particular look attractively valued, as long as growth continues and default rates don’t start to rise too much (Chart 12). Chart 11When Bonds And Equities Diverge… When Bonds And Equities Diverge... When Bonds And Equities Diverge... Chart 12Junk Bonds Attractively Valued Junk Bonds Attractively Valued Junk Bonds Attractively Valued Currencies: A pick-up in global growth would be negative for the U.S. dollar, typically a counter-cyclical currency (Chart 13). BCA’s currency strategists have slowly been moving towards a more positive stance on some currencies versus the dollar, particularly the euro and Australian dollar. We would expect to see the trade-weighted dollar start to depreciate in H2 once global growth accelerates, fueled by the very skewed long-dollar positioning currently. However, this may be only a six- to 12-month move, since growth and interest-rate differentials suggest that the structural dollar bull market that began in 2012 has not yet fully run its course. Commodities: Oil remains dominated by supply-side dynamics. How much the ending of waivers on Iranian oil sanctions, plus troubles in Venezuela and Libya, push up oil prices will depend on whether President Trump can persuade Saudi Arabia and UAE to increase production. BCA’s energy team expects he will be only partially successful in doing so, and see Brent reaching $80 a barrel and WTI $77 (from $72 and $64 currently) during 2019. Industrial commodities prices will depend on the strength and nature of China’s reflation: our commodities strategists see copper, the most sensitive metal to Chinese demand, as the best way to play this.1 Garry Evans Chief Global Asset Allocation Strategist garry@bcaresearch.com Chart 13Stronger Growth Would Be Dollar Negative Stronger Growth Would Be Dollar Negative Stronger Growth Would Be Dollar Negative   Footnotes 1       Please see Commodity & Energy Strategy Weekly Report, “Copper Will Benefit Most From Chinese Stimulus,” dated April 25, 2019, available at ces.bcaresearch.com GAA Asset Allocation  

Highlights Central bankers appear to be in a rush to boost inflation expectations before the next economic downturn. This in practice should be stimulative for the global economy. Historically, currencies of small, open economies are typically the first to benefit from rebounding global growth. Ditto for those whose output gaps have fully closed. However, there appears to be a shift in the behavior of certain currency pairs in the current cycle. For example, the U.S. dollar has tended to perform better in a low-volatility environment in recent years, a shift from the past. Correspondingly, its safe-haven status may have been marginally eroded. The U.S. decision not to extend waivers on Iranian oil exports beyond the May 2 deadline is bullish for petrocurrencies such as the RUB and NOK. The Bank of Canada kept rates on hold but will be hard pressed to meet its inflation mandate before the next downturn. This suggests standing aside on USD/CAD. Rising net short positioning on the yen and Swiss franc is making them attractive from a contrarian standpoint. Place a limit-buy on CHF/NZD at 1.45. Feature Chart I-1Volatility Is Due For A Bounce Volatility Is Due For A Bounce Volatility Is Due For A Bounce The four most important financial variables that could give a near-complete snapshot of the world economy at any point in time are probably the level of the S&P 500, the U.S. 10-year Treasury yield, the trade-weighted dollar and a commodity bellwether, say, crude oil prices. Any permutation of these variables can identify what quadrant the world economy is operating in, with the two most important states being either boom or bust. Taking three of those variables today – the S&P 500 breaking to all-time highs, crude oil prices up 40% from their lows and U.S. 10-year Treasury yields off by almost 100 basis points from their October highs – it is hard to justify why the dollar has hardly budged, this week’s rally aside. Obviously, this is a very simplified view of an intricately complex world economy. But it highlights a point we have been making in recent bulletins: that extended periods of low currency volatility have been very unusual in the post-Bretton Woods world (Chart I-1). The typical narrative has been that as we enter a reflationary window, pro-cyclical currencies should outperform. The reason is simple enough: These economies are export-oriented and tied to the global cycle. So, a rising current account surplus as demand for their goods and services picks up provides underlying support for the currency. Should there be little slack in their domestic economies, this also raises the probability that the central bank tightens monetary policy to fend off future inflationary pressures. It does not hurt if these countries are also commodity producers, since rising terms of trade also provides an additional exchange-rate boost. The reality is that the world is not static, and some of these dynamics have been shifting. The evidence is in the counterfactual: At current levels, China’s credit injection should have lit a fire under pro-cyclical trades because they tend to work in real-time rather than with a lag. The foreign exchange market is one of the deepest and most liquid where new information tends to get digested and discounted instantaneously. As such, the lack of more pronounced strength in pro-cyclical currencies like the Australian, New Zealand and Canadian dollar exchange rates is genuine reason for concern and worth investigation. Why Is The Dollar Breaking Higher? Our Special Report1 on March 29th highlighted the fact that the dollar should be 5-10% higher simply based on measures of relative trends, and recent data corroborate this view. The growth differential between the U.S. and the rest of the world remains wide. Meanwhile, exports and industrial production from Southeast Asia continue to decelerate. Interbank rates in China are spiking higher, suggesting most of the monetary stimulus may have already been frontloaded. And on the earnings front, U.S. profit leadership also continues. It is unclear which of these catalysts was the actual trigger for dollar strength, since these have been in place for a while now, but confirmation from any and all of them was sufficient to reinvigorate the dollar bulls. That said, it is important to pay heed to shifting market forces, but it will be imprudent to change investment strategy on this week’s moves alone. Given these moves, a few observations are in order: Almost all currencies are already falling versus the U.S. dollar – a trend that has been in place for several months now (Chart I-2). This means most of the factors putting upward pressure on the dollar are well understood by the market. For example, global growth has been slowing for well over a year, based on the global PMI. Putting on fresh U.S. long positions is at risk of a washout from stale investors, just as it was back in 2015, a year after growth had peaked. Dollar technicals are also very unfavorable (Chart I-3). Speculators are holding near-record long positions, sentiment is stretched and our intermediate-term indicator is also flagging yellow. Over the past five years, confirmation from all three indicators has been followed by some period of U.S. dollar indigestion. This time should be no different. Chart I-2Is It Time To Initiate Fresh Dollar Longs? Is It Time To Initiate Fresh Dollar Longs? Is It Time To Initiate Fresh Dollar Longs? Chart I-3Dollar Technicals Are Unfavourable Dollar Technicals Are Unfavourable Dollar Technicals Are Unfavourable A breakout in the dollar along with rising equity markets suggests that the correlation is once again shifting. The dollar has tended to trade as a counter-cyclical currency for most of the time, with a negative correlation even to global equities (Chart I-4). Importantly, given current low levels of volatility and elevated equity market valuations, the dollar would have been a great insurance policy for any stock market correction. But with U.S. interest rates having risen significantly versus almost all G10 countries in recent years, the dollar has itself become the object of carry trades. This has also come with a good number of unhedged trades, as the rising exchange rate has lifted hedging costs (Table I-1). Chart I-4The Dollar Remains A 'Risk-Off' Currency The Dollar Remains A 'Risk-Off' Currency The Dollar Remains A 'Risk-Off' Currency Chart I- It will be difficult for the dollar to act as both a safe-haven and carry currency, because the forces that drive both move in opposite directions. For one, safe-haven assets tend to be lower-yielding but also during episodes of capital flight, investors choose to repatriate capital to pay down debt, with creditor nations having the upper hand. And given U.S. investors have already been repatriating close to $400 billion in assets over the past 12 months, it is unlikely this pace persists (Chart I-5). The bottom line is that investors who believe that the U.S. dollar has become a high-beta currency should be prepared to stampede out the door on any rise in volatility. Our bias remains that the U.S. dollar will ultimately weaken, given that the forces driving it higher are mostly behind us. Meanwhile, currencies such as the Japanese yen or even Swiss franc that have been used to fund carry trades are very ripe for short-covering flows. Putting everything together suggests at minimum building portfolio hedges. It will be difficult for the dollar to act as both a safe-haven and carry currency. One such hedge is going long CHF/NZD. This trade has a high negative carry, so we do not intend to hold it for longer than three months. But speculative positioning and relative economic trends also support this cross for the time being (Chart I-6). We are placing a limit-buy at 1.45. Chart I-5How Much More Will Repatriation Flows Help? How Much More Will Repatriation Flows Help? How Much More Will Repatriation Flows Help? Chart I-6CHF/NZD Is An Attractive ##br##Hedge CHF/NZD Is An Attractive Hedge CHF/NZD Is An Attractive Hedge A Shifting Landscape If the dollar eventually weakens, let’s consider the premise that the most export-dependent economies should benefit more from a rebound in global growth, and by extension, their currencies should appreciate the most. Within the G10 universe, this will be notably the European currencies led by the Swiss franc, the Swedish Krona, the euro and the pound (Chart I-7). However, from the trough in the global Purchasing Managers’ Index (PMI) in December 2008 until the peak in April 2010, it was the commodity currencies that outperformed. During that time frame, the Swiss franc actually fell. It is well known that Switzerland’s persistent trade surplus over the decades has been a key factor behind structural appreciation in the currency. However, at any point in time, other nuances such as whether the rebound is China or commodities driven, the starting point for valuations or even interest rate differentials take center stage in explaining currency moves. The lesson is that investors have to become nimble with currency investment strategy. The lesson is that investors have to become nimble with currency investment strategy. For pro-cyclical currencies, there have been dramatic shifts in the export share of GDP for various countries, according to World Bank data. Most euro area countries have massively expanded their export share of GDP as they have gained ground in value-added products and services. Meanwhile, the export share in Australian GDP has been stuck at 20% for many years, while that in Norway, New Zealand and Canada has seen a huge drop, even since 2009 (Chart I-8). At first blush, this suggests diminishing marginal returns to their currencies from global growth. Chart I-7 Chart I-8A Shifting Export ##br##Landscape A Shifting Export Landscape A Shifting Export Landscape Take the example of New Zealand, where commodities are over 75% of exports. Since the 2000s, the government has been actively trying to redistribute growth from net exports to domestic demand. This has been mainly via the skilled workers program. The result has been a collapse in the export share of GDP from 36% to about 26%. This means that the New Zealand dollar, which has typically been a higher-beta play on global growth, is giving way to other currencies such as the euro and the Swedish krone (Chart I-4). In addition to this, while global growth might eventually recover, part of the widespread deterioration since the global financial crisis may be structural. If the overarching theme over slowing global trade is a global economy that is trying to lift its precautionary savings and spend less, then the world may not see the high rates of trade growth registered in the 1990s anytime soon. This is because at a lower rate of potential GDP growth, trade elasticities also tend to fall.2 There are many reasons for this, including less willingness among creditor nations to finance current account deficits, the paradox of thrift or just outright saturation in the turnover of trade. All of this dampens marginal returns toward all pro-cyclical currency trades. Chart I-9Trade Volatility Has Fallen Trade Volatility Has Fallen Trade Volatility Has Fallen The bottom line is that the overall magnitude and volatility of trade relative to GDP has fallen, at least until the recent China – U.S. trade spat (Chart I-9). This has had the effect of dampening the volatility of the corresponding mediums of trade exchanges. Part of this is clearly cyclical, but a part may be structural as well. If we embrace confirmation that the Chinese economy has bottomed, it will be important to monitor if this cycle plays out like those in the past. Notes On Petrocurrencies, And The BoC The U.S. has decided not to extend waivers on Iranian oil exports beyond the May 2 deadline. Supposedly, a coalition with both Saudi Arabia and the United Arab Emirates would ensure that oil markets remain adequately supplied, though Saudi Arabia has since signaled they are in no rush to raise production. Overall, this increases the bullish narrative for oil. First, the Iranian response to a shutoff in their exports could be unpredictable. The U.S. threat of driving Iranian oil exports to zero increases the geopolitical risk premium in prices, as full implementation pushes Iran to a wall, raising the odds of retaliation. Chart I-10Iran Is A Meaningful Oil Supplier Iran Is A Meaningful Oil Supplier Iran Is A Meaningful Oil Supplier Second, oil production is being curtailed at a time when Venezuelan output is rapidly falling, conflict in Libya is reviving and OPEC spare capacity remains tight. This could nudge the oil market dangerously close to a negative supply shock (Chart I-10). Meanwhile, there is the non-negligible risk of unplanned outages which have been rising in 2019, which is another source of risk for oil supply Oil futures have responded positively to the news, with both Brent and WTI making fresh 2019 highs. However, while initially reacting favorably, petrocurrencies such as the Canadian dollar, Russian ruble and Norwegian krone are selling off amid dollar strength. We think Brent will continue to trade at a premium to WCS crude. This bodes well for currencies tied to North Sea production. Hold short CAD/NOK and long NOK/SEK positions, despite the selloff this week. As for Canada, we are neutral on the loonie both short and medium term. The dovish shift by the BoC and looser fiscal policy are likely to be growth tailwinds. So is the rise in oil prices. However, there appears to be a genuine slowdown in the Canadian economy that is not yet fully reflected in economic forecasts.  The key drivers for the CAD/USD exchange rate are interest rate differentials with the U.S. (which we think will compress further) and energy prices (which we think Canada benefits less from due to the discount Canadian oil sells for, and persistent infrastructure problems). As such, we think domestic conditions will continue to knock down whatever benefit comes from rising oil prices (Chart I-11). Chart I-11CAD/USD Will Benefit From##br## Rising Terms Of Trade CAD/USD Will Benefit From Rising Terms Of Trade CAD/USD Will Benefit From Rising Terms Of Trade Chart I-12Can The BoC Hike Given ##br##This Backdrop? (1) Can The BoC Hike Given This Backdrop? (1) Can The BoC Hike Given This Backdrop? (1) On the consumer side, real retail sales are deflating at the worst pace since the financial crisis, and demand for housing loans is falling off (Chart I-12). This is unlikely to improve if house prices continue to roll over (Chart I-13). A study by the Reserve Bank of New Zealand shows that on average, the elasticity of consumption growth to house price changes is asymmetric with negative housing shocks, hurting consumption by more than the boost received from positive shocks. This asymmetry may be due to the fact that at very elevated debt levels, leveraged gains are used to pay down debt aggressively, whereas leveraged losses hit bottom lines directly. There appears to be a genuine slowdown in the Canadian economy that is not yet fully reflected in economic forecasts. On the corporate side of the equation, the latest Canadian Business Outlook Survey is very telling. Firms’ expectations for sales have softened significantly, as businesses in several sectors are less optimistic about demand. This is driven by uncertainty in the oil patch, weak housing and weak external conditions. This in turn, has led to a steep drop in plans to increase capex (Chart I-14). For external investors, the large stock of debt in the Canadian private sector and overvaluation in the housing market are likely to continue leading to equity outflows on a rate-of-change basis. Chart I-13Can The BoC Hike Given This Backdrop? (2) Can The BoC Hike Given This Backdrop? (2) Can The BoC Hike Given This Backdrop? (2) Chart I-14Can The BoC Hike Given This Backdrop? (3) Can The BoC Hike Given This Backdrop? (3) Can The BoC Hike Given This Backdrop? (3) Technically, USD/CAD failed to break below the upward sloping trendline drawn from its 2017 lows. The next resistance zone is the 1.36-1.38 level. Our bias is that this zone will prove to be formidable resistance. We continue to recommend investors short the CAD, mainly via the euro. Housekeeping Our limit-buy on AUD/USD was triggered at 0.70. Place tight stops at 0.68 until further evidence that global growth has bottomed. Our short USD/SEK position garnered losses this week. The RiksBank’s dovish shift surprised the market, and triggered panic selling as important technical levels were broken. With a manufacturing PMI at 52.8, inflation at 1.8% and wages growing near 3%, this is not exactly the symptoms of an economy that needs more stimulus. We recommend holding onto positions, but will respect our stop loss a few hundred pips away. Finally, the dovish shift by the Bank of Japan does not change our thinking on the yen. The resilience in the currency might indicate the pool of yen bears has been exhausted.   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Special Report, titled “Tug Of War With Gold As Umpire,” dated March 29, 2019, available at fes.bcaresearch.com. 2 Cristina Constantinescu, Aaditya Mattoo, and Michele Ruta, “The Global Trade Slowdown: Cyclical Or Structural?” IMF working paper (2015). Currencies U.S. Dollar Chart II-1 USD Technicals 1 USD Technicals 1 Chart II-2 USD Technicals 2 USD Technicals 2 ​​​​​ Recent data in the U.S. suggest a weaker housing market: In March, building permits contracted by 1.7% month-on-month, falling to 1.27 million; housing starts decreased by 0.3% month-on-month, coming in at 1.14 million. March new home sales grew by 4.5% month-on-month, coming in at 0.69 million. However, existing home sales contracted by 4.9% month-on-month, falling to 5.21 million. The house price index grew by 0.3% month-on-month in February, in line with expectations. MBA mortgage applications decreased by 7.3% in April. The Chicago Fed National Activity index fell to -0.15 in March, underperforming expectations. Durable goods orders increased by 2.7% in March, surprising to the upside. DXY index appreciated by 1% this week, hitting the highest level since June 2017. While a more accommodative monetary policy stance has been taken in China, global growth momentum remains weak, which is a cause for concern. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 The Euro Chart II-3 EUR Technicals 1 EUR Technicals 1 Chart II-4 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area continue to soften: Italian business confidence and consumer confidence in March fell to 100.6 and 110.5, respectively. April preliminary consumer confidence in the euro area fell to -7.9, below expectations. German IFO business climate fell to 99.2 in April; expectations and current assessment fell to 95.2 and 103.3, respectively. French business confidence improved to 105, while business climate decreased to 101 in April. Italian trade balance came in at a larger surplus of 3.42 billion euro in April. EUR/USD depreciated by 1% this week. The incoming data from the euro area and globally have been weaker than expected. The recent ECB Economic Bulletin remains positive for the growth outlook going forward, stating that “the supportive financing conditions, favorable labor market dynamics and rising wage growth should continue to underpin the euro area expansion.” Report Links: Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 The Yen Chart II-5 JPY Technicals 1 JPY Technicals 1 Chart II-6 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: Headline inflation and core inflation were unchanged at 0.5% and 0.4% year-on-year in March, respectively. Machine tool orders in March contracted by -28.5% year-on-year. All industry activity index fell by 0.2% month-on-month in February, in line with expectations. USD/JPY surged initially by 0.4% ahead of BoJ’s rate decision, then fell sharply, returning flat this week. The BoJ has decided to keep the interest rate on hold at -0.1%. The shift to a calendar-based form of forward guidance is unlikely to be a game-changer on its own. Moreover, the BoJ expects the Japanese economy to pick up through 2021 supported by highly accommodative financial conditions and government spending, despite the weakness of global growth and scheduled consumption tax hike. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 A Trader’s Guide To The Yen - March 15, 2019 British Pound Chart II-7 GBP Technicals 1 GBP Technicals 1 Chart II-8 GBP Technicals 2 GBP Technicals 2 Recent data in the U.K. have been positive: Public sector net borrowing increased to 0.84 billion pounds in March. In April, the CBI retailing reported sales increased to 13. The CBI business optimism came in at -16 in April, an improvement compared to the last reading of -23. GBP/USD fell by 1% this week, mostly affected by the U.S. dollar’s broad strength. The pound is likely to rebound once we see more signs confirming the strength in global growth, given Brexit has been kicked down the road. Report Links: Not Out Of The Woods Yet - April 5, 2019 A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 Australian Dollar Chart II-9 AUD Technicals 1 AUD Technicals 1 Chart II-10 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been negative: Headline inflation fell to 1.3% year-on-year in Q1, missing expectations. Trimmed mean inflation in Q1 fell to 1.6% year-on-year. AUD/USD fell by 2.3% this week, which triggered our limit buy order at 0.7 on Wednesday. Inflation is a lagging indicator. While the Q1 inflation number missed expectations, the Australian dollar is likely to bottom as Chinese stimulus plays out and global growth starts to pick up. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Into A Transition Phase - March 8, 2019 New Zealand Dollar Chart II-11 NZD Technicals 1 NZD Technicals 1 Chart II-12 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand has been negative: Credit card spending contracted by 5.1% year-on-year in March, underperforming expectations. NZD/USD fell by 1.36% this week. We remain bearish on the New Zealand dollar due to the Achilles’ heel of an overvalued housing market. Moreover, the Kiwi is still expensive compared to its fair value. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13 CAD Technicals 1 CAD Technicals 1 Chart II-14 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been positive: Wholesale sales grew by 0.3% month-in-month in February, surprising to the upside. CFIB business barometer increased to 56.7 in April. USD/CAD surged by 0.95% this week. The Canadian dollar seems to be less responsive to the energy prices this week due to lots of concerns regarding the pipeline issue in Alberta. The Bank of Canada maintained its overnight interest rate target at 1.75% on Wednesday. In the April Monetary Policy Report, the BoC projects real GDP growth of 1.2% in 2019, and around 2% in 2020 and 2021. Given the current developments in household spending, energy investment, and trade conditions, a dovish stance by BoC is warranted. Report Links: A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swiss Franc Chart II-15 CHF Technicals 1 CHF Technicals 1 Chart II-16 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been mostly positive: Money supply M3 grew by 3.5% year-on-year in March, same as last month. ZEW survey expectations increased to -7.7 from the previous reading of -26.9. USD/CHF increased by 0.66% this week. While global growth is set to rebound, the uncertainties regarding geopolitical risks, trade conditions, and oil prices will weigh on the growth pace. We remain neutral on the Swiss franc against U.S. dollar, but acknowledge that the large short positioning is attractive from a contrarian standpoint. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Norwegian Krone Chart II-17 NOK Technicals 1 NOK Technicals 1 Chart II-18 NOK Technicals 2 NOK Technicals 2 There is no significant data from Norway this week. USD/NOK appreciated by 2.2% this week. We remain overweight the NOK based on our bullish outlook for oil. The Trump administration said they would not renew the waivers for Iranian oil exports, a move that roiled the energy market. The spike in oil prices will eventually benefit the Norwegian krone once global growth stabilizes. Report Links: A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swedish Krona Chart II-19 SEK Technicals 1 SEK Technicals 1 Chart II-20 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden suggest a more positive sentiment: Consumer confidence increased to 95.8 in April, surprising to the upside. Economic tendency survey increased to 102.7 in April. Moreover, the manufacturing confidence also improved to 108.4 in April. USD/SEK appreciated by 2.64% this week. The Riksbank has kept its interest rate unchanged at -0.25% this week, as widely expected. The dovish shift of central banks worldwide is likely to help the global economy, which will benefit the Swedish krona. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights The U.S. dollar will ultimately reach fresh cycle highs, but not before going through a weak phase starting this summer that could last 12 months. We closed our long DXY trade for a carry-adjusted return of 16.4% last week. We will go tactically short the index if it breaches 101 (about 3% above current levels). As a countercyclical currency, the dollar is likely to stumble in the second half of this year as global growth accelerates. Positioning and sentiment are currently very dollar bullish, which is likely to exacerbate any sell-off in the greenback. The dollar should begin to rally again late next year, as global growth decelerates while the Fed is forced to turn more hawkish in the face of rising inflation. Go long European banks as a tactical trade. Feature Moving To The Sidelines On The Dollar We closed our long DXY trade recommendation for a carry-adjusted gain of 16.4% at last Thursday’s close – too early it turns out, as the DXY has gained another 0.7% since then. The dollar is a high-momentum currency (Chart 1). The trend is the dollar’s friend at the moment, which makes betting against the greenback risky. Nevertheless, we would not chase the dollar higher at these levels. Long dollar positioning is highly stretched and sentiment is overly bullish (Chart 2). This makes a price reversal increasingly probable. Chart 1 Perhaps more importantly, the macro fundamentals, which have worked in favor of the dollar since early 2018, will likely start working against it as the summer months approach. Chart 2There Are A Lot Of Dollar Bulls Out There There Are A Lot Of Dollar Bulls Out There There Are A Lot Of Dollar Bulls Out There   Stronger Global Growth Will Hurt The Greenback The dollar is a countercyclical currency, meaning that it tends to move in the opposite direction of global growth (Chart 3). Global growth has been decelerating since early 2018, and that has helped boost the dollar’s value. The dollar is a countercyclical currency, meaning that it tends to move in the opposite direction of global growth. Chart 3The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency If anything, the growth divergence between the U.S. and the rest of the developed world has increased over the past few months. Goldman’s Current Activity Indicator (CAI) for the U.S. has been rising since January, while the European and Japanese CAIs have continued to fall (Chart 4). Looking out, the rest of the world is likely to catch up to the United States. The Chinese CAI has already moved sharply higher thanks in part to an acceleration in Chinese credit growth. Chart 4Growth Is Recovering In The U.S. And China Growth Is Recovering In The U.S. And China Growth Is Recovering In The U.S. And China Chart 5China: Credit Is Growing At A Moderately Faster Pace Than GDP China: Credit Is Growing At A Moderately Faster Pace Than GDP China: Credit Is Growing At A Moderately Faster Pace Than GDP We would downplay recent market speculation that the Chinese authorities are preparing to restart their deleveraging campaign. Credit growth is now running only modestly above nominal GDP growth (Chart 5). With the ratio of debt-to-GDP broadly stable, there is no need to further clamp down on credit formation. The Chinese government also wants to keep the economy buoyant in order to gain negotiating leverage in trade talks with the Trump administration.   Better Chinese Data Will Benefit The Rest Of The World Fluctuations in Chinese growth usually affect Europe with a lag of around six months (Chart 6). This suggests that European exports should strengthen starting this summer. Meanwhile, European domestic demand should benefit from an easing of fiscal policy of around 0.5% of GDP. Chart 6Europe Will Benefit From Improving Chinese Growth Europe Will Benefit From Improving Chinese Growth Europe Will Benefit From Improving Chinese Growth Chart 7Swings In Interest Rate Differentials Explain Some Currency Moves Swings In Interest Rate Differentials Explain Some Currency Moves Swings In Interest Rate Differentials Explain Some Currency Moves   Faster growth in the U.S. in relation to the euro area has caused the spread in expected interest rates to widen between the two regions. The spread in one-month, five-year forward OIS rates now stands at 202 bps, similar to the highs seen in late-2016 (Chart 7). If euro area growth recovers this summer, the market will price in a bit of tightening from the ECB starting late next year. This will cause the spread to narrow, leading to a stronger euro. A revival in Chinese growth should also help EM and commodity currencies. The market is currently pricing in 44 basis points of rate cuts in Australia, 33 bps of cuts in New Zealand, and 21 bps of cuts in Canada over the next 12 months. While domestic concerns around high household debt levels and overvalued real estate markets will keep central banks on guard in all three economies, a more robust global growth backdrop should allow some of the expected easing to be priced out. Japan remains a bit of a wildcard due to the government’s stated intention to raise the sales tax this October. We see little justification for increasing the sales tax given that inflation expectations are still nowhere close to the BOJ’s target. Japan needs easier, not tighter, fiscal policy. There is still an outside chance that the tax hike will be postponed, but even if it is, rising bond yields in the rest of the world will still hurt the yen. The BOJ has no intention of abandoning its yield curve targeting system anytime soon. In fact, it introduced new forward guidance at this week’s monetary policy meeting promising not to raise rates at least until the spring of 2020. Investors looking to trade the yen should consider going long EUR/JPY or AUD/JPY. We recommend going long European banks outright for a tactical trade. Bottom Line: If global growth accelerates later this year, the dollar will probably weaken. Accordingly, investors should use this week’s rally in the dollar to scale back exposure to the currency. We are also putting in a limit order to go short the DXY index if it reaches 101 (about 3% above its current level). Looking Further Out… Chart 8Low Odds Of An Imminent Major Inflationary Upswing In The U.S. Low Odds Of An Imminent Major Inflationary Upswing In The U.S. Low Odds Of An Imminent Major Inflationary Upswing In The U.S. Mini-cycles within the broader global business cycle tend to last around 12-to-18 months. If this pattern continues to hold, global growth will probably falter again in the second half of next year. At that point, the dollar is likely to strengthen again. By how much can the dollar rise? That depends on what the Fed does. A stronger dollar would entail a tightening in financial conditions. Normally that would cause the Fed to turn more dovish, limiting the upside for the greenback. The risk is that rising inflation prevents the Fed from turning more accommodative. Inflation is not much of a concern now. Leading indicators of inflation such as core intermediate goods prices and the prices paid component of the ISM remain well contained (Chart 8). Wage growth has picked up, but productivity growth has risen even more. As a result, unit labor costs, which tend to lead core inflation, have been decelerating since the middle of last year. If the U.S. economy continues to grow above trend, however, inflation could begin to break out late next year. That would force the Fed to start raising rates more aggressively than it would like, even in the face of slower growth. Such a stagflationary outcome will be awful for equities and other risk assets. As U.S. financial conditions tighten, global growth will slow, giving the dollar a further boost. The upshot is that the dollar could see a meaningful rally starting late next year. Stay Bullish On Stocks For Now… Until that fateful day arrives, we are inclined to maintain our bullish equity bias. We upgraded global stocks to overweight in December after having moved to the sidelines in June. Despite the run-up in stock prices, the forward P/E ratio on the MSCI All-Country World Index is still 7% below where it was at the start of 2018 and 3% below its long-term (30-year) average (Chart 9). Earnings estimates are also finally starting to increase (Chart 10). Accelerating global economic growth will ensure that profits continue to rise into year-end. Chart 9Global Stocks Are Not That Expensive Global Stocks Are Not That Expensive Global Stocks Are Not That Expensive Chart 10Earnings Estimates Have Turned The Corner Earnings Estimates Have Turned The Corner Earnings Estimates Have Turned The Corner     … And Buy Some European Banks For A Tactical Trade European banks are trading at distressed valuations (Chart 11). One can debate the long-term prospects for the European banking sector, but in the near term, one thing is clear: If European growth begins to surprise on the upside, bond yields in core European markets will rise, which should help European bank stock prices (Chart 12). Stronger economic growth will also translate into more credit demand and lower non-performing loans. This will boost bank earnings (Chart 13). With all this in mind, we recommend going long European banks outright for a tactical trade. Chart 11European Banks: A Good Value Play European Banks: A Good Value Play European Banks: A Good Value Play Chart 12Euro Area: Higher Bond Yields Bode Well For Bank Stocks Euro Area: Higher Bond Yields Bode Well For Bank Stocks Euro Area: Higher Bond Yields Bode Well For Bank Stocks Chart 13More Credit, Fatter Bank Earnings More Credit, Fatter Bank Earnings More Credit, Fatter Bank Earnings   Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com   Strategy & Market Trends MacroQuant Model And Current Subjective Scores Chart 14 Tactical Trades Strategic Recommendations Closed Trades