THE GLOBAL ECONOMIC OUTLOOK
US ELECTIONS AND BEYOND
November 2016
Laurence Boone
Chief Economist, AXA Group Head of Research, AXA IM [email protected]
Key messages US elections: significant change ahead, uncertainty prevails for now
The US election could prove a game changer, well beyond economics World affairs and domestic social issues are likely to be impacted by the Trump election. A radical redefinition of global governance is likely if the US retreats from international commitments On economics, Trump looks set to kick-start the ‘traditional’ boom-bust cycle over the next few years Uncertainty will prevail until Trump is inaugurated. Appointments made until 20th January will only be indicators
Fiscal support could boost the growth outlook in 2017 and especially in 2018 There is agreement between Trump and the Republicans to cut taxes for households and corporates, while the infrastructure spending programme is less consensual More complex: a relaxation of financial regulation is likely, albeit at regional levels. Other important sectors include energy, defence and security, healthcare (reform of the Affordable Care Act) The Fed should turn more hawkish than previously expected and hike twice in 2017, three times in 2018
Trade remains one of the most uncertain areas Renegotiations of NAFTA agreements with Mexico and trade restrictions with China would go against the Republican establishment and the interest of many US firms Trump received a popular mandate to protect manufacturing jobs, however, and has more power to act without Congress
2 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Key messages European outlook: risks from politics
Italian referendum: our base case is “no” but with a small majority PM Renzi has linked his fate to the referendum, but valid if large gap between yes and no Risk: a failed referendum would mean at best low reform dynamic, impact on yield and banks is possible Low but not null risk : forced new elections could lead to political confusion, euro sovereign risk could be back
The French and the German have national elections in 2017, anti-European parties have significant voices French presidential elections are due in April/May 2017 German general elections will take place in fall 2017; AFD rising Dutch general elections in March 2017 could also see far-right surf on anti-EU sentiment
European construction taking a stall? EU has to change for fear of diluting; EMU needs consolidation for full recovery Need a change in Franco-German leadership spirit to make things move What is needed: strong leadership for … true single market, complete banking union, budget only comes third
3 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Key messages Allocation: reduce EM exposure & mind political risk in Europe
Extreme proposals from the Trump administration could hit EM assets Any trade restriction should disproportionately hurt Latin America and Asia. We prefer EM Europe Despite improving fundamentals, EM could experience capital outflows as US bond yields rise Depreciations of EM currencies, especially Mexico, should put pressure on FX reserves and on external debt service
The sell-off in rates can be sustained Inflation expectations have risen but remain below our central scenario for the next few years Our Fed policy expectations are above current market pricing The term premium in government bond yields remains in negative territory, implying significant upside remains possible
Heavy political agenda in Europe and threats from the Italian referendum PM Renzi would be weakened in case of a no vote and may have to step down: widening of spreads and risks on financials could materialize if political uncertainty results from a large no France : Possible volatility around French elections
4 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month: politics in the US and Europe p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices: structural analysis p.63
5 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency Trump wins both Presidency and Congress opening doors to change
• Judged from even the start of this year where President-Elect Donald Trump was not even considered a contender to win the Republican nomination, and given at best a chance in three to win, Trump’s election has been a shock • Trump so far is a little short of Clinton on the popular vote (47.7% vs 47.4%). Older voters (45+), male voters, and white voters preferred Trump. Black voters voted 88% to 8% for Clinton over Trump. Young voters did not vote • As expected, Republicans retained a majority in the House of Representatives, and the Senate went with the Presidency. This is the first Republican clean sweep since 2006, suggesting a large share of Trump program may be implemented
Trump takes key battlegrounds to win Republicans achieve clean sweep Key State Polling/Projected outcomes
Trump lead
Nevada Wisconsin Michigan Ohio Penn Florida Iowa NCarolina Georgia New Hamp Virginia Colorado 8 1.5 1 4 0.5 0 0 -0.5 -4 -1 Clinton lead-8 -1.5 -2 -12 8 Nov State polling Republican/Democrat projected State outcome -2.5 -16 -3 Source: Real Clear Politics, BBC. Note: Mich. and New Hamp. still to declare Source: Associated Press/BBC
6 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency Uncertainty is high but the balance leans towards a boost to GDP
• Significant policy uncertainty prevails and could persist, with little indication what Trump’s policy priorities will be before January 20. His acceptance speech was designed to appease anxiety. • Before the election, we identified two Trump victory scenarios: a fiscal boost only and one that included the protectionist measures. We lean towards areas of convergence with traditional Republicans (tax cuts, financial deregulation among others), but are wary of substantial downside risk • We do not project full implementation of Trump’s fiscal stimulus (1.8pp of GDP versus 2.6pp announced), which would still provide material stimulus (+1.1pp over 2 years). We forecast GDP of 2.1% in 2017 and 1.9% in 2018
Estimated impact of Trump’s fiscal proposals Initial reaction to the US growth outlook
Estimated growth stimulus of Trumps fiscal US growth outlook (with pre-election scenario range) % pt GDP proposals % GDP % GDP 1.6 2.5 AXA IM pre-election scenario: stimulus only 2.5 1.2
0.8 1.5 1.5
0.4 AXA IM post-election base case 0.5 0.5 0.0
-0.5 AXA IM pre-election scenario: stimulus -0.5 -0.4 and protectionism
-0.8 -1.5 -1.5 2017 2018 2019 2020 2021 2016 2017 2018 2019
Source: Tax Foundation, FRB and AXA IM Research Source: AXA IM Research
7 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency With the economy at tight capacity, this should fuel inflation
• In an economy with little spare capacity, a fiscal boost is likely to raise the inflation outlook. We forecast CPI inflation rising to 1.8% in 2017 and 2.5% in 2018, somewhat tampered by a stronger dollar. • With fiscal-boosted growth above potential and inflation rising, we expect a quicker withdrawal of monetary policy stimulus in 2018. Our outlook remains of a more cautious tightening than suggested by a Taylor rule with 1 hike in 2016, 2 in 2017 and 3 in 2018, taking rates to 1.75-2.00% by end-2018. • This is abstracting from potential changes at the Fed Board (4 seats including the Chair by mid-2018)
Inflation to rise faster as demand stoked by fiscal stimulus Monetary policy rules using different GDP and inflation outlooks Projected inflation % yoy
Core PCE 3 CPI
2
1
0 Q4 2016 Q2 2017 Q4 2017 Q2 2018 Q4 2018 Source: Tax Foundation, FRB, AXA IM Research Source: FRB, AXA IM Research
8 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency Which in turn contributed to, but not only, a correction in rates
• Rates markets have sold off sharply following the Trump election, driven by both inflation and real rates, but primarily by rising inflation expectation in the US • Our term premium models also show a large repricing of the cost of holding duration • Curve steepening has continued, in line with our expectations, both in the 2-10 and the 10-30 sectors
Broad-based selloff in core rates Sharp turn in term premia Change in bond yields between 04 November and 11 November G4 term premia on 10Y government bonds Basis points GBP % 40 5Y5Y Breakeven inflation 5Y Breakeven inflation 1.5 DEM 5Y5Y real rates 5Y real rates USD 35 JPY Total 10Y nominal yield 1.0 30 0.5 25
20 0.0
15 -0.5 10
5 -1.0
0 -1.5 US Treasury German Bund UK Gilt Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Source: Bloomberg and AXA IM Research Source: Bloomberg and AXA IM Research
9 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency All DM rates are set to rise going forward, expect repricing of risk
• On the back of a quicker Fed policy normalisation and slightly stronger normalisation in term premia, we have made revisions to our rates forecasts across the US and Europe • We now expect 10Y US Treasury yields at 2.75% and 10Y German Bunds at 0.80% at a one-year horizon • European peripherals have risen as a result of both higher core rates and markets betting on higher probabilities of election surprises in 2017 (especially in France)
Broad-based rise in European peripheral spreads A higher path for US interest rates
10Y US Treasury yield forecast 10Y government bond spreads to Germany France Basis points 4.50 Spain Range 200 Italy Actual 180 4.00 Basecase 160 3.50 140 120 3.00 100 2.50 80
60 2.00 40 20 1.50 0 1.00 2014 2015 2016 2015 2016 2017 Source: Bloomberg and AXA IM Research Source: Bloomberg and AXA IM Research
10 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency EM likely first victim : we trim exposure after the election
• The Trump election has hit EM assets on two fronts: higher US yields leading to capital repatriation and expectations of trade policy tightening • As a result, we reduce EM exposure in both equities and debt, despite attractive valuation and improved fundamentals • We introduce additional protection to an EM downside scenario through FX, via a short AUDJPY. AUD is typically well correlated to China and base metals, expected to be hurt in case of disappointments there
Outflows from EM equities for the first time since June Spread differential between EM and US IG back at historical highs Net capital flows into EM equity ETFs Spread ratio EM Sov IG / USD IG
$ bn, 4-week average x 8 1.8 1.6 6 1.4 4 1.2 2 1.0
0 0.8 0.6 -2 0.4 -4 0.2
-6 0.0 2005 2007 2009 2011 2013 2015 -8 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 EM Sov IG / USD IG, current = 1.60 Average = 1.08 Source: Bloomberg and AXA IM Research Source: Bloomberg and AXA IM Research
11 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – Trump Presidency US equities find fresh support
• Equity markets have reacted favourably to the Trump election, boosted by expectations of stronger growth, corporate tax cuts and sector deregulations • We maintain our preference for US equities in this context, although we doubt that equity markets overall can deliver strong upside
Strong earnings boost implied by tax rate cut to 15% Buy-backs could be spurred by cash repatriations
United States: earnings growth, actual vs. model United States: buybacks and equity market in % yoy Index Index 45 Actual earnings growth 100 Buybacks 2,300 Model MSCI US (rhs) 35 2,000 Model + tax cuts 80 25 1,700 15 60 1,400 5 40 1,100 -5 20 800 -15 11 12 13 14 15 16 17 0 500 Model inputs include the change in US leading economic indicators, spot 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 commodity prices and trade weighted US Dollar (R2 = 72%) Source: Datastream and AXA IM Research Source: Bloomberg and AXA IM Research
12 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics European construction faces biggest challenge so far
. The European union is facing multiple crisis: A 3-step process to complete Euro area economic crisis, debt crisis, humanitarian crisis (refugee issue), security crisis and political crisis •Strengthen ESM •Complete Banking Union . The European and Monetary Union also needs •Better policy-mix 1. Restore •Reinforce political legitimacy completing confidence
. In pre-election period for both France and Germany and amid rising anti-EU views, do not •Country-specific structural reforms expect much concrete steps at the 60th •Define and implement a strategy in favor of investments Anniversary of Rome Treaty in March 2017 2. Implement •Simplify regulation euro area policies
. There is also a need for a change in Franco- German leadership mindset to move forward •Favor convergence by implementing common rules and policies •Set up a fiscal union 3. Reform Euro •Adjust institutions accordingly (euro-are area Treasury etc…)
Source: AXA IM Research
13 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics The fate of Europe in the hands of France, Germany and other elections
. Financial crisis, poor economic results, fear of Mixed EU support across countries competition from emerging markets and technological innovation are fueling rising Views of EU anxiety. . This takes the form of increasing rejection of globalization and the European project, as it Unfavorable Favorable stands, and feeds adhesion to unconventional political parties, across European countries. France 61 38 . The issue for Europe is to find political leaders who will: Spain 49 47 • commit to national and European reforms enabling short-term and medium term growth Germany 48 50 • design and strive for a new European vision • able to promote Europe where it is Netherlands 46 51 necessary, beyond their apparent immediate domestic interest . The risk is between: Italy 39 58 • too traditional candidates fearful of national protest Poland 22 72 • too radical candidates unfearful of dangerous macro policies and European dismantling Source: Spring 2016 PEW and AXA IM Research
14 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Italy) Italian referendum (4 Dec): test case for more anti-European sentiment
Baseline scenario (55%): No to referendum, PM Renzi stays or is quickly replaced. Less reform focus . Much of the same Downside scenario (25%): Large defeat, coalition breaks down, new elections in a confused electoral setting and with high political uncertainty, and M5S close to PD in polls. Turmoil Upside scenario (20%): Yes wins; PM Renzi is reinforced. Italy is finally in an efficient electoral and institutional setting which allows for more reforms. Confidence boost for all Europe
Referendum on Senate reform: the “No” is leading New elections could see a rise in 5-Star party Italian referendum polls 2n round voting polls (monthly average of polls) 56 56
54 54 52 52 Yes 50 50 No 48 48 46 PD 46 44 M5S 44 42
42 40 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16
Source: Sondaggipoliticoelletorali.it and AXA IM Research
15 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Italy) Italian referendum (4 Dec): market impact
Baseline scenario (55%): Small sell-off as already priced in. 20bp widening of Italian spread, comparable to the impact of the 2013 election and its aftermath. 10bp widening of other peripheral spreads, decline in equities. Downside scenario (25%): 150bp widening of Italian spread (vs Bund), 80bp for other peripheral spreads (+25bp for FR); unlikely to see levels from 2011 as containment tools are in place at the European level; Eurozone equities sharply down, especially financials; risk of banking turmoil spilling across Europe (as ECB does not buy financials and equities) Upside scenario (20%): Market rally: 30bp tightening of IT spread (vs Bund), back to early October levels; - 15bp for other peripheral spreads (-5bp less for FR).
Financial markets Referendum Prob Politics Macro outcome IT spread Other periph Equity Banks vs Bund spread vs Bund Renzi stays or is Baseline 55% No = +20bp +10bp ▼ ▼ quickly replaced Renzi resigns and Downside 25% Large No coalition breaks ▼ +150bp +80bp ▼ ▼ down Upside 20% Yes Renzi is ▲ -30bp -15bp ▲ =
Source: AXA IM Research
16 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Italy) Risk for Europe
M5* party has no official roadmap but key ideas are : a referendum on the euro energetic plan: environmental tax, renewable energies exploitation, electric transport, closing carbon centrals... measures for supporting poor households revenues (financed by lower public and military expenses) an audit on public debt structural reforms: anti-corruption law, actions to support innovation fiscal policy: alleviate SMEs and start up fiscal burden, sustain innovative investment (in the 4.0 era in particular)
Besides from the referendum on the euro, all these ideas raise the question of their financing
17 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Germany & France) What you should look for : economics and Europe
What matters for financial markets should be economics and Europe, because: . To escape secular stagnation, Europe needs the right balance between a supportive policy-mix and structural reforms : this depends both on their economic program and on their European appetite . France and Germany need to converge on: • appropriate policy-mix (fiscal policy to support monetary policy) • structural reforms in France (structure of public spending, regulatory burden ) and Germany (income tax, regulatory burden in services ) . ECB had launched the first arrow; they need to launch the second and third one for EMU to succeed . Disruptive policies on other matters (defense, immigration, trade) in the sense of Trump are unlikely in Europe
Political parties’ position in France & Germany Progressive
Greens Der Linke Verts
PCF/LO SPD PS En Marche ! State FDP Free-market Intervention
LR CDU/CSU
FN AfD
French party Source: AXA IM Research Conservative German party
18 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (France) France: many candidates, but a soft centre one at the end?
• The center right candidate looks set to be the most popular, offering a change with the past mandate and more consensual politics, but also reforms • Our base case is not far-right leader M Le Pen
Polls in favor of center and center-right candidate
On French politics • France has a semi-presidential political
system
• The executive (President and the st [26%,20%]
1 Government) has extensive powers round ~30% ~14% • The President is elected by universal MARINE LE PEN Les Républicains EMMANUEL MACRON suffrage for a 5-year term (Front National – far-right) Candidate (En Marche ! – center) • France has a multi-party system with 3 Center-right dominant parties: the far-right led by Front National, the center-right led by Les Républicains and the center-left led by Le Parti Socialiste
• Presidential elections date :
st rd nd [39%,34%] [66%, 61%] • 1 round : April 23 2 nd th
round • 2 round : May 7 MARINE LE PEN Les Républicains (Front National – far-right) Candidate Center-right
Source: IFOP, AXA IM Research
19 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (France) France: candidates’ economic and European stances
Economic Proposals Positions on Europe F.Fillon Fiscal adjustment (Reduce public spending, public sector Control borders, defense and security weight) Lean towards fiscal convergence LR (center-right) Reduce corporate taxes Sovereign trade policy Labour flexibility (remove 35 hours-week, reform administrative Treasury and debt mutualisation burden) A.Juppé Balance budget by 2022 Harmonise NFC tax base, converge on benefits policies Tax cuts for households (including suppression of wealth tax) Common immigration policy LR (center-right) Reduce corporate income tax
E.Macron Labour flexibility (remove 35hour-week for the youth, European integration, with a federal structure retirement age modulated) En Marche ! Increase social cover to some extent (unemployment benefits (center) for auto entrepreneurs and independent workers) Privatize some state-owned firms A.Montebourg Support demand (reduce tax for middle & lower classes) Reform the UE and lean towards a more social EU Support investment (life-insurance to finance SMEs, create a Fiscal stimulus Le Projet France national bank) (Left) Economic patriotism (public contracts to SMEs settled in France) M. Le Pen Protectionism and patriotism (social contribution on imported Put an end to the European construction by renegotiating goods, selection of French firms for public contracts ) treaties (using Article 50) FN (far-right) Debt monetization Take control of French borders. Retirement age at 60 Leave the Euro Suppression of benefits for foreigners Pan European Union with Russia & Switzerland (excluding Increase taxes for high revenues (46%) and for capital Turkey) incomes
N/A at this stage Maintain tax advantages for employment, suppress tax niches Fight against tax evasion Focus on long term unemployment Develop an investment agreement on a continental scale PS (center-left) Reinforce democratic control over European policies
Source: AXA IM Research
20 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (France) How relevant for markets ?
• Traditionally, French election did not have a significant impact on equity or bond markets • France-Germany spread have widened recently and widened during the crisis when dissensions between France and Germany appeared • However, this time it matters because it will set the stage for the Franco-German leadership for Brexit, EMU consolidation and more generally a vision for the future of EU
No precise orientation for equity markets Spreads had risen to historical high in 2011 French Equity markets around elections (100 at election day) OAT/Bund Spread (2010-2013)
130 200 bps Election day 180 120 160 110 140 120 100 100 90 80
80 60 40 70 20 60 0 D-90 D-60 D-30 D D+30 D+60 D+90 Jan-10 Sep-10 May-11 Jan-12 Sep-12 May-13 Jan-14
1988 1995 2002 2007 2012 Source: Datastream, AXA IM Research Source: Datastream, AXA IM Research
21 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Germany) Germany : CDU/CSU still dominates but refugees lifting AfD
• Chancellor Merkel is candidate; S Gabriel likely for SPD but weaker than in 2012 : option are open for the next coalition with Greens, FDP ..unlikely to be AfD • Since summer 2015 and the refugee crisis, CDU/CSU has been falling in polls while populist AfD has been gaining weighing on the European debate • A Green coalition is likely to be more pro-European than the current coalition
On German politics Merkel’s CDU/CSU is falling in polls • Germany is a federal parliamentary republic German federal election polls • Power is divided between the federal 50 Refugee crisis and state governments 45 40 • The leader of the winning party becomes 35 Chancellor 30 25 • Germany has a multi-party system with 20 2 main players : the center-left Social 15 Democratic Party (SPD), center-right 10 CDU/CSU union between the Christian 5 0 Democratic Union (CDU) and the Christian Social Union in Bavaria (CSU) • Schedule : between August, 27th & October, 22nd CDU/CSU SPD The Left Green Party FDP AfD Source: ISNA, EMNID, GMS, Forsa, Ipsos and AXA IM Research
22 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Germany) What matters is the possible coalition
Economic Proposals Positions on Europe Angela Merkel Set up active labour market policies, focusing on Development of economic and monetary union granting job access to long-term unemployed Improve fiscal consolidation CDU/CSU (center-right) Strengthen collective bargaining along with the Foster competitiveness and investments at a expansion of Workers Act. European level Security policy
Sigmar Gabriel Adjust taxes and increase sanctions to fight tax fraud Fair and effective tax system building the European Support SMEs and municipalities (ease obligations Financial Transaction Tax in 2017 SPD (center-left) for SMEs and Investment package for municipalities) Commit to a meaningful overall strategy to fight Minimum wages including for part time workers terrorism and the spread of terror
Frauke Petry & Jörg Maintain minimum wages, modest old-age care. Leave the euro Meuthen Reject free trade agreements Protect EU external borders Reduce bureaucracy AfD (far-right) Simpler & fairer tax system, relieve low-income Abolish Climate protection treaties
Christian Lindner Encourage innovation and companies creations, No bail-out. through tax system reform. Harmonize taxes in order to prevent tax arbitrage at the FDP (center-right) Focus on education and social security European level
Source: AXA IM Research
23 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Theme of the month – European politics (Netherlands) Netherlands : more fuel to euroskepticism ?
• The key uncertainty is around how many seats Geert Wilders’ populist anti-EU, anti-immigration, Freedom Party (PVV) will get and if it will be able to form a government • Wilders is asking for a Dutch referendum on leaving the EU and latest opinion polls suggest a divided country on the issue, slightly in favour of EU, but so was the UK in the run-up of the Brexit vote… • Admittedly, the main impact for Europe will be J Djissenbloem leaving the Eurogroup where he has been instrumental for managing (the Greek) crisis
On Dutch politics VVD and PVV neck-to-neck in polls • The Netherlands is a constitutional Dutch General Elections poll (since Sept. 2016) monarchy & parliamentary republic • The lower chamber, the House of 35 Seats Representatives has 150 members. 30 • The leader of the winning party becomes 25 Prime minister 20 • The Netherlands have a multi-party 15 system with 2 main players : the center- right People's Party for Freedom and 10 Democracy (VVD), center-left Labour 5 Party (PvDA) which form the current Lib- 0 Lab coalition 4-Sep 18-Sep 2-Oct 16-Oct 30-Oct 13-Nov • Schedule of elections : March, 15th VVD PvdA PVV SP CDA
Source: Peil, I&O, Ipsos, De Stemming and AXA IM Research
24 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month: politics in the US and Europe p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices p.63
25 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – US Growth rebounds
• Q3 GDP growth accelerated to 2.9% (saar) from 1.4%, firmer than consensus expectations, and the strongest quarterly expansion in two years • Early survey evidence remains upbeat for Q4 ; auto sales and preliminary estimates of retail spend suggest that consumers started Q4 with solid momentum • We expect growth to reach 1.6% in 2016 after 2.4% in 2015
Q3 GDP accelerates Business surveys remain robust in Q4 US quarterly GDP growth ISM indices and GDP growth GDP (% % saar ISM indices Forecast qoq saar) 6 60 4% 3 55
2% 0 50
-3 45 0% GDP (qoq saar, LHS) -6 Non mfg ISM (comp) 40 ISM (RHS) -2% -9 35 2010 Q1 2011 Q4 2013 Q3 2015 Q2 Q3 1997 Q4 2000 Q1 2004 Q2 2007
Source: BEA, AXA IM Source: ISM, AXA IM
26 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – US Labour market tightens and wage inflation accelerates
• While payrolls dipped a little in October, the average pace of employment growth year-to-date has been 181k, down from 229k on average in 2015 • The pick-up in labour supply that has attenuated the fall in unemployment may be fading as suggested by recent figures. Question remains of how much the decline in participation is structural, not cyclical • A quickening pace of earnings growth is additional evidence of a tightening labour market
The rise in labour supply has faded of late Earnings growth accelerates Labour supply growth and unemployment rate Average earnings growth % % mom % yoy 10 0.6 4.5 AHE (non-supervisory) 0.4 AHE (total) 4.0 8 0.2 3.5 0.0 6 3.0 -0.2 2.5 -0.4 4 Labour supply (RHS) 2.0 Unemployment rate (LHS) -0.6 1.5 3 per. Mov. Avg. (Labour supply (RHS)) 2 -0.8 1.0 Jan-10 Jan-12 Jan-14 Jan-16 Jun-01 Sep-04 Dec-07 Mar-11 Jun-14
Source: BLS, AXA IM Source: BLS, AXA IM
27 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Fed Markets priced 25bp rate hike for December, ignoring uncertainty
• Markets remain expectant of a December Fed rate hike (~95%) supported by recent economic data. We concur • Financial markets were extremely volatile on US election night. Such volatility could return if the Trump administration gets back to a protectionist agenda. This alone would likely dissuade the Fed from a hike
Market implied probability of December FOMC rate hike Election night volatility could still be repeated Probability of 25bps hike in December FOMC % chance meeting 100
80
60
40
20
0 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Source: Bloomberg Source: Bloomberg
28 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Euro area Stable domestic-driven recovery, inflation rising in 2017
• Ongoing recovery confirmed: Q3 GDP unchanged at 0.3%q-o-q. We expect GDP to grow at 1.5% in 2017. • Private consumption and investment to stay resilient (supported by confidence recovery), net trade to improve thanks to weakening euro • Fiscal stance broadly neutral / mildly easing in 2017 in the euro area (+0.1pp in structural balance): neutral budget in Germany and France, more supportive in Italy; Spanish new government promised a structural effort of 0.5% of GDP. • Pdt Juncker’s speech advocating +0.5pp stimulus will have only marginal operational consequences, as country by country public finance trajectories remain valid
Consumption will support growth Fiscal stance is neutral in 2017
Contributions to euro-area GDP growth 2017 fiscal stance (impulse in % of GDP) 2.5 %YoY 0.6 Eur. Commission 2.0 IMF tightening 1.5 0.4 OECD 1.0
0.5 0.2
0.0 0.0 -0.5 -1.0 -0.2 -1.5 easing -2.0 -0.4 2011 2012 2013 2014 2015 2016 2017 Net Trade Inventories -0.6 Fixed Investment Government EMU DE FR IT SP Private Consumption GDP Growth Source: European Commission, IMF, OECD and AXA IM Research Source: Eurostat, AXA IM Research
29 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Euro area Peripheral spreads rising again
• Moving away from central banks support : return of risk pricing
• Rumors of ECB tapering started to push spreads higher from October 7
• Rise was reinforced by Trump victory effect
Rise in spreads across the board Shifts in yield curve 10Y government bond spreads to Germany Spanish Yield Curve
Basis points France 1.4 % Trump 200 Spain 1.2 180 1 Italy 160 Tapering chatter 0.8 140 0.6 120 0.4 100 0.2 80 0 60 -0.2 40 -0.4 1 2 3 4 5 6 7 8 9 10 20 0 30-sept 09-Nov 07-Oct Jan-16 Apr-16 Jul-16 Oct-16
Source: Datastream, AXA IM Research Source: Datastream, AXA IM Research
30 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – ECB ECB: QE for longer but one step at a time
• Inflation will still be very low by December (but expected to pick up). The ECB expects inflation at 1.2% in 2017 and 1.6% in 2018. We expect them to pencil in 2% for 2019 in the December forecast • We therefore expect a roll over of QE with enough parametric adjustments to offer 6 months if needed among (the rise in rate itself allows 3 additional months of Bund purchases -€60-70bn- , ceteris paribus): Increasing the 33% limit on non-CAC bonds to 40% (and up to 50%) Increasing monthly credit purchases (CSPP) Moving from an absolute deposit rate limit to an average limit
Inflation metrics do not allow for a tightening yet… …but will in 2017 as Inflation above 1¼% after January
ECB's Inflation Landscape Historical range (10%-90% percentile) % YoY Forecast Headline inflation Core inflation % 5th percentile 4.0 3.0 Median 2.5 Current 3.5 2.0 3.0 1.5 2.5 1.0 2.0 0.5 0.0 1.5 -0.5 1.0 0.5
0.0
Staff forecast Staff HICP (6M avg) (6M HICP
avg) -0.5
Prof forecasters 5Y forecasters Prof
Core HICP (6M avg) (6M HICP Core
Inflation swap 1Y1Y swap Inflation 1Y4Y swap Inflation 5Y5Y swap Inflation Shorter term 2Y forecasters Proff -1.0
GDP deflator (2Q avg) (2Q deflator GDP Longer term
Comp per employee (2Q employee per Comp 2007 2009 2011 2013 2015 2017
Source: ECB and AXA IM Research Source: Eurostat and AXA IM Research
31 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – UK Brexit developments
• The UK High Court ruled that the government does not have the legal right to trigger Article 50 without approval of Parliament which is likely to lean towards a “softer” Brexit • The government is to appeal the decision, but we expect this adds uncertainty to the outlook and may delay PM May’s timetable to trigger Art 50 by March 2017. At the extreme, this process could conceivably see a second referendum or early elections, not our base case
High Court decision opens a range of outcomes Sterling recovers some ground
Sterling fx £ TW index £:$ 78 1.3 £ TW (LHS) GBPUSD (RHS) 1.28 76 1.26
1.24 74 1.22
72 1.2 26/09/2016 10/10/2016 24/10/2016 07/11/2016
Source: AXA IM Research Source: Datastream and AXA IM Research
32 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – UK GDP growth outlook
• GDP grew by +0.5% in Q3, above our expectations (+0.3%) and the BoE August assumptions (+0.1%) from 0.7% in Q2 • Q3 was lifted by an exceptional growth in transport, services and communications. In turn, the “video and sound production” subsector provided the largest contribution • We do not expect this exceptional expansion to be repeated: a slowdown should start materialising in Q4 and bring growth to 2.0% in 2016 and just 0.7% in 2017
GDP growth proves resilient post referendum GDP strength reflects strong rise in transport services
GDP growth Output in key sectors of economy qoq yoy % qoq 2.5 Q4 2015 Forecast Q1 2016 Q2 2016 1.0% 3.0% 1.5 Q3 2016
0.5 0.5% 2.0% -0.5
0.0% 1.0%
-1.5
Servs Manu Cons Transport fin & Bus GDP QoQ (LHS) IP YoY (RHS) -0.5% 0.0% Q3 2012 Q4 2013 Q1 2015 Q2 2016 Q3 2017
Source: National Statistics, November 2016 Source: National Statistics, BRC– September 2016
33 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – BoE BoE faces difficult balancing act
• The BoE upgraded its growth outlook for 2017, but lowered 2018 and 2019. Overall, GDP was envisioned modestly lower. We consider risks to the downside for the coming years • The timing and magnitude of the exchange rate pass through to inflation is uncertain. The BoE recently quickened its expected pass through. We expect sterling’s depreciation to lift inflation further with a peak around 3% in H2 2018/H1 2019 • As the economy slows, we still expect additional easing from the BoE through rate cuts and QE in mid 2017*
Sharp sterling depreciation to lift inflation Inflation to rise from 0 to 3% GDP outlook Inflation projections % yoy % (y/y) 6 Actual Historic/BoE Nov 16 2.5 AXA-IM AXA-IM Consensus 4 BoE forecast (Aug 2016) 2.0 BoE
1.5 2
1.0 0 0.5
-2 0.0 Q1 2012 Q3 2013 Q1 2015 Q3 2016 Q1 2018 2015 2016 2017 2018
Source: National Statistics, BoE, AXA IM Research – November 2016 Source: BoE, AXA IM Research – November 2016
34 34 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Japan Moderate expansion and boost from the US
• 2016Q3 GDP growth printed at +2.2% qoq thanks to strong exports (+8.1% qoq), in track with our 2016 GDP forecast of +0.7% • In the short run, despite risks of US protectionism, Trump fiscal stimulus should be positive for Japan. We revise slightly up our 2017 growth forecast revised to +1.3% from +1.2%, on the back of positive trade spillover and the stronger dollar • Despite higher rates across the board (led by the US), 10Y JGB rates remained in line the BoJ “yield curve control” target • Stronger dollar and higher uncertainty around US policies is also likely to drive BoJ to leave policy unchanged
Growth should be supported by fiscal stimulus & the US 10Y JGB Yields resilient to “Trump effect” Japan: GDP growth contributions G4 Bond Yields (since Sept. 16) % YoY US elections 2.5 2.5 %
2.0 2
1.5 1.5 1.0 1 0.5 0.5 0.0
-0.5 0
-1.0 -0.5 2012 2013 2014 2015 2016 2017 1-Sep 15-Sep 29-Sep 13-Oct 27-Oct 10-Nov Net Trade Inventories Fixed investment Government Consumption GDP UST 10Y JGB 10Y Bund 10Y Gilt 10Y Source: Cabinet Office, AXA IM Research Source: Datastream, AXA IM Research
35 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – China Expansion little likely to be disturbed by the US …except if
• Economic backdrop in China remained stable in early Q4, thanks to a recovery in investment growth • Trump polices can affect China via four channels: 1) trade protection, 2) stronger US growth, 3) rising USD/more aggressive Fed, and 4) financial market linkages • 1) and 3) are the most significant, but we think 1) will be watered down, from universal to targeted tariffs • Full implementation of Trump’s tariff proposal could hurt the US economy via imported inflation and trade retaliation from China
FAI growth accelerates on real estate investment China and US are intricately linked via trade
Top three trading partners of the US % Trade US US % GDP Imports from Exports to 20 3.0 % of total exports [Lhs] 18 % of total imports [Lhs] 2.5 16 % of GDP [Rhs] 14 2.0 12
10 1.5
8 1.0 6
4 0.5 2
0 0.0 China1 Mexico2 Canada3 China4 Mexico5 Canada6 Source: CEIC, and AXA IM Research (as of Nov-2016) Source: CEIC, and AXA IM Research (as of Nov-2016)
36 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – China The key manifestation of Trump uncertainty could be the currency
Trump could force a faster depreciation of the RMB by: 1. threatening to label China as a currency manipulator, even though this is not supported by fundamental criteria 2. starting a trade war against China, disregarding the adverse impact for the US economy China may choose to devalue its currency (not our central scenario), if: 1. the USD continues to rally strongly, with the PBoC allowing the RMB to move in line with other currencies 2. Chinese economy, particularly exports, weakens sharply, and the RMB is allowed to reflect the weakness
Recent CNY/USD moves driven by dollar strength CNY/USD has become more market-driven
Source: Bloomberg, CEIC, and AXA IM Research (as of Nov-2016) Source: Bloomberg, CEIC, and AXA IM Research (as of Nov-2016)
37 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – China Capital outflows, while still sizable, are no longer disruptive so far
• Recent FX depreciation has prompted a reacceleration of capital outflows and declines in FX reserves • But these outflows have not triggered a market dislocation nor any adverse economic impacts typically associated with a capital flight. However, there remains risks of a disruption, as the economy is still highly leveraged • As RMB becomes more market-oriented and the PBoC is more hands-off, the capital account should register a deficit to offset the surplus in the current account. Capital outflows could be the new normal as RMB depreciation continues • RMB REER has fallen by c7% over 2016, helping to unwind the “overvaluation” accumulated since 2014
Capital outflows re-accelerate recently REER declines and may overshoot
Source: CEIC, and AXA IM Research (as of Nov-2016) Source: BIS, and AXA IM Research (as of Nov-2016)
38 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Korea Political scandal clouds the macro outlook
• President Park and her administration have encountered political upheaval since late October, which has already led to a reshuffle of the cabinet, and may cause the president to resign or be impeached • The market has priced in a benign scenario, where President Park will maintain her position, but pass on the power to the new cabinet and Prime minister • Economic implication is still too early to tell, but the spectre of political uncertainty could have a negative influence on the financial market. For example, the KRW has significantly underperformed other Asian currencies • The BoK held its policy rate steady last week in order to keep the powder dry for emerging risks further down the road
Political scandal could limit fiscal supports KRW underperforms Asian peers
Source: CEIC, and AXA IM Research (as of Nov-2016) Source: Bloomberg, and AXA IM Research (as of Nov-2016)
39 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Emerging Markets Improving economic backdrop…about to be Trumped?
• The EM business cycle is firmly in the recovery phase (below the long-term average but increasing), but Trump trade policies may derail this outlook, especially in Mexico and more largely NAFTA countries • October PMI readings imply an acceleration in the real GDP growth momentum in Emerging Europe and Latin America to 3% qoq saar in 2016Q4 (from 2.9% in 2016Q3) and -0.3% (from -0.4%) respectively • The October Emerging Asia PMI reading implies that the real GDP growth momentum will soften to 7.1% qoq saar in 2016Q4 from 7.3%, absent any trade disruption
EM business cycle in recovery mode Growth momentum improving
EM Growth Cycle Index (GDP weighted Z scores) Actual and forecasted regional real GDP growth - Growth above long-term average 4 - Growth above long-term average - Decreasing cyclical momentum - Rising cyclical momentum implied by the PMIs 20 % qoq saar % qoq saar 20 3 15 Forecast 15 2 10 10
1 Apr '10 5 5
0 0 0 -0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5 -5 -5 -1 Central Eastern Europe -10 -10 -2 Latin America
Sep '16 -15 Emerging Asia -15 -3 - Growth below long-term average - Growth below long-term average -20 -20 - Decreasing cyclical momentum - Rising cyclical momentum 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -4 Source: Bloomberg, Markit, Datastream, AXA IM Research Source: Bloomberg, Markit, Datastream, AXA IM Research
40 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Emerging Markets Mexico the first and main victim?
The MXN depreciation could reach 25% in 2016, bringing headline inflation to 3.4% in 2017 from 2.9% in 2016 The central bank is expected to take the policy rate to 5.75% (from 5.25%) by year-end and to 6.5% by end-2017 With MXN depreciation, the external debt service is set to increase by 0.6pp to 3.2% of GDP in 2017, with the burden mostly felt by non-financial corporates for which the debt service would amount to 2.1% of GDP from 1.7% in 2017 with the government’s debt service following (1% of GDP) Remittances from Mexicans living in the US (2%-3% of GDP over the last decade) would be curbed if the Trump Presidency targets immigration; 23% of the US-residing Mexicans are illegal immigrants A balance of payment crisis is not expected as 73% of the current account deficit (3% of GDP) is financed by non- volatile foreign direct investment while foreign exchange reserves are sufficient to cover foreign capital outflows equivalent to the full money supply M2 of the economy
FX and maturity risks are limited FX passing through to inflation not yet realised in full Gross external debt by currency and maturity, 2016q2 Mexico, inflation vs MXN/USD 7.0% 0.05 India MXN/USD Philippines 6.5% Argentina Inflation ( L) 0.06 Thailand 6.0% Peru Short-term foreign currency debt MXN/USD (values in reverse, R) Mexico Long-term foreign currency debt 5.5% Russia 0.07 The MXN Colombia Short-term domestic currency debt 5.0% depreciates South Africa Long-term domestic currency debt Romania 4.5% vs the US$ 0.08 Turkey 4.0% Chile 0.09 Czech Republic 3.5% Poland Bulgaria 3.0% Kazakhstan 0.1 Ukraine 2.5% Hungary 2.0% 0.11 0% 20% 40% 60% 80% 100% 120% 140% 160% % of GDP 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: World Bank, IMF, AXA IM Research Source: Datastream , AXA IM Research
41 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – Emerging Markets Egypt is granted a US$12bn IMF loan
• With the current account deficit widening, the coverage of imports by FX reserves dropping below 4 months, the country was at the verge of a balance of payment crisis • The central bank dropped the FX peg and raised by 300bp its overnight rates as a pre-emptive measure to improve the chances to secure the IMF loan • The currency depreciated more than 70% in the black FX market and the current non deliverable forward FX rate implies another 10-20% depreciation (vs the US$) in the pipeline • The IMF granted a US$12bn 3-year loan to Egypt aiming at improving investors’ confidence via cuts in state subsidies
More EGP depreciation (vs the US$) to come Staring into a balance of payment crisis Egypt current accoutn balance 15 % of GDP 15 Transfers 10 Trade 10 Current account balance
5 5
0 0
-5 -5
-10 -10
-15 -15 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Datastream , AXA IM Research
42 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro outlook – EM Monetary Policy Ample space for accommodation or tightening
• The inflation outlook is still benign helped by stronger currencies and low energy prices. Inflation exceeds the target only in a handful of countries • Monetary policy remains dovish across the board (except in Mexico and Turkey) with ample space to cut interest rates …or to rise (except Brazil) • Brazil started cutting rates but the pace will be determined by fiscal consolidation progress and inflation dynamics
Inflation not far from target EM monetary policy Inflation rate 18 Actual vs market-implied interest rates %
16 16 % 14 14 Actual policy interest rate A year ago 12 A month earlier 12 Policy rate at end next year Oct-16 Policy rate by year-end 10 Inflation target 8.5 10
8 7.2 8 6.1 5.9 6 5.0 6 4.3 3.0 4 3.3 2.9 4 2.3 1.7 2 1.3 1.3 1.5 0.8 1.0 0.3 2 0 -0.2 -0.2 -0.3 0 -2 CZ HU PL RU SK TU ZA CN HK IN ID KO MY PH SG TW TH BR* CL MX* BR CL CO CZ HU IN KO MY MX PL ZA TW TU * Sep '16 Source: Bloomberg, Markit, Datastream, AXA IM Research Source: Bloomberg, AXA IM Research
43 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month: politics in the US and Europe p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices p.63
44 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy Cross-asset allocation: reduce EM exposure post US election
We remain cautions about risk appetite overall We expect core rates to rise further All assets are richly priced and central banks’ support Central banks should prove more hawkish than markets looks set to decline expect The stock-bond correlation limits diversification and Inflation will rise in coming months protection benefits from bonds Markets are positioning for higher rates We reduce EM exposure following the US election We keep a defensive positioning in equities Uncertainty is high on trade policies that could hurt EM We are not as confident as the equity markets seem to Stronger USD and higher US yields reduce EM be post elections attractiveness The pro-business stance of the new Trump administration confirms our US overweight
Tactical allocation: overall exposure
Duration = -1
EM = 0 Curve = +1
Equity = -1 Inflation = +1
Credit = +2 Scores range from -2 to +2, 0 stands for a neutral position Source: AXA IM Research
45 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Cross-asset allocation Allocation & tactical tilts
Asset class Positioning Core rates ● United States ● Germany ● UK ● Japan = Swap spreads = Inflation break-evens ● United States ● Euro = Global allocation Positioning Credit ● Corporate Investment Grade ● Cash ● United States = Euro = Core rates ● Euro periphery government ● Credit ● Emerging Markets government = Equities ● Corporate High Yield ● United States = Europe = Equities ● United States ● Euro area ● UK = Switzerland = Japan = Emerging Markets = Latin America ● Emerging Europe ● Emerging Asia =
Source: AXA IM Research
46 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Cross-asset allocation We remain cautious about risk appetite
• Markets have reacted strongly to the Trump election and now look very optimistic on US growth: we remain more cautious as uncertainty dominates and risks remain high outside the US • Stock-bond correlation has turned of late, with higher yields and higher equities. We doubt this can be sustained and rather expect higher yields to weigh on equity markets performance • Overall, we maintain our preference for taking risk in the credit space than in equities, with risk/return more attractive
Markets have sharply reassessed the growth outlook Stock-bond correlation has turned sharply Macro indicators vs. market pricing of growth USD 3M-rolling stock-bond returns correlation 60% Z-Score Positive bond returns Macro indicators 1.0 40% Negative bond returns Market pricing of growth 0.5 20% 0% 0.0 -20% -0.5 -40%
-1.0 -60%
-1.5 -80% 2012 2013 2014 2015 2016 2013 2014 2015 2016
Source: Datastream and AXA IM Research Source: Datastream and AXA IM Research
47 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Rates The correction in core rates should be sustained
• We were expecting yields to go higher but the move to be initiated in Europe, as opposed to the US • There is still room for upside as central banks (fed, ECB) tighten policies and inflation expectations normalise • A broad set of sentiment indicators (CFTC, primary dealers, CTAs) suggest that market positioning has turned sharply and looks for further upside in rates, both in the US and Europe
Market pricing of Fed policy still below our base case Speculative investors scale down duration exposure
Performance correlation between CTA funds & govt bonds
Correlation Cum. Bps Future Rate Levels 1.00 Meeting Date Priced in 0.38% 0.63% 0.88% 1.13% 1.38% 0.80 14/12/2016 22 13% 87% 02/01/2017 24 12% 81% 7% 0.60 15/03/2017 27 10% 70% 18% 1% 0.40 05/03/2017 30 9% 65% 23% 3% 0% 0.20 14/06/2017 36 7% 52% 33% 8% 1% 0.00 -0.20
-0.40
-0.60
-0.80 2000 2003 2006 2009 2012 2015 Source: Datastream and AXA IM Research Source: Bloomberg and AXA IM Research
48 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Rates We keep a negative bias on German Bunds
• We expect ECB decisions to put upward pressure on German Bund yields, which look still expensive on a relative basis • UK Gilts look more attractive after the US-led selloff especially as we expect more QE from the Bank of England in 2017 • We keep a negative bias on the European periphery ahead of important political events and in a context of rising yields
UK Gilts look more attractive following the correction German Bunds have room to rise back to fair value
10Y GBP yield model 10Y Bund yield model % 4.50 % 10Y Bund yield 4.00 4.00 Model 3.50 3.50 3.00 3.00 2.50 2.50 2.00 2.00 1.50 1.50 1.00 1.00 0.50 10Y Gilt yield 0.00 0.50 Model 0.00 -0.50 2010 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016 Source: Bloomberg and AXA IM Research Source: Bloomberg and AXA IM Research
49 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Credit Technicals remain strong but uncertainty has risen
• Global central bank liquidity remains ample, underpinning broader risk premia including credit spreads. Eurozone is facing an astute negative net supply due to the ECB’s asset purchase programs • Yield differentials continue to favour US credit over Europe, pulling global investors into US credit and driving US credit spreads tighter. However, Trump’s election is raising duration aversion, the risk of higher FX hedging costs due to USD appreciation, posing a threat to the positive technical • Credit market liquidity conditions remain reasonable, as evident by the price impact of flows in US HY ETF. Similarly, ECB corporate purchases have had a limited adverse effect on EUR credit liquidity
Supply/demand technicals remain very strong, particularly in € Trading liquidity conditions remain benign – US HY ETF Eurozone FI net supply, 4Q rolling here 800 € bn 600 400 200 0 -200 -400 -600 -800 2000 2002 2004 2006 2008 2010 2012 2014 2016
Govies Fins NonFins ECB QE Net
Source: Citi and AXA IM Research Source: Bloomberg and AXA IM Research
50 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Credit Rich top-down valuations could pose a headwind
• Recent asset volatility has halted the tightening momentum in spreads, helping credit valuations stabilise. US IG remains very expensive at ~1.5 sigma • The duration aversion driven by expectations of Trumpflation may prove a key driver for wider spreads, narrowing the overvaluation in US IG • Perceptions that central banks may be rethinking monetary policy is likely to entrench duration aversion, making us more cautious on IG credit (longer duration) than HY credit (shorter duration)
USD IG currently trading rich to its fair value by over 1 sigma Amid developed markets, only UK IG is trading cheap still
Source: Bloomberg, BAML and AXA IM Research Source: Bloomberg and AXA IM Research
51 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Equities UW equities on fragile earnings outlook and expensive valuations
• Excess liquidity no longer a driver for multiple re-rating from current levels and we expect Central banks to prove more hawkish than markets expect • Implied equity risk premiums suggest markets are ‘priced for perfection’ despite elevated global policy uncertainty with the new US leadership, Brexit proceedings and Italian referendum • Earnings growth headed for a soft rebound in 2017 although well below consensus estimates while valuations still remain slightly expensive, limiting the upside for equities
Implied ERP suggests markets are ‘priced for perfection’ Current real yields suggest a lower PE multiple
MSCI World: DDM implied equity risk premium US real yields & P/E 6.0% 40 5.5% 35 5.0% 30 Current P/E 4.5% 25 4.0% 20 Trend 3.5% Shiller PE 15 3.0% 10 2.5% 5 Current real yield 2.0% 0 1.5% -6 -4 -2 0 2 4 6 8 10 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 Real bond Yields (%) Source: AXA IM Research, Bloomberg and Data stream Source: AXA IM Research, Bloomberg and Data stream
52 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Equities UW equities on fragile earnings outlook and expensive valuations
Prefer United States over euro-area equities Regional equity tilts • The US macro and earnings story is more resilient • Euro area not cheap based on the historical valuation gap Owerweight Underweight
• Defensive nature makes US equities comparatively United States vs. Euro area appealing EM Asia vs. Emerging markets Asia remains our preferred region within EM EM EMEA vs. Latin America • Ability to provide more monetary and fiscal support than other EMs
• Cheap valuations with superior profitability position Euro area still not cheap compared to the US
• Most major emerging Asian countries remain under-owned EMU - US Valuation Gap 1.1 • Key risks include Trump’s trade policies and China tails risks 1 0.9 Prefer EMEA over LatAm within EM equities 0.8 • Policy stimulus appears to more reliable in EM EMEA 0.7 • EMEA provides deep value with relatively credible growth 0.6 estimates EMU / US PE ratio 0.5 Average • Latin America more geared to US trade; subject to Trump +/- 1 Sd 0.4 policies 2001 2003 2005 2007 2009 2011 2013 2015 2017
Source: AXA IM Research, Bloomberg and Datastream
53 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Investment Strategy – Foreign Exchange USD appreciation likely but not against EUR in the short run
• With a stronger pace of Fed hikes in the next few years, encouraging further capital inflows, we see a stronger outlook for the dollar (+8% for TWI) • However, with asymmetric risk on ECB, we are neutral EURUSD at the current level (~1.07) in the short run • Short EURUSD over the medium term with further monetary decoupling • FX volatility barely jumped and remains low
Net short on € decreasing from highest since early 2016 FX volatility barely jumped and remain low Net speculative positions and € 3M implied volatility on FX markets 1.6 150000 20 20 100000 1.5 50000 1.4 15 15 0
1.3 -50000
-100000 1.2 10 10 -150000 1.1 -200000
1.0 -250000 5 5 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 2010 2011 2012 2013 2014 2015 2016 JPM EM FX Hist avg JPM G7 Net Speculative positions EUR vs USD (rhs) EUR/USD (lhs) Source: CFTC and AXA IM Research Source: JP Morgan and AXA IM Research
54 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices p.63
55 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Macro forecast summary
Annual forecasts 2015 2016* 2017* Annual forecasts Annual forecasts 2015 2016* 2017* GDP (%) World 3.5 3.4 3.7 Inflation (%) Advanced economies US 2.4 1.6 (1.5) 2.1 (2.3) Advanced economies 0.1 0.9 2.4 Euro area 1.9 1.6 (1.5) 1.5 (1.3) US 0.0 1.1 (1.2) 2.4 (2.2) Japan 0.6 0.7 (0.6) 1.3 (0.8) Euro area 0.0 0.2 (0.2) 1.2 (1.3) UK 2.4 2.0 (1.7) 0.7 (0.7) Japan 0.8 -0.1 (-0.2) 0.3 (-0.4) Switzerland 0.8 1.2 (1.5) 1.5 (1.4) UK 0.1 0.7 (0.7) 1.9 (2.3) Switzerland -1.1 -0.5 (-0.4) 0.1 (0.3) Emerging economies Asia China 6.8 6.6 (6.6) 6.2 (6.3) Rest of Asia 6.3 6.4 6.3 LatAm Brazil -3.8 -3.2 1.2 Mexico 2.5 1.6 1.5 CEE Russia -3.7 -0.6 1.1
Oil prices Crude oil (Brent), US$/bbl 53 45 53 % change -47 -15 18 Note: numbers in parenthesis are consensus forecasts
Source : Datastream, AXA IM Research
56 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Forecasts Expectations on central banks
Central banks’ policies: meeting dates and expected changes
Current déc-16 janv-17 févr-17 mars-17 avr-17 mai-17 End of 2016 End of 2017 Date 13th-14th 31st-1st -- 14th-15th -- 2nd-3rd United States - Fed 0.25-0.5 0.5-0.75 1.00-1.25 Rates (bp) / QE +25bps unch -- unch -- unch Date 8th 19th -- 9th 27th -- Euro area - ECB 0.00 / 80bn 0.00 / 80bn 0.00 / 20bn Rates (bp) / QE +3m QE unch unch unch unch -- Date 19th-20th 30th-31st -- 15th-16th 26th-27th -- Japan - BoJ -0.1 / 80tn (JGBs) -0.1 / 80tn (JGBs) -0.1 / 60tn (JGBs) Rates (bp) / QE unch unch unch unch unch -- Date 15th 12th 2nd 16th -- 11th UK - BoE 0.25 / 70bn 0.25 / 70bn 0.10 / 60bn Rates (bp) / QE unch unch unch unch -- unch
Source : Datastream, AXA IM Research
57 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Forecasts Asset classes forecasts
Asset classes Target Reference Current 3 months 12 months Rates US 10Y Treasury 2.22 2.45 2.75 German 10Y Bund 0.31 0.50 0.80 British 10Y Gilt 1.38 1.60 1.70 Japanese 10Y JGB 0.01 0.00 0.00 Credit USD Investment Grade BofA C0A0 136 135 140 EUR Investment Grade BofA ER00 115 110 105 USD High Yield BofA H0A0 511 475 470 EUR High Yield BofA HE00 405 385 360 Equities US MSCI US 2,061 2,050 2,040 Eurozone MSCI Euro 106 106 104 Japan MSCI Japan 843 830 800 Emerging markets MSCI EM 839 835 825 FX EUR/USD 1.07 1.08 1.05 USD/JPY 109 107 104 GBP/USD 1.24 1.23 1.26
Source : Bloomberg, AXA IM Research
58 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices p.63
59 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Calendar Risks to short-term outlook
Macro Politics • UK • UK 15Dec – BoE meeting March – PM May’s deadline for triggering Article 02 Feb – BoE meeting 50 16 Mar – BoE meeting • Euro area March – EU Summit in Rome, Dutch elections • Euro area 23 April / 7 May 2017 – French Presidential 8 Dec – ECB meeting elections 19 Jan – ECB meeting October 2017 – German Federal elections 9 Mar – ECB meeting
• EM
• US July – Elections in India 14 Dec – FOMC meeting October – Elections in Czech Rep 01 Feb – FOMC meeting October – General elections in Chile 14-15 Mar – FOMC meeting October – Legislative elections in Argentina
• Japan 20 Dec – BoJ meeting 31 Jan – BoJ meeting 15-16 Mar – BoJ meeting
60 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices p.63
61 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Latest publications
Italian referendum: get ready for another political shock
23 November 2016
Mexico got trumped!
17 November 2016
US Elections: A game changer?
15 November 2016
US reaction: initial thoughts on a Trump victory
9 November 2016
Chinese GDP data - rebalancing is taking place
28 October 2016
US elections: looking into a Trump victory
14 October 2016
62 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I Themes of the Month p.5
II Macro Outlook p.25
III Investment Strategy p.44
IV Forecasts p.55
V Calendar p.59
VI Latest Publications p.61
VII Appendices : on structural analysis p.63
63 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 I US & German forward curves p. 65
I Euro Area – Periphery rates p. 67
I FX market movements p. 68
I Farewell the “new mediocre” p. 69
I Baseline 2015-25 : interest rates p. 70
I Fed policy : lessons from the past p. 75
I China p. 78
I Europe & European Banks p. 81
I Global Commodities p. 85
I Long term themes - longevity p. 87
64 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 US forward curve Although dampened by QE, US forwards foresee expansion
• Currently, bond yields are depressed by past purchases of US Treasuries by the Fed and by spillovers from global QE programs • The forward curve remains slightly upward sloped and remains positive on US cycle
% US: 1Y forward rates derived from the zero curve % Risk-adjusted 1Y forwards (from ZC Treasury curve) 6 6 2.50 2.25 5 5 2.00 1.75 4 4 1.50 3 3 1.25 1.00 2 2 0.75 13/11/2016 -394 bps 0.50 1 1 19/11/2015 0.25 0 0 0.00 1Y ...in 1Y ...in 2Y ...in 3Y ...in 4Y ...in 5Y ...in 6Y ...in 7Y ...in 8Y ...in 9Y Initial End N End N+1 End N+2 End N+3 End N+4 End N+5 -1 Average 1999-2007 25/12/2009 24/12/2010 -1 date (N)
30/12/2011 28/12/2012 11/11/2016
Source: Fed, AXA IM Research
65 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 German forward curve Hammered by QE, the German curve keeps a positive slope
• Dragged down below zero by the ECB’s unconventional policies, short term forwards are pricing three more years of negative rates. • The slope of the forward curve is significantly positive
% Germany:1Y forward rates derived from the zero curve 6 6
5 5
4 4
3 3
2 2 -466 bps
1 1
0 0 1Y ...in 1Y ...in 2Y ...in 3Y ...in 4Y ...in 5Y ...in 6Y ...in 7Y ...in 8Y ...in 9Y
-1 Average 1999-2007 25/12/2009 27/12/2013 -1
28/12/2012 11-Nov-16
Source: Datastream, AXA IM Research
66 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Euro area Movements in Periphery rates
• Spreads are rising across the board since tapering chatters and Trump elections • Cross exposures within euro area and especially French exposure to Italy and Spain
Spreads on the rise Large cross exposures in Euro banking system Peripheral spreads since 2015 Exposure to Euro area banks (Billion US dollar) 200 400 Germany 70 180 350 France 160 300 60 Italy 140 Spain 120 250 50 100 200 40 80 150 60 100 30 40 20 50 20 0 0 Jan-15 Jul-15 Jan-16 Jul-16 10 Italy Spain Netherlands 0 Belgium Ireland Portugal (rhs) Exposure of banks from: Source: Datastream, AXA IM Research Source: BIS, AXA IM Research
67 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 FX Markets Movements in Foreign Exchange Markets
• Trump victory sent the USD higher vs EUR and GBP • Looking at real exchange rates, GBP is undervalued vs EUR, while other currencies tend to be overvalued vs EUR
Real exchange rate against the euro 40 currency is undervalued against euro (nominal) currency should appreciate against the euro 30
20
10
0
2014 = 0, deviation in % in deviation 0, 2014 = - -10
-20 average 1999 average
-30 currency is overvalued against euro (nominal) currency should depreciate against the euro -40
US$ GB£ JP¥ CHF
68 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Farewell the “new mediocre”
• New normal …?
• Sluggish global growth 2009-2016: 3.2% (down from 4.3% in 1998-2008)
• Global trade trend down from 8.5% to less than 2%
• High debt despite deleveraging efforts • …Not quite 1. Central banks reducing support should lead to higher rates
• Fed tightening to come, and at faster pace because of Trump
• BoJ already took a step back with “yield curve control”
• ECB close to tapering 2. Fiscal policies to return
• Trump fiscal stimulus to come in the US
• European Commission’s president is advocating for a +0.5pp stimulus
69 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Baseline 2015-25: US interest rates
• US Fed rate policy expectations : next hike this December, potentially followed by 2 hike in 2017. • US Treasury curve: steady normalization of the term premium
5.0% US rates: AXA IM scenario 5.0% US rates: Fed dots and baseline scenario 4.5% 4.5% 4.0% 4.0% Positive term premium 3.5% 3.5% 3.0% 3.0% 2.5% 2.5% Term Premium 2.0% 10Y Treasury yield 2.0% 1.5% 5Y Treasury yield 1.5% 'Risk free' 10Y rate 1.0% 1.0% FOMC median (15 Jun 2016) 0.5% 0.5% 10Y FFR target, AXA IM Baseline 0.0% 0.0% 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
US, end of... 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 FFR 0.41% 0.63% 1.13% 1.88% 2.08% 2.28% 2.48% 2.69% 2.89% 3.09% 3.30% 1Y 0.78% 0.88% 1.50% 1.98% 2.18% 2.38% 2.59% 2.79% 2.99% 3.20% 3.40% 5Y 1.68% 1.78% 2.22% 2.48% 2.79% 3.09% 3.40% 3.68% 3.92% 4.13% 4.29% 10Y 2.26% 2.38% 2.75% 2.95% 3.25% 3.53% 3.80% 4.04% 4.26% 4.46% 4.64% 'risk free' 10Y 2.38% 2.65% 2.85% 3.00% 3.13% 3.25% 3.34% 3.41% 3.46% 3.49% 30Y 2.99% 3.03% 3.22% 3.28% 3.53% 3.78% 4.02% 4.25% 4.47% 4.69% 4.90% Source: Datastream, AXA IM Research
70 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Baseline 2015-25: €-area / German interest rates
• ECB policy expectations: QE roll over with enough parametric adjustments to offer 6 months if needed • German Bund curve: term premium becoming positive in the near future
3.5% ECB / German rates: baseline 3.5% German rates: baseline scenario 3.0% Term Premium Refi / Eonia 3.0% 2.5% 5Y Bund yield 2.5% 'Risk-free' 10Y rate 2.0% 2.0% 10Y Bund yield 10Y 1.5% 1.5%
1.0% 1.0%
0.5% 0.5%
0.0% 0.0%
-0.5% -0.5% 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
EUR, end of... 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 O/N = Eonia -0.35% -0.35% -0.35% -0.35% -0.10% 0.40% 0.90% 1.27% 1.64% 2.01% 2.38% 1Y -0.71% -0.60% -0.50% -0.28% 0.15% 0.65% 1.09% 1.46% 1.83% 2.20% 2.57% 5Y -0.39% -0.22% 0.12% 0.71% 1.15% 1.58% 1.98% 2.33% 2.61% 2.81% 2.94% 10Y 0.23% 0.50% 0.83% 1.46% 1.83% 2.16% 2.44% 2.68% 2.88% 3.04% 3.16% 'risk free' 10Y 0.5% 0.8% 1.2% 1.5% 1.8% 2.1% 2.3% 2.5% 2.6% 2.7% 2.7% 30Y 0.9% 1.1% 1.2% 1.6% 1.9% 2.2% 2.5% 2.7% 3.0% 3.2% 3.4% Source: Datastream, AXA IM Research
71 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Baseline 2015-25: Japan interest rates
• BoJ policy expectations: step back from QE and gradual tapering. • JGB curve: yields capped below BoJ target. Trump election provides a successful test for “yield curve control”.
3.0% Japan rates: baseline scenario 3.0% Japan rates: baseline scenario 2.5% 2.5% Term Premium 2.0% O/N = call rate 2.0% 'Risk free' 10Y rate 1.5% 5Y JGB yield 1.5% Positive term 10Y premium 1.0% 10Y JGB yield 1.0%
0.5% 0.5%
0.0% 0.0%
-0.5% -0.5% 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 JP, end of... 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 O/N = call rate -0.05% -0.05% -0.05% -0.05% -0.05% 0.20% 0.58% 1.08% 1.45% 1.83% 2.08% 1Y -0.27% -0.25% -0.25% -0.15% 0.03% 0.39% 0.83% 1.27% 1.64% 1.95% 2.16% 5Y -0.12% -0.19% -0.13% -0.13% 0.28% 0.76% 1.22% 1.55% 1.85% 2.12% 2.28% 10Y 0.01% -0.04% 0.01% 0.01% 0.45% 0.87% 1.26% 1.60% 1.90% 2.16% 2.39% 'risk free' 10Y 0.52% 0.76% 1.01% 1.26% 1.50% 1.72% 1.91% 2.05% 2.15% 2.21% 2.24% 30Y 0.57% 0.55% 0.53% 0.52% 0.87% 1.21% 1.54% 1.86% 2.16% 2.45% 2.73% Source: Datastream, AXA IM Research
72 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Baseline 2015-25: UK interest rates
• BoE policy expectations: one or two rate cuts in 2016/17, QE in order to support a weakening economy post Brexit vote
• Gilts curve: steady normalization of the term premium
5.0% UK rates: baseline scenario 5.0% UK rates: baseline scenario
4.0% 4.0% Positive term premium
3.0% 3.0%
2.0% O/N = base rate 2.0% Term Premium 5Y Gilt yield 'Risk-free' 10Y rate' 1.0% 1.0% 10Y Gilt yield 10Y 0.0% 0.0% 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
UK, end of... 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 O/N = base rate 0.25% 0.25% 0.10% 0.10% 0.50% 0.93% 1.36% 1.79% 2.21% 2.64% 3.07% 1Y 0.25% 0.18% 0.10% 0.30% 0.71% 1.14% 1.57% 2.00% 2.43% 2.86% 3.29% 5Y 0.64% 0.69% 0.86% 1.24% 1.76% 2.27% 2.79% 3.26% 3.65% 3.95% 4.17% 10Y 1.38% 1.45% 1.68% 2.02% 2.51% 2.96% 3.37% 3.73% 4.05% 4.33% 4.56% 'risk free' 10Y 1.15% 1.45% 1.78% 2.12% 2.45% 2.73% 2.96% 3.16% 3.31% 3.41% 3.48% 30Y 2.02% 2.11% 2.12% 2.24% 2.57% 2.89% 3.20% 3.49% 3.76% 4.02% 4.27% Source: Datastream, AXA IM Research 73 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Baseline 2015-25: Swiss interest rates
• SNB policy expectations: deep negative (but stable) o/n until 2021 • Federal bonds yield curve: negative term premium
3.5% Swiss rates: baseline scenario 3.5% Swiss rates: baseline scenario 3.0% 3.0% Term Premium Positive 2.5% 2.5% term 2.0% 2.0% 'Risk free' 10Y rate premium O/N 1.5% 1.5% 10Y 1.0% 5Y 1.0% 0.5% 10Y 0.5% 0.0% 0.0% -0.5% -0.5% -1.0% -1.0% 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
CHF, end of... 11-16 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 O/N -0.80% -0.80% -0.80% -0.80% -0.55% -0.11% 0.32% 0.76% 1.19% 1.63% 2.06% 1Y -0.65% -0.65% -0.65% -0.58% -0.28% 0.10% 0.54% 0.98% 1.41% 1.85% 2.28% 5Y -0.62% -0.45% -0.22% 0.31% 0.71% 1.14% 1.58% 1.98% 2.29% 2.51% 2.65% 10Y -0.13% -0.18% 0.13% 0.75% 1.16% 1.55% 1.90% 2.21% 2.47% 2.69% 2.87% 'risk free' 10Y 0.49% 0.49% 0.81% 1.12% 1.43% 1.71% 1.95% 2.15% 2.30% 2.41% 2.48% 30Y 0.37% 0.56% 0.67% 1.08% 1.42% 1.76% 2.09% 2.40% 2.70% 2.98% 3.25% Source: Datastream, AXA IM Research 74 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Fed policy After the Fed lift-off, what happens? Lessons of the past (1)
• Five tightening cycles took place, since the fed funds rate is the main policy tool, starting in 1986, 1988, 1994, 2004. One year after the lift off, the Fed was still in tightening mode (but in 1987) Average increase after 12M: 200bps • Bond yields rose in each cycle but in 2004 Average increase: 50bps after 12M • The yield curve flattened in each cycle but in 2004 (‘bond conundrum’) Average flattening: -150bps after 12M
% Fed funds rate target, after lift-off % Change of 10Y US Treasury yield (zero coupon) 10 10 2.5 9 9 2.0 8 8 1.5 7 7 1.0 6 6 0.5 5 5 0.0 4 4 -0.5 3 3 -1.0 2 2 Months from first tightening -1.5 1 1 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 5 6 7 8 10 11 12 Dec 1986 Mar 1988 Feb 1994 04/12/1986 29/03/1988 Months from first tightening Jun 1999 Jun 2004 Mean 21/03/1994 29/06/2004 29/06/1999 Mean
Source: Fed, AXA IM Research
75 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Fed policy After the Fed lift-off, what happens? Lessons of the past (2)
• Markets progressively adjusted (up) their risk-adjusted expected rates (over next 10Y), Average increase after 12M: +120bps • The term premium declined in each cycle but in 1986-1987 Average decrease after 12M: -70bps • This time is different: 1. Initial term premium at zero, more likely to rise than to decline 2. Fed guidance insists on gradualism: 100bps expected by end-16 (less than any previous cycle but 86) • Conclusion: yields will rise but volatility is likely to rise as well
% Change of risk adjusted 10Y rate % Change of term premium - 10Y Treasury bonds 2.0 1.5
1.0 1.5 0.5 1.0 0.0
0.5 -0.5
-1.0 0.0 -1.5 -0.5 -2.0 Months from first tightening Months from first tightening -1.0 -2.5 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 Dec 1986 Mar 1988 Feb 1994 Dec 1986 Mar 1988 Feb 1994 Jun 1999 Jun 2004 Mean Jun 1999 Jun 2004 Mean Source: Fed, AXA IM Research
76 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Fed policy Low R-star coupled with inflation argues for hike
• Whether a central bank interest rate policy is expansionary or restrictive depends on whether the policy rate is above or below the level consistent with full employment. This is the ‘natural rate’ (R-star) • While the real neutral rate is not observable, the Fed is using several models to estimate its level. They are all indicating ‘close to zero’ in the most recent period. • Since inflation is around 2%, and the unemployment rate at 5.0%, the neutral nominal rate should be above 1%, significantly above the actual fed funds rate. • This should make the FOMC comfortable about hiking
US Neutral Interest Rate
5
4
3
2
1
0
-1 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: FRBSF, based on Laubach & Williams (2003)
77 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 China Near term stability but structural challenges ahead
• Economy stabilises after a poor start to the year, though Trump’s election could be a high threat. • Reviving housing market and proactive policy supports put a floor under growth • China is not out of woods, with many structural challenges yet to be resolved • China is aging as fast as many DM countries, and faces the risk of falling into the mid-income trap • Changing population policies is a start, but no silver-bullet; avoiding the Trap requires continuous reforms
Fiscal stimulus underpins infrastructure investment Falling into the mid-income trap is a risk
Source: CEIC, and AXA IM Research (as of Sep-2016) Sources: Various sources , and AXA IM Research
78 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 China Economic reforms and rebalancing are the only way out
• China’s economic cycle fits perfectly with the reform cycle • Extending the “China miracle” requires reviving the reform engine • Like reforms, China is not new to economic rebalancing – it had successfully rebalanced, twice!
Reforms drives China’s productivity cycle Rebalancing 1.0 – from domestic demand to exports
Source: Various media sources, and AXA IM Research (as of Sep-2016) Source: CEIC, and AXA IM Research (as of Sep-2016)
79 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 China China rebalancing
• Rebalancing 1.0 “open door” policy, which turned the economy to externally-oriented • Rebalancing 2.0 occurred post-GFC, which forced China to shift its reliance to domestic demand • Rebalancing 3.0 has started in recent years, as China alters its growth engine from investment to consumption & services • Successful rebalancing will not only affect China, but also has implications for the world • New winners and losers will be created among China’s trading partners, depending on their exposures • Those who cater to the new China will benefit at the expense of those that serve the old economy
Rebalancing 3.0 – internally from investment to consumption Reduced energy demand as economy rebalances
Source: CEIC, and AXA IM Research (as of Sep-2016) Source: CEIC, and AXA IM Research (as of Sep-2016)
80 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Europe Recessions are political bombs
• Extent of recessions endured by several euro area countries is dramatic enough to fuel anti-euro or nationalistic political reactions.
• Which countries are better off, compared to where they stood Gross domestic product per capita at constant prices before EMU? We look at real GDP 155 Indexed, 100=1998 145 per capita. Ireland 150 140 • Average growth at or above 1.0% Germany 145 p.a. from 1998 to 2015: 135 * Ireland (2.78%) 140 Finland 130 * Finland (1.30%) 135 Netherlands 125 * Austria (1.24%) 130 * Germany (1.36%) Belgium 125 120 • * Netherlands (1.10%) France 120 115 * Belgium (1.07%) Spain 115 • Average growth below 1.0%: 110 Greece * Spain (0.95%) 110 105 * France (0.86%) 105 Portugal 100 * Portugal (0.48%) 100 Italy * Greece (0.27%) 95 95 * Italy (-0.13%) 1998 2001 2004 2007 2010 2013 2016e
Source: IMF, AXA IM Research
81 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Europe Asymmetric correction in imbalances
• Pre-2008 single currency prevented current account imbalances correction within the euro area (German surplus vs. Spanish deficit) • The correction had to come from asset prices (stocks, properties and bonds), wages and domestic prices • Ireland and Spain, where excesses came from the private sector, the macro adjustment is largely done via deleveraging and fiscal retrenchment. In Portugal and Greece, where excesses came from government spending ‘austerity’ has been doing the job. Almost all countries have C/A in surplus or at equilibrium
Current account balance: deficit €-area countries Current account balance: surplus €-area countries 4 4 14 14 % of GDP France % of GDP 2 2 12 12
0 0 10 10 Netherlands -2 -2 Spain 8 8
-4 -4 6 6 Germany -6 -6 Portugal 4 4
-8 -8 2 2 Ireland 0 0 -10 -10 Italy
-12 -12 -2 -2
-14 -14 -4 -4 Greece -16 -16 -6 -6
Source: National accounts, AXA IM Research Latest data: 1Q 2016
82 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Europe Entering a long period of weak euro?
• Looking at the euro (very short) history, three periods appear: 01/01/1999 to 05/12/2003 : euro undervalued (=below average) 06/12/2003 to 26/12/2014 : euro overvalued Since 27/12/2014 : euro undervalued • What matters for real economies is the cumulated deviation • Tentative conclusion: € likely to depreciate more and/or stay undervalued for years
Euro / US$ exchange rate, adjusted for inflation trends 130 100 = average (99-15) 130
120 120
110 110
100 100
90 90
80 80
70 70 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Datastream, AXA IM Research
83 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 European Banks In need of restructuring
• Italian banking system is still an issue, and MPS plan not likely to be implemented before referendum • More broadly, issues regarding profitability and size of banking system across Europe need to be addressed…but not likely
The banking sector in the four main countries NPL in Euro area Euro-area banks' non-performing loans Germany Italy France Spain 40.0 % Number of Banks 1766 649 589 264 35.0 (June 2016) 30.0 Banks closed -45 -19 -25 -12 25.0 (since Jan 2015) 20.0 2008 Assets of banking sector 7 708 3 665 7 018 2 760 15.0 2015 € Bn (as of Dec 2015) 10.0
Source: ECB, National Central Banks and BIS 5.0 0.0
Source: Datastream, AXA IM Research
84 Research & Investment Strategy November 2016 Global commodities Oil market: bouncing back
• After a period of oversupply, oil prices are bouncing back thanks to tightening fundamentals • Despite rising dollar, spot and future prices remain around the $50 threshold
Crude oil futures, ICE Brent contracts Shape of the oil future market 130 130 60% 150 US$/bl US$ / bl 120 120 Brent 1M swap, $/bl 140 50%
110 110 (right hand scale) 130 Contango 120 100 100 40% 110 90 90 30% 100
80 80 90 20% 70 70 80 10% 70 60 60 60 50 50 0% 50 Spot Dec-2017 40 40 40 -10% 30 Dec-2016 Dec-2019 30 Brent swaps, 30 (3Y-1M) as % of 1M -20% 20 20 20 Backwardation 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: ICE, Datastream, AXA IM Research
Source: ICE
85 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Global commodities Commodity prices no longer in free fall
• The prices of the three main families of commodities (energy, industrial, agricultural) have declined until early 2016
• Since then, oil prices have been on the rise while food and industrial tend to stabilize
5 000 LME index HWWA Agriculture Raw Brent, US$/bbl 220 HWWA Index 4 500 Materials Index -RHS 200
4 000 180
3 500 160
3 000 140
120 2 500 100 2 000 LME Metal Index 80 1 500 60 1 000 Brent 40
500 20 Source: Reuters Datastream, AXA IM Research, weekly averages 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Datastream, AXA IM Research
86 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Long term theme – longevity (1) Human longevity up 3 months per year since 1840
• The rise in human longevity (different from life expectancy) has been practically linear since 1840, according to demographers, adding 3 months to life expectancy in the ‘champion’ countries every year
• Neither major medical breakthrough (antibiotics) of change in habits (smoking) can explain this linear trend. Note that the speed of increase is itself slowing down
• So far, the safest assumption for the future is that this trend will continue
Source: J. Oeppen and JW Vaupel, Science, 2012
87 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Long term theme – longevity (2) Living longer in good health AND richer
• There is a close non-linear relationship between ‘healthy life expectancy’ and national income per capita. This relationship is consistent with some sort of upper average limit for life expectancy, itself dependant on wealth per capita. • From 2007 to 2013, this ‘upper limit’ increased by two years, consistent with the long term trend • Societies may adapt to rising longevity and aging, providing that they leverage the potential of older generations, which are each year better fit, in the countries at the frontier at least
100 Gross National Income (GNI) per capita 100 Gross National Income (GNI) per capita 2007, PPP (1,000$) 2013, PPP (1,000$) 90 90
80 80
70 70
60 60
50 50
40 40
30 30
20 20
10 10
0 0 30 40 50 60 70 80 30 40 50 60 70 80
Healthy life expectancy at birth (HALE), years Healthy life expectancy at birth (HALE), years
5 -3.5 2 Pseudo-harmonic model: GNIc = 1.6*105 *(88-HALE)-3.1 [R2 = 0.74] Pseudo-harmonic model: GNIc = 9.0*10 *(90-HALE) [R = 0.69] Source: WHO, AXA IM Research Eric Chaney
88 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Long term theme – longevity (3) Rising longevity gives an edge to flexible economies
• Rising longevity (an old story indeed) raises well know challenges: compounded with the consequences of the post-WWII baby boom, it raises dramatically dependency ratios, makes pension systems crafted in the post-war period (pay-as-you-go or defined benefits) unsustainable and changes the political framework (older generations vote more than younger, all else equal) • A growing set of research shows that productivity growth is impacted by aging. On US data, Maestas and alii (NBER WP 22452) conclude that a 10% increase in the share of 60+ would cut GDP per capita growth by 5.5% (say from 2.0% to 1.9%), most of the decrease coming from slower workers’ productivity. • Aging will test the adaptive capabilities of societies: a steady increase of the effective retirement age, commensurate to the steady rise in longevity, and compensation schemes reflecting changing productivity would make economies and social relationships more resilient • Interestingly, pay-as-you-go pension systems may benefit from lower financial returns (r), if the latter fall below GDP growth (g), in comparison with funded systems, whereas the opposite was true in the post-war years
• In the end, societies will adapt to aging, yet some will adapt faster and more consistently than others. In this relative game, there will be winners and losers.
89 Laurence Boone, Chief Economist AXA Group, Head of Research, AXA IM November 2016 Disclaimer
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