Currencies

Highlights Metals prices are likely to suffer in the short term on the back of weakening Chinese demand and fading inflationary pressures. Accordingly, in our most recent Global Asset Allocation (GAA) Quarterly Outlook, we downgraded the AUD to underweight against the greenback. Bond yields, globally, are bound to rise moderately over the course of the coming 12 months. Australian yields, however, are likely to rise slower than those in the US. The RBA has been explicit in communicating what it would take to adjust its policy stance and is likely to lag behind other central banks in DM. We therefore recommend investors favor Australian government bonds in a global bond portfolio. Australian equities, now dominated by Financials rather than the Materials sector, would benefit from a rise in bond yields. However, a weaker AUD and declining metal prices warrant no more than a benchmark exposure to Australian equities within a global equity portfolio. Introduction Recently, clients have often been asking about Australia. The reasons seem clear. With a potential commodities “super-cycle” driven by a shift to renewable energy and electric vehicles (EVs), both the Australian economy and equities should be in a position to benefit. The reality, however, has been much less positive. Particularly the divergence between the core driver of the Australian market, industrial metals, and the performance of both equities and the currency over the past few years has been a concern (Chart 1). Over the past year and a half, Australian equities have underperformed the MSCI ACWI by 12.4% (Chart 2, panel 1). This underperformance was mainly due to the outperformance of the US. However, even against global markets excluding the US, Australian equities did not match the rise in commodity prices – particularly industrial metals (Chart 2, panel 2). Chart 1Despite The Rise In Metals Prices... Despite The Rise In Metals Prices... Despite The Rise In Metals Prices... Chart 2...Australian Equities Have Not Outperformed ...Australian Equities Have Not Outperformed ...Australian Equities Have Not Outperformed   Chart 3Financials Dominate Australian Equities Financials Dominate Australian Equities Financials Dominate Australian Equities The structure of the Australian market has changed over the past few years. The commodities boom and subsequent global liquidity boom over the past two decades have fueled a housing bubble in Australia and an unsustainable rise in household debt. As a result, Australian equities are no longer dominated by metals and mining stocks, but rather by banks (Chart 3). We structured this Special Report in a Q&A format, answering questions we think are most relevant for investors to assess both the short- and long-term outlook for Australia. We aim to provide an overview of the economy and draw some conclusions on how investors should be positioned. Our conclusions are as follows: Over the past year and a half, the Australian economy has shown how complementary actions between fiscal and monetary policy, as well as social restriction measures, can mitigate both economic and human damage. The Reserve Bank of Australia (RBA) will be in no rush to adjust its policy stance until wage growth is back to its 3% target. However, RBA officials risk running the economy hot in the meantime given that measures of employment are back to their pre-pandemic levels. The RBA is not likely to change its policy stance before reaching its wage growth and inflation targets and will probably lag behind other global central banks in tightening. In that case, investors should favor Australian government bonds in a global bond portfolio. Australian banks remain well-funded and in good health. But their excessive exposure to the housing sector puts them at grave risk if home prices collapse. Despite this, there seems to be a feedback loop where a decline in mortgage rates fuels further demand for loans, pushing up home prices. A slowdown in Chinese credit growth and economic activity will hamper commodity demand, weighing down on Australian equities. The longer-term outlook remains compelling for Australian equities and metals as we enter into a new commodities “supercycle” fueled by a transition to renewable and alternative energy. The Australian economy stands to benefit given that the country has high levels of both production and reserves of the minerals needed for this transition.   Q: How Does The Economy Look In The Short-Term? A: Australia can be regarded as one of the few countries that successfully navigated the pandemic with a minimal amount of damage, both to its population and economy. With swift measures to limit travel and implement social restrictions, the spread of the outbreak was curtailed to slightly over 30,000 total cases, representing only 0.12% of its population (Chart 4). On the other hand, its vaccination campaign has been much slower (at 38 doses administered per 100 people) than in other DM economies such as the US, UK, France, or Germany with 100, 120, 90, and 102 doses per 100 people, respectively. In the short term, this might not seem particularly damaging to the economy. However, if vaccination rates do not pick up rapidly, Australia’s international travel restrictions (which cannot sustainably be kept in place) will hamper economic growth and become a major drag on the tourism and education sectors (Chart 5, panels 1 & 2). Chart 4Government Policies Contained The Pandemic Outbreak... Government Policies Contained The Pandemic Outbreak... Government Policies Contained The Pandemic Outbreak... Chart 5...At The Expense Of Tourism ...At The Expense Of Tourism ...At The Expense Of Tourism Ample fiscal support – in the form of wage subsidies and business support through the JobKeeper program – mitigated the shortfall in household incomes (Chart 6). This provided a boost to both consumers and businesses with Q1 GDP growth coming in at 1.8% quarter-on-quarter (7.4% annualized). GDP expectations for the remainder of this year and next show a resilient strong momentum for Australian growth and domestic demand (Chart 7). Chart 6Fiscal Stimulus Supported Employment... A Deeper Dive Into The Land Down Under A Deeper Dive Into The Land Down Under Chart 7...And Overall Growth ...And Overall Growth ...And Overall Growth Chart 8Labor Market Back To Pre-Pandemic Levels... Labor Market Back To Pre-Pandemic Levels... Labor Market Back To Pre-Pandemic Levels...   The labor market recovery has been an excellent example of how fiscal support and lockdown measures complement each other. Most employment indicators have almost recovered or surpassed their pre-pandemic levels: The unemployment rate stands at 4.90%, compared to 5.13%, the underemployment rate is at 7.44%, compared to 8.60%. The total number of those employed is now above its pre-pandemic level, albeit still below the 2018-2019 growth trend (Chart 8).   Q: When Will The RBA Shift Its Policy Stance? A: The RBA has been explicit in communicating that changes in its policy stance hinge on Australian wage growth rising sustainably towards 3% – a level last reached in Q1 2013. Even with economic activity mostly restored, wage growth remains low at 1.49% (Chart 9). Our belief is that until that occurs, the RBA will probably maintain its accommodative stance. Our global fixed-income strategists, in a recent report, highlighted their belief that the RBA is likely to be less hawkish than markets currently expect – on both tapering and hiking rates. We agree with that assessment. Comments by RBA Governor Lowe earlier last month back our dovish belief: He stated that “The Board is committed to maintaining highly supportive monetary conditions to support a return to full employment in Australia and inflation consistent with the target…This is unlikely to be until 2024 at the earliest”. Market expectations nevertheless remain much more hawkish – pointing to a first rate hike by mid 2022 and almost 70 basis points of hikes by 2024 (Chart 10). Chart 9...However Wage Growth Remains Muted ...However Wage Growth Remains Muted ...However Wage Growth Remains Muted Chart 10Market Expects A Hawkish RBA... Market Expects A Hawkish RBA Market Expects A Hawkish RBA   Chart 11...And Is Already Pricing That Down The Curve ...And Is Already Pricing That Down The Curve ...And Is Already Pricing That Down The Curve Chart 12Inflation Remains Well-Below The RBA's Target Inflation Remains Well-Below The RBA's Target Inflation Remains Well-Below The RBA's Target This means that the RBA will probably risk running the economy hot for a while. With total employment back to its pre-pandemic level and other employment indicators closely behind, inflationary pressures, sooner or later, will begin to mount. Higher growth prospects and inflation risks are being discounted further down the curve (Chart 11). The June CPI print is likely to reflect a transitory short-term base effect and the RBA is mostly going to see through that. In the meantime, we would watch other broad inflation indicators to gauge for price pressures. Broader measures such as the trimmed-mean inflation index or median inflation remain subdued at 1.1% and 1.3%, respectively. The 10-year breakeven rate currently stands at 2.1%, within the RBA’s range of 2%-3%, highlighting the market’s belief that long-term inflation remains well under control (Chart 12). Bottom Line: The RBA is likely to maintain its dovish stance for longer than the market expects. A return to sustainable levels of wage growth and inflation will remain the top objectives and it is unlikely that policy will be reversed before they are achieved. Our global fixed-income strategists laid out a checklist of what would make the RBA turn less dovish. So far, only 1 out of 5 items on their list (the recovery in private-sector demand) signals the need for a more hawkish stance. The remaining items signal no imminent pressure on the RBA to adjust policy (Table 1). The RBA is also wary of the currency appreciating if it took a more hawkish stance ahead of other central banks (e.g., the Fed) and is therefore likely to switch policy only after other central banks do so (Chart 13). Accordingly, investors should favor Australian government bonds within a global bond portfolio. Table 1RBA Checklist A Deeper Dive Into The Land Down Under A Deeper Dive Into The Land Down Under Chart 13The RBA Will Be Wary Of A Rising AUD The RBA Will Be Wary Of A Rising AUD The RBA Will Be Wary Of A Rising AUD   Q: Are There Signs Of Improvement In The Banking Sector? A: Headline indicators of the health of the Australian banking sector paint a picture of a well-capitalized, highly funded, and profitable industry. Return on equity (ROE) has averaged 12.1% over the past decade. Capital adequacy and Tier 1 capital ratios stand at 14.5% and 18.2%, respectively – much higher than at the start of the Global Financial Crisis (GFC). The ratio of non-performing loans remains low and Australian banks’ reliance on leverage has also decreased (Chart 14). Chart 14Banks Look Healthy... Banks Look Healthy... Banks Look Healthy... Chart 15...But Remain Exposed To The Housing Sector... ...But Remain Exposed To The Housing Sector ...But Remain Exposed To The Housing Sector However, these indicators mask a major underlying risk. Banks remain heavily exposed to the housing market, with housing loans as high as 62% of banks’ gross outstanding loans and 40% of total assets (Chart 15, panel 1). Over the past decade and a half, banks have lent an average of A$56 of housing-related loans for every A$100 in total loans (Chart 15, panel 2).   Chart 16...Which Is Showing No Signs Of Slowing Down ...Which Is Showing No Signs Of Slowing Down ...Which Is Showing No Signs Of Slowing Down Chart 17Households Remain Heavily Indebted Households Remain Heavily Indebted Households Remain Heavily Indebted With interest rates falling over the past few decades, construction activity has boomed. Consequently, the demand for loans for new homes has been rising, leading home prices higher (Chart 16). This also meant that household debt levels have climbed and currently standing at a staggering 130% of GDP and 180% of disposable income (Chart 17).   So what does this mean for banks’ stock prices? The short answer is that absent a bursting of the bubble in house prices, banks should continue to fare well. Interestingly, the long-standing relationship between bond yields and banks’ relative stock price returns – one that works in other financial-heavy markets such as the euro area – did not hold in Australia, at least until recently. In fact, we find that, historically, Australian banks outperformed the broad market when bond yields were falling. This relationship changed post-GFC, most likely when inflation expectations became unanchored and trended lower – reflecting lower commodity prices (Chart 18). Bottom Line: Rising rates, reflecting better growth prospects and higher long-term inflation, should be a tailwind for bank stocks in the short term. Accommodative monetary policy will spur activity in the property market, propping up bank profits. This, however, puts banks at even greater risk when profitability starts to decline, NPLs rise and regulations tighten further. The latter risk is one we would highlight following RBA deputy governor Guy Debelle’s statement that monetary policy will not be used as a tool to curtail housing prices and that there are other tools to address that issue. Chart 18Rising Yields Will Be A Tailwind For Australian Equities Rising Yields Will Be A Tailwind For Australian Equities Rising Yields Will Be A Tailwind For Australian Equities   Q: How Does Chinese Policy Impact Australian Growth? A: China's role in global supply chains, as both a producer and consumer, has increased dramatically since the early 2000s. China’s demand for commodities generally and industrial metals in particular has grown over the past two decades from an average of 10% of total global demand to 50% for most metals (Chart 19). Australia stood to benefit, redirecting more and more of its metals’ production away from the rest of the world and towards China. For example, during the same period, the share of Australian iron ore exports to China increased fourfold (Chart 20). Chart 19China Is A Major Consumer Of Metals... China Is A Major Consumer Of Metals... China Is A Major Consumer Of Metals... Chart 20...And This Has Benefited Australia Over The Past Two Decades ...And This Has Benefited Australia Over The Past Two Decades ...And This Has Benefited Australia Over The Past Two Decades     However, this dynamic leaves the Australian economy very exposed to the Chinese business cycle – one that is heavily reliant on policymakers’ decisions on how much liquidity to inject into the economy. After strong credit and fiscal support throughout 2020, the Chinese authorities – wary of excessive leverage in the economy – have begun paring back stimulus which is likely to lead to weaker growth in the second half of the year and put downward pressure on metal demand (Chart 21). Chart 21Weakening Chinese Demand Will Hurt Metals In The Short-Term Weakening Chinese Demand Will Hurt Metals In The Short-Term Weakening Chinese Demand Will Hurt Metals In The Short-Term Heightened political tensions between Australia and China have also played a role. China recently imposed restrictions, including additional tariffs and bans, on Australian imports such as beef, wine, coal, and other goods. Consequently, Australian exports to China slowed. However, the goods not imported by China were absorbed by other economies – Australian export growth did not fall that much. It is unlikely that a new commodity-heavy marginal buyer will emerge in the short-term to replace Chinese demand. The recent rise in commodity prices reflected a return to economic activity, as well as inflationary fears, and supply, shipping, and logistical backlogs. These will ease in the short term, weighing on both the AUD and Australian equities.   Q: Can The Shift To Renewable Energy Spur Future Australian Growth? A: The shift to renewable energy and electrification – particularly in the transport sector – will occur sooner rather than later. Some commodity-exporting countries stand to benefit, and Australia is likely to be one. We previously highlighted that modeling longer-term demand is tricky since it relies on assumptions for the emergence of new technologies, metals’ efficiency and recycling rates, and the rate of conversion to renewables. Chart 22The Shift To Renewables Will Require More Resources... A Deeper Dive Into The Land Down Under A Deeper Dive Into The Land Down Under The mechanics of the future demand/supply relationship hinge on the following: Demand will rise during this energy transition period – simply due to the fact that the new clean energy systems require more minerals (such as copper and zinc) than the current traditional hydrocarbon-fueled energy system (Chart 22, panel 1). Electric vehicles (EVs) require about four and a half times more of certain commodities – particularly copper, nickel, and graphite – than conventional vehicles do (Chart 22, panel 2). Supply limitations, on the other hand, are what might propel metal prices even higher and lead the world economy into a new commodities “supercycle”. A study by the Institute for Sustainable Futures has shown that, in the most positive energy transition scenarios, demand for some metals will exceed supply, in terms of both available resources and reserves (Table 2). Table 2...Which Are Likely To Be In Short Supply A Deeper Dive Into The Land Down Under A Deeper Dive Into The Land Down Under For some of those metals, Australia is either among the top producers, or has the largest reserves. For example, Australia produces almost 45% and 12% of the world’s lithium and zinc, and has 22% and 27% of the world’s reserves. Looking at other metals, supply disruptions – particularly in economies where political, social, and environmental influences are an issue – might be the driver of further price rises. For example, Chile has the largest shares of global lithium reserves (~44%), and copper reserves (~23%), while South Africa has the largest share of global manganese reserves (~40%). Bottom Line: The transition to renewable energy is already underway and is likely to intensify. Forecast demand should outstrip supply and Australia stands to benefit given its large share of current production and/or reserves. How much will depend on the pace of renewable energy integration but miners are likely to be long-term winners.   Q: What Is The Outlook For The AUD? A: The Global Asset Allocation (GAA) service, in its latest Quarterly Outlook, turned negative on the AUD. The currency has historically had a high positive correlation with commodity prices and industrial metals prices, which in turn are very sensitive to Chinese demand (Chart 23). Given our outlook for metals in the short term (falling demand driven by slowing Chinese activity), we expect some weakening in the AUD over the coming 9-to-12 months (Chart 24). Chart 23The AUD Is Highly Correlated To Metal Prices... The AUD Is Highly Correlated To Metal Prices... The AUD Is Highly Correlated To Metal Prices... Chart 24...Which In Turn Are Highly Correlated To Chinese Activity ...Which In Turn Are Highly Correlated To Chinese Activity ...Which In Turn Are Highly Correlated To Chinese Activity Additionally, short-term weakness in the economy, caused by further lockdowns as Delta-variant COVID cases rise, is a risk since it might reduce domestic demand. From a valuation perspective, the AUD is slightly below its fair value (Chart 25). However, this on its own does not compel us to remain positive on the currency. We also consider other indicators such as investor positioning – which has reached a decade high, according to Citibank’s FX Positioning Alert Indicator (PAIN) (Chart 26). This indicator suggests that active FX traders hold substantial long positions in the AUD against the USD. Historically, this indicator has provided contrarian signals, with extreme optimism (pessimism) providing useful short (long) signals. Chart 25The AUD Is Close To Fair Value The AUD Is Close To Fair Value The AUD Is Close To Fair Value Chart 26Investors Are Long The AUD Investors Are Long The AUD Investors Are Long The AUD Bottom Line: Short-term weakness in the economy and a reversal in metal prices warrant caution on the currency. While valuations do not signal overbought conditions, investor positioning (a contrarian indicator) does.   Q: How Should Equity Investors Be Positioned? A: Our recent Special Report on whether country or sector effects drive equity performance showed that sector composition was relatively important in Australia, given the large difference in sector weightings relative to the global benchmark. Our analysis showed that cumulative Australian sector performance over the past two decades detracted from overall returns (Chart 27). Given that framework, and the relationship between the Australian economy and industrial metals, we find that Australian equity performance relative to the US mirrors the performance of global metal and mining relative to global tech stocks (Chart 28). This underperformance makes sense: Commodity prices have been in a structural downtrend throughout the past decade. Chart 27Country Vs Sector Effect Country Vs Sector Effect Country Vs Sector Effect Chart 28Australia / US = Metals / Tech Australia / US = Metals / Tech Australia / US = Metals / Tech Therefore, given our view of the outlook for metals, we would not want to shun Australian equities. The Global Asset Allocation (GAA) service is currently neutral the Australian market within a global equity portfolio, and underweight the Materials sector over the next 12 months. We believe this positioning makes sense given the slowdown in the Chinese economy and the improbability that another country will emerge as the alternative marginal buyer of commodities. The longer-term outlook is more compelling however, as the shift to decarbonization, renewables, and alternative energy gets underway. Conclusions In the short term metals prices are likely to suffer on the back of weakening Chinese demand (with no immediate substitute as a marginal buyer) as well as fading inflationary fears and an easing of supply/logistical issues. Our analysis shows that sector composition is a larger driver of Australian equity relative performance than country composition. While Australian equities – dominated by Financials – would benefit from a moderate rise in global bond yields, yields will rise more slowly in Australia than in the US and the AUD is likely to weaken. Over the next 12 months, investors should remain neutral on Australian equities within a global equity portfolio. The RBA is likely to lag other central banks in tightening policy. Investors should therefore favor Australian government bonds over other developed economies such as the US and Canada.   Amr Hanafy, Senior Analyst Global Asset Allocation amrh@bcaresearch.com        

Highlights The ECB has changed its inflation target, but its credibility remains weak. Inflation will not allow the ECB to tighten policy anytime soon. Instead, the ECB will have to add to its asset purchase program next year and may even consider dual interest rates. EUR/USD should continue to appreciate because of the weakness in the USD, but EUR/GBP, EUR/NOK, and EUR/SEK will soften. The SNB will follow the ECB; buy Swiss stocks / sell Eurozone defensives as an uncorrelated trade. China matters more than COVID-19 for the cyclical/defensive ratio. Despite our pro-cyclical medium- to long-term portfolio bias, the reflation trade is pausing. Remain tactically long telecom / short consumer discretionary as a hedge. European momentum stocks are near critical levels relative to growth equities. Feature The European Central Bank has found a new way to shed its Bundesbank heritage further and to justify the continuation of its QE program well after other central banks around the world will have ended their asset purchases. The early results of the Strategy Review and the subsequent comments by President Christine Lagarde will make it near impossible for the ECB to taper its asset purchases anytime soon. Practically, this means that the European yield curve will steepen relative to that of the US. Additionally, this policy should not hurt EUR/USD, but it will hurt EUR/GBP, EUR/NOK, and EUR/SEK. In the equity space, Swiss stocks will outperform European defensive equities, creating an opportunity for an uncorrelated trade. A New Tougher Target The ECB has abandoned its long-standing target of “close but below” 2% inflation. Even more importantly, the ECB followed the Bank of Japan and the Fed in adopting an approach whereby both downside and upside deviations from the 2% inflation target are to be fought. The ECB’s credibility was already hurt by its inability to achieve its more modest previous inflation target. Since 2009, the Euro Area HICP only averaged 1.2% (Chart 1). To prevent losing further credibility under its new mandate, the ECB will have to increase its stockpile of assets. Moreover, the ECB is far from achieving its new mandate, which will add to the ECB’s need to expand stimulus to the system even once the impact of owner-equivalent rent is included in CPI. Chart 1Mission Impossible Mission Impossible Mission Impossible Chart 2Narrow Inflationary Pressures Narrow Inflationary Pressures Narrow Inflationary Pressures Today, the ECB’s measure of core inflation stands at 1%, while headline inflation is 1.9%. As the economy re-opens, a surge in inflation is likely, but this spike will be transitory, even more so than in the US. As we recently showed, our estimate of the Eurozone trimmed-mean CPI has plunged close to 0%, which highlights that inflation pressures remain narrow (Chart 2). The labor market is another hurdle that will prevent Eurozone inflation from durably reaching 2% anytime soon. Currently, the total hours worked in the Euro Area remains well below the equilibrium level implied by the working-age population (Chart 3), which historically constrains wages. Moreover, it generally takes many quarters after labor shortages become prevalent before inflation begins to inch higher (Chart 4). Chart 3No Wage Pressure Yet No Wage Pressure Yet No Wage Pressure Yet Chart 4No Inflation Labor Shortages For A While No Inflation Labor Shortages For A While No Inflation Labor Shortages For A While The euro is the last force that caps European inflation. Despite the recent depreciation in EUR/USD, the trade-weighted euro remains near all-time highs, which historically imparts strong deflationary pressures to the economy (Chart 5). Beyond the time it will take for realized inflation to reach the ECB’s new target, inflation expectations are still inconsistent with 2% inflation. As the top panel of Chart 6illustrates, market-based inflation expectations in the Eurozone remain well below both 2% and the levels that prevailed before the Great Financial Crisis, even though rising commodity prices are lifting global inflation expectations. Market participants are not alone in doubting the ECB; professional forecasters do not see inflation at 2% in the near-term or the long-term (Chart 6, bottom panel). Chart 5The Euro Is Deflationary The Euro Is Deflationary The Euro Is Deflationary Chart 6The ECB Lacks Credibility The ECB Lacks Credibility The ECB Lacks Credibility   In addition to the continued inability of the ECB to achieve its previous inflation target, let alone its present one, sovereign risk still hamstrings the central bank. The Italian economy remains fragile, because little structural reform has taken place. The Spanish economy cannot stand on its own two feet while the tourism industry continues to suffer due to COVID-19 related fears. And the exploding debt load of the French economy as well as its structural current account deficit raise the possibility that OATs will become unmoored. The ECB will ensure that spreads in those nations do not widen, or Eurozone inflation will never reach the new 2% target. Bottom Line: When it was time to achieve near—but below—2% inflation, the credibility of the ECB was already limited. The new target will be even harder to reach, but the symmetry around it gives the ECB more leeway to provide additional support to the Eurozone economy. Market Implications The ECB is now bound to maintain policy accommodation beyond the scheduled end of the PEPP program in March 2022, or the new policy target will be even less credible than the previous one. BCA Global Fixed Income Strategy team expects the ECB to maintain its asset purchase program beyond the stated end of the PEPP. Practically, this means that the ECB will fold the program into the pre-pandemic APP. The ECB cannot tighten policy while it remains so far from its target, especially now that missing the goalpost to the downside is as problematic as missing it to the upside. We expect the ECB to hint at this on Thursday. Chart 7The EONIA Curve Anticipated The Strategy Review The EONIA Curve Anticipated The Strategy Review The EONIA Curve Anticipated The Strategy Review The ECB will also not increase interest rates for the foreseeable future, which the EONIA curve already anticipates (Chart 7). Money markets only expect a first hike in late 2024, which is appropriate. Compared to a month ago, overnight rates 10-year forward fell by more than 10bps, from 0.75% to 0.61%. We are inclined to fade this move. More stimulus raises the outlook for long-term policy rates. Amid the correction in global bond yields, betting against the decline in the long-term EONIA rate is akin to catching a falling knife; however, because the ECB is easing relative to the Fed, a box trade of buying European steepeners at the same time as US flatteners remains appropriate. The ECB could also lower the rate on TLTRO operations, resulting in a dual interest rate regime in the Eurozone. As Megan Greene and Eric Lonergan have argued, this policy would provide a further lift to the Euro Area economy by boosting the attractiveness of borrowing; at the same time, it would limit the deleterious impact of ever-more negative deposit rates on the profitability of the banking sector, because banks would borrow at extremely negative rates to finance lending activities.  Chart 8JPY And YCC JPY And YCC JPY And YCC The effect of the policy on the euro is more complex. When Japan announced its Yield Curve Control strategy in September 2016, it defined price stability as achieving a 2% inflation rate over the span of the business cycle. In other words, the BoJ implemented a backdoor average inflation mandate. Following this announcement, USD/JPY strengthened (Chart 8), but this move reflected the dollar rally and the global bond selloff around the US election, not yen-specific factors. This suggests that the euro will continue to track the USD inversely. BCA’s FX Strategy team remains bearish on the greenback, as a result of the growing US current account deficit and the fact that the Fed continues to target an overshoot in inflation, which suggests that, even if US nominal interest rates rise, real rates will lag behind. The EUR is nonetheless set to underperform compared to other European currencies. In the UK, house price gains are accelerating, the jobless count is declining rapidly as the economy re-opens, and the cheapness of the pound is accentuating positive inflation surprises. This combination suggests that the BoE is likely to follow the path of the Bank of Canada or the Reserve Bank of New Zealand, by beginning to tighten policy by early next year. Norway also faces a similar set of circumstances and has already announced it will lift interest rates this year. As we argued two months ago, the Riksbank is likely to follow its western neighbor, because the Swedish housing market is roaring, and the economy will remain well supported by the upcoming global capex boom. Hence, EUR/GBP, EUR/NOK, and EUR/SEK will depreciate.  The Swiss National Bank should be the outlier that will follow the ECB. Swiss headline and core inflation linger at 0.6% and 0.4%, respectively. Wage growth is a meager 0.5%, because the Swiss output gap remains a massive 5.5% of GDP (Chart 9, top panel). Meanwhile, consumer confidence and retail sales are much weaker than those of Sweden, Norway, or the UK. Finally, Swiss private debt stands at 270% of GDP, which means that this economy still risks falling into a Fisherian debt-deflation trap. As a result, the SNB will continue to try to cap the upside in the CHF vis-à-vis the EUR, because the currency remains the main determinant of Swiss monetary conditions. Moreover, according to the central bank, the Swiss franc is still 10% overvalued relative to the euro, which is weighing on the country’s competitiveness (Chart 9, bottom panel). To fight the recent depreciation of EUR/CHF, the SNB will not raise rates for a long time and will intervene further in the FX market. The liquidity injections should prompt additional increases in the SNB’s domestic sight deposits, which since 2015 have resulted in a rise of Swiss bond yields relative to those of Germany (Chart 10). While counterintuitive, this relationship reflects the reflationary impact of the SNB’s asset purchases. It also means that the Swiss real estate market is set to become ever bubblier. Chart 9The SNB Will Follow The ECB The SNB Will Follow The ECB The SNB Will Follow The ECB Chart 10Swiss/German Spreads To Widen Swiss/German Spreads To Widen Swiss/German Spreads To Widen For Swiss shares, the picture is more complex. Swiss equities are extremely defensive, but, while they underperform Euro Area stocks when global yields rise, widening Swiss / German spreads often provide a lift to the SMI. A simple model, assuming US 10-year Treasury yields rise to 2.25% by the end of 2022 (BCA’s US Bond Strategy forecast) and that Swiss/German spreads widen to 20bps as the SNB domestic sight deposits swell, suggests that Swiss stocks will underperform that of the Euro Area over the coming 18 months (Chart 11). However, if we compare Swiss equities to European defensive sectors, then the widening in Swiss/German spreads should prompt an outperformance of Swiss equities, because their multiples benefit from ample liquidity conditions in Switzerland (Chart 12). Chart 11Swiss Stocks Are Too Defensive To Outperform Durably... Swiss Stocks Are Too Defensive To Outperform Durably... Swiss Stocks Are Too Defensive To Outperform Durably... Chart 12...But They Will Beat Euro Area Defensives ...But They Will Beat Euro Area Defensives ...But They Will Beat Euro Area Defensives Bottom Line: The results of the ECB Strategy Review will force this central bank to remain a laggard and continue to expand its balance sheet well after the expected end of the PEPP program. Eurozone interest rates will also fall behind that of other major economies. The ECB may even consider cutting the interest rate on TLTROs to boost lending. These policies will have a minimal impact on EUR/USD, which will continue to be dominated by the dollar’s fluctuations. However, EUR/GBP, EUR/SEK, and EUR/NOK will suffer. Finally, the SNB will follow the ECB and expand its balance sheet further, which will paradoxically lift Swiss/German spreads. As a result of their defensive nature, Swiss stocks will underperform Euro Area ones over the next 18 months, but they will outperform European defensive equities. Go long Swiss equities relative to European defensives, as a trade uncorrelated to the broad market. Follow China, Not Delta Chart 13 The ECB’s New Groove The ECB’s New Groove In recent days, doubts have grown about the European re-opening trade because of the resurgence of COVID-19 cases. The Delta variant (or any subsequent mutation for that matter) will cause hiccups along the way, but, ultimately, the re-opening will continue to proceed. As a result of the growing rate of vaccination, hospitalizations and deaths remain stable even if new cases are climbing rapidly in many countries (Chart 13). As long as the burden on the healthcare system remains limited, governments will find it difficult to justify further large-scale lockdowns. Instead, measures such as Macron’s Pass Sanitaire will provide increasing, widespread incentives for greater vaccination. Despite this sanguine take on the Delta variant, we remain concerned for the near-term outlook for cyclical equities because of the Chinese economy, even after the recent 50bps cut in the Reserve Requirement Ratio. BCA’s China Investment Strategy service believes that the RRR cut does not signal the beginning of a policy easing cycle.  More evidence would be needed, such as additional RRR cuts, rising excess reserves, or supportive policies for the infrastructure and real estate sectors. For now, we heed the message from PBoC official Sun Guofeng that “the RRR cut is a standard liquidity operation.” Chart 14Fade The RRR Cut Fade The RRR Cut Fade The RRR Cut The dominant force for the Chinese economy remains the previous deterioration in the credit impulse, which suggests that Q3 and Q4 growth will decelerate materially (Chart 14, top panel). Moreover, the softening impulse is consistent with weaker global economic activity, as approximated by our Global Nowcast (Chart 14, middle panel), especially since the lingering effect of the past RRR increases is still consistent with a global deceleration (Chart 14, bottom panel). In this context, we continue to hedge our long-term preference for cyclical stocks because of the near-term risks created by China and the excessively rapid move in the cyclical-to-defensives ratio (Chart 15). In response to this pause in the reflation trade, we continue to favor a long telecom/short consumer discretionary tactical position, which is supported by valuations and RoE differentials, as well as the still extended relative momentum (Chart 16). The period of risk to the global reflation trade should also allow the dollar to remain firm in the near-term, which means that for the coming months, the euro will not go beyond its trading range in place since the beginning of the year. Chart 15Cyclicals Remain Tactically Vulnerable Cyclicals Remain Tactically Vulnerable Cyclicals Remain Tactically Vulnerable Chart 16Stay Long Telecom / Short Consumer Discretionary Stay Long Telecom / Short Consumer Discretionary Stay Long Telecom / Short Consumer Discretionary Bottom Line: China’s RRR cut is not yet enough to bet against the temporary pause in the global reflation trade. Thus, investors should continue to hedge pro-cyclical long-term bets in their portfolios via a long telecom / short consumer discretionary position. An Exciting Chart A chart caught our eye this week: The underperformance of Eurozone momentum stocks relative to growth stocks is massively overdone (Chart 17). For now, we only want to highlight the phenomenon, but, in the coming weeks, we will delve deeper into the topic to gauge if these oversold conditions constitute an attractive opportunity. Chart 17Washed Out Moment Washed Out Moment Washed Out Moment   Mathieu Savary, Chief European Investment Strategist Mathieu@bcaresearch.com   Currency Performance The ECB’s New Groove The ECB’s New Groove Fixed Income Performance Government Bonds The ECB’s New Groove The ECB’s New Groove Corporate Bonds The ECB’s New Groove The ECB’s New Groove Equity Performance Major Stock Indices The ECB’s New Groove The ECB’s New Groove Geographic Performance The ECB’s New Groove The ECB’s New Groove Sector Performance The ECB’s New Groove The ECB’s New Groove

Highlights The dollar smile theory was valid around the COVID-19 crisis but does not stand the test of time. A more useful framework for determining the long-term trend in the dollar is observing global business cycle dynamics. The 2000s experience could provide a useful roadmap for the dollar this coming decade. We remain dollar bears over a 9-to-12-month horizon, although the dollar could stage a short-lived rally in the interim. Feature The “dollar smile” theory1 is the premise that the dollar tends to rise when the US economy is either too strong or too weak. Only in the precise environment, when the US economy is neither too hot nor too cold would you experience a dollar decline (Chart I-1). Chart I-1The Dollar Smile Theory The Dollar Smile Theory The Dollar Smile Theory This theory particularly resonates with traders and financial speculators as each handle of the smile can be explained by economic theory. For example, when the US economy is running hot, this usually prompts the Federal Reserve to hike interest rates. This supports the dollar. When the US economy is entering a recession, this is generally accompanied by a flight to safety. Inflows into safe-haven US bonds and defensive sectors of the stock market would also tend to boost the dollar. The fact that the dollar can rise in these polarizing set of circumstances makes a long dollar view particularly attractive as the default position. The key questions therefore for investors are: First, how does this theory hold up in terms of evidence? and, second, how should FX portfolios be positioned in the current environment? The Evidence During the height of the COVID-19 crisis, the smile theory certainly proved correct. Chart I-2 shows that the DXY index tended to rise approximately 58% of the time when the S&P 500 was either up by 2% or down by 2%. However, when the sample size is broadened, even to a few years, the theory falls apart. From 2010-2020, the DXY index rose only 37% of the time when the S&P 500 was up 2%, while it rose almost 50% of the time when the S&P 500 was down 2% (Chart I-3). Meanwhile, this sample size is particularly biased since during that period, the dollar was in a bull market, and the US economy was quite strong. Chart I-2The Dollar Smile Around The 2020 Pandemic The Dollar Smile Theory The Dollar Smile Theory Chart I-3The Dollar Smile Around Full Business Cycles The Dollar Smile Theory The Dollar Smile Theory Chart I-4US Industrial Production And The Dollar: No Correlation The Dollar Smile Theory The Dollar Smile Theory In economic terms, we get a similar picture. The relationship between US industrial production and the greenback is weak at best, with little evidence of a smile (Chart I-4). For example, there was no discernable trend in the dollar when US industrial production was between 0-5%, or even 5-10%. Admittedly, the dollar does rise when US manufacturing is in recession. A More Useful Framework Chart I-5US Relative Growth And The Dollar: Linear Correlation The Dollar Smile Theory The Dollar Smile Theory While the dollar is a complex variable, explaining its longer-term trend boils down to two simple rules of thumb: Is the global economy recovering or contracting? And if so, is the US leading or lagging this recovery? Chart I-5 shows that the dollar tends to rise when US economic activity is picking up relative to the world, but tends to fall otherwise, albeit with a few outliers. Meanwhile, one of the reasons the US dollar has done well during recessions is that the US economy generally has had more shallow recessions than other advanced economies in recent years. Through this lens, the US performs comparatively better during global downturns (Chart I-6). Going forward, the IMF predicts that non-US growth should fare better than growth in the US over the next few years. We side with the IMF: The global economic recovery will remain intact and will rotate from the US to other economies. Chart I-6US Growth Usually Outperforms During Recessions The Dollar Smile Theory The Dollar Smile Theory Chart I-7Spectacular Recovery In Vaccinations Outside The US Spectacular Recovery In Vaccinations Outside The US Spectacular Recovery In Vaccinations Outside The US The primary rationale is that most G10 countries lagged the US in their vaccination campaigns in 2020 and earlier this year. That is starting to change now, as vaccinations in the rest of the G10 are ramping up (Chart I-7). Meanwhile, vaccinations are proving effective against death and hospitalizations for the Delta variant of the COVID-19 virus. A turnaround in the vaccination campaign would not only boost public opinion about the COVID-19 response but would also be a welcome fillip to much subdued consumer and business sentiment outside the US. Taking a step back, there is a strong case to be made that cyclically, both eurozone and Japanese growth could surprise to the upside due to pent-up demand. For the eurozone, the debt crisis from 2010-2012 was a severe blow to the recovery. In Japan, rolling crises from the Fukushima disaster in 2011 to the consumption tax hikes both in 2014 and 2019 were growth handicaps. Chinese monetary tightening in 2015 caused a sharp manufacturing recession that was a severe blow to non-US economies, including Japan and the eurozone. This time around, coordinated monetary and fiscal stimulus could allow for a few years of a genuine growth recovery. In a nutshell, the dollar smile that occurred around the pandemic last year was due to the uncertainty about the future path of growth, while the US was leading the world in both monetary and fiscal stimulus. The US also led in the vaccination campaign. As other economies adopt this template, the smile should fade, as has empirically been the case over time. Echoes From The 2000s The 2000s experience could provide a useful roadmap for the dollar in this coming decade (Chart I-8). US growth was underperforming the rest of the world during that time. The primary driver was a commodity boom driven by massive infrastructure spending in China. This time around, a concerted push towards green energy will sustain bull markets in metals such as copper, nickel, cobalt, aluminum, and silver, benefiting the economies of producer countries (Chart I-9). Leaders in building renewable energy infrastructure, such as Europe, could also see a boom as demand for their goods and services rise. Chart I-8A Roadmap For The Dollar In The Next Decade A Roadmap For The Dollar In The Next Decade A Roadmap For The Dollar In The Next Decade Chart I-9At The Cusp Of A New Commodity Super Cycle? At The Cusp Of A New Commodity Super Cycle? At The Cusp Of A New Commodity Super Cycle? The aftermath of the tech bubble bust created extremely easy policy settings for the US. The Federal Reserve cut interest rates to a low of 1% in 2003. Meanwhile, fiscal policy was much more accommodative than what was needed to close the output gap. The combination led to a massive expansion in the US twin deficits, a similar situation to today (Chart I-10). Chart I-10A 2000s Roadmap A 2000s Roadmap A 2000s Roadmap Chart I-11Real Yields: Now Versus Then Real Yields: Now Versus Then Real Yields: Now Versus Then Excess demand in the US started to create inflationary pressures, with headline inflation consistently between 2-4% from 2000-2008. Real rates in the US cratered, which hurt the dollar. This time around, inflation is rising fastest in the US (even if it is transitory). Meanwhile, The Fed is the only central bank that has an asymmetric inflation target. Other central banks (such as the Reserve Bank of New Zealand, the Bank of Canada or Norges Bank) have stated they will normalize policy, even though they also view their inflation as transitory. So real rates are and will be rising faster outside the US (Chart I-11). In short, most of the conditions that have usually characterized a dollar bear market for a decade or so are in place today. The Federal Reserve is committed to staying easy, US real rates are depressed, and growth should be stronger outside the US compared to within it, a similar template to what we saw in the 2000s. From A Dollar Shortage To An Avalanche The dollar smile theory works particularly well when there is a shortage of dollars, like in 2020. The lack of dollar liquidity was a tailwind behind the dollar bull market during the last decade. Today, the Fed’s balance sheet is still expanding, and the massive liquidity injection from quantitative easing has tremendously improved the global supply of dollars. One measure of global dollar liquidity is the sum of the Federal Reserve’s custody holdings together with the US monetary base. Every time this measure has severely contracted in the past, the shortage of dollars has exacerbated a blow-up somewhere, typically among other countries running twin deficits (Chart I-12). For example, since the global financial crisis, a deceleration in this measure coincided with the European debt crisis, the China slowdown, and more recently, the COVID-19 crisis, with steep depreciation in many procyclical currencies and a vicious rally in the dollar. Chart I-12An Explosion In The US Monetary Base An Explosion In The US Monetary Base An Explosion In The US Monetary Base Fast forward to today and it is difficult to imagine such a scenario playing out over the next 9-12 months. The Fed has swap lines with many foreign developed and emerging market central banks that can draw on dollar liquidity until the end of this year. These lines are likely to be extended if the economic environment deteriorates before year-end. Meanwhile, the lack of uptake from these lines suggests foreign central banks are flush with dollars (Chart I-13). The Federal Reserve’s custody holdings also argue that there is little shortage of dollars internationally, compared to 2008 or 2020 (Chart I-14). With the US current account deficit widening, outflows of US dollars will continue to keep global dollar liquidity flush. Chart I-13Swap Lines Are Not Being Tapped Swap Lines Are Not Being Tapped Swap Lines Are Not Being Tapped Chart I-14Custody Holdings Are Picking Up Custody Holdings Are Picking Up Custody Holdings Are Picking Up Cross-currency basis swaps are well contained, suggesting no US dollar funding pressures abroad. Chart I-15Rising Non-USD Debt Rising Non-USD Debt Rising Non-USD Debt It is important to note that euro- and yen-denominated debt are also expanding (Chart I-15). These are smaller in outstanding amounts than US-denominated debt but reflect the gradual shift in the allocation of currencies away from dollars. In a nutshell, the system is awash with both dollars and other international reserve currencies, limiting the negative feedback loop that dollar shortages have usually triggered. Concluding Thoughts We made the case last week that the dollar is experiencing a countertrend bounce, likely to continue over the next month or so. Beyond that, however, the dollar should depreciate towards the end of the year into next year. Meanwhile, our analysis suggests the dollar smile theory works best near recessions when the US economy is likely to outperform and the safe-haven status of US Treasuries is likely to buffet the greenback. Outside of these periods which represent only 5% of the last four decades, the dollar smile theory falls apart.    Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com   Currencies US Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2   There were a few strong data releases out of the US: Inflation continues to inflect higher in the US. Headline CPI came out at 5.4% versus expectations of 4.9% in June. Core came in at 4.5% versus expectations of 4.0%. The PPI report was equally robust, with core prices rising well above expectations to the tune of 5.6%. The NFIB small business optimism survey jumped from 99.6 to 102.5. Empire manufacturing data for July was 43 versus 17.4 the prior month. The US dollar DXY index is up 0.4% this week. The big data release was the increase in US inflation but relative calm in bond markets seems to cement the view that financial participants consider it transitory. There is still scope for the US dollar to work off oversold conditions, but our bias is that it will be lower in the next 9-12 months.   Report Links: Arbitrating Between Dollar Bulls And Bears - March 19, 2021 The Dollar Bull Case Will Soon Fade - March 5, 2021 Are Rising Bond Yields Bullish For The Dollar? - February 19, 2021 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2   There was scant data out of the eurozone this week: The Bloomberg GDP survey showed that both Q2 and Q3 GDP growth were revised higher. 2022 growth was also revised higher from 4.2% to 4.3%. In the same survey, there was no change expected in policy rates in the foreseeable future. CPI across eurozone countries was in line with expectations: 2.5% in Spain, 2.1% in Germany and 1.9% in France for the month of June. Over the weekend, in a Bloomberg interview, Christine Lagarde told us to expect a significant update to the eurozone’s monetary policy and forward guidance in the July 22 meeting. Our bias is that given the new symmetric inflation target, PEPP will be rolled over into a new program, revised asset purchases will be announced to accommodate for climate change, and possibly more forward guidance that gives us a window into when the ECB will exit negative rates. Report Links: Relative Growth, The Euro, And The Loonie - April 16, 2021 The Euro Dance: One Step Back, Two Steps Forward - April 2, 2021 On Japanese Inflation And The Yen - January 29, 2021 The Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2   There was some positive news out of Japan this week: Core machine orders rose 12.2% year on year in May, versus an expectation of a 6.3% increase. PPI came in at 5% year on year in June, in line with expectations. Machine tool orders rose 97% year on year in June. Importantly, domestic orders grew faster. The yen was down 0.14% against the dollar this week, after a stellar performance last week. The yen continues to sit in a sweet spot among G10 currencies. Falling nominal yields elsewhere are increasing the appeal of yen cash in real terms. Meanwhile, there is the upshot of cyclical improvement in Japan, which will benefit inflows into yen assets.   Report Links: The Case For Japan - June 11, 2021 The Dollar Bull Case Will Soon Fade - March 5, 2021 On Japanese Inflation And The Yen - January 29, 2021 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2   There was significant data out of the UK this week: The 3-month-on-3-month GDP release for May came in at 3.6%, below expectations. Industrial production growth for May was 20.6% year on year, below the 27.5% increase in April. The trade deficit improved from GBP 11bn to GBP 8.5bn. CPI was above target in June, with core at 2.3% and the RPI at 3.9%. The house price index rose 10% year on year in May. Employment increased 25K in May, which disappointed expectations of a 91K increase. The pound rose 0.5% against the US dollar this week. The market reacted positively to the upside surprise in inflation, suggesting the BoE might normalize policy sooner than expected.   Report Links: Why Are UK Interest Rates Still So Low? - March 10, 2021 Portfolio And Model Review - February 5, 2021 Thoughts On The British Pound - December 18, 2020   Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2   There were a few important data releases out of Australia this week: NAB business conditions deteriorated. The conditions component fell from 37 to 24 in June, while the confidence component fell from 20 to 11. Westpac consumer confidence rose slightly to 108.8 from 107.2 in July. The employment report was better than expected. There were 29.1K jobs added in June, pushing the unemployment rate down to 4.9%. The mix was also great with 51.6K full-time jobs added versus a loss of 22.5K part-time jobs. The AUD was up 0.13% this week against the USD. Melbourne has joined Sydney in the lockdown, and so there is room for economic data to keep disappointing over the next few weeks. In hindsight, the RBA’s decisively dovish bias relative to other central banks seemed to be the appropriate strategy. In the end, if the COVID-19 crisis proves transient, it will create a coiled spring response for the AUD. Report Links: The Dollar Bull Case Will Soon Fade - March 5, 2021 Portfolio And Model Review - February 5, 2021 Australia: Regime Change For Bond Yields & The Currency? - January 20, 2021 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2   The was scant data out of New Zealand this week: REINZ house prices rose 6.2% year on year in June. Net migration for May was 1182 versus 1087 the prior month. The NZD was up 60bps versus the US dollar this week. While the RBNZ kept interest rates at 0.25%, it signaled QE will end on July 23, a full year ahead of schedule. Markets are now priced for a rate hike as early as August. Our long CHF/NZD position was offside in this environment. Our conviction on this trade has fallen given the hawkish shift from the RBNZ, but we recommend holding onto this trade, as a reset in global asset prices could increase currency volatility and hurt the pair. Report Links: How High Can The Kiwi Rise? - April 30, 2021 Portfolio And Model Review - February 5, 2021 Currencies And The Value-Versus-Growth Debate - July 10, 2020 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2   Data out of Canada this week has been robust: The employment report was stellar. 231K new jobs were added in June. The unemployment rate fell from 8.2% to 7.8%. The participation rate also increased from 64.6% to 65.2%. The BoC kept interest rates on hold at 0.25% but cut its weekly asset purchases from C$3 billion to C$2 billion. The Bloomberg Nanos Confidence index held steady at 66.4. The CAD fell by 0.2% this week and was flat on the announcement. The loonie has softened since the bottom in the DXY index, as overbought conditions are being worked off. There was no new information out of the recent BoC meeting – the central bank is on pace to start lifting rates ahead of the Fed as long as Canada approaches full employment and inflation remains above target. This will limit downside on the CAD. Report Links: Relative Growth, The Euro, And The Loonie - April 16, 2021 Will The Canadian Recovery Lead Or Lag The Global Cycle? - February 12, 2021 The Outlook For The Canadian Dollar - October 9, 2020 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2   The was scant data out of Switzerland this week: Producer prices rose by 2.9% year on year in June. Total sight deposits were unchanged at CHF 712 bn for the week of July 9. The Swiss franc was down 0.3% this week, after a nice run-up last week. Falling yields will continue to improve the relative appeal of the franc, like the yen. The franc will also benefit from safe-haven inflows if equity markets correct. We are long the CHF/NZD cross on this basis and are sticking with this recommendation. Report Links: An Update On The Swiss Franc - April 9, 2021 Portfolio And Model Review - February 5, 2021 The Dollar Conundrum And Protection - November 6, 2020 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2   Data out of Norway is improving: June CPI came in at 2.9% as expected. Underlying CPI was also 1.4%. PPI came in at 37.1% year on year in June, driven by high oil prices. The trade balance improved from NOK 15.5bn to NOK 25bn in June. The NOK was down by 1.7% this week against the dollar. We have a limit-buy on the Scandinavian currencies at -1.4% from current levels, on expectation that the sell-off is short lived. Report Links: The Norwegian Method - June 4, 2021 Portfolio And Model Review - February 5, 2021 Revisiting Our High-Conviction Trades - September 11, 2020   Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2   Recent data from Sweden have been somewhat soft: Headline CPI fell from 1.8% in May to 1.3% in June. The core measure also fell from 2.1% to 1.6% but was better than expectations. The core core measure came in at 0.9% as expected. The SEK was the weakest G10 currency this week, falling by 0.7%. A disappointment in Swedish inflation is a surprise, given the inflationary overshoots we are seeing elsewhere. As Sweden is a small, open economy, inflation there will pick up (via imported inflation), which will lift expectations that the Riksbank will normalize policy. Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 Sweden Beyond The Pandemic: Poised To Re-leverage - March 19, 2020   Footnotes 1The theory was proposed by Stephen Jen, a former IMF economist and now a hedge fund manager at Eurizon SLJ Capital in London. Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights It is too early to conclude that the PBoC’s surprise rate cut last Friday to its reserve requirement ratio (RRR) marks the beginning of another policy easing cycle.  Historically it took more than a single RRR reduction to lower interest rates and to boost credit growth. Overall economic conditions do not yet suggest that Chinese policymakers will initiate a broad-based policy easing to spur demand. The end-of-July Politburo meeting will shed more light on whether there is a decisive turn in China’s overall policy stance. In previous cycles, consecutive RRR cuts led to bond market rallies, but were not good leading indicators for equities, which have been more closely correlated with cyclical swings in credit and business cycle. We recommend patience. Chinese onshore stocks are richly valued and their prices can still correct in Q3 when corporate profits and economic growth slow further. Feature The speed and magnitude of the PBoC’s 50-basis point trim in its RRR rate last week exceeded market expectations. The RRR rate drop, combined with June’s better-than-expected credit data, sparked speculation that China’s macroeconomic policy had shifted to an easier mode. A single RRR cut does not indicate that another policy easing cycle is underway. Rather, the PBoC’s intention is to prevent rising demand for liquidity in 2H21 from significantly pushing up interest rates. In addition, we do not expect that the credit impulse will decisively turn around until later this year. We will remain alert to any signs of additional policy easing, particularly because policymakers will face more pressure to maintain trend growth next year. The July Politburo meeting may provide more information on the direction of Chinese macro policy going forward. Meanwhile, investors should stay the course. In previous cycles there were long lags between the first RRR cut and sustained rallies in China’s onshore stock markets. We will continue to maintain an underweight stance towards Chinese stocks through the next three months, given that economic data and corporate profits will likely weaken further in Q3. Surprise, Surprise! The PBoC lowered the RRR rate only two days after the State Council mentioned the possibility, which exceeded the consensus. Historically, the PBoC has always made more than one RRR reduction during easing cycles, separated by about three months. Are more RRR cuts pending and does the initial decrease mark the beginning of another policy easing cycle? It is too early to conclude that a broad-based easing cycle has started, for the following reasons: First, economic fundamentals do not suggest an urgent need for policy easing. The economy is softening, but it is softening from a very elevated level (Chart 1). Importantly, production is weakening at a faster pace than demand and partially due to COVID-related idiosyncrasies. This supply-side issue cannot be solved by monetary easing.  For example, the production subcomponent of the manufacturing PMI fell in June while new orders increased (Chart 2). Since its trough in April last year, the gap between new orders and production has consistently narrowed for 11 of the past 15 months, highlighting that the demand-side recovery has been outpacing the supply-side. The recent resurgence in COVID-19 cases and local lockdowns in Guangdong province, which is China’s manufacturing and export powerhouse, may have curbed June’s manufacturing production and new export orders. Global supply shortages in raw materials and chips also add to the sluggishness in manufacturing production. Chart 1Chinese Economy Is Slowing, But Not Too Slow Chinese Economy Is Slowing, But Not Too Slow Chinese Economy Is Slowing, But Not Too Slow Chart 2Demand Not As Soft Compared With Production Demand Not As Soft Compared With Production Demand Not As Soft Compared With Production Similarly, China’s service PMI slipped notably in June and has closely tracked the country’s domestic COVID-19 situation. The decline is an issue that policy easing and boosting demand will not solve (Chart 3). Secondly, global supply chains are still impaired and commodity prices remain elevated. Even though China’s PPI on a year-over-year basis rolled over in June, it is at its highest level since 2008 (Chart 4). As such, spurring demand through monetary easing would only exacerbate inflationary pressures among producers. Chart 3Slow Recovery In Services Largely Due To Lingering COVID Effects Slow Recovery In Services Largely Due To Lingering COVID Effects Slow Recovery In Services Largely Due To Lingering COVID Effects Chart 4Producer Prices Remain Elevated Producer Prices Remain Elevated Producer Prices Remain Elevated Apart from COVID-related disruptions, the weakness in China’s economy this year has been driven by slower growth in infrastructure and real estate investment due to tightened regulatory oversights that were put in place late last year (Chart 5). Construction PMI declined sharply from its peak in March and both excavator sales and loader sales have plummeted since Q1 this year (Chart 5, bottom panel). However, regulatory tightening towards the housing market and infrastructure projects remain firmly in place, suggesting that policymakers are not looking to stimulate the old economy sectors to support growth. Lastly, despite weaker home sales, housing prices in tier-one cities continue to escalate (Chart 6). The rising prices will keep authorities vigilant about excessive liquidity in the market.    Chart 5It Has Been Chinese Policymakers' Intention To Slow The 'Old Economy' Sectors It Has Been Chinese Policymakers' Intention To Slow The 'Old Economy' Sectors It Has Been Chinese Policymakers' Intention To Slow The 'Old Economy' Sectors Chart 6Housing Market Mania Remains Authorities' Pressure Point Housing Market Mania Remains Authorities' Pressure Point Housing Market Mania Remains Authorities' Pressure Point Bottom Line: Supply-demand dynamics in the global economy and China’s domestic inflationary pressures suggest that it is premature to assume that the RRR cut marks the beginning of another policy easing cycle.  Why Now? Chart 7More 'Pain' Needed For Broad Easing More 'Pain' Needed For Broad Easing More 'Pain' Needed For Broad Easing The drop in the RRR highlights the PBoC’s determination to maintain a low interest-rate environment without any further easing, and does not indicate that the central bank has shifted its current policy setting framework. The PBoC has been reactive rather than proactive in the past as it typically waits for severe signs of economic weakness before broadly relaxing its policy (Chart 7). The PBoC cited two main reasons for the RRR cut. One is to ease liquidity pressures of small to medium enterprises (SMEs), which have been struggling with rising input prices and subdued output prices (Chart 8). This motive is consistent with the PBoC’s monetary position so far this year –the central bank has kept rates at historical low levels while scaling back credit creation (Chart 9).   Chart 8SMEs Under Elevated Pricing Stress SMEs Under Elevated Pricing Stress SMEs Under Elevated Pricing Stress Chart 9The PBoC Has Kept Rates At Historic Low Levels The PBoC Has Kept Rates At Historic Low Levels The PBoC Has Kept Rates At Historic Low Levels Demand for liquidity will rise meaningfully in the second half of the year due to an acceleration in local government bond issuance and the large number of expiring medium-term lending facility (MLF) loans and bonds. The liquidity gap could significantly push up interbank and market-based interest rates without the central bank’s intervention. The amount of maturing MLF and government bonds could be more than RMB1 trillion in July. Thus, the 50bp RRR cut, which the PBoC indicates will free up about RMB1 trillion of liquidity to the banking system, will ensure that interest rates remain stable. Chart 10Bank Lending Rates Have Not Declined With Policy Rates Bank Lending Rates Have Not Declined With Policy Rates Bank Lending Rates Have Not Declined With Policy Rates The PBoC also stated that it intends to keep down financing costs for both banks and SMEs. The statement is vague, but the PBoC may mean it plans to guide bank lending rates lower for SMEs and, at the same time, provide banks (particularly smaller banks) with enough liquidity to encourage lending to those enterprises. To achieve this goal, a broad-based RRR cut would be more effective than other monetary policy tools, such as open-market operations or MLF injections, which normally benefit large commercial banks more than their smaller counterparts. While interbank rates have been sliding since Q4 last year, the weighted average lending rates moved sideways and even ticked up slightly this year (Chart 10). As of Q1 2021, more than half of bank loans charged higher interest rates than the loan prime rate (LPR), highlighting a distribution matrix unfavorable to SMEs (Chart 11). Loan demand from SMEs, as shown in the PBoC survey, peaked much earlier and tumbled more rapidly than their large peers (Chart 12). Chart 11SMEs Face Rising Input And Funding Costs China’s Monetary Policy: Easy, But Not Easing China’s Monetary Policy: Easy, But Not Easing Chart 12Waning SMEs' Demand For Bank Credit Waning SMEs' Demand For Bank Credit Waning SMEs' Demand For Bank Credit Lowering lending rates for SMEs is usually at the cost of the banks by bearing higher default risks and lower profits. A RRR reduction, coupled with recent changes in banks’ deposit rate pricing mechanisms,1 are measures that can potentially reduce the banks’ liability costs. Bottom Line: The PBoC is using a RRR cut to avoid a sudden jump in interest rates from their low levels in 1H21, and to reduce funding costs for the SMEs and banks. What About Credit Growth? Chart 13Credit Numbers In June Beat Market Expectations Credit Numbers In June Beat Market Expectations Credit Numbers In June Beat Market Expectations Credit numbers beat the market’s expectations in June. Both credit growth and impulse rose slightly after a fast deceleration in much of 1H21 (Chart 13). We continue to expect the credit impulse to hover at a low level throughout Q3. Local government bond issuance will pick up in 2H21, but the acceleration will not necessarily lead to a reversal in credit growth (Chart 14). On a year-over-year basis, high base during Q3 last year will depress credit growth and impulse in the next three months. Moreover, in the past couple years, on average local government bonds account for only about 18% of annual total social financing. As such, the pace of bank loan expansion would need to substantially accelerate to reverse the slowdown in credit growth in the next three months. In previous cycles, on average it took more than one RRR cut and about two quarters for credit growth to turn around (Chart 15). Therefore, even if monetary policy is on an easing path, we expect credit growth to pick up in Q4 at the earliest. Chart 14LG Bonds Only A Small Part Of Total Credit Creation China’s Monetary Policy: Easy, But Not Easing China’s Monetary Policy: Easy, But Not Easing Chart 15Credit Growth Lags RRR Cuts By About Two Quarters Credit Growth Lags RRR Cuts By About Two Quarters Credit Growth Lags RRR Cuts By About Two Quarters Furthermore, policymakers are unlikely to deviate from targeting credit growth in line with nominal GDP this year. Based on our estimate, the target suggests that the overall credit impulse relative to 2020 will be negative this year (Chart 16). Chart 16Negative Credit Impulse In 2021 Relative To 2020 Negative Credit Impulse In 2021 Relative To 2020 Negative Credit Impulse In 2021 Relative To 2020 Chart 17The Credit Structure, Rather Than Volume, Will Improve In 2H21 The Credit Structure, Rather Than Volume, Will Improve In 2H21 The Credit Structure, Rather Than Volume, Will Improve In 2H21   Meanwhile, we think that the PBoC will focus on improving the structure of credit creation by continuing to encourage medium- to long-term lending, while scaling back shadow banking and short-term loans (Chart 17). Corporate bond financing improved slightly in June. However, room for further improvement in corporate bond issuance is small this year, given tightened financing reglations on local government financing vehicles. Downside potential for corporate bond yields is also limited in 2H21, when the economy slows and corporate bond default risks are rising (Chart 18).  Given elevated housing prices and tightened regulations to contain the property sector’s leverage, bank lending to real estate developers and mortgages will continue to trend down in the foreseeable future, regardless the direction of interest rates (Chart 19). Chart 18Limited Upsides For Corporate Bond Issuance In 2H21 Limited Upsides For Corporate Bond Issuance In 2H21 Limited Upsides For Corporate Bond Issuance In 2H21 Chart 19Bank Loans To Property Market Unlikely To Pick Up In 2H21 Bank Loans To Property Market Unlikely To Pick Up In 2H21 Bank Loans To Property Market Unlikely To Pick Up In 2H21 Bottom Line: Regardless changes in monetary policy, credit growth will not decisively bottom until later this year. Investment Implications Chart 20Chinese Stock Prices Failed To Break Out Chinese Stock Prices Failed To Break Out Chinese Stock Prices Failed To Break Out Chinese stocks in both onshore and offshore equity markets failed to reverse their trend of underperformance relative to global stocks (Chart 20). Investors should be patient in upgrading their allocation to Chinese stocks from underweight to overweight, in both absolute terms and within a global equity portfolio.  Historically, there has been a long lag between an initial RRR trim and a trough in Chinese onshore stock prices (Chart 21). Although prices moved up along with RRR cut announcements in the past, the price upticks were short lived. Stock prices in previous cycles troughed when the credit impulse and/or the economy bottomed. Given our view that a single RRR decrease does not indicate a broad-based policy easing and the credit impulse is unlikely to pick up until later this year, investors should wait for more price setbacks in Q3 before favoring Chinese stocks again.  Chart 21Long Lags Between First RRR Cut And Stock Market Troughs Long Lags Between First RRR Cut And Stock Market Troughs Long Lags Between First RRR Cut And Stock Market Troughs We are slightly more optimistic than last month about Chinese bonds because the RRR cut has reduced the possibility for any substantial rise in interest rates in 2H21. However, we maintain a cautious view on Chinese government and corporate bonds in Q3. In previous cycles, onshore bond yields often fluctuated sideways or even climbed a bit following the first RRR reduction. It often took several RRR drops, more policy easing signals and sure signs of economic weakening for the bond market to enter a tradable bull run (Chart 22). Therefore, we recommend investors stay on the sidelines for a better entry price point. Chart 22It Takes More Than One RRR Cut To Start A Bond Market Bull Run It Takes More Than One RRR Cut To Start A Bond Market Bull Run It Takes More Than One RRR Cut To Start A Bond Market Bull Run It is also unrealistic to expect the RRR cut will lead to significant and sustained devaluation in the RMB relative to the US dollar. We expect the dollar index to rebound somewhat in Q3 on the back of positive US employment data surprises which will push US bond yields higher. However, following previous RRR cuts, the RMB had sizeable depreciations only when geopolitical events (the US-China trade war in 2018/19) or drastic central bank intervention (the August 2015 de-pegging from the USD) coincided with the RRR cuts. These scenarios are not likely to play out in the next six months (Chart 23). As such, we maintain our view that the CNY will slightly weaken against the USD in Q3 but will end the year at around 6.4. Chart 23Expect Muted And Short-Lived Movements In The USDCNY From A Single RRR Cut Expect Muted And Short-Lived Movements In The USDCNY From A Single RRR Cut Expect Muted And Short-Lived Movements In The USDCNY From A Single RRR Cut   Jing Sima China Strategist jings@bcaresearch.com Qingyun Xu, CFA Associate Editor qingyunx@bcaresearch.com   Footnotes 1The reform changes the way banks calculate and offer deposit rates. The upper limit is set on their deposit interest rates by adding basis points to the central bank’s benchmark deposit rates, rather than multiplying the benchmark rates by a specific number. Exclusive: Banks Prepare to Lower Deposit Rates as Rate Cap Reform Takes Effect (caixinglobal.com) Cyclical Investment Stance Equity Sector Recommendations

Feature Since the end of the first quarter, the decline in Treasury yields has been the most important trend in global financial markets. It has contributed to the return of the outperformance of growth stocks relative to value stocks, the underperformance of Eurozone equities relative to the S&P 500, and the tepid results of cyclicals relative to defensive equities. This decline in yields is a temporary phenomenon, because the global economy continues to re-open and inventory levels remain so low that further restocking is in the cards. The cyclical picture is not without blemish; COVID-19 variants remain a concern. However, if these risks were to materialize into another delayed re-opening, then further reflationary efforts by both monetary and fiscal authorities would buoy financial markets. The greatest near-term worry for the global economy and markets comes from China. The Chinese credit impulse is slowing markedly and fiscal support has yet to come to the rescue. This phenomenon is the main reason why this publication maintains a cautious tactical stance on Eurozone cyclical stocks, even if we believe these sectors have ample scope to outperform over the remainder of the business cycle. As a corollary, we believe that yields will likely remain within range this summer and Eurozone benchmarks will lag behind the US. This week, we review key charts, organized by theme, highlighting some of these key concepts. As an aside, none covers inflation. Even if the balance of evidence suggests that any sharp increase in Eurozone inflation will be temporary, the proof will only become more visible by early 2022. The Opening Is On Track… The pace of vaccination across the major Eurozone economies has picked up meaningfully since the spring. Consequently, the number of doses distributed per capita is rapidly approaching that of the US, even as it still lags behind that of the UK (Chart 1). As a result of this improvement, the stringency of lockdown measures is declining, which is allowing European mobility to recover (Chart 2). While this phenomenon is evident around the world, EM still lag in terms of vaccination rates. However, the Global Health Innovation Center at Duke University expects 10 billion vaccine doses to be produced by the year’s end, which will be enough to inoculate most (if not all) the vulnerable people in the world by early 2022. Consequently, the re-opening of the economy will remain a potent tailwind behind global growth for three or four more quarters. Chart 1Vaccination Progress... Vaccination Progress... Vaccination Progress... Chart 2...Leads To Greater Activity ...Leads To Greater Activity ...Leads To Greater Activity   … But Near-Term Headwinds Remain The re-opening of the global economy will allow growth to stay well above trend for the upcoming 12 months, at least. Global industrial activity could nonetheless decelerate this summer. Input costs have risen. The two most important ones, oil and interest rates, are already consistent with a peak in the US ISM manufacturing and the global PMI (Chart 3). In this context, the decelerating Chinese credit impulse is concerning (Chart 4) because it portends a hit to global trade and industrial activity. The effect of this slowdown should be most evident in the third and fourth quarters of 2021. However, it will be temporary because Beijing only wants credit to grow in line with GDP, rather than an outright deleveraging. Thus, the credit impulse will stabilize before the year’s end, which will allow the positive effect of the global re-opening to be fully experienced once again. Chart 3Rising Input Costs... Rising Input Costs... Rising Input Costs... Chart 4...And China's Credit Slowdown Matter ...And China's Credit Slowdown Matter ...And China's Credit Slowdown Matter   Domestic Tailwind In Europe Despite the extreme sensitivity of the European economy to the global business cycle, Europe should continue to produce positive surprises. The supports to the domestic economy are strong. The NGEU funds means that Europe will suffer one of the smallest fiscal drag among G-10 nations next year. Moreover, the re-opening will support household income and allow the positive effect of the increase in the money supply to buoy consumption (Chart 5). Finally, rising consumer confidence, and the ebbing propensity to save will reinforce the tailwinds behind consumption (Chart 6). Chart 5Europe's Domestic Activity Europe's Domestic Activity Europe's Domestic Activity Chart 6...Will Improve Further ...Will Improve Further ...Will Improve Further   Higher Bond Yields Are Coming… The environment continues to support higher yields. Our BCA Pipeline Inflation Indicator is surging, which historically translates into higher global borrowing costs (Chart 7). Most importantly, our Nominal Cyclical Spending Proxy remains very robust, which normally leads to rising yields (Chart 8). While US inflation expectations at the short end of the curve already fully reflect current inflationary pressures, the 5-year/5-year forward inflation breakeven rates will have additional upside. Moreover, the term premium and real rates remain depressed, and policy normalization will cause these variables to climb higher over time. Chart 7Higher Yields Will Come... Higher Yields Will Come... Higher Yields Will Come... Chart 8...Later This Year ...Later This Year ...Later This Year   … But Not This Summer It could take some time before the bearish backdrop for bonds results in higher bond yields. First, bonds have yet to purge fully their oversold status created by the 125 basis-point surge that took place between August 2020 and March 2021 (Chart 9). This vulnerability is even more salient in an environment in which the Chinese credit impulse is decelerating. As Chart 10 illustrates, a slowing total social financing number reliably leads to bond rallies. While the chart looks dire for bond bears, it must be placed in context, in which global fiscal policy remains accommodative considering the decline in the private sector savings rate and in which Advanced Economies’ capex will stay strong. Thus, instead of betting on a large swoon in yields in the coming quarters, we expect US yields to remain stuck between 1.20% and 1.70% for a few more months before they resume their upward path once the Chinese economy stabilizes. Chart 9But Bonds Are Still Oversold... But Bonds Are Still Oversold... But Bonds Are Still Oversold... Chart 10...And Fundamentals Cap Yields For Now ...And Fundamentals Cap Yields For Now ...And Fundamentals Cap Yields For Now   A Positive Cyclical Backdrop For The Euro The near-term forces suggest that the euro will remain range bound over the summer, between 1.16 and 1.23. EUR/USD is a pro-cyclical pair, and so the near-term lack of upside to global growth will act as a temporary ceiling on this currency. Nonetheless, the 18-month outlook continues to favor the common currency. Investors have shed Eurozone exposure for more than 10 years and are structurally underweight this region (Chart 11). Hence, EUR/USD should benefit from any positive reassessment of the growth path in the Euro Area compared to that of the US. Additionally, the euro benefits from a structural current account surplus compared to the USD, which translates into a positive basic balance of payments (Chart 12). In an environment in which US real interest rates are low in relation to foreign ones and in which the Fed wants to maintain accommodative monetary conditions to achieve maximum employment, the capital account balance is unlikely to come to the rescue of the dollar. In this context, EUR/USD still possesses significant cyclical upside and is likely to move back above 1.30 by the year’s end of 2022. Chart 11Investors Underweight Eurozone Assets... Investors Underweight Eurozone Assets... Investors Underweight Eurozone Assets... Chart 12...And The BoP Favors The Euro ...And The BoP Favors The Euro ...And The BoP Favors The Euro   The Bull Market In Global Stocks Is Not Over The cyclical outlook for equities remains supportive. To begin with, in most years, equities eke out positive returns, as long as a recession is not around the corner; we do not expect a recession anytime soon. Moreover, while the balance of valuation risk and monetary accommodation is not as supportive of stocks as it was last year, it is not pointing to an imminent deep pullback either (Chart 13). The equity risk premium echoes this message. Our ERP measure adjusts for the expected growth rate of earnings as well as the lack of stationarity of the ERP. According to this indicator, equities are not an urgent buy, but they are not at risk of a bear market either (Chart 14). This combination does not prevent corrections, but it suggests that pullbacks of 10% are to be bought. Chart 13Equities Are Not A Screaming Buy... Equities Are Not A Screaming Buy... Equities Are Not A Screaming Buy... Chart 14...Nor A Screaming Sell ...Nor A Screaming Sell ...Nor A Screaming Sell   Europe’s Structural Underperformance Is Intact… Eurozone stocks have been underperforming their US counterparts since the GFC. As Chart 15 highlights, this subpar performance reflects the decline in European EPS relative to US ones. There is very little case to be made for this underperformance to end on a structural basis. Europe remains saddled with an excessive capital stock and ageing assets. This combination is weighing on European profit margins and RoE (Chart 16). To put an end to this structural underperformance, either European firms will have to consolidate within each industry (allowing cuts to the excess capital stock, to increase concentration, and to boost profit margins) or the regulatory burden must rise in the US to curtail rates of returns in relation to European levels. Chart 15Europe's Underperformance... Europe's Underperformance... Europe's Underperformance... Chart 16...Reflects Profitability Problems ...Reflects Profitability Problems ...Reflects Profitability Problems   …But The Window For A Cyclical Outperformance Remains Open Despite a challenging structural backdrop, European equities have a window to outperform US stocks, similar to the outperformance of Japan from 1999 to 2006, which only marked a pause within a prolonged relative bear market. European stocks beat their US counterparts when global yields rise (Chart 17). This is because European benchmarks underweight growth stocks relative to US markets. The effect of higher yields on the relative performance of the Euro Area is not limited to the impact of higher discount rates. Yields rise when global economic activity is above trend. As Chart 18 highlights, robust readings of our Global Growth Indicator correlate with an outperformance of the EPS of value stocks compared to growth equities. Thus, when rates rise, Europe should enjoy both a period of re-rating relative to the US and stronger profits. Chart 17Yields Drive European Stocks... Yields Drive European Stocks... Yields Drive European Stocks... Chart 18...And So Does Global Growth ...And So Does Global Growth ...And So Does Global Growth   Positives For Euro Area Financials Like the broad European market, the financials’ fluctuations are linked to interest rates. Moreover, Euro Area banks also move in line with EUR/USD (Chart 19). As a result, our positive view on both yields and the euro for the next 18 months or so should translate into an outperformance of financials in Europe. Additionally, European banks are inexpensive, embedding not just depressed long-term growth expectations, but also a wide risk premium. Europe’s structural problems mean that investors are correct to expect poor earnings growth from the region’s banks. However, the risk premium is overdone. Eurozone banks are much safer than they were 10 years ago. Banks now sport significantly higher Tier 1 capital adequacy ratios and NPLs have shrunk considerably (Chart 20). Moreover, governmental supports and credit guarantees implemented during the pandemic should limit the upside to NPL in the coming quarters. Finally, the so-called doom-loop that used to bind government and bank solvency together is not as problematic as it once was, because the ECB is a willing buyer of government paper and the NGEU programs create the embryo of fiscal risk sharing that limit these dynamics. As a result, investors should overweight this sector for the next 18 months. Chart 19Financials Have A Window To Shine... Financials Have A Window To Shine... Financials Have A Window To Shine... Chart 20...And Are Less Risky ...And Are Less Risky ...And Are Less Risky   A Tactical Hedge Our worries about the impact on the global economy of the Chinese credit slowdown are likely to prompt some downside in European cyclical equities relative to defensive ones. Moreover, cyclicals are still significantly overbought relative to defensives, while our relative Combined Mechanical Valuation Indicator confirms the near-term threat (Chart 21). A high-octane vehicle to play this tactical underperformance of cyclicals relative to defensives is to buy Euro Area telecom stocks relative to consumer discretionary equities. Not only are the discretionary stocks massively overbought and expensive relative to telecoms (Chart 22), they also offer a lower RoE. This backdrop makes the short discretionary / long telecoms bet a great hedge for portfolios with a pro-cyclical bias over one- to two-year horizons.  Chart 21Cyclicals Are Tactically Vulnerable... Cyclicals Are Tactically Vulnerable... Cyclicals Are Tactically Vulnerable... Chart 22...But This Risk Can Be Hedged Away ...But This Risk Can Be Hedged Away ...But This Risk Can Be Hedged Away   Currency Performance Currency Performance Summer Charts Summer Charts Fixed Income Performance Government Bonds Summer Charts Summer Charts Corporate Bonds Summer Charts Summer Charts Equity Performance Major Stock Indices Summer Charts Summer Charts Geographic Performance Summer Charts Summer Charts Sector Performance Summer Charts Summer Charts  

Highlights Our sense remains that the dollar is undergoing a countertrend bounce, rather than entering a new bull market. The litmus test for this view is if the DXY fails to break above the 93-94 level that marked the March highs. Stay short USD/JPY. The drop in global bond yields should give this trade a welcome fillip. Short GBP/JPY positions also make sense. We are long CHF/NZD as a play on a potential increase in currency volatility. Look to rebuy a basket of Scandinavian currencies versus the USD and EUR at a trigger point of -2% from today’s levels. Remain long silver both in absolute terms and relative to gold. Our limit buy on EUR/USD was triggered at 1.18. Place tight stops given the potential for the dollar rally to continue for the next few weeks. We also believe the change in the ECB’s framework portends another bullish tailwind for the euro beyond the near term. Feature In our webcast last week, we made the case that the recent FOMC meeting (perceived as hawkish by market participants) has not altered the longer-term downtrend in the US dollar. This week, we are revisiting some of the sentiment and technical indicators that could help gauge how high the dollar can rise in the interim. Our view remains that three fundamental forces will continue to dictate currency market trends into the year end and beyond. First, the Federal Reserve will lag other central banks in raising rates amidst a shift in economic momentum from the US towards the rest of the world. This will boost short-term interest rates outside the US and provide a floor for procyclical currencies. Second, US inflation will prove stickier compared to other countries such as the eurozone or Japan. This will depress real interest rates in the US relative to the rest of the world, and curb bond inflows. And finally, an equity market rotation towards non-US stocks will improve flows into cyclical currencies. The transition could prove volatile in the coming month or so. Equity markets remain overbought, bond yields are falling, PMIs have stopped rising, and cyclical stocks are lagging growth stocks. More widespread infection from the Delta variant of Covid-19 will continue to reprice risk to the downside. As a countercyclical currency, the dollar will be a critical variable to watch. Sentiment and technical indicators make up an important component of our currency framework and are usually good at gauging significant shifts in financial markets. Our sense remains that the dollar is undergoing a countertrend bounce, rather than entering a new bull market. The litmus test for this view is if the DXY fails to break above the 93-94 level that marked the March highs. Momentum Indicators Our momentum indicators suggest that while the dollar is very oversold, the bear market remains very much intact. The dollar advance/decline line is sitting below its 200-day moving average (Chart I-1). Historically, bull markets in the dollar have been characterized by our advance/decline line breaking both above its 200-day and 400-day moving averages. This suggests a rally towards these critical resistance levels is in play but will constitute more of a countertrend bounce. Speculators are only neutral the dollar while, admittedly, leveraged funds are very short (Chart I-2). Historically, whenever the percentage of leveraged funds that are short the dollar has dipped near 40%, a meaningful rally has ensued. There are two important offsets to this. First, as Chart I-1 suggests, the dollar is a momentum currency. As such, during the bull market of the last decade, speculators were either neutral or long the dollar. If indeed the paradigm has shifted to a decade-long bear market, we expect speculators to be either short or neutral. Meanwhile, leveraged funds are a small subset of overall open interest, suggesting they are not the elephant in the room when it comes to dictating dollar movements. Leveraged funds were short the dollar during most of the bull market run last decade. Chart I-1The US Dollar Downtrend Is Intact The US Dollar Downtrend Is Intact The US Dollar Downtrend Is Intact Chart I-2Leveraged Funds Are Short The Dollar Leveraged Funds Are Short The Dollar Leveraged Funds Are Short The Dollar Carry trades are relapsing anew, suggesting the environment may be becoming unfavorable for high-yielding developed and emerging market currencies. The dollar has been negatively correlated with the Deutsche Bank carry ETF, DBV, since investors ultimately dump carry trades and fly to the safety of Treasurys on any market turbulence (Chart I-3). High-beta carry currencies such as the RUB, ZAR, MXN, and BRL have been consolidating recent gains. These currencies are usually good at sniffing out a change in the investment landscape, specifically one becoming precarious for carry trades. Our carry index tends to do well when the yield spread between US Treasuries and the indexes’ constituents’ is low. As such, there is some more adjustment underway, but one of limited amplitude (Chart I-4). Chart I-3The Carry Trade Rally Is Relapsing The Carry Trade Rally Is Relapsing The Carry Trade Rally Is Relapsing Chart I-4Carry Trades Have Hit An Air Pocket Carry Trades Have Hit An Air Pocket Carry Trades Have Hit An Air Pocket Chart I-5Currency Volatility Is Very Low Currency Volatility Is Very Low Currency Volatility Is Very Low Both expected and actual currency volatility are extremely depressed. Whenever currency volatility has been this low, the dollar has staged a meaningful rally. For example, the most significant episodes were the lows of 1996-1997, 2007-2008, and 2014-2015, and early 2020 (Chart I-5). Usually, low currency volatility is a sign of complacency, while higher volatility allows for a more balanced and healthy market rotation. The nature in which currency volatility adjusts higher this time around might be the same playbook as in previous episodes. The Asian crisis of the late 90s set the stage for the dollar bear market of the 2000s. The adjustment higher in the dollar during the Global Financial crisis jumpstarted the bull market the following decade. This time around, the Covid-19 crisis might have commenced a renewed dollar bear market. If this analogy is correct, then we should be selling the dollar on strength rather than buying on weakness. It is important to remember that the policy environment remains bearish for the dollar. These include deeply negative real rates, quantitative easing (which, admittedly, will soon end), generous liquidity swap lines to assuage any dollar funding pressures abroad (Chart I-6), and a global economy on the cusp of a renewed cycle. In our portfolio, we are long CHF/NZD since this cross has historically been a good hedge against rising currency volatility (Chart I-7). So is being short AUD/JPY. Being short the GBP/JPY cross might prove even more profitable, given that the UK has been a pandemic winner this year. Chart I-6The Fed Extended Its Swap Lines The Fed Extended Its Swap Lines The Fed Extended Its Swap Lines Chart I-7Buy CHF/NZD As Insurance Buy CHF/NZD As Insurance Buy CHF/NZD As Insurance Bottom Line: The message from our momentum indicators is that the bounce in the dollar was to be expected. We remain in the camp that believes the rally will be short-lived but are opportunistically playing what could be a more volatile environment. Equity Markets Signals A potential catalyst that could trigger further upside in the dollar is an equity market correction. Both the dollar and equities tend to be inversely correlated (Chart I-8). On this front, a few equity market indicators continue to flag that the rally in the dollar has a bit further to go.  Chart I-8The Dollar And Equities Move Opposite Ways The Dollar And Equities Move Opposite Ways The Dollar And Equities Move Opposite Ways Chart I-9Global Industrials Are Relapsing Anew Global Industrials Are Relapsing Anew Global Industrials Are Relapsing Anew The underperformance of cyclical stocks, especially global industrials, suggests equity markets could be entering a more volatile phase (Chart I-9). The dollar tends to strengthen when cyclical stocks are underperforming defensive ones. This is because non-US equity markets have a much higher concentration of cyclical stocks in their bourses. In more general terms, non-US markets are underperforming the US, a clear sign that the marginal dollar is rotating back towards the US (Chart I-10A and I-10B). Technology stocks have also been well bid in recent weeks, on the back of lower bond yields. These are all temporary headwinds for dollar weakness. Chart I-10ANon-US Stock Markets Are Underperforming Non-US Stock Markets Are Underperforming Non-US Stock Markets Are Underperforming Chart I-10BNon-US Stock Markets Are Underperforming Non-US Stock Markets Are Underperforming Non-US Stock Markets Are Underperforming Chart I-11US Relative Earnings Revisions Are High, But Rolling Over US Relative Earnings Revisions Are High, But Rolling Over US Relative Earnings Revisions Are High, But Rolling Over Earnings revisions continue to head higher across most markets, but US profit expectations are still higher compared to other countries (Chart I-11). Non-US bourses will need much higher earnings revisions to stimulate portfolio inflows, and for the dollar bear market to resume. On this front, both the euro area and emerging markets are showing only tentative improvement. The character of any selloff in equity markets will be worth monitoring. Cyclicals and value stocks are at historically bombed-out levels and could start to outperform high-flying stocks on any market reset.    Bottom Line: Whether a correction ensues, or the bull market continues, requires a change in equity market leadership from defensives to cyclicals. This is a necessary condition for the dollar bear market to resume. Commodities, Bonds, And The Dollar Commodity and bond prices give important cues about the health of the global economy. For example, rising copper prices and rising yields are a sign that industrial activity is humming, which in turn points to accelerating global growth. As a counter-cyclical currency, the dollar usually weakens in this scenario. Rising gold prices are generally a sign that policy settings remain ultra-accommodative, which also points to a weaker dollar. At the FX strategy service, we tend to focus more on the internal dynamics of commodity and bond markets, which can provide early warning signs. Chart I-12The Copper-To-Gold Ratio Is Consolidating Gains The Copper-To-Gold Ratio Is Consolidating Gains The Copper-To-Gold Ratio Is Consolidating Gains The copper-to-gold ratio is important since it indicates whether the liquidity-to-growth transmission mechanism is working. A rising ratio suggests policy settings are stimulating growth, while a falling ratio is a warning shot that the environment might be becoming deflationary. Correspondingly, this ratio has tended to track the dollar closely (Chart I-12). The copper-to-gold ratio is consolidating at very high levels. This is consistent with a healthy reset, rather than a reversal in the dollar bear market. The gold/silver ratio (GSR) tends to track the US dollar, and its recent price action also appears to be a welcome reset (Chart I-13). Like copper, silver benefits from rising industrial demand, especially in the electronics and renewable energy space. A falling GSR will be a sign that the manufacturing cycle is still humming. We are short the GSR with a target of 50, and a stop-loss at 71. The bond-to-gold ratio has bounced from very oversold levels. Both US Treasurys and gold are safe-haven assets and thus are competing assets. Remarkably, the ratio of the total return in US government bonds-to-gold prices has tracked the dollar pretty well since the end of the Bretton Woods system in the early ‘70s (Chart I-14). Gold has always been considered the perfect anti-fiat asset vis-à-vis the dollar, making the bond-to-gold ratio both a good short-term and long-term sentiment indicator. For now, the bounce in the ratio is not yet worrisome. We have noticed that inflows into US government bonds have risen sharply, while those into gold are falling. This should soon reverse with the fall in US rates, and the correction in gold prices. Chart I-13The Gold-To-Silver Ratio Is Consolidating Losses The Gold-To-Silver Ratio Is Consolidating Losses The Gold-To-Silver Ratio Is Consolidating Losses Chart I-14Competing Assets And The Dollar Competing Assets And The Dollar Competing Assets And The Dollar Bottom Line: The US is ultimately generating the most inflation in the G10, which is dampening real rates, and should curtail investor enthusiasm for gold relative to US Treasurys. The underperformance of Treasurys relative to gold will be a bearish development for the dollar. A Final Word On The Euro The strategic review from the European Central Bank had three key changes. The ECB now has a symmetric 2% inflation target. This is not a game changer, since it brings it in line with other global central banks, including the Bank of Japan. House prices will meaningfully begin to impact monetary policy, as the committee eventually includes owner’s equivalent rent (OER) in the HICP index (the ECB’s preferred inflation measure) for the euro area. This could be a game changer for the ECB’s price objective. Climate change was reiterated as important for price stability. Financial stability was also repeated as an important objective. As FX strategists, the second change was the most important. Shelter constitutes 17.7% of the euro area CPI basket, but it is 32.9% of the US CPI basket (Table I-1). Meanwhile, the shelter component of both the CPI basket in the US and euro area have tracked each other (Chart I-15). Table I-1Euro Area CPI Weights An Update On Dollar Sentiment And Technical Indicators An Update On Dollar Sentiment And Technical Indicators Chart I-15What Will Happen To Eurozone Inflation? What Will Happen To Eurozone Inflation? What Will Happen To Eurozone Inflation?   An adjustment in the weight of the shelter component in the euro area will boost the European CPI relative to the US and could trigger a major policy shift from the ECB in the coming years. This will especially be the in case if the current environment generates an inflationary shock. Bottom Line: The ECB will stay very accommodative in the next 1-2 years, but the change in its mandate could portend a bullish tailwind for the euro beyond the near term. Investment Implications We expect the current dollar rebound to be short-lived. As such, our strategy is as follows: Stay long other safe-haven currencies. Our preferred vehicle is the Japanese yen, which sports an attractive real rate relative to the US. Investors can also short GBP/JPY from current levels. Chart I-16The Euro, Yen And Real Rates The Euro, Yen And Real Rates The Euro, Yen And Real Rates Our limit-buy on EUR/USD was triggered at 1.18. Given our expectation that the dollar could rally in the near term, we are setting the stop-loss at the same level. However, the improvement in real rates in the euro area relative to the US could cushion any downside (Chart I-16). We are also long CHF/NZD, as a bet on rising currency volatility. Correspondingly, we are setting a limit buy on Scandinavian currencies relative to the euro and USD at a trigger level of -2%. Both gold and silver benefit from the current environment, but we prefer silver to gold, due to the former’s call option on continued improvement in global growth. We are short the gold/silver ratio from the 68 level. Overall, we expect the dollar to weaken towards the end of the year, as has been the case since the 1970s (Chart I-17). Chart I-17The Yen And Swiss Franc Are Usually Winners In H2 An Update On Dollar Sentiment And Technical Indicators An Update On Dollar Sentiment And Technical Indicators   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies US Dollar USD Technicals 1 USD Technicals 1 USD Technicals 1 USD Technicals 2 USD Technicals 2 USD Technicals 2 The recent data out of the US have been robust: June non-farm payrolls showed an increase of 850K jobs, versus expectations of a 700K increase. The unemployment rate was relatively flat at 5.9% in June.  Factory orders came in at 1.7% year-on-year in May, in line with expectations. The US dollar DXY index is relatively flat this week, but with tremendous volatility. It was a relatively quiet week in the US, due to Independence Day, but the key theme remained a drop in US yields, with the 10-year yield moving from a high of near 1.8% this year to 1.3% currently. This move has catalyzed rallies in lower beta currencies, such as the yen and Swiss franc. The FOMC minutes released this week continue to suggest a Fed that will remain very patient in both tapering asset purchases and lifting interest rates.   Report Links: Arbitrating Between Dollar Bulls And Bears - March 19, 2021 The Dollar Bull Case Will Soon Fade - March 5, 2021 Are Rising Bond Yields Bullish For The Dollar? - February 19, 2021 The Euro EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data from the euro area were mixed: The PPI print for May came in at 9.6%, in line with expectations. Both the services and composite PMI were revised higher by 0.3 in June. At 59.2, the composite PMI is the highest in over a decade. ZEW expectations for the euro area fell sharply from 81.3 to 61.2. In Germany, there was a big decline in automotive surveys. The euro was flat this week against the dollar, despite gains overnight. The big news was the change in the ECB’s monetary policy objectives, which we discussed briefly in the front section of this report. The euro rallied on the news of three fundamental drivers in our view – real rate differentials are improving in favor of Europe, the ECB’s consideration for house price inflation could allow its price stability objective to be achieved sooner, and consideration for financial stability will be less favorable for negative interest rates.   Report Links: Relative Growth, The Euro, And The Loonie - April 16, 2021 The Euro Dance: One Step Back, Two Steps Forward - April 2, 2021 On Japanese Inflation And The Yen - January 29, 2021   The Yen JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 JPY Technicals 2 JPY Technicals 2 JPY Technicals 2   Recent data from Japan remains subpar, but is improving: Labor cash earnings rose 1.9% in May, in line with expectations. Household spending rose 11.6% in May, in line with expectations. The Eco Watchers Survey for June came in at 47.6 from a May reading of 38.1. The outlook component rose from 47.6 to 52.4. The yen was up by 1.6% against the USD this week, the best performer. We argued a month ago that the yen is the most underappreciated G10 currency today. The catalyst that triggered yen gains were a drop in US real rates, that favored other safe-haven currencies. Going forward, further yen gains should materialize on the back of Japan successfully overcoming the pandemic like its Western counterparts. Report Links: The Case For Japan - June 11, 2021 The Dollar Bull Case Will Soon Fade - March 5, 2021 On Japanese Inflation And The Yen - January 29, 2021   British Pound GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 There was scant data out of the UK this week: The construction PMI rose from 64.2 to 66.3 in June. House prices remain robust, with the RICS house price balance printing an elevated 83% in June. The pound was flat this week against the USD. The new delta variant of the COVID-19 virus is gaining momentum in the UK and will likely erode some of the dividends GBP had priced in from a fast vaccine rollout. As such, short GBP positions may pay off in the near term. Shorting GBP/CHF could be an attractive near-term hedge.   Report Links: Why Are UK Interest Rates Still So Low? - March 10, 2021 Portfolio And Model Review - February 5, 2021 Thoughts On The British Pound - December 18, 2020   Australian Dollar AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 There was scant data out of Australia this week: The Melbourne Institute of Inflation survey came it at 3% year on year in June, from 3.3%. The RBA kept interest rates unchanged at 0.1%, reiterating its commitment to stay accommodative until inflation and wages pick up meaningfully. The AUD was down by 0.4% this week against the USD. The RBA is decisively lagging other central banks in communicating less monetary accommodation in the coming years. This will create a coiled spring response for the AUD, because the RBA will have to eventually play catchup as the global economic cycle gains momentum.   Report Links: The Dollar Bull Case Will Soon Fade - March 5, 2021 Portfolio And Model Review - February 5, 2021 Australia: Regime Change For Bond Yields & The Currency? - January 20, 2021   New Zealand Dollar NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 The was scant data out of New Zealand this week: ANZ commodity price index rose by 0.8% in June. The NZD was down 0.3% against the dollar this week. Our long CHF/NZD position paid off handsomely in this environment. We recommend holding onto this trade, as a reset in global rates hurts the hawkish pricing in the NZD forward curve. Report Links: How High Can The Kiwi Rise? - April 30, 2021 Portfolio And Model Review - February 5, 2021 Currencies And The Value-Versus-Growth Debate - July 10, 2020   Canadian Dollar CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Canadian data softened but remained robust: Building permits fell by 14.8% month on month in May. The Markit manufacturing PMI fell from 57 to 56.5 in June. The Canadian trade balance deteriorated from C$0.6bn to a deficit of -C$1.4bn in May. Business Outlook Survey indicator hit the highest level on record. As the Bank of Canada put it, improving business sentiment is broadening. The CAD fell by 0.8% against USD this week. The results of the BoC survey highlight that a reopening phase is categorically bullish for economic activity in general and financial prices. Until recently, the CAD was one of the best performing currencies in the G10. This is a sea change from a country that was previously a laggard in vaccination efforts. CAD should hold up well once the dollar rally fades, but other currency laggards such as SEK and JPY could do even better.   Report Links: Relative Growth, The Euro, And The Loonie - April 16, 2021 Will The Canadian Recovery Lead Or Lag The Global Cycle? - February 12, 2021 The Outlook For The Canadian Dollar - October 9, 2020 Swiss Franc CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 The was scant data out of Switzerland this week: The unemployment rate was near unchanged at 3.1% in June, from 3.0%. Total sight deposits were unchanged at CHF 712 bn on the week of July 2. The Swiss franc was up by 1.1% this week against the USD. Falling yields improved the relative appeal of the franc that has bombed out interest rates. The franc is also benefiting from the rising bout of volatility as a safe-haven currency. On this basis, we are long CHF/NZD cross, which performed well this week. Report Links: An Update On The Swiss Franc - April 9, 2021 Portfolio And Model Review - February 5, 2021 The Dollar Conundrum And Protection - November 6, 2020   Norwegian Krone NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Data out of Norway is improving: The unemployment rate fell from 3.3% to 2.9% in July. Industrial production growth came in at 2.1% year-on-year in May. Mainland GDP rose by 1.8% month on month in May. The NOK was down by 1.8% this week against the dollar, the worst performing G10 currency. The NOK is bearing the brunt of a reset in the US dollar, but our bias is that we are nearing a buy zone. NOK is cheap, would benefit from high oil prices and the economy is on the mend. We are looking to sell EUR/NOK and USD/NOK on further strength.   Report Links: The Norwegian Method - June 4, 2021 Portfolio And Model Review - February 5, 2021 Revisiting Our High-Conviction Trades - September 11, 2020   Swedish Krona SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data from Sweden have been mildly positive: The Swedbank/Silf composite PMI fell from 70.2 to 66.9 in June. Industrial production came in at 24.4% year on year in May, after a rise of 26.4% in April. Household consumption jumped 8.8% year on year in April. The SEK was also up this week against the USD. Bombed-out interest rates in Sweden have also improved the appeal of the franc, given falling global bond yields. Meanwhile, the SEK remains one of the cheapest currencies in our models.   Report Links: Revisiting Our High-Conviction Trades - September 11, 2020 More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 Sweden Beyond The Pandemic: Poised To Re-leverage - March 19, 2020   Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Three distinct forces are likely to make South Asia’s geopolitical risks increasingly relevant to global investors. First, India’s tensions with China stem from China’s growing foreign policy assertiveness and India’s shift away from traditional neutrality toward aligning with the US and its allies. This creates a security dilemma in South Asia, just as in East Asia. Second, India’s economy is sputtering in the wake of the COVID-19 pandemic, adding fuel to nationalism and populism in advance of a series of important elections. India will stimulate the economy but it could also become more reactive on the international scene. Third, the US is withdrawing from Afghanistan and negotiating a deal with Iran in an effort to reduce the US military presence in the Middle East and South Asia. This will create a scramble for influence across both regions and a power vacuum in Afghanistan that is highly likely to yield negative surprises for India and its neighbors. Traditionally geopolitical risks in South Asia have a limited impact on markets. India’s growth slowdown and forthcoming fiscal stimulus are more relevant for investors. However, a sharp rise in geopolitical risk would undermine India’s structural advantages as the West diversifies away from China. Stay short Indian banks. Feature Geopolitical risks in South Asia are slowly but surely rising. India-Pakistan and China-India are well-known “conflict-dyads” or pairings. Historically, these two sets have been fighting each other over their fuzzy Himalayan border with limited global financial market consequences. But now fundamental changes are afoot that are altering the geopolitical setting in the region. Specifically, the coming together of three distinct forces could trigger a significant geopolitical event in South Asia. The three forces are as follow: Force #1: Sino-Indian Tensions Get Real About a year ago, Indian and Chinese troops clashed in Ladakh, a disputed territory in the Kashmir region. Following these clashes China reduced its military presence in the Pangong Tso area but its presence in some neighboring areas remains meaningful. Besides the troop build-up along India’s eastern border, China is building more air combat infrastructure in its India-facing western theatre. China’s major air bases have historically been concentrated in China’s eastern region, away from the Indian border (Map 1). Consequently, India has historically enjoyed an advantage in airpower. But China appears to be working to mitigate this disadvantage. Map 1Most Of China’s Major Aviation Units Are Located Away From India South Asia: A Slowdown And A Showdown South Asia: A Slowdown And A Showdown Owing to China’s increased military focus along the Sino-India border, India’s threat perception of China has undergone a fundamental change in recent years. Notably, India has diverted some of its key army units away from its western Indo-Pak border towards its eastern border with China. India could now have nearly 200,000 troops deployed along its border with China, which would mark a 40% increase from last year.1 Turning attention to the Indo-Pak border, India’s problems with Pakistan appear under control for now. This is owing to the ceasefire agreement that was renewed by the two countries in February 2021. However, this peace cannot possibly be expected to last. This is mainly because core problems between the two countries (like Pakistan’s support of militant proxies and India’s control over Kashmir) remain unaddressed. History too suggests that bouts of peace between the two warring neighbors rarely last long. These bouts usually end abruptly when a terrorist attack takes place in India. With both political turbulence and economic distress in Pakistan rising, the fragile ceasefire between India and Pakistan could be upended over the next six months. In fact, two events over the last week point to the fragility of the ceasefire: Two drones carrying explosives entered an Indian air force station located in Jammu and Kashmir (i.e. a northern territory that India recently reorganized, to Pakistan’s chagrin). Even as no casualties were reported, this attack marks a turning point for terrorist activity in India as this was the first-time terrorists used drones to enter an Indian military base. Hours later, another drone attack struck an Indian base at the Ratnuchak-Kaluchak army station, the site of a major terrorist attack in 2002. Chart 1China, Pakistan And India Cumulatively Added 41 Nuclear Warheads Over 2020 South Asia: A Slowdown And A Showdown South Asia: A Slowdown And A Showdown Given that the ceasefire was agreed recently, any further increase in terrorist activity in India over the next six months would suggest that a more substantial breakdown in relations is nigh. Distinct from these recent tensions, China’s troop deployment along India’s eastern arm and Pakistan’s presence along India’s western arm creates a strategic “pincer” that increasingly threatens India. India is naturally concerned. China and Pakistan are allies who have been working closely on projects including the strategic China-Pakistan Economic Corridor (CPEC). The CPEC is a collection of infrastructure projects in Pakistan that includes the development of a port in Gwadar where a future presence of the People's Liberation Army Navy (PLAN) is envisaged. Gwadar has the potential of providing China land-based access to the Indian Ocean. Trust in the South Asian region is clearly running low. Distinct from troop build-ups and drone-attacks, China, Pakistan, and India cumulatively added more than 40 nuclear warheads over the last year (Chart 1). China is reputed to be engaged in an even larger increase in its nuclear arsenal than the data show.2 From a structural perspective, too, geopolitical risks in the South Asian peninsula are bound to keep rising. When it comes to the conflicting Indo-Pak dyad, India’s geopolitical power has been rising relative to that of Pakistan in the 2000s. However, the geopolitical muscle of the Sino-Pak alliance is much greater than that of India on a standalone basis (Chart 2). Chart 2India Has Aligned With The QUAD To Counter The Sino-Pak Alliance South Asia: A Slowdown And A Showdown South Asia: A Slowdown And A Showdown China’s active involvement in South Asia is responsible for driving India’s increasing desire to abandon its historical foreign policy stance of non-alignment. India’s membership in the Quadrilateral Security Dialogue (also known as the QUAD, whose other members include the US, Japan, and Australia) bears testimony to India’s active effort to develop closer relations with the US and its allies (Chart 2). India’s alignment with the US is deepening China’s and Pakistan’s distrust of India. Conventional and nuclear military deterrence should prevent full-scale war. But the regional balance is increasingly fluid which means geopolitical risks will slowly but surely rise in South Asia over the coming year and years. Force #2: A Growth Slowdown Alongside India’s Loaded Election Calendar The pandemic has hit the economies of South Asia particularly hard. South Asia historically maintained higher real GDP growth rates relative to Emerging Markets (EMs). But in 2021, this region’s growth rate is set to be lower than that of EM peers (Chart 3). History is replete with examples of a rise in economic distress triggering geopolitical events. South Asia is characterized by unusually low per capita incomes (Chart 4) and the latest slowdown could exacerbate the risk of both social unrest and geopolitical incidents materialising. Chart 3South Asian Economies Have Been Hit Hard By The Pandemic South Asia: A Slowdown And A Showdown South Asia: A Slowdown And A Showdown Chart 4South Asia Is Characterized By Very Low Per Capita Incomes South Asia: A Slowdown And A Showdown South Asia: A Slowdown And A Showdown To complicate matters a busy state elections calendar is coming up in India. Elections will be due in seven Indian states in 2022. These states account for about 25% of India’s population. State elections due in 2022 will amount to a high-stakes political battle. During state elections in 2021, the ruling Bharatiya Janata Party (BJP) was the incumbent in only one of the five states. In 2022, the BJP is the incumbent party in most of the states that are due for elections, which means it has the advantage but also has a lot to lose, especially in a post-pandemic environment. Elections kick off in the crucial state of Uttar Pradesh next February. Last time this state faced elections Prime Minister Narendra Modi was willing to go to great lengths to boost his popularity ahead of time. Specifically, he upset the nation with a large-scale and unprecedented de-monetization program. Given the busy state election calendar in 2022, we expect the BJP-led central government to focus on policy actions that can improve its support among Indian voters. Two policies in particular are likely to come through: Fiscal Stimulus Measures To Provide Economic Relief: India has refrained from administering a large post-pandemic stimulus thus far. As per budget estimates, the Indian central government’s total expenditure in FY22 is set to increase only by 1% on a year-on-year basis. But the expenditure-side restraint shown by India’s central government could change. With elections and a pandemic (which has now claimed over 400,000 lives in India), the central government could consider a meaningful increase in spending closer to February 2022. Map 2Northern India Views Pakistan Even More Unfavorably Than Rest Of India South Asia: A Slowdown And A Showdown South Asia: A Slowdown And A Showdown India’s Finance Minister already announced a fiscal stimulus package of $85 billion (amounting to 2.8% of GDP) earlier this week. Whilst this stimulus entails limited fresh spending (amounting to about 0.6% of India’s GDP), we would not be surprised if the government follows it up with more spending closer to February 2022. Assertive Foreign Policy To Ward-Off Unfriendly Neighbors: India’s northern states are known to harbor unfavorable views of Pakistan (Map 2). The roots of this phenomenon can be traced to geography and the bloody civil strife of 1947 that was triggered by the partition of British-ruled India into the two independent dominions of India and Pakistan. Given the north’s unfavorable views of Pakistan and given looming elections, Indian policy makers may be forced to adopt a far more aggressive foreign policy response, to any terrorist strikes from Pakistan or territorial incursions by China. This kind of response was observed most recently ahead of the Indian General Elections in April-May 2019. An Indian military convoy was attacked by a suicide-bomber in early February 2019 and a Pakistan-based terrorist group claimed responsibility. A fortnight later the Indian air force launched unexpected airstrikes across the Line of Control which were then followed by the Pakistan air force conducting air strikes in Jammu and Kashmir. While the next round of Pakistani and Indian general elections is not due until 2023 and 2024, respectively, it is worth noting that of the seven state elections due in India in 2022, four are in the north (Uttar Pradesh, Punjab, Uttarakhand, and Himachal Pradesh). Force #3: Power Vacuum In Afghanistan The final reason to be wary of the South Asian geopolitical dynamic is the change in US policy: both the Iran nuclear deal expected in August and the impending withdrawal from Afghanistan in September. The US public has now elected three presidents on the demand that foreign wars be reduced. In the wake of Trump and populism the political establishment is now responding. Therefore Biden will ultimately implement both the Iran deal and the Afghan withdrawal regardless of delays or hang-ups. But then he will have to do damage control. In the case of Iran, a last-minute flare-up of conflict in the region is likely this summer, as the US, Israel, Saudi Arabia, and Iran underscore their red lines before the US and Iran settle down to a deal. Indeed it is already happening, with recent US attacks against Iran-backed Shia militias in Syria and Iraq. A major incident would push up oil prices, which is negative for India. But the endgame, an Iranian economic opening, is positive for India, since it imports oil and has had close relations with Iran historically. In the case of Afghanistan, the US exit will activate latent terrorist forces. It will also create a scramble for influence over this landlocked country that could lead to negative surprises across the region. The first principle of the peace agreement between the US and Afghanistan states that the latter will make all efforts to ensure that Afghan soil is not used to further terrorist activity. However, the enforceability of such a guarantee is next to impossible. Notably, the US withdrawal from Afghanistan will revive the Taliban’s influence in the region. This poses major risks for India, which has a long history of being targeted by Afghani terrorist groups. The Taliban played a critical role in the release of terrorists into Pakistan following the hijacking of an Indian Airlines flight in 1999. Furthermore, the Haqqani network, which has pledged allegiance to the Taliban, has attacked Indian assets in the past. Any attack on India deriving from the power vacuum in Afghanistan would upset the precarious regional balance. Whilst there are no immediate triggers for Afghani groups to launch a terrorist attack in India, the US withdrawal will trigger a tectonic shift in the region. Negative surprises emanating from Afghanistan should be expected. Investment Conclusions Chart 5Indian Banks Appear To Have Factored In All Positives Indian Banks Appear To Have Factored In All Positives Indian Banks Appear To Have Factored In All Positives We reiterate the need to pare exposure to Indian assets on a tactical basis. India’s growth engine is likely to misfire over the second half of the Indian financial year. Macroeconomic headwinds pose the chief risk for investors, but major geopolitical changes could act as a negative catalyst in the current context. So we urge clients to stay short Indian Banks (Chart 5). Financials account for the lion’s share of India’s benchmark index (26% weight). India could opt for an unexpected expansion in its fiscal deficit soon. Whilst we continue to watch fiscal dynamics closely, we expect the fiscal expansion to materialize closer to February 2022 when India’s most populous state (i.e. Uttar Pradesh) will undergo elections. Over the long run, India’s sense of insecurity will escalate in the context of a more assertive China, stronger Sino-Pakistani ties, and a power vacuum in Afghanistan. For that reason, New Delhi will continue to shed its neutrality and improve relations with the US-led coalition of democratic countries, with an aim to balance China. This process will feed China’s insecurity of being surrounded and contained by a hegemonic American system. This security dilemma is a source of South Asian geopolitical risk that will become more globally relevant over time. China’s conflict with the US and western world should create incentives for India to attract trade and investment. However, its ability to do so will be contingent upon domestic political factors and regional geopolitical factors.   Ritika Mankar, CFA Editor/Strategist ritika.mankar@bcaresearch.com Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Footnotes 1 Sudhi Ranjan Sen, ‘India Shifts 50,000 Troops to China Border in Historic Move’, Bloomberg, June 28, 2021, bloomberg.com. 2 Joby Warrick, “China is building more than 100 missile silos in its western desert, analysts say,” Washington Post, June 30, 2021, washingtonpost.com.

Highlights Gold is – and always will be – exquisitely sensitive to Fed policy and forward guidance, as last month's "Dot Shock" showed (Chart of the Week). Its price will continue to twitch – sometimes violently – as the widening dispersion of views evident in the Fed dots keeps markets on edge and pushes forward rate expectations in different directions. Fed policy is important but will remain secondary to fundamentals in oil markets. Increasingly inelastic supply will force refiners to draw down inventories, which will keep forward curves backwardated. OPEC 2.0's production-management policy is the key driver here, followed closely by shale-oil's capital discipline. Between these market bookends are base metals, which will remain sensitive to Fed policy, but increasingly will be more responsive to tightening supply-demand fundamentals, as the pace of the global renewables and EV buildout challenges supply. The one thing these markets will share going forward is increasing volatility. Gold volatility will remain elevated as markets are forced to parse sometimes-cacophonous Fed forward guidance; oil volatility will increase with steeper backwardation; and base metals volatility will rise as fundamentals continue to tighten. We remain long commodity-index exposure (S&P GSCI and COMT ETF) and equity exposure (PICK ETF). Feature Gold markets still are processing last month's "Dot Shock" – occasioned by the mid-June move of three more Fed bankers' dots into the raise-rates-in-2022 camp at the Fed – and the sometimes-cacophonous forward guidance of post-FOMC meetings accompanying these projections. Following last month's meeting, seven of the 18 central bankers at the June meeting now favor an earlier rate hike. This dot dispersion fuels policy uncertainty. When policy uncertainty is stoked, demand for the USD typically rises, which generally – but not always – contributes to liquidation of dollar-sensitive positions in assets like commodities. This typically leads to higher price volatility.1 This is most apparent in gold, which is and always will be exquisitely sensitive to Fed guidance and the slightest hint of a change in course (or momentum building internally for such a change). This is what markets got immediately after the June meeting. When this guidance reflects a wide dispersion of views inside the Fed, it should come as no surprise that price volatility increases among assets that are most responsive to monetary policy. This dispersion of market expectations – as a matter of course – is intensified by discordant central-bank forward guidance.2 Fundamentals Reduce Oil's Sensitivity To Fed Policy Fed policy will always be important for the evolution of the USD through time, which makes it extremely important for commodities, since the most widely traded commodities are priced in USD. All else equal, an increase in the value of the USD raises the cost of commodities ex-US, and vice versa. Chart of the WeekGold Still Processing Dot Shock Gold Still Processing Dot Shock Gold Still Processing Dot Shock Chart 2Oil Market Remains Tight... Oil Market Remains Tight... Oil Market Remains Tight... The USD's impact is dampened when markets are fundamentally tight – e.g., when the level of demand exceeds supply, as is the case presently for oil (Chart 2).3 When this occurs, refiner inventories have to be drawn down to make up for supply deficits (Chart 3). This leads to a backwardation in the oil forward curves – i.e., prices of prompt-delivery oil are higher than deferred-delivery oil – reflecting the fact that the supply curve is becoming increasingly inelastic (Chart 4). This backwardation benefits OPEC 2.0 member states, as most of them have long-term supply contracts with customers indexed to spot prices, and investors who are long commodity-index exposure, as it is the source of the roll yield for these products.4 Chart 3Forcing Inventories To Draw... Forcing Inventories To Draw... Forcing Inventories To Draw... Chart 4...And Backwardating Forward Curves ...And Backwardating Forward Curves ...And Backwardating Forward Curves Copper's Sensitivity To Fed Policy Declining Supply-demand fundamentals in base metals – particularly in the bellwether copper market – are tightening, which, as the oil market illustrates, will make prices in these markets less sensitive to USD pressures going forward (Chart 5). We expect the copper forward curve to remain backwardated for an extended period (Chart 6), which will distance the evolution of copper prices from Fed policy variables (e.g., interest rates and the USD). Chart 5Copper USD Sensitivity Will Diminish As Balances Tighten Copper USD Sensitivity Will Diminish As Balances Tighten Copper USD Sensitivity Will Diminish As Balances Tighten Chart 6Expect Persistent Backwardation In Copper Expect Persistent Backwardation In Copper Expect Persistent Backwardation In Copper Indeed, our modeling suggests this already is occurring in the metals markets, as can be seen from the resilience of copper prices during 1H21, when China's fiscal and monetary stimulus was waning and, recently, during the USD's recent rally, which was an unexpected headwind generated by the Fed's June meeting. If, as appears likely, China re-engages in fiscal and monetary stimulus in 2H21, the global demand resurgence for metals, copper in particular, will receive an additional fillip. Like oil, copper inventories will have to be drawn down over the next two years to make up for physical deficits, which have been a persistent problem for years (Chart 7). Capex in copper markets has yet to be incentivized by higher prices, which means these physical deficits likely will widen as the world gears up for expanded renewables generation and the grids required to support them, not to mention higher electric vehicle (EV) demand. If, as we expect, copper miners do not invest in new greenfield mine projects – choosing instead to stay with their brownfield expansion strategies – the market will tighten significantly as the world ramps up its demand for renewable energy. This means copper's supply curve will, like oil's, become increasingly inelastic. At the limit – i.e., if new mining capex is not incentivized – price will be forced to allocate limited supply, and may even have to get to the point of destroying demand to accommodate the renewables buildout. Chart 7Supply-Demand Balance Tightening In Copper Supply-Demand Balance Tightening In Copper Supply-Demand Balance Tightening In Copper A Word On Spec Positioning We revisited our modeling of speculative influence on these markets over the past couple of weeks, in anticipation of the volatility we expect and the almost-certain outcry from public officials that will ensue. Our modeling continues to support our earlier work, which found fundamentals are determinant to the evolution of industrial commodity prices. Using Granger-Causality and econometric analysis, we find prices mostly explain spec positioning in oil and copper, and not the other way around.5 We do find spec positioning – via Working's T Index – to be important to the evolution of volatility in WTI crude oil options, along with other key variables (Chart 8).6 That said, other variables are equally important to this evolution, including the St. Louis Fed's Financial Stress Index, EM equity volatility, VIX volatility and USD volatility. These variables are not useful in modeling copper volatility, where it appears fundamental and financial variables are driving the evolution of prices and, by extension, price volatility. We will continue to research this issue, and will continue to subject our results to repeated trials in an attempt to disprove them, as any researcher would do. Chart 8Oil Volatility Drivers Oil Volatility Drivers Oil Volatility Drivers Investment Implications Gold will remain hostage to Fed policy, but oil and base metals increasingly will be charting a path that is independent of policy-related variables, chiefly the USD. There is no escaping the fact that gold volatility will increasingly be in the thrall of US monetary policy – particularly during the next two years as the Fed attempts to guide markets toward something resembling normalization of that policy.7 However, as the events of the most recent FOMC meeting illustrate, gold price volatility will remain elevated as markets are forced to parse oftentimes-cacophonous Fed forward guidance. This would argue in favor of using low-volatility episodes as buying opportunities in gold options – particularly calls, as we continue to expect gold prices to end the year at $2,000/oz. We also favor silver exposure via calls, expecting price to go to $30/oz this year. In oil and base metals, we continue to expect supply-demand fundamentals in these markets to tighten, which predisposes us to favor commodity index products. For this reason, we remain long commodity-index exposure – specifically the S&P GSCI index, which is up 6.8% since inception, and the COMT ETF, which is up 8.7% since inception. We expect the base metals markets to remain very well bid going forward, and remain long equity exposure in these markets via the PICK ETF, which we re-entered after a trailing stop was elected that left us with a 24% gain since inception at the end of last year.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Commodities Round-Up Energy: Bullish US crude oil stocks (ex SPR) fell 6.7mm barrels in the week ended 25 June 2021, according to the US EIA. Total crude and product stocks were down 4.6mm barrels. Domestic crude oil production was unchanged at 11.1mm b/d over the reporting week. Total refined-product demand surpassed the comparable 2019 reporting period, led by higher distillate consumption (4.2mm b/d vs 3.8mm b/d). Gasoline consumption remains a laggard (9.2mm b/d vs 9.5mm b/d), as does jet fuel (1.4mm b/d vs 1.9mm b/d). Propane and propylene demand surged over the period, likely on the back of petchem demand (993k b/d vs 863k b/d). Base Metals: Bullish Base metals prices are moving higher in anticipation of tariffs being imposed by Russia to discourage exports beyond the Eurasian Economic Union, according to argusmedia.com. In addition to export tariffs on copper, aluminum and nickel, steel exports also will face levies to discourage material from leaving the EAEU (Chart 9). The tariffs are expected to remain in place from August through December 2021. Separately, premiums paid for high-quality iron ore in China (65% Fe) reached record highs earlier this week, as steelmakers scramble for supply, according to reuters.com. The premium iron ore traded close to $36/MT over benchmark material (62% Fe) this week. Precious Metals: Bullish Gold prices continue to move lower following the FOMC meeting on June 16. The yellow metal was down 0.6% y-o-y at $1762.80/oz as of Tuesday’s close after being up a little more than 13% y-o-y before the FOMC meeting earlier this month (Chart 10). We believe the USD rally, which, based on earlier research we have done, could be benefitting from safe-haven demand arising from global concern over the so-called Delta variant of COVID-19, which has spread to at least 85 countries. Public-health officials are fearful this could cause a resurgence in COVID-19 cases and additional mutations in the virus if vaccine distribution in EM states is not increased. Ags/Softs: Neutral Widely disparate weather conditions in the US west and east crop regions – drought vs cooler and wetter weather – appear to be on track to produce average crop yields for corn and beans this year, according to agriculture.com's Successful Farming. In regions where hard red spring wheat is grown, states experiencing low rainfall likely will have poor crops this year. Chart 9 "Dot Shock" Continues To Roil Gold; Oil … Not So Much "Dot Shock" Continues To Roil Gold; Oil … Not So Much Chart 10 US Dollar To Keep Gold Prices Well Bid US Dollar To Keep Gold Prices Well Bid   Footnotes 1     We model gold prices as a function of financial variables sensitive to Fed policy – e.g., real rates and the broad trade-weighted USD – and uncertainty, which is conveyed via the Global Economic Policy Uncertainty (GEPU) index published by Baker, Bloom & Davis.  2     Please see Lustenberger, Thomas and Enzo Rossib (2017), "Does Central Bank Transparency and Communication Affect Financial and Macroeconomic Forecasts?" SNB Working Papers, 12/2017. The Swiss central bank researchers find "… the verdict about the frequency of central bank communication is unambiguous. More communication produces forecast errors and increases their dispersion. … Stated differently, a central bank that speaks with a cacophony of voices may, in effect, have no voice at all. Thus, speaking less may be beneficial for central banks that want to raise predictability and homogeneity among financial and macroeconomic forecasts. We provide some evidence that this may be particularly true for central banks whose transparency level is already high." (p. 26) 3    Please see OPEC 2.0 Vs. The Fed, published on February 8, 2018, for additional discussion. 4    Please see The Case For A Strategic Allocation To Commodities As An Asset Class, a Special Report we published on March 11, 2021 on commodity-index investing.  It is available at ces.bcaresearch.com. 5    The one outlier we found was Brent prices, for which non-commercial short positioning does Granger-Cause price.  Otherwise, price was found to Granger-Cause spec positioning on the long and short sides of the market. 6   Please see BCA Research's Commodity & Energy Strategy Weekly Report, "Specs Back Up The Truck For Oil," published on April 26, 2018, in which we introduce Holbrook Working's "T Index," a measure of speculative concentration in futures and options markets. It is available at ces.bcaresearch.com. Briefly, Working's T Index shows how much speculative positioning exceeds the net demand for hedging from commercial participants in the market. 7     Please see How To Re-Shape The Yield Curve Without Really Trying published by our US Bond Strategy group on June 22 for a deeper discussion of the outlook for Fed policy.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Image