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BNP PARIBAS MARKETS CALL Summary

Core Content

This document is the weekly cross-asset market view from BNP Paribas Markets Call, dated 22 March 2017. It outlines the firm's market outlook across various asset classes and provides actionable trading insights.

Main Views and Key Information

Market Focus Shifting to Volatility

• Volatility as Key Factor: The document highlights that market direction is increasingly influenced by volatility rather than central bank decisions.
• Fed's Rate Hikes: The Fed is expected to hike rates twice more in 2017, which aligns with the median view. However, the market only prices this in with a 52% probability.
• USD Positioning: Long USD positioning has been unwound, returning to neutral. This suggests the USD may be oversold.
• USDJPY: USDJPY is considered undervalued relative to its STEER™ (short-term equilibrium exchange rate) due to the current low-volatility environment.

Asset Class Flows and Performance

• US Stocks: Slight outflows observed, but not significant enough to be a concern at this time.
• US High Yield (HY) Bonds: Continued outflows, with the market not pricing in further rate hikes. The firm advises waiting to buy HY bonds due to the current environment.
• Emerging Markets (EM): Flows into EM dollar-denominated bonds have increased, and EM stocks have shown positive performance. EM FX has also performed well due to USD weakness.
• EU Stocks and Bonds: Mixed flows with some positive trends, but the firm suggests caution as the market is more volatile than the US.
• UK Gilt Valuation: The 10y gilt yield is considered too low, with a valuation model indicating an 80bp premium embedded due to previous QE. The firm suggests shorting 10y gilt ASW positions.
• Volatility and Risk Appetite: Low volatility levels are encouraging risk-taking, as Value-At-Risk (VAR) has decreased. Seasonality suggests that vols may rise in May and June, which could be a concern for riskier assets.

Macroeconomic Outlook

• UK Economic Strength: The UK's economic indicators (GDP, PMI, HICP) are strong, suggesting that rates may be low relative to the economic backdrop.
• Inflation and Volatility: The long-end of the UK market is considered too expensive given the outlook for inflation and volatility. The lagged impact of GBP depreciation on inflation is expected to keep prices rising.
• FX and Rates: The firm believes that the current low-volatility environment may lead to a stronger USD, which could be beneficial for USD-denominated assets.

Trading Recommendations

• Trade of the Week: Short 10y gilt ASW (UKT 1H 26 bond) at -5bp.
  • Initial Target: 5bp
  • Stop: -10bp
  • Carry: -0.5bp
• Reasons for the Trade:
  1. Fundamental Valuation: Gilt yields may rise due to no further QE and hawkish central banks.
  2. Technical Valuation: Gilt ASWs have returned to levels seen after the Brexit vote and have diverged from typical relationships with rates.
  3. Model Valuation: The gilt QE premium model suggests that 10y gilts are overvalued.
  4. Seasonal Patterns: 10y gilts have underperformed swaps 78% of the time in the days following the start of the new financial year.
  5. Supply Dynamics: Net supply net of QE is expected to rise in 2017, which may improve liquidity in the 7-15y sector.

Market Outlook for 2017

• US Market: The firm expects a more hawkish rate outlook, supporting a stronger USD.
• Eurozone (EZ): The EZ market is less supportive compared to the US, with lower yields and tighter spreads.
• UK Market: The UK market is seen as being undervalued, with gilt yields expected to rise due to strong economic performance and potential for higher rates.

Supporting Charts and Data

• Chart 1: BNP Paribas expects two more hikes in 2017 followed by four in 2018.
• Chart 2: Markets are pricing in only a 52% probability for rates above 1.25% by the end of 2017.
• Chart 3: US 10y real yield remains close to recent highs, while European yields are rising from low levels.
• Chart 4: The firm's CLEER™ model suggests that GBPUSD could decline to 1.13.

Dial-In and Replay Numbers

• Live Call: Every Wednesday at the following times:
  • New York: 10:00
  • London: 14:00
  • Brussels: 15:00
  • Hong Kong: 22:00
  • Tokyo: 23:00
• Password: 'The BNP Paribas Markets Call'
• Replay Available: For 5 days after the call.

Legal Notice

• This document is non-independent research and may be subject to conflicts of interest.
• It is a marketing communication and not investment research.
• It is intended for Professional Clients and Eligible Counterparties under MiFID.
• No investment, financial, legal, or tax advice is provided.
• The information is for informational purposes only and may be subject to change.
• The firm may have a financial interest in the securities mentioned, and may have acted upon the information before publication.