New Zealand

Highlights In this Weekly Report, we present our semi-annual chartbook of the BCA Central Bank Monitors. All of the Monitors are now below the zero line, indicating the need for continued easy global monetary policy to help mitigate the COVID-19 recession (Chart of the Week). Central bankers have already responded in an intense and rapid fashion to the crisis, delivering a series of rate cuts, increased asset purchase programs and measures to support bank lending to businesses suffering under quarantines. All of these vehicles have helped trigger a powerful rally in global bond markets that helped revitalize risk assets as well. After the coordinated global easing response of the past few months, the optimal policy choices now differ from country to country. This creates opportunities to benefit from country allocation decisions even in a world of puny government bond yields. The overall signal from our Central Bank Monitors is still bond bullish, however – at least over the next few months until there is evidence of how fast global growth is rebounding from the COVID-19 lockdowns. An Overview Of The BCA Central Bank Monitors Chart of the WeekUltra-Accommodative Monetary Policies Are Still Required Ultra-Accommodative Monetary Policies Are Still Required Ultra-Accommodative Monetary Policies Are Still Required Chart 2A Bond-Bullish Message From Our CB Monitors A Bond-Bullish Message From Our CB Monitors A Bond-Bullish Message From Our CB Monitors The BCA Central Bank Monitors are composite indicators designed to measure the cyclical growth and inflation pressures that can influence future monetary policy decisions. The economic data series used to construct the Monitors are not the same for every country, but the list of indicators generally measure the same things (i.e. manufacturing cycles, domestic demand strength, commodity prices, labor market conditions, exchange rates, etc). The data series are standardized and combined to form the Monitors. Readings above the zero line for each Monitor indicate pressures for central banks to raise interest rates, and vice versa. Through the nexus between growth, inflation, and market expectations of future interest rate changes, the Monitors do exhibit broad correlations to government bond yields in the Developed Markets (Chart 2). All of the Monitors are indicating intense pressure to maintain very easy monetary policies in response to the global COVID-19 recession. While the bad economic and inflation news is largely discounted in the depressed level of bond yields worldwide, there are still opportunities to position country allocations within a government bond portfolio based on the message from our Monitors (overweighting the US, the UK and Canada, underweighting Germany and Japan). All of the Monitors are indicating intense pressure to maintain very easy monetary policies in response to the global COVID-19 recession.  In each BCA Central Bank Monitor Chartbook, we include a new chart for each country that we have not shown previously. In this edition, we show the components of the Monitors, grouped into those focusing on economic growth and inflation, plotted alongside our estimate of the appropriate level of central bank policy interest rates derived using a Taylor Rule. Fed Monitor: Policy Must Stay Accommodative Our Fed Monitor has collapsed below the zero line to recessionary levels (Chart 3A) in response to the coronavirus crisis. The Fed has already delivered a series of aggressive policy responses since March to help support an economy ravaged by the virus, including: interest rate cuts; quantitative easing (QE), including buying corporate and municipal debt; and setting up lending schemes for small businesses. The lockdown of almost the entire country has helped “flatten the curve” of the spread of COVID-19, but at a painful economic cost. The unemployment rate rose to 14.7% in April, the highest level since the Great Depression, and is expected to peak at levels above 20%. The result is unsurprising: a massive increase in spare economic capacity with a threat of deflation as headline CPI inflation plummeted to 0.3% in April (Chart 3B). Chart 3AUS: Fed Monitor US: Fed Monitor US: Fed Monitor Chart 3BUS Realized Inflation Flirting With 0% US Realized Inflation Flirting With 0% US Realized Inflation Flirting With 0% Within the components of our Fed Monitor, weakening growth has been the main driver of the decline (Chart 3C). Our Taylor Rule estimate suggests a deeply negative fed funds rate is “appropriate”, although the Fed is likely to pursue other avenues of easing like yield curve control before ever attempting a sub-0% policy rate. Chart 3CNegative Rates Are 'Required' In The US, But The Fed Has Other Options Negative Rates Are 'Required' In The US, But The Fed Has Other Options Negative Rates Are 'Required' In The US, But The Fed Has Other Options The fall in US Treasury yields over the past few months has been in line with the decline in our Fed Monitor (Chart 3D). While the US economy is slowly awakening from lockdowns, consumer and business confidence are likely to remain fragile given the numerous risks from a second wave of COVID-19, worsening US-China relations and, more recently, social unrest. Thus, we continue to recommend an overweight strategic allocation to the US within global government bond portfolios. The fall in US Treasury yields over the past few months has been in line with the decline in our Fed Monitor Chart 3DTreasury Yields Fully Reflect Pressure For More Fed Easing Treasury Yields Fully Reflect Pressure For More Fed Easing Treasury Yields Fully Reflect Pressure For More Fed Easing BoE Monitor: Negative Rates On The Horizon? Our Bank of England (BoE) Monitor has collapsed to the lowest level in its history on the back of the severe COVID-19 recession (Chart 4A). The BoE already cut the Bank Rate to 0.1% in March, ramped up asset purchases, and introduced a Term Funding scheme to support business lending. Any additional easing from here might entail negative policy rates, which markets are already discounting. The UK unemployment rate is expected to peak around 8%, with the BoE projecting the economy to shrink by -14% this year, which would be the worst recession in modern history. Inflation has dropped sharply on the back of the dual collapse of energy prices and economic growth, ending a period of currency-fueled inflation increases (Chart 4B). Chart 4AUK: BoE Monitor UK: BoE Monitor UK: BoE Monitor Chart 4BUK Realized Inflation Is Slowing Rapidly UK Realized Inflation Is Slowing Rapidly UK Realized Inflation Is Slowing Rapidly The components of our BoE Monitor fully reflect the dire economic situation (Chart 4C), with weak growth – led by sharp falls in business confidence – driving the collapse of the Monitor more than falling inflation pressures. Our Taylor Rule estimate of the policy rate is not yet calling for negative rates, but that is because we are using the New York Fed’s estimate of r* as the neutral real rate, which is a relatively high 1.4% (by comparison, r* in the US is estimated to be 0.5%). Chart 4CNegative Rates Are Not Yet Required In The UK Negative Rates Are Not Yet Required In The UK Negative Rates Are Not Yet Required In The UK The sharp fall in the BoE Monitor suggests that Gilt yields will remain under downward pressure in the coming months (Chart 4D). New BoE Governor Andrew Bailey has stated that a move to negative rates is not imminent, but markets will continue to flirt with the notion of sub-0% interest rates until the economy and inflation stabilize. We maintain an overweight stance on UK Gilts. Chart 4DBoE Monitor Suggests Continued Downward Pressure On Gilt Yields BoE Monitor Suggests Continued Downward Pressure On Gilt Yields BoE Monitor Suggests Continued Downward Pressure On Gilt Yields ECB Monitor: Continued Monetary Support Is Needed Our European Central Bank (ECB) Monitor is now well below the zero line, signaling a strong need for easier monetary policy to fight the COVID-19 downturn (Chart 5A). The ECB has delivered multiple measures to ease monetary conditions, including a new €750bn bond-buying vehicle and liquidity operations to help banks maintain lending to European businesses.​​​​​​​​​​​​​​ The recession has hit the region hard, with real GDP declining by -3.8% in Q1, the sharpest fall since records began in 1995. Unemployment rates have climbed higher, although to much lower levels than seen in the US thanks to more generous government labor support programs that have helped to limit layoffs. The sharp downturn has resulted in both a surge in spare economic capacity and plunge in headline inflation to 0.3% in April (Chart 5B). Chart 5AEuro Area: ECB Monitor Euro Area: ECB Monitor Euro Area: ECB Monitor Chart 5BEurope Is On The Edge Of Deflation Europe Is On The Edge Of Deflation Europe Is On The Edge Of Deflation Within the individual components of our ECB Monitor, both weaker growth and near-0% inflation have both contributed to the Monitor’s decline (Chart 5C). Our Taylor Rule measure shows that the ECB’s current stance of having policy rates modestly below 0% is appropriate. Chart 5CThe ECB Needs To Keep Its Foot On The Monetary Accelerator The ECB Needs To Keep Its Foot On The Monetary Accelerator The ECB Needs To Keep Its Foot On The Monetary Accelerator Despite the ECB’s easing measures, and in contrast to the message from our ECB Monitor, the downward momentum in core European bond yields has been fading (Chart 5D). With the ECB reluctant to push policy rates deeper into negative territory, and with reliable cyclical indicators like the German ZEW and IFO surveys showing signs that euro area growth is starting to recover from the lockdowns, the case for even lower core European yields in the coming months is not strong. We maintain our recommended underweight stance on German and French government bonds. We maintain our recommended underweight stance on German and French government bonds. Chart 5DNo Pressure For Higher German Bund Yields No Pressure For Higher German Bund Yields No Pressure For Higher German Bund Yields BoJ Monitor: What More Can Be Done? Our Bank of Japan (BoJ) Monitor has fallen further below zero, indicating easier policy is required (Chart 6A). The BoJ has already introduced additional easing measures in the past couple of months: extending forward guidance (inflation is projected to remain below the BoJ’s 2% target for the next three years), increasing asset purchases and enhancing loan programs to small and medium sized companies. New cases of COVID-19 have slowed sharply in Japan, prompting an end to the national state of emergency last week. Importantly, the virus did not hit Japan's labor market as severely as in other developed countries. The unemployment rate did reach a two-year high in April, but is still only 2.6% (Chart 6B). Fiscal stimulus and measures to protect job losses have played a major role in preventing a bigger spike in joblessness. Even with those measures, growth remains weak and realized inflation is heading back towards deflation. Chart 6AJapan: BoJ Monitor Japan: BoJ Monitor Japan: BoJ Monitor Chart 6BJapan Nearing Deflation Once Again Japan Nearing Deflation Once Again Japan Nearing Deflation Once Again Looking at the components of our BoJ Monitor, contracting growth, more than weakening inflation pressures, is the bigger driver of the fall in the Monitor below zero (Chart 6C). However, our Taylor Rule estimate does not suggest that the current level of the policy rate is out of line. Chart 6CBoJ Needs More Easing (Somehow) Until The Economy Revives BoJ Needs More Easing (Somehow) Until The Economy Revives BoJ Needs More Easing (Somehow) Until The Economy Revives The BoJ’s current combined policies of negative rates, QE and yield curve control are keeping JGB yields at near-0% levels. Those policies are also suppressing yield volatility and preventing an even bigger fall in JGB yields (with larger capital gains) as suggested by our BoJ Monitor (Chart 6D). We continue to recommend a maximum underweight in Japanese government bonds in a yield-starved world. Chart 6DJGB Yields Will Be Anchored For Some Time JGB Yields Will Be Anchored For Some Time JGB Yields Will Be Anchored For Some Time BoC Monitor: Deflationary Pressures Intensifying Our Bank of Canada (BoC) Monitor has collapsed into “easier policy required” territory, reaching levels last seen during the 2009 recession (Chart 7A). The central bank has already introduced several easing measures to help boost the virus-stricken economy, including cutting the Bank Rate to a mere 0.25% and starting a QE program to buy government bonds for the first time ever. Before the COVID-19 outbreak, some softening of the economy was already underway. Now, after the imposition of nationwide lockdowns to limit the spread of the virus, the unemployment rate has spiked to 13% - a level last seen in the early 1980s. The result is a massive deflationary output gap has opened up (Chart 7B), with realized headline CPI inflation printing at -0.2% in April. Chart 7ACanada: BoC Monitor Canada: BoC Monitor Canada: BoC Monitor Chart 7BOutright Headline CPI Deflation In Canada Outright Headline CPI Deflation In Canada Outright Headline CPI Deflation In Canada The fall in our BoC Monitor has been driven by both collapsing economic growth and weakening inflation pressures (Chart 7C). Our Taylor Rule estimate suggests that one of new BoC Governor Tiff Macklem’s first policy decisions may need to be a move to negative interest rates. Macklem and other BoC officials have not played up the possibility of cutting rates below 0%. However, the fact that the BoC provided no economic growth forecasts in the most recent Monetary Policy Report highlights the extreme uncertainties surrounding the economic impact from COVID-19 – even with the Canadian government providing a large fiscal response to the pandemic. Chart 7CBoC Monitor Plunging Due To High Unemployment & Low Inflation BoC Monitor Plunging Due To High Unemployment & Low Inflation BoC Monitor Plunging Due To High Unemployment & Low Inflation We upgraded our recommended stance on Canadian government debt to overweight back in March, and the collapse of the BoC Monitor suggests continued downward pressure on Canadian yields (Chart 7D). Stay overweight. The collapse of the BoC Monitor suggests continued downward pressure on Canadian yields.  Chart 7DCanadian Yield Momentum In Line With The BoC Monitor Canadian Yield Momentum In Line With The BoC Monitor Canadian Yield Momentum In Line With The BoC Monitor RBA Monitor: Rate Cutting Cycle Is Done Due to a slump in export demand and a weakening housing market, our Reserve Bank of Australia (RBA) monitor has been consistently calling for rate cuts since April 2018 (Chart 8A). Australia began its easing cycle early, having delivered a total of 125bps of stimulus since June 2019, with the two most recent cuts coming directly in response to the COVID-19 crisis. As in other developed markets, the unemployment gap in Australia has widened dramatically, owing to job losses concentrated in tourism, entertainment, and dining out (Chart 8B). Although inflation briefly breached the low end of the RBA’s 2-3% target band in Q1, this will not be a lasting development. The RBA sees headline CPI deflating by -1% year-on-year in Q2/2020 and, even as far as 2022, only sees it growing at 1.5%. Chart 8AAustralia: RBA Monitor Australia: RBA Monitor Australia: RBA Monitor Chart 8BInflation Will Remain Stuck Below RBA 2-3% Target Inflation Will Remain Stuck Below RBA 2-3% Target Inflation Will Remain Stuck Below RBA 2-3% Target Although both the growth and inflation components of our RBA Monitor are below zero, the former drove the most recent decline (Chart 8C) led by consumer confidence almost touching the 2008 lows. The RBA has already responded by cutting rates to near 0%, well below the Taylor Rule implied estimate, and initiating yield curve control with a cap on 3-year government bond yields at 0.25%. Chart 8CNo Pressure For The RBA To Go To Negative Rates No Pressure For The RBA To Go To Negative Rates No Pressure For The RBA To Go To Negative Rates Overall, Australian bond yields have accurately priced in the dovish signal from our RBA Monitor (Chart 8D). With COVID-19 relatively well contained in Australia, there is less pressure on the RBA to ease further. Governor Lowe has also ruled out negative rates, which will put a floor under yields. Owing to these factors, we confidently reiterate our neutral stance on Australian government debt within global fixed income portfolios. Australian bond yields have accurately priced in the dovish signal from our RBA Monitor. Chart 8DAustralian Bond Yields Are Unlikely To Move Much Lower Australian Bond Yields Are Unlikely To Move Much Lower Australian Bond Yields Are Unlikely To Move Much Lower RBNZ Monitor: Cause For Concern After a resurgence late last year, our Reserve Bank of New Zealand (RBNZ) Monitor has declined to a level slightly below zero (Chart 9A). The RBNZ responded to the pandemic by delivering a massive -75bps cut in March, but has since left the policy rate untouched, preferring to deliver further stimulus by doubling the size of its QE program. Forward guidance is signaling that the policy rate will remain at 0.25% until 2021, but the central bank has not ruled out negative rates in the future. ​​​​​​​Although the actual unemployment numbers do not yet capture the impact of the pandemic, both consensus and RBNZ forecasts call for a blowout in the unemployment gap (Chart 9B). The RBNZ expects the steady improvement in inflation seen up to Q1/2020 to be wiped out, with headline CPI projected to remain below the 1-3% target range until mid-2022. Chart 9ANew Zealand: RBNZ Monitor New Zealand: RBNZ Monitor New Zealand: RBNZ Monitor Chart 9BRealized NZ Inflation Was Drifting Higher, Pre-Virus Realized NZ Inflation Was Drifting Higher, Pre-Virus Realized NZ Inflation Was Drifting Higher, Pre-Virus Surprisingly, the inflation component of our RBNZ Monitor is actually calling for tighter monetary policy, owing to significant strength in the housing market (Chart 9C). However, this trend is likely to reverse - the RBNZ foresees a -9% decline in house prices over the remainder of 2020. Meanwhile, growth components such as consumer confidence and employment will remain depressed, holding down our RBNZ monitor. Chart 9CGrowth, Now Inflation, Has Driven The RBNZ Monitor Lower Growth, Now Inflation, Has Driven The RBNZ Monitor Lower Growth, Now Inflation, Has Driven The RBNZ Monitor Lower Overall, the momentum in New Zealand bond yields seems to have overshot the message from our RBNZ Monitor (Chart 9D). However, with so much uncertainty about business investment and cash flows from key sectors such as tourism and education, it is too early to bet on an improvement in yields. We therefore maintain a neutral recommendation on NZ sovereign debt. Chart 9DNZ Bond Yields Are Unlikely To Move Lower NZ Bond Yields Are Unlikely To Move Lower NZ Bond Yields Are Unlikely To Move Lower Riksbank Monitor: Worries For The Coronavirus Mavericks Amid the global pandemic, our Riksbank Monitor has collapsed to all-time lows (Chart 10A). In its April monetary policy decision, the Riksbank opted for continued asset purchases and liquidity measures to support bank lending to companies over a move to negative rates. One of the primary concerns for the Riksbank is headline CPI inflation, which fell into mild deflation (-0.4% year-over-year) in April on the back of lower energy prices and weaker domestic demand (Chart 10B). This could spill over into a lasting decline in long-term inflation expectations if the economy does not quickly improve. Chart 10ASweden: Riksbank Monitor Sweden: Riksbank Monitor Sweden: Riksbank Monitor Chart 10BSwedish Realized Inflation Back To 0% Swedish Realized Inflation Back To 0% Swedish Realized Inflation Back To 0% Both the growth and inflation components of our Riksbank Monitor are calling for further easing, with the growth component now at post-crisis lows (Chart 10C). The collapse on the growth side can be attributed to historic falls in retail confidence, the manufacturing PMI and employment while the inflation component remains depressed due to low headline numbers and inflation expectations. Chart 10CThe Riksbank Hates Negative Rates, But Could Still Need Them If The Economy Worsens The Riksbank Hates Negative Rates, But Could Still Need Them If The Economy Worsens The Riksbank Hates Negative Rates, But Could Still Need Them If The Economy Worsens The sharp downward move in our Riksbank Monitor suggests Swedish bond yields should remain under downward pressure in the coming months (Chart 10D). The key factor for yields will be the effect of the relatively lax measures implemented by Sweden to combat the pandemic. Sweden saw positive GDP growth in Q1/2020 due to fewer restrictions on the economy. However, infection and mortality rates are much higher in Sweden than in neighboring countries and, as a result, Denmark and Norway excluded Sweden from their open border agreement. Continued restrictions of the sort are bearish for growth – and bullish for bonds – in this trade-dependent economy. Chart 10DSwedish Bond Yields Will Remain Under Downward Pressure Swedish Bond Yields Will Remain Under Downward Pressure Swedish Bond Yields Will Remain Under Downward Pressure   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Ray Park, CFA Research Analyst ray@bcaresearch.com ​​​​​​​Shakti Sharma Research Associate ShaktiS@bcaresearch.com Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index BCA Central Bank Monitor Chartbook: Collapse BCA Central Bank Monitor Chartbook: Collapse ​​​​​​​ Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Highlights The pillars of dollar support continue to fall, but the missing catalyst is visibility on the trajectory of global growth. For now, we remain constructive on the DXY short term, but bearish longer term. Market internals and currency technicals have become supportive of pro-cyclical trades in recent days. There is tremendous value in the Norwegian krone, Swedish krona and British pound. Buy a basket of NOK and SEK against a basket of USD and EUR. Feature Markets are getting some semblance of calm after being flooded with vast amounts of monetary and fiscal stimulus. The DXY index, having breached the psychological 100 level, failed to break above 103, and is now in a volatile trading pattern of lower intra-day highs. The message is that the Federal Reserve’s injection of liquidity, along with generous USD swap lines for major central banks, has eased the funding crisis (Chart I-1).1 All eyes will now begin to focus on fiscal support, especially from the US. As we go to press, US leaders have agreed to a $2 trillion fiscal package. As we highlighted last week, a central bank cannot do much about an economy in a liquidity trap, but governments can step in and be spenders of last resort. While fiscal stimulus is a welcome catalyst, the impact on the economy is likely to be felt a bit later. More importantly, until the number of new Covid-19 cases peak, the global economy will remain in shutdown, and visibility on the recovery will be opaque (Chart I-2). This provides an air pocket in which the dollar can make new highs, especially if the slowdown is not of a garden variety, but a deep recession. Chart I-1A Shortage Of Dollars A Shortage Of Dollars A Shortage Of Dollars Chart I-2Some Reason For Optimism Some Reason For Optimism Some Reason For Optimism We continue to monitor the behavior of market internals and currency technicals to gauge a shift in market dynamics. Both liquidity and valuation indicators are USD bearish, but as a momentum currency, the dollar will benefit from any signs we are entering a more protracted slowdown. In this report, we use a simple framework for ranking G10 currencies – the macroeconomic environment, valuation and sentiment. There has been a tectonic shift in currency markets over the last few weeks which has uncovered some very compelling opportunities. This is good news for investors willing to stomach near-term volatility. In short, we like the pound, Swedish krona and Norwegian krone. Are Policy Actions Enough? Chart I-3The Dollar And Interest Rates Diverge The Dollar And Interest Rates Diverge The Dollar And Interest Rates Diverge There has been an unprecedented wave of monetary and fiscal stimulus announced in recent weeks.2 This should eventually backstop economic activity. Below we highlight a few key developments, along with our thoughts. USD: The Fed has cut interest rates to zero and announced unlimited QE. As we go to press, a $2 trillion fiscal package has been passed. This represents a much bigger monetary and fiscal package compared to the 2008 Great Recession. The near-term impact will be to boost aggregate demand, but the massive increase in the supply of dollars should lower the USD exchange rate. As a rule of thumb, lower interest rates in the US have usually been bearish for the currency (Chart I-3). EUR: The European central bank has announced a €750 billion package effectively backstopping the peripheral bond market. The good news is that the structural issues in the periphery are much less pronounced than during the 2010-2011 crisis. This is positive for the euro over the longer term, as cheaper funding should boost capital spending and productivity. GBP: The Bank of England has cut interests to almost zero and expanded QE. Meanwhile, there has been an intergenerational shift in the pound. The lesson from the imbroglio in British politics since 2016 is that cable at 1.20 has been the floor for a “hard Brexit” under normal conditions. This makes the latest selloff an indiscriminate liquidation of the pound. On a real effective exchange rate-basis, the pound is close to two standard deviations below its mean since 1965. On this basis, only two currencies are cheaper: the Norwegian krone and Swedish krona. AUD: The Reserve Bank Of Australia cut interest rates to 25 basis points and has introduced QE. The Aussie is now trading below the lows seen during the Great Financial Crisis. This suggests any shock to Aussie growth will have to be larger than 2008 to nudge the AUD lower. CAD: The Bank Of Canada has cut rates to 75 basis points and introduced a generous fiscal package. More may be needed if the downdraft in oil prices persists beyond the near term. We highlighted a few weeks ago how the landscape was rapidly stepping into one of competitive devaluations.3 We can safely assume that we are already into this zone. One end result of competitive devaluations is that as interest rates converge to zero, relative fundamentals resurface as the key drivers of currency performance. In short, the last few weeks have seen long bond yields converge in the developed world (Chart I-4). That means going forward, picking winners and losers will become as much a structural game as a tactical one. From a bird’s eye view, below are a few key indicators we are monitoring.  Chart I-4The Race To Zero The Race To Zero The Race To Zero G10 Basic Balances Chart I-5CHF, EUR, AUD and NOK Are Supported CHF, EUR, AUD and NOK Are Supported CHF, EUR, AUD and NOK Are Supported The basic balance captures the ebb and flow of demand for a country’s domestic assets. Persistent basic balance surpluses are usually associated with an appreciating currency, and vice versa. This is especially important since the rise in offshore dollar funding has been particularly pernicious for deficit countries. Switzerland sports the best basic balance surplus in the G10 universe, followed by the euro area, Australia and then Norway (Chart I-5). Surpluses imply a constant underlying demand for these currencies - either for domestic goods and services or for investment into portfolio assets. The UK and the US rank the worst in terms of basic balances. As for the UK, the basic balance deficit explains why the recent flight to safety hit the pound particularly hard. Net International Investment Position Both Switzerland and Japan have the largest net international investment positions. These tend to buffet their currencies during crises, since foreign assets are liquidated and the proceeds repatriated home. This is at the root of their status as safe-haven currencies. There has been structural improvement in most G10 net international investment positions, especially compared to the US (Chart I-6). Should the returns on those foreign assets be sufficiently high, this will lead to income receipts for surplus countries, providing an underlying boost for their currency. Chart I-6Structural Increase In G10 NIIP Structural Increase In G10 NIIP Structural Increase In G10 NIIP Interest Rates The race to the zero bound has pushed real interest rates into negative territory for most of the developed world. This has also greatly eroded the yield advantage of the US dollar against its G10 peers (Chart I-7). Within the G10 universe, the commodity currencies (Aussie, kiwi and loonie) have become the high yielders in real terms. This yield advantage should help stem structural depreciation in their currencies. Chart I-7Most Of The G10 Has Negative Real Rates Most Of The G10 Has Negative Real Rates Most Of The G10 Has Negative Real Rates Valuation Models One of our favored valuation models for currencies is the real effective exchange rate. The latest downdraft in most G10 currencies has nudged them between one and two standard deviations below fair value (Chart I-8A and Chart I-8B). According to the BIS measure, the Norwegian krone and Swedish krona are currently the cheapest currencies, with the krone trading at more than three standard deviations below its mean fair value. Chart I-8ASome G10 Currencies Are Very Cheap Some G10 Currencies Are Very Cheap Some G10 Currencies Are Very Cheap Chart I-8BSome G10 Currencies Are Very Cheap Some G10 Currencies Are Very Cheap Some G10 Currencies Are Very Cheap Most importantly, despite the recent rise in the US dollar, it is not yet very expensive. The trade-weighted dollar will need to rise by 8% to bring it one standard deviation above fair value. This was a definitive top in the early 2000s. This rise will also knock the euro lower and push many pro-cyclical currencies into bombed-out levels, making them even more attractive over the long term. Chart I-9NOK and SEK Are Deeply Undervalued NOK and SEK Are Deeply Undervalued NOK and SEK Are Deeply Undervalued Other valuation measures corroborate this view: Our in-house purchasing power parity (PPP) models show the US dollar as only slightly overvalued, by 7%. These models adjust the CPI baskets across countries so as to get closer to an apples-to-apples comparison. The cheapest currencies according to the model are the SEK, NOK, AUD and GBP (Chart I-9). The yen is more attractive than the Swiss franc as a safe-haven currency. Our intermediate-term timing models (ITTM) show the dollar as fairly valued. The main ingredients in these models are real interest rate differentials and a risk factor. On a risk-adjusted return basis, a dynamic hedging strategy based on our ITTMs has outperformed all static hedging strategies for all investors with six different home currencies since 2001. According to these models, the Australian dollar and Norwegian krone are the most attractive currencies, while the Swiss franc is the least attractive. Our long-term FX models are also part of a set of technical tools we use to help us navigate FX markets. Included in these models are variables such as productivity differentials, terms-of-trade, net international investment positions, real rate differentials, and proxies for global risk aversion. These models cover 22 currencies, incorporating both G10 and emerging market FX markets. According to these models, the US dollar is at fair value (mostly against the euro), but the yen, the Norwegian krone and the Swedish krona are quite cheap. In a forthcoming report, we will show how valuation can be used as a tool to enhance excess returns in the currency space. For now, the universal message from our models is that the cheapest currencies are the NOK, SEK, AUD and GBP. Speculative Positioning Chart I-10Speculators Have Been Taking Profits Speculators Have Been Taking Profits Speculators Have Been Taking Profits Our favorite sentiment indicator is speculative positioning. More specifically, positioning is quite useful when it is rolling over from an overbought or oversold extreme. Being long Treasurys and the dollar has been a consensus trade for many years now (Chart I-10). According to CFTC data, this has been expressed mostly through the aussie and kiwi, although our bias is that the Swedish krona and Norwegian krone have been the real victims. The key question is whether the unwinding of dollar long positions we have seen in recent days reflects pure profit-taking, or represents a fundamental shift in the outlook for the greenback. Our bias is the former. Net foreign purchases of Treasurys by private investors have reaccelerated anew. Given the momentum of these purchases tends to be persistent over a six-month horizon, it is too early to conclude that dollar gains are behind us. That said, speculative positioning has also uncovered currencies in which investor biases are lopsided. This includes the Australian and New Zealand dollars. Currency Rankings And Portfolio Tweaks The depth and duration of the economic slowdown remain the primary concern for most investors. Should the world economy see a more protracted slowdown than in 2008, then more gains lie ahead for the greenback. This is on the back of a currency that is not too expensive, relative to history. That said, there have been a few currencies that have been indiscriminately sold with the global liquidation in risk assets. These include the Norwegian krone, the British pound and the Swedish krona, among others. To reflect the fundamental shift in both valuation and sentiment indicators, we are buying a basket of the Scandinavian currencies against a basket of both the dollar and euro. Finally, our profit targets on a few trades were hit, and we were stopped out of a few. Please see our trading tables for the latest recommendations. Appendix Table I-1 Which Are The Most Attractive G10 Currencies? Which Are The Most Attractive G10 Currencies? Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Weekly Report, titled “The Dollar Funding Crisis”, dated March 19, 2020, available at fes.bcaresearch.com. 2 Please refer to Appendix Table 1.  3 Please see Foreign Exchange Strategy Weekly Report, titled “Are Competitive Devaluations Next?”, dated March 6, 2020, available at fes.bcaresearch.com. Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been negative: The Markit manufacturing PMI dropped to 49.2 while the services PMI tanked to 39.1 from 49.4 in March. Initial jobless claims hit 3.3 million, a record high, in the week ended March 20. Nondefense capital goods orders, excluding aircraft, shrank by 0.8% month-on-month in February. The DXY index depreciated by 2.6% this week. The US Senate passed a $2 trillion economic relief package, which is now pending approval by the House. The bill includes direct payments to individuals, US$350 billion in loans to small businesses and investments in medical supplies. The Fed has created a backstop for investment grade bonds by vowing to purchase as many securities as needed to prop up the market. Report Links: The Dollar Funding Crisis - March 19, 2020 Are Competitive Devaluations Next? - March 6, 2020 The Near-Term Bull Case For The Dollar - February 28, 2020 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been negative: ZEW economic sentiment crashed to -49.5 from 10.4 while consumer confidence fell to -11.6 from -6.6 in March. The Markit manufacturing PMI decreased to 44.8 from 49.2 while the services PMI tumbled to 28.4 from 52.6 in March. This pulled the composite index down to 31.4 from 51.6 in March. The current account increased to EUR 34.7 billlion from EUR 32.6 billion while the trade balance fell to EUR 17.3 billion in January. The euro appreciated by 2.4% against the US dollar this week. ECB President Lagarde argued for the one-off issuance of “coronabonds,” a shared debt instrument among member economies that pools risk and lowers lending costs for the more indebted nations affected by the pandemic.  Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanse Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: The Jibun bank manufacturing PMI fell to 44.8 from 47.8 in March. The coincident index increased to 95.2 from 94.4 while the leading index fell to 90.5 from 90.9 in January. Imports shrank by 14% while exports shrank by 1% year-on-year in February. The Japanese yen appreciated by 0.9% against the US dollar this week. As expected, the Tokyo Olympics were postponed, striking a further blow to economic activity and the tourism sector. The government is considering a JPY 56 trillion stimulus package that includes cash payments to households and subsidies for small businesses, restaurants and other tourist-related sectors. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been negative: The Markit manufacturing PMI declined to 28 from 51.7 while the services PMI collapsed to 35.7 from 53.2 in March. Retail sales contracted by 0.3% month-on-month in February from an increase of 1.1% in January. Headline CPI grew by 1.7% year-on-year in February. The public sector net borrowing deficit shrank to GBP 0.4 billion from GBP 12.4 billion in February. The British pound appreciated by 4.3% against the US dollar this week. The Bank of England (BoE) left rates unchanged at 0.1% and decided to continue purchases of UK government bonds and nonfinancial investment grade bonds, bringing the total stock to GBP 645 billion. The BoE has stated that it can expand asset purchases further if needed. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been negative: The Commonwealth bank manufacturing PMI decreased slightly to 50.1 while the services PMI plunged to 39.8 from 49 in March. The house price index grew by 3.9% quarter-on-quarter from 2.4% in Q4. Unemployment decreased slightly to 5.1% in February. The Australian dollar appreciated by 5.1% against the US dollar this week. The government pledged an additional A$64 billion package, bringing total stimulus to 10% of GDP. The package includes assistance for individuals and small businesses impacted by the virus. Prime Minister Morrison said that more stimulus, including direct cash handouts to households, is likely to be announced over coming weeks. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been negative: Exports increased to NZD 4.9 billion, imports shrank to NZD 4.3 billion and the monthly trade balance showed a surplus of NZD 593 billion. Credit card spending grew by 2.5% in February from 3.7% the previous month. The New Zealand dollar appreciated by 4.2% against the US dollar this week. The RBNZ turned to quantitative easing and announced the purchase of up to NZ$30 billion of government bonds, at a pace of NZ$750 million per week. The government announced fiscal stimulus of just over NZ$12 billion that includes wage subsidies for businesses, income support, tax relief and support for the airline industry.     Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: Headline CPI grew by 2.2% year-on-year in February. Retail sales excluding autos fell by 0.1% month-on-month in January, compared to growth of 0.5% the previous month. Wholesale sales grew by 1.8% month-on-month in January from 1% the previous month. Jobless claims soared to 929 thousand in the week ended March 22, representing almost 5% of the labor force. The Canadian dollar appreciated by 2.8% against the US dollar this week. The government approved a C$107 billion stimulus package that includes payments of C$2,000 per month to individuals unemployed due to Covid-19 and C$55 billion in deferred tax payments for businesses and individuals. Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been negative: Producer and import prices contracted by 2.1% from 1% year-on-year in February. ZEW expectations sank to -45.8 from 7.7 in March. Imports fell to CHF 15.7 billion from CHF 16 billion while exports fell to CHF 19.2 billion from CHF 20.7 billion in February. The Swiss franc appreciated by 1.6% against the US dollar this week. The Swiss government proposed stimulus worth CHF 32 billion, bringing total stimulus to 6% of GDP. The package will largely consist of bridge loans to small- and medium-sized businesses, social insurance and tax deferrals. The SNB also set up a refinancing facility to provide liquidity to banks. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 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 Recent data in Norway have been negative: The trade balance declined to 18.3 billion from 21.2 billion in February. Norwegian unemployment soared to 10.9% in March, the highest level since the Great Depression. The Norwegian krone appreciated by 7% against the US dollar this week. The Norges Bank cut rates from 1% to a record low of 0.25%, citing worsening conditions since the 50 basis point cut on March 13. Parliament approved loans, tax deferrals, and extra spending worth NOK 280 billion. The government expects private-sector activity to contract by 15-20% in the near-term. The government will likely need to draw on its sovereign wealth fund to finance spending. Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been negative: The producer price index contracted by 1.2% year-on-year in February, deepening from 0.4% the previous month. Consumer confidence dropped to 89.6 from 98.5 in March. The trade balance grew to SEK 13.2 billion from SEK 11.8 billion in February. The unemployment rate rose to 8.2% from 7.5% in February. The Swedish krona appreciated by 3.5% against the US dollar this week. The Swedish government bucked the lockdown strategy, choosing to keep businesses open during the pandemic. In addition, the government announced stimulus measures of up to SEK 300 billion, which includes relief for employees that have been laid off or taken sick leave. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Policy Responses: The COVID-19 pandemic has become a full-blown global crisis and recession. Governments and central bankers worldwide are now responding with aggressive monetary easing and fiscal stimulus. Markets will not respond positively to such stimulus, however, until there is some visibility on the true depth, and duration, of the economic downturn. Fixed Income Strategy: With a global recession now a certainty, bond yields will remain under downward pressure and credit spreads should widen further. Given how far yields have already fallen, we recommend emphasizing country and credit allocation in global bond portfolios, while keeping overall duration exposure around benchmark levels. Model Portfolio Changes: Following up on our tactical changes last week, we continue to recommend overweighting government debt versus spread product. Specifically, overweighting US & Canadian government bonds versus Japan and core Europe, and underweighting US high-yield and all euro area and EM credit. Feature In stunning fashion, the sudden stop in the global economy due to the COVID-19 pandemic has triggered a rapid return to crisis-era monetary and fiscal policies. The battle has now shifted to trying to fill the massive hole in global private sector demand left by efforts to contain the spread of the virus. It is unlikely that lower interest rates and more quantitative easing can mitigate the negative growth effects from travel bans, closing of bars and restaurants, and full scale lockdowns of cities. Fiscal policy, combined with efforts to boost market liquidity and ease the coming collapse of cash flows for the majority of global businesses, are the only plausible options remaining. It is unlikely that lower interest rates and more quantitative easing can mitigate the negative growth effects from travel bans, closing of bars and restaurants, and full scale lockdowns of cities. While the speed of these dramatic policy moves is unprecedented, the reason for them is obvious. Plunging equities and surging corporate bond credit spreads are signaling a global recession, but one of uncertain depth and duration given the uncertainties surrounding the spread of COVID-19 (Chart of the Week). Chart of the WeekCan Crisis-Era Monetary Policies Be Effective During A Pandemic? Can Crisis-Era Monetary Policies Be Effective During A Pandemic? Can Crisis-Era Monetary Policies Be Effective During A Pandemic? Chart 2Risk Assets Will Not Bottom Until New COVID-19 Cases Ex-China Peak Risk Assets Will Not Bottom Until New COVID-19 Cases Ex-China Peak Risk Assets Will Not Bottom Until New COVID-19 Cases Ex-China Peak The ability for policymakers to calibrate stimulus measures is pure guesswork at this point. The same thing goes for investors who see zero visibility on global growth, with the full extent of the virus yet to be felt in large economies like the United States and Germany – even as new cases in China, where the epidemic began, approach zero. The response from central bankers has been swift and bold – rapid rate cuts, increased liquidity programs for bank funding and increased asset purchases. The fact that global financial markets have remained volatile, even after what is a clear coordinated effort from policymakers, highlights how the unique threats to growth from the COVID-19 pandemic may be beyond fighting with traditional demand-side stimulus measures. We continue to recommend a cautious near-term investment stance, particular with regards to corporate bond exposure, until there is clear evidence that the growth rate of new COVID-19 cases outside China has peaked (Chart 2). Policymakers Throw The Kitchen Sink At The Problem The market moves and policy announcements have come fast and furious this past week, from virtually all major economies. We summarize some of the moves below: United States The Fed cut rates by -100bps in a Sunday night emergency move, taking the funds rate back to the effective lower bound of 0% - 0.25%. Importantly, Fed Chair Powell made it clear at his press conference that negative rates are not on the table, suggesting that we may have seen the last of the rate cuts for this cycle. A new round of quantitative easing (QE) was also announced, with purchases of $500 billion of Treasury securities and $200 billion of agency MBS that will occur in the “coming months”; Powell hinted that those amounts could be increased, if necessary (Chart 3). The MBS purchases are a clear effort to help bring down mortgage rates, which have not declined anywhere near as rapidly as US Treasury yields during the market rout (bottom panel). The Fed also cut the discount window rate – the rate at which banks can borrow from the Fed for periods of up to 90 days – by -150bps, bringing it down to 0.25%. The Fed said it is “encouraging banks to use their capital and liquidity buffers” – essentially telling banks to hold less cash for regulatory purposes. The Fed also reduced the rate on its US dollar swap lines with other central banks. The new rate is OIS +25bps. Coming on top of the massive increase in existing repo lines last week, the Fed is attempting to ensure that banks, both in the US and globally, that need USD funding have more liquidity available to support lending. Already, there are signs of worsening liquidity in the bank funding markets, like widening FRA-OIS spreads, but also evidence of illiquidity in financial markets like wide bid-ask spreads on longer-maturity US Treasuries and the growing basis between high-yield bonds and equivalent credit default swaps (Chart 4). Chart 3A Return To Fed QE A Return To Fed QE A Return To Fed QE Chart 4Market Liquidity Issues Forced The Fed's Hand Market Liquidity Issues Forced The Fed's Hand Market Liquidity Issues Forced The Fed's Hand Turning to fiscal policy, the full response of the Trump administration is still being formed, but a major $850bn spending package has been proposed that would provide tax relief for American households and businesses while also including a $50bn bailout of the US airline industry. This comes on top of previously announced plans to offer free testing for the virus, paid sick leave, business tax credits and a temporary suspension of student loan interest payments. Chart 5The ECB Has Limited Policy Options The ECB Has Limited Policy Options The ECB Has Limited Policy Options Euro Area The European Central Bank (ECB) unexpectedly made no changes to policy interest rates last week. It opted instead to increase asset purchases by €120bn until the end of 2020 (both for government bonds and investment grade corporates), while introducing more long-term refinancing operations (LTROs) to “provide a bridge” to the targeted LTRO (TLTRO-3) that is set to begin in June. The terms of TLTRO-3 were improved, as well; banks that accessed the liquidity to maintain existing lending could do so at a rate up to -25bps below the current ECB deposit rate of -0.5%, for up to 50% of the existing stock of bank loans. The ECB obviously had to do something, given the coordinated nature of the global monetary policy response to COVID-19. Yet the decisions taken show that the ECB is much more limited in its ability to ease policy further, with interest rates already negative, asset purchases approaching self-imposed country limits and, most worryingly, inflation expectations falling to fresh lows (Chart 5). The bigger responses to date have come on the fiscal front, with stimulus packages proposed by France (€45bn), Italy (€25bn), Spain (€3bn) and the European Commission (€37bn). The biggest news, however, came from Germany which has offered affected businesses tax breaks and cheap loans through the state development bank, KfW – the latter with an planned upper limit of €550bn (and with the German government assuming a greater share of risk on those new KfW loans). The German government has also vaguely promised to temporarily suspend its so-called “debt brake” to allow deficit financing of virus-related stimulus programs, if necessary. Other Countries The Bank of England cut interest rates by -50bps last week, while also lowering capital requirements for UK banks by allowing use of counter-cyclical buffers for lending. On the fiscal side, a £30bn package was introduced last week that included a tax cut for retailers, cash grants to small business, sick pay for those with COVID-19 and extended unemployment benefits. The Bank of Japan held an emergency meeting this past Sunday night, announcing no changes in policy rates but doubling the size of its ETF purchase program to $56 billion a year to $112 billion, while also increasing purchases of corporate bonds and commercial paper. The central bank also announced a new program of 0% interest loans to increase lending to businesses hurt by the virus. The Bank of Canada delivered an emergency -50bps cut in its policy rate last Friday, coming soon after the -50bp reduction from the previous week. The central bank also introduced operations to boost the liquidity of Canadian financial markets. The Canadian government also announced a fiscal package of up to C$20bn, including increased money for the state business funding agencies. The Reserve Bank of Australia did not cut its Cash Rate last week, which was already at a record-low 0.5%. It did, however, signal that it would begin a quantitative easing program for the first time, and introduce Fed-like repo operations, to provide more liquidity to the economy and local financial markets. The Australian government has also announced A$17bn of fiscal stimulus. Fiscal packages have also been introduced in New Zealand (where the Reserve Bank of New Zealand just cut its policy rate by -75bps), Sweden, Switzerland, Norway, and South Korea. To date, China has leaned more on monetary and liquidity measures – lowering interest rates and cutting reserve requirements – rather than a big fiscal stimulus package. Will all these policy measures be enough to offset the hit to global growth from COVID-19 and help stabilize financial markets? It is certainly a good start, particularly in countries with low government and deficit levels that have the fiscal space for even more stimulus, like Germany, Australia and Canada (Chart 6). Given these competing forces of global recession and monetary policy exhaustion on one side, but with increasingly more expansive fiscal policy on the other, we recommend a neutral (at benchmark) stance on overall global duration exposure on both a tactical and strategic basis. The ability to calibrate the necessary policy response is impossible to assess without knowing the full impact of COVID-19 pandemic on the global economy – including the size of related job losses and corporate defaults/bankruptcies. Policymakers are likely to listen to the combined message of financial markets – equity prices, credit spreads and government bond yields. The low level of yields and flat yield curves, despite near-0% policy rates across the developed world (Chart 7), suggests that investors see monetary policy as “tapped out”, leaving fiscal stimulus as the only way to fight the economic war against COVID-19. Chart 6At Global ZIRP, The Policy Focus Shifts To Fiscal At Global ZIRP, The Policy Focus Shifts To Fiscal At Global ZIRP, The Policy Focus Shifts To Fiscal Chart 7Are Bond Yields Discounting A Global Liquidity Trap? Are Bond Yields Discounting A Global Liquidity Trap? Are Bond Yields Discounting A Global Liquidity Trap? Given these competing forces of global recession and monetary policy exhaustion on one side, but with increasingly more expansive fiscal policy on the other, we recommend a neutral (at benchmark) stance on overall global duration exposure on both a tactical and strategic basis. Bottom Line: The COVID-19 pandemic has become a full-blown global crisis and recession. Governments and central bankers worldwide are now responding with aggressive monetary easing and fiscal stimulus. Markets will not respond positively to such stimulus, however, until there is some visibility on the true depth, and duration, of the economic downturn. Corporate Bonds In The US & Europe – Stay Tactically Defensive Chart 8This Crisis Is Different Than 2008 This Crisis Is Different Than 2008 This Crisis Is Different Than 2008 The COVID-19 global market rout has generated levels of market volatility not seen since the 2008 Global Financial Crisis. The US VIX index of option-implied equity volatility spiked to a high of 84, while the equivalent German VDAX measure reached a shocking high of 93. Equity valuations in both the US and Europe remain much higher on a forward price/earnings ratio basis compared to the troughs seen in 2008, even after the COVID-19 bear market. Yet even though volatility has returned to crisis-era extremes, and corporate credit has sold off hard in both the US and Europe, credit spreads remain well below the 2008 highs (Chart 8). Nonetheless, the credit selloff seen over the past few weeks has still been intense. Both investment grade and high-yield spreads have blown out, and across all credit tiers in both the US (Chart 9) and euro area (Chart 10). Even the highest-rated segments of the corporate bond universe have seen spreads explode, with AAA-rated investment grade spreads having doubled in both the US and Europe. Chart 9Broad-Based Spread Widening For Both Investment Grade... Broad-Based Spread Widening For Both Investment Grade... Broad-Based Spread Widening For Both Investment Grade... Chart 10...And High-Yield ...And High-Yield ...And High-Yield With the COVID-19 pandemic tipping the global economy into recession, it is not clear that the spread widening seen to date has been enough to compensate for the typical surge in downgrades and defaults seen during recessions – even though spreads do look wide on a duration-adjusted basis. With the COVID-19 pandemic tipping the global economy into recession, it is not clear that the spread widening seen to date has been enough to compensate for the typical surge in downgrades and defaults seen during recessions – even though spreads do look wide on a duration-adjusted basis.  One of our favorite metrics to value corporate bonds is to look at option-adjusted spreads, adjusted for interest rate duration risk. We call this the 12-month breakeven spread, as it measures the amount of spread widening over one year that would leave corporate bond returns equal to those of duration-matched US Treasuries. We then look at the percentile rankings of those breakeven spreads versus their history as one indicator of corporate bond value. Chart 11US Corporates Look Cheaper On A Duration-Adjusted Basis US Corporates Look Cheaper On A Duration-Adjusted Basis US Corporates Look Cheaper On A Duration-Adjusted Basis For the US, the 12-month breakeven spreads for the overall Bloomberg Barclays investment grade and high-yield indices are in the 82nd and 97th percentiles, respectively (Chart 11). This suggests that the latest credit selloff has made corporate debt quite cheap, although only looking through the prism of spread risk rather than potential default losses. Another of our preferred valuation metrics for high-yield debt is the duration-adjusted spread, or the high-yield index option-adjusted spread minus default losses. We then look at that default-adjusted spread versus its long-run average (+250bps) as a measure of high-yield value. To assess the current level of spreads, we use a one-year ahead forecast of the expected default rate using our own macro model. Over the past 12 months, the high-yield default rate was 4.5% and our macro model is currently calling for a rise to 6.2%. That estimate, however, does not yet include the certain hit to corporate profits from the COVID-19 recession. By way of comparison, the default rate peaked at 11.2% during the 2001/02 default cycle and at 14.6% during the 2008 financial crisis. In Chart 12, we show the historical default rate, our macro model for the default rate, and the history of the default-adjusted spread. We also show what the default-adjusted spread would look like in four different scenarios for the default rate over the next 12 months: 6%, 9%, 11% and 15%. The placement of these numbers in the bottom panel of Chart 12 indicates where the Default-Adjusted Spread will be if each scenario is realized. Chart 12US High-Yield Is Not Cheap On A Default-Adjusted Basis US High-Yield Is Not Cheap On A Default-Adjusted Basis US High-Yield Is Not Cheap On A Default-Adjusted Basis Right now, our expectation is that there will be a virus driven US recession, but it will be shorter in magnitude than past recessions; this suggests a peak default rate closer to 9%. Such a scenario would still be consistent with a positive default-adjusted spread and likely positive excess returns for US high-yield relative to US Treasuries on a 12-month horizon. However, if a default rate similar to that seen during past recessions (11% or 15%) is realized, that would lead to a negative default-adjusted spread. Adding up both pieces of our valuation framework suggests that, while US high-yield spreads offer value on a duration-adjusted basis, spreads do not compensate enough for potential default losses if the US recession lasts longer than we expect. Thus, we recommend a tactical underweight position in US high-yield until we see better visibility on the severity, and duration, of the US recession. Adding up both pieces of our valuation framework suggests that, while US high-yield spreads offer value on a duration-adjusted basis, spreads do not compensate enough for potential default losses if the US recession lasts longer than we expect.  As for euro area corporates, spreads for both investment grade and high-yield do look relatively wide on a breakeven spread basis, although less so than US credit (Chart 13). However, with the World Health Organization declaring Europe as the new epicenter of the COVID-19 pandemic, the harsh containment measures seen in Italy, Germany, France and elsewhere – coming from a starting point of weak overall economic growth – suggest that euro area spreads need to be wider to fully reflect downgrade and default risks. Chart 13Euro Area Corporates Look A Bit Cheaper On A Duration-Adjusted Basis Euro Area Corporates Look A Bit Cheaper On A Duration-Adjusted Basis Euro Area Corporates Look A Bit Cheaper On A Duration-Adjusted Basis We recommend a tactical underweight allocation to both euro area corporate debt and Italian sovereign debt, as spreads have room to reprice wider to reflect a deeper recession (Chart 14). Chart 14Stay Underweight Euro Area Spread Product Stay Underweight Euro Area Spread Product Stay Underweight Euro Area Spread Product Bottom Line: Corporate bond spreads on both sides of the Atlantic discount a sharp economic slowdown, but the odds of a deeper recession – and more spread widening - are greater in Europe relative to the US. A Quick Note On Recent Changes To Our Model Bond Portfolio In last week’s report, we made several adjustments to our model bond portfolio recommended allocations on a tactical (0-6 months) basis.1 Specifically, we downgraded our overall recommended exposure to global spread product to underweight, while increasing the overall allocation to government debt to overweight. The specific changes made to the model bond portfolio are presented in tables on pages 14 & 15. Within the country allocation of the government bond side of the portfolio, we upgraded US and Canada (markets more sensitive to changes in global bond yields, and with central banks that still had room to ease policy) to overweight, while downgrading core Europe to underweight and Japan to maximum underweight (both markets less sensitive to global yields and with no room to cut rates). On the credit side of the portfolio, we downgraded US high-yield to underweight (with a 0% allocation to Caa-rated debt), while also downgrading euro area investment grade and high-yield debt to underweight. We also lowered allocations to emerging market USD denominated debt, both sovereign and corporate, to underweight. We left the allocation to US investment grade debt at neutral, as the other reductions left our overall spread product allocation at the desired level (35% versus the 43% spread product weighting in our custom benchmark portfolio index). In terms of the specific weightings, the portfolio is now +11% overweight US fixed income versus the benchmark, coming most through US Treasury exposure. The portfolio is now -7% underweight euro area versus the benchmark, equally thorough government bond and corporate debt exposure. The portfolio is now also has a -7% weight in Japan versus the benchmark, entirely from government bonds. Note that these weightings represent a tactical allocation only, as we are recommending a defensive stance on spread product exposure given the near-term uncertainties over COVID-19 and global growth. On a strategic (6-12 months) horizon, however, we are neutral overall spread product exposure versus government bonds. Corporate bond spreads already discount a sharp economic slowdown and some increase in defaults. However, the rapid shift to aggressive monetary and fiscal easing by global policymakers to combat the virus will likely limit the duration and, potentially, the severity of the global slowdown currently discounted in wide credit spreads.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1 Please see BCA Global Fixed Income Strategy Weekly Report, "The Train Is Empty", dated March 10, 2020, available at gfis.bcarsearch.com. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Panicked Policymakers Move To A Wartime Footing Panicked Policymakers Move To A Wartime Footing Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Highlights The latest interest rate cuts by central banks confirms the narrative that the authorities view economic risks as asymmetrical to the downside. This all but assures that competitive devaluation will become the dominant currency landscape in the near future. If the virus proves to be just another seasonal flu, the global economy will be awash with much more stimulus, which will be fertile ground for pro-cyclical currencies. In the event that we get a much more malignant outcome, discussions around interest rate cuts will rapidly evolve into quantitative easing and debt monetization. The dollar will be the ultimate loser in both scenarios, but this path could be lined with intermediate strength. Our highest-conviction call before the dust settles is to short USD/JPY. We are also making a few portfolio adjustments in light of recent market volatility. Buy NOK/SEK and NZD/CHF and take profits soon on long SEK/NZD. Feature The DXY rally that began last December faltered below overhead psychological resistance at 100, and has since broken below key technical levels. The V-shaped reversal has been a mirror image of developments in equity markets, with the S&P 500 off 6% from its lows. The catalyst was aggressive market pricing of policy action from the Federal Reserve, to which the authorities yielded. The latest policy action confirms the narrative that most central banks continue to view deflation as a much bigger threat than inflation, since few have been able to achieve their mandate. This all but assures that competitive devaluation will become the dominant currency landscape, as each central bank prevents appreciation in their respective currency. Should the Fed continue on the path of much more aggressive stimulus, this will have powerful implications for the dollar and across both G10 and emerging market currencies.   The US 10-year Treasury yield broke below 1% around 1:40 p.m. EST on March 3rd. This was significant not because of the level but because it emblematically erased the US carry trade for a number of countries (Chart I-1). Should the Fed continue on the path of much more aggressive stimulus, this will have powerful implications for the dollar and across both G10 and emerging market currencies.  Chart I-1The Big Convergence The Big Convergence The Big Convergence To Buy Or Sell The DXY? If the virus proves to be only slightly more lethal than the seasonal flu, the global economy will be awash with much more stimulus, which will be fertile ground for pro-cyclical currencies. As a counter-cyclical currency, the dollar will buckle, lighting a fire under our favorites such as the Norwegian krone and the Swedish krona. The euro will be the most liquid beneficiary of this move. Chart I-2 shows that the global economy was already on a powerful V-shaped recovery path before the outbreak. More importantly, this recovery was on the back of easier financial conditions. Chart I-2V-Shaped Recovery At Risk V-Shaped Recovery At Risk V-Shaped Recovery At Risk Chart I-3A Second Wave Of Infections? A Second Wave Of Infections? A Second Wave Of Infections? Our roadmap is the peak in the momentum of new infections outside of China. During the SARS 2013 episode, the bottom in asset prices (and peak in the DXY) occurred when the momentum in new cases peaked. Currency markets are currently pricing a much worse outcome than SARS. The risk is that we are entering a second wave of infections outside Hubei, China, which will be more difficult to control than when it was relatively more contained within the epicenter (Chart I-3). As we aptly witnessed a fortnight ago, currency markets will make a binary switch to risk aversion on such an outcome. This warns against shorting the DXY index or buying the euro or pound in the near term. As we go to press, the virus has been identified on almost every continent except Antarctica. Even in countries such as the US, with modern and sophisticated health facilities, the costs to get tested are exorbitant for underinsured individuals.1 This all but assures that the number of underreported cases is likely non-trivial, which could trigger another market riot once they surface. Chart I-4DXY and USD/JPY Tend To Move Together DXY and USD/JPY Tend To Move Together DXY and USD/JPY Tend To Move Together Our highest-conviction call before the dust settles is therefore to short USD/JPY. As Chart I-1 highlights, the Bank of Japan is much closer to the end of their rope in terms of monetary policy tools. Long bond yields have already hit the zero bound, which means that real rates in Japan will continue to rise until the authorities are forced to act. One of the triggers to act will be a yen soaring out of control, which is not yet the case. Speculative evidence is that it will take a yen rally in the order of 12% to catalyze the BoJ. More importantly, the speed of the rally will matter. This was the trigger for negative interest rates in January 2016 as well as yield curve control in September of 2016. The first rally from USD/JPY 125 to around 112 and the subsequent rise towards 100 were both in the order of 12%. A similar rally from the recent peak near 112 will pin the USD/JPY at 100.   Bottom Line: The yen is the most attractive currency to play dollar downside at the moment. Remain short USD/JPY. If global growth does pick up and the dollar weakens, the USD/JPY and the DXY tend to be positively correlated most of the time, providing ample room for investors to rotate into more pro-cyclical pairs (Chart I-4). Competitive Devaluation? In the event that we get a much more malignant outcome, discussions around interest rate cuts will rapidly evolve into quantitative easing and debt monetization. The Reserve Bank of Australia has already stated that QE is on the table if rates touch 0.25%.2 Other central banks are likely to follow suit. As the chorus of central banks cutting rates and stepping into QE on COVID-19 rises, the rising specter of currency brinkmanship is likely to unnerve countries pursuing more orthodox monetary policies. The currency of choice will be gold and other precious metals, though the dollar, Swiss franc, and yen are likely to also outperform.  The velocity of money in both the US and the euro area was in a nascent upturn, but has started to roll over.  Whether or not countries adopt QE, what is clear is that balance sheet expansion at both the Fed and the European Central Bank is set to continue. Chart I-5 shows that the velocity of money in both nations was in a nascent upturn, but has started to roll over. This tends to lead inflation by a few quarters. On a relative basis, our bias is that the pace of expansion should be more pronounced in the US. This will eventually set the dollar up for a significant decline, albeit after a knee-jerk rally. Chart I-5ADownside Risks To US Inflation Downside Risks To US Inflation Downside Risks To US Inflation Chart I-5BDownside Risks To Euro Area Inflation Downside Risks To Euro Area Inflation Downside Risks To Euro Area Inflation In terms of quantitative easing, it is most appealing when a country has low growth, low inflation, and large amounts of public debt. If we are right that inflation is about to roll over in the US, then the public debt profile and political capital to expand the budget deficit places the nation as a prime candidate for QE (Chart I-6). Fiscal stimulus is a much more difficult discussion in Europe, Japan, or elsewhere for that matter, and likely to arrive late. Chart I-6US Government Debt Is Very High US Government Debt Is Very High US Government Debt Is Very High The backdrop for the US dollar is a 37% rise from the bottom. The New York Fed estimates that a 10 percentage point appreciation in the dollar shaves 0.5 percentage points off GDP growth over one year, and an additional 0.2 percentage points in the following year.3 With growth now hovering around 2%, a strong currency could easily nudge US growth to undershoot potential.  The Fed is one of the few G10 central banks with room to ease monetary policy. This sets the dollar up for an eventual decline. However, the path to QE will be lined by a strong dollar if the backdrop is flight to safety. This entails rolling currency depreciations among some developed and emerging markets. When looking for the next candidates for competitive devaluation, the natural choices are the countries with overvalued exchange rates that are exerting a powerful deflationary impulse into their economies. Chart I-7 shows the deviation of real effective exchange rates from their long-term mean, according to the BIS. Chart I-7Competitive Devaluation Candidates Are Competitive Devaluations Next? Are Competitive Devaluations Next? Bottom Line: The Fed is one of the few G10 central banks with room to ease monetary policy. This sets the dollar up for an eventual decline. It will first occur among the safe havens (currencies with already low interest rates), before it rotates to more procyclical currencies. Where Does US Politics Fit In? Politics should start to have a meaningful impact on the dollar once the democratic nominee is sealed. Super Tuesday revealed a powerful shift to the center, pinning former Vice President Joe Biden as the preferred candidate (Chart I-8). The dollar tends to thrive as political uncertainty rises. While not a forgone conclusion, a Sanders–Trump rivalry would have been a very polarized outcome, putting a bid under the greenback. Markets are likely to take a more conciliatory tone from a Biden victory, which will be negative for the greenback.   Chart I-8US Politics Will Be Important Are Competitive Devaluations Next? Are Competitive Devaluations Next? Our colleague Matt Gertken, chief geopolitical strategist, just published his analysis of Super Tuesday.4 While a contested convention remains unlikely, it will likely favor Trump’s reelection odds. What is common about a Biden-Sanders-Trump trio is that fiscal policy is set to expand in the US. This will ultimately be dollar bearish (Chart I-9). Chart I-9The Dollar And Budget Deficits The Dollar And Budget Deficits The Dollar And Budget Deficits Bottom Line: The election is still many months away and much can change between now and then. For now, Biden is the preferred democratic nominee. Portfolio Adjustments Chart I-10Sell CHF/NZD Sell CHF/NZD Sell CHF/NZD The sharp rally in the VIX index has opened up a trading opportunity on the short side. The historical pattern of previous spikes in the VIX is that unless the market starts to price in an actual recession, which is quite plausible, the probability of a short-term reversal is close to 100%. Given our base case that we are not headed for a recession over the next six to 12 months, we are opening a short CHF/NZD trade today. The cross tends to benefit from spikes in volatility, correcting sharply as the market unwinds overreactions. More importantly, the cross has already priced in an overshoot in the VIX in an order of magnitude akin to 2008. Place stops at 1.75 with a target of 1.45 (Chart I-10). We are also placing a limit buy on NOK/SEK at parity. The risk to this trade is a further down-leg in oil prices, but at parity, the cross makes for a compelling tactical trade. Momentum on the cross is currently bombed out. We will be closely watching whether Russia complies with OPEC production cuts and act accordingly. Remain long NOK within our petrocurrency basket against the euro. We are also looking to take profits on our long SEK/NZD trade, a nudge below our initial target. The market has fully priced in a rate cut by the Reserve Bank of New Zealand, suggesting the kiwi could have a knee-jerk rally, similar to the Aussie on the actual announcement. Finally, we were stopped out of our short gold/silver trade for a loss of 5.5%. We will be looking to re-establish this trade in the coming weeks. Stay tuned. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Bertha Coombs and William Feuer, “The coronavirus test will be covered by Medicaid, Medicare and private insurance, Pence says,” CNBC, dated March 4, 2020. 2 Michael Heath, “RBA Says QE Is Option at 0.25%, Doesn’t Expect to Need It,” Bloomberg News, dated November 26, 2019. 3 Mary Amiti and Tyler Bodine-Smith, “The Effect of the Strong Dollar on U.S. Growth,” Federal Reserve Bank of New York, dated July 17, 2015. 4  Please see Geopolitical Strategy Special Report, titled “US Election: A Return To Normalcy?”, dated March 4, 2020, available at gps.bcaresearch.com. Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been positive: The ISM manufacturing PMI fell slightly to 50.9, dragged down by the prices paid and new orders component, while the non-manufacturing index ticked up to 57.3. Core PCE inflation increased to 1.6% year-on-year in January. Unit labor costs came in at 0.9% quarter-on-quarter in Q4 of last year. This is a deceleration from the previous print of 2.5%. The DXY index depreciated by 1.4% this week. Following a conference call with G7 central banks, the Fed made an emergency rate cut of 50bps. Chairman Powell cited risks to the outlook from Covid-19 but acknowledged that the Fed can keep financial conditions accommodative, not fix broken supply chains or cure infections. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Building A Protector Currency Portfolio - February 7, 2020 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been positive: Core CPI inflation increased slightly to 1.2% year-on-year in February.  The producer price index contracted by 0.5% year-on-year in January. The unemployment rate remained flat at 7.4% in January. Retail sales grew by 1.7% year-on-year in January, remaining flat from the previous month. The euro appreciated by 3.6% against the US dollar this week. As the ECB is limited by the zero lower bound, the euro strengthened on expectations that rate differentials with the US will continue to narrow. The ECB could resort to policy alternatives such as a special facility targeting small and medium enterprises. Markets are pricing in an 81% probability of a rate cut as we go into the ECB meeting next week. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: The Tokyo CPI excluding fresh food grew by 0.5% year-on-year in February from 0.7% the previous month. The jobs-to-applicants ratio decreased to 1.49 from 1.57 while the unemployment rate increased to 2.4% from 2.2% in January. The consumer confidence index declined to 38.4 from 39.1 in February. Housing starts contracted by 10.1% year-on-year in January from 7.9% the previous month. The Japanese yen appreciated by 2.5% against the US dollar this week. Lower US yields, combined with continued risk-on flows, have extended the rally in the Japanese yen. Weakness in the Japanese economy is broad based, but the BoJ has limited policy space and fiscal action looks unlikely anytime soon. Global central bank action will drive the yen in the near term. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been mixed: Consumer credit decreased to GBP 1.2 billion from GBP 1.4 billion while net lending to individuals fell to GBP 5.2 billion from GBP 5.8 billion in January. Mortgage approvals increased to 70.9 thousand from 67.9 thousand in January, while the Nationwide housing price index grew by 2.3% year-on-year in February from 1.9% the previous month.  The British pound appreciated by 0.2% against the US dollar this week. At a hearing this week, incoming governor Andrew Bailey stated that the BoE is still assessing evidence on the nature of the shock from Covid-19. The BoE has limited room to cut and is constrained by possible stagflation; we expect targeted supply chain finance and cooperation with fiscal authorities to take precedence.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mixed: GDP grew by 2.2% year-on-year in Q4 2019, improving from 1.7% the previous quarter.  Imports and exports both contracted by 3% while the trade balance dropped to AUD 5.2 billion in January. Building permits contracted by a dramatic 15.3% month-on-month in January, compared to growth of 3.9% in December. The RBA commodity price index contracted by 6.1% year-on-year in February.  The Australian dollar appreciated by 0.8% against the US dollar this week. The Reserve Bank of Australia cut its official cash rate to 0.5%, an all-time low, citing the impact of Covid-19 on domestic spending, education, and travel. Watch to see if the signal from building permits is confirmed by other housing market indicators. The RBA might not be done easing. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been negative: The terms of trade index grew by 2.6% quarter-on-quarter in Q4 2019, improving from 1.9% in Q3. The ANZ commodity price index contracted by 2.1% in February, deepening from 0.9% the previous month. Building permits contracted by 2% month-on-month in January, from growth of 9.8% in December.  The global dairy trade price index contracted by 1.2% in March.  The New Zealand dollar appreciated by 0.3% against the US dollar this week. There is pressure on the Reserve Bank of New Zealand (RBNZ) to ease at its next meeting on March 27, with markets pricing in 42 basis points of easing over the next 12 months. However, the RBNZ has dispelled notions of a pre-meeting cut. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: Annualized GDP grew by 0.3% quarter-on-quarter in Q4 2019, slowing from 1.4% the previous quarter.  The raw material price index contracted by 2.2% and industrial product price index contracted by 0.3% month-on-month in January.  Labor productivity contracted by 0.1% quarter-on-quarter in Q4 2019, compared to growth of 0.2% the previous quarter. The Canadian dollar depreciated by 0.1% against the US dollar this week. The Bank of Canada (BoC) followed the Fed and cut rates by 50bps. In addition to the confidence hit from Covid-19, the BoC cited falling terms of trade, depressed business investment, and dampened economic activity due to the CN rail strikes. The BoC stands ready to ease further, and Prime Minister Trudeau has raised the possibility of a fiscal response.   Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been positive: GDP grew by 1.5% year-on-year in Q4 2019, from growth of 1.1% the previous quarter. The SVME PMI increased to 49.5 from 47.8 in February. The KOF leading indicator increased to 100.9 from 100.1 in February. CPI contracted by 0.1% year-on-year in February, from growth of 0.2% the previous month. The Swiss franc appreciated by 1.6% against the US dollar this week. A combination of strong domestic data and global risk-off flows contributed to strength in the Swiss franc. However, the Swiss government will be revising down growth forecasts and a recent UN report has estimated that Switzerland lost US$ 1 billion in exports in February due to Chinese supply disruptions. Combined with a strong franc, this puts the domestic outlook at risk.  Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 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 Recent data in Norway have been positive: The current account decreased to NOK 19.1 billion from NOK 29.5 billion in Q4 2019. The credit indicator grew by 5% year-on-year in January. Registered unemployment decreased slightly to 2.3% from 2.4% in February.  The Norwegian krone appreciated by 1.3% against the US dollar this week. Expect the petrocurrency to trade on news from the OPEC meetings in the coming days. The committee has proposed a production cut of 1.5 million barrels per day through Q2 2020, conditional on approval from Russia, to offset the demand shock from Covid-19.  Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been positive: The Swedbank manufacturing PMI increased to 53.2 from 52 in February. Industrial production grew by 0.9% year-on-year, from a contraction of 2.6% the previous month. GDP grew by 0.8% year-on-year in Q4 2019, slowing from 1.8% the previous month. The Swedish krona appreciated by 1.5% against the US dollar this week. After hitting a 2-decade high near 10, USD/SEK has violently reversed and is now trading at the 9.45 level. What is evident from incoming data is that the cheap currency has been a perfect shock absorber, cushioning the domestic economy. We are protecting profits on long SEK/NZD today and we will be looking for other venues to trade SEK on the long side.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The elevated uncertainty about global growth stemming from the COVID-19 virus in China has not only made investors more anxious, but central bankers as well. This means that, only six weeks into the year, policymakers may already be having to rethink their expected strategies for 2020 - which were, for the most part, sitting on hold after the monetary easing in 2019. This has important implications for the direction of global bond yields, which were starting to see a cyclical increase before the viral outbreak. In this report, we present what we see as the most important data for investors to focus on in the major developed markets to get the central bank call correct. This is based on our interpretation of recent speeches, press conferences and published research. We also provide our own suggested data series to watch for each country – which do not always line up with what central bankers are saying they are most worried about. We conclude that it is still not clear that the global growth backdrop has turned sustainably more bond bullish, but there is no pressure on any of the major central banks to move away from extremely accommodative policy settings. Feature Over the past four weeks, all of the major central banks have had the opportunity to formally communicate their current views to financial markets. Whether it was through post-policy- meeting press conferences or published monetary policy reports, central bankers have tried to signal their intentions about future changes in the direction of interest rates, given the heightened uncertainties about the momentum of global growth. At the moment, our global leading economic indicator (LEI) is still signaling that 2020 should see some rebound in global growth – and bond yields – after the sharp 2019 manufacturing-led slowdown (Chart 1). Unfortunately, the latest read on the global LEI uses data as of December, so it does not include what is almost certainly to be a very severe slowdown in the Chinese (and global) economy in the first quarter of 2020 due to the COVID-19 virus outbreak. Underlying stories within each developed market economy – on growth, inflation and potential financial imbalances – suggest that the additional interest rate cuts now discounted globally may not come to fruition if the China shock is contained to the first quarter of the year.  Central bankers are in the same spot as investors, trying to ascertain the extent of the hit to global growth from the virus, both in terms of size and, more importantly, duration. This comes at a time when many central banks were already formally rethinking how to meet their own individual inflation-targeting mandates given the persistence of low global inflation alongside tight labor markets (Chart 2). Chart 1Global Bond Yields: Think Globally, Act Locally Global Bond Yields: Think Globally, Act Locally Global Bond Yields: Think Globally, Act Locally Chart 2Common Worries For All CBs: China & Global Inflation Common Worries For All CBs: China & Global Inflation Common Worries For All CBs: China & Global Inflation That all sounds potentially very bond-bullish, but a lot of bad economic news is already discounted in the current low level of global bond yields. More importantly, the underlying stories within each developed market economy – on growth, inflation and potential financial imbalances – suggest that the additional interest rate cuts now discounted globally may not come to fruition if the China shock is contained to the first quarter of the year. In this Weekly Report, we provide a brief synopsis of what we believe are the biggest concerns for each of the major developed economy central banks. This is based on our read of recent policy decisions and central banker statements, as well as our own understanding of the current reaction function of policymakers. Our intention is to provide a short list of indicators to watch for each central bank, to help cut through the noise of data and news during this current period of unusual uncertainty, as well as our own assessment of what policymakers should be focusing on more. We conclude that it is still too soon to expect a new wave of bond-bullish global monetary policy easings in 2020. It will take evidence pointing to an extended shock to global growth from the COVID-19 virus to reverse the bond-bearish signal from other indicators like our global LEI. Federal Reserve Chart 3Federal Reserve: Focus On Financial Conditions & Inflation Expectations Federal Reserve: Focus On Financial Conditions & Inflation Expectations Federal Reserve: Focus On Financial Conditions & Inflation Expectations Currently, the Fed’s commentary suggests a policy bias that can be described as “neutral-to-dovish”, but it is giving no indication that additional rate cuts are likely in 2020 after the 75bps of cuts last year. Markets remain skeptical, however, with -42bps of cuts over the next twelve months now priced into the USD overnight index swap (OIS) curve according to our Fed Discounter (Chart 3). What the Fed seems most focused on: Fed officials seem focused on measures of market-based inflation expectations, like TIPS breakevens, as the best indication that current policy settings are appropriate (or not) relative to the growth outlook of investors. While FOMC members have expressed concern about TIPS breakevens being persistently below the 2% inflation target, they would not necessarily respond to a further decline in breakevens with more rate cuts without first seeing the US Treasury curve becoming inverted for a prolonged period, just like in 2019 (middle panel). Right now, with the 10-year TIPS breakeven at 1.67% and the 10-year/3-month US Treasury curve now at only -1bp, another decline in longer-term inflation expectations will likely invert the Treasury curve. What the Fed should be more focused on: US financial conditions are highly stimulative, with equity indices back near all-time highs and corporate credit spreads remaining well-contained at tight levels. Given the usual lead times of financial conditions indices to US cyclical growth indicators like the ISM manufacturing index (bottom panel), a continuation of the most recent bounce in the ISM is still the most likely result – even allowing for a near-term hit to global growth from China. While FOMC members have expressed concern about TIPS breakevens being persistently below the 2% inflation target, they would not necessarily respond to a further decline in breakevens with more rate cuts without first seeing the US Treasury curve becoming inverted for a prolonged period, just like in 2019. Bottom Line: The incoming US growth data is critical to determine the Fed’s next move. If there is no follow through from easy financial conditions into faster growth momentum, the odds increase that the Treasury curve will become more deeply inverted for a longer period of time – an outcome that would likely prompt more rate cuts, especially if equity and credit markets also begin to sell off as growth disappoints. European Central Bank Chart 4ECB: Focus On Manufacturing & Inflation Expectations ECB: Focus On Manufacturing & Inflation Expectations ECB: Focus On Manufacturing & Inflation Expectations The ECB has been clearly signaling that it still has a dovish bias, although central bank officials have acknowledged that the options available to them to ease further are limited with policy rates already in negative territory. The market agrees, as there are only -7bps of cuts over the next twelve months now priced into the EUR OIS curve according to our ECB Discounter (Chart 4). What the ECB seems most focused on: The ECB has been paying the most attention to the contractions in euro area manufacturing data (like PMIs) and exports seen in 2019. Rightly so, as nearly all of the two percentage point decline in year-over-year euro area real GDP growth since the late-2017 peak has come from weaker net exports. The central bank has also been concerned about the depressed level of inflation expectations, with the 5-year EUR CPI swap rate, 5-years forward, now at only 1.23% - far below the ECB’s inflation target of “at or just below” 2%. What the ECB should be more focused on: We agree that the focus for the ECB should be most concerned about the weakness in manufacturing/exports and low inflation expectations – the latter having not yet responded to extremely stimulative euro area financial conditions (most notably, the weak euro). The euro area economy is highly leveraged to Chinese demand, with exports to China representing 11% of total euro area exports. This makes leading indicators of Chinese economic activity, like the OECD China LEI and the China credit impulse, critically important indicators in determining the future path of European export demand. The COVID-19 outbreak in China could not have come at a worse time for the ECB, as there have been tentative signs of stabilization in cyclical euro area indicators like manufacturing PMIs in recent months. Bottom Line: The COVID-19 outbreak in China could not have come at a worse time for the ECB, as there have been tentative signs of stabilization in cyclical euro area indicators like manufacturing PMIs in recent months. If the China demand shock to euro area exports is large enough, the ECB will likely be forced to deliver a modest interest rate cut – or an expansion of the size of its monthly asset purchases – to try and boost growth. Bank Of England Chart 5Bank Of England: Focus On Business Sentiment & Labor Costs Bank Of England: Focus On Business Sentiment & Labor Costs Bank Of England: Focus On Business Sentiment & Labor Costs The Bank of England (BoE) has a well-deserved reputation as having an unpredictable policy bias under outgoing Governor Mark Carney, but the central bank does appear to be currently leaning on the moderately dovish side of neutral. Short-term interest rate markets also feel the same way, with -19ps of easing over the next twelve months priced into the GBP OIS curve according to our BoE Discounter (Chart 5). What the BoE seems most focused on: The BoE has been paying a lot of attention to indicators of UK business sentiment, which had been negatively impacted by both Brexit uncertainty and global trade tensions in 2019. The BoE has focused on the link from depressed business sentiment to weak investment spending and anemic productivity growth as an important reason why UK potential GDP growth has been so low and why UK inflation expectations have been relatively high. What the BoE should be more focused on: We agree that business sentiment should be the BoE’s greatest area of focus. Sentiment has shown a solid improvement of late, after the signing of the “phase one” US-China trade deal in December and the formal exit of the UK from the EU on January 31. The CBI Business Optimism survey (measuring the net balance of optimists versus pessimists) soared from -44 in October to +23 in January – the biggest quarterly jump ever recorded in the series. It remains to be seen if this improvement in confidence can be sustained and begin to arrest the steady decline in UK capital spending and productivity growth, and the associated surge in unit labor costs and inflation expectations, that has taken place since the 2016 Brexit vote. Bottom Line: The BoE’s next move, under the new leadership of incoming Governor Andrew Bailey, is not clear. Inflation expectations remain elevated but the recovery in business sentiment is still fragile. One potential risk to watch: UK Prime Minister Boris Johnson may choose to take a bolder stand on trade negotiations with the EU after his resounding election victory in December, risking an outcome closer to the “no-deal Brexit” scenario that was most feared by UK businesses. Bank Of Japan Chart 6Bank of Japan: Focus On Exports & The Yen Bank of Japan: Focus On Exports & The Yen Bank of Japan: Focus On Exports & The Yen The Bank of Japan (BoJ) seems to have had a perpetually dovish bias since the 1990s. Yet the current group of policymakers under Governor Haruhiko Kuroda, realizing that they have run out of realistic policy options after years of extreme stimulus, has not been signaling that fresh easing measures are on the horizon, even with economic growth and inflation remaining very weak in Japan. Markets have taken the hint, with only -6bps of rate cuts over the next twelve months priced into the JPY OIS curve according to our BoJ Discounter (Chart 6). What the BoJ seems most focused on: The BoJ has been vocally concerned about the recent slump in Japanese consumer spending, which declined -2.9% (in real terms) in Q4 after the sales tax hike last October. That blow to consumption was expected, but could not have come at a worse time for a central bank that was already worried about plunging Japanese manufacturing activity and exports – the latter declining by -8% in nominal terms as of December 2019. There is little hope for a near-term rebound given the certain hit to global growth and export demand from virus-stricken China. What the BoJ should be more focused on: Given that Japan is still an economy with a large manufacturing sector that is levered to global growth, the BoJ should remain focused on the path for Japanese exports. A bigger risk, however, comes from the Japanese yen, which has remained very stable over the past year. It has proven very difficult to generate any rise in Japanese inflation without some yen weakness, and with headline CPI inflation now only at +0.2%, a burst of yen strength would likely tip Japan back into outright deflation. Bottom Line: The BoJ is now stuck in a very bad spot, with no real ability to provide a major monetary policy stimulus for the stagnant Japanese economy. At best, all the central bank could do is deliver a small interest rate cut and hope for a quick rebound in global manufacturing activity and/or some yen weakness to boost flagging inflation. Bank Of Canada Chart 7Bank of Canada: Focus On Housing & Capital Spending Bank of Canada: Focus On Housing & Capital Spending Bank of Canada: Focus On Housing & Capital Spending The Bank of Canada (BoC) surprised many observers by keeping policy on hold last year, even as central banks worldwide engaged in various forms of monetary easing to offset the effects of the global manufacturing downturn. The BoC’s recent messaging has been relatively neutral, in our view, although Governor Stephen Poloz has not completely dismissed the possibility of rate cuts in his speeches. The markets are strongly convinced that the BoC will need to belatedly join the global easing party, with -32bps of rate cuts now priced into the CAD OIS curve according to our BoC Discounter (Chart 7) What the BoC seems most focused on: The BoC remains highly concerned over the high level of Canadian household debt, especially given how Canadian consumer spending has been highly geared towards trends in house price inflation over the past few years. This is likely why the BoC has been reluctant to cut policy rates as “insurance” against the effects of a prolonged global growth slump, to avoid stoking a new Canadian housing bubble. Interestingly, the commentary from BoC officials has taken on a bit more dovish tone whenever USD/CAD has threatened to break down below 1.30, suggesting some fears of unwanted currency appreciation. What the BoC should be more focused: The BoC should continue to monitor developments in the Canadian housing market, given the implications for consumer spending and, potentially, financial stability if there is another boom in house prices. The central bank should also pay even greater attention than usual to the subdued level of oil prices, which has triggered a deep slump in the oil-rich Alberta province that has weighed on the overall level of Canadian business investment spending. Persistently soft oil prices would also force the BoC to continue resisting strength in the Canadian dollar. It would likely take a breakdown in oil prices, or an outright decline in house prices, for the rate cut expectations currently discounted in the CAD OIS curve to come to fruition. Bottom Line: The BoC appears under no pressure to make any near-term interest rate adjustments, especially with realized inflation now sitting at the midpoint of the BoC’s 1-3% target band. It would likely take a breakdown in oil prices, or an outright decline in house prices, for the rate cut expectations currently discounted in the CAD OIS curve to come to fruition. Reserve Bank Of Australia Chart 8Reserve Bank Of Australia: Focus On Underemployment & Housing Reserve Bank Of Australia: Focus On Underemployment & Housing Reserve Bank Of Australia: Focus On Underemployment & Housing The Reserve Bank of Australia (RBA) has been very transparent over the past year, loudly signaling a dovish bias and following through with 75bps of rate cuts that took the Cash Rate to a record low of 0.75%. The latest messaging has been a bit more balanced, while still leaving the door to additional rate cuts if the economy worsens. Markets are expecting at least one more easing, with -24bps of rate cuts over the next twelve months priced into the AUD OIS curve, according to our RBA Discounter (Chart 8). What the RBA seems most focused on: The RBA’s main concerns have centered around the persistent undershoot of Australian inflation, with core inflation remaining below the central bank’s 2-3% target band since the beginning of 2016. The central bank has attributed this to persistent excess capacity in the Australian labor market, as evidenced by the elevated underemployment rate. The RBA is also paying close attention to the Australian housing market and its links to consumer spending, with house prices already responding positively to last year’s RBA rate cuts. The outlook for exports is also on the RBA radar, particularly after the recent surge that lifted the Australia trade balance into surplus but is now at risk from a plunge in Chinese demand. What the RBA should be more focused on: We agree that the labor market should be the main focus for the RBA, particularly the underemployment rate which is still high at 8.3%, signaling that core CPI inflation should remain subdued (bottom panel). We also see the RBA as potentially being more sanguine about the risks of a renewed upturn in the housing market than many observers expect, since that would provide a potential offset to a likely pullback in exports which are now a record 25% of GDP (middle panel). Bottom Line: The RBA still has a clear dovish bias, even though they are currently on hold to assess the impact of last year’s easing. RBA Governor Philip Lowe noted in a recent speech that more cuts may be necessary “if the unemployment rate deteriorates”, suggesting that the labor market is the main area of focus for the central bank. Reserve Bank Of New Zealand Chart 9Reserve Bank Of New Zealand: Focus On The Terms Of Trade & Non-Tradeables Inflation Reserve Bank Of New Zealand: Focus On The Terms Of Trade & Non-Tradeables Inflation Reserve Bank Of New Zealand: Focus On The Terms Of Trade & Non-Tradeables Inflation The Reserve Bank of New Zealand (RBNZ) was one of the more dovish central banks in 2019, cutting the Cash Rate by 75bps to a record low of 1%. The overall tone of the central bank’s recent commentary remains cautious, but has taken on a more balanced tone. Markets are priced appropriately, with only -13bps of rate cuts over the next twelve months discounted in the NZD OIS curve according to our RBNZ Discounter (Chart 9). What the RBNZ seems most focused on: The latest messaging from the RBNZ has highlighted the downside risks to New Zealand from weak global growth, but those are now more manageable since the central bank estimates the economy is operating at full employment. In its latest Monetary Policy Statement (MPS), the RBNZ noted that the economy has been able to weather the weakness in global growth thanks to the positive terms of trade effect from elevated New Zealand export prices – a trend that the central bank expects will persist in 2020 even if external demand remains sluggish (middle panel). The central bank has also expressed some concern over the recent pickup in domestically-driven inflation measures, with core CPI inflation back above 2% (bottom panel). What the RBNZ should be more focused on: The RBNZ is right to focus on global growth, particularly given the coming demand shock from virus-stricken China. While the New Zealand dollar has always been a critical variable for the RBNZ in its policy decisions, the currency now takes on added importance given the central bank’s expectation that export prices and the terms of trade will remain elevated. If the latter turns out to be wrong, the RBNZ will be far more likely to take actions to ensure that the Kiwi dollar stays undervalued. Bottom Line: The RBNZ still has a dovish policy bias, but the hurdle to deliver additional rate cuts after last year’s easing seems a bit higher now. It would likely take a major downturn in global growth, combined with a decline in New Zealand export prices and some cooling of domestic inflation, to get the RBNZ to cut again in 2020. Investment Conclusions Based on our “whirlwind tour” of the major developed market central banks in this report, we can make the following conclusions regarding the expected path of interest rates, and bond yields, in these countries: There are no central banks with anything resembling a hawkish bias – not surprising in the current slow global growth environment with heightened uncertainty. The least dovish central banks are the BoC and the RBNZ, which are not signaling any urgency to cut rates. The most dovish central bank is the RBA, which is indicating a clear willingness to cut again if domestic growth deteriorates. The Fed and the BoE are somewhere in the middle of the “dovishness” spectrum, with both likely willing to ease policy but only under a specific set of circumstances. The ECB and BoJ are clearly boxed in having policy rates already below the zero bound, limiting their ability to ease further if needed. In our view, the rate cut probabilities in the US and Canada seem a bit too aggressive, as we are not anticipating major growth slowdowns in either country over the next 6-12 months.  Looking back at our Central Bank Discounters, the largest amount of rate cuts over the next year are now discounted in the US (-42bps), Canada (-32bps), Australia (-24bps) and the UK (-19bps). At the same time, the fewest cuts are priced in Japan (-6bps), the euro area (-7bps) and New Zealand (-13bps). In our view, the rate cut probabilities in the US and Canada seem a bit too aggressive, as we are not anticipating major growth slowdowns in either country over the next 6-12 months. The odds seem more “fair” in the other countries, in terms of the size of rate cut expectations versus the probability of those cuts actually being delivered because of domestic economic considerations. What does this all mean for global bond investing this year? For that we can turn to our Global Golden Rule framework, which links expected returns of government bonds versus cash to the difference between actual and expected rate cuts.1 US Treasuries and Canadian government bond yields are most at risk of underperforming their global peers in 2020 as the Fed and BoC disappoint the current dovish rate cut expectations discounted in interest rate markets.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1 Please see BCA Research Global Fixed Income Strategy Special Report, "The Global Golden Rule Of Bond Investing", dated September 25th 2018, available at gfis.bcaresearch.com. Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index What Central Banks Are (Or Should Be) Watching What Central Banks Are (Or Should Be) Watching Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Highlights Net inflows into US assets have been rolling over since the beginning of 2019, given that the repatriation associated with the 2017 tax cuts was a one-off effect. Besides, fading interest rate differentials are making US Treasuries less attractive, which is a headwind for the greenback.  A trade war ceasefire between the US and China should improve the balance of payments dynamics for export-oriented nations. We maintain a pro-cyclical stance.  A revival in oil demand and curbs on supply should underpin oil prices through 2020, which could lift the trade balances of Norway and Canada. However, we expect the Canadian dollar to underperform, weighed by pipeline constraints and the divergence between WCS and WTI prices. Stay short CAD/NOK. Feature The balance of payments is one of the key indicators we watch on a regular basis to gauge the direction of exchange rates. While the power of BoP on currency moves differs from one country to another, it provides a big picture view of a country's transactions with other nations. Generally speaking, persistent surpluses are usually associated with appreciation in currencies, and vice versa. Ongoing trade disputes since early 2018 have caused some fluctuation in current account balances globally. Political uncertainties and rising protectionism have also limited foreign investments in some countries. Going forward, should global growth stabilize amid a possible trade détente, export-oriented regions will have more scope to improve their balance of payments dynamics. In what follows we present balance of payments across G10 through five categories: the trade balance, the current account balance, foreign direct investment, the basic balance, and lastly, portfolio investment. United States Chart 1US Balance Of Payments US Balance Of Payments US Balance Of Payments The US trade deficit has been more or less flat, lingering around 3% of GDP. The trade deficit mostly comes from manufactured goods. On the positive side, the US has been producing and exporting more petroleum and related products, which has decreased oil demand from abroad. Meanwhile, exports of pharmaceutical products are on the rise. The current account is at a smaller deficit of 2.5% of GDP, thanks to a positive net international investment position. Foreign direct investment had been increasing due to repatriation by US companies since the 2017 Trump tax cuts. If this one-off tax break was a source of US dollar strength in 2018, that support is now gone. Meanwhile, dollar strength since the beginning of 2018 may have made US assets less attractive to foreign investors. Since the beginning of 2019, net inflows into US assets have been rolling over, and have fallen to 0.9% of GDP. This has brought the US basic balance down to -1.6% of GDP. In terms of portfolio investment, US bond markets are still appealing to foreign investors, but interest rate differentials are moving against the greenback. Total foreign purchases of US Treasury bonds have been negative this year, of which official purchases stand at US$350 billion of net outflows. In short, the path of least resistance for the US dollar is down, due to a widening current account deficit, waning foreign direct investment, fading interest rate differentials and increasing dollar liquidity. Euro Area Chart 2Euro Area Balance Of Payments Euro Area Balance Of Payments Euro Area Balance Of Payments The slowdown in global trade has hit European exports, but the trade balance is still sporting a “healthy” surplus of 1.7% of GDP, albeit far below its peak. As a result, the current account as of September 2019 was still at a healthy level of 2.7% of GDP. Should a US-China "phase one" deal be finalized, the trade balance in the euro area is likely to rebound going into 2020. Foreign direct investment has been increasing to the point of being at its highest level over the past 20 years, or 1% of GDP. This has been aided in part by the peripheral countries, further evidence that we are getting a convergence in competitiveness across Eurozone countries. The cheap euro and lower cost of capital have helped. As a result, the basic balance for the euro area reached a new high of 3.8% of GDP in September 2019. Portfolio investment into the euro area has stopped deteriorating since the beginning of 2017 and is now sporting net inflows of 0.8% of GDP. European purchases of both foreign equities and foreign bonds are falling, probably a sign that domestic assets are becoming more attractive. For example, ETF inflows are accelerating. The restart of the European Central Bank’s asset purchase program will continue to act as an anchor for spread convergence in the euro area. Meanwhile, a rally in European equities will be another signal of recovery in the euro area. A healthy current account balance and improving foreign investments both signal a higher euro going forward. Japan Chart 3Japanese Balance Of Payments Japanese Balance Of Payments Japanese Balance Of Payments The trade slowdown has dealt a small blow to Japan’s current account balance. The trade deficit widened further in 2019, reaching -0.5% of GDP in Q3. Exports have been falling for a 10th consecutive month, weighed down in part by lower sales of auto parts and semiconductor equipment. But these will pick up should a trade truce be reached. Among its major trading partners, sales to the US, China and other Asian countries have fallen, but have risen in the Middle East and Western Europe. That said, Japan’s large net international investment position has helped keep the current account surplus at an elevated level of 3.4% of GDP. Foreign direct investment in Japan has been dismal for many years due to an offshoring of industrial production. Net FDI is currently standing at -4% of GDP, which has brought the basic balance below zero for the first time since 2016. The recent deceleration is further evidence that corporate Japan needs structural reforms. Portfolio investment remains in negative territory mostly due to Japanese residents' large purchases of foreign long-term bonds. Going forward, fund inflows to Japan could face more headwinds with the proposed change to the Foreign Exchange and Foreign Trade Act. The change aims to lower the minimum stake for foreign investors without government approval from 10% to 1%. Other changes include requiring foreign directors to seek permission before becoming a board member. That said, Japan’s large net international investment position, which produces a high current account surplus, will continue to make the yen a safe haven amid global uncertainties. United Kingdom Chart 4UK Balance Of Payments UK Balance Of Payments UK Balance Of Payments So far, a cheap pound has not yet staunched the deterioration in UK balance of payments. The UK trade deficit remained wide at 7% of GDP in the third quarter. Among its major trading partners, the trade deficit comes mainly from Germany and China, offset by a smaller surplus from the US, the Netherlands and Ireland. Net receipts are positive, but the current account balance is still in negative territory at -5% of GDP. The Brexit imbroglio has led to an exodus of foreign direct investment. Many international companies are fleeing the UK, but to the extent that we get a quick resolution after the December elections, the uncertainty is likely to subside. Portfolio investment in the UK has been volatile over the past few years and has not really helped dictate any discernable trend in the UK basic balance. More recently, inflows into UK gilts have been £19 billion in the second quarter, while flows into equities are also improving. Relative interest rate differentials are also likely to move in favor of the UK, especially if reduced uncertainty provides scope for the Bank of England to hike interest rates. At a minimum, compared with other European nations, gilts remain appealing to international investors. We remain positive on the pound and are long GBP/JPY in our portfolio. Canada Chart 5Canadian Balance Of Payments Canadian Balance Of Payments Canadian Balance Of Payments The Canadian trade deficit has been hovering near -1% of GDP over the past few years. The goods trade deficit narrowed this year, led mostly by an increase in energy exports and lower imports of transportation equipment. Further improvement in energy product sales will require an improvement in pipeline capacity and a smaller gap between WCS and Brent crude oil prices. The current account deficit has been narrowing, now standing at -2% of GDP, the smallest since 2008. This is helped by net receipts, especially driven by a rise in direct investment income. FDI has been the bright spot in Canadian BoP dynamics. FDI inflows have been in part helped by increased cross- border M&A activities. Net FDI into Canada now accounts for 2.7% of GDP. This has brought the basic balance back above zero for the first time since 2015. Portfolio investment is positive on a net basis, but the trend looks quite worrisome. Foreign entities are fleeing Canada. In the meantime, Canadian investment in foreign securities is on the rise, reaching C$6 billion in Q3. Profitability, liquidity concerns and a global push towards sustainable investing are making Canadian energy and mining companies unappealing for foreign capital. Moreover, with elevated house prices and depressed interest rates, the outlook for banking profitability is also concerning. A drop in the US dollar will help the loonie in the short term. Over the longer term, however, we prefer to be underweight the Canadian dollar, especially via the Australian dollar and the Norwegian krone, which have a better macro outlook. Australia Chart 6Australian Balance Of Payments Australian Balance Of Payments Australian Balance Of Payments Australia has seen the best balance of payments improvement among the G10. The Australian trade balance soared this year and now stands at 2.5% of GDP, the highest in several years. Terms of trade, which have increased by 45% since their 2016 bottom, have been one of the main drivers. Exports of iron ore and concentrates increased by 64% year-on-year in September 2019, adding to the positive trade balance. Ergo, Australia is benefitting from both a price and volume boost. Trade has lifted the current account to be on track to post its first surplus since the ‘70s. Going forward, we expect Australian trade to continue improving amid the US-China trade détente. Foreign direct investment dipped slightly in 2019, but from very elevated levels. At present, it still stands at 3.5% of GDP. This has allowed for a very healthy basic balance surplus of 2.9% of GDP. The largest sources of Australian foreign direct investment are the US and the UK. The FDI inflows tend to be concentrated in the mining and manufacturing sectors and generate a negative income balance for Australia. This has been part of the reason behind the country’s chronic current account deficit, but it is impressively becoming less and less important. Portfolio investment in Australia plunged in 2019, and now stands at -4.2% of GDP. This has been driven by an exodus from the bond market. The repatriation of capital back to the US probably helped exacerbate this trend. The Australian dollar is likely to rebound from a contrarian perspective. We are playing Aussie dollar strength via the New Zealand and Canadian dollars. New Zealand Chart 7New Zealand Balance Of Payments New Zealand Balance Of Payments New Zealand Balance Of Payments New Zealand is also benefitting from a terms-of-trade boost. The trade deficit marginally narrowed to -1.7% of GDP in the third quarter. Exports rose by 4% year-on-year in the third quarter, while imports rose by 3.6% year-on-year. Terms of trade increased in 2019, mainly driven by a rise in dairy and meat prices. It appears the pork crisis in China is benefitting New Zealand exports. As a result, the current account deficit narrowed slightly to 3.4% of GDP. Foreign direct investment in New Zealand rose sharply to 3.1% of GDP, partly driven by reinvestment in the banking sector. This almost brought the basic balance back into positive territory. If this trend continues, it will be the first time the basic balance is in positive territory in two decades. Portfolio investment in New Zealand has been deteriorating, with net outflows of $6.2 billion in the second quarter. This is almost 4% of GDP on an annualized basis. The withdrawal of equity and investment fund shares by foreign entities, as well as divestment of debt securities by the general government, are some of the reasons behind falling portfolio investment. In a nutshell, increased portfolio investment in New Zealand will be predicated on a terms-of-trade shock that boosts margin growth for agricultural exporters, or a policy shift that boosts domestic return on capital. We like the kiwi versus the dollar, but are underweight against its pro-cyclical peers, namely the Australian dollar and the Swedish krona. Switzerland Chart 8Swiss Balance Of Payments Swiss Balance Of Payments Swiss Balance Of Payments The Swiss trade balance has been in a structural surplus, and hugely underpins the nation’s large current account surplus. The improvement this year, a rebound to 5.4% of GDP in the third quarter, is notable. The increase in exports has been partly driven by higher sales of chemical and pharmaceutical products, jewelry, and metals. Combined with income inflows from its large net international investment position, this has produced a current account balance of 10.7% of GDP. The slowdown in foreign direct investment has eased sharply from a record-low of -16% to -8% of GDP. Tax breaks from the US Jobs Act in 2017 allowed for favorable divestment of FDI in Switzerland and repatriation back to the US. This was a one-off that is now behind us, which explains why the basic balance is shifting back into surplus territory, to the tune of 2.5% of GDP.  Portfolio investment has been gradually improving and now stands at 0.3% of GDP. Swiss paper and equities (which are defensive) have benefitted from increased safe-haven demand this year. The Swiss franc is likely to continue its slow structural appreciation in the years to come, interspersed with bouts of volatility. In the short-term, however, the Swiss National Bank is likely to use the currency to fight deflationary pressures. This suggests the EUR/CHF has upside tactically. Sweden Chart 9Swedish Balance Of Payments Swedish Balance Of Payments Swedish Balance Of Payments The Swedish trade balance has been in structural decline since 2004 and turned negative in 2016. A large component of Swedish exports are machinery and automobiles which have suffered stiff competition from other global giants. The good news is that the weak krona is starting to help. The third-quarter trade balance shifted to a surplus for the first time since 2016 and is currently standing at 0.2% of GDP. Combined with inflows from Sweden’s external investments, this has nudged the current account balance to 3.3% of GDP. Despite net FDI inflows falling to -2.1% of GDP, the basic balance still managed to remain stable at 1.2% of GDP due to the improvement in the current account balance. The recent decline in Swedish FDI has mirrored those in other countries. However, Swedish exports will benefit from a trade détente as well as from a broader improvement in global growth. This should stem FDI outflows. Net portfolio investment in Sweden has been volatile in recent years, but our expectation is for improvement. A weak krona has typically helped the manufacturing sector with a lag of 12 months. Moreover, with the krona trading at a large discount to its long-term fair value, foreign investors will likely benefit from both equity and currency returns, should cyclical stocks continue to outperform defensives. In summary, Sweden’s basic balance should recover to levels that have prevailed over the past few years. Norway Chart 10Norwegian Balance Of Payments Norwegian Balance Of Payments Norwegian Balance Of Payments The bottom in oil prices since 2016 has gone a long way towards improving Norway’s trade balance. Net trade has fallen marginally this year due to lower exports of oil and natural gas, but still stands at 7.2% of GDP. The trade balance is the primary driver of the current account balance, and the latter now stands at 6.4% of GDP. Norway has seen an exodus of foreign capital from both direct and portfolio investment.  Net FDI and portfolio investment stand at -3% and -4% of GDP, respectively. Declining oil production in the North Sea has been partly responsible for falling FDI. On the portfolio side of the equation, it has been mainly due to increased purchases of foreign equities and bonds, especially via the Oil Fund. Concerns around sustainable investing have also likely diverted investors away from Norwegian assets. Despite this, Norway still sports a basic balance surplus of 3.4% of GDP. Eventually, this basic balance will move from being supported by trade to income inflows from Norway’s large net international investment position. The Norwegian krone is cheap on many metrics, and is one of our favorite petrocurrencies at the moment. Should global growth stabilize, which will revive oil demand, inflows into Norway should improve.   Kelly Zhong Research Analyst kellyz@bcaresearch.com Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Dear Client, In addition to this short weekly report, you will also receive our 2020 outlook, published by the Bank Credit Analyst. Next week, I will be on the road visiting clients in South Africa. I hope to report my discussions and findings the following week. Best regards, Chester Ntonifor Highlights According to a simple attractiveness framework, the most desirable currencies are the Norwegian krone, the Swedish krona, and the Japanese yen. The least attractive are the New Zealand dollar and the British pound. Take profits soon on our long GBP/JPY position. Feature In this report, we use a simple framework for ranking G10 currencies. First, we consider the macroeconomic environment using as proxies a country’s basic balance and external vulnerability. Next, we look at valuation metrics,  surveying a variety of both short-term and longer-term models. Finally, we consider positioning, to gauge if our view is mainstream or out of consensus. Below are our results. Basic Balance Chart I-1Basic Balance A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies We consider the basic balance to be one of the most important concepts in determining the attractiveness of a currency. In a nutshell, it captures the ebb and flow of demand for a country’s domestic assets. Persistent basic balance surpluses are usually associated with an appreciating currency and vice versa. The euro area sports the best basic balance surplus in the G10 universe, followed by Norway and then Australia (Chart I-1). In simple terms, this means there is constant strong underlying demand for these currencies - either for domestic goods and services, or for investment into portfolio assets. The UK and the US rank the worst in terms of basic balances, driven by Brexit uncertainty and the ebbing of tax reform benefits in the US. We will explore balance of payments dynamics within all of the G10 countries in detail next week. External Debt A currency is sometimes only as vulnerable as its external liabilities. In an absolute sense, external debt as a share of GDP is highest in the UK, euro area, and Switzerland (Chart I-2). However, what matters most times for vulnerability are net external assets rather than gross liabilities. On this measure, Japan, Switzerland, and Norway are the most attractive countries, while the US and Australia rank the worst (Chart I-3). Chart I-2External Vulnerability A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies Chart I-3US Is Least Attractive A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies Purchasing Power Parity (PPP) Chart I-4PPP Model A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies Various models have shown PPP to be a very poor tool for managing currencies, but an excellent one at extremes. However, there is a roadblock that comes from measurement issues, since consumer price baskets tend to differ in composition from one country to the next. In order to get closer to an apples-to-apples comparison across countries, two adjustments are necessary. First, categorizing the consumer price index (CPI) into five major groups. In most cases, this breakdown captures 90% of the national CPI basket. This includes food, restaurants and hotels (1), shelter (2), health care (3), culture and recreation (4), and energy and transportation (5). The second adjustment is to run two regressions with the exchange rate as the dependent variable. The first regression (call it REG1) uses the relative price ratios of the five groups as independent variables. This allows us to observe the most influential price ratios that help explain variations in the exchange rate. The second regression (call it REG2) uses a weighted average combination of the five groups to form a synthetic relative price ratio. If, for example, shelter is 33% in the US CPI basket, but 19% in the Swedish CPI basket, relative shelter prices will represent 26% of the combined price ratio. This allows for a uniform cross-sectional comparison, as opposed to using the national CPI weights. The US dollar is overvalued, especially versus the Swedish krona, Japanese yen, and Norwegian krone.  The results show the US dollar as overvalued, especially versus the Swedish krona, Japanese yen, and Norwegian krone. Commodity currencies are closer to fair value, and within the safe-haven complex, the Japanese yen is more attractive than the Swiss franc. The euro is less undervalued than implied by the overvaluation in the DXY index (Chart I-4). Intermediate-Term Timing Model (ITTM) Back in 2016, we developed a set of currency indicators to help global portfolio managers increase their Sharpe ratio in managing currency exposure. The idea was quite simple: For every developed world country, there were three key variables that influenced the near-term path of its exchange rate versus the US dollar. Our intermediate-term timing models are not sending any strong signals at the moment.  Interest Rate Differentials: Under the lens of interest rate parity, if one country is expected to have lower interest rates versus another, the incumbent’s currency will fall today so as to gradually appreciate in the future and nullify the interest rate advantage. Chart I-5Intermediate-Term Model A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies Inflation Differentials: Assuming no transactional costs, the price of sandals cannot be relatively high and rising in Mumbai versus Auckland. Either the Indian rupee needs to fall, the kiwi rise, or a combination of the two has to occur to equalize prices across borders. Risk Factor: Exchange rates are not government bonds in that few treasury departments and central banks can guarantee a par value on them. Ergo, the ebb and flow of risk aversion will have an impact on the Norwegian krone as well as the yen. For the most part, our models have worked like a charm. On a risk-adjusted return basis, a dynamic hedging strategy based on our ITTMs has outperformed all static hedging strategies for all investors with six different home currencies since 2001. These results give us confidence to continue running these models as a sanity check for our ever-shifting currency biases. That said, our intermediate-term timing models are not sending any strong signals at the moment. The Swedish krona, Norwegian krone, and New Zealand dollar are the most attractive currencies, while the British pound and Swiss franc are the least attractive (Chart I-5). Long-Term Fair Value Model Chart I-6Long-Term Model A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies Our long-term FX models are also part of a set of technical tools we use to help us navigate FX markets. Included in these models are variables such as productivity differentials, terms-of-trade shocks, net international investment positions, real rate differentials, and proxies for global risk aversion. These models cover 22 currencies, incorporating both G10 and emerging market FX markets. The models are not designed to generate short- or intermediate-term forecasts. Instead, they reflect the economic drivers of a currency's equilibrium. Their main purpose is to provide information on the longevity of a currency cycle, depending on where we are in the economic cycle. Our long-term FX models are not sending any strong signals right now, with the US dollar at fair value. The cheapest currencies are the yen, the Norwegian krone, and Swedish krona (Chart I-6). The priciest currencies are the South African rand and the Saudi riyal. Real Interest Rates One defining feature of the currency landscape is that pretty much across the G10 countries, we have negative real rates (Chart I-7). Within  the G10 universe, the US and New Zealand dollars are the highest-yielding currencies, while the British pound and Swedish krona are the least attractive. Chart I-7Real Rates A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies Speculative Positioning Being long Treasurys and the dollar has been a consensus trade for many years now (Chart I-8). According to CFTC data, this has been expressed mostly through the aussie and kiwi, although our bias is that the Swedish krona and Norwegian krone have been the real victims. Chart I-8Positioning A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies That said, flow data highlights just how precarious being long US dollars is right now. Net foreign purchases by private investors are still positive, but the momentum of these flows is clearly rolling over. This is being more than offset by official net outflows. As interest rate differentials have started moving against the US, so has foreign investor appetite for Treasury bonds. Concluding Thoughts Should the nascent pickup in global growth morph into a synchronized recovery, it will go a long way in further eroding the US’ yield advantage. More specifically, the currencies that have borne the brunt of the manufacturing slowdown should also experience the quickest reversals. For example, yields in Norway, Sweden, Switzerland, and Japan have risen by much more than those in the US since the bottom. The most attractive currencies are the Swedish krona, the Norwegian krone, and the Japanese yen. The least attractive are the British pound and New Zealand dollar. This is the message being sent by an aggregate of our ranking model. The most attractive currencies are the Swedish krona, the Norwegian krone, and the Japanese yen. The least attractive are the British pound and New Zealand dollar (Chart I-9). Take profits soon on our long GBP/JPY position. Chart I-9Favor Norway, Japan and Sweden A Simple Attractiveness Ranking For Currencies A Simple Attractiveness Ranking For Currencies   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been mixed: Retail sales grew by 0.3% year-on-year in October. Industrial production contracted by 0.8% month-on-month in October. On the housing market front, building permits and housing starts both increased by 5% and 3.8% month-on-month in October. However, MBA mortgage applications contracted by 2.2% for the week ended November 15th. The NY Empire State Manufacturing index fell to 2.9 from 4 in November. The Philly Fed manufacturing index, on the other hand, soared to 10.4 from 5.6 in November. The DXY index depreciated by 0.3% this week. The FOMC minutes released this Wednesday showed that the Fed now sees little need to further reduce rates. Last week, we did a reassessment of global growth and the USD, and entered a limit sell for the DXY index at 100. Report Links: Place A Limit Sell On DXY At 100 - November 15, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4UR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been mostly positive: The seasonally-adjusted trade balance fell to €18.3 billion in September. The current account surplus slightly narrowed by €0.3 billion to €28.2 billion. Headline and core inflation were both unchanged at 1.1% and 0.7% year-on-year respectively in October. Consumer confidence improved from -7.6 in October to -7.2 in November. EUR/USD increased by 0.5% this week. The improvement in soft data confirms that the economy is in a bottoming process in the euro area. The fact that the largest economy, Germany, skirted a recession last week also boosted investor confidence. We continue to remain overweight the euro. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Battle Of The Central Banks - June 21, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been positive: Exports decreased by 9.2% year-on-year in October. Imports slumped by 14.8% year-on-year. The total trade balance shifted to a surplus of ¥17.3 billion.  The industry activity index increased by 1.5% month-on-month in September. USD/JPY fell by 0.2% this week. While global growth is set to improve given a possible trade détente and easy monetary policy worldwide, uncertainties continue to loom. The US Senate unanimously passed legislation on the "Hong Kong Human Rights and Democracy Act," adding more difficulties to finalize the Phase I trade deal. Global trade uncertainty is positive for safe-haven demand. Report Links: Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 A Few Trade Ideas - Sept. 27, 2019 Has The Currency Landscape Shifted? - August 16, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been positive: The Rightmove house price index increased by 0.3% year-on-year in November. Public sector net borrowing increased by £3 billion to £10.5 billion in October. The British pound continues to appreciate by 0.7% against the US dollar this week. With Brexit being less of a threat, the pound is poised to rise through next year. We are long GBP/JPY in our portfolio and it is in the money at 6.1%. Report Links: A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Battle Of The Central Banks - June 21, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been soft: The Westpac leading index fell by 0.1% month-on-month in October, following a slight decline the previous month. AUD/USD has been more or less flat this week. In the monetary policy minutes released this week, the RBA expressed their expectations for stronger growth at 2.75% in 2020 and around 3% in 2021, supported by accommodative monetary policy, infrastructure spending, stabilizing house prices, and strong steel-intensive activities in China. The minutes also presented an argument against lower interest rates: while lower interest rates can support the economy through the usual transmission channels, they could be negative for savers and confidence. That said, the RBA is "prepared to ease monetary policy further if needed." Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been positive: Both output and input components of the producer price index have increased in Q3: the output component grew by 1% quarter-on-quarter and input component by 0.9% quarter-on-quarter. NZD/USD increased by 0.7% this week. Both growth and inflation in New Zealand are showing signs that the economy is in a bottoming process. We are positive on the kiwi against the US dollar while we remain short against the Australian dollar and Swedish Krona. Report Links: Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Where To Next For The US Dollar? - June 7, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: Manufacturing shipments fell by 0.2% month-on-month in September. Both headline and core inflation were unchanged at 1.9% year-on-year in October. ADP employment showed a loss of 22.6K jobs in October. The Canadian dollar fell by 0.6% against the US dollar this week. While a possible trade détente between US and China and rising oil prices could put a floor under the loonie, the pipeline constraints in Canada have dampened the correlation between the oil prices and the loonie.  This will limit the upside potential for the Canadian dollar. Report Links: Making Money With Petrocurrencies - November 8, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 Preserving Capital During Riot Points - September 6, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been positive: The trade surplus narrowed to CHF 3.5 billion in October from CHF 4.1 billion the previous month, due primarily to growth in imports, which grew by 1.9 billion month-on-month. Exports also increased by 1.3 billion month-on-month. Import demand remains firm for chemical products. Industrial production grew by 8% year-on-year in Q3. USD/CHF increased by 0.2% this week. The trade balance still remains at a high level in Switzerland, which is bullish for the franc. Moreover, global uncertainties could underpin the safe-haven franc. Report Links: Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been positive: The trade balance shifted to a surplus of NOK 5.9 billion in October, after a deficit of NOK 1.4 billion in September. However, this is compared to a surplus of NOK 32.6 billion in the same month last year. On a year-on-year basis, exports slumped by 27%, caused by a decrease in exports of mineral fuels and chemical products. The Norwegian krone appreciated by 0.3% against the US dollar this week, supported by the oil price recovery. On Wednesday, the EIA posted an increase of crude oil inventories by 1.4 million barrels from the previous week, lower than expectations. WTI crude oil prices thus surged by 4% on the news. Going forward, we remain overweight energy prices and the Norwegian krone. Report Links: Making Money With Petrocurrencies - November 8, 2019 A Few Trade Ideas - Sept. 27, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been positive: Capacity utilization increased to 0.5% in Q3, up from 0.1% in the previous quarter. The Swedish krona increased by 0.7% against the US dollar this week. The Swedish krona has depreciated by 23% against the USD since its 2018 peak. A global growth revival is likely to give a boost to the krona from a valuation perspective. Report Links: Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Global Growth: The latest readings from our global leading economic indicator and the global ZEW index show further improvement in growth momentum. Maintain a below-benchmark stance on global duration, favoring inflation-linked bonds/swaps over nominal bond exposure, while positioning for steeper government bond yield curves. New Zealand: The RBNZ is likely done cutting rates, amid signs that the momentum is bottoming for both growth and inflation in New Zealand. Take profits on our long-standing recommended NZ-US and NZ-Germany 5-year government bond spread trades. Feature Investors have a lot of information to process at the moment. The daily ebb and flow of headlines on the US-China trade negotiations remains the biggest source of intraday volatility. Yet there are also mixed signals coming from economic data releases. “Soft” survey data like global manufacturing PMIs are showing some improvement, while “hard” measures of economic activity like export volumes and capital goods orders continue to languish in both the developed and emerging economies. As we have discussed in recent reports, these sorts of cross-currents are typical at cyclical inflection points. “Hard” data is reported with a lag after “soft” data, making the latter a better indicator of future economic activity than exports or fixed investment data (or even GDP data) that can be several months old once reported, reducing their market-moving relevance. The indicators that we trust the most are sending a bullish message on growth – and a bearish message for government bonds. When global growth is in the process of bottoming, as appears to be the case now, leading economic indicators are more reliable guides to follow for investment decision-making. To that end, the indicators that we trust the most are sending a bullish message on growth – and a bearish message for government bonds. The Latest From Our Global LEI & Global ZEW Chart of the WeekMore Cyclical Upward Pressure On Bond Yields More Cyclical Upward Pressure On Bond Yields More Cyclical Upward Pressure On Bond Yields We received updates on two of our most reliable indicators – our global leading economic indicator (LEI) and the global ZEW expectations index – last week. Both showed broad-based improvement, highlighting that the sharp downward momentum in global growth seen over the past year is in the process of bottoming out. The global LEI and the global ZEW index are key inputs into our Duration Indicator, which has historically led developed market bond yields by between six and nine months (Chart of the Week). The Duration Indicator bottomed back in January of this year and, right on cue, the yield on the Bloomberg Barclays Global Treasury Index has gone up 28bps from the low seen on September 3. The improvement in our global LEI is also broad based. The diffusion index (i.e. the share of countries with a rising LEI) shows that around 75% of the countries in the global LEI are experiencing improved economic activity. Importantly, that share is consistent across both the developed market (DM) and emerging market (EM) nations in the indicator, heralding a synchronized improvement in global growth. (Chart 2).   In absolute level terms, however, the EM sub-component of our global LEI has shown the most dramatic improvement over the past several months, compared to the DM sub-index that is only in the process of bottoming out. The EM index is boosted by improvements in large economies like China and Mexico – countries that have seen significant easing of monetary policy and financial conditions over the past 6-9 months. At the same time, the lagging performance of the DM component of our global LEI is consistent with the more subdued signals to date from the individual DM country data. The US LEI continues to drift lower, while the LEIs within the euro area for Germany, Italy and (most notably) France have all been moving higher (Chart 3). Even the Japan and UK LEIs have picked up a bit, although both remain at only moderate levels. At the same time, the expectations components of the individual country ZEW surveys have all begun to increase (bottom panel), despite more mixed performance within the current conditions components of the same ZEW survey (top panel). Chart 2Our Global LEI Continues to Climb, Led By EM Our Global LEI Continues to Climb, Led By EM Our Global LEI Continues to Climb, Led By EM Chart 3A Mixed Bag Of DM Growth Indicators A Mixed Bag Of DM Growth Indicators A Mixed Bag Of DM Growth Indicators Without a doubt, a reduction of US-China trade tensions would flatter the bullish growth signals seen in the global LEI and ZEW indices. Yet the turn in these indicators is so consistent, across so many countries, that we suspect it has more to do with the easier monetary policies, and the associated loosening of financial conditions, that have taken place in response to the uncertainty over global trade. The turn in these indicators is so consistent, across so many countries, that we suspect it has more to do with the easier monetary policies, and the associated loosening of financial conditions, that have taken place in response to the uncertainty over global trade. Taken together, these signals are all bond-bearish, on the margin. The diffusion index of our global LEI has proven to be an excellent leading indicator of the real component of DM bond yields, leading the latter by around one year, and is pointing to higher yields ahead (Chart 4). At the same time, the inflation expectations component of DM yields (measured using CPI swaps rates) is also expected to drift higher in the next 6-12 months, led by firmer oil prices and some softening of the US dollar. Global central banks will maintain a dovish bias over at least the first half of 2020, to ensure that there is enough positive growth momentum to push inflation expectations back up towards policymaker targets. This means that there can be some modest bear-steepening of government bond yield curves across the major DM nations over the next 6-9 months (Chart 5), as policymakers will not begin to raise policy interest rates too soon. Chart 4Global Yields Moving Higher For The Usual Reasons Global Yields Moving Higher For The Usual Reasons Global Yields Moving Higher For The Usual Reasons Chart 5Higher Inflation Expectations = Steeper Yield Curves Higher Inflation Expectations = Steeper Yield Curves Higher Inflation Expectations = Steeper Yield Curves Chart 6Global Yields Starting To Climb Above Moving Averages Global Yields Starting To Climb Above Moving Averages Global Yields Starting To Climb Above Moving Averages The notable exception is the UK. Inflation expectations there are already elevated due to Brexit uncertainty, which has depressed the pound and reduced UK productivity growth while forcing the Bank of England to maintain highly accommodative monetary policy – all factors that should result in higher UK inflation, both realized and expected. Yet even there, the nominal Gilt curve has been bear-steepening of late, alongside the similar trends seen in the other major DM countries like the US and Germany. The move upward in global bond yields suggested by our most reliable leading indicators suggests more of a slow grinding increase in yields (through higher inflation expectations) rather than a rapid acceleration of real rates. The latter would require a shift towards more hawkish central bank monetary policies, which will not happen before there is a sustained pickup in both growth momentum and inflation expectations. The Federal Reserve is the central bank that is likely to lead that transition, but not until late in 2020 and perhaps not until after the November US presidential election. At the country level, the move upward in yields since the early September lows has begun to take out some technical targets (Chart 6). The benchmark 10-year government bond yield is above the 100-day moving average for the major DM countries (the US, Germany, UK, Japan, Canada and Australia). The 200-day moving averages represent the next key resistance level for those markets. The 10-year yield in Japan has already breached that level, perhaps signaling that similar breakouts are on the way in other major markets. Bottom Line: The latest readings from our global leading economic indicator and the global ZEW index show further improvement in growth momentum. Maintain a below-benchmark stance on global duration, favoring inflation-linked bonds/swaps over nominal bond exposure, while positioning for steeper government bond yield curves. Time To (Finally) Take Profits On Our New Zealand Spread Trades We have been structurally positive on New Zealand (NZ) government bonds since mid-2017. This was originally a shorter-term “tactical” view based on expectations that the Reserve Bank of New Zealand (RBNZ) would be forced to keep policy rates steady due to sub-par domestic economic growth and sluggish inflation. Since this was occurring at a time of improving global economic growth in 2017, especially in the US and euro area, we expressed our view as spread trades between 5-year government bonds in NZ versus equivalent maturity debt in the US and Germany (hedged back into US dollars and euros, respectively). The “tactical” trade turned into a medium-term recommendation, as the NZ economy and inflation slowed more than expected. NZ government bonds significantly outperformed global peers as a result, helping boost the returns on our recommended trades. The 5-year NZ-US yield spread has fallen from +74bps when we first initiated the trade to -52bps today, while the spread for 5-year NZ-Germany has narrowed from +292bps to +171bps (Chart 7). We now see several good reasons to take profits on those long-standing positions: NZ economic growth is set to improve The year-over-year growth rate of real GDP in NZ has slowed from 3.1% in mid-2017 (when we initiated our spread trades) to 2.1% in the Q2/2019 (Chart 8). This has occurred in both the manufacturing and services sides of the economy, based on the sharp drop in the PMIs (middle panel). Export growth has also slowed, particularly during the recent global manufacturing downturn, leading to sharp declines in business confidence and capital spending plans. The economic weakness was enough to push NZ real GDP growth below the rate of potential GDP - which is estimated by the RBNZ to have fallen from 3% to 2.5% due primarily to slowing population growth related to reduced net immigration into the country. Chart 7NZ Bonds Have Solidly Outperformed NZ Bonds Have Solidly Outperformed NZ Bonds Have Solidly Outperformed Chart 8NZ Growth Should Soon Bottom Out NZ Growth Should Soon Bottom Out NZ Growth Should Soon Bottom Out The long slump in NZ manufacturing appears to have ended, however. The manufacturing PMI index jumped 3.8 points to 52.6 in October, with the New Orders component rising 5.3 points to 56.2. This pushed the New Orders-to-Inventories ratio – a leading indicator of overall NZ business sentiment – to the highest level since March 2017 (bottom panel). The domestic side of the NZ economy is also set to improve (Chart 9). Consumer spending has been weighed down by both the structural factor of slowing immigration and the cyclical factor of slowing house prices. Median NZ house price growth has perked up of late, however, in response to the RBNZ’s rate cuts this year, which should help boost consumer spending through wealth effects. Business investment should also start to speed up as manufacturing activity improves, especially with the terms of trade (relative prices of NZ exports to imports) now starting to accelerate (middle panel). The external side of the economy is also set for some improvement. In the November 2019 RBNZ Monetary Policy Statement (MPS) published last week, the central bank laid out a very cautious forecast for an increase in the GDP growth of NZ’s trading partners in 2020 (bottom panel). The sharp pickup in the EM component of our global LEI, however, suggests that global growth, and demand for NZ exports, may be much stronger than the central bank envisions next year. NZ’s economy is running at close to full capacity In the November MPS, the RBNZ also presented its own estimates for spare capacity in the NZ economy, using a variety of economic models for both the output gap and the full employment “NAIRU” (Chart 10). The median estimate of the output gap models is around 0% and is expected to stay around those levels for the next two years. The NZ unemployment rate is projected to be stable around 4% through 2020, which is close to the median model estimate of NAIRU. Thus, by the central bank’s own reckoning, the NZ economy is running at full capacity. Chart 9An Upside Growth Surprise In 2020? An Upside Growth Surprise In 2020? An Upside Growth Surprise In 2020? Chart 10NZ Does Not Need More Rate Cuts NZ Does Not Need More Rate Cuts NZ Does Not Need More Rate Cuts The RBNZ also produces model estimates of the neutral level of its policy rate, the Overnight Cash Rate (OCR). The current OCR of 1.0% is at the low end of the range of model estimates (bottom panel). This seems inconsistent with an economy that may be operating with no spare capacity, as the RBNZ’s other models suggest. Those models appear to be giving an accurate read on the inflationary tendencies of the NZ economy, though. Underlying NZ inflation is accelerating While headline CPI inflation fell to 1.5% in Q3/2019, close to the bottom of the RBNZ’s 1-3% target band, core CPI inflation accelerated to 1.9% - just below the midpoint of the band (Chart 11). The decline in headline inflation can be attributed to weakness in the tradeables component of the CPI, but this should soon start to increase based on the lagged impact of the acceleration of energy prices denominated in NZ dollars (middle panel). With both growth and inflation dynamics now bottoming out in NZ, the RBNZ’s recent rate cuts may be working too well. Meanwhile, non-tradeables (i.e. domestically generated) CPI inflation has accelerated over the past few quarters and is now at 3.2% - above the top end of the RBNZ inflation band. This has occurred alongside an acceleration of average hourly earnings growth to 4.2%, suggesting a tight labor market that confirms the message from the RBNZ’s NAIRU models. NZ monetary conditions are now very easy With both growth and inflation dynamics now bottoming out in NZ, the RBNZ’s recent rate cuts may be working too well. The central bank also produces estimates of the neutral real rate in NZ, using the same “r*” framework used by the US Federal Reserve (Chart 12). The neutral real rate is estimated to be 1.25% which, when added to the 2% midpoint of the RBNZ’s target band, produces a neutral nominal rate of 3.25% - a whopping 225bps above the current OCR rate. Chart 11NZ Inflation Bottoming Out NZ Inflation Bottoming Out NZ Inflation Bottoming Out Chart 12NZ Monetary Conditions Now Appear Too Easy NZ Monetary Conditions Now Appear Too Easy NZ Monetary Conditions Now Appear Too Easy With rates so far below neutral in nominal terms, it is no surprise that the NZ dollar is at such low levels versus both the US dollar and the euro (bottom panel). This is providing an additional easing of monetary conditions that will help boost NZ growth and inflation over at least the next year – and likely force the RBNZ to stop cutting rates and, perhaps, even begin to lay the groundwork for taking back some of the 2019 rate reductions. In sum, the combination of improving growth momentum, accelerating inflation dynamics, loose monetary policy settings, and overvaluation make a powerful case for closing out our NZ-US and NZ-Germany spread trades at a healthy profit. NZ yields look too low versus the US and Germany Our fair value regression models for both the 5-year NZ-US spread (Chart 13), and the 5-year NZ-Germany spread (Chart 14), are both signaling that NZ government bonds are relatively expensive. These models estimate the fair value of the spreads as a function of relative central bank policy rates, relative unemployment rates and relative inflation rates. Both models suggest that the cross-country yield spreads have tightened too much relative to the economic fundamentals of NZ, the US and Germany. Chart 13NZ Government Bonds Look Expensive Versus US Treasuries ... NZ Government Bonds Look Expensive Versus US Treasuries ... NZ Government Bonds Look Expensive Versus US Treasuries ... Chart 14... And German Government Debt ... And German Government Debt ... And German Government Debt In sum, the combination of improving growth momentum, accelerating inflation dynamics, loose monetary policy settings, and overvaluation make a powerful case for closing out our NZ-US and NZ-Germany spread trades at a healthy profit (see the Tactical Overlay Trade table on Page 16). Bottom Line: The RBNZ is likely done cutting rates, amid signs that the momentum is bottoming for both growth and inflation in New Zealand. Take profits on our long-standing recommended NZ-US and NZ-Germany 5-year government bond spread trades Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index When In Doubt, Trust The Leading Indicators When In Doubt, Trust The Leading Indicators Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns