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June 28, 2017
Global investors have recently been forced to sift through mixed signals from macro data and markets. Chief among these discordant messages is the apparent dichotomy between softer inflation, lower yields and flatter curves, and falling oil prices on the one hand, and still solid global growth and firm risk sentiment on the other hand. We remain generally optimistic in our global macro outlook despite these mixed signals. Supply-side factors, rather than a weaker demand outlook, underpin the fall in oil prices, and this is positive for growth for oil importers. The softening core inflation trend is due primarily to temporary factors, particularly in the US, and the uptrend should resume given the solid growth momentum.Indeed, our global growth outlook is little changed since the start of the year. We marked down US growth on lower odds of Trump’s policy agenda, but still expect deregulation and modest fiscal stimulus to support above-trend growth. This downgrade is compensated by upgrades to eurozone and China growth. Our market views largely reflect this overall constructive tone: we are not concerned about the discordance between firming risk assets and falling rates; the normalisation of US and Europe rates should resume in coming months. In FX we have turned more positive on the euro but stay bearish sterling. Our base case that political risk would not escalate is playing out. Moreover, the intervention to resolve ailing banks in Veneto is positive and lowers risk in Italy. The exception, as expected, is the UK, where the outcome of Brexit has become more binary: the risk of a soft Brexit has risen, but so has that of a crash Brexit. David Folkerts-Landau, Group Chief Economist Key pages this month: P6 Mixed signals P8 Oil less a concern for risk assets P11 Flat US yield curve but low risk of recession P17 Europe political risk not materialising P23 Limited scope for further oil weaknessYou can access a two-page update of Deutsche Bank Research's views on g [more]
Deustche Bank Research The House View: The Final Countdown Research Deutsche Bank The House View Mixed signals DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. 28 June 2017 marcos.arana@db.com matthew.luzzetti@db.com michael.hsueh@db.com Distributed on: 28/06/2017 09:26:01 GMT 0bed7b6cf11c Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com Month in Review 2 FT, 9 - Jun - 2017 FT, 13 - Jun - 2017 Bloomberg, 18 - May - 2017 NY Times, 8 - Jun - 2017 FT, 8 - Jun - 2017 Bloomberg, 12 - Jun - 2017 USA Today, 12 - Jun - 2017 Reuters, 31 - May - 2017 FT, 14 - Jun - 2017 CNBC, 9 - Jun - 2017 Reuters, 9 - Jun - 2017 FT, 30 - May -- 2017 CNBC, 14 - June - 2017 FT, 21 - June - 2017 Daily FX, 8 - June - 2017 Bloomberg, 8 - June - 2017 FT, 14 - Jun - 2017 CNBC, 1 - Jun - 2017 The Telegraph, 21 - June - 2017 The Guardian, 18 - June - 2017 FT, 27 - Jun - 2017 Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com Global investors have recently been forced to sift through mixed signals from macro data and markets . Chief among these discordant messages is the apparent dichotomy between softer inflation, lower yields and flatter curves, and falling oil prices on the one hand, and still solid global growth and firm risk sentiment on the other hand . We remain generally optimistic in our global macro outlook despite these mixed signals . Supply - side factors, rather than a weaker demand outlook, underpin the fall in oil prices, and this is positive for growth for oil importers . The softening core inflation trend is due primarily to temporary factors, particularly in the US, and the uptrend should resume given the solid growth momentum . Indeed , our global growth outlook is little changed since the start of the year . We marked down US growth on lower odds of Trump’s policy agenda, but still expect deregulation and modest fiscal stimulus to support above - trend growth . This downgrade is compensated by upgrades to eurozone and China growth . Our market views largely reflect this overall constructive tone : we are not concerned about the discordance between firming risk assets and falling rates ; the normalisation of US and Europe rates should resume in coming months . In FX we have turned more positive on the euro but stay bearish sterling . Our base case that political risk would not escalate is playing out . Moreover, the intervention to resolve ailing banks in Veneto is positive and lowers risk in Italy . The exception, as expected, is the UK, where the outcome of Brexit has become more binary : the risk of a soft Brexit has risen, but so has that of a crash Brexit . David Folkerts - Landau, Group Chief Economist 3 The House View , 28 June 2017 Mixed signals 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 Table of contents Introduction  4 - boxes  Total returns Mixed signals  Risk rally vs. falling rates, oil prices  Softening inflation vs. robust growth outlook  Flat yield curve but low recession risk Macro outlook  US  Eurozone  China Monetary policy  Fed  ECB Politics  Europe  Brexit  US Market views  Summary  Rates, FX, oil views Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  Fed : announcement on balance sheet policy in September, rate hike in December.  ECB : slowly progressing toward exit. Next move QE extension at slower pace, announced by year - end  BoJ : no change expected in target short rate or yield curve control policy for much of this year  BoE : expect to stay on hold, but hawks within BoE becoming more vocal, risk of rate hike has risen  PBoC : baseline is no benchmark interest rate hike in 2017 - 18 but chance of one in 2018 rising  EM : mixed outlook, generally easing (ex - Asia) or waiting to unwind tightening (e.g., Turkey)  Global growth to rise to 3.6% in 2017 (from 3.1%) and pick up further to 3.7% in 2018. Momentum softening on the margin, but still robust  US economy to accelerate; forecast 2.5% growth on average in 2017 - 18 . Some downside risk on policy disappointment, but risk of recession remains low  Eurozone above - trend growth to continue . Forecasts revised up to 1.8% in 2017, 1.6% in 2018. Less drag than expected from political uncertainty  EM: growth to pickup to 4.7% in 2017, 4.9% in 2018 . China growth has likely peaked  Mixed signals : macro and markets are sending mixed signals about growth, inflation, risk appetite. We think inflation concerns are temporary, growth robust  Political risk : our base case of high event risk not materialising is playing out . UK and Brexit negotiations the key, though expected , exception  US regime shift : optimism about Trump’s policies is waning. Our expectation remains that deregulation, some fiscal stimulus will boost growth in 2018 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 ). 4  Trump disappointment: policies tilted to negatives, under - delivery vs. expectations , US growth doesn’t rise  China financial instability : property bubble deflates; rising dollar, DM yields put pressure on outflows, RMB  Political risk escalation in Europe derails recovery – Italy remains the key flash point  Low inflation signals deeper growth issues  De - globalisation : rise of anti - trade policies exacerbates anaemic global trade and sharply slows growth M M L L Global growth remains firm and we view softer inflation as temporary. We continue to expect no escalation of political risk L Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 18 12 12 11 10 10 9 7 5 3 -15 5 4 4 1 3 1 5 4 3 2 8 -19 -25 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 MSCI EM French CAC 40 Italy Milan German DAX 30 Europe Stoxx 600 US S&P 500 Mexico IPC UK FTSE 100 Japan Nikkei Shanghai Composite Russia Micex US HY ex - energy US IG EUR HY EUR IG US HY energy US France Germany EUR JPY EM FX GBP CNY GBPEUR Dollar Index Gold Brent Oil Iron Ore Since US election Returns* per asset class in 2017 Equities Commodities** FX** Sovereign debt Corporate Credit YTD2017 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 COB, 26 June 2017 Risk assets performed strongly this year, and since US election. This contrasts with round trips for rates, the dollar and oil Strong performance for risk assets overall supported by positive macro backdrop Sterling suffered from PM May’s election setback, “crash Brexit ” fears Rates rally, dollar loses as Trump enthusiasm fades, inflation disappoints Sharp drop in oil mostly a supply story, weighing on US HY energy Outperformance as political risk did not materialise Unwind of Trump foreign policy trades Gold supported by weaker dollar, central bank buying Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com Investors have been getting mixed signals in recent months 6 Mixed signals Macro Positive macro  Solid global growth momentum  Above trend US  Upgrades to Europe, China Negative macro  Softening core inflation  Slumping oil, commodities  Macro surprises weakening Markets Positive signals  Extended risk rally  Soaring equities, tight credit spreads  Low volatility Negative signals  Falling rates  Rising gold prices  Falling inflation expectations vs. vs. Central banks Hawkish  ECB abandoning rate guidance...  Fed hiking rates, signaling balance unwind...  BoE inching toward rate hikes... Dovish  ...but signalling slow and gradual exit  ...but will closely watch inflation  ...but Carney has sounded more dovish vs. Mixed signals... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  Risk assets have had a very strong run since the US election in November  Since March, the risk rally continued but now coincides with falling core rates, rising gold prices  While these often reflect risk - off concerns, it is not the case at the moment − Lower rates due to falling commodities, US inflation disappointment – but growth story intact − Gold rally influenced more by the US dollar and central bank buying than rising risk perceptions and safe haven buying  We do not share in the concern that risk assets will be under pressure once rates start rising again − Rising rates will be reflective of robust growth and normalising inflation − This should support business and consumer confidence and be positive for risk overall 1.6 1.8 2.0 2.2 2.4 2.6 2.8 2,000 2,100 2,200 2,300 2,400 2,500 Nov - 16 Dec - 16 Jan - 17 Feb - 17 Mar - 17 Apr - 17 May - 17 Jun - 17 S&P 500 (lhs) US 10Y Treasury Yield (rhs) Source: Bloomberg Finance LP, Deutsche Bank Research Equity and treasuries divergence since March 7 We are not concerned about the dichotomy between soaring risk assets and falling rates - 8% - 4% 0% 4% 8% 12% S&P 500 Stoxx 600 EM Equities US HY EUR HY US Rates EU Rates JPY/ USD Gold US election to mid - March Since mid - March Note: (*) Total return for equities, credit and rates; spot return for FX and commodities. Source: Bloomberg Finance LP, Deutsche Bank Research In the last few months, both risk assets and safe havens have rallied simultaneously Return* Risk assets Safe havens Mixed signals... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  Different backdrop to 2015 - 16, when lower oil was bad for risk − Global growth concerns faded − Greater confidence that low oil reflects positive supply story − Spot not far from 2 - yr average − Three years of low oil have prompted adjustment, e.g., country current accounts − Lower oil breakeven costs mean there will be a smaller impact on oil industry capex  Naturally oil producers are under pressure – persisting falling oil prices could threaten the benign low oil / risk appetite link − Lack of FX flexibility, political spillover from tightening fiscal accounts threatens oil producing countries − EM FX key contagion channel 8 As per falling oil prices, it is less of a concern to risk appetite this time around, compared to 2015 - 16 25 30 35 40 45 50 55 60 1,800 1,900 2,000 2,100 2,200 2,300 2,400 2,500 Jun - 15 Dec - 15 Jun - 16 Dec - 16 Jun - 17 S&P 500 WTI (rhs) Source: Bloomberg Finance LP Disconnect between oil prices and risk (1) Oil vs. US equities USD/bbl Is oil a different beast for global risk? – 20-Jun-2017 25 30 35 40 45 50 55 60 65 220 230 240 250 260 270 Jun - 15 Dec - 15 Jun - 16 Dec - 16 Jun - 17 EM carry index WTI (rhs) Source: Bloomberg Finance LP (2) Oil vs. EM 20 40 60 80 100 120 120 140 160 180 200 220 240 2013 2014 2015 2016 2017 Base metals index WTI (rhs) Source: Bloomberg Finance LP Contagion from lower oil could feed into EM FX via other commodity prices USD/bbl Mixed signals... - 400 - 300 - 200 - 100 0 100 200 300 400 2014 2015 2016 2017 US HY credit sprd (bps) Fitted (PMI, commodity px) Projection Source: Bloomberg Finance LP, Deutsche Bank Research Impact to be more limited in US HY spreads than in 2016 bps Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 9  After some evidence of an improving inflation trend, recent inflation data have been mixed  In the US, core inflation has been surprisingly weak − One - offs have contributed (e.g., wireless prices plunged on a provider’s unlimited data plan) − But there is broader softness – e.g., core goods inflation, especially apparel, has disappointed  Conversely, eurozone inflation has been close to expectations , outside of some seasonal distortions Inflation data have been mixed recently, but we expect core inflation to rise on the back of solid economic growth - 70 - 50 - 30 - 10 10 30 50 70 90 - 1 0 1 2 3 4 5 2005 2008 2011 2014 2017 G7 CPI Brent oil prices, 10w lead (rhs) Oil recently a tailwind for headline inflation, but recent oil declines will become a drag % yoy % yoy Source: Bloomberg Finance LP, Haver Analytics, Deutsche Bank Research  Looking ahead, oil prices will be key to headline inflation dynamics − Recent declines in oil prices will help to depress headline inflation in developed economies − This disinflation is not necessarily bad – lower oil prices should boost growth in DM oil importers  A bove - trend growth, further labour market tightening should put raise core inflation − E specially true in the US where unemployment is expected to fall well below NAIRU estimates 0 1 2 3 2013 2014 2015 2016 2017 2018 EU US Core inflation % yoy Source: Haver Analytics , Eurostat , BLS, Deutsche Bank Research Core inflation expected to improve from recent lows 0.5 1.0 1.5 2.0 2.5 3.0 37 41 45 49 53 57 61 65 2000 2004 2008 2012 2016 ISM Nonmanufacturing, 19m lag (ls) Core CPI (rs) Source: Haver Analytics , BLS, ISM, Deutsche Bank Research Macro momentum supports rebound in core inflation Index %yoy Mixed signals... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 10 Indeed our global growth outlook is little changed since January, with upgrades to EU, China offset by a downgrade to US growth - 2.0 - 1.5 - 1.0 - 0.5 0.0 0.5 1.0 1.5 - 90 - 60 - 30 0 30 60 90 May - 15 Nov - 15 May - 16 Nov - 16 May - 17 Index US (ls) China (ls) Eurozone (rs) Source: CITI, Bloomberg Finance LP, Deutsche Bank Research Data surprises have turned lower, especially in the US Index 48 50 52 54 2012 2013 2014 2015 2016 2017 Global manufacturing PMI Source: Haver Analytics , Markit , Deutsche Bank Research Growth momentum off highs but still solid (e.g., manufacturing PMI) Index 0 1 2 3 4 5 World China EM US Eurozone Germany Japan Latest As of Jan - 2017 Source: Deutsche Bank Research Global growth outlook little changed since start of year GDP forecast % yoy 7 5  The global economy entered 2017 with the best growth momentum in several years − Earlier this year global manufacturing PMI reached highest level since 2011 − Strengthening was broad - based across EM and DM, with PMIs reaching multi - year highs  There is some recent evidence of a softening in global growth momentum − PMIs have turned down modestly − Macro surprise indicators have plunged in the US and are off recent highs more broadly; Europe surprises have recently turned negative  Despite this softening we see global growth momentum as still solid − Global growth expected to be 3.6% in 2017 – little changed from our forecast in Jan - 2017 − Modest upgrades to growth expectations in China and Eurozone offsetting downgrade to the US − Downside risk from political risk diminishing Mixed signals... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  Long - term yields in the US have fallen substantially more than short - term yields in recent months , causing a sharp flattening of the yield curve − This follows string of disappointing data, especially inflation, and lowered odds of fiscal stimulus  Y ield moves are potentially worrying, as the curve typically flattens ahead of growth slowdowns / recessions  Despite some negative signals from the yield curve, we think US recession risks are low (about 10% over next year) − Limited evidence that cyclical sectors (e.g., housing, capex ) are over - extended − Monetary policy remains very loose  Indeed, with unemployment already at 4.3%, there are greater risks that the economy overheats in the next year  If unemployment falls more sharply than we expect, pushing inflation higher, Fed could be forced to tighten, causing a recession in late - 2019 or 2020 0 20 40 60 80 100 1973 1978 1983 1988 1993 1998 2003 2008 2013 Recession probability over the next 12 months: DB model Source: FRB, BEA, Haver Analytics , Deutsche Bank Research Recession odds low over next 12 months according to DB model % 11.7% 11 The flattening of the US yield curve has raised concerns of a US recession; we think risks are actually low over the next year Global Economic Perspective: The Next US Recession: 12 - June - 2017 - 1 0 1 2 3 4 5 2000 2002 2004 2006 2008 2010 2012 2014 2016 Treasury yields: 10y - 3m Source: FRB, Haver Analytics , Deutsche Bank Research US yield curve slope flattens prior to recessions pp, US yield curve Flattening of yield curve ahead of recession Mixed signals... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 0 1 2 3 4 5 6 2014 2015 2016 2017 Real personal consumption expenditure Source: Haver Analytics , BEA, Deutsche Bank Research Consumer spending rebounded from recent weakness %3m, annualised rate 5 year average  US economy poised to bounce back from another weak Q1 − Consumer spending has rebounded after soft Q1 − Survey data signal strong pickup in capital spending − Sentiment remains buoyant, though some signs of peaking  Still expect 2.4% growth for 2017  Labour market at full employment and likely to improve further − Job growth slowing but still well above levels needed to bring down unemployment − Return of participation down - trend, soft productivity growth will lower unemployment  Beyond 2017, growth should slow back toward potential − Key uncertainty is Trump’s tax reform, i.e., fiscal policy − W e expect limited stimulus 12 - 30 - 20 - 10 0 10 20 30 - 30 - 20 - 10 0 10 20 01 03 05 07 09 11 13 15 17 % bal Real private nonresidential fixed investment (ls) Capex future plan (rs) Source: BEA, FRB Richmond, FRBPHIL, FRBNY, FRBKC, FRB Dallas, Haver Analytics , Deutsche Bank Research Capex outlook looks strong % qoq , annualised rate US growth momentum solid, led by consumer rebound, stronger capex . Fiscal policy a key uncertainty but we have little factored in Macro outlook... 150 180 210 240 270 4 5 6 7 8 2013 2014 2015 2016 2017 Unemployment rate (ls) NAIRU (ls) Nonfarm employment (rs) Source: Haver Analytics , BLS, CBO, Deutsche Bank Research Job growth has slowed but labor market at full employment % Thous. 12mma 0 20 40 60 80 100 120 50 60 70 80 90 100 110 2004 2008 2012 2016 Chg mom Consumer sentiment (ls) Consumer opinions about govt economic policy (relative score, rs) Source: Haver Analytics , UMICH, Deutsche Bank Research Sentiment remains elevated but some signs views about the government are worsening Index, 3mma Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  Political risk has been less of a drag on eurozone activity than we had expected − We did not expect political risk to materialise, but saw risk of uncertainty weighing on activity – this has not been significant − Political uncertainty did not translate into higher cost of financing, partly thanks to ECB policy  We raised our growth forecasts across the region and expect growth to continue above trend − Forecast growth in line with consensus around 1.7% for 2017 - 18 − Data signal growth at 2%, with surveys implying growth closer to 3% − Large upward revisions for France, Italy − Intervention to resolve ailing banks in Veneto is positive and removes some systemic risk in Italy  On the downside, improved growth remains mostly cyclical, not structural − Growth supported by pent - up corporate sector demand, looser fiscal stance, euro depreciation − Faster sustainable growth unlikely without a step - up in structural reform 13 The e urozone growth outlook has proved more resilient than expected, and we have revised up our forecasts Macro outlook... Focus Europe: Quarterly Update: Firmer, broader, more resilient: 12 - May - 2017 - 0.6 - 0.4 - 0.2 0.0 0.2 0.4 0.6 0.8 Q1 - 2012 Q3 - 2012 Q1 - 2013 Q3 - 2013 Q1 - 2014 Q3 - 2014 Q1 - 2015 Q3 - 2015 Q1 - 2016 Q3 - 2016 Q1 - 2017 Q3 - 2017 Q1 - 2018 Q3 - 2018 Actual Forecast Jan - 17 forecast Potential growth Source: Eurostat, Deutsche Bank Research Robust eurozone growth continues; we have revised up our forecasts and expect above - trend growth to continue %qoq 0 1 2 3 Euro - zone Spain Portu - gal Nether - lands Ger - many France Italy Latest As of Jan - 2017 Source: Deutsche Bank Research Upward revisions to eurozone GDP forecasts since the start of the year, especially for countries with high political risk GDP forecast % yoy Less drag from political risk Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 14 China’s structural growth slowdown continues despite stronger momentum in early 2017. Downside risks could rise in 2018 0% 5% 10% 15% 20% 25% Fixed asset investment Property investment growth New housing starts (3mma) Property sales volume Electricity production Apr - 17 May - 17 Source: WIND, Deutsche Bank Research Monthly activity data in May reinforce view on moderate slowdown yoy  China’s structural growth slowdown continues despite better than expected momentum in early - 17 − Growth likely peaked in Q1 − Momentum expected to slow gradually toward 6.5% by year - end and 6.3% in 2018  Property cycle continues to cool, but it is not collapsing − H ousing starts, property sales slowed in May − Gradual slowdown likely to continue as mortgage rates rise  Solid growth allowed policy makers to push a tighter stance; this is unlikely to change in next few months − Tighter financial regulation to continue in Q3  If growth slows by end of Q3, as we expect, policy stance will have to shift back toward loosening − Government will not want growth to slow below 6.5 % before National Congress in Q4  We are more concerned about risks in 2018 − Financial sector deleveraging has been positive − But prospects for higher inflation in ’18 could constrain PBoC’s ability to support growth Macro outlook... 6.7 6.7 6.7 6.8 6.9 6.8 6.6 6.5 6.9 6.7 6.7 6.3 6.0 6.2 6.4 6.6 6.8 7.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 15 16 17 18 Source: CNBS, Deutsche Bank Research China growth slowing down as regulators tighten financial controls and broad credit growth slows % yoy 2016 2017 Actual Forecast Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 15  We expect next policy chance to be announcement to start phasing out the Fed’s balance sheet reinvestment (likely in September) − Fed should pause its hiking cycle in September to assess impact of announcement  We expect the next rate hike to occur in December − Inflation developments will be key, but the Fed has set the bar reasonably low  In 2018, we see four rate increases, slightly above the Fed (3) and well above the market (~1)  Despite recent disappointing inflation prints, the Fed has stuck to the script on tightening − Fed raised rates for the third time since December at its June meeting − Downplayed soft inflation , attributing much of the decline to one - off factors  Easing financial conditions (i.e., equities higher, dollar weaker, credit spreads tighter) is one reason the Fed has continued to tighten − Financial condition easing equals ~25bp rate cut - 8 - 6 - 4 - 2 0 2 4 6 - 5 - 4 - 3 - 2 - 1 0 1 2 00 02 04 06 08 10 12 14 16 2q % chg, AR DB high frequency FCI (1q ahead, ls) RGDP (rs) Source: BEA, Haver Analytics , Deutsche Bank Research Loose financial conditions supporting growth Index, 13w MA Despite soft inflation, Fed stays on tightening path: we expect announcement on reinvestment in September, next hike in Dec. 0 20 40 60 80 2017 2018 2019 2020 2021 2022 2023 Allow to mature Reinvest Reinvestment cap Source: US Treasury, Deutsche Bank Research Projection of roll-off of Fed Treasury holdings USDbn Fed Notes: Loose financial conditions helping to keep the Fed on track: 05 - June - 2017 Monetary policy... Team – updated chart showing Fed dots, median, DB, and market 0 1 2 3 4 5 FOMC projections Median projections Market pricing DB forecasts 2017 2018 2019 Longer run Source: FRB, Bloomberg Finance LP, Deutsche Bank Research % Disconnect persists between Fed, market Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com ECB exit plan: a slow, dovish exit DB expectation Market pricing Rates guidance  Jun - 17: completed QE  Dec - 17: 6 - month extension to Jun - 18, taper to € 40bn/ mth  H2 - 18: QE to continue, at lower pace, e.g., € 20bn/ mth  Extension priced in, but no tapering beyond a one - off reduction from € 60 to € 40bn/ mth Deposit rate hike  Mid - 18: possible, conditional on euro depreciation  15bp hike priced by Mar - 19, 25bp fully priced by Sep - 19  Suggests market not pricing a one - off deposit rate hike Rate hikes  Mid - 19: start of rate hiking cycle 16 The ECB has embarked on a slow and gradual exit from easy monetary policy  Slow progress toward exit from ultra easy monetary policy continues  ECB has taken small exit steps, justified on the basis of declining deflation risk... − Dec - 16: QE taper from € 80 to € 60bn per month − Jun - 17: end signalling that rates could go lower  ...and signalled trend is toward removing stimulus − Draghi sounded less dovish at end - June, stating the need to gradually withdraw accommodation to keep policy stance unchanged  ECB appears optimistic on growth outlook, though more cautious on inflation − Deflation threat ended, reflationary forces at play − However, inflation held back by temporary factors and not yet self - sustaining  We expect the next policy move to be an extension and taper of QE, likely by year - end  Slow exit is consistent with core inflation forecasts, financial conditions remaining at current levels  Euro appreciation, weak wage inflation, declining inflation expectations, would threaten ECB exit plan 0.0 0.5 1.0 1.5 2.0 2.5 2016 2017 2018 2019 2016 2017 2018 2019 Jun - 17 Mar - 17 Source: ECB, Deutsche Bank Research ECB staff forecasts: optimistic on growth, but cautious on inflation %yoy +0.1 +0.1 +0.1 - 0.1 - 0.1 xx Change vs. March forecasts, pp Data Flash: ECB: A slow, dovish exit: 08 - June - 2017 Monetary policy... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com Germany federal election  Next government coalition at stake  Little overall risk, limited to fine tuning of domestic policy  2017 was to be a year fraught with political risk especially in Europe  At the half - year mark, our base case of political risk not escalating is playing out − Underperformance of right - wing eurosceptics in France and Netherlands − Most market - friendly outcome to French elections − Latent risk but no disruption in Italy, Spain  While political risk events remain in H2 - 2017, the same pattern of no escalation should prevail  UK and Brexit negotiations the key, though expected, exception January February March April M T W T F S S M T W T F S S M T W T F S S M T W T F S S 1 1 2 3 4 5 1 2 3 4 5 1 2 2 3 4 5 6 7 8 6 7 8 9 10 11 12 6 7 8 9 10 11 12 3 4 5 6 7 8 9 9 10 11 12 13 14 15 13 14 15 16 17 18 19 13 14 15 16 17 18 19 10 11 12 13 14 15 16 16 17 18 19 20 21 22 20 21 22 23 24 25 26 20 21 22 23 24 25 26 17 18 19 20 21 22 23 23 30 24 31 25 26 27 28 29 27 28 27 28 29 30 31 24 25 26 27 28 29 30 May June July August M T W T F S S M T W T F S S M T W T F S S M T W T F S S 1 2 3 4 5 6 7 1 2 3 4 1 2 1 2 3 4 5 6 8 9 10 11 12 13 14 5 6 7 8 9 10 11 3 4 5 6 7 8 9 7 8 9 10 11 12 13 15 16 17 18 19 20 21 12 13 14 15 16 17 18 10 11 12 13 14 15 16 14 15 16 17 18 19 20 22 23 24 25 26 27 28 19 20 21 22 23 24 25 17 18 19 20 21 22 23 21 22 23 24 25 26 27 29 30 31 26 27 28 29 30 24 31 25 26 27 28 29 30 28 29 30 31 September October November December M T W T F S S M T W T F S S M T W T F S S M T W T F S S 1 2 3 1 1 2 3 4 5 1 2 3 4 5 6 7 8 9 10 2 3 4 5 6 7 8 6 7 8 9 10 11 12 4 5 6 7 8 9 10 11 12 13 14 15 16 17 9 10 11 12 13 14 15 13 14 15 16 17 18 19 11 12 13 14 15 16 17 18 19 20 21 22 23 24 16 17 18 19 20 21 22 20 21 22 23 24 25 26 18 19 20 21 22 23 24 25 26 27 28 29 30 23 30 24 31 25 26 27 28 29 27 28 29 30 25 26 27 28 29 30 31 17 Regarding political risk in Europe, our base case of high event risk not materialising is playing out UK trigger Article 50  Started two - year negotiation countdown for exit 2017 European political calendar Politics... Netherlands general election  Right - wing, eurosceptic PVV party underperformed vs. expectations  Government formation ongoing France elections  Most market - friendly result  President Macron has abs - olute Parliament majority  Positive outlook for reform in France, for EU / eurozone UK early general election  PM May’s election fiasco increased political uncertainty Political uncertainty  Catalonia independence referendum in October is headline grabbing but little risk  At national level, weak centre - right government continues Italy election  Political uncertainty to continue  Collapse of electoral reform means 2017 election is unlikely  Eurosceptic government in 2018 possible but unlikely* Austria election  Right - wing FPO party most popular since mid - 2015  May not make 2nd largest in parliament but may join coali - tion with mainstream parties Note: (*) Eurosceptic Five Star Movement underperformed in most recent elections Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  June’s snap election was supposed to resolve the country’s political constraint ahead of Brexit talks − Very slim majority gave eurosceptic Tory MPs high leverage over the government’s Brexit plan  Election instead weakened government’s hand  Timeline for negotiations is too tight to agree the exit deal and the future relationship – a transitional deal is a must to avoid a disorderly exit  Yet it is politically difficult for this fragile government to move away from current hard Brexit strategy  As a result Brexit outlook has become more binary − Chance of the government delivering orderly on its current plan reduced − Continued political paralysis raises risks of “crash Brexit ” − Higher chance of more benign “softer Brexit ” – but only after another political crisis  UK politics constrain options – alternative at best a Labour - led coalition, with more positive Brexit goal but much less business - friendly domestic policy  A more accommodating EU could improve chances of an orderly exit – but this looks far from likely 18 The outlook for Brexit talks is unlikely to improve meaningfully in the short - term following the shock UK election result Politics... - 50 0 50 100 150 200 Note: (*) DUP support gives government a slim majority Source: House of Commons, Deutsche Bank Research June election was supposed to give much larger majority to government, but Conservatives ended losing seats Government majority, MPs Small majority turned into minority* Brexit outlook has become more binary Description How do we get there Crash Brexit  EU exit in 2019 without transitional or future agreement in place  Weak UK government unable to compromise  Talks fail, time runs out Hard Brexit  Future deal satisfying UK immigration, ECJ, EU budget constraints  Transitional deal in place*  Became more difficult for current government  Another government is less likely to pursue this Softer Brexit  Comprehensive free trade agreement  Transitional deal in place*  Very difficult under current government Note: (*) Transitional deal to bridge period between EU exit and future agreement kicking in More market friendly More likely More likely Less likely Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  About five months into Trump’s presidency, there is some evidence that optimism is starting to wane − Consumer confidence is still elevated but has started to roll over for Republicans − Market inflation expectations have fully retraced the rise from “Trump reflation” hope  There have been some setbacks to Trump’s agenda − Russia investigation dominating headlines − So far lack of legislative “wins” on some key issues (e.g., health care and tax reform) − Challenges to travel ban  But agenda moving forward in some key areas − Supreme Court nominee approved − Deregulation ongoing, e.g. Treasury plan to ease capital cost of some assets would support credit  The coming weeks will be key for Trump’s agenda − Senate likely to vote on health care reform bill − Form and timing of tax reform could depend on health care outcome  Our base case remains that deregulation and some modest fiscal stimulus will add a few tenths to growth in 2018 19 Optimism about Trump’s presidency has started to wane. Events in the coming weeks could be crucial for Trump’s policy agenda 30 40 50 60 70 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Bloomberg US weekly consumer comfort index Republicans Democrats Source: Bloomberg Finance LP, Deutsche Bank Research Some evidence that consumer confidence may be starting to roll over for Republicans % bal US election 1.25 1.50 1.75 2.00 2.25 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 10 yr break even inflation rate 5yr 5yr forward break even inflation rate Source: Bloomberg Finance LP, Deutsche Bank Research Rise in market inflation expectations post - election has been completely unwound % Politics... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 20 Summary of market views Asset class View Rationale Equities  Europe vulnerable to turn in surprises  European equities have been supported by strong macro momentum  Slumping macro data surprises could weigh, favour defensives over cyclicals  Rising US rates not damaging to US equities  Constructive US equities overall. US macro surprises bottoming out and set to rebound. Equities should be resilient to rising US rates, favour financials over consumer staples and utilities Rates  Strategically bearish  Commodities sell - off, US inflation disappointments interrupted sell - off  We see these as transitory and expect normalisation to resume  Curve flattening especially in US appears excessive FX  Turning more positive euro  Euro to rise toward 1.16. Market has room to price in a positive political risk premium to the euro on the back of the Macron / Merkel alliance; in the US, market reluctant to price the Fed rate path  Bearish sterling  UK election outcome adds downside to an already bleak fundamental sterling outlook. Remain bearish sterling vs. dollar, euro, swiss Credit  Constructive Europe  Performance more positive than expected  Long Europe credit to earn carry, as near - term risks appear manageable  US HY resilient  Energy sector under significant pressure , but ex - energy weakness limited to retail. Oil weakness not yet a concern for broader HY market EM  Neutral view stance  Tight valuations coupled with deterioration of growth and fiscal outlook across large EMs offset still supportive flow / carry dynamics Com - modities  Oil slump temporary  Oil correction mostly supply - driven  Limited scope for further weakness – though rebound may take some time Markets... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com  Expectations for rates to sell - off were disappointed in recent months as concerns resurfaced that inflation was not rising − Sharp drop in commodity prices, especially oil − Successive misses in US core inflation readings  We see these inflation concerns as transitory  In parallel, upcoming monetary policy moves should push rates higher , especially in the long - end − Fed expected to announce unwind of its balance sheet in September − ECB likely to announce extension of QE but at lower pace in December − Neither of these is currently fully priced  Rates normalisation should therefore resume in coming months − Expect 40 - 60bp sell - off in US, EU by year - end  Further inflation disappointments, continued commodities weakness could delay the process 40 45 50 55 60 1.2 1.6 2.0 2.4 2.8 Jun - 16 Aug - 16 Oct - 16 Dec - 16 Feb - 17 Apr - 17 Jun - 17 US 10y yield Brent oil (rhs) Source: Bloomberg Finance LP, Deutsche Bank Research Core rates sold off in recent months on the back of falling commodity prices, disappointments in US core inflation % $/bbl US core in - flation misses US core in - flation misses 0.0 0.5 1.0 1.5 2.0 2.5 US UK EU Japan Pre - Fed hikes Current Source: Bloomberg Finance LP, Deutsche Bank Research Core rates have not risen despite the Fed 100bp hikes since 2015 10y yields, % (Nov - 2015) 21 We are strategically short US and Europe rates, and expect the normalisation to resume in coming months Markets... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 22 In FX we have turned more positive on the euro, but remain bearish sterling  UK election outcome adds downside ... − Political paralysis, increased risk of “crash Brexit ” to weigh on currency  ...to an already bleak fundamental sterling outlook − Negative macro outlook as real income shock from lower sterling kicks in, political / Brexit uncertainty hurts confidence and spending plans − Very limited room for BoE to provide stimulus , given rising inflation; any hikes, while short - term sterling positive, would weaken macro picture  We remain bearish sterling vs. dollar, euro, swiss  Euro rally since April has paused, but currency remains around multi - month highs  We have turned more positive on the euro − Dollar less responsive to Fed, ECB policy − More room to price positive surprise from Macron / Merkel pro - EU alliance − Positioning structurally underweight euro − Market reluctant to price the Fed rate path  Expect rally to resume, euro to rise toward 1.16  Drivers traditionally explaining EUR/USD moves broken down, correlations at multi - year lows 1 1.1 1.2 1.3 1.4 1.1 1.2 1.3 1.4 1.5 May - 16 Aug - 16 Nov - 16 Feb - 17 May - 17 GBP/USD GBP/EUR (rhs) Source : Bloomberg Finance LP, Deutsche Bank Research Expect further sterling weakness Brexit vote UK election 0.0 0.2 0.4 0.6 0.8 1.0 2005 2007 2009 2011 2013 2015 2017 Note: (*) Series plots at each point in time the highest 3m correlation of EUR/USD to 30 market variables Source: Bloomberg Finance LP, Deutsche Bank Research Most traditional drivers that usually explain EUR/USD moves have broken down and correlations are around multi - year lows 3m correlation between EUR/USD and most significant market driver* Correlations were only this low in 2007 and 2014, both years of exceptionally low correlations Too early to price soft Brexit , GBP outlook negative – 12 - Jun - 2017 1 Euro to rise toward 1.16 vs. dollar 2 Bearish sterling Markets... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 23 - 15 - 10 - 5 0 5 10 15 20 1 3 5 7 9 11 13 15 17 19 21 23 Week Diff to 2010 - 14 weekly build* Note: (*) Over / under weekly inventory build, relative to the average for the same week in 2010 - 14. Source: EIA, Deutsche Bank Research Oil reacted to the build - up in US inventories, despite having largely ignored a string of mbbl Mostly oil price positive 7 - Jun shock The 20% drop in oil prices since April reflects supply, not demand issues; we see limited scope for further weakness 0.0 0.5 1.0 1.5 2.0 2.5 3.0 Libya Nigeria Source: IEA, Deutsche Bank Research Output from OPEC countries exempt from agreed cuts has increased mbpd 0 100 200 300 400 2017 2018 Current March Source: IEA, Deutsche Bank Research Latest OECD projections signal higher oil surplus than in March mbpd , projected surplus  The 20% drop in oil prices attracted much attention − “Bear market” headlines − Concern over growth, inflation, risk implications  This sell - off is primarily supply - driven , tied to a run of supply-related news and data points − US inventory build surprise in early June − Rising output from exempt OPEC countries − Upward revision to OECD oil surplus projections, signalling much lower surplus reduction in 2018  Scope for further weakness is limited ... − Despite several episodes of weakness, Brent oil has not broken below $40/bbl in over a year  ...Though it may be some time until prices rebound − US shale producers are the marginal producers − Hedging temporarily shields producers from lower prices − Prices need to remain low for some time in order to trigger a supply cutback Markets... Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com Keep informed with our regular The House View publications at houseview.research.db.com The House View range The House View Infographic Special Snapshot Macro Forecasts  Monthly report  Summarises key financial and economic developments  Provides context on Deutsche Bank’s forecasts and outlook for economic growth, monetary policy and financial markets  A one - pager that tackles a current topic in a few charts and visuals  Ad - hoc in depth reports on major underlying topics affecting global economic growth and markets  A handy two - page summary of Deutsche Bank Research macro and markets views  A summary of Deutsche Bank Markets Research macroeconomic, fixed income, foreign exchange and commodities forecasts 24 Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com 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 (%) 2015 2016F 2017F 2018F CPI inflation, YoY * (%) 2015 2016F 2017F 2018F Global 3.3 3.1 3.6 3.7 US 0.1 1.3 2.3 2.1 US 2.6 1.6 2.4 2.6 Eurozone 0.0 0.2 1.6 1.5 Eurozone 1.9 1.7 1.8 1.6 Japan 0.8 - 0.1 0.4 0.5 Germany 1.7 1.9 1.6 1.5 UK 0.1 0.6 2.7 2.8 France 1.0 1.1 1.4 1.6 China 1.4 2.0 1.7 2.7 Italy 0.8 0.9 1.0 1.0 Spain 3.2 3.2 2.7 2.1 Central Bank policy rate (%) Current Q4 - 17F Q4 - 18F Q4 - 19F Japan 1.1 1.0 1.2 0.7 US 1.125 1.375 2.375 3.125 UK 2.2 1.8 1.6 1.2 Eurozone 0.00 0.00 0.25 0.50 China 6.9 6.7 6.7 6.3 Japan - 0.10 - 0.10 - 0.10 - 0.10 India 7.5 7.9 7.0 7.8 UK 0.25 0.25 0.25 0.25 EM Asia 6.2 6.2 6.1 6.1 China 1.50 1.50 1.50 1.50 EM CEEMEA 1.6 1.4 2.5 2.8 EM LatAm - 0.3 - 1.1 1.2 2.4 Key market metrics Current Q4 - 17F Q4 - 18F Q4 - 19F EM 4.2 4.2 4.7 4.9 US 10Y yield (%) 2.14 2.75 3.00 3.25 DM 2.1 1.6 2.0 2.0 EUR 10Y yield (%) 0.25 0.65 #N/A #N/A EUR/USD 1.118 1.16 under review USD/JPY 112 118 122 110 S&P 500 2,439 2,600 #N/A #N/A Stoxx 600 389 375 #N/A #N/A Oil WTI (USD/bbl) 43.4 52.0 52.0 53.0 Oil Brent (USD/bbl) 45.8 55.0 55.0 56.0 Current prices as of 26 - Jun - 2017 Research Deutsche Bank The House View – 28 June 2017 thehouseview@list.db.com http://houseview.research.db.com Analyst Certification This report covers more than one security and was contributed to by more than one analyst. 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