Goldman Sachs Market Outlook Document on UK M&A and Emerging Market Currencies (Jan 2017)

Exhibit 75: UK Cash Merger and Acquisition Announcement Pipeline Continued inbound M&A activity could benefit the pound. 6-Month Rolling Sum, $ bn 150 Capital Into the UK = Pound Appreciation 100 50 + Outbound M&A = Pound Depreciation Net M&A a= 100 - INSOLE |: Out of the UK -150 ~ Nov-16 Dec-16 May-16 — Jun-16 Jul-16 = Aug-16 = Sep-16 Oct-16 Data through December 31, 2016. Note: October 2016 outbound M&A adjusted to exclude stock portion of British American Tobacco’s takeover of Reynolds. Source: Investment Strategy Group, Bloomberg. through to higher domestic inflation. In turn, higher UK interest rates would make sterling- denominated assets more appealing to foreign investors and support the currency. Finally, while sterling certainly has scope to depreciate, market participants are already well- positioned for further weakness. Those positions may become vulnerable if the UK’s negotiations with its trade partners turn more amicable and the domestic UK economy remains resilient. With these upside risks being tempered by the unknowable evolution of Brexit negotiations for now, we see balanced risks for the pound this year and thus remain tactically neutral. Emerging Market Currencies Emerging market currencies caught a welcome updraft last year, following a 45% freefall since mid-2011. The flight was not without turbulence, however. Following a 12% rally in the first half of the year—reflecting a dovish shift in US monetary policy and waning fears about Chinese capital outflows—emerging market currencies hit an air pocket that erased much of these gains following the surprise outcome of the US elections. We believe this downdraft is likely to persist. The prospect of higher US interest rates, a stronger dollar and China’s bumpy deceleration spells tighter global financial conditions and a risk of capital outflows from emerging markets— conditions that have historically constituted a stiff headwind to their currencies. These risks are magnified by the uncertainty surrounding the incoming US administration’s trade policies. Fears of protectionism have already negatively impacted the currencies of China and Mexico—the two largest sources of manufacturing exports to the US—with the peso and Chinese renminbi down 11.6% and 2.3%, respectively, since the election. Even so, we do not think a broad tactical short in emerging market currencies is appealing at this stage. Despite the small rally last year, emerging market currencies remain attractively valued (see Exhibit 76), particularly given their enticing 5% yield differential to the US dollar. Moreover, the new US administration may prove to be more measured in its actions than its rhetoric—a non- negligible risk that could revive sentiment and improve prospects for emerging market currencies. The Mexican peso, in particular, could benefit in that event. For now, we remain tactically positioned to benefit from further renminbi weakness given our long-standing concerns about China’s economic vulnerabilities and the likelihood of looser policy, policy mistakes and capital outflows. The potential for US trade protectionism directed at China, though not our base case, would further benefit this position. 2017 Global Fixed Income Outlook Last year witnessed a notable reversal of fortune for global interest rates. Despite reaching all-time closing lows shortly after the surprise Brexit vote, 10-year yields in developed markets had reclaimed much—if not all—of those declines by year-end. In the US, a more than one percentage point swing was sufficient to turn the 10-year bond’s 9% gain into a loss. While some have portrayed this reversal as just another setback in the now three-decade-old bond bull market, we are more skeptical. The policy mix that has depressed interest rates in the post-crisis period—a combination of fiscal austerity, negative or near-zero central bank policy rates and large-scale asset purchases—is losing favor, as even policymakers acknowledge the often counterproductive impact of these policies. At 64 | Goldman Sachs | JANUARY 2017 HOUSE_OVERSIGHT_014597