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BNP PARIBAS MARKETS CALL SUMMARY – 14 DEC 2016

Core Content

BNP Paribas provided a weekly cross-asset market view on 14 December 2016, highlighting key trends and outlooks for various asset classes. The report emphasized the ECB's cautious approach to tapering stimulus, the Fed's expected rate hike, and the impact of term premium and volatility on market dynamics.

Main Market Outlook

• ECB Policy: The ECB delivered a "dovish taper," ensuring that markets remain confident in the possibility of further stimulus if needed.
• Fed Hike: The Fed's rate increase on 13 December was fully priced by markets. The focus now shifts to how the Fed communicates about future hikes and the potential pace.
• Market Drivers: According to the MarFA™ framework, US term premium and FX/equity volatilities are the main explanatory variables for market movements.
• Equity Valuations: Equity indices have risen on reflation expectations, but the report warns that earnings growth may not keep up with the stronger USD and higher labor costs, making valuations appear overextended.
• Oil Market: The report expects US shale producers to maintain oil prices near their recent peak, despite additional cuts by non-OPEC producers, due to the inability of supply cuts to offset US production.

Key Asset Views

Equity Markets

• Global Equities: Valuations are elevated, and earnings per share (EPS) growth has not yet materialized. The market is seen as expensive relative to GDP.
• US SPX Index: Supported by buybacks, but higher rates could be a headwind.
• Euro STOXX 600: Economy is stable, but EPS growth is weak.
• Japan (NYK): Short-term support from fiscal policy, with a positive outlook for equities.
• EM MSCI EM: Weak fundamentals after a strong rally, with long-term prospects remaining bleak.
• VIX: Volatility is in a range due to the S&P close to its peak. Uncertainty around Trump policies could keep it elevated.

Government Bonds

• US Gvt Bonds: First hike is fully priced. The market may underestimate the number of future hikes.
• EZ Core Gvt Bonds: Supported by extended QE, but rates may rise due to US market pressures and possible end of QE.
• EZ Peripheral Gvt Bonds: Less attractive if ECB bond purchases decrease.
• GILTS: Higher inflation and weak GBP may push yields up.
• JGBs (10y): Supported by the BoJ, but yields could jump if the BoJ removes its rate cap.

Credit Markets

• US IG: Carry trade remains attractive, but higher rates may slow re-leveraging.
• US HY: Boosted by oil and reflation, but higher rates could increase risk premiums.
• EU IG: Not much value, but ECB buying is supportive.
• EU HY: Carry trade in place with QE extension, and rates are expected to remain low.

FX Markets

• EURUSD: Market momentum is weakening, with the potential for EUR to reach parity.
• USDJPY: Expected to rise as JPN investors seek higher yields.
• USDGBP: GBP is underperforming the eurozone.
• USDCAD: Positive outlook due to US/Canada rate differentials and oil prices. Recommended to go long via an option strategy.
• USDHY: USD trade-weighted index is strong, supporting its value against other currencies.

Strategic Recommendations

• Trade of the Week: A 3m USDCAD 1x1 call spread is recommended. Buy 1.34 call, sell 1.36 call with a 4.9:1 payout and a spot reference of 1.3120.
• Reasons for USDCAD Call:
  1. Oil prices are at their top, and USDCAD is expected to rise.
  2. The Bank of Canada is expected to ease in January, which will benefit the USD.
  3. Market positioning has turned long on CAD, which could be vulnerable to a drop in oil prices or a weaker risk environment.

Market Conditions

• Financial Conditions: Tightened slightly after the ECB meeting, but not enough to unsettle risky assets.
• Term Premium: Rising in the US, which pushes global yields higher and steepens yield curves, especially favoring the USD.
• Volatility: Declining FX and equity volatility is positive for equities and credit indices, and positively correlated with oil prices.

Key Charts and Data

• Chart 1: Financial conditions stable over the past week.
• Chart 2: Real yields continue to rise.
• Chart 3: Equity risk premium for SPX is high, indicating overvaluation.
• Chart 4: USD economic data are strong.
• Chart 5: Term premium is an important variable.
• Chart 6: Equity and FX volatility is also important.
• Chart 7: Gold appears overvalued relative to market factors.
• Chart 8: Financials have improved more than peripherals.

Dial-in Numbers

• Live Call: Every Wednesday.
• Password: "The BNP Paribas Markets Call"
• Dial-in Details: Available at the back of the document.
• Country-specific Numbers: Provided for various regions, including North America, Europe, Asia, and others.

Legal Notice

• The document is non-independent research and may be subject to conflicts of interest.
• It is a marketing communication and not investment research.
• BNP Paribas may have a financial interest in the assets mentioned and may be involved in related transactions.
• The information is not guaranteed to be accurate or complete and should not be relied upon as such.
• Past performance is not an indicator of future results.
• The document is for professional clients and eligible counterparties as defined by MiFID and other relevant regulations.