Fixed Income

Dear Client, China Investment Strategy will take a summer break next week. We will resume our publication on July 14th. Best regards and we wish you a happy and healthy summer. Jing Sima, China Strategist   Highlights A USD rebound and higher domestic bond yields pose near-term challenges to Chinese risk assets. A sharp deceleration in credit growth in the past seven months will lead to weaker-than-expected data from China’s old-economy sectors in the second half of the year.  Robust global trade has propelled Chinese exports, allowing the country to pursue financial deleverage and structural reforms. However, next year policymakers will face increased pressure to support the domestic economy as the global economic recovery peaks and demand slows. Investors should maintain an underweight stance towards Chinese stocks in 2H21, but remain alert to any improvements in China’s policy tone.  An easing monetary policy may signal a potential upgrade catalyst in 1H22. Feature Most recent macro figures confirm that China’s impressive economic upcycle has peaked. We expect that the official manufacturing and non-manufacturing PMIs, which will be released as this report is published, will come in modestly down. We maintain the view that a major relapse in economic activity is unlikely, but the strong tailwinds that have propelled China's recovery since Q2 last year have since abated and will lead to softer growth. Meanwhile, the rate of economic and export expansions has given Chinese policymakers confidence to scale back leverage and continue with market reforms. In the second half of the year, investors' sentiment towards Chinese stocks will be tested based on three risks: A rebound in the US dollar index. A tighter liquidity environment and higher interest rates. A weakening in macro indicators beyond market expectations. As the global economic recovery peaks into 2022, pressures to support the domestic economy will become more urgent if policymakers want to maintain an average rate of 5% real GDP growth in 2020 - 2022. The current policy settings are not yet favorable to overweight Chinese risk assets. Major equity indexes remain richly valued and the market could easily correct if domestic rates move higher. However, signs of policy easing may emerge by yearend, which would prompt us to shift our view to overweight Chinese stocks in both absolute and relative terms. The Case For A Dollar Rebound On a tactical basis (next three months), a rebound in the US dollar index may curb investors’ enthusiasm for Chinese stocks. A stronger dollar will give the RMB’s appreciation some breathing room and will be reflationary for China’s economy. However, in the short term a stronger USD will also lead to weaker foreign inflows to China’s equity markets. Chinese stock prices have become more closely and negatively correlated with the dollar index since early 2020 (Chart 1). A weaker dollar is usually accompanied by a global economic upturn and a higher risk appetite from investors, propelling more foreign portfolio flows to emerging markets (which includes Chinese risk assets). Although foreign inflows account for a small portion of the Chinese A-share market cap, global institutional investors’ sentiment has become more influential and has led fluctuations in Chinese onshore stock prices (Chart 2). Chart 1Closer Correlations Between Chinese Stocks And The Dollar Index Closer Correlations Between Chinese Stocks And The Dollar Index Closer Correlations Between Chinese Stocks And The Dollar Index Chart 2Foreign Investors Matter To Chinese Onshore Stock Prices Foreign Investors Matter To Chinese Onshore Stock Prices Foreign Investors Matter To Chinese Onshore Stock Prices Chart 3Rising Market Expectations For The Fed's Rate Liftoff Rising Market Expectations For The Fed's Rate Liftoff Rising Market Expectations For The Fed's Rate Liftoff The US Federal Reserve delivered a slightly more hawkish surprise at its June FOMC meeting with the message that it will move the projected timing of its first fed fund rate liftoff from 2024 to 2023. Since then, market expectations have shifted from growth and inflation to focusing on the next monetary policy tightening phase, with the short end of the US yield curve rising sharply (Chart 3). Given that currency markets trade off the short end of the yield curve, higher US interest rate expectations will at least temporarily lift the US dollar. The timing and pace of the Fed’s tapering of asset purchases and rate hikes will be determined by how rapidly the US economy approaches the US central bank’s definition of “maximum employment.” BCA’s US Bond Investment strategist anticipates that sizeable and positive non-farm payroll surprises will start in late summer/early fall, which will catalyze a move higher in bond yields. As such, we expect additional upside risks in the dollar index in the coming months, which will discourage foreign investors’ appetite for Chinese equities. Bottom Line: A rebound in the dollar index will be a near-term downside risk to Chinese stocks. Risk Of Higher Chinese Interest Rates Another near-term risk to Chinese stock prices is a tightening in domestic liquidity conditions and a rebound in interest rates, particularly in Q3. Chart 4The PBoC Has Managed To Keep Domestic Rates Low While Pulling Back Overall Stimulus The PBoC Has Managed To Keep Domestic Rates Low While Pulling Back Overall Stimulus The PBoC Has Managed To Keep Domestic Rates Low While Pulling Back Overall Stimulus So far this year the PBoC has kept liquidity conditions accommodative to avoid massive debt defaults, while allowing a faster deceleration in the pace of credit expansion and a sharp contraction in shadow banking (Chart 4). In the coming months, however, the trend may reverse. Even though we do not think China’s current inflation and growth dynamics warrant meaningful and sustainable monetary policy tightening, there is still room for rates to normalize to their pre-pandemic levels in the next few months. Our view is based on the following:  First, there was a major delay in local government bond issuance in the first five months of the year. The supply of government bonds will pick up meaningfully in Q3 to meet the annual quota for 2021. An increase in government bond issuance will remove some liquidity from the banking system because the majority of these local government bonds are purchased by commercial banks. Adding to the liquidity gap is a large number of one-year, medium-term lending facility (MLF) loans that will be due in 2H21. Secondly, the PBoC may shift its policy tightening from reducing the volume of total credit creation (measured by total social financing) to raising the price of money. Credit growth (on year-over-year basis) in the first five months of 2021 dropped by three percentage points from its peak in Q4 last year, much faster than the 13-month peak-to-trough deceleration during the 2017/18 policy tightening cycle. As the rate of credit creation approaches the government’s target for the year, which we expect around 11%, the pressure to further compress credit expansion has eased into 2H21. China’s policy agenda is still focused on de-risking in the financial and real estate sectors, therefore, we expect policymakers to keep overall monetary conditions restrictive by raising the price of money. Furthermore, we do not rule out the possibility of a hike in mortgage rates. Chart 5Rising Risk For A Bear Flattening In Domestic Yield Curve In Q3 Rising Risk For A Bear Flattening In Domestic Yield Curve In Q3 Rising Risk For A Bear Flattening In Domestic Yield Curve In Q3 Lastly, as the Fed prepares market expectations for its rate liftoff and China’s domestic economy is still relatively solid, the PBoC may seize the opportunity to guide market-based interest rates towards their pre-pandemic levels. Thus, the market will likely price in tighter liquidity conditions while lowering expectations for the economy and inflation. The short end of the yield curve will rise faster than the longer end, resulting in a flattening of the curve (Chart 5). There is a nontrivial risk that the market will react negatively to tighter liquidity conditions and rising bonds yields, particularly when the economy is slowing. We mentioned in previous reports that rising policy rates and bond yields do not necessarily lead to lower stock prices, if rates are rising while credit keeps expanding and corporate profit growth accelerates. However, currently credit impulse has decelerated sharply, and corporate profit growth has most likely peaked in Q2. Therefore, even a small increase in bond yields or market expectations of higher rates will likely trigger risk asset selloffs. Bottom Line: Bond yields will move higher in Q3, risking market selloffs. Chinese Economy Standing On One Leg China’s economic fundamentals also pose downside risks to Chinese stock prices. Macro indicators on a year-over-year comparison will soften further in 2H21 when low base effects wane, although they will weaken from very high levels. This year’s sharp credit growth deceleration will start to drag down domestic demand, with the risk of corporate profits disappointing the market. A positive tailwind from global trade prevented China's old economy from decelerating more in the first half of the year. It is reflected in the nominal imports and manufacturing orders components in the BCA Activity Index (Chart 6). However, while rising commodity prices boosted the value of Chinese imports, the volume of imports has been moving sideways of late (Chart 7). Chart 6Our BCA Activity Index Is Still Rising... Our BCA Activity Index Is Still Rising... Our BCA Activity Index Is Still Rising... Chart 7...But The Volume Of The Import Component Has Rolled Over ...But The Volume Of The Import Component Has Rolled Over ...But The Volume Of The Import Component Has Rolled Over Chart 8Export Growth Is Moderating From Current Level Export Growth Is Moderating From Current Level Export Growth Is Moderating From Current Level Moreover, China’s export volume is peaking as the reopening in other countries shifts consumer demand from goods to services. Strong export growth would likely decelerate and converge to global industrial production growth in the coming 12 months, even though a regression-based approach suggests that export growth will stay above trend-growth if global economic activity remains robust (Chart 8). All three components of the official Li Keqiang Index, which measures China’s industrial sector activity and incorporates electricity consumption, railway transportation and bank lending, have rolled over (Chart 9). Among the three components in BCA’s Li Keqiang Leading Indicator, only the monetary conditions index improved on the back of lower real rates. Contributions from the money supply and credit expansion components to the overall indicator have been negative (Chart 10). Chart 9The Official Li Keqiang Index Is Weakening... The Official Li Keqiang Index Is Weakening... The Official Li Keqiang Index Is Weakening... Chart 10...So Is Our BCA Li Keqiang Leading Indicator ...So Is Our BCA Li Keqiang Leading Indicator ...So Is Our BCA Li Keqiang Leading Indicator Chart 11Household Consumption Recovery Remains A Laggard Household Consumption Recovery Remains A Laggard Household Consumption Recovery Remains A Laggard The recovery in household consumption remains well behind the industrial sector in the current cycle (Chart 11). We expect consumption and services to continue recovering very gradually. Apart from China’s long-standing structural issues, such as sliding household income growth and a high propensity to save, the cyclical recovery in consumption is dependent on China’s domestic COVID-19 situation. The country is on track to fully vaccinate 40% of its population by the end of June and 80% by year-end (Chart 12). However, hiccups in the service sector recovery are expected through 2H21, given China’s “zero tolerance” policy on confirmed COVID cases, which could trigger sporadic local lockdowns (Chart 13). Chart 12China Is Racing To Reach “Full Inoculation Rate” By Yearend China Outlook: A Mid-Year Recap China Outlook: A Mid-Year Recap Chart 13Expect Some Hiccups In Service Sector Recovery In 2H21 Expect Some Hiccups In Service Sector Recovery In 2H21 Expect Some Hiccups In Service Sector Recovery In 2H21 Bottom Line: Any moderation in exports in the rest of 2021 may add to the slowdown in China’s economic activity. Don’t Count On Fiscal Support Chart 14Fiscal Spending Has Been Disappointing In 1H21 Fiscal Spending Has Been Disappointing In 1H21 Fiscal Spending Has Been Disappointing In 1H21 During the first five months of the year, fiscal spending has downshifted (Chart 14). The amount of local government special-purpose bonds (SPBs) issued was far less than in the same period of the past two years, and below this year’s approved annual quota. Although we expect fiscal support to increase into 2H21, backloading SPBs would qualify, at best, as a remedial measure rather than a meaningful boost to economic activity. The RMB3 trillion SPBs to be issued in 2H21 represent only about 10% of this year’s total credit expansion. To substantially boost credit impulse and economic activity, the pickup in SPB issuance will need to be accompanied by looser monetary policy and an acceleration in bank loans (Chart 15). We do not expect that liquidity conditions will remain as lax as in 1H21. Additionally, given that the central government’s focus is to rein in the leverage of local governments and their affiliated financial vehicles (LGFV), provincial officers have little incentive to take on more bank loans against a restrictive policy backdrop. Historically, a stronger fiscal impulse linked to hefty increases in local government bond issuance has not necessarily led to meaningful improvements in infrastructure investment, which has been on a structural downshift since 2017 (Chart 16). Following a V-shaped recovery in 2H20, the growth in infrastructure investment will likely continue to slide in 2H21 due to sluggish government spending. Chart 15Bank Loans Still Hold The Key To Stimulus Impulse Bank Loans Still Hold The Key To Stimulus Impulse Bank Loans Still Hold The Key To Stimulus Impulse Chart 16Don't Count On SPBs To Meaningfully Boost Infrastructure Investment Don't Count On SPBs To Meaningfully Boost Infrastructure Investment Don't Count On SPBs To Meaningfully Boost Infrastructure Investment Bottom Line: There are no signs that the overall policy stance is easing to facilitate a higher fiscal multiplier from an upturn in local government bond issuance. As such, fiscal support for infrastructure spending and economic activity will disappoint in 2H21 despite more SPB issuance. Investment Conclusions Monetary conditions may tighten in Q3 although credit growth will decelerate at a slower pace. Pressures to support domestic demand will be more pronounced next year as tailwinds abate from the global recovery and domestic massive stimulus. Our view is that Chinese authorities will likely ease on the policy tightening brake towards the end of this year and perhaps even signal some reflationary measures in early 2022.  Therefore, while we maintain an underweight stance on Chinese stocks for the time being, investors should remain alert to any improvements in China's policy direction. In particular, any monetary policy easing by end this year/early 2022 may signal a potential catalyst to upgrade Chinese stocks to overweight in absolute terms. Although both Chinese onshore and investable equities are currently traded at a discount relative to global stocks, they are richly valuated compared with their 2017/18 highs (Chart 17). China's economy is slowing and the corporate sector has substantially increased its leverage in the past decade. We believe that the current discount in Chinese equities relative to global stocks is warranted. Chart 18 presents a forecast for A-share earnings growth in US dollars, based on earnings’ relationship with the official Li Keqiang index. The chart shows that while an earnings contraction is not probable, without more stimulus the growth rate may fall sharply in the next 12 months from its current elevated level. This aspect, combined with only a minor valuation discount relative to global stocks, paints an uninspiring outlook for Chinese onshore stocks. Chart 17Chinese Onshore Stocks Are Traded At A Slight Discount To Global Equities Chinese Onshore Stocks Are Traded At A Slight Discount To Global Equities Chinese Onshore Stocks Are Traded At A Slight Discount To Global Equities Chart 18An Uninspiring Domestic Equity Earnings Outlook An Uninspiring Domestic Equity Earnings Outlook An Uninspiring Domestic Equity Earnings Outlook Our baseline view is that Chinese authorities will be more willing to step up policy supports into 2022. Fiscal impulse will likely turn negative for most major economies next year and global economic recovery will have peaked. In this scenario, both China’s economy and stocks will have the potential to outperform their global peers next year.   Jing Sima China Strategist jings@bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations

This week, we present the third edition of the BCA Research Global Fixed Income Strategy (GFIS) Global Credit Conditions Chartbook—a review of central bank surveys of bank lending standards and loan demand. The data from lending surveys during the first quarter of 2021 point towards easing standards in developed markets (Chart 1). Credit standards for business loans eased outright in most regions except for the euro area and New Zealand where the pace of tightening slowed significantly. On the whole, banks expected the easing trend to continue into Q2. Chart 1Credit Standards Moving Towards Or Deeper Into Easy Territory Credit Standards Moving Towards Or Deeper Into Easy Territory Credit Standards Moving Towards Or Deeper Into Easy Territory With credit spreads at historical tights, banks across the board cited increased competition from other lenders as a reason behind easing standards, confirming that easy financial conditions are not limited solely to booming financial markets. This will help maintain a market-friendly economic growth backdrop as developed economies put pandemic restrictions behind them. At the same time, an absence of tightening lending standards by commercial banks puts incremental pressure on central banks to move towards bond-bearish tightenings of monetary policy. An Overview Of Global Credit Conditions Surveys Chart 2Credit Standards And Spreads Are Correlated Credit Standards And Spreads Are Correlated Credit Standards And Spreads Are Correlated After every quarter, major central banks compile surveys to assess prevailing credit conditions. The purpose is to obtain from banks an assessment of how their lending standards and demand for loans, for both firms and consumers, changed over the previous quarter. Most surveys also ask questions about the key factors driving these changes and expectations for the next quarter.1 For fixed income investors, these surveys are valuable for a few reasons. Firstly, data on consumer lending is a window into consumer health while business loan demand sheds light on the investment picture. These help derive a view on the path of future economic growth and interest rates and, thus, the appropriate duration stance of a bond portfolio. Also, credit standards can tell us about the pass-through from fiscal and monetary policy measures to realized financial conditions (i.e. corporate borrowing rates). Most importantly, credit standards exhibit a direct correlation with corporate bond spreads (Chart 2). As loan officers have access to detailed, non-public information on a large number of borrowers, they are uniquely positioned to evaluate corporate health. When banks are tightening standards, they see an issue with the credit quality of current or future loans, which impacts borrowing costs in the corporate bond market. Tightening standards indicate a worsening borrowing backdrop and weaker growth, which then pushes up corporate spreads. Vice versa, easing standards imply a favorable backdrop and plentiful liquidity—both bullish signs for spread product. US In the US, a net percentage of domestic respondents to the Fed’s Senior Loan Officer Survey, reported easing standards for commercial and industrial (C&I) loans to firms of all sizes over Q1/2021 (Chart 3). Nearly 20% of respondents cited an improving or less uncertain economic outlook as a very important factor behind the decision to ease standards, while roughly one-third cited increased competition from other lenders. Chart 3US Credit Conditions US Credit Conditions US Credit Conditions Chart 4High-yield Borrowers Are Exposed To A Widening In Spreads High-yield Borrowers Are Exposed To A Widening In Spreads High-yield Borrowers Are Exposed To A Widening In Spreads Although it did not strengthen on net, C&I loan demand did weaken at a much slower pace in Q1. The factors driving loan demand suggest a buoyant economic backdrop—about a quarter of banks reporting increased demand cited merger and acquisition needs and increased investment as very important reasons. Meanwhile, weaker loan demand was attributed to less precautionary demand for cash and an increase in internally generated funds among customers. On the consumer side, loan demand improved slightly on the whole, driven largely by a significant improvement in auto loan demand. While consumer loan demand has historically correlated well with the year-over-year growth in personal consumption expenditures, those two series diverged remarkably in Q1, with spending growth far outpacing loan growth. This divergence reflects the tremendous impact of pandemic-related transfer payments and benefits. We expect a continued recovery in consumer lending demand as unemployment benefits are withdrawn and consumers once again have to borrow to finance spending. As part of the special ad-hoc questions in this edition of the survey, respondents were asked about how lending standards had changed compared to the pre-pandemic period by borrower risk rating. Interestingly, large banks actually eased their standards for investment grade borrowers, reflecting the impact of Fed’s massive liquidity injections (Chart 4). However, despite spreads on high-yield having tightened to post-GFC lows, credit standards for below-investment grade borrowers remain much tighter than before the pandemic. So far, lower-quality borrowers have been able to go to public debt markets for financing, but this highlights a downside risk—if there is an event which causes corporate bond spreads to widen, high-yield borrowers may be starved of cheap financing options with banks still holding purse strings taut. Euro Area In the euro area, banks continued to tighten standards to enterprises, albeit at a much-reduced pace, in Q1/2021 (Chart 5). The tightening, however, was lower than expected in the previous quarter, possibly reflecting prolonged policy support and improving risk sentiment. Deteriorating risk perceptions related to the general economic and firm-specific situation were the primary contributing factor to tightening. But this was partly offset by increased competition from other lenders. The reduced pace of tightening does confirm the signal from the high-yield default rate, which is rolling over. Going forward, banks expect the pace of tightening to slow very slightly going into Q2. Chart 5Euro Area Credit Conditions Euro Area Credit Conditions Euro Area Credit Conditions Chart 6Credit Standards For Major Euro Area Economies Credit Standards For Major Euro Area Economies Credit Standards For Major Euro Area Economies Business credit demand continued to weaken at a faster pace in Q1, marking three consecutive quarters of deterioration. Weak fixed investment continued to be the biggest drag on demand, while the previous positive contribution from inventory and working capital needs has disappeared entirely. As we highlighted in the last edition of this chartbook, the continued drag on demand for investment reflects a lingering uncertainty regarding the pandemic which could possibly lower potential long-term growth in the euro area.2 As in the US, however, the reduction in demand also reflected already built-up liquidity buffers and the availability of internal and market-based financing. In Q2, banks expect a strong rebound in enterprise loan demand, especially from small and medium-sized enterprises (SMEs). Consumer credit demand continued to decline at a stronger pace in Q1, reflecting the continued pandemic-related restrictions in Europe over the quarter. The key drivers were lower durable goods spending and weakening consumer confidence. Banks also reported increased use of internally-generated funds, which is consistent with accumulated savings and pent-up demand during the lockdown. Assuming that the emerging Delta variant does not sidetrack the European return to normalcy, we will likely see the expected consumer credit demand rebound come to fruition. This would be consistent with recent strong consumer confidence prints out of the region. Looking individually at the four major euro area economies, credit standards for enterprises tightened in Germany, Italy, and Spain but were unchanged in France (Chart 6). In countries where standards tightened, worsening risk perceptions were the primary factor. In France, increased competition from other lenders contributed to easing on the margin. Going into Q2, standards are expected to tighten very modestly in the two core European economies while diverging in peripheral Europe—Spanish banks expect an increased pace of tightening while Italian ones expect standards to remain unchanged. UK In the UK, overall corporate credit standards, measured as an average of standards for medium and large non-financial firms, eased slightly in Q1/2021 (Chart 7A). This increase in credit availability was driven primarily by an improving economic outlook and sector-specific risk picture. As in the US and euro area, competition from capital markets also played a role and is expected to contribute to the further easing expected in Q2. Chart 7AUK Credit Conditions UK Credit Conditions UK Credit Conditions Chart 7BInvestment And Inventory Financing Expected To Pick Up In The UK GFIS Credit Conditions Chartbook Q2/2021: Easing Up GFIS Credit Conditions Chartbook Q2/2021: Easing Up Meanwhile, corporate loan demand is picking up at a pace not seen since Brexit, excluding the 2020 spike driven by emergency funding needs, signaling a buoyant picture. In particular, the surge in demand was driven by large non-financial firms which are also expected to drive the demand pick-up in Q2. Household loan demand fell slightly in the first quarter but is expected to rebound. Consumer confidence, which had initially lagged behind loan demand, appears to have caught up as the UK’s “Freedom Day” from pandemic restrictions approaches in July. Lenders are also expected to ease availability for unsecured household loans, primarily on the back of market share objectives. This should create the ideal backdrop for a consumption boom if the Delta variant does not further limit the UK government’s ability to deliver on its promise of a full reopening. Delving into the factors behind booming corporate loan demand, there are promising signs for the broader UK economy (Chart 7B). In a Special Report published earlier this year, we argued that UK real interest rates were depressed because the country suffered from a series of rolling economic and political shocks, the effects of which were now expected to fade.3 There are already some signs of this in the credit data, with capital investment and inventory financing demand expected to rebound in Q2. Despite work-from-home effects dampening the need for office space, on the margin, UK commercial real estate demand is strong and expected to further strengthen. Japan Chart 8Japan Credit Conditions Japan Credit Conditions Japan Credit Conditions In Japan, credit standards to firms and households eased at a slower pace in Q1/2021 (Chart 8). The vast majority of respondents indicated that standards were basically unchanged, with none of the firms reporting any tightening, and a small number reporting some degree of easing. The most important factors driving easing were aggressive competition from other bank and non-bank lenders, as well as strengthened efforts to grow the business. Going into Q2, the pace of easing is expected to continue to slow. Business loan demand, which behaves somewhat counter-cyclically in Japan, increased over Q1. The entirety of this pickup can be attributed to small firms; large and medium-sized firms on the whole decreased their loan demand. Counter to trends in other regions, firms in Japan actually saw a decrease in internally-generated funds, which was the most important factor contributing to increased loan demand. Consumer loan demand fell slightly on balance but was mostly unchanged from the previous quarter. Respondents reporting weaker demand saw a decrease in household consumption as the most important factor. Sentiment remains subdued and has lagged the recovery in loan demand seen last year. Our colleagues at BCA Research Foreign Exchange Strategy are eyeing a recovery for the Japanese economy as the government turns around its vaccination campaign and the Olympics jumpstart consumption.4 On that basis, the very modest recovery in loan demand expected by Japanese banks appears too pessimistic. Canada And New Zealand In Canada, business lending standards continued to ease at a faster pace in Q1/2021, coinciding with rebounding business confidence which is now back to pre-pandemic levels (Chart 9). This is in line with a remarkable vaccine rollout—68% of the population has already received its first dose and the pace of daily vaccinations is showing no signs of rolling over. Chart 9Canada Credit Conditions Canada Credit Conditions Canada Credit Conditions Chart 10New Zealand Credit Conditions New Zealand Credit Conditions New Zealand Credit Conditions However, housing is a major concern for Canadian policymakers. In a recent Special Report, co-authored with our colleagues at The Bank Credit Analyst, we highlighted both Canada and New Zealand as “higher risk” countries more exposed to ballooning house prices.5 In addition to low rates, mortgage lending standards, which have been easing since Q3/2020, have undoubtedly contributed to this issue. However, the Bank of Canada (BoC), with its hawkish messaging, has signaled that it will not idly stand by; there is also popular support behind raising rates to tamp down house prices. Expect mortgage standards to tighten and a pick-up in mortgage rates as the BoC nears liftoff, most likely in 2022. Credit standards in New Zealand were mostly unchanged in Q1/2021, reversing the tightening trend of previous quarters (Chart 10). Over the next six months, standards are expected to ease considerably. Business loan demand was unchanged on net, with corporates decreasing and SMEs increasing demand. SMEs are also expected to increase demand slightly over the next six months. Tepid loan demand is consistent with business confidence hovering around the neutral zero line. As in Canada, soaring house prices are a major issue for the New Zealand economy. Data on household lending is alarming on that front. Although consumer loan demand continued to weaken, demand for residential mortgages spiked to an all-time high in Q1. While demand is expected to normalize going forward, the Q1 datapoint indicates froth in the market. The Reserve Bank of New Zealand is considering a variety of macroprudential measures but will have to raise rates sooner rather than later to effectively cool down the housing market. Appendix: Where To Find The Bank Lending Surveys A number of central banks publish regular surveys of bank lending conditions in their domestic economies. The surveys, and the details on how they are conducted, can be found on the websites of the central banks: US Federal Reserve: https://www.federalreserve.gov/data/sloos.htm European Central Bank: https://www.ecb.europa.eu/stats/ecb_surveys/bank_lending_survey/ Bank of England: https://www.bankofengland.co.uk/credit-conditions-survey/2021/2021-q1 Bank of Japan: https://www.boj.or.jp/en/statistics/dl/loan/loos/index.htm/ Bank of Canada: https://www.bankofcanada.ca/publications/slos/ Reserve Bank of New Zealand: https://www.rbnz.govt.nz/statistics/c60-credit-conditions-survey   Shakti Sharma Senior Analyst ShaktiS@bcaresearch.com Footnotes 1 The weblinks to each individual survey for the US, euro area, UK, Japan, Canada and New Zealand can be found in the Appendix on page 12. 2 Please see BCA Research Global Fixed Income Strategy Report, "GFIS Global Credit Conditions Chartbook Q1/2021: A Tentative Recovery", dated February 16, 2021, available at gfis.bcaresearch.com. 3 Please see BCA Research Global Fixed Income Strategy Special Report, "Why Are UK Interest Rates Still So Low?", dated March 10, 2021, available at gfis.bcaresearch.com. 4 Please see BCA Research Foreign Exchange Strategy Report, "The Case For Japan", dated June 11, 2021, available at fes.bcaresearch.com. 5 Please see BCA Research Global Fixed Income Strategy Special Report, "Global House Prices: A New Threat For Policymakers", dated May 28, 2021, available at gfis.bcaresearch.com.

Highlights Spread Product: The macro environment is highly supportive for spread product and it will likely remain supportive for the next 12-18 months, at least until the yield curve flattens to below 50 bps. Remain overweight spread product versus Treasuries in US bond portfolios. High-Yield: High-yield spreads still look fairly valued, or even slightly cheap, compared to our base case outlook for corporate defaults. Investors should continue to favor high-yield over investment grade corporates and maintain an overweight allocation to high-yield in US bond portfolios. EM Corporates: Within the A and Baa credit tiers, US bond investors should favor USD-denominated EM corporates over USD-denominated EM sovereigns and should favor both over US corporate bonds. Within the Aa credit tier, investors should favor USD-denominated EM sovereigns over USD-denominated EM corporates and should favor both over US corporate bonds. Feature Chart 1Fed Meeting Didn't Shock Credit Markets Fed Meeting Didn't Shock Credit Markets Fed Meeting Didn't Shock Credit Markets Last week’s report looked at how the June FOMC meeting prompted a massive re-shaping of the Treasury curve.1 It didn’t discuss, however, the impact that June’s meeting had on credit spreads. There’s a simple reason for this. Corporate bond spreads didn’t move very much post-FOMC. In fact, neither investment grade nor high-yield spreads have widened significantly during the past two weeks, despite the Fed’s apparent “hawkish turn” (Chart 1). The VIX jumped briefly above 20 in the days following the Fed meeting but it has since re-discovered its lows (Chart 1, bottom panel). This week’s report considers whether the corporate bond market is too complacent. The first section updates our assessment of where we are in the credit cycle based on two indicators that did see large swings post-Fed. The second section updates our outlook for high-yield defaults and considers whether junk spreads continue to offer adequate compensation. Finally, the third section of this report presents an introductory look at valuation in the USD-denominated Emerging Market (EM) corporate sector. We find that, for the most part, investment grade EM corporates are attractively valued relative to EM sovereigns and US corporates of the same credit rating and duration. Credit Cycle Update Chart 2Credit Cycle Indicators Credit Cycle Indicators Credit Cycle Indicators As we have repeatedly stated in past research, the slope of the yield curve is a very important credit cycle indicator.2 We have documented that spread product tends to outperform duration-matched Treasuries by a wide margin when the yield curve is steep. This outperformance tapers off once the 3-year/10-year Treasury slope falls below 50 bps and it falls off even more when the slope dips below zero.3 With that in mind, it is notable that the Treasury curve flattened dramatically following the June FOMC meeting (Chart 2). At 106 bps, the 3-year/10-year Treasury slope remains well above the 50 bps threshold that would start to get concerning for spread product. However, it’s likely that the yield curve will continue to flatten as we approach a Fed rate hike in 2022. In other words, we expect that monetary conditions will turn sufficiently restrictive for us to reduce our recommended spread product allocation within the next 12-18 months. On the other hand, one positive development for spread product returns is that the 5-year/5-year forward TIPS breakeven inflation rate declined following the June FOMC meeting. In fact, it is now below the 2.3% to 2.5% range that is consistent with the Fed’s inflation target (Chart 2, bottom panel). This is a positive development for spread product because the Fed will strive to ensure that monetary conditions stay accommodative at least until these long-dated inflation expectations are consistent with the 2.3% to 2.5% target. Or put differently, a rebound in long-maturity TIPS breakeven inflation rates back to the target range will slow the near-term pace of curve flattening, giving the credit cycle a small amount of extra running room. In short, the macro environment is highly supportive for spread product and it will likely remain supportive for the next 12-18 months, at least until the yield curve flattens to below 50 bps. Investment Grade Corporates The highly supportive macro environment applies to investment grade corporate bonds, just as it does to all spread sectors. However, investment grade corporates have the problem that valuation is extremely tight. Much like a flat yield curve environment, a tight spread environment tends to coincide with low excess corporate bond returns. However, our research reveals that tight spreads alone are not sufficient for investment grade corporates to underperform duration-matched Treasuries. Table 1 classifies each month since May 1973 based on the investment grade corporate bond spread and the 3/10 Treasury slope. It then shows a 90% confidence interval for corporate bond excess returns during the following 12 months. It shows that, even when the corporate bond spread is below 100 bps (it is 81 bps today), investment grade corporates still tend to outperform duration-matched Treasuries as long as the 3/10 Treasury slope is above 50 bps. Table 1Expected 12-Month Corporate Bond Excess Return* (BPs) Based On OAS And Yield Curve Slope The Post-FOMC Credit Environment The Post-FOMC Credit Environment Bottom Line: The yield curve has started to flatten but it remains very steep, consistent with spread product outperforming duration-matched Treasuries. We remain overweight spread product versus Treasuries but will re-consider this position once the yield curve flattens to below 50 bps. We expect this could happen within the next 12-18 months. We maintain only a neutral allocation to investment grade corporate bonds because of stretched valuations. We see more attractive opportunities in high-yield corporates (see next section), municipal bonds, USD-denominated EM sovereigns and USD-denominated EM corporates (see final section below). High-Yield Default Update We last updated our default rate outlook in March.4 At that time, we concluded that junk spreads offered adequate compensation for expected default losses. Since then, we have received nonfinancial corporate sector profit and debt growth data for the first quarter of 2021, crucial inputs to our macro-based default rate model. Our macro-based model of the 12-month trailing speculative grade default rate is based on nonfinancial corporate sector gross leverage (i.e. pre-tax profits over total debt) and C&I lending standards (Chart 3). Lending standards enter our model with a lag, but we need a forward-looking estimate of gross leverage for our model to generate predictions. Chart 3Macro-Driven Default Rate Model Macro-Driven Default Rate Model Macro-Driven Default Rate Model To estimate gross leverage we first model corporate profit growth based on real GDP (Chart 4) and assume that real GDP grows by 7% over the next four quarters, consistent with the Fed’s median forecast. This gives us a profit growth expectation of roughly 30%. Chart 4Profit & Debt Growth Profit & Debt Growth Profit & Debt Growth We also need an estimate for corporate debt growth. Corporate debt exploded last year, growing 10% in 2020, but it then slowed to an annualized rate of 4% in Q1 2021. We think corporate debt growth will remain slow going forward. The nonfinancial corporate sector financing gap has been negative in each of the past four quarters (Chart 4, bottom panel), meaning that retained earnings have exceeded capital expenditures. In other words, firms have built up a lot of excess capital that can be deployed in place of debt to finance new investment opportunities. Table 2 shows our model’s predicted 12-month default rate based on different assumptions for profit and debt growth. If we assume corporate profit growth of 30% and corporate debt growth between 0% and 8%, then our model predicts that the 12-month default rate will fall from its current 5.5% to a range of 2.3% - 2.8%. Table 2Default Rate Scenarios The Post-FOMC Credit Environment The Post-FOMC Credit Environment Next, we need to consider what sort of expected default rate is priced into the High-Yield index. Our analysis of historical junk spreads and returns suggests that we should require a minimum excess spread of 100 bps in the High-Yield index after subtracting default losses to be confident that junk bonds will outperform Treasuries.5 If we also assume a recovery rate of 40% on defaulted debt, then we calculate that the High-Yield index is fairly priced for a 12-month default rate of 2.9% (Chart 5). That is, junk spreads appear slightly cheap compared to the 2.3% - 2.8% range predicted by our macro model.  Finally, it’s worth noting that actual corporate default events have been quite rare in recent months. In the first five months of 2021 we’ve seen between 1 and 3 default events per month. If we extrapolate that trend and assume we see 3 defaults per month going forward, then we calculate that the 12-month trailing default rate will fall to 2.0% by December, before leveling off at 2.2% (Chart 6). In other words, the recent trend has been one of significantly fewer defaults than predicted by our macro model Chart 5Spread-Implied Default Rate Spread-Implied Default Rate Spread-Implied Default Rate Chart 6Recent Default Trends Recent Default Trends Recent Default Trends Bottom Line: High-yield spreads still look fairly valued, or even slightly cheap, compared to our base case outlook for corporate defaults. Investors should continue to favor high-yield over investment grade corporates and maintain an overweight allocation to high-yield in US bond portfolios. An Attractive Opportunity In EM Corporates This week we present an introductory look at the risk/reward opportunity in USD-denominated EM corporate bonds. Specifically, we look at the investment grade Bloomberg Barclays USD-denominated EM Corporate & Quasi-Sovereign index. We compare this index to both the investment grade USD-denominated EM Sovereign index and the US Credit index.6 First, we look at recent performance trends and average index statistics (Table 3). Both the EM Corporate and EM Sovereign indexes have average credit ratings between A and Baa, so we compare their performance to the A-rated and Baa-rated US Credit indexes. We observe a significant option-adjusted spread (OAS) advantage in both the EM indexes, though part of the extra spread offered by the Sovereign index is compensation for its longer duration. The EM Corporate index sticks out as offering an extremely attractive OAS per unit of duration. Table 3Performance Trends & Index Statistics The Post-FOMC Credit Environment The Post-FOMC Credit Environment As for performance, we see that the EM Corporate index experienced less of a drawdown (in excess return terms) during the COVID recession, though it has also returned less than both the EM Sovereign index and the Baa Credit index during the recent upswing. Chart 7Spreads Versus Credit Rating & Duration-Matched US Credit The Post-FOMC Credit Environment The Post-FOMC Credit Environment Next, we look at each individual credit tier of both the EM Corporate & Quasi-Sovereign index and the EM Sovereign index, and we calculate the spread relative to a credit rating and duration-matched position in the US Credit index (Chart 7). In general, we see that both EM indexes offer a spread advantage versus duration-matched US Credit across all credit rating tiers. EM sovereigns look better than EM corporates in the Aa credit tier. This is the result of attractive spreads on the sovereign bonds of UAE and Qatar. However, EM corporates clearly dominate sovereigns in both the A and Baa credit tiers. Finally, we consider the risk/reward trade-off in our EM indexes by using our Excess Return Bond Map. Our Excess Return Bond Map shows the relationship between expected return (on the vertical axis) and risk (on the horizontal axis). In Chart 8A our risk measure is the 12-month spread widening required for each index to lose 100 bps versus a position in duration-matched Treasuries divided by that index’s historical spread volatility. It can be thought of as the number of standard deviations of spread widening required for the index to provide an excess return of -100 bps. A higher value corresponds to less risk, and vice-versa. Chart 8B uses the same risk measurement, only we use the spread widening required to lose 500 bps versus Treasuries to assess the risk of a large drawdown. Both Charts 8A and 8B use OAS as the measure of expected return. Chart 8AExcess Return Bond Map (100 BPs Loss Threshold) The Post-FOMC Credit Environment The Post-FOMC Credit Environment Chart 8BExcess Return Bond Map (500 BPs Loss Threshold) The Post-FOMC Credit Environment The Post-FOMC Credit Environment The first thing that sticks out in Charts 8A & 8B is that Baa-rated EM corporates offer greater expected return and less risk than the EM Sovereign index and the Baa US Credit Index. This is true whether our loss threshold is set at 100 bps or 500 bps. Unfortunately, we do not have sufficient data to split the EM Sovereign index by credit tier in these charts. A-rated EM corporates offer slightly less expected return than the EM Sovereign index but with significantly less risk, they also clearly dominate the A-rated US Credit Index. Aa-rated EM corporates appear to offer a similar risk/reward trade-off as the EM Sovereign index, though we know from Chart 7 that sovereigns have a spread advantage in the Aa credit tier. The bottom line is that USD-denominated EM corporates are attractively valued relative to investment grade US corporate bonds with the same duration and credit rating. EM corporates also look preferable to EM sovereigns in the A and Baa credit tiers. EM sovereigns are more attractive than EM corporates in the Aa credit tier. Within the A and Baa credit tiers, US bond investors should favor USD-denominated EM corporates over USD-denominated EM sovereigns and should favor both over US corporate bonds. Within the Aa credit tier, investors should favor USD-denominated EM sovereigns over USD-denominated EM corporates and should favor both over US corporate bonds. Ryan Swift US Bond Strategist rswift@bcaresearch.com Footnotes 1 Please see US Bond Strategy / Global Fixed Income Strategy Weekly Report, “How To Re-Shape The Yield Curve Without Really Trying”, dated June 22, 2021. 2 Please see US Bond Strategy Weekly Report, “Lower For Longer, Then Faster Than You Think”, dated May 25, 2021. 3 We use the 3-year/10-year Treasury slope in place of the more widely tracked 2-year/10-year slope in our credit cycle research only because using the 3-year/10-year slope allows us to include more historical cycles in our analysis. 4 Please see US Bond Strategy Weekly Report, “That Uneasy Feeling”, dated March 30, 2021. 5 Please see page 33 of the US Bond Strategy Quarterly Chartpack, “Testing The Limits Of Transitory Inflation”, dated May 18, 2021. 6 The US Credit Index consists predominantly of US corporate bonds, but also some non-corporate credit such as: Sovereigns, Foreign Agencies, Domestic Agencies, Local Authority bonds and Supranationals. Fixed Income Sector Performance Recommended Portfolio Specification

Feature Chart 1A Tug-Of-War In The US Treasury Market A Tug-Of-War In The US Treasury Market A Tug-Of-War In The US Treasury Market This week, we are publishing one of our periodic reports, covering global central bank lending standard surveys. Yet given some of the moves seen in US bond markets recently, we felt the need to also provide some additional thoughts, along with that previously scheduled report. The short-term volatility of longer-maturity US Treasury yields since the June 16 FOMC meeting has been a bit extreme, to say the least. The 30-year yield fell from an intraday peak of 2.21% just before the Fed meeting to an intraday low of 1.93% on June 21, a 28bp plunge in a span of just three trading days, but has climbed back to 2.10% as we go to press. Over that same time frame, shorter maturity yields have been relatively more stable. After the 5-year yield rose from 0.78% on 0.93% immediately following the “hawkish” Fed surprise on FOMC Day, the yield has largely held those gains, hitting only a brief intraday low of 0.84% on June 21, and now sits at 0.90%. This price action is consistent with the two opposing forces currently at work in the US Treasury market. Investors are slowly repricing the expected path of Fed policy, pulling forward the liftoff date of the fed funds rate in line with the new “guidance” from the FOMC interest rate forecasts. This is putting upward pressure on the shorter maturity part of the Treasury curve. At the same time, the market continues to work off the deeply oversold condition that had developed in longer-maturity Treasuries, as we discussed in a recent report.1 The sharp volatility of the 30yr yield is consistent with a rapid adjustment of positioning, which had become very short when looking at measures like the CFTC data on 30-year bond futures net positioning (Chart 1). Chart 2Corporate Bond Investors Appear Far Less Worried Than Equity Investors Corporate Bond Investors Appear Far Less Worried Than Equity Investors Corporate Bond Investors Appear Far Less Worried Than Equity Investors Once that overhang of short positioning in longer maturity yields is worked off, the overall Treasury yield curve will begin moving higher again, continuing the cyclical bear market. The next increase in yields, however, will look different than what occurred between August 2020 and March 2021, when rising growth and inflation expectations resulted in a bearish steepening of the Treasury curve. The next move will be led by yields rising more at the front end of the curve, as the Fed begins the long march toward policy normalization. This will result in a bearish flattening of the Treasury curve, which motivated us to introduce a new US yield curve trade last week along with our colleagues at BCA Research US Bond Strategy – going short a 5-year bullet versus going long a duration-matched 2-year/10-year barbell. We have added that trade to our Tactical Overlay portfolio using specific on-the-run Treasury bonds, as can be seen in the table on page 7.2 While yields are jumping around in government bond markets, credit markets remain calm. Corporate bond spreads have been grinding tighter, in line with the steady decline in the VIX index of US equity volatility (Chart 2). Yet investors in other asset classes are exhibiting more cautious optimism. The soaring SKEW index has climbed to an all-time high, suggesting that demand for downside portfolio protection via S&P 500 put options is very robust with the equity index also at an all-time high. However, with the VIX falling, economic growth remaining solid, bank lending standards easing and the Fed not expected to even begin tapering its asset purchases until the start of 2022, the backdrop remains generally positive for US corporate debt versus US Treasuries. Next week, we will be presenting our quarterly review of the Global Fixed Income Strategy model bond portfolio, where we will present our base case and tail risk scenarios for global bond markets over the remaining months of 2021, along with our recommended portfolio positioning.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1 Please see BCA Research Global Fixed Income Strategy Report, “A Summer Nap For Global Bond Yields”, dated June 9, 2021, available at gfis.bcaresearch.com. 2 Please see BCA Research US Bond Strategy/Global Fixed Income Strategy Report, “How To Re-Shape The Yield Curve Without Really Trying”, dated June 22, 2021, available at gfis.bcaresearch.com. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Some Brief Comments On Recent US Bond Market Moves Some Brief Comments On Recent US Bond Market Moves Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Highlights Euro Area debt loads have increased significantly during the pandemic. Debt loads are not uniform. While Germany and, to a lesser extent, Spain look best, France has a less attractive total debt profile than Italy. Government debt-service ratios are not a problem for Europe. Private sector debt service ratios do not represent an imminent risk, but the French corporate sector is an important source of long-term vulnerability for the region. As a result of this indebtedness, Euro Area bond yields will not rise much and will be capped below 1.5% over this business cycle. For now, Eurozone corporate bonds remain attractive within a European fixed-income portfolio. High-yield bonds are appealing, but investors should avoid the energy sector. Feature Like the US, the Eurozone economy has witnessed a large increase in debt following the COVID-19 crisis. This debt load will have a long legacy that will impact the ability of the European Central Bank to increase interest rates over the coming years. The French corporate sector will be a particularly vulnerable pressure point. Nonetheless, in the short-term, this uptick in indebtedness will not have a major impact on European debt markets. Disparate Debt Loads… Chart 1The Eurozone's Heavy Debt Load The Eurozone's Heavy Debt Load The Eurozone's Heavy Debt Load After a period of decline in the wake of both the GFC and the European debt crisis, total nonfinancial debt rose by 29% of GDP since the COVID-19 pandemic began (Chart 1). While some of this increase reflects a declining GDP, Euro Area Households and Corporations together added EUR609 billion of debt, while governments accumulated over EUR1 trillion more to their borrowings. The aggregate European picture does not impart the more complex reality. While all countries experienced a marked rise in indebtedness, some major economies are in a much more precarious position than others. The Good Among the largest Eurozone economies, Germany sports the most favorable debt profiles and represents the smallest threat to the Eurozone. Compared with the other major Euro Area countries, Spain shows healthier trends, even if its overall debt load remains important. At 202%, Germany’s nonfinancial-debt-to-GDP ratio is still below its all-time high of 211% (Chart 2, top panel). During the crisis, household debt rose by EUR296 billion or 4% of GDP, but it still stands well below the 72% registered at the turn of the millennium. In absolute terms, nonfinancial corporate debt has increased to a record, but it remains 5% below its 2003 high (Chart 2, third panel). Despite a 9% rebound to 70% of GDP, government debt still lies nearly 12% below its 2010 summit (Chart 2, bottom panel). In Spain, total nonfinancial debt rose by 45% of GDP since the pandemic started, but remains 12% below its 2013 all-time high of 301%. However, the private sector’s borrowing is well behaved, and it has only risen to 170% of GDP, well below the 227% level recorded in 2010 (Chart 3, top panel). Both the household and corporate sectors have gone a long way toward improving their debt situation, with borrowing 23% and 33%, respectively, below their crisis peaks (Chart 3, second and third panel). Spain’s problem is government debt. The pandemic forced the public sector to borrow EUR316 billion, which pushed its debt load to 120% of GDP (Chart 3, bottom panel). Chart 2Germany Is The Best Student Germany Is The Best Student Germany Is The Best Student Chart 3Spain's Previous Efforts Have Paid Off Spain's Previous Efforts Have Paid Off Spain's Previous Efforts Have Paid Off The Bad Chart 4Italy Remains Problematic Italy Remains Problematic Italy Remains Problematic Italian debt remains a troublesome spot for the Eurozone, which sheds some light on the higher interest rate commanded by BTPs. Burdened by tepid GDP growth, Italy’s total nonfinancial debt did not decline much in the years between the European debt crisis and the onset of the pandemic. As a result, overall nonfinancial debt jumped to an all-time high of 276% of GDP in response to COVID-19 (Chart 4, top panel). Private sector nonfinancial credit is high by Italian standards, but at 120% of GDP, it is low compared with other major European or G-10 nations. Italian household debt has hit a record high of 45% of GDP, which also compares well to other countries, while corporate debt rose to 76% of GDP, which is also well below historical highs and other nations (Chart 4, second and third panels). Italy’s perennial problem remains the public sector’s debt, which stands at 156% of GDP, the highest reading among major Eurozone nations. The Ugly The major Eurozone country with the worst debt situation is France, and we expect this country to become an increasingly large hurdle on the ability of the ECB to lift rates in the future. Next week, we will devote a Special Report to the French situation. Chart 5France's Debt Binge France's Debt Binge France's Debt Binge France’s nonfinancial debt towers above 350% of GDP, and the private sector nonfinancial debt has also hit an all-time high of 240% of GDP (Chart 5, top panel). No sector is spared. French households have accumulated EUR239 billion of liabilities during the pandemic, which pushed their leverage ratio to an all-time high of nearly 70% of GDP (Chart 5, second panel). Meanwhile, after rising by 21%, nonfinancial corporate credit stands above 170% of GDP (Chart 5, third panel). Finally, at 116% of GDP, public debt may not be as high as in Italy, but it is comparable to that of Spain (Chart 5, bottom panel). Bottom Line: The Eurozone indebtedness has hit a record high, but considering this factor in isolation oversimplifies a complicated picture. Among the major economies, Germany has the cleanest balance sheet, especially in terms of its private sector. Spain continues to sport high leverage, but the private sector remains in much better shape than last decade. Italy has made little progress, but it still looks good compared with France, where both the public and private sector borrowings stand at record highs. … And Debt Servicing Costs With the exception of the French corporate sector, debt-servicing costs do not represent a great risk for Europe. Chart 6Interest Payments Are Not The Government's Problem Interest Payments Are Not The Government's Problem Interest Payments Are Not The Government's Problem When it comes to governments, the picture is particularly benign. As Chart 6 illustrates, debt-servicing costs as a percentage of GDP or tax revenues are extremely low in both France and Germany. While these two variables are higher in Italy and Spain, they remain distant from the levels recorded during the European debt crisis. Beyond their low levels, a very accommodative policy environment limits the risk created by Europe’s public debt servicing costs. The ECB has purchased EUR1.3 trillion of government bonds since April 2020, which added to its already large ownership. Moreover, BCA’s Global Fixed Income Strategy service, as well as this publication, anticipates that the ECB will roll the stock of government paper purchased under the PEPP into the PSPP. Beyond the ECB’s actions, the NGEU funds also create the embryo of fiscal risk sharing in the EU, which limits how far yields (and thus debt servicing costs) will rise in the Italy or Spain. For the private sector, the picture is more nuanced. In Germany, household debt-servicing costs are low, both historically and compared with other nations. Meanwhile, BIS data highlights that the nonfinancial corporate debt services consume a larger share of operating cash flows than at any point over the past 20 years, but they remain low by international standards (Chart 7, top panel). Meanwhile, in Spain and Italy, both the household and nonfinancial corporate sectors sport historically low debt servicing costs (Chart 7, second and third panels), which also compare well to other OECD nations. Once again, France stands out. Its household debt servicing costs are historically elevated, even if they are not particularly demanding at a global level. However, the corporate sector spends a substantial share of its cash flow on debt, both compared with its own history and internationally (Chart 7, bottom panel). Chart 7Debt Servicing Costs Across Europe Debt Servicing Costs Across Europe Debt Servicing Costs Across Europe Bottom Line: Generally, the debt-service picture in Europe does not represent a major threat for now. While risks are particularly well contained on the government front, the French corporate sector creates danger for the private sector. Investment Implications The elevated debt load in the Euro Area, especially in the corporate sector, constitutes a crucial limiting factor for interest rates in Europe over the coming business cycle. Compared with global economies, the Eurozone corporate sector sports elevated debt ratios. As Chart 8 illustrates, the Eurozone’s net debt-to-equity ratio is higher than that of the US across most sectors, and even surpasses that of Canada, another country with a heavily indebted corporate sector, for telecommunication firms and financials. The picture is even worse when looking at the net debt-to-EBITDA ratio. Except for energy and utilities, the Eurozone carries poorer numbers than both the US and Canada (Chart 9). Chart 8Debt-To-Equity Ratio Comparison A Lot Of Debt A Lot Of Debt Chart 9Net Debt-To-EBITDA Comparison A Lot Of Debt A Lot Of Debt The picture for debt service payments is even more damning. Despite the very low European corporate bond rates, Eurozone corporations generally have poorer interest rate coverage ratios than both the US and Canada (Chart 10). This indicates that, unless the subpar European profitability is resolved, significantly higher interest rates will cause significant damage to the European corporate sector. Chart 10Interest Coverage Lags In Europe A Lot Of Debt A Lot Of Debt Chart 11The French Corporate Sector And Dutch Households Will Limit The ECB A Lot Of Debt A Lot Of Debt On this front, the French corporate sector once again stands out as the most likely place for an accident. As the top panel of Chart 11 shows, French firms are positioned especially poorly, with both their debt-to-GDP and debt-servicing costs among the highest in advanced economies. Meanwhile, in the household sectors, only the Netherlands represents a potential risk (Chart 11, bottom panel). The level of corporate debt in the Eurozone and in France in particular suggests that the current level of yields in Canada may represent a cap on European long-term rates. Thus, it will be difficult for German yields to move beyond the 1% to 1.5% zone this cycle. For now, despite the elevated debt loads of the European corporate sector, we continue to overweight corporate bonds within European fixed-income portfolios. The ECB will maintain very accommodative monetary conditions for the next 24 months, at least. Moreover, the European recovery, especially in the service sector, will improve the operating cash flows of the corporate sector, and thus, increase the tolerance of the private sector for higher yields in the near terms. Finally, the strength in the Euro anticipated by BCA’s Foreign Exchange strategists will limit the upside to Eurozone inflation, and thus, to yields in the region. Nonetheless, investors should avoid certain sectors (see next section). Market Focus: How To Play Euro Area High Yield Bonds? Chart 12Valuations Are Getting Expensive Valuations Are Getting Expensive Valuations Are Getting Expensive We have argued that investors should continue to favor investment grade corporate bonds within European fixed-income portfolios over high-yield corporate bonds. Eurozone investment grade credit still offered enough value to delay a move down in quality (Chart 12). However, this value cushion is thinning and spreads are only 10 bps from their 2018 lows. BCA Research’s Global Fixed-Income strategists have recently increased their allocation to Euro Area high-yield to overweight, with a focus on the Ba-rated credit tier, while maintaining a neutral weighting in IG credit.  However, European high-yield is also becoming expensive. The yield on the overall index is a meagre 44 bps away from its lows of 2018. Moreover, the breakeven spreads of European junk bonds have only been more expensive 11% of the time since 2000 (Chart 12, bottom panel). Despite these observations, high-yield credit is not a uniform block. Caa-rated debt still offers decent value, with a breakeven spread historical percentile standing at 27%. The stretched level of valuation suggests that investors should become more selective in the high-yield space, in order to avoid the industries with the worst risk profiles. To assess the sectors most at risk of experiencing significant spread widening or default occurrences in the coming quarters, we evaluate how the 10 main high-yield industry groups, as defined by Bloomberg Barclays, perform on the following credit metrics: Risk profile The share of firms rated Caa Growth in value of debt outstanding over the past 10 years Change in net debt-to-EBITDA ratio over the past 10 years Risk Profile Chart 13Risk Profile Of HY Sectors A Lot Of Debt A Lot Of Debt We look at the duration-times-spread (DTS) ratio to determine the risk profile of each sector (Chart 13). The DTS is a simple measure that correlates closely with excess return volatility for corporate bonds. The ratio of an issue’s, or sector’s DTS, to that of the benchmark index is loosely equivalent to the beta of a stock or industry to the equity benchmark. A DTS ratio above 1.0 signals that the sector is cyclical (or “high beta”); a DTS ratio below 1.0 indicates that the sector is defensive (or “low beta”). Cyclical sectors are expected to outperform (underperform) the benchmark when spreads are narrowing (widening), while the opposite is expected of defensive sectors. In Europe, only three sectors sport a high DTS. Within these cyclical sectors, energy clearly stands out as essentially being the one most at risk of underperforming during the next episode of spread widening. Meanwhile, materials, healthcare, and utilities display the lowest DTS ratios and should trade defensively relative to the high-yield benchmark index. Share of Caa-rated debt Chart 14High Share Of Caa-Rated Debt Implies Higher Risk Of Default A Lot Of Debt A Lot Of Debt The bulk of defaults happens in the Caa-rated space and below. Hence, evaluating sector risk starts by assessing the share of Caa-rated (and below) debt sported by each industry (Chart 14). Sectors bearing a larger share of low-rated debt should display higher spreads. Consumer non-cyclicals and healthcare have the highest instance of low-rated debt, 16% and 13% respectively, and yet their spreads do not adequately compensate investors for this threat. The energy sector also stands out: spreads are wide because, despite the low percentage of Caa-rated debt, this sector has amassed considerable debt and has seen a meaningful deterioration in net debt-to-EBITDA (see below). Meanwhile, utilities shine under this metric, as they have not issued debt rated Caa or lower. Debt Growth Chart 15Debt Growth Justify Spread Levels A Lot Of Debt A Lot Of Debt The speed and amount of debt accumulated during economic recoveries are other important determinants of future spread volatility, because the sectors that have rapidly levered-up are more likely to experience defaults. Chart 15 shows that, if we ignore the outlying utilities, then there is a robust positive linear relationship between this metric and spreads. Utilities, energy, and the tech sectors have added the most debt, while debt accumulation in the basic materials and health care sectors has lagged over the past 10 years. Crucially, tech and communications spreads trade below what their debt growth implies. Net Debt-To-EBITDA Chart 16Only Financials Have Improved Their Net Debt-To-EBITDA A Lot Of Debt A Lot Of Debt A rapid debt accumulation is not a concern, as long as earnings are rising more rapidly or at least at the same pace. From this case, we infer that companies are using the new debt issued efficiently, for CAPEX or to pursue projects exceeding their IRR. In this light, wide spreads are justified for the energy, consumer cyclical, and consumer non-cyclical sectors (Chart 16). Conversely, financials have seen improvement. Bottom Line: After surveying Euro area high-yield corporate sectors based on four credit metrics, it appears that the sectors most at risk are energy and consumer non-cyclical. By contrast, basic materials seem to be a good sector in which to hide.   Mathieu Savary, Chief European Investment Strategist Mathieu@bcaresearch.com Jeremie Peloso, Associate Editor JeremieP@bcaresearch.com Currency Performance A Lot Of Debt A Lot Of Debt Fixed Income Performance Government Bonds A Lot Of Debt A Lot Of Debt Corporate Bonds A Lot Of Debt A Lot Of Debt Equity Performance Major Stock Indices A Lot Of Debt A Lot Of Debt Geographic Performance A Lot Of Debt A Lot Of Debt Sector Performance A Lot Of Debt A Lot Of Debt

Highlights The ongoing transition to a post-pandemic state and fiscal policy are either positive or net-neutral for risky asset prices. Fiscal thrust will turn to fiscal drag over the coming year, but the negative impact this will have on goods spending will likely be offset by a significant improvement in services spending, and thus is not likely to cause a concerning slowdown in overall economic activity. A modestly hawkish shift in the outlook for monetary policy is likely over the coming year, potentially occurring over the late summer or early fall in response to outsized jobs growth. However, such a shift is not likely to become a negative driver for risky asset prices over the coming 6-12 months, barring a major rise in market expectations for the neutral rate of interest. This may very well occur once the Fed begins to raise interest rates, but not likely before. Investors should overweight risky assets within a multi-asset portfolio, and fixed-income investors should maintain a below-benchmark duration position. We continue to favor value over growth on a 6-12 month time horizon, although growth may outperform in the near term. A bias toward value over the coming year supports an overweight stance toward global ex-US equities, and an overall pro-risk stance favors bearish US dollar bets. Feature Three factors continue to drive our global macroeconomic outlook and our cyclical investment recommendations. The first factor is our assessment of the global progress that is being made on the path to a post-pandemic state, and the return to pre-COVID economic conditions; the second is the likely contribution to growth from fiscal policy over the coming year; and the third is the outlook for monetary policy and whether or not monetary conditions will remain stimulative for both economic activity and financial markets. If the world continues to progress meaningfully on the path to a post-pandemic state, and if the impact of fiscal and monetary policy remains in line with market expectations, then we see no reason to alter our recommended investment stance. Equity market returns will be modest over the coming 6 to 12 months in this scenario given how significantly stocks have rebounded from their low last year, but we would still expect stocks to outperform bonds and would generally be pro-cyclically positioned. We present below our assessment of these three factors and their potential to deviate from consensus expectations over the coming year, to determine their likely impact on economic activity and financial markets. The Ongoing Transition To A Post-Pandemic World Chart I-1Enormous Progress Has Been Made In The Fight Against COVID-19 Enormous Progress Has Been Made In The Fight Against COVID-19 Enormous Progress Has Been Made In The Fight Against COVID-19 Chart I-1 highlights that meaningful progress continues to be made in vaccinating the world's population against COVID-19. North America and Europe continue to lead the rest of the world based on the share of people who have received at least one dose, but South America continues to make significant gains, and recent data updates highlight that Asia and Oceania are also making meaningful progress. Africa is the clear laggard in the war against SARS-COV-2 and its variants, but progress there has been delayed, at least in part, by India’s export restrictions of the Oxford-AstraZeneca/COVISHIELD vaccine. This suggests that, while Africa will continue to lag, the share of Africans provided with a first dose of vaccine will begin to rise once India resumes its exports and deliveries to African countries under the COVAX program continue. If variants of the disease were not a source of concern, Chart I-1 would highlight that the full transition to a post-pandemic economy over the next several months would be near certain. However, as evidenced by the recent decision in the UK to postpone the lifting of COVID-19 restrictions by 4 weeks due to the spreading of the Delta variant, the global economy is not entirely out of the woods yet. Encouragingly, the delay in the UK genuinely appears to be temporary. Chart I-2 highlights that while the number of confirmed UK COVID-19 cases has been rising over the past month, the uptick in hospitalizations and fatalities has so far been quite muted. Importantly, the rise in hospitalizations appears to be occurring among those who have not yet been fully vaccinated, underscoring that variants of the disease are only truly concerning if they are vaccine-resistant. The evidence so far is that the Delta variant is more transmissible and may increase the risk of hospitalization, but that two doses of COVID-19 vaccine offer high protection. Of course, vaccines only offer protection if you get them, and evidence of vaccination hesitancy in the US is thus a somewhat worrying sign. Chart I-3 shows that the daily pace of vaccinations in the US has slowed significantly from mid-April levels, resulting in a slower rise in the share of the population that has received at least one dose (second panel). On this metric, the US has recently been outpaced by Canada, and the gap between the UK and the US is now widening. Germany and France are close behind the US and may surpass it soon. Chart I-2The UK Delay In Removing Restrictions Seems Genuinely Temporary The UK Delay In Removing Restrictions Seems Genuinely Temporary The UK Delay In Removing Restrictions Seems Genuinely Temporary Chart I-3Recent Vaccination Progress In The US Has Been Underwhelming Recent Vaccination Progress In The US Has Been Underwhelming Recent Vaccination Progress In The US Has Been Underwhelming   Sadly, Chart I-4 highlights that there is a political dimension to vaccine hesitancy in the US. The chart shows that state by state vaccination rates as a share of the population are strongly predicted by the share of the popular vote for Donald Trump in the 2020 US presidential election. Admittedly, part of this relationship may also be capturing an urban/rural divide, with residents in less-dense rural areas (which typically support Republican presidential candidates) perhaps feeling a lower sense of urgency to become vaccinated against the disease. Chart I-4The US Politicization Of Vaccines Raises The Risk From COVID-19 Variants July 2021 July 2021 But given the clear politicization that has already occurred over some pandemic control measures, such as the wearing of masks, Chart I-4 makes it difficult to avoid the conclusion that the same thing has occurred for vaccines. This is unfortunate, and seemingly raises the risk that the Delta variant may spread widely in red states over the coming several months, potentially delaying economic reopening, or risking the reintroduction of pandemic control measures. However, there are two counterarguments to this concern. First, non-vaccine immunity is probably higher in red than blue states, and CDC data suggest that this effect could be large. While this figure is still preliminary and subject to change (and likely will), the CDC estimates that only 1 out of 4.3 cases of COVID-19 were reported from February 2020 to March 2021. Taken at face value, this implies that there were approximately 115 million infections during that period, compared with under 30 million reported cases. That gap accounts for 25% of the US population, and given that red states were slower to implement pandemic control measures last year and their residents often more resistant to the measures, it stands to reason that a disproportionate share of unreported cases occurred in these states. Second, as noted above, the evidence thus far suggests that the Delta variant is not vaccine resistant, at least for those who are fully vaccinated. This is significant because if Delta were to spread widely in red states over the coming several months, the resulting increase in hospitalizations would likely convince many vaccine hesitant Americans to become vaccinated out of fear and self-interest – two powerfully motivating factors. Thus, the Delta variant may become a problem for the US in the fall, but if that occurs a solution is not far from sight. And, in other developed countries where vaccine hesitancy rates appear to be lower, it would seem that a new, vaccine-resistant variant of the disease would likely be required in order to cause a major disruption in the transition to a post-pandemic state. Such a variant could emerge, but we have seen no evidence thus far that one will before vaccination rates reach levels that would slash the odds of further widespread mutation. Fiscal Policy: Passing The Baton To Services Spending Chart I-5 highlights that US fiscal policy is set to detract from growth over the coming 6-12 months, reflecting the one-off nature of some of the fiscal response to the pandemic. This is true outside of the US as well, as Chart I-6 highlights that the IMF is forecasting a two percentage point increase in the Euro Area’s cyclically-adjusted primary budget balance, representing a significant amount of fiscal drag relative to the past two decades. Chart I-5Fiscal Thrust Will Eventually Turn To Fiscal Drag In The US… July 2021 July 2021 Should investors be concerned about the impact of fiscal drag on advanced economies over the coming year? In our view, the answer is no. The reason is that much of the fiscal response in the US and Europe has been aimed at supporting income that has been lost due to a drastic reduction in services spending, which will continue to recover over the coming months as the effect of the pandemic continues to ebb. Chart I-7 underscores this point by highlighting the “gap” in US consumer goods and services spending relative to its pre-pandemic trend. The chart highlights that US goods spending is running well above what would be expected, whereas there is a sizeable gap in services spending (which accounts for approximately 70% of US personal consumption expenditures). Goods spending will likely slow as fiscal thrust turns to fiscal drag, but services spending will improve meaningfully – aided not just by a post-pandemic normalization in economic activity, but also by the sizeable amount of excess savings that US households have accumulated over the past year (Chart I-7, panel 2). Chart I-6... And In Europe ... And In Europe ... And In Europe Chart I-7But Reduced Transfers Will Only Impact Spending On Goods, Not Services But Reduced Transfers Will Only Impact Spending On Goods, Not Services But Reduced Transfers Will Only Impact Spending On Goods, Not Services While some of these savings have already been deployed to pay down debt and some may be permanently saved in anticipation of higher future taxes, the key point for investors is that the negative impact on goods spending from reduced fiscal thrust will be offset by a significant improvement in services spending, and thus is not likely to cause a concerning slowdown in overall economic activity. Monetary Policy: A Modestly Hawkish Shift Is Likely This leaves us with the question of whether or not monetary policy will become a negative driver for risky asset prices over the coming 6-12 months, which is especially relevant following last week’s FOMC meeting. The updated “dot plot” following the meeting shows that 7 of the 18 FOMC participants anticipate a rate hike in 2022, and the majority (13 members) expect at least one rate hike before the end of 2023, raising the median forecast for the Fed funds rate to 0.6% by the end of that year. Chart I-8 highlights that while 10-year Treasury yields remains mostly unchanged following the meeting, yields moved higher at the short-end and middle of the curve. Chart I-8The FOMC Meeting Resulted In Higher Short- And Mid-Term Yields The FOMC Meeting Resulted In Higher Short- And Mid-Term Yields The FOMC Meeting Resulted In Higher Short- And Mid-Term Yields Investor fears that the Fed may shift in a significantly hawkish direction at some point over the next year have been far too focused on inflation, and far too little focused on employment. It is not a coincidence that the Fed’s guidance was updated following the May jobs report, which saw a stronger pace of jobs growth relative to April. Table I-1 updates our US Bond Strategy service’s calculations showing the average monthly nonfarm payroll growth that will be required for the unemployment rate to reach 3.5-4.5% assuming a full recovery in the participation rate, which is the range of the Fed’s NAIRU estimates. May’s payroll growth number of 560k implies that the Fed’s maximum employment criterion will be met sometime between June and September next year, if monthly payroll growth continues at that pace. Table I-1Calculating The Distance To Maximum Employment July 2021 July 2021 Chart I-9Lighter Restrictions In Blue States Will Push Down The Unemployment Rate Lighter Restrictions In Blue States Will Push Down The Unemployment Rate Lighter Restrictions In Blue States Will Push Down The Unemployment Rate It is currently difficult to assess with great confidence what average payroll growth will prevail over the coming year, but we noted in last month’s report that there were compelling arguments in favor of outsized jobs growth this fall.1 In addition to those points, we note the following: Blue states have generally been slower to reopen their economies, and Chart I-9 highlights that these states have consequently been slower to return to their pre-pandemic unemployment rate. Among blue states, California and New York are the largest by population, and it is notable that both states only lifted most COVID-19 restrictions on June 15 – including the wearing of masks in most settings. This implies that services jobs are likely to grow significantly in these states over the coming few months. Both consensus private forecasts as well as the Fed’s expectation for real GDP growth imply that the output gap will be closed by Q4 of this year (Chart I-10). These expectations appear to be reasonable, given the substantial amount of excess savings that have been accumulated by US households and the fact that monetary policy remains extremely stimulative. When the output gap turned positive during the last economic cycle, the unemployment rate was approximately 4% – well within the Fed’s NAIRU range. Chart I-10 also shows that the Fed’s 7% real GDP growth forecast for this year would put the output gap above its pre-pandemic level, when the unemployment rate stood at 3.5%. In fact, it is possible that annualized Q2 real GDP growth will disappoint current consensus expectations of 10%, due to the scarcity of labor supply (scarcity that will be eased by labor day when supplemental unemployment insurance benefit programs end). Were Q2 GDP to disappoint due to supply-side limitations, it would strengthen the view that job gains will be very strong this fall ceteris paribus, as it would highlight that real output per worker cannot rise meaningfully further in the short-term and that stronger growth later in the year will necessitate very large job gains. Chart I-11 highlights that US air travel and New York City subway ridership have already returned close to 75% and 50% of their pre-pandemic levels, respectively. Based on the trend over the past three months, the chart implies that air travel will return to its pre-pandemic levels by mid-October of this year, and New York City subway ridership by June 2022. This underscores that travel-related services employment will recover significantly in the fall, and that jobs in downtown cores will rebound as office workers progressively return to work. Chart I-10Expectations For Growth This Year Suggest A Rapid Decline In The Unemployment Rate Expectations For Growth This Year Suggest A Rapid Decline In The Unemployment Rate Expectations For Growth This Year Suggest A Rapid Decline In The Unemployment Rate Chart I-11Services Employment Will Recover In The Fall Services Employment Will Recover In The Fall Services Employment Will Recover In The Fall   On the latter point, one major outstanding question affecting the outlook for monetary policy is the magnitude of the likely permanent impact of work from home policies on employment in central business districts. Fewer office workers commuting to downtown office locations suggests that some jobs in the leisure & hospitality, retail trade, professional & business services, and other services industries will never return or will be very slow to do so, arguing for a longer return to maximum employment (and the Fed’s liftoff date). We examine this question in depth in Section 2 of this month’s report, and find that the “stickiness” of work from home policies will likely cause permanent central business job losses on the order of 575k (or 0.35% of the February 2020 labor force). While this would be non-trivial, when compared with a pre-pandemic unemployment rate of 3.5%, WFH policies alone are not likely to cause a long-term deviation from the Fed’s maximum employment objective. Outsized jobs growth this fall, at a pace that quickly reduces the unemployment rate, argues for a first Fed rate hike that is even earlier than the market expects. Chart I-12 presents The Bank Credit Analyst service’s current assessment of the cumulative odds of the Fed’s liftoff date by quarter; we believe that it is likely that the Fed will have raised rates by Q3 of next year, and that a rate hike in the first half of 2022 is a possibility. These odds are slightly more aggressive than those presented by our fixed-income strategists in a recent Special Report,2 but are consistent with their view that the Fed will raise interest rates by the end of next year. Chart I-12The Bank Credit Analyst’s Assessment Of The Odds Of The First Rate Hike July 2021 July 2021 The odds presented in Chart I-12 are also more hawkish than the Fed funds rate path currently implied by the OIS curve, meaning that we expect investors to be somewhat surprised by a shifting monetary policy outlook at some point over the coming year, potentially over the next 3-6 months. Payroll growth during the late summer and early fall will be a major test for the employment outlook, and is the most likely point for a hawkish shift in the market’s view of monetary policy. Is this likely to become a negative driver for risky asset prices over the coming 6-12 months? In our view, the answer is “probably not.” While investors tend to focus heavily on the timing of the first rate hike as monetary policy begins to tighten, the reality is that it is the least relevant factor driving the fair value of 10-year Treasury yields. Investor expectations for the pace of tightening and especially for the terminal Fed funds rate are far more important, and, while it is quite possible that expectations for the neutral rate of interest will eventually rise, it seems unlikely that this will occur before the Fed actually begins to raise interest rates given that most investors accept the secular stagnation narrative and the view that “R-star” is well below trend rates of growth (we disagree).3 Chart I-13 highlights the fair value path of 10-year Treasury yields until the end of next year, assuming a 2.5% terminal Fed funds rate, no term premium, and a rate hike pace of 1% per year. The chart highlights that while government bond yields are set to move higher over the coming 6-12 months, they are likely to remain between 2-2.5%. This would drop the equity risk premium to a post-2008 low (Chart I-14), which would further reduce the attractiveness of stocks relative to bonds. But we doubt that this would be enough of a decline to cause a selloff, and it would still imply a stimulative level of interest rates for households and firms. Chart I-1310-Year Yields Will Rise Over The Coming Year, But Not Sharply 10-Year Yields Will Rise Over The Coming Year, But Not Sharply 10-Year Yields Will Rise Over The Coming Year, But Not Sharply Chart I-14Rising Yields Will Cause An Unwelcome But Contained Decline In The ERP Rising Yields Will Cause An Unwelcome But Contained Decline In The ERP Rising Yields Will Cause An Unwelcome But Contained Decline In The ERP   Investment Conclusions Among the three factors driving our global macroeconomic outlook and our cyclical investment recommendations, continued progress on the path toward a post-pandemic state and fiscal policy remain either positive or mostly neutral for risky assets. A potentially hawkish shift in the outlook for monetary policy this fall remains the chief risk, but we expect the rise in bond yields over the coming year to remain well-contained barring a sea change in investor expectations for the terminal Fed funds rate – which we believe is unlikely to occur before the Fed begins to raise interest rates. Consequently, we continue to recommend that investors should overweight risky assets within a multi-asset portfolio, and that fixed-income investors should maintain a below-benchmark duration position. We expect modest absolute returns from global equities, but even mid-single digit returns are likely to beat those from long-dated government bonds and cash positions. While value stocks may underperform growth stocks over the coming 3-4 months,4 rising bond yields over the coming year will ultimately favor value stocks and will likely weigh on elevated tech sector (and therefore growth stock) valuations (Chart I-15). Chart I-16 highlights that the attractiveness of US value versus growth is meaningfully less compelling for the S&P 500 Citigroup indexes, suggesting that investors should continue to favor MSCI-benchmarked value over growth positions over a 6-12 month time horizon.5 Chart I-15Value Is Extremely Cheap Value Is Extremely Cheap Value Is Extremely Cheap Chart I-16Value Vs. Growth: The Benchmark Matters Value Vs. Growth: The Benchmark Matters Value Vs. Growth: The Benchmark Matters   The likely outperformance of value versus growth also has implications for regional allocation within a global equity portfolio. The US is significantly overweight broadly-defined technology relative to global ex-US stocks, and financials – which are overrepresented in value indexes – have already meaningfully outperformed in the US this year compared with their global peers and are now rolling over (Chart I-17). This underscores that investors should favor ex-US stocks over the coming year, skewed in favor of DM ex-US given that China’s credit impulse continues to slow (Chart I-18). Chart I-17Favor Global Ex-US Stocks Over The Coming Year Favor Global Ex-US Stocks Over The Coming Year Favor Global Ex-US Stocks Over The Coming Year Chart I-18Concentrate Global Ex-US Exposure In Developed Markets Concentrate Global Ex-US Exposure In Developed Markets Concentrate Global Ex-US Exposure In Developed Markets   Finally, global ex-US stocks also tend to outperform when the US dollar is falling, and we would recommend that investors maintain a short dollar position on a 6-12 month time horizon despite the recent bounce in the greenback. Chart I-19 highlights that the dollar remains strongly negatively correlated with global equity returns, and that the dollar’s performance over the past year has been almost exactly in line with what one would have expected given this relationship. Thus, a bullish view toward global stocks implies both US dollar weakness and global ex-US outperformance over the coming year. Chart I-19A Bullish View Towards Global Stocks Implies A Dollar Bear Market A Bullish View Towards Global Stocks Implies A Dollar Bear Market A Bullish View Towards Global Stocks Implies A Dollar Bear Market Jonathan LaBerge, CFA Vice President The Bank Credit Analyst June 24, 2021 Next Report: July 29, 2021   II. Work From Home “Stickiness” And The Outlook For Monetary Policy Work from home policies, originally designed as emergency measures in the early phase of the COVID-19 pandemic, are likely to be “sticky” in a post-pandemic world. This will negatively impact the labor market in central business districts, via reduced spending on services by office workers. The potential impact of working from home is often cited as an example of what is likely to be a lasting and negative effect on jobs growth, but we find that it is not likely to be a barrier to the labor market returning to the Fed’s assessment of “maximum employment.” The size of the impact depends importantly on whether employee preferences or employer plans for WFH prevail, but our sense is that the latter is more likely. A weaker pace of structures investment in response to elevated office vacancy rates will likely have an even smaller impact on growth than the effect of reduced central business district services employment. The contribution to growth from structures investment has been small over the past few decades, office building construction is a small portion of overall nonresidential structures, and there are compelling arguments that the net stock of office structures will stay flat, rather than decline. Our analysis suggests that job growth over the coming year could be even stronger than the Fed and investors expect, possibly resulting in a first rate hike by the middle of next year. This would be earlier than we currently anticipate, but it underscores that fixed-income investors should remain short duration on a 6-12 month time horizon, and that equity investors should favor value over growth positions beyond the coming 3-4 months. The outlook for US monetary policy over the next 12 to 18 months depends almost entirely on the outlook for employment. Many investors are focused on the potential for elevated inflation to force the Fed to raise interest rates earlier than it currently anticipates, but it is the progress in returning to “maximum employment” that will determine the timing of the first Fed rate hike – and potentially the speed at which interest rates rise once policy begins to tighten. In this report, we estimate the extent to which the “stickiness” of working from home (WFH) policies and practices could leave a lasting negative impact on the US labor market. We noted in last month's report that a large portion of the employment gap relative to pre-pandemic levels can be traced to the leisure & hospitality and professional and business services industries, both of which – along with retail employment – stand to be permanently impaired if the office worker footprint is much lower in a post-COVID world.6 Using employee surveys and a Monte Carlo approach, we present a range of estimates for the permanent impact of WFH policies on the unemployment rate, and separately examine the potential for lower construction of office properties to weigh on growth. We find that the impact of reduced office building construction is likely to be minimal, and that WFH policies may structurally raise the unemployment rate by 0.3 to 0.4%. While non-trivial, when compared with a pre-pandemic unemployment rate of 3.5%, WFH policies alone are not likely to cause a long-term deviation from the Fed’s maximum employment objective. Relative to the Fed’s expectations of a strong, lasting impact on the labor market from the pandemic, this suggests that job growth over the coming year could be even stronger than the Fed and investors expect, possibly resulting in a first rate hike by the middle of next year. This would be earlier than we currently anticipate, but it underscores that fixed-income investors should remain short duration on a 6-12 month time horizon, and that equity investors should favor value over growth positions beyond the coming 3-4 months (a period that may see outperformance of the latter). Quantifying The Labor Market Impact Of The New Normal For Work In a January paper, Barrero, Bloom, and Davis (“BBD”) presented evidence arguing why working from home will “stick.” The authors surveyed 22,500 working-age Americans across several survey “waves” between May and December 2020, and asked about both their preferences and their employer’s plans about working from home after the pandemic. Chart II-1 highlights that the desired amount of paid work from home days (among workers who can work from home) reported by the survey respondents is to approximately 55% of a work week, suggesting that a dramatic reduction in office presence would likely occur if post-pandemic WFH policies were set fully in accordance with worker preferences. Chart II-1Employee Preferences Imply A Dramatic Reduction In Post-COVID Office Presence July 2021 July 2021 However, Table II-1 highlights that employer plans for work from home policies are meaningfully different than those of employees. The table highlights that employers plan for employees to work from home for roughly 22% of paid days post-pandemic, which essentially translates to one day per week on average.7 BBD noted that CEOs and managers have cited the need to support innovation, employee motivation, and company culture as reasons for employees’ physical presence. Managers believe physical interactions are important for these reasons, but employees need only be on premises for about three to four days a week to achieve this. Table II-1 also shows that employers plan to allow higher-income employees more flexibility in terms of working from home, and less flexibility to employees whose earnings are between $20-50k per year. Table II-1Employer Plans, However, Imply Less Working From Home Than Employees Prefer July 2021 July 2021 Based on the survey results, BBD forecast that expenditure in major cities such as Manhattan and San Francisco will fall on the order of 5 to 10%. In order to understand the national labor market impact of work from home policies and what implications this may have on monetary policy, we scale up BBD’s calculations using a Monte Carlo approach that incorporates estimate ranges for several factors: The percent of paid days now working from home for office workers The amount of money spent per week by office workers in central business districts (“CBDs”) The number of total jobs in CBDs The percent of CBD jobs in industries likely to be negatively impacted by reduced office worker expenditure The average weekly earnings of affected CBD workers The average share of business revenue not attributable to strictly variable expenses The percent of affected jobs likely to be recovered outside of CBDs Our approach is as follows. First, we calculate the likely reduction in nationwide CBD spending from reduced office worker presence by multiplying the likely percent of paid days now permanently working from home by the number of total jobs in CBDs and the average weekly spending of office workers. This figure is then increased due to the estimated acceleration in net move outs from principal urban centers in 2020 (Chart II-2); we assume a 5% savings rate and an average annual salary of $50k for these resident workers, and assume that all of their spending occurred within CBDs. We also assume that roughly 50% of jobs connected to this spending are recovered. Chart II-2Fewer Residents Will Also Lower Spending In Central Business Districts July 2021 July 2021 Then, we calculate the gross number of jobs lost in leisure & hospitality, retail trade, and other services by multiplying this estimate of lost spending by an estimate of non-variable costs as a share of revenue for affected industries, and dividing the result by average weekly earnings of affected employees. For affected CBD employees in the administrative and waste services industry, we simply assume that the share of jobs lost matches the percent of paid days now permanently working from home. Finally, we adjust the number of jobs lost by multiplying by 1 minus an assumed “recovery” rate, given that some of the reduction in spending in CBDs will simply be shifted to areas near remote workers’ residences. We assume a slightly lower recovery rate for lost jobs in the administrative and waste services industry. Table II-2 highlights the range of outcomes for each variable used in our simulation, and Charts II-3 and II-4 present the results. The charts highlight that the distribution of outcomes based on employer WFH intensions suggest high odds that nationwide job losses in CBDs due to reduced office worker presence will not exceed 400k. Based on average employee preferences, that number rises to roughly 800-900k. Table II-2The Factors Affecting Permanent Central Business District Job Losses July 2021 July 2021 Chart II-3The Probability Distribution Of CBD Jobs Lost… July 2021 July 2021 Chart II-4…Based On Our Monte Carlo Approach July 2021 July 2021   This raises the question of whether employer plans or employee preferences for WFH arrangements will prevail. Our sense is that it will be closer to the former, given that we noted above that employer WFH plans are the least flexible for employees whose earnings are between $20-50k per year (who are presumably employees who have less ability to influence the policy of firms). Chart II-5 re-presents the projected job losses shown in Chart II-4 as a share of the February 2020 labor force, along with a probability-weighted path that assumes a 75% chance that employer WFH plans will prevail. The chart highlights that WFH arrangements would have the effect of raising the unemployment rate by approximately 0.35%. However, relative to a pre-pandemic starting point of 3.5%, this would raise the unemployment rate to a level that would still be within the Fed’s NAIRU estimates (Chart II-6). Therefore, the “stickiness” of WFH arrangements alone do not seem to be a barrier to the labor market returning to the Fed’s assessment of “maximum employment,” suggesting that the conditions for liftoff may be met earlier than currently anticipated by investors. Chart II-5CBD Job Losses Will Not Be Trivial, But They Will Not Be Enormous July 2021 July 2021 Chart II-6Sticky WFH Policies Will Not Prevent A Return To Maximum Employment Sticky WFH Policies Will Not Prevent A Return To Maximum Employment Sticky WFH Policies Will Not Prevent A Return To Maximum Employment The Impact Of Lower Office Building Construction A permanently reduced office footprint could also conceivably impact the US economy through reduced nonresidential structures investment, as builders of commercial real estate cease to construct new office towers in response to expectations of a long-lasting glut. However, several points highlight that the negative impact on growth from US office tower construction will be even smaller than the CBD employment impact of reduced office worker presence that we noted above. First, Chart II-7 highlights the overall muted impact that nonresidential building investment has had on real GDP growth by removing the contribution to growth from nonresidential structures and for overall nonresidential investment. The chart clearly highlights that the historically positive contribution to real US output from capital expenditures over the past four decades has come from investment in equipment and intellectual property products, not from structures. Chart II-8 echoes this point, by highlighting that US real investment in nonresidential structures has in fact been flat since the early-1980s, contributing positively and negatively to growth only on a cyclical basis (not on a structural basis). Chart II-7Structures Have Not Contributed Significantly To US Growth For Some Time Structures Have Not Contributed Significantly To US Growth For Some Time Structures Have Not Contributed Significantly To US Growth For Some Time Chart II-8Nonresidential Structures Investment Has Been Flat For Four Decades Nonresidential Structures Investment Has Been Flat For Four Decades Nonresidential Structures Investment Has Been Flat For Four Decades Second, Table II-3 highlights that office properties make up a small portion of investment in private nonresidential structures. In 2019, nominal investment in office structures amounted to $85 billion, compared with $630 billion in overall structures investment, meaning that office properties amounted to just 13% of structures investment. Table II-3Office Structures Investment Is A Small Share Of Total Structures Investment July 2021 July 2021 Table II-4Conceivably, Vacant Office Properties Could Be Converted To Luxury Residential Units July 2021 July 2021 Third, it is true that investment is a flow and not a stock variable, meaning that, if the net stock of office buildings were to fall as a result from WFH policies, then the US economy would see a potentially persistently negative rate of growth from nonresidential structures (which would constitute a drag on growth). But if the net stock were instead to remain flat, then gross office property investment should equal the depreciation of those structures. The second column of Table II-3 highlights that current-cost depreciation of office structures was $53 billion in 2019 (versus nominal gross investment of $85 billion). Had office property investment been ~$30 billion lower in 2019, it would have reduced nominal GDP by a mere 14 basis points (resulting in an annual growth rate of 3.84%, rather than 3.98%). Fourth, there is good reason to believe that the net stock of office properties will stay flat, as the economics of converting offices to luxury housing units (whose demand is not substantially affected by factors such as commuting) – either fully or partially into mixed-use buildings – appear to be plausible. Table II-4 highlights that the average annual asking rent for office space per square foot in Manhattan was $73.23 in Q1 2021, and that the recent median listing home price per square foot is roughly $1,400. In a frictionless world where office space could be instantly and effortlessly sold as residential property, existing prices would imply a healthy (gross) rental yield of 5.2%. Thoughts On The Future Of Office Properties Of course, reality is far from frictionless. There are several barriers that will slow office-to-residential conversion as well as construction costs, which will meaningfully lower the net value of existing office real estate in large central business districts such as Manhattan. In a recent article in the Washington Post, Roger K. Lewis, retired architect and Professor Emeritus of Architecture at the University of Maryland, College Park, detailed several of these technical barriers (which we summarize below).8 Office buildings are typically much wider than residential buildings, the latter usually being 60 to 65 feet in width in order to enable windows and natural light in living/dining rooms and bedrooms. This suggests that office-to-residential conversion might require modifying the basic structure of office buildings, including cutting open parts of roof and floor plates on upper building levels to bring natural light into habitable and interior rooms, and other costly structural modifications to address the additional plumbing and infrastructure that will be needed. Lewis noted that floor-to-floor dimensions are typically larger in office buildings, which is beneficial for office-to-residential conversion because increased room heights augments the sense of space and openness, while allowing natural light to penetrate farther into the apartment. It also allows for extra space to place needed additional building infrastructure, such as sprinkler pipes, electrical conduits, light fixtures, and air ducts. But unique apartment layouts are often needed to use available floor space effectively in an office-to-residential conversion, which will increase design costs and raise the risk that nonstandard layouts may result in unforeseen quality-of-living problems that will necessitate additional future construction to correct. Zoning regulations and building code constraints will likely add another layer of costs to office-to-housing conversions, as these rules are written for conventional buildings, meaning that special exceptions or even regulatory changes are likely to be required. So it is clear that the process of converting office space to residential property will be a costly endeavor for office tower owners, which will likely reduce the net present value of these properties relative to pre-pandemic levels. But; this process appears to be feasible and, when faced with the alternative of persistently high vacancy rates and lost revenue, our sense is that office tower owners will choose this route – thus significantly reducing the likelihood that the growth in national gross investment in office properties will fall below the rate of depreciation. In addition, the trend in suburban and CBD office property prices suggests that there are two other possible alternatives to widespread office-to-residential conversion that would also argue against a significant and long-lasting decline in office structures investment. Chart II-9 highlights that the average asking rent has already fallen significantly in most Manhattan submarkets, and Chart II-10 highlights that suburban office prices are accelerating and rising at the strongest pace relative to CBD office prices over the past two decades, possibly in response to increased demand for workspace that is closer to home for many workers who previously commuted to CBDs. Chart II-9Working From The Office Is Getting Cheaper July 2021 July 2021 Chart II-10Suburban Offices Are Getting More Expensive Suburban Offices Are Getting More Expensive Suburban Offices Are Getting More Expensive Thus, the first alternative outcome to CBD office-to-residential conversion is that an increase in suburban office construction offsets the negative impact of outright reductions in CBD office investment if residential conversions prove to be too costly or too technically challenging. The second alternative is that owners of CBD office properties “clear the market” by dramatically cutting rental rates even further, to alter the cost/benefit calculation for firms planning permissive WFH policies. We doubt that existing rents reflect the extent of vacancies in large cities such as Manhattan, so we would expect further CBD office price declines in this scenario. But if owners of centrally-located office properties face significant conversion costs and a decline in the net present value of these buildings is unavoidable and its magnitude uncertain, owners may choose to cut prices drastically as the simpler solution. Investment Conclusions Holding all else equal, the fact that owners of CBD office properties are likely to experience some permanent decline in the value of these real estate assets is not a positive development for economic activity. But these losses will be experienced by firms, investors, and ultra-high net worth individuals with strong marginal propensities to save, suggesting that the economic impact from this shock will be minimal. And as we highlighted above, a decline in the pace of gross office building investment to the depreciation rate will have a minimal impact on the overall economy. This leaves the likely impact on CBD employment as the main channel by which WFH policies are likely to affect monetary policy. As we noted above and as discussed in Section 1 of our report, the Fed is now focused entirely on the return of the labor market to maximum employment, which we interpret as an unemployment rate within the range of the Fed’s NAIRU estimates (3.5% - 4.5%) and a return to a pre-pandemic labor force participation rate. Chart II-11On A One-Year Time Horizon, Favor Value Over Growth On A One-Year Time Horizon, Favor Value Over Growth On A One-Year Time Horizon, Favor Value Over Growth Our analysis indicates that WFH policies may structurally raise the unemployment rate by 0.3 to 0.4%. While non-trivial, when compared with a pre-pandemic unemployment rate of 3.5%, this suggests that WFH policies alone are not likely to cause a long-term deviation from the Fed’s maximum employment objective. The implication is that job growth over the coming year could be even stronger than the Fed and investors expect, which could mean that the Fed may begin lifting rates by the middle of next year barring a major disruption in the ongoing transition to a post-pandemic world. This is earlier than we currently expect, but the fact that it would also be earlier than what is currently priced into the OIS curve underscores that fixed-income investors should remain short duration on a 6-12 month time horizon. In addition, as noted in Section 1 of our report, while value stocks may underperform growth stocks over the coming 3-4 months,9 rising bond yields over the coming year will ultimately favor value stocks and will likely weigh on elevated tech sector valuations. Chart II-11 highlights that the relative valuation of growth stocks remains above its pre-pandemic starting point (Chart II-11), suggesting that investors should continue to favor MSCI-benchmarked value over growth positions over a 6-12 month time horizon. Finally, as also noted in Section 1 of our report, we do not expect rising bond yields to prevent stock prices from grinding higher over the coming year, unless investor expectations for the terminal fed funds rate move sharply higher – an event that seems unlikely, although not impossible, before monetary policy actually begins to tighten. Jonathan LaBerge, CFA Vice President The Bank Credit Analyst III. Indicators And Reference Charts BCA’s equity indicators highlight that the “easy” money from expectations of an eventual end to the pandemic have already been made. Our technical, valuation, and sentiment indicators are very extended, highlighting that investors should expect positive but more modest returns from stocks over the coming 6-12 months. Our monetary indicator has aggressively retreated from its high last year, reflecting a meaningful recovery in government bond yields since last August. The indicator still remains above the boom/bust line, however, highlighting that monetary policy remains supportive for risky asset prices. Forward equity earnings already price in a complete earnings recovery, but for now there is no meaningful sign of waning forward earnings momentum. Net revisions remain very strong, and positive earnings surprises have risen to their highest levels on record. Within a global equity portfolio, there has been a modest tick down in global ex-US equity performance, driven by a rally in growth stocks (which may persist for a few months). EM stocks had previously dragged down global ex-US performance, and they continue to languish. A bias towards value stocks on a 1-year time horizon means that investors should still favor ex-US stocks over the coming year, skewed in favor of DM ex-US given that China’s credit impulse continues to slow. The US 10-Year Treasury yield has trended modestly lower since mid-March, after having risen to levels that were extremely technically stretched. Despite this pause, our valuation index highlights that bonds are still expensive, and we expect that yields will move higher over the cyclical investment horizon if employment growth in Q3/Q4 implies a faster return to maximum employment than currently projected by the Fed. We expect the rise to be more modest than our valuation index would imply, but we would still recommend a short duration stance within a fixed-income portfolio. The extreme rise in some commodity prices over the past several months is beginning to ease. Lumber prices have fallen close to 50% from their recent high, whereas industrial metals and agricultural prices are down roughly 5% and 17%, respectively. We had previously argued that a breather in commodity prices was likely at some point over the coming several months, and we would expect further declines as supply chains normalize, labor supply recovers, and Chinese demand for metals slows. US and global LEIs remain in a solid uptrend, and global manufacturing PMIs are strong. Our global LEI diffusion index has declined significantly, but this likely reflects the outsized impact of a few emerging market countries (whose vaccination progress is still lagging). Strong leading and coincident indicators underscore that the global demand for goods is robust, and that output is below pre-pandemic levels in most economies because of very weak services spending. The latter will recover significantly later this year, as social distancing and other pandemic control measures disappear. EQUITIES: Chart III-1US Equity Indicators US Equity Indicators US Equity Indicators Chart III-2Willingness To Pay For Risk Willingness To Pay For Risk Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators US Equity Sentiment Indicators US Equity Sentiment Indicators   Chart III-4US Stock Market Breadth US Stock Market Breadth US Stock Market Breadth Chart III-5US Stock Market Valuation US Stock Market Valuation US Stock Market Valuation Chart III-6US Earnings US Earnings US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations US Treasurys And Valuations US Treasurys And Valuations Chart III-10Yield Curve Slopes Yield Curve Slopes Yield Curve Slopes Chart III-11Selected US Bond Yields Selected US Bond Yields Selected US Bond Yields Chart III-1210-Year Treasury Yield Components 10-Year Treasury Yield Components 10-Year Treasury Yield Components Chart III-13US Corporate Bonds And Health Monitor US Corporate Bonds And Health Monitor US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Global Bonds: Developed Markets Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets Global Bonds: Emerging Markets Global Bonds: Emerging Markets   CURRENCIES: Chart III-16US Dollar And PPP US Dollar And PPP US Dollar And PPP Chart III-17US Dollar And Indicator US Dollar And Indicator US Dollar And Indicator Chart III-18US Dollar Fundamentals US Dollar Fundamentals US Dollar Fundamentals Chart III-19Japanese Yen Technicals Japanese Yen Technicals Japanese Yen Technicals Chart III-20Euro Technicals Euro Technicals Euro Technicals Chart III-21Euro/Yen Technicals Euro/Yen Technicals Euro/Yen Technicals Chart III-22Euro/Pound Technicals Euro/Pound Technicals Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Broad Commodity Indicators Broad Commodity Indicators Chart III-24Commodity Prices Commodity Prices Commodity Prices Chart III-25Commodity Prices Commodity Prices Commodity Prices Chart III-26Commodity Sentiment Commodity Sentiment Commodity Sentiment Chart III-27Speculative Positioning Speculative Positioning Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop US And Global Macro Backdrop US And Global Macro Backdrop Chart III-29US Macro Snapshot US Macro Snapshot US Macro Snapshot Chart III-30US Growth Outlook US Growth Outlook US Growth Outlook Chart III-31US Cyclical Spending US Cyclical Spending US Cyclical Spending Chart III-32US Labor Market US Labor Market US Labor Market Chart III-33US Consumption US Consumption US Consumption Chart III-34US Housing US Housing US Housing Chart III-35US Debt And Deleveraging US Debt And Deleveraging US Debt And Deleveraging   Chart III-36US Financial Conditions US Financial Conditions US Financial Conditions Chart III-37Global Economic Snapshot: Europe Global Economic Snapshot: Europe Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China Global Economic Snapshot: China Global Economic Snapshot: China   Jonathan LaBerge, CFA Vice President The Bank Credit Analyst Footnotes 1 Please see The Bank Credit Analyst "June 2021," dated May 27, 2021, available at bca.bcaresearch.com 2 Please see US Bond Strategy/Global Fixed Income Strategy Special Report "A Central Bank Timeline For The Next Two Years," dated June 1, 2021, available at usbs.bcaresearch.com 3 Please see The Bank Credit Analyst Special Report "R-star, And The Structural Risk To Stocks," dated March 31, 2021, available at bca.bcaresearch.com 4 Please see US Equity Strategy "Rotate Into Growth Stocks, Be Granular In The Selection Of Cyclicals," dated June 14, 2021, available at uses.bcaresearch.com 5 For a discussion of the differences in value and growth benchmarks, please see Global Asset Allocation Special Report “Value? Growth? It Really Depends!” dated September 19, 2019, available at gaa.bcaresearch.com 6 Please see The Bank Credit Analyst "June 2021," dated May 27, 2021, available at bca.bcaresearch.com 7 Readers should note that the desired share of paid work from home days post-COVID among employees is shown to be lower in Table II-1 than what is implied by Chart II-1 on a weighted-average basis. This is due to the fact that Table II-1 excludes responses from the May 2020 survey wave, because the authors did not ask about employer intensions during that wave. This underscores that the average desired number of paid days working from home declined somewhat over time, and thus argues for the value shown in Table II-1 as the best estimate for employee preferences. 8 Roger K. Lewis, “Following pandemic, converting office buildings into housing may become new ‘normal,’ Washington Post, April 3, 2021. 9 Please see US Equity Strategy "Rotate Into Growth Stocks, Be Granular In The Selection Of Cyclicals," dated June 14, 2021, available at uses.bcaresearch.com