EFTA01458994.pdf

8 December 2015 World Outlook 2016: Managing with less liquidity The goods-services divide suggests the Fed and ECB are misdiagnosing 'Figure 5: Trend like global growth underlying inflation: low goods inflation is a global phenomenon that reflects the dollar up and commodity down cycles. which are accelerated by monetary 6 % Y51 ... ..ow yor c4id aoe rlr a. i Nrata : °MF d"W % 6 policy divergence: services inflation is running much stronger and rising. Core 5 goods inflation (25% weight in the US; 38% weight in Europe) consistently runs well below core services inflation. In the US, core goods inflation has s been running slightly negative for three years, while core services a much 2 7 1745. eivrclverdte stronger 2.5% for the last four years and recently moved to a new cycle high. 04:0419. pain In the Euro area, core goods inflation is running higher than in the US 0 0 reflecting the depreciation of the euro, while core services has been moving up and is running at 1.4%. Core goods inflation in the US is strongly correlated with import price inflation. Zero or slightly negative core goods inflation in the 5; F Walla. deeptrc I ye rents le 2 US can also be thought of as foreign inflation less the dollar's appreciation. 24.411* M1F Dana* S' Rued, Core services inflation in the US has moved up over the last three months and has a fair degree of catch up to do with the decline in unemployment relative to the NAIRU and rental vacancies. igure (5: Dollar cycle has 10% to go 120 I Wet 13) — ustrva The dollar up cycle should have In'-; to care medium term but -steed bit:takers 20 I — rrn Impboci 2041.04ne '20 are now in place to slow the pace. The US trade-weighted dollar rose 23% rio '0 during Jun 2014-Mar 2015, the fastest pace ever with about three years of bool 140 appreciation in a typical dollar up cycle packed into nine months. The rapid 00 appreciation erected two speed breakers which should slow the pace: lower core goods inflation prompted the Fed to push out rate guidance in April so (marking a top in the dollar for next seven months); the drag on US growth and 70 earnings has seen a big reallocation (S-150bn) out of US equities into Europe. CO 1074 1002 1000 1120 2004 2014 Historically turns in productivity are led by the dollar. typical lag implies we are Sara toe's ., &SW Lk (444040ontawair. at the cusp. Historically, over the post-World War II period, productivity has grown at a trend rate of 2.1% per year, with long multi-year cycles in the level of productivity around this trend. The current level is near the bottom of the iFigure 7: Dollar leads productivity — USO TM New bat PPP 'mobs& 124 lead. MO trend channel, a level last seen in 1995. Incentives matter: the dollar looks to — US Sea arm Paeountary "dee ?rem byre? VK$ have been an important driver of productivity historically. There has been a 40 14 10 relatively strong correlation between the lagged level of the trade weighted 30 dollar and productivity. The average lag looks to have been about three years. IS ? • 20 10. • % I Cyclical asset allocation: large over.a€location to fixed income at the expense 0 of equities persists. Around recessions, flows overweight bonds over equities. - .10 Asset allocation re-normalizes around Fed hiking cycles. This time various QEs, 4 calendar guidance and Twist prompted investors to put even more money into .20 Carrel ?meaner 0114 bonds long after the recession. Despite equity inflows resuming in 2013 ao -10 (especially after the taper) cumulative overweight in bonds is still $748bn and underweight in equities $1.4 ten. Each episode of rising rates over the last five San SS, Diana.* Sant Rwarolt years saw robust reallocations from bonds to equities. The cross asset rates minder IFigure 8: Over allocation to bonds Rata row Rate normalization cycles have long been associated with significant price 2C0 1.70 tie .1.41) La 24tO losses on the 10y. Previous rate hiking cycles each saw long-lived capital 2•255 Dam Sews Isa):11 losses on the 10y, averaging -11%. We estimate that a catch back up of et... name IC55 1(.O0 market expectations to the Fed's guidance is worth +150bps in the l0y implying a significant potential re-pricing. The current divergence two years try: • ahead is comparable with historical experience near turning points in rate 455 202 cycles. 11 F ; I ggl; sane 1O, °assent SagItarecal Page 68 Deutsche Dank AG/London CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0119175 CONFIDENTIAL SDNY_GM_00265359 EFTA01458994