Market commentary linking Trump presidency to macro trends and asset class moves

Chart 3: EM debt and equity have been hit Chart 4: While Banks versus Staples has gone ballistic 950 r 40 0.43 ——MSCI EM _ 900 SSW eG TRS EN LSI SEE ERG ; , ———S&P 500 Banks relative to Food & Bev 0.39 (RHS) 850 0.37 0.35 800 0.33 750 0.31 700 0.29 0.27 650 0.25 Oo Oo Wo Oo Oo Ob Oo 0 0 Oo 0 Oo 8 po WwW WOW © © © © © © © © © © SSReRPERELZERS SSR SR ER SESE ES Source: Bloomberg Source: Bloomberg The moves since Nov 8" have certainly been violent in certain asset classes. USD/JPY stands out, but the sell-off in US treasuries has been very marked, the hit to EM fixed income equally big, while in equity markets the outperformance of the Russell, the surge in the US banks and the sell-off in long duration equities has been remarkable. Some of these moves, such as stronger USD, higher yields, banks vs staples were extensions of moves that had already begun. Others, such as Russell vs S&P, JPY, Nikkei, were the start of new moves where 8 Nov marked a key turning point. The moves that had already started are now getting quite stretched with US 10Y yields up 5 standard deviations from the July low, with US Banks up by a similar amount vs Staples. The USD/JPY move though is more like a 2 SD move, with the NKY similar (if we exclude the 7% drop on US election day). Peak liquidity, deflation, Inequality and globalisation —- watch for Peak Trump So what does a Trump presidency mean for the world? Michael Hartnett, our Chief Investment Strategist sums it up nicely with four of his seven peaks. Peak liquidity — the era of excess liquidity is over; Peak inequality — with fiscal stimulus to address inequality; Peak globalisation- free movement of trade, labour and capital ending, FX wars starting; and Peak deflation — the secular low point in bond yields now behind us. We would add a peak to that which investors need to bear in mind —- Peak Trump. What we mean by that is at what point do the policy changes of the Trump presidency get fully discounted in markets. We have moved pretty quickly to do that but we suspect there is more to go, even if the quick returns have probably already been made. If we think about these peak questions, the two that stand out to use as obvious and not really open to challenge are Peak liquidity and Peak deflation. The Fed left its peak liquidity position behind ages ago, the BO) has moved to yield rather than liquidity targeting, the BOE may extend its current programme of QE one more time but then is probably done and even the ECB is talking about tapering, even if they are unlikely to do it in December. The Peak deflation theme follows on from this with the secular low in bond yields surely behind us if the central banks are stepping away from flooding the world with ever more liquidity. Peak liquidity/deflation means higher yields - inflation expectations adjusting The question then is how much yields will likely rise from here. Much of course depends on how quickly inflation picks up. Markets have already moved to price in a significant pick-up in expected inflation as the two charts below show. To our mind breakeven inflation rates had been too low for too long, which is one reason we wanted to be defensive in bond markets. It would seem to us that inflation expectations are now up with events. US headline CPI at 2.5% is consistent with the Fed modestly overshooting Bankof America 2 Global Cross Asset Strategy - Year Ahead | 30 November 2016 5 Merrill Lynch HOUSE_OVERSIGHT_014436