Resea
rch
D
euts
che B
ank
The
House V
iew
Politics take centre stage
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI(P) 057/04/2016
18 October 2016
Distributed on: 18/10/2016 04:10:00 GMT
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Month in Review
2
Reuters, 1st October 2016
FX Street, 7th October 2016
MarketWatch, 6th October 2016
Daily Mail, 5th October 2016
Seeking Alpha, 5th October 2016
IMF, 4th October 2016
Bloomberg, 29th September 2016
Bloomberg, 7th October 2016 Bloomberg, 7th October 2016
WSJ, 7th October 2016
WSJ, 5th October 2016
CNN, 7th October 2016
FT, 9th October 2016
Fortune, 21st September 2016
The Guardian 2nd October 2016
WSJ, 5th October 2016
The Week, 13th October 2016
The Local, 12h October 2016
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
The political calendar is filled with risk events over the next year. The US elections in
a few weeks are likely to yield a Clinton win and continued gridlock. Spain continues
without a government, but an end to the impasse could be nearing. In Italy, however,
the risk is rising that December’s Senate referendum will be rejected. In this case,
new elections, though unlikely, cannot be ruled out. Anti-EU parties might also make
gains in next year’s German and French elections. In the UK, the government’s hard-
line rhetoric and an uncompromising EU stance are paving the way for a hard Brexit.
On the macro front, global growth remains sluggish, although there have been some
signs of improvement. US growth is expected to pick up slightly but the eurozone is
yet to feel the full impact of Brexit. Importantly, political headwinds prevent necessary
structural reforms and limit meaningful fiscal stimulus programmes.
Meanwhile, there has been a chorus of calls for such responses from central
bankers, as incremental monetary easing is increasingly seen as less effective and
even counterproductive. We expect the ECB to extend its QE programme this year,
but the Fed is eager to raise rates before year-end, and the BoJ has taken measures
to stem the decline in long-end yields.
The ongoing policy rethink informs our market views. The sell-off in rates should be
sustained, and possibly extended next year. In FX, we are bullish the yen and the
dollar post election, and bearish the euro and sterling. We are cautious on US and
European equities. EM assets have performed well on the back of material inflows,
but we expect a short-term pause in these dynamics ahead of key risk events.
David Folkerts-Landau, Group Chief Economist
3
The House View, 18 October 2016 – Politics take centre stage
The views in this publication are informed by Deutsche Bank’s Global Strategy Group, which advises management and
clients on broad market risks and global economic and financial developments. The views and forecasts of the group,
which consists of senior research staff, may occasionally differ from those disseminated by their research colleagues
Editors: Marcos Arana, Aditya Bhave,
Matthew Luzzetti, Rajni Thakur
Table of contents
Introduction 4-boxes
Total returns
Macro
update
Global growth
Outlook for US, Europe,
and China
Monetary
policy
A new framework?
Outlook for ECB, BoJ and
Fed
Politics
US election
Brexit
European political risk
Markets
Summary of market views
Recent market drivers
FX, rates, EM, credit and
equity views
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Fed: November hike almost fully ruled out; expect hike
in December, and very cautious cycle thereafter
ECB: easing bias. 9-12 month QE extension in Dec.;
further deposit rate cuts unlikely. Taper talk unfounded
BoJ: introduced 10Y yield target. Additional easing
could involve rate cuts, but substantial cuts unlikely
BoE: aggressive easing post-Brexit may be premature.
Expect further rate cut around year-end if data weaken
PBoC: return to easing in H1-2017
EM: easing bias in Asia, CEEMEA (ex- South Africa).
LatAm picture less uniform
Sluggish global growth outlook. 2016 at 3.0%, slowest
pace post-crisis, rising modestly into 2017 to 3.4%
US growth subdued and well below recent years’ trend.
2016 at 1.3%, half the rate in 2015. Growth should rise
moderately in coming quarters
Downbeat view on eurozone recovery. Growth resilient
in 2016 at 1.6%, but set to slow in 2017 as Brexit adds
to existing downside risks
EM outlook similarly subdued, but signs of bottoming
across several major economies. Expect some
acceleration next year in LatAm and CEEMEA
Politics: taking centre stage, political uncertainty high
over next 12 months. US election unlikely to have
substantial impact on macro or markets
Policy rethink: increasing recognition of reduced impact
of additional monetary easing, but little to expect from
fiscal stimulus, structural reforms
Brexit: hard Brexit increasingly likely given tough UK
rhetoric that makes finding a compromise difficult. If /
when economic pain rises, positions may soften
European banks: underlying issue remains unresolved,
continues to be a source of downside risk for growth
Views on key themes
Economic outlook Central bank watch
Key downside risks to our view
Notes: H / M / L indicates estimated probability of risk (High, Medium, Low).
(*) Sharp deceleration in growth, e.g., growth falling below 5%
(**) Non-performing loans
4
Negative spillover from banking stress / political risk
escalation in Europe that derails recovery
China hard landing: sharp contraction that drags down
global growth, possibly due to deflating property bubble
Market corrections / volatility episodes, e.g., unexpect-
ed shock from US election, reassessment of Fed hikes
Corporate credit crisis and wave of defaults; rising
dollar, US rates put pressure on EM corporates and US
HY, especially energy sector
Sharper US slowdown than our below-consensus view
M
M
M
L
L
Global growth remains sluggish and is expected to improve only modestly in 2017. Political risk to remain high in next 12 months
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
42
16 16 15 11
9 6
-2 -5 -5
-11 -12 -19
14 8 7 6
11
5 5
16
4 1
-1
-17
38
32
20 18
-20
-10
0
10
20
30
40
50
Bra
zil
Bovespa
Russia
Mic
ex
MS
CI E
M
UK
FT
SE
100
Turk
ey B
IST
India
Nifty
US
S&
P 5
00
Germ
an D
AX
30
Euro
pe S
toxx 6
00
Spain
IB
EX
35
Japan N
ikkei
Shanghai C
om
posite
Italy
Mila
n
US
HY
US
IG
EU
R H
Y
EU
R IG
UK
Germ
any
US
JP
Y
EM
FX
EU
R
Dolla
r In
dex
GB
P
Bre
nt O
il
Iron O
re
BB
G C
mdty
Index
Gold
Since Fed / BoJ meeting (21 Sept)
2016 YTD and since Fed / BoJ meeting on 21st September 2016
% Equities Commodities** FX** Sovereign
debt Corporate
Credit
2016 YTD
5
Note: (*) Total return accounts for both income (interest or dividends) and capital appreciation. (**) FX, Commodities are spot returns.
Source: Bloomberg Finance LP, Deutsche Bank Research. As of 17th October 2016
Hopes of Opec cuts
sent oil up, gold
down on higher
inflation expectation
Credit has rallied
strongly this year;
little changed since
rates have risen
European equities down
this year, but UK equities
have been boosted by
much weaker sterling
Weak fundamentals
and rising risk of
“hard Brexit” driving
continued GBP fall
UK sovereign bonds have
underperformed significantly
as pound plunged, inflation
expectations surged
Dollar strengthened,
yen fell recently,
reversing earlier
trends
EM equities have
outperformed this year but
underperformed since DM
rates started to rise
Risk assets have been generally resilient to the recent sell-off in sovereign bond yields
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
After slowing sharply in 2015 and
early-2016, global growth mom-
entum has picked up recently,
though it remains subdued
− Acceleration more evident in
manufacturing than services
− Global manufacturing PMI
highest level since mid-2015
over past 3 months
The breadth of the improvement
has been impressive…
− Number of countries with dec-
lining PMIs lowest in 3 years
…With EM accelerating most
rapidly…
− EM composite PMI up two
points over past year
…But momentum has also picked
up modestly across DM
− Manufacturing trend moved
higher across US, Eurozone,
Japan and UK
50
51
52
53
2013 2014 2015 2016
Global manufacturing momentum has
improved in recent months
Global manufacturing PMI, 3m MA
48
50
52
54
56
58
2013 2014 2015 2016
Momentum has improved everywhere but EM
economies have accelerated more rapidly
Composite PMI, 3m MA
DM
EM
Global growth momentum picked up modestly in recent months but remains subdued
6
47
49
51
53
UK Euro- zone
US* China Japan
Avg. Jan-Jun Avg. Jul-Sep
Manufacturing PMIs have improved broadly
relative to H1 2016
Index
5
10
15
20
25
2013 2014 2015 2016
Breadth of improvement impressive, with
limited countries experiencing falling PMIs
# countries with declining
manufacturing PMIs, 2m MA
Number of declining
PMIs lowest since 2013
Note: (*) ISM. Source: Markit, ISM, Haver Analytics, Bloomberg Finance LP, Deutsche Bank Research
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
0
1
2
3
4
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Actual Forecast
%qoq
saar
2015 2016
GDP growth to remain below trend in the next few quarters
Source: BEA,
Deutsche Bank Research
Current-cycle trend growth rate
2017
US growth will remain sluggish through year-end. Headwinds should fade slightly next year, allowing for a small acceleration
-80
-60
-40
-20
0
20
40
-5
0
5
10
15
2010 2012 2014 2016
Ex-Energy Business Investment
Energy Business Investment, rhs
Business investment has slowed even
excluding energy
%yoy
Source: BEA, Haver Analytics, Deutsche Bank Research
%yoy
-4
0
4
8
12
16
-1.0
-0.5
0.0
0.5
2012 2013 2014 2015 2016
Contribution of net exports to real GDP (4q MA) Trade-weighted USD, rhs
Source: FRB, BEA, Haver Analytics, Deutsche Bank Research
%pt % yoy
The dollar drag on trade is fading
However, there are some upside risks:
− Trade data improving as dollar has stabilized
…Will Fed hike cause renewed dollar strength?
− Advances in September PMIs also encouraging
…Nonmanufacturing ISM at year-to-date peak
− Next President could enact large fiscal stimulus
…Government spending has room to improve
as it has been very weak in this cycle
− Recent oil rally might boost energy capex
…But it might also weigh on consumption
We expect US GDP growth to remain weak through
2016 and improve only modestly next year
− Growth of 1.3% in 2016, 1.7% in 2017
− Weak productivity will likely fail to offset slowing
labour gains as economy nears full employment
− Recent growth supported by consumption alone
…Non-consumer portion of economy shrinking
…Capex drag to continue through year-end
− Fed GDP trackers for Q3 have declined, moving
towards our well-below-consensus forecast
7
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Eurozone growth slow but stable at 1.2-1.5% over
the last couple of years despite many shocks...
− Latest data point to Q3 growth around this level
...But the recovery is vulnerable
− Cyclical picture weak – rising oil prices, euro not
depreciating as was expected, fiscal policy likely
to be less supportive in 2017
− Structural issues of high debt, low growth, low
competitiveness still unresolved
− Political event risk high in 5 largest economies
We forecast growth of just 1.1% in 2017, down from
1.6% this year – but risks tilted to the downside
− Persistent policy uncertainty (political, fiscal,
monetary) could weigh further on investment
and growth, and keep productivity low
− With banking sector issues unresolved, credit
growth could stall and hurt domestic demand
…Consensus growth forecasts need an
ambitious 3-4% credit growth in 2017
…Latest credit data suggest slower growth
− Brexit impact still to be felt
Our macro view on the eurozone remains unchanged: growth has been resilient, but risks are tilted to the downside
8
-10
-8
-6
-4
-2
0
2
4
6
2005 2007 2009 2011 2013 2015
Credit impulse, % of GDP
Private domestic demand, % yoy
Credit impulse still positive but slower, pointing to domestic demand
growth of 1.5% yoy by early 2017, down from 2% in recent quarters
Focus Europe-European Quarterly Update:30 September 2016
Euro PMIs: confirming slower momentum - 5 October 2016
-3
-2
-1
0
1
2
3
50 100 150 200 250 300
Persistent high uncertainty could weigh on investment spending
EU economic policy uncertainty index
Note: (*) 4q lag. Source: Eurostat, www.policyuncertainty.com, Deutsche Bank Research
Eu
rozone in
ve
stm
ent, %
qo
q*
Sovereign crisis Post-Lehman
Note: (*) Credit impulse: Deutsche Bank’s non-consensus view is that it is not credit growth but rather the
change in credit growth that is important for domestic demand growth. A slowdown in the pace of
deleveraging boosts spending growth, even if credit growth may still be negative
Source: ECB, Eurostat, Haver Analytics, Deutsche Bank Research
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
With China’s economy in the middle of a structural
growth slowdown, concerns about a credit-fuelled
property bubble have intensified
− Property prices are up sharply on ballooning
mortgage debt
− Developers could face steep losses if price rises
slow after paying high land auction premiums
Near-term, strong property sector should slightly
boost growth...
− Pressure on FX, capital controls, outflows could
be partly relieved by better near-term growth
…And lower likelihood of imminent policy easing
− Government has actually tightened credit supply
to developers to contain bubble
− Interest rate cut possible in Q2 2017 if property
sector begins to cool
A deflating property bubble poses material
downside risk to the economy
− Growth likely to slow to 6.2% in Q1 2017
− 2018 GDP growth forecast cut by 0.5pp to 6%
− Outflow pressures to intensify: FX reserves to
fall below $3tn; RMB weaken to 7.4 by end-17
0
20
40
60
15
20
25
30
2010 2011 2012 2013 2014 2015 2016
Broad credit growth (avg. of previous 2 Qs)
Land auction premium (avg. of current and next Q, rhs)
Surge in broad credit growth has fuelled property bubble
Source: CREIS, WIND, Deutsche Bank Research
%yoy
Correlation 0.86
%
In China, a rising property bubble could modestly boost near-term growth but raises risks into 2017 and 2018
9 China’s property bubble – 28-Sep-2016
17.8 24.7
19.5 16.2 25.3 22.8 26
34.8
71.2
0
20
40
60
80
2009 2010 2011 2012 2013 2014 2015 2016 H1
2016 Jul-Aug
Mortgage share of total new RMB loans
Mortgage share of total loans more than doubled in recent months
%
Source: WIND, Deutsche Bank Research
China’s property bubble II: Government tightens developers financing – 13-Oct-2016
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Years of ultra-loose monetary policy have failed to
reignite growth and raise inflation across DM
− Monetary policy can address cyclical issues but
not structural ones
− Easing was effective initially, when rates, risk
premia were high – but this is no longer the case
− Political constraints leaving central banks’ calls
for structural reform, fiscal stimulus unanswered
Additional material easing increasingly seen as
ineffective and even counterproductive...
− Inflation expectations have risen but remain low
− Euro, yen ‘not responding’ to additional easing
− Hunt for yield continues to distort asset prices
...with even ECB, BoJ taking a pause
− While defending policy to date, both CBs
acknowledged negative impact of their policies
(especially flat yield curves) on banks, insurers
Monetary policy to remain very accommodative, but
focus shifting away from rate cuts, flat yield curves
− Expect little in terms of fiscal easing
After years of extreme accommodation, we are going through a monetary policy rethink
10 The House View - Infographic: Change in the policy mix - 14 September 2016
0
10
20
30
40
50
50
60
70
80
90
100
Jan Feb Mar Apr May Jun Jul Aug Sep Oct
Germany
Japan (rhs)
Central banks increasingly wary of impact of monetary policy on
banks, insurers. Focus shifting away from flat yield curves
bps
Source: Bloomberg Finance LP, Deutsche Bank Research
bps
Steepening of
yield curves
BoJ meeting
“[T]he stimulus provided by lowering interest rates (...) would of course be
much weaker. (…) [E]xtended use of unconventional measures could
come with rising side effects, for instance on financial stability, financial
intermediation and international spillovers.”
Benoit Coeure, ECB board member, Jackson Hole speech, Aug-2016
“[T]he significant fall in lending rates [following the introduction of negative
interest rates] (…) has been achieved at the expense of financial
institutions' profits.”
Haruhiko Kuroda, Governor of the BoJ, Kisaragi-kai speech, Sep-2016
ECB, BoJ conscious of diminishing returns of policy easing, impact
on financial firms’ profitability
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Given likely QE extension, asset scarcity a concern
− Under existing rules and at current pace, ECB
would run out of Bunds to buy around Jun-2017
Expect changes to the current QE rules to be
announced at the same time as the extension
− Several options possible: Yield floor removal,
soft capital keys change, increase in issue limit
all possible
− Could be done individually or in combination
Announcements not to be made until December
− October meeting to shed light on what’s likely
− ECB could take risk of waiting until March
Further ECB easing is likely. We expect an announcement of QE extension in December, but no further rate cuts
11 Focus Europe – Wary of premature tapering : 14-Oct-2016
European Fixed Income Weekly – Preparing the ground for December: 14-Oct-2016
With inflation rising but still low and vulnerable to
shocks, the ECB maintains a clear easing bias
Expect ECB to announce 9-12 month QE extension
− No further depo rate cuts: ECB has no urgency
to weaken euro, further cuts would hurt banks
− A shorter extension is possible
Taper discussion premature at this stage
− Core inflation at 0.8% currently is far lower than
levels that would justify a taper (1.2-1.3%)
− ECB only expects core inflation to reach these
levels in H2-2017 – but that looks optimistic
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
US* Eurozone Germany France Italy Spain
Note: Core inflation. (*) Inflation as of May 2013, when the Fed announced that it would start tapering its QE
purchases. Source: SOEC,BLS, Haver Analytics, Deutsche Bank Research
Core inflation still below levels consistent with taper – though intra-
region variation is high
Inflation relative to 99-07 avg., pp yoy
Fed signalled taper when
inflation was around 0.4pp
lower than 99-07 avg.
Eurozone
inflation still
materially lower
ECB rules governing QE purchases
What: can buy bonds... Commentary
Removal of
yield floor
W/ yield below depo rate
In practice, more short-
dated bonds
Steepens yield curve
Likely with ‘caveats’ rather
than total removal
Soft capital
key change
Of other countries if
scarcity becomes a
constraint
Tighter spreads to Bunds
Highest market impact if
no credit rating constraint*
Increase of
issue limit
Beyond current 33% issue
limit
Flattens yield curve
Legally difficult to expand
to CAC bonds**
Note: (*) e.g., replacement purchases of an issuer of similar credit rating. (**) Issue limit intended to avoid
being caught by collective action clauses; raising issue limit for CAC bonds removes this protection.
De
cre
asin
g li
ke
liho
od
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
The BoJ announced a new monetary policy
framework at its September meeting
− Introduced target 10-year JGB yield around 0%,
in part to keep yield curve steeper
− Abandoned monetary base growth target
− Kept short-term policy rate unchanged at -0.1%
Re-think comes as BoJ struggles to raise inflation
While details of the new regime are still uncertain, it
will likely lead to a de facto tapering of QE
− Higher long yields require a reduction in duration
of purchases (i.e. shift from long- to short-term
bonds) or slower balance sheet growth
Policy risks being pro-cyclical: positive shocks that
raise long-term yields would require more BoJ
purchases to hit yield target (and vice versa)
Looking ahead, further near-term easing is unlikely,
as BoJ gauges impact of new framework
− Significant exogenous shock (e.g., sharp yen
appreciation) likely required for new action
If it occurs, additional easing would likely take form
of cuts to the policy rate and 10-year yield target
-0.4
-0.2
0.0
0.2
0.4
Oct-15 Jan-16 Apr-16 Jul-16 Oct-16
JGB 10 year yield
Bank of Japan’s 0% target for 10-year yields is above current levels
%
Source: Bloomberg Finance LP, Deutsche Bank Research
The BoJ’s new yield curve targeting framework is likely to lead to a de facto tapering; further easing is unlikely near-term
12
0 10 20 30 40 50
Japan US Eurozone
BoJ holds greater share of outstanding government debt than peers
% of central government debt held by central bank
Source: ECB, BOJ, FRB, Treasury, Haver Analytics, Deutsche Bank Research
0%
target
revealed
Japan Monetary Policy Watch- Effect of BoJ's JGB purchasing: Stock view vs. flow view : 5 October 2016
Japan Monetary Policy Watch - Can the Bank of Japan control the yield curve? : 19 September 2016
-1
0
1
2
2012 2013 2014 2015 2016 2017 2018
CPI Core CPI Core Core
Inflation in Japan is expected to remain stuck well below target over
at least the next several years
%yoy
Note: Core inflation excludes fresh food. Core-core inflation excludes food, beverages and energy.
Source: Cabinet Office of Japan, MIC, Haver Analytics, Deutsche Bank Research
Inflation target
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
We maintain our long-held view that the next rate
increase will be in December
− The markets are pricing a ~65% chance of a
rate hike by yearend
Markets expecting about 2 cumulative hikes
through 2018, likely due to recession risk
− In addition to a December rate increase, we
forecast 2 hikes each in 2017 and 2018
− However, some inflation metrics suggest the
Fed might have to hike at a faster pace
Most FOMC participants want to raise rates in 2016
− Only 3 of 17 participants want to remain on hold
until next year
November rate hike not expected
− Markets pricing only ~20% rate-hike probability:
with meeting only six days before US Election,
risk of severe market reaction is elevated
− Data not so strong as to force Fed’s hand
− Instead, November statement likely to strongly
signal a December move
As for the Fed, a November hike is almost completely ruled out, while a December hike is “just right”
13
0
1
2
3
4 FOMC projections
Median projections
OIS
The Fed is looking to hike once this year and then at a much faster
pace than the market is pricing
%
Source: FRB, Bloomberg Finance LP, Deutsche Bank Research
2016 2017 2018 2019 Longer run 0.5
1.0
1.5
2.0
2.5
3.0
3.5
2006 2008 2010 2012 2014 2016
Atlanta Fed core Sticky CPI FRB Cleveland Median CPI Core CPI Core PCE
While the core PCE is subdued, other metrics suggest a more robust
increase in inflation
%yoy
Source: BEA, BLS, FRBCLE, FRBATL, Haver Analytics, Deutsche Bank Research
US inflation rising across several
metrics
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Possible government outcomes: a divided government most likely
Senate
White House
Democrat Republican
Divided
government
Narrow Senate
control
Divided
government
No Senate control
Unlikely: Trump
win only if strong
Republican vote
Most likely chance
of unified
government
Most forecasts show a widening lead for Clinton in
the presidential race – likelihood higher than 4 to 1
− Note that lead in popular vote is only around 5pp
Both candidates promise higher fiscal spending – a
marginal positive for growth, but no game changer
Beyond agreement on headline fiscal stimulus, the
policy platforms are starkly opposed
The race for the Senate is less clear-cut, but
likelihood also favour the Democrats
With the Republicans favoured to retain the House,
another divided government is most likely – pointing
to continued political gridlock
A Clinton win appears increasingly likely in the US. Base case is a divided government, but a Democratic sweep is possible
14
The House View Special: US election: Policy continuity or paradigm shift – 4-Oct-2016
But a Democratic sweep cannot be excluded
− Likelihood of Democrats winning both Senate
and House have risen
This scenario or a Trump win are not priced and
would have significant market repercussions
− Trump win signals policy change
− Democratic sweep means most extreme Clinton
policy measures, e.g., on tax, become likely
− Higher volatility across asset classes
Weakest Administration Strongest Administration
Increasing
likelihood
Note: Scenarios sorted anti-clockwise by increasing order of likelihood, from bottom left (least likely).
Source: Wikipedia, Deutsche Bank
0
25
50
75
100
June July August September October November Notes: Net Clinton lead = probability of Clinton win minus probability of Trump win
Source: FiveThirtyEight Polls plus forecast, Iowa Electronic Markets, Deutsche Bank Research
Clinton’s lead has widened materially over the last month. Likelihood
of Democrats winning both Senate and House have also risen
% Election Day
8-November
Net Clinton
lead
Democrat
Congress
Presidential
debates
In the UK, as hardline Brexiters gain momentum, chances rise of a future for the UK without access to the EU’s single market
UK has given more clarity on Brexit timeline
a future for the UK without access to the EU’s single market
Hard-line rhetoric from the UK and uncompromising response from Europe points to increasing likelihood of hard Brexit UK has given more clarity on Brexit timeline
− Trigger Art.50 by end-March 2017, starting 2-year countdown for exit by Q1-2019*
The key in negotiations is the trade-off between single market access and free movement of people
“There must be a threat, there must be a risk, there must be a price. Otherwise we will be in a
“The simple truth is that if a requirement of [single market] membership is giving up control f b d I thi k th t k
Europe points to increasing likelihood of hard Brexit
Hard-line UK rhetoric... ...and uncompromising EU
single market access and free movement of people A workable compromise should be possible but the
recent tone from the UK makes it less likely− UK emboldened by resilience of economy so far− Hard-line Brexiters have upper hand as PM May
“We are not leaving the EU only to give up control of immigration
price. Otherwise we will be in a negotiation that cannot end well.”
French president F Hollande
of our borders, I think that makes it very improbable.”UK Brexit Secretary David Davis
“If we don't say that full access to the single market is linked to full acceptance of freedom ofpp y
needs eurosceptic MPs’ support in Parliament− UK’s ‘red lines’ include full control on migration
Europe response uncompromising, as expected− No incentive at this stage to be accommodating
again. And we are not leaving only to return to the jurisdiction of the ECJ.” PM T May
There should be room for compromise – but hard-line rhetoric from UK side makes a soft Brexit look less likely
acceptance of freedom of movement, then everyone will start doing what they want.”
German Chancellor A Merkel
g g− EU negotiations difficult: 27 countries’ interests,
timing overlaps with key elections in 2017**− UK’s harsh stance potentially a miscalculation of
EU’s trade-offs and room for manoeuvre
U s de a es a so t e t oo ess e y
More
ontro
l /
eign
ty
WTO UK pref-erred Not
possible
As long as UK refuses to compromise, a future without single market access is very well possible− Uncompromising UK would make an interim
arrangement post exit highly unlikelyE i i if it ft th UK’
Economic dealWorse
Less
UK
Co
Sov
ere
EEA±
Better
ResearchDeutsche Bank
The House View – 18 October [email protected] http://houseview.research.db.com
− Economic pain, if it comes, may soften the UK’s stance and increase the chances of soft Brexit
15Notes: (*) 2-year timeline can only be extended by unanimous consent of remaining 27 EU countries, which is highly unlikely. (**) Netherlands general election in Q1, France presidential election in May, Germany Federal election in H2. (#) European Court of Justice. (±) European Economic Area. Grants full access to single market in exchange for contribution to EU budget, acceptance of four freedoms, implementation of most EU rules.
Source: Deutsche Bank Research Full access to single market
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Italy’s Senate referendum on 4-Dec intended to improve governability*
Vote now partly about PM Renzi Approval of Senate reform is best
case scenario, but it is no panacea Rejection negative but not neces-
sarily means new election – even if tail risk would weigh on sentiment
Outcome of vote too close to call but risk of rejection rising
Overall risk exacerbated by fact that key challenges of low growth, bank concerns will remain
Spain has been under a caretaker
government since Dec-2015
− Two elections have not yielded
a workable Parliament majority
Deadline for new government is 31-
Oct, otherwise election triggered
But chance of ending deadlock
− Interim PM Rajoy of PP # needs
to win a confidence vote
− Resignation of PSOE # leader
opens door for party to abstain
from confidence vote – allowing
a minority PP government
− Polls suggest PSOE has little to
gain from a third election
New election not necessarily a bad
outcome
− Polls point to potential PP,
Citizens centre-right majority
− Alternative is continued gridlock
– but risk of anti-establishment
or eurosceptic government low
21-Oct DBRS rating review could
cost Portugal IG rating, making it
ineligible for ECB QE purchases
− Portugal already rated junk by
S&P, Moody’s, Fitch
− Base case is no downgrade
Political situation less unstable, but
outlook for fiscal consolidation,
reform remains weak
Aid programme reviews, fund dis-
bursements delayed and likely to
drag well into 2017
Debt relief negotiations not
advanced, and election calendar
makes negotiations difficult
Risk that IMF exits programme
− IMF participation, a must for
Germany, conditional on debt
relief, fiscal sustainability
Political risk in Europe remains high and could derail the recovery – especially in Italy
16
Tail risk of credit downgrade Possible end to deadlock Senate referendum tail risk
IMF participation at risk
Note: (*) Proposal to narrow Senate’s role in favour of Lower House, reducing chance of political gridlock. (**) Euro-
sceptic, anti-establishment 5 Star Movement. (±) Binding referendum not allowed by law, but could hold a consultative,
non-binding referendum. (#) PP is centre-right incumbent Partido Popular; PSOE is main opposition socialist party
Italy: Key recent developments – 29-Sep-2016
Range of outcomes in Italy
Approved Rejected,
new gvmt.
Rejected,
new election
Govm’t. Renzi
continues
Interim,
maybe Renzi
Risk of
5SM**
Govm’t.
scope As is
Limited to
electoral law As is
Next
election Q2-2018 Mid-2017 Q1-2017
Reform
outlook
No major
new reform
Electoral law
only
Reform
reversal risk
EU /
euro n/a n/a
Risk of euro
referendum± Decreasing market
friendliness
Spain: Decision time – 2-Oct-2016
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com 17
Summary of market views
Asset View Rationale
Markets Cautious on risk
assets Overall cautious stance on risk assets, even though benign backdrop can
last a little longer with DM central bank policy remaining accommodative
Equities
Cautious stance
US, Europe: no
upside into year-end
US: risk of pullback; index within 3% of historic high despite macro and
political uncertainty, weak earnings outlook
Europe: downside into year-end on macro, political risks and bank concerns
Rates
DM sell-off likely
sustainable
Neutral on Bunds,
USTs into year-end
Increase in inflation expectations makes DM rates sell-off more sustainable
as it is bullish risk assets
Shift by BoJ, ECB to lift US long-end further in 2017 via higher term premia
Bunds little changed: QE extension could affect slope of yield curve
FX
Near-term neutral
USD Uncertainty ahead of election limits near-term strength
Dollar strength should then resume as market prices Fed hikes
Bearish sterling Rising risks of “hard” Brexit add to already-weak fundamentals
Bearish euro Weaker on persistent outflows but near-term risk of remaining range-bound
Bullish yen BoJ 10Y target risks stronger yen if financial conditions tighten
Credit
US: wider spreads Wider spreads into year-end. HY looks relatively rich; IG to outperform
Europe: slightly less
supportive technicals Technicals supportive but have become slightly less so. Expect financials to
non-financials differential to compress
EM
Strong inflows vs.
little improvement in
fundamentals
EM has benefited from substantial relocation of capital away from core
markets, even though EM macro outlook has not improved materially
More cautious stance into November as inflows could slow ahead of risk
events (e.g., US election). Positive trend to resume as uncertainty eases
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
The bond market sell-off on the back of the oil rally, a hawkish Fed have driven markets. Hard Brexit fears sent pound tumbling
18
20
30
40
50
60
Oct-15 Jan-16 Apr-16 Jul-16 Oct-16
Sharp rally in oil to highest level in a year...
Brent crude price, $ / barrel
Sharp rally in oil on
OPEC freeze talks
OPEC freeze
0%
5%
10%
15%
20%
0%
20%
40%
60%
80%
100%
Jun-16 Aug-16 Oct-16
Oil price factor* QE factor* (rs)
...making oil again the key driver for markets
Note: (*) Data show % of variation in 14 total returns series explained by a given factor. (**) Derived from 5y5y inflation swaps. Source: Bloomberg Finance LP, Deutsche Bank Research
92
94
96
98
100 25
30
35
40
45
50
55
60
Jan-16 Mar-16 May-16 Jul-16 Sep-16
Brent Oil
Trade weighted Dollar (inverted, rhs)
Dollar- oil price relationship shifting
$/bbl
1.20
1.25
1.30
1.35 2.75
3.00
3.25
3.50
3.75
Jun-16 Aug-16 Oct-16
Inflation expectations** GBPUSD (rs, inverted)
Hard Brexit sent pound tumbling, UK inflation
expectations soaring
%yoy
0
20
40
60
80
Jun-16 Aug-16 Oct-16
Hawkish Fed signals raised likelihood of Dec
hike
Prob. of Fed rate hike by Dec-2016 (%)
0.00
0.05
0.10
0.15
0.20
US Eurozone
Inflation expectations**
10y yields
Higher oil led to a rise in inflation
expectations, and nominal bond yields
pp change
since OPEC
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Sterling is set to weaken further,
as risks of a “hard” Brexit rise
Several factors are bearish GBP
− Growth still weak, fiscal eas-
ing hasn’t helped GBP in past
− Downside risk to near-record-
high data surprises
− Positioning is not stretched
− UK has large twin deficits
Bearish GBP on a trade-weighted
basis, 10% further downside
Still strategically bearish the euro
− Structurally, large outflows
should persist
− Market should price Fed hikes
But near-term euro should stay
range-bound against the dollar
− Fed on hold until December
− Market pricing too much for
ECB rate cuts
Year-end EURUSD target of 1.05
FX: Still bearish sterling, bullish yen, and expect further euro weakness beyond near-term resilience
19
Yen strength set to resume
− BoJ yield targeting risks high-
er real rates, stronger yen by
tightening financial conditions
− No let-up in Japanese hedging
demand, which supports yen
− Political uncertainty should be
negative for USD and EUR
Bullish JPY against USD and
EUR, targeting moves to the low
90s and 100s, respectively
-6
-4
-2
0
2
4
6
8
NO CH SE EZ JP NZ CA US AU UK
Twin deficits
The UK has the worst twin deficit* in the G10
% of GDP
Note (*): Budget and current account deficits.
Source: IMFWEO, Haver Analytics, Deutsche Bank Research
1.0
1.1
1.2
1.3
1.4
2014 2015 2016
EUR/USD
Source: Bloomberg Finance LP, Deutsche Bank Research
Euro range-bound since 2014 plunge
1 Sterling: Brexit shock not over 2 Yen: expect further strength 3 Euro: strategically bearish but
directionless near-term
-30
-20
-10
0
10
20
30
40
2000 2004 2008 2012 2016 Note: (*) Calculated by obtaining the residual from a regression of 1yr
USDJPY cross-currency basis on the 5-yr basis and a bank stress index
Source: Bloomberg Finance LP, Deutsche Bank Research
JPY hedging demand at record high
Implied* hedging demand from Japanese
FX Blueprint-End of worlds: 27 September 2016
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
DM long-end rates have sold off substantially since
late September, with curves steepening
− E.g., since September 28, 10Y Treasury yield up
19 bps and 10Y Bund yield up 20 bps
− ECB, BoJ moves have mitigated hunt for yield
− As a result, downward pressure on US term
premium has eased
− US short-end also up due to expected Fed hike
Sell-off in Treasuries, Bunds due in roughly equal
parts to real rates and breakevens – increase in
latter more sustainable as it is bullish for risk assets
We have raised our US yield forecasts:
− 10Y yield to remain near current levels through
year-end, rise to 2.0% next year
We are roughly neutral on Bund yields for this year
− 10Y yield to increase to 0.25% by year-end 2017
UK yields have increased even more dramatically
− Real yields up slightly this month after collapsing
post-Brexit
− Breakevens have soared due to GBP weakness
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
2.0
2.2
2.4
2.6
2.8
3.0
3.2
Jan-16 Apr-16 Jul-16 Oct-16
10y breakeven inflation 10Y real yield
UK breakeven inflation has spiked; real yields plummeted post
Brexit but are little changed in recent months
%
Source: Bloomberg Finance LP, Deutsche Bank Research
Rates: DM yields expected to hold steady in 2016, sell-off moderately further in 2017
20
12 11
7 9
0
2
4
6
8
10
12
14
16
US Germany
10y breakeven inflation 10y real yield
The rise in breakeven inflation makes the DM rates sell-off more
sustainable
bps, change since 28th Sep
Source: Bloomberg Finance LP, Deutsche Bank Research
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Expect short-term pause in inflows as key risk
events approach (US election, Fed meeting)
But trend should resume afterwards as uncertainty
dissipates
− Material policy shift in DM unlikely (e.g., fiscal
easing and monetary tightening) – search for
yield to continue
− EM growth outlook to improve marginally as low
inflation allows for easier EM monetary policy
4.2
4.7
3
4
5
6
Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16
2016 2017
Source: Deutsche Bank Research
…Despite no improvement to EM macro outlook
DB Real GDP growth forecast for EM, %yoy
If anything, growth forecasts are
lower than a few months ago
Material inflows into EM assets in recent months...
− Pick-up particularly large post-Brexit vote
− At the expense of Europe / other risky assets
...Despite no significant improvement in EM macro
outlook
− Despite marginal rise recently our EM growth
forecasts remain lower than a few months ago
Relocation of capital underpinned by search for
yield on the back of still dovish monetary policy
− No Fed hike, dovish tone from ECB and BoJ
-10%
-5%
0%
5%
10%
15%
Jan-16 Mar-16 May-16 Jul-16 Sep-16
Source: EPFR, Haver Analytics, Deutsche Bank Research
EM has received material inflows since mid-year…
Cumulative flows ytd
(% of AUM) EM bonds
EU equities
US HY
US IG
US treasuries
EM assets have benefited from inflows despite no improvement in fundamentals; expect pause in inflows but only short-term
21 EM Monthly: Re-Inflating EM – 6-Oct-2016
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
In US (ex-financials), HY tightened materially since
late-April – supported by continued search for yield
Meanwhile IG spreads have barely moved in the
same period
For the first time in a year HY appears rich vs. IG
Difficult to expect further HY outperformance,
expect instead IG to outperform
− Fed hike approaching
− HY yields now less attractive, especially for
overseas investors given rise in FX hedging cost
− Trade works in cash, not CDS
-10
0
10
20
30
40
30
60
90
120
150
Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16
Fin.- non-fin. Differential (rhs) iTraxx Fin. Snr. (5Y) iTraxx Main non-fin. (5Y)
Source: Markit, Bloomberg Finance LP, Deutsche Bank Research
bp
Expect financials to non-financials differential to compress after
widening this year
bp
In IG, non-financial spreads have compressed on
the back of the ECB’s corporate bond QE buys
Financials meanwhile have widened on banks
concerns – but while we are cautious financial
equities, we are constructive senior unsecured
credit of major European banks
Financials to non-financials differential to compress
− Differential has already tightened slightly in the
last week, but we see further value
− Trade works in cash or CDS spaces
In credit, we are constructive financials in Europe despite bank stress, while in the US we see value in IG vs. HY
22 Europe IG Cash & CDS strategy update – 5-Oct-2016
1 Europe: constructive financial credit 2 US: HY rich vs. IG (ex-financials)
US HY vs. IG relative value in cash and CDS – 8-Oct-2016
300
400
500
600
700
90 100 110 120 130 140 150 160 170
HY vs. IG spreads regression, non-financials
R² = 0.75
Note: Cash indices excluding financials and commodities. Since 2014
Source: Bloomberg Finance LP, Deutsche Bank Research IG
HY
Current
HY is rich vs. IG
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
1,700
1,800
1,900
2,000
2,100
2,200
2,300
Jan-15 Jul-15 Jan-16 Jul-16 Note: Columns denote previous instances of 5%+ corrections
Source: Bloomberg Finance LP, Deutsche Bank Research
S&P500: Risk of 5-10% correction with index within 3% of record
high
S&P500
5-10% correc-
tion range
Brexit vote China fears
post Fed hike China fears
~1,920
~2,025
S&P500 overdue a 5-10% correction...
− Index within 3% of historic high despite macro
and political uncertainty, weak earnings outlook
Several potential triggers...
− US election uncertainty – though this has
diminished in recent weeks
− Dollar strength as Fed hike approaches
− Scope for disappointment on Q3 earnings
...But no near-term bear market – S&P500 more
likely to reach 2,500 before 20%+ decline
70
75
80
85
90
95 100
110
120
130
140
150
160
170
2013 2014 2015 2016
UK exporters vs. domestic, rel. performance
GBP TWI (rhs, inverted)
A FTSE100 exporters vs. domestic basket is our cleanest short
sterling play
Source: Bloomberg Finance LP, Deutsche Bank Research
Implied upside from
5% GBP TWI
depreciation
We introduced several Brexit trades that benefit
when sterling depreciates
− Long FTSE100 vs. FTSE250
− Long FTSE100 vs. Stoxx600
− Long UK exporters vs. domestics
Very strong performance to date – but expectation
of further sterling weakness suggest further upside
Exporters vs. domestics trade has highest FX
sensitivity – 8% return for every 5% GBP TWI fall
Bloomberg baskets: DBCTBXEP Index (exporters),
DBCTBXDP Index (domestic)
In equities we see further scope for outperformance in our Brexit trades in Europe, while we remain cautious on the S&P500
23
1 Europe: maintain Brexit trades*
Don’t exit Brexit trades – 12-Oct-2016
2 US: cautious S&P500, risk of a correction
Note: (*) The key risk to our Brexit trades is a bout of sterling strength.
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
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DB forecasts
Source: Deutsche Bank Research
25
ASIA: China, HK, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Sri Lanka, Taiwan,
Thailand, Vietnam
DM: Australia, Canada, Denmark , Eurozone, Japan, New Zealand, Norway, Sweden,
Switzerland, UK, US
* CPI (%) forecasts are period averages
CEEMEA: Czech Rep., Israel, Egypt, Hungary, Kazakhstan, Nigeria, Poland, Romania, Russia, Saudi
Arabia, South Africa, Turkey, UAE and Ukraine
LATAM: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela
GDP growth (%) 2014 2015 2016F 2017F CPI inflation, YoY* (%) 2014 2015 2016F 2017F
Global 3.4 3.2 3.0 3.4 US 1.6 0.1 1.3 2.1
US 2.4 2.6 1.3 1.7 Eurozone 0.4 0.0 0.2 1.3
Eurozone 1.1 1.9 1.6 1.1 Japan 2.7 0.8 -0.2 0.5
Germany 1.6 1.7 1.9 1.0 UK 1.5 0.0 0.7 2.2
France 0.7 1.2 1.4 1.4 China 2.0 1.4 1.9 1.8
Italy 0.1 0.7 0.7 0.4
Spain 1.4 3.2 3.0 2.0 Central Bank policy rate (%) Current Q4-16F Q2-17F Q4-17F
Japan -0.1 0.6 0.6 0.9 US 0.375 0.625 0.875 1.125
UK 3.1 2.2 1.9 0.9 Eurozone 0.00 0.00 0.00 0.00
China 7.3 6.9 6.6 6.5 Japan -0.10 -0.10 -0.10 -0.10
India 7.0 7.2 7.5 7.6 UK 0.25 0.10 0.10 0.10
EM Asia 6.4 6.1 6.0 6.0 China 1.50 1.50 1.25 1.25
EM CEEMEA 2.3 1.0 1.9 2.6
EM LatAm 0.6 -0.3 -0.9 1.9 Key market metrics Current Q4-16F Q2-17F Q4-17F
EM 4.6 4.0 4.2 4.7 US 10Y yield (%) 1.76 1.75 2.00 2.00
DM 1.7 2.1 1.4 1.4 EUR 10Y yield (%) 0.05 0.00 0.15 0.25
EUR/USD 1.100 1.05 1.00 0.95
USD/JPY 104 94 94 94
S&P 500 2,133 2,150 #N/A 2,350
Stoxx 600 340 325 #N/A 345
Oil WTI (USD/bbl) 50.3 48.0 51.0 55.0
Oil Brent (USD/bbl) 51.6 50.0 53.0 57.0
Current prices as of 14-Oct-2016
Research Deutsche Bank
The House View – 18 October 2016 [email protected] http://houseview.research.db.com
Analyst Certification
This report covers more than one security and was contributed to by more than one analyst. The views expressed in this report accurately reflect the
views of each contributor to this compendium report. In addition, each contributor has not and will not receive any compensation for providing a specific
recommendation or view in this compendium report. Marcos Arana / Matthew Luzzetti / Aditya Bhave / Rajni Thakur
Attribution
The authors wish to acknowledge the contributions made by Shakun Guleria in the preparation of this report.
*Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg
and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations
or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global
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26
Appendix 1 Important Disclosures *Other information available upon request
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