The UniCredit Macro & Markets 2017 Outlook

December 2016

The UniCredit Macro & Markets

2017 Outlook

Economics & FI/FX Research 16 December 2016 Credit Research Equity Research Cross Asset Research

Improving economic fundamentals, but unprecedented political risks

■ Macro: We forecast stronger global growth in 2017, mainly driven by emerging markets. Growth in the US will probably accelerate on fiscal stimulus, while the eurozone is likely to maintain decent cruising speed. The Fed may raise rates at least twice and the ECB may announce further withdrawal of stimulus. Trump is a bigger risk to the global outlook than elections in Europe.

■ FI: We expect 10Y USTs to end 2017 at around 3%, driven by a further increase in both the 10Y breakeven inflation and the real rate. In the euro area, we expect 10Y Bund yields to rise further, reflecting firming inflation, influence from the US and ongoing discussion of tapering. Yield repricing should mainly involve the long and extra-long end.

■ FX: The tug of war between fundamentals, momentum and markets’ interpretation of policies will keep visibility low: we see some slowdown in the USD’s momentum early in the year followed by modest weakening, but uncertainty is unusually high.

■ Equities: We expect eurozone equities to rise. Financials and Materials are likely to outperform while sectors seen as substitutes for bonds, such as Telecoms, Utilities and Food & Beverage, should remain less attractive.

■ Credit: Rising risk-free yields will put technical pressure on safe-haven names due to allocation shifts into risky assets. We like shorter durations and lower credit qualities (BBB, hybrids, high yields) and, in particular, bank AT1s.

Editors: Marco Valli, Chief Eurozone Economist (UniCredit Bank Milan) Chiara Silvestre, Economist (UniCredit Bank Milan)

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December 2016 Economics & FI/FX Research

2017 Outlook

UniCredit Research page 2 See last pages for disclaimer.

Contents 3 Executive Summary

4 United States Fiscal stimulus to lift growth – but mind the risks

6 Eurozone Moderate recovery set to continue at steady pace ECB: the beginning of the end of QE

10 Germany A further splintering of the German political landscape

12 France Presidential election: cards stacked against Marine Le Pen

14 Italy 2017 to be an election year, the outcome is highly uncertain

16 Spain

17 Austria

18 United Kingdom A “slow burn”

19 Switzerland Steady growth and steady SNB

20 CEE region Ups and downs among deepening divergence

23 China

24 Other Emerging Markets A gradual and uneven recovery marred by plentiful risks

27 FI Strategy US Rates: Targeting 3% in 10Y UST EUR Rates: Steeper curve, higher yields, volatile spreads

34 FX Strategy USD: some slowdown in momentum early on followed by a modest weakening;

but political risks loom

42 Equity Strategy Higher index levels in 2017

44 Credit Strategy Fundamentally sound, but technical factors will prevail

46 Commodity OPEC decision to cut oil production leads to higher oil price level

48 Table 1: Annual macroeconomics forecasts 49 Table 2: Quarterly GDP and CPI forecasts 50 Table 3: Comparison of annual GDP and CPI forecasts 51 Table 4: FI forecasts 52 Table 5: FX forecasts 53 Table 6: Commodities forecasts 53 Table 7: Risky assets forecasts

Editorial deadline: 16 December 2016, 09:00 CET


2017 Outlook


Executive Summary ■ In this report we present our forecasts for 2017 and 2018. We focus on economics and markets, but – in our assessment –

the world is facing potentially colossal political shifts which, if they materialize, imply very large risks to the outlook.

■ If not disrupted by shocks, global growth is set to accelerate to about 3.5% in 2017 from 3.0% in 2016. If so, we’ll be heading into yet another year with the two greatest conundrums of global economics in recent years unsolved: namely mediocre productivity growth in the OECD and extremely low growth in global trade. The acceleration in global growth in 2017 will be driven mainly by emerging markets, where we see a growth rate of about 4.5%, up from around 4.0% in 2016. Growth in the OECD area will also accelerate, if modestly, mostly on account of the US and, to a lesser extent, Japan.

■ US growth in 2017 is particularly difficult to predict because of low visibility on the fiscal stance. In the extreme, the “reflation story” might work. Trump’s fiscal plan, as outlined during his campaign, could add stimulus during 2H17 and into 2018 to an extent that annualized GDP growth could reach 4% at around the end of 2017. Stimulating the economy to such an extent and this late in the cycle with full employment would surely boost inflation, and push the long end of the UST curve even higher. Maybe more realistically, a fiscal plan as suggested by the leadership of the House of Representatives, will be implemented, pushing US growth to 2 ¾% at around the end of 2017, before falling back to 2.0-2.5% towards end-2018.

■ Eurozone growth should remain broadly stable at around 1.5%, driven primarily by Germany, with France and Italy set to expand 1.2% and 0.8%, respectively. Growth in Central Europe is likely to ease slightly to just below (a still robust) 3%, while Russia should return to positive growth of about 1%. Growth in the UK is likely to drop to a little more than 1% due to Brexit uncertainties, which will imply some drag on key trading partners.

■ The Fed is likely to hike rates at least twice, followed by three more rate increases in 2018. The ECB will cruise through 2017 with the policy set-up announced at the December meeting, aimed at steepening the curve. Towards the end of the year, however, the ECB will probably announce some further withdrawal of stimulus, which would leave it on track to wind down QE over the course of 2018. The BoE will remain on hold, looking through a potentially significant increase in inflation.

■ In fixed income, we expect a further rise in yields, with the 10Y UST climbing to 3% and the 10Y Bund up to 0.80%. Curve-steepening, especially in the eurozone, is likely to be the main theme. Sovereign spread widening episodes should be viewed tactically as buying opportunities. In the FX universe, the tug of war between fundamentals, momentum and markets’ interpretation of policies will keep visibility low: we see some slowdown in the USD’s momentum early in the year followed by modest weakening, but uncertainty is unusually high. We expect eurozone equities to rise: Financials and Materials are likely to outperform while defensive sectors with high dividend yield, seen as a substitute for bonds, should remain less attractive. In credit, we prefer shorter durations and lower credit qualities (BBB, hybrids, high yields) and, in particular, bank AT1s.

■ Yet, for this picture to play out, the world will have to navigate potentially colossal shifts in global and domestic policies.

■ Most importantly, President-elect Trump has pledged to dial back the US from most international agreements, ranging from trade, to NATO, to the Iran nuclear deal, to the Paris climate agreement. He has also flirted with an end to the decades long “one-China policy” of the US, and threatened large tariffs on Chinese imports. If this is indeed the way the US goes, the global power vacuum will surely be occupied by other actors, including China, with potentially large implications for investment and trade flows, as well as for security matters. The uncertainties for 2017-18 relate not only to the policies of Mr. Trump, but as much to the reaction by other major powers to any changes a Trump administration might pursue.

■ 2017 will also see negotiations on Brexit get under way, which means that the considerable confusion about the UK’s intentions will begin to be fleshed out. The odds are that this will, in turn, lead to a realization of the complexities and downside risks for businesses in the UK, but the exact impact on growth remains highly uncertain.

■ Meanwhile, Continental Europe will go through a number of key elections, many with radical nationalist or anti-establishment parties threatening the mainstream political powers, including in France, the Netherlands and – possibly – Italy, where the probability of a vote before the end of the parliamentary term is rising. In contrast, the German elections are almost certain to lead to a continuation of mainstream governance. Political risk will remain high in Greece, but with few systemic implications.

Erik F. Nielsen, Global Chief Economist (UniCredit Bank London) +44 207 826-1765 [email protected]


2017 Outlook


United States

Fiscal stimulus to lift growth – but mind the risks Dr. Harm Bandholz, CFA Chief US Economist (UniCredit Bank New York) +1 212 672-5957 [email protected]

The US economy will remain one of the major engines of global growth in 2017. We expect real GDP growth to accelerate to 2.4% from 1.6% in 2016. In particular in the second half of the year, domestic demand should be lifted by sizeable fiscal stimulus. The boost towards the end of the year also means that additional effects should be felt in 2018, for which we project growth of 2.7%. Our baseline forecast assumes that the incoming Trump administration will refrain from imposing tariffs or other measures that would significantly restrain global trade. But the introduction of protectionist measures remains a non-trivial risk.

Underlying growth rate of 2% Even in the absence of fiscal stimulus, the US economy was bound to display somewhat stronger growth in 2017 than in 2016. The reason is that most of the headwinds that significantly weighed on the economy in 1H16 have faded. These include the lagged effect of the stronger USD, the investment recession in the energy space and a sizeable inventory correction. Growth rates have already picked up in 2H16, and we estimate that without stimulus, the US economy would expand at 2% to 2¼% next year. In this scenario, consumer spending would remain the main growth driver. While employment gains have started to slow as the economy has come close to full employment, wage gains have begun to pick up. In addition, there is some pent-up demand in business fixed investment, after companies had shown lots of restraint over the past couple of years. Stable energy prices and the return of positive profit gains should ensure that capex returns to positive growth after having been flat or even down since mid-2014.

How much stimulus? On top of this improved fundamental outlook, there will most likely be some fiscal stimulus. The only question seems to be how big it will be. During the campaign, president-elect Trump floated a massive plan to cut individual and corporate taxes, and to increase spending for defense and infrastructure. According to the Tax Foundation, this proposal would boost the deficit by a total of USD 5 trillion over the next ten years. While Republican lawmakers across the board will likely support tax cuts, some of them may still be opposed to such an immense increase in debt. A more feasible alternative – and that is our baseline scenario – is, thus, the tax plan that was agreed on by House Republicans in the middle of the year.1 The deficit impact of this plan is estimated to be about half as big compared to Mr. Trump’s original plan.

FISCAL STIMULUS TO SUPPORT GROWTH – AND IMPORTS

Domestic demand vs. imports Real GDP, % qoq (annualized)

Source: BEA, UniCredit Research

1 “A Better Way, Our Vision for a Confident America”, Speaker of the House of Representatives, 24 June 2016.

y = 2.7x - 1.3

-25

-20

-15

-10

-5

0

5

10

15

20

-6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 8.0

Rea

l im

ports

of g

oods

& s

ervi

ces,

% y

oy

Real domestic final demand, % yoy0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18

House plan (baseline)Trump planCurrent law


2017 Outlook


Lift from mid-17 to early 2018

Among the differences are lower standard deductions for individuals and a higher corporate tax rate (20% vs. 15%). Given that House Republicans have already approved this plan, it should easily pass Congress. And Mr. Trump should be willing to compromise in order to have his first important legislation pass smoothly.

We anticipate that the bill will be passed by the middle of the year, which means that household income should jump as soon as in the third quarter. Household spending will react immediately, but won’t go up as much as the rise in income. Instead, we expect households to spend their additional income over time. As a result of this consumption smoothing, the savings rate should temporarily rise in the second half of 2017 before coming down again in 2018. While the main impact of the stimulus will be visible in higher consumption expenditures, some of the stimulus provisions (corporate tax cuts, increased defense and infrastructure spending) will be reflected in business fixed investment and government expenditures as well. But we would like to emphasize that the multiplier for corporate tax cuts is usually rather small, as businesses tend to use large parts of tax-cut windfalls to bolster their balance sheets rather than to increase capex. In addition, increased domestic demand will certainly lead to an increase in imports. This, in turn, will reduce the impact of the stimulus on overall GDP growth. Even worse, such a development could once again stoke up anti-free-trade rhetoric within the administration.

Rising wage gains, faster core inflation, and higher rates

Fiscal stimulus at a time when the US economy is operating close to full employment should lead to a further acceleration in wage gains at a time when most measures of labor costs had finally started to move higher. If that happens too quickly and goes too far, concerns about sluggish wage gains will soon be replaced by concerns about companies’ profits due to elevated labor costs. Moreover, the international competitiveness of US business, the improvement of which is an explicit goal of the incoming administration, would be further undermined. The impact of such a development on inflation rates, on the other hand, should be somewhat more limited, given that a large proportion of the inflation basket (think of services prices or hedonic prices) is estimated in a way that results in limited correlation with the business cycle. However, we still anticipate the CPI core inflation rate to accelerate further from 2¼% yoy to 2½% in 2017, and beyond that in 2018. The core PCE deflator, the Fed’s preferred inflation gauge, which is currently running about half a percentage point below the core CPI, will accordingly hit 2% next year, and rise slightly above it in 2018. These developments will allow the Fed to continue its gradual pace of policy normalization. After raising its target rate only once in 2015 and once in 2016, we project two hikes for 2017 and another three hikes for 2018. Financial markets now share the outlook for 2017, but still remain more cautious over the medium term.

FASTER INFLATION GAINS KEEP FED’S MONETARY POLICY NORMALIZATION ON TRACK

Consumer price index (% yoy) Expectations for fed funds target rate (%)

Source: BLS, Federal Reserve, Bloomberg, UniCredit Research

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Headline CPI CPI ex food & energy

forecast

0.0

0.5

1.0

1.5

2.0

2.5

Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18

FOMC members' median projection (December 2016)UniCredit projectionFed funds futures (16 December 2016)Fed funds futures (4 November 2016)


2017 Outlook


Eurozone Moderate recovery set to continue at steady pace

Marco Valli, Chief Eurozone Economist (UniCredit Bank Milan) +39 02 8862-0537 [email protected]

2016 has brought mixed growth signals, although, on balance, positive news has prevailed. Resilience to shocks has been the most encouraging feature of the eurozone recovery in the year that closes. Despite severe market stress in January and February, Brexit and ongoing weakness in global trade, business and household confidence in the euro area has remained remarkably stable, and GDP is likely to have expanded by a respectable 1.6% in 2016 as a whole. This marks the second consecutive year of above-trend growth. The bad news is that this recovery phase remains weak by historical standards, with an average annualized pace of expansion of only 1.5%.

We think 2017-18 will show a continuation of this moderate recovery, with GDP growth likely to average 1.5% in 2017 and 1.4% in 2018. We assess the growth impulse originating from the exchange rate, oil prices, interest rates, global trade and fiscal policy, by estimating their contributions to GDP growth over time. Trajectories for the trade-weighted EUR, oil prices and interest rates can be found in the forecast tables at the end of this publication.

Currency and oil to start weighing on growth

The slight GDP deceleration from 2016 is mainly due to the expected currency appreciation (the trade-weighted EUR rises by about 3% both in 2017 and 2018) and higher oil prices (averaging USD 56.5/bbl in 2017 and USD 62/bbl in 2018). On the assumption that bank lending rates will bottom out in 1H17, we estimate that the growth contribution from interest rates in 2017 will be similar to that of 2016 (+0.25pp), although it will start weakening over the course of 2018. We also forecast that the contribution from fiscal policy will remain small but positive throughout the forecast horizon, although somewhat weaker than in 2016.

The important role of global trade

As the currency and oil prices progressively turn from support factors into a drag, the trajectory of global trade will be important to shape the eurozone growth path going forward. In particular, some recovery in global trade will be needed to keep the pace of expansion in the euro area broadly stable in 2017. We expect faster growth in the US and signs of improvement in the EM business cycle to trigger a moderate re-acceleration in global growth from 3% or so in 2016 to about 3.5% in 2017-18. In this context, some slow normalization in trade-to-GDP elasticity back towards one should prompt a gradual pick-up in global trade growth towards 3.5% at end 2018. We estimate that this will add 0.15-0.20pp to eurozone GDP growth in both 2017 and 2018, after the drag of 2015-16. If the improvement in global trade does not materialize – possibly because of a resurgence of protectionism, a big shock from a hard Brexit or another bad year in EM – eurozone growth will likely disappoint.

SLOW RECOVERY BY HISTORICAL STANDARDS GROWTH DRIVERS AT A GLANCE

Source: Bloomberg, CPB, EC, ECB, Eurostat, IMF, UniCredit Research

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1Q99-1Q01 3Q03-1Q08 3Q09-1Q11 2Q13-to date

Average GDP growth in recovery phase (% annualized)

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

FX Oil Rates Global trade Fiscal

2015 2016 2017 2018

Contributions to eurozone GDP growth (pp)


2017 Outlook


Private consumption may start losing some shine

Domestic components will probably remain in the driver’s seat in 2017, although momentum may ease somewhat, starting with private consumption. In our forecasts, nominal disposable income continues to cruise at a healthy pace of 2.5-3%, although the employment-compensation mix is likely to be slightly different than in 2015-16. While employment has been unusually responsive to GDP growth over the past two years and there has been a clear flattening of the Phillips curve, going forward we project a slightly weaker pace of employment growth, along with improving compensation dynamics. However, higher inflation will start biting into nominal disposable income, eroding some of the purchasing power of households. Assuming a broadly unchanged savings rate after the increase recorded since the final quarter of 2015, we project real consumer spending to slow to about 1.3% in 2017 from 1.7% in 2016. The peak of the durable-goods cycle is probably already behind us.

Outlook for fixed investment remains positive

Fixed investment will continue to benefit from the improvement in firms’ profitability, the sizeable (and rising) net-saving position of the corporate sector and still very loose financing conditions. We project investment to grow about 2.5% in 2017, from just below 3% in 2015-16. Given the moderate pace of the overall GDP recovery, this remains a reasonably good number. In 2017, the growth pace of machinery investment is likely to broadly stabilize, as the trend in profit growth flattens out in the wake of rising oil prices and with the bottoming out of borrowing costs. In contrast, investment in transport equipment is set for a material slowdown as normalization kicks in following double-digit growth in 2016, which was partly fuelled by temporary factors. We expect construction investment to remain well supported: public investment continues to follow a trend of slow, albeit steady, growth, while good prospects for household income keep residential activity on track for healthy expansion.

At about 2.5%, we expect export performance in 2017 to improve only slightly from 2016, as the impulse from faster global trade may be largely offset by currency appreciation. Therefore, although improving, support from external demand will likely remain feeble – a distinctive feature of this recovery phase.

Broadly stable growth in the Big Three. Spain to normalize

In 2017, we forecast a broad stabilization in the pace of GDP growth in the three largest euro area countries. Germany will probably expand 1.8% after 1.7% in 2016 (both numbers are adjusted for working days), France is likely to grow by 1.2% (in line with 2016), while in Italy we project growth of 0.8% (from 0.9% in 2016). In Spain, the recovery will probably lose a bit of steam as GDP growth eases to 2.4% from 3.2%. However, we regard this as normalization from high levels, rather than a genuine loss of momentum: at almost one full percentage point, the growth differential between Spain and the eurozone as a whole remains significant. More details on forecasts for individual countries can be found on pages 10-17.

FIRMS’ PROFITABILITY REMAINS IN GOOD SHAPE GROWTH FORECASTS BY COUNTRY

Source: Eurostat, UniCredit Research

-20

-15

-10

-5

0

5

10

15

2Q01 4Q03 2Q06 4Q08 2Q11 4Q13 2Q16

NFCs - Net operating surplus (yoy)

Machinery investment (yoy)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

EMU Germany France Italy Spain

GDP (% yoy)

2016 2017 2018


2017 Outlook


Inflation to move towards the 1.5% area soon

Inflation acceleration is gaining traction and headline CPI is likely to climb to around 1.5% yoy in 1Q17. Energy will be the main driver of the move – due to a combination of rising oil prices and a base effect – while any upward impulse from core inflation will probably be limited over the next two years as the output gap narrows slowly. Leading indicators for food inflation remain subdued, but they generally suggest scope for a moderate recovery in processed food prices. Overall, we see inflation fluctuating within a narrow range around 1.5% for most of the forecast horizon, but with no clear breakthrough towards 2%. In yearly average terms, after 0.2% in 2016, we forecast inflation at 1.5% in 2017 and 1.4% in 2018.

Core inflation: very slow recovery ahead

The path for core inflation warrants special attention, given there are virtually no signs of improvement from the cyclical lows touched in early-2015. Three main factors explain the flat trajectory in core prices so far: 1. the lack of responsiveness of wage growth to the improving labor market outlook, which has exerted downward pressure on services prices; 2. subdued import price dynamics, and 3. second-round effects from the past drop in the price of oil and other commodities.

OUR BASELINE SCENARIO FOR INFLATION WAGE GROWTH PUTS THE BREAK ON SERVICES INFLATION

Source: Eurostat, UniCredit Research

We expect all three factors to slowly start changing or reversing over the forecast horizon, as the persistence of above-potential GDP growth and signs of life in the global commodity cycle gradually feed through to the price formation chain, offsetting the downward pressure from a likely deceleration in durable goods consumption. Following 0.9% in 2016, we project core inflation to average 1.0% in 2017 and 1.2% in 2018.

WEAK PIPELINE PRESSURE SO FAR… …BUT THINGS MAY SLOWLY CHANGE

Source: Eurostat, Markit, UniCredit Research

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Dec-12 Jun-14 Dec-15 Jun-17 Dec-18

Headline HICP (% yoy)

Core HICP (% yoy)

Forecast

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1Q99 3Q02 1Q06 3Q09 1Q13 3Q16

Services CPI (% yoy)Wages (% yoy)

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Feb-06 Oct-08 Jun-11 Feb-14 Oct-16

Core goods PPI (% yoy, 3MMA)Core goods CPI (% yoy, 3MMA) - RS

35

40

45

50

55

60

65

Sep-98 Mar-03 Sep-07 Mar-12 Sep-16

PMI survey - Output prices

Manufacturing sectorService sector

Dec-16


2017 Outlook


ECB: the beginning of the end of QE A less predictable ECB

The extension of asset purchases until December 2017 at a reduced pace of EUR 60bn per month after March leaves a sizeable ECB presence in the market throughout 2017. Therefore, financial conditions should remain supportive overall, while the relaxation of the deposit rate constraint and the extension of eligible maturities to 1Y tend to steepen the curve and bring some relief to the financial sector. However, the ECB decision also raises uncertainty about the central bank’s reaction function. This is because the Governing Council (GC) had promised EUR 80bn per month until a “sustained” inflation adjustment towards price stability had been achieved, while on 8 December the complete lack of underlying price pressure actually forced the ECB to further reduce its overly optimistic core CPI forecasts. Therefore, the decision to cut the monthly flow of purchases seems to reveal the GC’s increased unease at the size of the QE program. To some extent, this starts being reflected in a shift of the focus of monetary stimulus away from flows towards the stock of purchases and the growing size of the ECB balance sheet. In all this, we suspect that political considerations and, to a lesser extent, technical constraints, have already started to exert some influence. As a result, we think that the predictability of ECB policy may suffer going forward.

Most likely next step: another reduction in the monthly flow, but it is a close call

Our outlook for growth and inflation – with headline CPI hovering around 1.5% throughout the forecast horizon and core prices eventually entering a very shallow improving trend – makes it likely that 2017 will bring the announcement of a further adjustment to monetary policy, probably in September. It is a close call, but we suspect that another reduction in the pace of monthly purchases, maybe to EUR 40bn until about mid-2018, is slightly more likely than outright tapering – defined as a commitment to gradually reducing asset purchases to zero over a given time span.

This would leave the ECB on track to wind down its QE program completely by the end of 2018 or early 2019 at the latest, with additional net asset purchases from January 2017 to the termination date likely to be in the EUR 1.1-1.2tn area. With the deposit rate floor gone and the extension of eligible maturities to 1Y, we estimate that purchases of this size would be achievable without changes to the ISIN limit or the capital keys, two self-imposed restrictions the ECB seems unwilling to abandon. However, the ECB would have to draw on all eligible assets classes, especially with respect to Germany. If the ECB were to formally shift towards a “stock approach” to its asset purchases, the likelihood of QE being wound down more quickly would increase significantly.

Scenario analysis The policy decision taken on 8 December suggests that energy prices will be an important source of risk to our QE forecasts, in both directions. We estimate that if oil prices were to rise to USD 65/bbl by the end of 1Q17 and stay there until 3Q17, by the time of its September meeting, the ECB would face average headline inflation of 1.8% in the first eight months of 2017 – basically, at or very close to price stability. If higher oil prices do not place significant pressure on economic activity, the ECB would then be under increased pressure to announce outright tapering, or at least a more frontloaded slowdown of asset purchases than we currently predict. In contrast, if we assume oil prices decline to USD 45/bbl by the end of 1Q17 and stay there until 3Q17, the ECB would face average headline inflation of only 1.2% between January and August 2017. This would increase the probability of a steady-hand approach to QE, at least into the first months of 2018.

Rate increases not before 2019 Finally, with QE on a path of progressive slowdown and the GC sticking to its commitment to keeping rates “at present or lower levels for an extended period of time, and well past the horizon of [its] net asset purchases”, any increase in the deposit rate facility is unlikely to come before 2019.


2017 Outlook


Germany Dr. Andreas Rees, Chief German Economist (UniCredit Bank) +49 69 2717 2074 [email protected]

■ We expect the German economy to grow by 1.5% in 2017 and 1.6% in 2018 after 1.8% this year (each on a non-working day adjusted basis; see left chart below).

■ Adjusted for calendar effects, growth will be 1.8% next year (given that the number of working days does not vary between 2017 and 2018, calendar adjustment does not change our forecast for 2018, which remains 1.6% growth).

■ Internal demand will remain the major driver of growth in 2017, although some (moderate) headwinds have emerged. On a positive note, the labor market will continue to create new jobs and wages will rise further. At the same time, higher headline inflation caused by a rising oil price is denting purchasing power. Fiscal policy will be moderately expansive, as some tax cuts will kick in at the start of the year. However, the overall growth impulse will be weaker than in 2016, since the reduced influx of refugees will dampen both private and public consumer expenditure.

■ Despite some recent volatility, activity in the construction sector will be brisk. Although the need for additional accommodation for refugees has already been falling, there is still substantial excess demand for housing. Tellingly, business sentiment among construction companies improved further and again hit record post-reunification highs.

■ After the recent breather, we expect capex spending to re-accelerate in the next few quarters. This is signaled by a significant pick-up in bank lending to the non-financial corporate sector (see right chart). However, instead of creating new capacity, the replacement of outdated machinery and equipment will continue to dominate.

■ German export activity should accelerate. Besides rising economic activity in the US and steady growth in the eurozone, positive impulses should also come from major emerging markets such as China and Russia (assuming no additional sanctions). This is already signaled by rising business sentiment in emerging markets and has probably also been a factor contributing to the improving mood among German business managers in the last few months (Ifo, PMI).

OUR GROWTH FORECASTS AT A GLANCE LOANS TO NON-FINANCIAL CORPORATES ACCELERATING

Source: FSO, ECB, UniCredit Research

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Forecast

Real GDP (nwda), in % yoy

-4

-2

0

2

4

6

8

10

12

2004 2006 2008 2010 2012 2014 2016

Loans to non-financial corporate sector, in % yoy


2017 Outlook


A further splintering of the German political landscape Autumn general election

The next general election will take place in the autumn of 2017, probably in September. Angela Merkel has been chancellor since 2005, leading two grand coalitions between the CDU/CSU and the SPD and one CDU/CSU-FDP government (from 2009 to 2013).

State election in North-Rhine Westphalia

In the run-up to the general election, there will be three federal state elections. The most important litmus test will be the election in North-Rhine Westphalia in May, since it is the most populous federal state in Germany.

Recent opinion polls

The latest opinion polls point to a further splintering of the political landscape. Instead of four parties currently in the Bundestag (CDU-CSU, SPD, Left, and Greens), opinion polls suggest that the Alternative for Germany (AfD) and the FDP will manage to clear the 5%-hurdle (see left chart). The CDU/CSU would get 36% of the vote share, the Social Democrats 22%, the Greens and the Left 10% each, the AfD 13% and the FDP 5%-6%.

Baseline: another grand coalition

Given the further splintering of votes and the emergence of the AfD, our baseline scenario for the general election is a third grand coalition under Chancellor Merkel. Such a government would continue to be strongly committed to the eurozone and the EU. Abrupt changes in domestic economic policy are also unlikely. Instead, a steady hand can be expected with some (moderate) left-wing elements comparable to the policies that have been pursued since 2013. For instance, the Social Democrats pushed for a reregulation of temporary employment. It is unlikely that the goal of a balanced budget endorsed by the CDU/CSU will be given up.

Two additional scenarios

While another grand coalition is the most likely scenario, there are two other conceivable permutations: a so-called red-red-green coalition consisting of the SPD, the Left and the Greens; alternatively, the CDU/CSU and the Greens could join forces. Both permutations have already been tried at a federal state level. A red-red-green coalition was just formed in the city of Berlin, while CDU-Greens governments are in office in Hessen and Baden-Württemberg (with the CDU as a junior partner in the latter federal state). A government consisting of SPD-Left-Greens could entail a shift to the left in economic policy and include more stringent regulation of the labor market, a reduction in the retirement age, tax hikes, etc. A CDU-Greens government would probably be more business-friendly.

Uncertainty about the AfD’s share of the vote

The AfD’s share of the vote in opinion polls rose strongly after the start of the refugee crisis in the summer of 2015 (see right chart). In the last twelve months, the AfD has remained steadily above the 10% mark and temporarily even close to 15%. Uncertainties are comparatively high, since it is a new party and the issue of “hidden voters” in opinion polls could play an important role.

OPINION POLLS (%) OPINION POLL FOR AFD (%)

Source: Emnid, UniCredit Research

0%

5%

10%

15%

20%

25%

30%

35%

40%

CDU/CSU SPD AfD Greens Left FDP

0

2

4

6

8

10

12

14

16

Jan-

14Fe

b-14

Mar

-14

Apr

-14

May

-14

Jun-

14Ju

l-14

Aug

-14

Sep

-14

Oct

-14

Nov

-14

Dec

-14

Jan-

15Fe

b-15

Mar

-15

Apr

-15

May

-15

Jun-

15Ju

l-15

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16Fe

b-16

Mar

-16

Apr

-16

May

-16

Jun-

16Ju

l-16

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Dec

-16


2017 Outlook


France

Tullia Bucco, Economist (UniCredit Bank Milan) +39 02 8862-0532 [email protected]

■ We expect GDP growth to stabilize at 1.2% in 2017. A mildly expansionary fiscal stance will partially compensate for the fading of the stimulus from currency depreciation and the decline in oil prices. In 2018, the pace of quarterly expansion is likely to ease marginally, bringing average GDP growth down to 1.1%.

■ Household consumption is likely to remain the main growth engine, although we expect it to expand at a slower pace in 2017 compared to 2016, due to a moderation in household purchasing power as a result of faster inflation more than offsetting a moderate acceleration in labor income growth.

■ Capex growth is likely to subside in 2017, after the strong (government-supported) performance recorded in 2016 (of nearly 6.0%). The uncertainty surrounding the outcome of the presidential election may induce firms to postpone investment plans, at least in the first part of the year, while the positive stimulus of the increase in the CICE tax credit (“Tax credit for competitiveness and employment”) from 6% to 7% on wages paid in 2017 will not materialize until 2018. On the positive side, the latest data on housing starts and permits indicate that the recovery in residential investment will likely gain momentum.

■ Net exports will probably continue to subtract from GDP as import growth outpaces that of export. Export growth is likely to moderately accelerate as a pick-up in demand from major trading partners will offset the fading stimulus of the euro’s past depreciation.

■ France remains committed to reducing the general government deficit-to-GDP to below 3.0% in 2017. The 2017 budget bill envisages a decline in the deficit from 3.3% in 2016 to 2.7% in 2017, in line with the numbers included in the multi-annual stability program presented last April. However, the commitment to deficit reduction appears ambitious given that 1. a 1.5% forecast for 2017 GDP growth looks optimistic; 2. the expected reduction in social security spending hinges on a successful renegotiation of the unemployment insurance agreement between the social partners, and talks are currently stalling. Overall, we stick to our 3.1% deficit-to-GDP forecast for 2017, after 3.3% in 2016.

PRIVATE CONSUMPTION TO REMAIN MAIN GROWTH ENGINE RESIDENTIAL INVESTMENT ON THE MEND

Source: Eurostat, INSEE, UniCredit Research

80

85

90

95

100

105

110

1Q08 4Q08 3Q09 2Q10 1Q11 4Q11 3Q12 2Q13 1Q14 4Q14 3Q15 2Q16

Italy France

Germany Spain

Eurozone

Household & NPISH consumption expenditure (1Q08=100)

-12

-10

-8

-6

-4

-2

0

2

4

6

8

-30

-20

-10

0

10

20

30

4Q01 2Q05 4Q08 2Q12 4Q15

housing permits (%yoy, smooth.)

housing starts (%yoy, smooth.)

residential investment (%yoy, LS)


2017 Outlook


Presidential election: cards stacked against Marine Le Pen Mainstream parties suffer deep internal divisions

The presidential campaign has been lengthened as a result of the decision by the two mainstream political parties – the Socialist Party (PS) and Les Républicains (LR) – to hold primary elections to choose their candidate. This is a first in the country’s political history, where candidates have been traditionally nominated via obscure internal procedures. Primaries offered to parties the least controversial instrument to overcome deep internal ideological fragmentation, and fend off Marine Le Pen’s appropriation of their voters. According to opinion polls, the leader of the far-right National Front (FN) is scoring nearly 25% in the first round of presidential elections, having very good chances to make it to the run-off. Ms. Le Pen’s efforts to steer the FN party away from its neo-fascist roots while preserving the party’s anti-immigration and anti-globalization stance has been successful in attracting an important share of mainstream voters disappointed with unkept promises by successive governments, and worried about refugees, leaky borders and Islamist radicalism.

The nomination of François Fillon has reshaped the political map

Against this background, the recent nomination of François Fillon – who runs on a platform of social conservatism and family values – as the frontrunner of LR has reshaped the political map. On the one hand, it has accelerated the FN’s transformation into a defender of the poor, low-skilled and unemployed who feel abandoned by the mainstream political class. Mr. Fillon’s rhetoric has so far mainly targeted the bourgeoisie, the high earners and the business community. On the other hand, it has prompted former PM Manuel Valls – who entered the race soon after François Hollande decided not to run for a second term – to tone down the reformist drive that alienated many PS members from the government, and instead to appeal to core PS voters and the center-left in general. Mr. Fillon’s candidacy leaves ample room for maneuver to those placing themselves in the center of the political spectrum, such as the independent Emmanuel Macron who considers himself “neither left nor right”, and François Bayrou, who is still pondering whether to enter the race (it would be the third time running for him).

Opinion polls suggest François Fillon would face Marine Le Pen in the run-off

Opinion polls suggest that: 1. Mr. Fillon would win the first round of presidential elections (scheduled for 23 April) and face Ms. Le Pen in the second round (on 7 May); 2. Mr. Hollande’s decision to refrain from running in the center-left primaries has not increased the Socialists’ chances to make it to the second round, highlighting the deep internal divisions within the PS. The most favorable scenario for the PS is attached to the hypothesis of Mr. Valls being elected as its frontrunner, and centrists not entering the race (which is unlikely); 3. Mr. Macron benefits from the ideological fragmentation of the center-left, and also attracts many votes from the center-right; 4. Mr. Fillon would defeat Ms. Le Pen by a large margin (65% vs. 35%) in the run-off; 5. Despite all the talk, Ms. Le Pen’s chances of winning the run-off are low. She would be defeated by both Mr. Macron and Mr. Valls if they were to make it to the second round.

Ms. Le Pen’s chances of becoming president are severely diminished by the FN’s shortage of potential allies. Ms. Le Pen and the FN remain fiercely anti-system, losing the sympathy of other mainstream parties, which rules out the possibility of an alliance. As regional elections have shown, this is a heavy burden for the FN, given that the mainstream parties, which during an electoral campaign never admit the possibility of supporting each other in the runoff, ultimately decide to join forces and mobilize the electorate to prevent a victory of Le Pen. In the regional elections of December 2015, the FN received the highest share of the vote at the first round but eventually failed to gain control of any region thanks to strategically distributed withdrawals of PS candidates from electoral lists to ensure that center-right and centrist candidates could win against the FN.


2017 Outlook


Italy Dr. Loredana Federico, Lead Italy Economist (UniCredit Bank Milan) +39 02 8862-0534 [email protected]

■ A steady but modest economic recovery is expected to continue, with GDP growth of 0.8% in 2017 and 0.9% in 2018. As seen so far in the recovery phase, Italy is likely to continue to underperform its main eurozone peers. The quick resolution of the government crisis and the installation of a political government is expected to prevent any abrupt deterioration in private-sector confidence. Therefore, economic activity might fully benefit from the two main tailwinds remaining in force, loose financing conditions and a positive fiscal impulse, especially in 2017. The expected acceleration in global trade will be the other key ingredient in the recovery story.

■ There are two key trends we are penciling for 2017. First of all, the export outlook is expected to be more favorable than in 2016, when, due to continued weak world trade, export growth has been on average 1.5% annualized, just half that of 2015. While export growth is likely to be outpaced by an increase in imports, leaving a slightly negative contribution to GDP from net trade, it will be key to supporting the long-awaited recovery in machinery and equipment investment. This has proved to be the main disappointment in 2016 – partly offset by further buoyant expansion in investment in means of transport. Besides higher demand from abroad, firms could also benefit from tax cuts and a strengthening of fiscal incentives, still-easy financing conditions and a starting position of abundant liquidity. This leads us to our second theme, which is a switch from private consumption to fixed investment supporting the recovery in domestic demand. Indeed, after expanding at about 2.0% annualized from 1Q15 to 1Q16, private consumption growth softened, in line with a worsening of households’ confidence, and to the benefit of an increase in households’ savings. Consumer confidence is unlikely to recover significantly from here, given the uncertain political situation. This, together with higher inflation and slower job growth (due to the fading out of fiscal incentives), is expected to lead to a moderation in consumer spending growth over the coming quarters.

■ On the fiscal front, the government strategy will continue to focus on supporting growth while trying to keep public finance under control. The final outcome will be a very gradual reduction in fiscal deficit/GDP and broad stabilization of public debt/GDP, which at the end of 2018 will still be around 133% – if public money is used to fix the most problematic banks, the debt/GDP might increase by 1pp. There remain many challenges ahead for the government, including uncertain revenues, ambitious privatization targets to be achieved in a market environment that needs to prove better than in the past year (when privatization revenues were just 0.1% of GDP vs. +0.5% to be achieved both in 2017 and 2018) and the debate with the EU on avoiding the opening of an excessive deficit procedure. The situation will inevitably be complicated by 2017 most probably being an election year.

ITALY UNDERPERFORMING ITS MAIN PEERS LABOR MARKET TO REMAIN IN GOOD SHAPE

Source: Eurostat, ISTAT, UniCredit Research

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Germany France Italy

Recovery phase (1Q15-3Q16): a comparison with main peers

Average growth rate (annualized, %)

Average quarterly growth (%)

0

2

4

6

8

10

12

14

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Labor Force Survey

Employment (yoy %)

Unemployment rate (in %)


2017 Outlook


2017 to be an election year, the outcome is highly uncertain PM Gentiloni’s government… …and the reform of the electoral law

After the rejection of the proposed constitutional referendum on 4 December, Mr. Paolo Gentiloni has taken Mr. Matteo Renzi’s place as prime minister. Mr. Gentiloni’s government is expected to be a transitional government, aiming to promote a reform of the electoral system, while continuing to address Mr. Renzi’s commitment to key economic issues, as confirmed by the decision to maintain almost all of Mr. Renzi’s ministers in their posts. While the formal end of the parliamentary term is scheduled for early 2018, Mr. Gentiloni might not last so long in his new position, with Italy most likely to go to the polls again in 2017.

The only concrete obstacle ahead of the next election is the need to reform the electoral system and, in particular, to harmonize the way in which the two chambers of parliament are elected – now that the No vote in the referendum has confirmed Italy’s perfect bicameralism. While proposing changes to the electoral law will probably be a task for parliament, Mr. Gentiloni’s government will be called upon to exercise its influence to accelerate the process and to encourage convergence among the different political parties in parliament. In addition, the Constitutional Court will rule on the current electoral law for the lower house (the Italicum) on 24 January. On the one hand, this postpones any final approval of the new electoral law to after this date. On the other hand, this ruling will be important to understand whether the majoritarian features of the Italicum (which aims to guarantee governability) can be preserved, potentially opening up the possibility to extend them to the Senate, where the election is currently based on a pure proportional system. Otherwise, if the Constitutional Court deems the majoritarian features of the Italicum unconstitutional, the adoption of a more proportional electoral system will become easier, also considering that a broad consensus is emerging for increasing representativeness (at the expense of governability).

1H17 to be politically busy Italy’s tri-polar system increases uncertainty on the election outcome

Still, while two of the main opposition parties – Five Star Movement (M5S) and Northern League (NL) – will continue to demand a new election as soon as possible, other factors may reduce the likelihood of immediate elections: 1. The center-left Democratic Party (PD) and the center-right have to convene party congress and conduct primaries for choosing their respective leaders (and potential next PM). If nothing else, this will gain time for them; 2. Italy will chair and host several international and European summits in the first months of 2017; 3. 1Q17 could be used by PM Gentiloni to fix weak banks and complete some pending reforms, such as the public administration, the justice and, probably, the labor market reform.

Finally, another element that could create further uncertainty is the ruling of the Constitutional Court on the admissibility of a referendum on Mr. Renzi’s labor market reform (the Jobs Act), expected on 11 January. If the Constitutional Court deems that the referendum on the Jobs Act is constitutional, the government could be called to a select a date in 2Q17 to conduct an abrogative referendum2. This may also play a role in determining the timing of the next election.

Regarding the election outcome, Italy has become a tri-polar system, as the latest opinion polls show that the M5S, the PD and a potential center-right coalition (which includes Forza Italia, NL and Brothers of Italy) may each receive about 30% of votes in the next general election. If the reform of the electoral law moves towards a proportional system, achieving a parliamentary majority may require the formation of a broad coalition. We continue to think that mainstream parties might be more inclined to seek an alliance, while this may not be the case for the M5S. In the end, this may imply that obstacles could arise for M5S as it tries to form a government. The negative news here might be that government stability and political visibility regarding the future reform agenda could be somewhat limited.

2 The abrogative referendum, in contrast to the constitutional referendum, requires a quorum of at least 50% of people with the right to vote to be binding.


2017 Outlook


Spain Edoardo Campanella, Economist (UniCredit Bank Milan) +39 02 8862-0522 [email protected]

■ The deceleration of the Spanish economy is set to continue over the next two years at a more sustained pace. After expanding by 3.2% in 2016, we see growth declining to 2.4% in 2017 and 2.0% in 2018. According to the most recent surveys, Spain is expected to end the year posting 0.6% qoq GDP expansion in 4Q16. In our forecast horizon, domestic demand will remain the main growth driver, albeit to a lesser extent due to the reversal of some supporting factors, such as low oil prices. Yet, strong employment growth and still strong purchasing power will support private consumption going forward. At the same time, the significant increase in firms’ profitability in recent years, coupled with capacity utilization approaching its long-term average, is likely to support investment in the short term, while net exports will provide a mildly positive boost on the back of the recovery in global trade. The fiscal stance will be broadly neutral.

■ This growth deceleration also stems from structural factors. Spain’s potential growth has decreased considerably over time, shifting from about 3.0% between 2001 and 2007 to about 0.5% during the crisis years. In the coming years, it is expected to stabilize at around 1%. The immigration reversal due to the bursting of the real-estate bubble, coupled with low fertility rates, is weighing on the working-age population. In addition, skill shortages, the low innovation capacity of Spain’s small firms and low R&D spending as a percentage of GDP, are likely to prevent productivity from picking up, once cyclical tailwinds start fading. On top of this, the fiscal consolidation of the crisis years have likely weighed on Spain’s potential growth by protracting the persistence of the demand shock triggered by the financial meltdown through hysteresis effects. Only the adoption of further structural reforms, ranging from effective activation programs to incentives for the scaling up of Spain’s smallest firms could revive potential GDP. But given the political weakness of the current government, we deem this option unlikely.

■ On the fiscal front, the budget deficit is expected to improve from 4.6% of GDP to 3.8% in 2017 and 3.2% in 2018, mostly as a result of amendments to the corporate income tax and a rather favorable growth outlook, which will support tax revenues and keep social transfers in check. The presence of a proper government in Madrid, even if politically weak, should facilitate the enforcement of spending rules at the local level, the breaching of which has repeatedly caused Spain to miss the budget target agreed with Brussels.

■ The main political risk for Spain in 2017 are Catalonia’s secessionist ambitions. Barcelona plans to hold an independence referendum in September, even if popular support for secessionism has lost ground in the wake of improving economic conditions. While the PP is prone to preserve the status quo, both Ciudadanos and the Socialists are open to a more federalist solution. We think that there will eventually be a convergence towards the latter, which may represent the most pragmatic way to preserve Spain’s territorial integrity.

DECLINING POTENTIAL GDP GROWTH CATALONIA’S INDEPENDENCE: OPINION POLLS

Source: Eurostat, different polling sources, UniCredit Research

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1983-1990 1991-2000 2001-2007 2008-2015 2016-2019

Spain's potential growth (%)

0

10

20

30

40

50

60

2011 2012 2013 2015 2016

Catalonia's independence

In favor Against


2017 Outlook


Austria Stefan Bruckbauer, Chief Economist Austria (Bank Austria) +43 50505 41951 [email protected] Walter Pudschedl, Economist (Bank Austria) +43 50505 41957 [email protected]

■ The Austrian economy gained momentum in 2016. With sound growth towards the end of the year, GDP growth reached 1.5% for 2016 as a whole, well above the 1% recorded in 2015. The momentum of the current year will be carried over into 2017, and the domestic economy will remain buoyant. We have raised our growth forecast for 2017 to 1.6%. However, global risks may prevent the full extent of such growth. We expect moderate growth of 1.4% for 2018.

■ While the economy will be driven by domestic demand in 2017-18, the impetus provided by the latter is likely to be somewhat weaker than in 2016. The stimulus from the 2016 tax reform and the positive effect from low inflation will subside. As the wage agreements will not fully offset the resulting loss in purchasing power, consumption will moderate slightly in 2017. In addition, investment activity, influenced by a global environment characterized by higher risk, will be less dynamic than in 2016. While the investment in plant and equipment will not be able to maintain the growth rate of 2016, the outlook for construction investment remains favorable; the order books of structural engineering companies are well-filled. The stabilization of the growth momentum will largely depend on a revival of global growth in 2017-18. Stronger growth in the US and a more favorable economic development in a number of EM economies suggest that Austrian exporters may benefit from a stronger impetus compared with previous years. Net exports will make a small contribution to GDP growth, following a neutral impact in 2016, since import growth will be curbed by the weaker momentum in domestic demand.

■ Although inflation has accelerated since autumn, Austria’s inflation rate will average 0.9% in 2016 and therefore match the level of 2015. The upward trend will continue in the forthcoming months. In the first half of 2017, Austria’s inflation rate will come close to 2%, driven by the trend in commodity prices and the continued strong price momentum of some services and rents. We expect inflation in Austria to rise to an average of 1.8% in 2017, one of the highest inflation rates in the euro area.

■ Budget performance is largely on track to meet the target for 2016 of a deficit of 1.4% of GDP. The draft budget for 2017 calls for a deficit of 1.2% of GDP. The possibility to deduct expenditure for migration and fighting terrorism means that the structural budget deficit will amount to no more than 0.5% of GDP. Austria therefore complies with the relevant EU requirements and with the requirements of its own stability program. The decline in new debt is expected to lower total government debt from its peak level of 85.5% of GDP in 2015 to 80.2% in 2018, which includes an easing of the debt burden through the resolution of the portfolios of the bad banks Heta, KA-Finanz and Immigon.

ONGOING RECOVERY DESPITE GROWING UNCERTAINTY COMMODITY PRICES TO DRIVE INFLATION IN 2017

Source: Statistik Austria, UniCredit Research


2017 Outlook


United Kingdom

A “slow burn” Daniel Vernazza, Ph.D. Lead UK Economist (UniCredit Bank London) +44 20 7826-7805 [email protected] Economic uncertainty to remain high for the next two years Higher imported inflation will weigh on household consumption BoE likely to remain on hold

UK economic activity has been surprisingly resilient since the Brexit vote, particularly household consumption and housing market activity, but we remain convinced that growth will slow next year. We expect GDP growth of 1.2% in 2017 (consensus 1.3%) and 0.8% in 2018 (consensus 1.4%). There are two main drivers of the expected slowdown:

■ Economic uncertainty will likely remain elevated as the UK negotiates its exit from the EU. We expect the UK government to trigger Article 50 in February/March 2017 with a draft “withdrawal agreement” announced in late 2018. Beyond that, there could be a transitional agreement towards a new trade deal, which is likely to be akin to the EU-Canada arrangement, but huge uncertainty surrounds this. Uncertainty leads businesses to defer investment (business investment intentions have already eased) and consumers to delay consumption. GfK’s index of consumer confidence recently fell back to -8 in November, below its pre-referendum level of -1.

■ The FX market has so far taken a much more pessimistic view of the UK’s future than UK consumers. The effective sterling exchange rate has fallen 16% since November 2015 and 10% since the EU referendum, despite rallying 7% since mid-October. Based on historical relationships, around 60% of this will be passed through to the prices of imported goods, which account for around 30% of the consumption basket. This would mean a cumulative rise in CPI inflation of almost 3pp but, due to lags in production chains and FX hedging, the full impact will be spread over a period of around two years. Much higher inflation (we expect 2.7% yoy by end-2017) will squeeze real household income growth next year and this will be a significant drag on household consumption growth.

In November, following stronger-than-expected economic activity and a further fall in the value of sterling, the Bank of England’s MPC shifted from an easing bias to a “neutral bias” for the direction of monetary policy going forward. While the MPC has said there are “limits” to its willingness to look through above-target inflation, to the extent that medium-term inflation expectations remain well-anchored, we think the MPC’s tolerance for a temporary, if persistent, period of FX-induced higher inflation is high. In other words, the MPC will likely choose to support employment and output over the next couple of years. As such, we expect the MPC to leave its monetary policy stance unchanged throughout next year and 2018.

GDP FORECASTS BUSINESS INVESTMENT INTENTIONS

Source: BCC; BoE; CBI; ONS; UniCredit Research

-0.8

0.0

0.8

1.6

2.4

3.2

4.0

4.8

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18

Real GDP (% qoq)Real GDP (% yoy) - RS

Forecast

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16

Business investment

BCC - RS

CBI - RS

BoE Agents - RS

Differences from averages since 2000 (number of standard deviations)% yoy

Economics & FI/FX Research December 2016

2017 Outlook


Switzerland

Steady growth and steady SNB Dr. Tobias Rühl, Economist (UniCredit Bank) +49 89 378-12560 [email protected]

We expect the Swiss economy to stay on a moderate but steady growth path. For 2016 overall, we assume GDP growth of 1.4%. In 2017, growth will probably increase slightly to 1.5% and for 2018 we forecast a moderate acceleration to 1.7%. Major supportive factors will be that Swiss companies seem to have adjusted to the current FX level and the projected slow depreciation of the Swiss franc will help to support export activity going forward. The most important limiting factor will be the moderate growth outlook for Europe since the EU is the most important single trading partner for Switzerland.

Exports and consumption to pick up

Economic growth is likely to be mainly driven by a recovery in export activity and further increases in domestic consumption. Swiss export-oriented companies will continue to benefit from a slow but steady depreciation of the Swiss franc against the euro during 2017 and 2018, supported by a continuation of expansionary monetary policy by the SNB. About 54% of Switzerland’s exports are shipped to EU countries (21% to Germany alone), and the euro/franc exchange rate is therefore crucial for Switzerland’s export activities.

CPI to rise to 1% by end-2018 Concerning inflation, we assume that CPI growth rates will increase further over the next few quarters to around 0.8% yoy by the end of 2017. By the end of 2018, we see Swiss headline CPI numbers close to 1.0%. Major drivers are again the strongly expansive monetary policy and the assumed franc depreciation, which will increase prices for imported goods.

Further FX intervention Currently, both the SNB and us regard the Swiss franc as overvalued. SNB officials have repeatedly announced that they are willing to (continue to) intervene in the FX market and would push the interest rate even further into negative territory if necessary. While FX market interventions have been used in the past and will remain the SNB’s preferred tool to counteract any significant appreciation pressures, we do not see the case for additional rate cuts anytime soon. In fact, we think the risk is that the SNB might even tighten its super-expansive monetary policy by increasing rates to a less negative level by the end of 2018. The increased inflation rate will reduce the need for expansive monetary policy by then and ECB QE tapering, which is assumed to remain in place until 2018, will also take some weight off the SNB’s shoulders.

REBOUND IN LEADING INDICATORS SWISS FRANC LIBOR

Source: Bloomberg, Thomson DataStream, UniCredit Research

60

70

80

90

100

110

120

130

140

30

35

40

45

50

55

60

65

70

Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10 Oct-12 Oct-14 Oct-16

Manufacturing PMI KOF Barometer - rs

-2.00-1.50-1.00-0.500.000.501.001.502.002.503.003.504.004.50

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16

SNB Libor Target Range SNB Libor Target


2017 Outlook


CEE region Ups and downs among deepening divergence

Lubomir Mitov, Chief CEE Economist (UniCredit Bank London) +44 207 826-1772 [email protected] CEE-EU again outperformed the rest of CEE and most other EM… …even though a slowdown in EU funds absorption weakened growth temporarily Croatia and Serbia did well, too Russia and Ukraine continue to struggle Turkey: 2016 was the worst year since the global financial crisis

2016 has been a year of political shocks, financial markets volatility and (largely unwarranted) concerns about CEE. As the year draws to an end, the divergence within the region has widened, with the core, comprising the new central European EU (CEE-EU3), clearly outperforming the rest of CEE and EM as a whole. Solid fundamentals have helped the countries weather the market storm that followed Mr. Trump’s victory in the US presidential election in November relatively unscathed.

This said, growth in CEE-EU in 2016 is likely to have slowed to just below 3% from 3.9% in 2015. The main culprit for this is the drop in EU funds absorption, due to the shift to a new programming period, which shaved 1.5pp off growth in 2016. Not surprisingly, the countries with the best EU funds absorption, such as Hungary and Poland, have seen the sharpest slowdowns. Apart from EU-funded investment, performance has remained strong, with all other expenditure components posting solid growth. EU funds absorption will pick-up in 2017, adding back 1pp to growth, but the sharp slowdown in 2016 underscores the high dependence of CEE-EU on EU transfers for growth and investment.

Outside CEE-EU, both Croatia and Serbia did quite well in 2016, with growth picking-up nicely. Solid demand in the eurozone has played a role, but perhaps more important was the rebound in private consumption and investment on the back of firming confidence. An improved perception among foreign investors has helped, too, with both countries having made significant progress in fiscal adjustment and emerging from parliamentary elections with stronger pro-reform majorities.

Further east, the region’s three most populous economies continued to struggle. Russia will record another year of output contraction – albeit much shallower than in 2015 -- with the long-awaited recovery still not in sight despite sound policies and the partial return of foreign capital that has helped cushion the adverse impact of the post-Trump sell-off. In Ukraine, growth has returned but remains feeble and uneven, and is subject to numerous risks with reforms lagging.

For Turkey, 2016 will be a year to forget. Hit by political shocks, such as the failed coup in July, the Russian travel and export bans (partially lifted only in September) and growing security concerns, the economy has slipped into recession in 2H16. For FY16, growth is likely to come in at just 1.5%, the worst outcome since the global financial crisis.

THE CORE OF CEE DECOUPLED FROM THE REST OF THE EM DIVERGING GROWTH PERFORMANCE IN CEE

Emerging markets sovereign bonds spreads (bps, EMBIG spreads) Real GDP (%)

Source: Bloomberg, UniCredit Research 3 CEE-EU include the EU members that joined in 2004-07 and have not adopted the euro (Bulgaria, Czech Republic, Hungary, Poland and Romania)

0

500

1000

1500

2000

2500

3000

12/27/1996 12/21/2001 12/15/2006 9/12/2011 2/12/2016

AfricaAsiaEuropeLatamMiddle East

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

2012 2013 2014 2015 2016F 2017F 2018F

EA TR RU CEE5 HR UA SRB


2017 Outlook


The slowdown in Turkey has been accompanied by rising macroeconomic imbalances 2017 and 2018 ought to be good years for CEE Stronger growth in most of CEE at slightly above 3%... …with Croatia and Serbia slightly behind Monetary policy on hold amid gradual reflation… ..and fiscal headroom available only in a handful of countries Russia back to (slow) growth

Moreover, the economic slowdown has been accompanied by a widening in the C/A deficit and renewed price pressures with the TRY weakening sharply. These developments reflected in part misguided policies, which focused on boosting growth via major fiscal and monetary easing, but ignored the underlying structural deficiencies. This policy stance has done little for growth, but has boosted the already sizable imbalances, leaving Turkish markets among the worst performers among the major EM in the wake of the Trump sell-off.

Looking forward, 2017-2018 ought to be good years for CEE. The outlook for both the euro area and the UK has been upgraded with the fallout from Brexit likely to take longer and be back-loaded. EM growth looks set to firm as well amid recovering commodity prices and a gradual pick-up in global trade. Finally, the fiscal stimulus promised by the incoming US administration is expected to boost global demand, especially in 2018. On the other hand, rising oil prices and gradual reflation are likely to constrain private consumption.

Against this background, we expect growth to be stronger in CEE both in 2017 and 2018. The only exception will be Romania, where growth is likely to slow from an especially brisk pace in 2016 as the pre-election fiscal stimulus is withdrawn by the new government. In CEE-EU, a pick-up in EU transfers will support growth in both years as well. All in all, we expect growth in CEE-EU to top 3% in both years and to be slightly stronger in 2017 (adjusted for leap-year effects). Growth in Croatia and Serbia will remain solid as well, close to its 2016 levels but still somewhat slower than in CEE-EU, partly due to the need for further fiscal adjustment.

Scope for policy accommodation will be more limited also in CEE-EU. With policy rates at record lows and the trough in inflation behind us, scope for further monetary easing is all but non-existent. We do not expect tightening within the next twelve months with inflation unlikely to hit central bank targets until late 2017. Even so, with real interest rates easing as inflation rises, monetary conditions could still ease somewhat. Prospects beyond that will depend on the course of ECB policy. Scope for fiscal accommodation is larger, especially in Bulgaria, Hungary and the Czech Republic, but is absent in Poland and Romania.

In Russia, we expect the economy to grow by around 1% in both 2017 and 2018, supported by the expected recovery in oil prices to USD 60/bbl by the end of 2017 and USD 65/bbl a year later. Growth will also be supported by the return of capital inflows to non-sanctioned entities. In the short term, growth will be constrained also by continued tight fiscal and monetary stances. We do not expect the CBT to cut rates before March 2017 at the earliest and then only cautiously, keeping the real policy rate at 3% or more, by far the highest in CEE. However, the confidence this policy stance has instilled and the remarkable decline in inflation achieved are likely to pay off over the longer term by facilitating investment.

INFLATION TO PICK UP GRADUALLY IN 2017 EXTERNAL POSITIONS STRONG IN CEE-EU, WEAK IN TURKEY

Inflation (%, yoy) Basic balance (% of GDP)

Source: Haver, UniCredit Research

-2.0

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18.0

2009 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F

CEE5 TR RU HR SRB

-6.0

-4.0

-2.0

0.0

2.0

4.0

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TK UA RU SRB RO PL CZ HR BG HU

2015 2016f 2017f 2018F


2017 Outlook


Debt sustainability concerns in Ukraine

In Ukraine, by contrast, where policies remain largely in limbo, growth will remain sluggish at just under 2% in both years – a pace that appears insufficient to dispel growing debt sustainability concerns once IMF disbursements cease and debt repayments rise from 2018.

Growth will rebound in Turkey in 2017… …but macro-economic imbalances will keep financial markets on edge Downside risks for CEE have subsided The rise in core yields will have a limited impact on CEE-EU Turkey will remain among the most vulnerable EMs Domestic political risks have risen, particularly in Turkey

After a dismal 2016, we expect growth in Turkey to rebound to 3.4% in 2017, buoyed by the expected partial recovery in tourism, the lifting of the Russian ban on Turkish agricultural exports and competitiveness gains, with the TRY now at its lowest level in real effective terms since the 2001 crisis. Continued aggressive policy accommodation would also be a supportive factor, but will also contribute to the further increase in macroeconomic imbalances. Rising oil prices are likely to push the C/A deficit back above 5% of GDP, and currency weakness given the CBRT’s reluctance to tighten as much as needed to stabilize the TRY and lure back investors are likely to leave inflation in the double-digits for most of 2017. These developments will leave Turkish financial markets highly susceptible to even modest shifts in market sentiment.

With the immediate concerns about Brexit subsiding, downside risks for the region as a whole have abated. The expected changes in economic policy by the new US administration look unlikely to affect the region directly, but the indirect impact (via a slowdown in global growth and trade) could still be significant. While the rise in core yields will lead to a re-pricing of CEE bonds, for most of CEE the risks seem well contained, with the exception of Turkey.

In CEE-EU, financing needs are low thanks to large extended basic surpluses and modest fiscal deficits, leaving the region resilient to the pressures that have plagued other EMs. The same factors, along with an attractive carry are likely to support Russian assets, too, as will a growing perception about a possible thaw in Russia-US relations under president Trump.

Turkey, on the other hand, remains among the most vulnerable EMs to the rise in core yields. Given current policies, Turkish markets will remain volatile and continue underperforming their peers and limiting foreign interest despite attractive nominal returns. A change in attitude can be expected only once the political situation stabilizes – which we do not expect until April or May – and if the CBRT shows more determination to tackle the rise in inflation.

Conversely, domestic political risks have been on the rise. These risks are most pronounced in Turkey, where the intensification of the conflict in the southeast, the purge of vast swaths of the civil service and the upcoming referendum on granting the president executive powers will weigh on confidence well into 2017. In Bulgaria and Romania, protest votes underscore the disillusionment with the elite and, while unlikely to have an immediate economic impact, may affect future reform prospects. Finally, in Serbia, the recently elected government has decided to call early elections in April, which could slow reforms and delay IMF lending.

BUDGET DEFICITS LARGELY UNDER CONTROL LIMITED EXPOSURE TO THE US

Budget balance (% of GDP) Exports and imports to the US

Source: IMF, WEO, UniCredit Research

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CEE5 TR RU HR SRB

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US exports US imports

1980 1990 2000 2010 2015% of US GDP


2017 Outlook


China Edoardo Campanella, Economist (UniCredit Bank Milan) +39 02 8862-0522 [email protected] Kiran Kowshik, EM FX Strategist (UniCredit Bank London) +44 207 826-6080 [email protected] Risks stemming from the high corporate debt Accommodative monetary policy USD-CNY on the rise

China’s soft landing is set to continue throughout our forecast horizon. We expect GDP growth to drop to 6.3% in 2017 and to 6.2% in 2018, from 6.7% in 2016. The growth deceleration is mostly due to the structural rebalancing towards a more sustainable growth model. Rising wages will boost private consumption, while the removal of entry restrictions in some services industries will support investment at a time when companies in traditional sectors are cutting back their production capacity. Fiscal policy remains highly supportive, especially infrastructure projects that could have the unintended effect of further misallocating capital within the economy and fuelling the credit bubble. Finally, net exports are expected to provide a slightly negative contribution to growth due to weak, if strengthening, global trade.

The cleanup of Chinese banks continues through debt-to-equity swaps, if on a bumpy road. According to September’s guidelines, banks are not allowed to hold the equity stake in the company directly, but have to sell the distressed debt to another entity, whose ownership usually belongs to insurance companies, the national social security fund and wealth funds. So, the burden sharing is shifting from banks to the rest of the financial sector and, potentially, to households. With non-performing loans on the rise, at about 6% if one takes into account the so-called special-mention loans, corporate debt remains the number one risk.

Monetary policy will likely remain accommodative over the next two years. Absent any major shock, the PBoC will be more focused on safeguarding financial stability than on adding further monetary stimulus. In 2017, we expect a cumulative 25bp lending rate cut to 4.1%, while the RRR should remain stable at 17%.

We forecast USD-CNY rising to 7.25 for the end of 2017 (7.00 prior) and to 7.55 for 2018. First, China is likely to face persistent depreciation pressures as capital outflows (of a structural nature) overwhelm a declining current account surplus. Second, authorities would prefer allowing gradual CNY depreciation rather than drawing down heavily on FX reserves. In 2016, policymakers have accommodated the outflows via a combination of currency depreciation and declining reserves. Chinese reserves are sizeable, but using reserves to accommodate outflows (which could run as high as USD 600bn per year) would not be a sustainable strategy. Third, we assume that the US will not put in place damaging trade policies. Should the US label China a currency manipulator, we would expect verbal rhetoric but would not expect a response on the FX front. Across-the-board tariffs remain a risk and would result in China’s trade surplus weakening, leading to a more bearish path for CNY than we forecast.

CAPITAL OUTFLOWS OVERWHELMING THE C/A SURPLUS C/A SURPLUS WILL SHRINK IN YEARS AHEAD

Source: PBoC, National Bureau of Statistics of China, UniCredit Research

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8.5-10

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-98

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C/A IMF forecast% GDP


2017 Outlook


Other Emerging Markets A gradual and uneven recovery marred by plentiful risks

Lubomir Mitov, Chief CEE Economist (UniCredit Bank London) +44 207 826-1772 [email protected] EM aggregate GDP picked up marginally in 2016 Towards the end of the year, positive signs have emerged We expect global EM growth (ex-China) to pick up to 3.6%

2016 was another challenging year for emerging markets. A further decline in commodity prices to a ten-year low, sluggish global trade and repeated bouts of financial-market volatility continued to weigh on growth. On the positive side, the ongoing extraordinary monetary accommodation by the major central banks kept risk appetite strong through most of the year, resulting in record-high portfolio inflows. However, these have reversed since November’s US presidential election, resulting in intense exchange-rate and bond-price pressure.

All in all, real GDP growth among the major EM is likely to have picked up marginally in 2016 to 4.2% from about 4% in 2015. Ex-China, EM are likely to have grown by 2.5% in 2016. This would be a slight acceleration from 2.2% in 2015, but still one of the lowest growth rates for 15 years. Moreover, virtually all the improvement reflects smaller contractions in Russia and Brazil, with growth in the majority of the rest of the EM languishing near last year’s record lows.

While the factors constraining activity remained largely in place in 2016, there have been shifts that should favor stronger growth going forward. Activity in China has held up well and is likely to remain robust in the near term thanks to continued stimulus, which should support commodity exporters and the rest of Asia. Oil prices seem to have turned the corner, following OPEC’s agreement to cut production and they look set to remain on a gradual upward trajectory. Finally, the UK’s vote to leave the EU has had little impact on the rest of the EU so far. While we still think that Brexit will ultimately have a significant adverse impact on the UK and, to a lesser extent, the EU, this impact is likely to come later and will not affect the near-term outlook. This, along with the fiscal stimulus promised by the incoming US Administration should lift growth in the advanced economies and support EM exports.

Under these considerations, and with several major EMs such as Argentina, Brazil and Russia exiting recessions, we expect global EM growth (ex-China) to accelerate to 3.6% in 2017 and to close to 4% in 2018. This, however, will still be below the 15-year average of 4.7%. Moreover, excluding the contribution of the aforementioned three major EMs, the pick-up in growth would be much smaller, on the order of just 0.4pp from 2016. Even with this pick-up, global EM output, according to the IMF, will remain below potential through 2018.

EM HAVE LAGGED GLOBAL GROWTH SINCE 2014 USUAL DRIVERS OF EM GROWTH TO UNDERPERFORM

Real GDP (% change yoy) EM GDP, exports, commodity prices and capital flows

Source: IMF WEO, IMF commodity price statistics, IIF, UniCredit Research

-8

-6

-4

-2

0

2

4

6

8

10

12

2000 2002 2004 2006 2008 2010 2012 2014 2016e 2018f

EM ex-China LatAm MENAAsia ex China Emerging Europe CIS

-20

-15

-10

-5

0

5

10

15

20

25

2000 2002 2004 2006 2008 2010 2012 2014 2016e 2018f

Advanced LatAMm MENAAsia Emerging Europe CIS


2017 Outlook


Potential growth has slowed significantly as of late

While the cyclical upturn in global trade and commodity prices should support some pick-up in growth, none of the habitual drivers of EM growth from the past are likely to approach their pre-crisis levels anytime soon. EM are therefore facing a relatively weak growth patch, with potential growth down to 3.6-3.8% in 2016-2017 from more than 6% on average in 2005-2013.

This drop reflects in part the significant structural rigidities in many EMs that remained unnoticed during the boom years. These vary by country, but typically include excessive regulation and red tape, bloated governments, poor governance and corruption and, for many, excessive reliance on foreign savings. Since the 2008 crisis, progress in catching up with advanced economies on matters such as business environment, quality of human capital, economic freedom and equality has stalled or even reversed for some, with the new EU members in Central Europe (CEE-EU) a notable exception.

Economic policies have deteriorated in a number of countries Countries that followed prudent policies have performed better

While economic policies have diverged across countries, in many EMs they have recently taken a turn for the worse. Fiscal and current-account deficits in many countries have widened, facilitated in part by the availability of ample and cheap funding. The reversal of capital inflows that followed the US elections has hit these countries hard, especially Argentina, Brazil, Turkey, South Africa, Venezuela, and some Gulf oil producers. The combination of poor governance, political tensions and misguided policies has led to recessions or sharply slower growth as macro imbalances have built up. This has reinforced financial-market pressure, leaving these countries among the most vulnerable to shifts in market sentiment.

On the other hand, countries that have followed prudent macroeconomic policies, moved quickly to adjust to the new environment and have already begun to address their structural dislocations, have performed much better. Among the former, the CEE-EU countries stand out, as well as Mexico, Chile and, to some extent, Russia and India. This has opened the door to growth-supporting policies without jeopardizing macroeconomic stability. Not surprisingly, these countries have proven more resilient to the recent financial-market turmoil.

FISCAL STANCES HAVE WEAKENED AS OF LATE GROWTH TO BE DRIVEN BY ASIA, CEE-EU

Fiscal deficit, % GDP Real GDP growth by regions, %

Source: IMF WEO, IMF commodity price statistics, IIF, UniCredit Research

The outlook for commodity exporters has improved…

The outlook for the global commodity exporters has improved as well, given the expected gradual recovery in commodity prices. In Latin America, Brazil and Argentina will exit recessions, while the lack of reforms and the political stalemate in Venezuela will leave the country in turmoil. The outlook for Mexico, meanwhile, will depend to a large extent on the stance on free trade of the incoming US Administration. While the projected higher oil prices will provide some relief for oil-producing countries in the Middle East and North Africa, many

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2000 2002 2004 2006 2008 2010 2012 2014 2016e 2018f

GDP growth ex China Capital inflows (% GDP)

Global trade volumes (%) Commodity prices (2005=100) - rs

-10

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15

2002 2004 2006 2008 2010 2012 2014 2016 2018

EM Advanced LatAmMENA Emerging Europe CISAsia% GDP


2017 Outlook


…but vulnerabilities remain The main risks for EM in 2017

will remain vulnerable given insufficient progress in lowering the breakeven price of oil. Growth will also pick up somewhat in the CIS as well as Russia exits recession, but will remain low due to both the lack of reforms and the generally poor, medium-term outlook for Russia.

The main risks facing EM in 2107 will be the pace of the rise in US interest rates and the potential impact of the policies of the new US Administration. US government bond yields have surged since Mr. Trump’s victory, by much more than the anticipated Fed hikes, which has triggered major outflows from EM – more severe even than during the taper tantrum. This has resulted in sharp exchange-rate weakening and a surge in EM borrowing costs. While we think that most of the adjustment in US yields has already taken place, further increases appear likely. This would reinforce the current portfolio shift away from EM. While all EM will be hurt, countries with the largest macroeconomic imbalances and large borrowing needs such as Turkey, Brazil, South Africa will be most at risk.

Another potential risk is associated with the incoming US Administration’s stance on free trade and the outsourcing by US companies abroad. Despite the pre-election rhetoric, we still think that the US Administration will refrain from major protectionist actions. In case of widespread protectionist measures, Mexico is perhaps the country most at risk, along with Asia and, of course, China. (For more details, please see our Economics Thinking “CEE-EU: not quite EM anymore” published on 2 December 2016).

https://www.research.unicredit.eu/DocsKey/economics_docs_2016_157570.ashx?EXT=pdf&KEY=C814QI31EjqIm_1zIJDBJIkSk9J4aEFlw1wqoerr47Q=&T=1

https://www.research.unicredit.eu/DocsKey/economics_docs_2016_157570.ashx?EXT=pdf&KEY=C814QI31EjqIm_1zIJDBJIkSk9J4aEFlw1wqoerr47Q=&T=1


2017 Outlook


FI Strategy

US Rates: Targeting 3% in 10Y UST Michael Rottmann, Head of FI Strategy (UniCredit Bank) +49 89 378-15121 [email protected] Dr. Luca Cazzulani, Deputy Head of FI Strategy (UniCredit Bank Milan) +39 02 8862-0640 [email protected] Chiara Cremonesi, Fixed Income Strategist (UniCredit Bank London) +44 207 826-1771 [email protected] Alessandro Giongo, Fixed Income Strategist (UniCredit Bank Milan) +39 02 8862-0538 [email protected] Elia Lattuga, Fixed Income Strategist (UniCredit Bank London) +44 207 826-1642 [email protected]

10Y UST target at 3% by YE 2017 …

… with BEI inflation in the 2-2.5% range … … and real rates between 0.5% and 1%

■ We expect 10Y USTs to end 2017 at around 3%, driven by a further increase of the 10Y BEI towards the midpoint of the 2-2.5% range and the 10Y real yield moving towards the midpoint of the 0.5-1% range as the short-term natural rate is likely to increase slowly.

■ Curve-wise, we expect peak-steepness early in 2017. This should give way to a flatter curve starting in late 2017 and well into 2018.

■ In 2017 we expect 10Y US swap spreads to richen moderately from the current historically cheap levels as foreign outflows from UST should slow down. We expect 2Y swap spreads to remain around the current level, roughly in line with the last seven year average.

We expect 10Y USTs to end 2017 at levels around 3%, which is roughly 10bp above the forward rate, based on real GDP accelerating close to 3% in 2H17 and inflation remaining largely in line or slightly above the Fed's 2% PCE inflation mandate.

First, with headline inflation averaging 2.5% in 2017, it appears reasonable to expect the 10Y UST BEI rate rising to a range between 2% and 2.5%. As the left chart below highlights, with the output gap closing and both core and headline expected to return to the 2% to 2.5% area, according to our forecast, 10Y inflation compensation is likely to accelerate further from the current level of 1.97%.

Second, the right chart highlights that the 10Y real yield is fluctuating around the much hyped (unobservable) natural rate, with the Laubach-Williams calculation being the most prominent and cited measure. Assuming that accelerating real GDP will lead to a modest increase in the natural rate over the next four to six quarters, estimating the 10Y real rate in a range between 0.5% and 1% seems reasonable. This range is also underpinned by recent surveys. The average of pre-US-election estimates according to the NY Fed’s Survey of Market Participants (SMP) as well as the Survey of Primary Dealers (SPD) sees the neutral rate increasing to 0.5-0.88% by YE17 and improving further towards 0.5-1.0% by the end of 2018.

Using the mid-point of the 10Y BEI and real rate range, we expect nominal 10Y USTs to reach 3% by the end of 2017.

WITH 10Y BEI RATES LIKELY TO REACH THE MID-POINT OF THE 2-2.5% RANGE …

… AND REAL RATES BETWEEN 0.5% AND 1%, 10Y USTS ARE LIKELY TO HIT 3%

Source: Federal Reserve Bank of San Francisco, Bloomberg, UniCredit Research

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10Y BEI rate (yearly average)US output gap as a % of potential GDP (IMF forecast)core CPI yoy (yearly average)CPI yoy (yearly average)

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10Y UST real rateNatural rate according to Laubach-WilliamsNatural rate (average of median estimate according to SMP and SPD)25th and 75th percentile


2017 Outlook


An alternative approach…

… and the increase of the term premium towards 50bp …

… also adds up to around 3%.

Under a pure expectations hypothesis, our 10-year average Fed funds forecast points to a “fair value” of the 10Y UST currently at 2.35%, which implies a positive term premium of around 20bp. Going forward, we see the expectations component for the 10Y UST rising to 2.55% by the end of 2017, and expect the term premium to increase further towards 50bp for several reasons.

1. Expected fiscal stimulus under Trump via tax cuts and infrastructure overcompensates long-term growth fears to some extent. 2. While not in the limelight these days, we may very well see intensifying discussions about the US central bank’s reinvestment strategy. Again citing the SPD and SMP, first changes of the Fed’s re-investment strategy are expected once the key rate hits a level between 1.38% and 1.19% (although the symmetry is clearly towards higher rates). When asked for the time frame, the medium-term expectation was between April and June 2018. This does not point to upcoming tensions anytime soon. Nevertheless, the discussion may gain traction later in 2017. 3. Under almost any Taylor rule variation, the US central bank is in an accommodative mode. For example, using the LW natural rate at 0.21% as r* with the current core PCE and unemployment rate reading according to the Atlanta Fed’s Taylor Rule Utility, the Fed funds target rate should be closer to 1.75%. By the Fed’s own forecasts for next year taken from actual Survey of Economic Projections (SEP) and the estimate of a real natural rate at 0.5%, this would point to 2.5% by the end of 2017 (left chart). As we do not see the Fed becoming that aggressive, the consequence would be a steady increase in the term premium. 4. Additional nervousness might be fueled by the nomination of vacant seats at the Federal Reserve; later in 2017, this may intensify further with the term of Janet Yellen ending in February 2018.

Curve-wise, we expect peak-steepness reached in 1H17

For the curve momentum, this translates into a continuation of the reflation trade with peak-steepness reached in 1H17.

We expect the 2-10s as well as 10-30s to peak in the course of 1H17 at levels around 140 and 70bp, which, in a historic context, is still a modest level. The ultra-long end of the curve may stay under pressure conditional upon ongoing discussions about the issuance of much longer maturities. If it becomes more concrete, in the latter part of 2017, that the Fed will start to catch up, we expect the switch to a more traditional pattern of bear-steepening during tightening cycles, which may very well hold throughout 2018.

“BEHIND THE CURVE” DISCUSSION SUGGESTS … … THE TERM PREMIUM IS UNLIKELY TO STAY AT SUBDUED LEVELS

Source: Federal Reserve Bank of Atlanta, Federal Reserve Bank of New York, Bloomberg, UniCredit Research

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https://www.frbatlanta.org/cqer/research/taylor-rule.aspx?panel=1


2017 Outlook


Swap spreads: we expect a very moderate richening at the long-end… ….and a stabilization around current levels at the short-end

10Y US Treasuries started trading cheaper than the 10Y US swap spread in 4Q15 and the cheapening trend continued during 2016. The 10Y swap spread currently trades at -10bp (Swap yield-Treasuries yield). Historically, the main driver of swap spreads at the 10Y maturity has been the government budget deficit. The steep rise in the deficit in 2008-2009 well explains the tightening of swap spreads in the same period; however, the correlation between these two variables has declined to almost 0 in recent years. On the other hand, selling flows from foreign investors, especially official investors across Asia and the Middle East, seem to have become a major driver of the swap spread performance since last year. Indeed, over the last year, the major central banks in China, Japan and Saudi Arabia saw their reserves decline sharply (by 11% and 15% in China and Saudi Arabia, respectively); as the US dollar appreciated in the same period, we estimate that these central banks were selling US dollar assets (this is confirmed by the TICs data, which show heavy selling of USTs over the last year by China and by foreign officials). Moreover, regulation, namely the rising cost of the balance sheet, is often mentioned as a driver of the tightening of swap spreads, too. Last but not least, the rise in corporate debt issuance is also an element that led to a cheapening of USTs vs. swaps.

What can we expect for 2017? It is very difficult to predict the flows by foreign investors into and out of US Treasuries, but 1) we expect a moderate depreciation of the US dollar for 2017 and 2) while China will face persistent depreciation pressures of its currency, the Chinese authorities would prefer allowing gradual CNY depreciation alongside some tightening of capital controls, rather than drawing down heavily on FX reserves next year; This suggests selling flows from central banks around the world should be less of a driver of the swap-spread performance in 2017. On the other hand, the budget deficit (via an increase in UST issuance) could return as a driver, given that the Trump administration will put a lot of emphasis on fiscal expansion. For 2017, we expect a deficit of 4.1%, which is in line with that for 2016; in 2018, we expect the budget deficit to increase to 5.1% (the assumption is that the Trump plan is only partly implemented). Finally, we assume that the impact of regulation on swap spreads will not change. Given that we project the deficit to remain under control and international flows should no longer be supportive of UST cheapening, we expect a moderate richening of UST vs. swaps next year: we project 10Y swap spreads to close 2017 at -5bp. In 2018, we expect only a moderate further richening of USTs vs. swaps to 0bp.

At the 2Y tenor, US govies richened vs. swaps in the first half of 2016. This was likely related to the reform of money market funds in the USD, which saw a lot of money flowing out of prime funds into government bond funds. The 2Y swap spread currently trades at 25bp, which is in line with the average since 2010. Barring other regulatory changes, we expect 2Y swap spreads to remain around the current level next year and in 2018.

US 10Y SWAP SPREADS: NO LONGER DRIVEN BY DEFICIT …BUT DRIVEN BY FOREIGN FLOWS

Source: Bloomberg, UniCredit Research

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2017 Outlook


EUR Rates: Steeper curve, higher yields, volatile spreads ■ We see three reasons why German yields should rise in 2017: 1. a firming of eurozone

inflation outlook, 2. the influence from the US and 3. discussion about tapering (we expect the ECB to further scale back purchases in 2018). Yield repricing should mainly involve the long and extra-long end, while the Schatz should correct modestly from current levels.

■ Periphery credit spread will face support from ECB buying and yield hunting but also strong challenges from political developments. With tapering discussion going on through the year, there is little case to forecast a significant tightening from current levels. With volatility expected to be high, a tactical approach is warranted.

Bund yields driven strongly by QE and inflation expectations in 2016

In the first nine months of 2016, Bund yields were driven strongly by falling inflation expectations, which fuelled QE. The 10Y started at 0.60% in January and fell to around 0.20% by March. After the ECB stepped up QE to EUR 80bn/month and given the uncertainty created by Brexit, the 10Y fell below zero in the summer. It was only with the US elections that inflation expectations started to rise. This has eased scarcity concerns and, in turn, driven the 10Y Bund yield up to 0.40%. While yields at the long end have risen both in the US and in Germany since the US elections, the short end has performed dramatically differently: 2Y yields have risen in the US reflecting Fed rate-hike expectations, while they have fallen in the eurozone, reflecting a number of factors ranging from collateral scarcity to risk aversion.

Three reasons why we expect higher Bund yields in 2017

Looking ahead to 2017, we see three reasons why German yields should rise: 1. a firming in the eurozone inflation outlook; 2. a marked improvement in US economic figures, which will continue to keep US yields under pressure. Higher US yields (given the already stretched US-Bund spread) are unlikely to be neutral for Bunds; 3. given our economic outlook, in 2H17 we see a strong likelihood that the focus will move to further QE reduction.

Inflation: modest improvement calls for a modest rise in yields

Starting with the economic fundamentals, our economists expect eurozone GDP to expand by 1.5% in 2017 and 1.4% in 2018, with headline inflation rising to around 1.5% and core inflation improving modestly from current levels (1.1% at the end of 2017 and 1.2-1.3% at the end of 2018). These projections suggest there is some room for a moderate normalization in 10Y Bund yields, although they do not offer an argument for a significant increase in yields. As the chart below shows, Bund yields have lagged the recent rise in the 5Y5Y forward inflation. If inflation expectations stabilize at around the current levels, there is room for a 30-40bp increase in Bund yields to close this misalignment.

10Y BUND YIELD, 5Y5Y INFLATION AND THE ECB UST-BUND: DECOUPLING

The grey vertical lines denote the announcement of QE, the step-up to EUR 80bn/month and the US elections

The rolling correlation is calculated on daily yield changes


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2017 Outlook


UST-Bunds: further decoupling ahead?

A second factor that should keep upward pressure on Bund yields comes from the US. Treasury yields are rising sharply as investors are pricing in the (reflationary) effect of “Trumponomics”. This has driven the spread between US and Bund yields to the widest level since the late ‘80s. Our fundamental outlook argues for ongoing decoupling, but history suggests that the UST-Bund correlation, while low, will remain positive.

The role of the ECB: similarities with 2016…

The ECB’s monetary policy will continue to be a key driver in 2017. The script has important similarities with the last two years, as well as key differences. First the similarities: even after the reduction in monthly purchases, the ECB should buy EUR 170bn of German public sector bonds, of which we estimate around EUR 145bn of Bunds (in cash terms). Once turned in face value terms, QE will represent a large share of the expected gross issuance for 2017 (not to mention net issuance). The flow story is unchanged relative to the last two years: QE buying will provide a formidable headwind to any realignment between yields and fundamentals. Purchases may be less intense at the extra-long end and focus more on the shorter tenors, but the overall effect will be to keep the market tight.

We also take into account that the balance of surprise has been positive recently. In this respect, any negative news is likely to bring yields, at least temporarily, back towards the 0-0.2% area.

…and differences! The main difference (and it will be a key one) with 2016 is that discussion about the end of QE will accompany us throughout 2017 and, if the inflation and growth outlook are good enough, focus will increasingly be on the idea that QE will be phased out during 2018. Removing QE support in a context of improving economic fundamentals will most likely drive yields up. Before QE started to be priced in (in mid-2014), the 10Y Bund was trading at around 1% (EONIA+100bp). To restore such levels vs. the EONIA, the 10Y should go to 0.7/0.8%. On the other hand, we doubt that the ECB will proceed with a reduction of monetary policy stimulus in a context where this would look economically inappropriate (but should this be the case, we would expect a decline in Bund yields and a significant widening in credit spreads).

2Y Schatz to ease only modestly

On the German curve, the short-end has richened massively during 2016, with the 2Y Schatz falling from -0.35% to -0.75%. As the chart below suggests, this is at least in part due to the ever-rising level of excess liquidity in the Eurosystem. With QE continuing in 2017 and purchases potentially more skewed towards the short-end, it is hard to see many reasons that could push 2Y yield up in Germany. However, some stress factors that have contributed to richening the Schatz are probably related to the year-end and may fade in January. Furthermore, we see two possible reasons for a modest rise in short-term yields: one is portfolio rebalancing, as investors move up along the curve to improve their portfolio yield. The second is that the ECB seems to be aiming to normalize tensions at the short end.

2Y BUND AND EXCESS LIQUIDITY THE EXTRA-LONG END UNDER STRONG ECB INFLUENCE


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2017 Outlook


Curve shape: we prefer to position on a 10/30Y steepening

With the 2Y yield likely to remain anchored, any rise in the long end is likely to lead to curve steepening. Indeed, we expect the 2/10Y to rise during the year, reaching 135bp from the current 110bp. However, this is a widely-held view, well reflected in forwards which already price-in a steepening of the curve to around this level on a 1-year horizon.

Betting on a steepening of the 10/30Y seems more promising. Our analysis indicates that the extra-long end has become more directional, so in case of a rise in yields, we should see steepening. Forwards price in a modest flattening of the curve, a view with which we disagree.

Periphery spreads: idiosyncratic factors matter

The dynamic of credit spreads in 2016 indicates that talking about the periphery as a group is becoming increasingly meaningless. Spain has been the best performer in the eurozone, while Italy and Portugal have underperformed the core; and in reality the so-called peripheral countries are becoming increasingly different from each other, as reflected by an average intra-group correlation considerably lower compared to that of the core countries. The left chart below also highlights how the credit spread for Italy, Spain and Portugal is becoming increasingly responsive to idiosyncratic developments.

Credit spreads going forward: supportive economic factors and risks

Looking forward, QE, yield hunting and an improving economic context are the main factors that should push credit spreads tighter. Political developments and tapering discussions (we expect the announcement of further QE reduction in 2018) will be the key risks.

Starting with the positive factors, QE in 2017 will buy more than the net issuance for Italy and for Spain (Portugal is trickier due to the issuer limit). Moreover, with yields in core countries expected to remain low, especially up to the belly, using credit risk to improve returns, especially at the short and mid-maturities, is likely to remain a popular strategy.

Tapering and political developments are the key risks

Political risk will be key to watch. In Italy there is a good chance that general elections will be held in 2017, and the recent experience with the constitutional referendum shows how sensitive investors (especially non-domestic) are to political issues. Political risk is less of a theme in Spain and Portugal, although both countries are led by minority governments and a fall of the executive is always a possibility. In the case of Spain, keep an eye on Catalonia’s intention to hold a referendum on independence in September.

Tapering discussion is likely to be spread negative, but we think the ECB would only reduce policy support with an appropriate economic context, which should ultimately mean only moderate pressure coming from QE reduction in 2018.

CREDIT SPREADS, QE AND THE US ELECTIONS BTP WIDENING HAS BEEN TEMPORARY

The grey vertical lines denote the announcement of QE, the step-up to EUR 80bn/month and the US elections


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2017 Outlook


Play credit risk tactically, not strategically

While year-end forecasts are subject to huge uncertainty, one thing is pretty clear: with volatility likely to be high, it is advisable to play credit risk with a tactical rather than a strategic approach. Looking at the last two years, political events have led to strong widening, but have also been followed by quick reversals. Take France as an example: OATs widened 25bp vs. Bunds in November 2016 following concerns about domestic political developments, yet they have already recovered about half of the movement. With the presidential elections scheduled for late-April, France could well open up interesting buying opportunities.

Regarding Italy, the credit spread is currently about 20bp above the last year’s average, reflecting the recent negative mood towards the country and suggesting that lots of negative sentiment is already priced in. In this respect, there is room for QE and yield hunting to drive the credit spread tighter in early-2017, when investment strategies for the year are established. Beyond 1Q17, political developments are likely to take the driver’s seat, keeping volatility high. Over recent years, political events have been characterized by quick (and large) spread movements, followed by a strong reversal. We expect a rather similar pattern in 2017.

With widening risks coming from the political agenda and given our expectations of a further reduction in QE (to be announced later in 2017), the spread is unlikely to be significantly tighter than now at the end of 2017; we target the 140/150bp area.

Our favorite part of the curve is the belly. The curve is steep, which creates a high roll-down. Carry is also attractive. Demand from domestic investors, especially banks, is likely to be healthy. Finally, the belly should enjoy relatively strong ECB support compared to the longer tenors.

We remain overweight Spain vs. Italy in 2017. Economic fundamentals will remain stronger, although less so than in 2016. Political risk is also stronger for Italy, although this difference is mostly already priced in, so risks are skewed to the other side. We would use times of BTP strength to buy Spain on dip.


2017 Outlook


FX Strategy

USD: some slowdown in momentum early on followed by a modest weakening; but political risks loom

Dr. Vasileios Gkionakis, Global Head of FX Strategy (UniCredit Bank London) +44 207 826-7951 [email protected] Kathrin Goretzki, CFA, FX Strategist (UniCredit Bank London) +44 207 826-6076 [email protected] Kiran Kowshik, EMFX Strategist (UniCredit Bank London) +44 207 826-6080 [email protected] Roberto Mialich, FX Strategist (UniCredit Bank Milan) +392 88 62-0658 [email protected] Why the dollar should weaken…

2016 leaves us with a bitter taste in the mouth: for a big part of the year currency markets were dancing to our tune of “USD overvaluation”, with the trade-weighted (TW) dollar having depreciated by 6% by August/September. Then the world turned upside-down and what seemed to represent (another) major headwind for the USD – Donald Trump’s election – turned out to be the trigger for a strong dollar rally as US rates rose sharply and reflation trades took center stage.

Looking into 2017, one thing seems certain to us: elevated uncertainty will keep volatility high and visibility low. The tug of war between fundamentals, momentum and the interpretation (or misinterpretation) by markets of which policies will be implemented (and to what extent) makes forecasting even more difficult than it usually is. Market dislocations can persist for long periods, while potential structural changes can be harder to identify.

Before delving into the specifics of our 2017-18 forecasts, we will briefly deliberate on arguments that point to USD weakness but also discuss why 2017 could see the greenback remaining strong or strengthening further. Our projections will then amount to a balancing exercise between the two, though we would re-emphasize that the degree of uncertainty remains high.

For a year now, we have been arguing that the USD is overvalued. This has been based on our view that for currency markets what matters are real rates and real rate differentials. Indeed, for the past 20 years or so, the correlation of the TW index with US real rates has been higher than that with nominal yields (see left chart) – and extending the analysis to the late 1970s gives similar results. On this metric, our findings suggest that the currency is currently trading more than 10% higher than can be justified by real rate differentials between the US and its major trading partners. What started in 2H14 as a fundamentally-driven appreciation escalated in 2015 to a significant divergence between the exchange rate and real yields (see right chart). Unless one envisages a scenario where the Fed hikes interest rates very aggressively, the USD would need to bear the brunt of a downward correction to align itself with fundamentals.

Although this wedge started closing in 2016 with the USD weakening, the market has taken the view recently that Mr. Trump’s promised policies, such as sizeable fiscal stimulus and a tax holiday to repatriate profits of US corporations stashed overseas will be a boon for the dollar.

CORRELATION COEFFICIENT BETWEEN TW USD AND US RATES, 1995 – 2016 (QUARTERLY DATA)

THE DOLLAR OUT OF SYNC WITH REAL RATE DIFFERENTIALS


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mailto:[email protected]


2017 Outlook


Fundamentally, our problem with this line of reasoning is as follows: first, the US economy is currently operating at near full capacity, which implies that substantial fiscal stimulus (lacking the ingredients to improve productivity) is likely to compress US real rates further via higher inflation. In fact, over the past 40 years or so, material fiscal expansions (more than 1.5% of GDP on an annual basis) when the economy’s output gap was similar to what it is now (between 0% and -2%) have been broadly associated with lower real rates and meaningful USD depreciation over the subsequent year.

Second, there is no empirical evidence to support the claim that profit repatriation translates into currency appreciation. Analyzing the 2004 experience when President George W Bush signed the Home Investment Act giving corporates a one-off (year-long) tax break to bring back profits held abroad suggests that this played no meaningful role in the 7% appreciation of the TW USD in 2005. Movements in US real rates (as the Fed hiked aggressively relative to other major central banks) and speculative positioning (as captured by the CFTC data) can be shown to explain about 90% of the dollar move.

And finally, we should not forget that Mr. Trump’s proposed policies on immigration and trade protectionism – if implemented – would run a high risk of hurting the US economy; and with it, the dollar.

So fundamentally, we think there are a number of strong arguments in favor of an upcoming downward correction in the dollar.

…but why there are risks that the dollar could stay strong

However, it is an undisputable truth that markets have become very excited in bidding the USD higher. The price momentum has grown so swiftly and strongly that being bearish the USD feels like standing in front of a runaway train. Technically, the TW index is now hovering around multi-year highs and a convincing break above these levels would only add fuel to the fire (see left chart).

And this momentum could accelerate further if Mr. Trump’s policies are seen to tick all the “right” boxes. The latter may or may not turn out to be a false dawn, but either way it may take time to find out and in the interim, investors are likely to have plenty of excuses (expectations of stronger growth, speculation of a faster pace of Fed hikes) to push the greenback higher and stretch the market dislocation further.

Additionally, it is possible that the Fed turns out to be more aggressive in its tightening cycle than we expect, something that would support the dollar in 2017.

Another risk is that the Trump presidency, through Treasury Secretary Steven Mnuchin, adopts a “strong dollar” policy along the lines of this “being in the nation’s interest”, reflecting a healthy economic engine and supporting foreign demand for US debt (though that would be somewhat difficult to square with the president-elect’s pledge to reinvigorate the domestic manufacturing sector).

TECHNICAL SUPPORT: THE DOLLAR AT MULTI-YEAR HIGHS 2Y REAL RATE SPREAD SUGGESTS EUR-USD IS CHEAP


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2017 Outlook


So where does all this leave us?

Furthermore, and with so many changes globally (especially at the political level), it is possible that structural changes that we have yet to identify have altered the regression coefficients of our models. Hence, what appears to be a major fundamental dislodgment might be closer to a new equilibrium of economic variables. As always, we remain committed to continuously assessing and evaluating our models and frameworks to identify any adjustments that may be necessary to reflect the ongoing changes.

As discussed, there are multiple layers of uncertainty. However, on balance, we still have faith in our fundamental assessment of USD overvaluation. Therefore, we have penciled in a USD stabilization early in 2017 followed by a modest depreciation.

One thing worth highlighting within this “low-visibility” FX world is that commodity currencies seem to be better placed to outperform peers (appreciating strongly in a lower USD scenario or experiencing limited downside in a stronger USD environment). This is because the rise in commodity prices started well before Mr. Trump’s election, suggesting a more sustained upswing. Chinese data normalization during 2H16 also points to a pickup in demand – especially for raw industrials – which should also be helpful. And the OPEC agreement to cut oil production should continue to support energy prices. As we will discuss further, among commodity FX currencies, we believe the CAD will outperform in G10 (on account of its significant undervaluation), while the RUB should perform well across the EM universe. The ZAR should see a strong start to the year but 2H17 will bring risks.

EUR-USD: a modest appreciation, but risks abound

Turning to our individual currency-pair forecasts, we start with the euro. We see EUR-USD at 1.10 by end-2017 (i.e. 5% higher than current levels) and at 1.16 by end-2018. Our constructive view (with a higher degree of uncertainty) reflects 1. our estimate of around a 13% undervaluation based on our medium-to-long term valuation model BEER by UniCredit, 2. a similar undervaluation using higher-frequency data (real rate differentials – see right chart on the previous page), 3. the strong support from the region’s C/A surplus (over 3% of GDP), and 4. the ECB withdrawing stimulus, which should, in principle, be positive for the euro.

There are, however, a number of headwinds which we have to emphasize. First, the strong dollar momentum has pushed EUR-USD back to this cycle’s lows (below 1.05) and there is a risk that the downward move could accelerate on the back of algorithmic and CTA trading. In that sense, EUR-USD at parity is a distinct possibility – especially in early 2017 – though we doubt that it could last for long. Second, a number of European elections in 2017 (most importantly in France) amid a rise in populist movements, are likely to keep political risk premia elevated and weigh on the euro – at least temporarily. Third, and despite the ECB’s tapering of asset purchases, the policy to steepen the curve and maintain pressure on yields at the short-end may be negative for the common currency since historically it has been the 2Y rates that have had the higher correlation with EUR-USD than 5Y or 10Y. Our EUR-USD forecasts, alongside the rest of our currency projections – which we discuss below – imply that the TW EUR will gain around 3% in 2017 and another 3% in 2018.

GBP: Dangerous to turn bullish; difficult to be too bearish

Sterling has seen a sizeable adjustment these past few quarters. Since the Brexit referendum result, TW sterling is 10% weaker, with GBP-USD bearing the brunt of the losses and trading some 15% lower. So where do we go from here?

The Brexit situation has made forecasting the GBP path exceptionally tricky at this stage, for two reasons. First, there is heightened uncertainty about the end-result (the form of Brexit) and how we get there (length of time, complexity of negotiations and political noise); and second, it is very difficult to utilize a valuation framework as an anchoring point because it is simply too early to know the extent of the damage done to underlying fundamentals. For example, our BEER by Unicredit model suggests a fair value in excess of 1.60 for GBP-USD. This seems way too high because the model 1. cannot so rapidly reflect any structural changes that might have taken place, and 2. cannot account for the political disturbance that has been (and is likely to continue to be) one of the main drivers for the foreseeable future.


2017 Outlook


According to real rate differentials – which certainly move much faster than hard data does – GBP-USD should be trading around 1.45, i.e. around 15% higher than current levels (see left chart). We believe that this discrepancy reflects the “Brexit uncertainty premium” which will likely stay with us over the next year and beyond. In addition to this uncertainty, we think there will be three factors that will weigh on sterling going into the early part of 2017, weakening it towards the 1.20 level again. First, the triggering of Article 50, which will increase political noise and raise risk premiums further. Second, expectations of higher inflation (due to the sterling depreciation) that will likely compress UK real rates. And third, the slowdown in growth on the back of deteriorating business and consumer confidence.

Afterwards, the path of sterling is tightly linked to the ongoing negotiations with the EU. If a transitional agreement becomes likely, then sterling would rally strongly, but if negotiations take a turn for the worse and the market sniffs an outright exit from the single market and a loss of passporting rights, then sterling would plunge. Ultimately, our forecasts amount to a scenario analysis in which we think it is a very close call between these two possibilities. We pencil in GBP-USD at 1.25 by end-2017 and 1.30 by end-2018; this brings us to EUR-GBP at 0.88 and 0.89, respectively.

JPY: recent weakness should be partially reduced

The JPY was the preferred vehicle through which reflationary and risk-on trades were played following Mr. Trump’s victory in the US presidential election. The yen has fallen more than 9% in TW terms since early November (though it still remains one of the best performing G10 FX in 2016) without the BoJ voicing concerns about increased volatility and the rapidness of the move. The renewed USD strength after Mr. Trump’s victory, widening spreads between US and Japanese nominal rates and some paring of the already overstretched short positioning were the predominant drivers of the USD-JPY rally. Still, USD-JPY is now even more overvalued in terms of long-term fundamentals (we estimate a fair value for USD-JPY at just below 95, which corresponds to a sizeable misalignment of 25% – see right chart).

We think that this overvaluation, although not fully absorbed, will be somewhat reduced going forward for at least three reasons. First while nominal yield spreads between the US and Japan have widened, real yield spreads point to a lower exchange rate (around 110, by regressing USD-JPY on the 2Y real swap spread between the two countries). Second, the monetary and fiscal policy mix in Japan is seen as supporting the yen: in our view the BoJ is pretty much done on the stimulus front, while the new fiscal plan approved in August should kick-start the Japanese economy (with positive signs having already emerged) and thus the JPY. And third, over the long term, the USD is exposed to a broad-based correction given its overvaluation.

UNCERTAINTY HAS BEEN THE MAIN DRIVER FOR STERLING DOWNSIDE

USD-JPY: THE RENEWED OVERVALUATION IS LIKELY TO BE PARTIALLY CORRECTED


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2017 Outlook


We do not expect an immediate return to “fair value” and see USD-JPY back to 112 by 4Q17 and to 104 by 4Q18. The risk, however, is that the USD remains strong for the reasons we discussed at the beginning, in which case the yen is likely to underperform given the BoJ’s ongoing attempts to maintain the 10Y yield at around zero.

CHF: a painfully slow convergence to “fair value”

The Swiss franc confirmed that it has lost its allure as a safe-haven currency, failing almost completely to react to global events in the course of 2016. This behavior is probably a reflection of the SNB’s strong commitment to prevent any strengthening of the franc even in the face of external shocks (the bank confirmed it intervened in the aftermath of the UK referendum result in June). Significantly negative Swiss rates have also played an important role in reducing incentives for locals to repatriate assets when risk aversion rose. We think this situation will remain in place in 2017.

Fundamentally, the franc remains overvalued against the euro (we estimate its equilibrium value at around 1.18), but we suspect that convergence towards its fair value will be slow in 2017, given the “headwinds” from the huge Swiss current account surplus (still close to 10% of GDP). We have penciled in a modest EUR-CHF appreciation to 1.12 by end-2017 and 1.14 by end-2018. We see USD-CHF struggling at around parity next year and slipping to 0.98 by end-2018.

SEK to see major relief when real rate dynamics turn NOK to continue its appreciation

With the Swedish economy proceeding on its recovery path and the CPI expected to rise gradually towards the Riksbank’s 2% target over the course of 2017, one would think the Riksbank has reason enough to reconsider its easing program. However, judging from past experience, and with the ECB having just committed to its presence in the market, we may have to wait longer to see Riksbank policy return to something more in line with Swedish fundamentals.

The SEK remains heavily undervalued according to long-term fundamentals, mainly driven by the Riksbank’s overly dovish stance. The latter has caused the development in real rate differentials between Sweden and the eurozone to be unfavorable for the SEK, as inflation differentials between Sweden and the eurozone have been rising faster than the corresponding nominal yield differentials (see left chart). When this turns as a result of relative developments in inflation and yields, we are likely to see a major recovery of the SEK. Our year-end forecast for EUR-SEK is at 9.30 for 2017 and 8.90 for 2018.

We expect EUR-NOK to continue on the long-term downward trend that started at the beginning of 2016. Higher oil prices leave room for further improvement in Norwegian growth dynamics. This should support the correction of the currency’s undervaluation. At the same time, the Norges Bank is unlikely to have any issues with some orderly NOK appreciation as economic dynamics improve and energy prices remain supported. We remain bullish the NOK with a EUR-NOK target of 8.50 for end-2017 and 8.10 for end-2018.

EUROZONE-SWEDEN REAL RATE DIFFERENTIALS ARTIFICIALLY HIGH IN 2016

WE FAVOR USD-CAD DOWNSIDE DUE TO OVERVALUATION


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15Fe

b-15

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-15

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-15

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-15

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l-15

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b-16

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l-16

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Eurozone-Sweden nominal rate differentialsEurozone-Sweden inflation differentialsEurozone-Sweden real rate differentials

%

0.9

1

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-97

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-98

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-99

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USD-CAD actual USD-CAD based on BEER by UniCredit


2017 Outlook


CAD to outperform on the back of higher oil prices and big undervaluation

We expect the Canadian dollar to be the main beneficiary of the rise in oil prices. Compared to our BEER estimate for USD-CAD of 1.19, the CAD remains substantially undervalued (see right chart on previous page). The CAD’s outperformance of its commodity FX peers since the OPEC agreement to cut production suggests that the market is gradually aligning itself with our constructive view of the currency. Canadian employment dynamics have improved significantly since oil production returned in 2H16. In due time, this should be reflected in higher inflation, which is not far from target anyway. Following that, markets are likely to start bringing forward the timing of rate hikes. We remain bullish the CAD, with a forecast for USD-CAD of 1.22 for end-2017 and 1.18 for end-2018.

Moderate upside for the AUD… We see further upside potential for the AUD as the Australian yield level in real terms remains one of the highest in G10. However, given that the market has now priced out any expectation of easing by the RBA, the fundamental overvaluation may act as a brake, limiting upside in AUD-USD (although there is certainly a case to be made that the fair value rises somewhat on the back of higher commodity prices and hence, an improvement in terms of trade). We forecast a gradual appreciation of the pair to 0.78 by end-2017 and 0.80 by end-2018.

…and the NZD For the NZD, the market has also thrown the towel in terms of expecting any more rate cuts – and we agree. Inflation dynamics in New Zealand remain sluggish, but the bar for the RBNZ to lower interest rates is now likely to be high given 1. the recent global steepening in yield curves and 2. the RBNZ’s assessment that the economy in New Zealand is growing above potential, the fact that there is now a small positive output gap and long-term inflation expectations remain well-anchored (and have recently been rising for the short term). Higher commodity prices should provide ongoing support for the currency from the fundamental side. We see NZD-USD at 0.76 by the end of 2017, and at 0.78 by the end of 2018.

In EM, favor commodity exporters over importers… … so long as China pushes fiscal stimulus further

Our view on EM currencies following the US election outcome has been the following: assuming US real yields are well-behaved and markets continue to price in reflation (signaled by rising industrial metals prices), an “across-the-board” bearish view on EM currencies is not justified (see FX Perspectives: EM FX & the "Trump Tantrum" – why this time could be different). While the evolution of US policy may impact US real yields, the view on China has been more important for EM-relevant commodities (such as industrial metals). We assume the Chinese authorities will continue with fiscal expansion to ensure growth holds up ahead of the 19th National Congress of the Communist Party of China (to be held in 2H17). This should translate into a preference for the currencies of commodity exporters (such as the RUB) over importers (like the TRY).

POLAND ACCUMULATING FX RESERVES AT A BRISK PACE REAL RATES STILL TOO LOW TO ALLOW FOR TRY REBOUND


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7

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3D

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3Ju

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15S

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Official reserve assets (3M sum, % of GDP) EUR-PLN (rs)

based on monthly data, last data point September

-150

-50

50

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350

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10

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14A

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14-week RSI on USD-TRY Real CBRT average funding rate (rs)

USD-TRY overstretched on momentum ...

...but much higher real rates required to allow

USD-TRY to sell-off

https://www.research.unicredit.eu/DocsKey/fxfistrategy_docs_2016_157346.ashx?EXT=pdf&KEY=KZGTuQCn4lsvclJnUgseVJ1YeU3c7Y14CDRYZc5y45UQKMrTAYRJyQ==&


2017 Outlook


PLN appreciation pressure to increase… …but will authorities allow currency appreciation?

A recovery in portfolio flows and the C/A surplus remaining strong has seen Poland’s broad basic balance of payments begin to signal appreciation pressure. We assume that the appreciation pressure will continue to build in 2017 as EU fund inflows recover strongly. That said, the 2016 appreciation pressure has been absorbed by rising currency reserves. Indeed, as a proportion of GDP, reserve accumulation is running at a pace not seen since the PLN was at much stronger levels (EUR-PLN at or below 4.00, see left chart on previous page). The authorities seem to favor a weaker currency, but we believe constraints, such as a negative cost of sterilizing reserves, will see policy makers allow currency appreciation in response to stronger inflows. However, the trend in reserves needs watching. We forecast EUR-PLN at 4.25 by end-2017.

NBH liquidity policy may have a diminishing impact on HUF in 1Q17 Barring an initial dip, EUR-CZK to be well supported after removal of floor

Hungary’s very strong balance of payments position and a recovery in foreign demand for debt supported the HUF until September. The currency came under pressure in 4Q16, in part due to the NBH’s policies aimed at increasing the banking-sector liquidity surplus. We think such policies could have a diminishing impact over 1Q17 allowing the HUF to perform slightly better. We forecast EUR-HUF at 320 by the end of 2017. Elsewhere, the EUR-CZK floor will likely be removed around June 2017 in line with the CNB’s guidance. Barring an initial 3-4% decline (perhaps to 26.00), the cross should grind back higher because of 1. somewhat higher global yields allowing the country to recycle the still-modest C/A surplus abroad and 2. the CNB likely continuing to maintain its intervention policy even after the floor is removed. We forecast EUR-CZK at 26.50 by the end of 2017.

There is still no reason to turn positive on the TRY A strong CBRT response would change our view

Despite three years of losses, most of the factors informing our bearish TRY view (see FX Perspectives Turkish Lira – the fragile one) remain intact. The current account is likely to remain under widening pressure as energy prices rise in the months ahead. Medium-term momentum indicators on USD-TRY are at levels that have preceded strong TRY relief rallies in the past. However, in all of those instances, the real CBRT funding rate (deflated by inflation expectations) was considerably above 100bp (right chart on previous page); currently, it is at just 30bp. Hence, we remain bearish the TRY even at current levels. A sharp tightening from the CBRT (over 200bp) would make us more constructive on the TRY; however such a prospect appears unlikely. A referendum on a move to a presidential system (likely around April) will keep foreign investors wary of committing to anything, beyond tactical positions. We forecast USD-TRY at 3.65 by the end of 2017.

We like the RUB on higher energy prices ZAR will perform well in 1H but 2H brings risks

While there is likely to be bouts of volatility, we continue to hold a constructive stance on RUB. The oil price (in RUB terms) is now close to RUB 3,400/bbl, the highest level in over a year and some 20% above the government’s current budget assumption of RUB 2720/bbl. Hence, there is plenty of scope for the RUB to catch up to rising terms of trade without sparking verbal intervention from the government. We forecast USD-RUB at 59.70 by the end of 2017 – with risks for more downside. For South Africa, we think it will be a year of two halves; better performance in 1H17 due to strong support from terms of trade and diminished political and rating risk, followed by some weakness in 2H17 for exactly the opposite reasons. In the absence of a recovery in growth, both S&P and Fitch are likely to downgrade the sovereign to sub-IG status in June. Alongside the ANC elective conference towards the end of 2017, political risks will re-surface from 2H17, in our view. We forecast USD-ZAR at 14.40 by the end of 2017.

CNY: depreciation pressure will remain with us over the next few years.

We are bearish the CNY and forecast USD-CNY ending 2017 at 7.25. China will face persistent depreciation pressure as capital outflows (of a structural nature) overwhelm a declining current account surplus. For most of the decade leading up to 2014, China’s current account and non-reserve financial account together amounted to a surplus of at least 5% of GDP. Between 2005 and 2010 this averaged 9.9% (of GDP) and between 2011 and 2014 4.2%. Over this period, the CNY saw persistent appreciation pressure (see chart on next page). However, since 2014 the tide has turned. That same measure has averaged minus 2.7% of GDP over the past four quarters. The switch has been driven by an increase in capital outflows as well as a decline in the current account surplus (due to a rising services deficit).

https://www.research.unicredit.eu/DocsKey/fxfistrategy_docs_2016_153768.ashx?EXT=pdf&KEY=KZGTuQCn4lsvclJnUgseVJ1YeU3c7Y14M8PXtwV9qKeumzdEQ7yPvQ==


2017 Outlook


If the US imposes tariffs, this would result in a more bearish CNY path than we forecast

These changes are likely structural and will continue to place the CNY under depreciating pressure. Going forward, we would expect the authorities to favor a gradual weakening of the currency and an intermittent tightening of capital controls (rather than drawing down on FX reserves).

Across-the-board tariffs from the US (which is a risk and not our central scenario) would result in a more bearish CNY path than we forecast as they would weigh on China’s trade surplus (to which the US contributed a sizeable 31% in 2015).

CHINA’S OUTFLOWS OVERWHELMING THE DECLINING C/A SURPLUS


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Non-reserve financial a/c % GDPC/A % GDPUSD-CNY (rs, inverse scale)


2017 Outlook


Equity Strategy Higher index levels in 2017

Dr. Tammo Greetfeld, Equity Strategist (UniCredit Bank) +49 89 378-18361 [email protected] Christian Stocker, Equity Strategist (UniCredit Bank) +49 89 378-18603 [email protected]

■ On the back of improved confidence in the growth outlook, we expect the Euro STOXX 50 to rise in the coming months. Our target for both mid-year and year-end is 3300 points.

■ The Euro STOXX 50 (as well as the DAX) is likely to outperform the S&P 500, on balance, in the coming months. USD strength benefits eurozone earnings relative to US earnings. Higher growth expectations and tax reform are providing support to US earnings, however, the high valuation of the US market limits its further upside.

■ Financials and Materials are among the biggest winners from improving growth and higher bond yields. So-called “bond proxies” such as Telecoms, Utilities and Food & Beverage will remain less attractive the next few months.

Key aspects of the macroeconomic environment

Continued resilient eurozone growth in 2017 as part of a brightened global picture is a central macroeconomic element supporting equity markets. This, accompanied by higher US government bond yields, rising yield levels globally and tighter US monetary policy, comes with continued USD strength (in the near term) and higher commodity prices. Much of the current positive macroeconomic developments have been shaped since November, with focus on potentially growth-positive elements of the Trump presidency while possible risks moved to the background.

Earnings-supportive factors have strengthened since November

Earnings expectations are benefitting from the improved confidence in the growth outlook. Financials’ earnings are benefitting from steeper yield curves, and rising oil prices are also contributing to an earnings improvement (reversing a burden in 2015 and early 2016). In addition, USD strength is contributing to the improving earnings outlook. Consensus expects earnings growth of 11% for the Euro STOXX 50 in 2017. In recent years actual realized earnings have tended to be much lower than initial expectations. In 2017, due to the factors mentioned above, we see a good chance that this time the actual earnings will be much closer to initial expectations – which would be a positive development compared to recent experience.

Higher index targets with limited valuation leeway

Earnings are crucial for a positive equity market performance, as the leeway for a further expansion in multiples seems limited. Since 2014, the valuation of the Euro STOXX 50 has mostly moved sideways in a range between about 11.8 and 13.6, and the valuation is now at the upper end of this range. When the QE program was introduced in 1Q15, valuations initially rose strongly, but this did not last. Over the medium term, the change in growth expectations is the key factor influencing changes in the equity market valuation (see left chart on the next page). The focus on growth might lead to valuations rising temporarily in 1H17, which would then need confirmation through improving earnings. For the Euro STOXX 50, our mid-year index target is 3300 points and we have the same target for year-end (DAX 12000 and FTSE MIB 18000; for mid-year and year-end). The DAX, in particular, should benefit from the growth outlook. For the FTSE MIB, political uncertainty remains a burden and the market will be sensitive to shifts in investor expectations.

International environment The strengthening confidence in the growth environment is likely to result in an outperformance of the Euro STOXX 50 and the DAX versus the S&P 500 in the coming months. The USD strength seen in recent months benefits eurozone earnings, while in the US it acts as a counterweight to the positive effects on US company earnings stemming from the expected US tax reforms. The high valuation of US market limits further upside. Past experience shows that continued Fed rate hikes also tend to weigh on valuations.

Reallocation has only just started

Sector trends have started to reflect improvements in growth expectations and rising yields and we think these trends will continue. Financials and Materials are among the biggest winners, while so-called “bond proxies” such as Telecoms, Utilities and Food & Beverage will remain less attractive the next few months due to rising inflation expectations and the resulting increase in


2017 Outlook


capital-market yields. Overall, we expect a modest, but broad-based acceleration in global growth. Basically, in such economic environment, the earnings momentum of cyclicals picks up and supports the trend to an outperformance. Therefore, the turnaround in cyclicals’ earnings growth estimates that started in mid-2016 should continue. Additionally, the rebound in commodity prices is already consistent with a modest increase in net profit margins in Materials that should continue. This is underpinned by the very positive 18.1% earnings revisions ratio of industrials. In contrast, defensives have a negative revisions ratio of -0.5%. In terms of sectors, we expect the best performers to be industrials such as Basic Resources, Chemicals, Construction & Materials and Industrial Goods & Services.

Financials profit from the development of capital market rates

Possible surprises

The yield curve in Europe is steepening. Given the increase in inflation expectations, this should continue. Historically, a steepening yield curve has indicated an outperformance of STOXX Europe 600 Banks over the total market. The earnings estimates for the European banking sector are stabilizing, the earnings revisions ratio has improved significantly in recent months and even net income shows initial signs of stabilization. In fact, with a stabilizing business environment for banks, the ratio should increase further in the coming quarters. For insurance companies, the interest environment, with the steepening of the yield curve and gradually increasing capital-market rates, is also brightening. We expect gradual relief from the negative impact of extremely low capital-market rates and, therefore, believe that the negative earnings revisions in the insurance sector will end. However, insurance companies’ P/E valuations are still elevated in historical terms, and they tend to decrease in an environment of increasing capital market rates. This limits the further recovery potential for the insurance sector, even if the earnings environment improves slightly.

One area of possible surprises is that some of those factors supporting equities as we move into 2017 – greater confidence in growth and stronger USD – might turn out to be stronger than expected, giving equities additional support initially. Many of the current positive macroeconomic impulses are linked to expectations regarding the Trump presidency. These expectations need to be confirmed by hard facts. On the other hand, risks (e.g. from trade policy) could come to the fore, while current optimistic expectations recede. On the international side, risks could come from China having difficulties in stabilizing the exchange rate due to rising US yields (capital outflows; pressure on domestic companies and growth expectations). In the eurozone, the slowdown in EMU money supply M1 warrants monitoring. In the past it has been a negative signal for earnings and valuation, but in 2016 the economic relationship has not been as reliable.

EURO STOXX 50 P/E AND IFO EXPECTATIONS IFO EXPECTATIONS AND RELATIVE EARNINGS TREND

Source: Thomson Datastream, UniCredit Research


2017 Outlook


Credit Strategy Fundamentally sound, but technical factors will prevail

Dr. Philip Gisdakis, Head of Credit & Cross Asset Strategy (UniCredit Bank) +49 89 378-13228 [email protected]

■ Given the anticipated low but stable growth environment, which is creditor-friendly, we expect European credit to remain fundamentally sound.

■ However, technical factors will dominate credit markets in 2017, resulting in moderate spread widening pressure overall.

CSPP to remain a dominant driving force in 2017

The ECB’s corporate sector purchase program (CSPP) has been the dominant driver in credit markets in 2016 and is set to remain center stage in 2017 as well. So far, the ECB has purchased almost EUR 50bn in corporate bonds, which corresponds to a weekly pace of purchases of almost EUR 2bn. To put this into perspective, this is the amount of net supply (i.e. issuance minus redemptions) in CSPP-eligible bonds that have been issued over the same period. As a result, the average spread of CSPP-eligible benchmark bonds was squeezed to below 30bp in July. This compares to a spread peak of almost 100bp before the announcement of the CSPP. Since August, however, the average spread has widened constantly, a development that was recently accelerated by the steepening in the risk-free yield curve (in the aftermath of the Trump election surprise) and concerns regarding the Italian referendum.

Due to the ECB’s decision to extend its asset purchases from March 2017 to December, the CSPP will remain a dominant factor for credit markets next year too. However, as the ECB has also announced that it plans to reduce the pace of purchases from EUR 80bn to EUR 60bn per month, there will be two opposing technical forces pulling on corporate credit spreads. While CSPP will offer technical support (depending on the amount of purchases, of course), a steepening of the yield curve on the back of a slowdown of purchases will put spreads under widening pressure, in particular for the safe-haven and low-spread names. This widening pressure stems from the fact that credit spreads are too tight to be able to sufficiently offset large parts of the anticipated yield increases. Hence, investors will likely chose to sell the exposure that is at risk of resulting in negative total returns.

CORPORATE CREDIT SPREADS: TIME SERIES AND HISTORIC CORRELATION COEFFICIENT TO BUND YIELDS

iBoxx Non-Financials Senior by country Rolling 6M correlation coefficient


Safe-haven spreads and yield curves to be positively correlated

However, wider credit spreads alongside rising yields would form a special dependency pattern, as corporate credit spreads have historically been inversely correlated with risk-free yields. Usually, spreads tighten when yields rise and vice versa. This dependency is driven by another underlying factor, namely the business cycle, as improving economic conditions drive yields higher and spreads lower. However, this has not been the case over the last few weeks.

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China & Commodities

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6M rolling correlation coefficient 5Y Bund Yield

Fundamental (negative) correlation

Technical (positive) correlation


2017 Outlook


The changes in the correlation pattern are illustrated by the rolling 6M correlation coefficient between corporate bond spreads and 5Y Bund yields (right chart above). The correlation coefficient has been in negative territory for most of the last ten years, falling as low as -0.8. However, time and again it has moved into positive territory. This positive correlation can be explained as being technically driven. It usually occurs when Bund yields rise, as investors who are facing corres-ponding mark-to-market losses therefore sell corporate bonds in order to avoid losses stemming from higher risk-free yields. As a result of this selling pressure, corporate credit spreads widen.

Strong issuance activity expected, but the CSPP could again absorb a large part of net supply

Another important technical factor will be the issuance activity of companies in 2017. Given that the odds for a substantial increase in funding costs are rising, issuers might rush to the market to secure still cheap financing. Our 2017 bottom-up issuance forecast suggests that while primary market supply will be slightly short of 2016 volumes, the investment grade non-financials market volume is likely to expand further, as we expect issuance volumes to exceed redemptions significantly. Overall, we expect roughly EUR 155bn in new bonds across all IG sectors, which compares to redemptions and index exclusions (due to 1Y maturity constraints) of more than EUR 80bn in 2017. Accordingly, iBoxx NFI IG net issuance would total roughly EUR 75bn in 2017 after EUR 115bn in 2016 YTD. However, net supply of EUR 75bn needs to be put into perspective with the CSPP. If the ECB were to maintain its purchasing volume at the current pace (i.e. at EUR 2bn per week), the ECB could easily absorb a volume that would be in excess of this net supply. And even if the CSPP volume was scaled down by 25% (i.e. proportional to the overall reduction from EUR 80bn to EUR 60bn), it would still absorb a substantial amount of the net supply. In this environment, issuers could be tempted to print as much as possible, which could result in issuance volumes exceeding our bottom-up forecast. In particular, the first quarter could see a huge wave of issuance, as the ECB would still be in the EUR 80bn purchasing mode, and the potential end of the buying program would still be sufficiently far away to find investors to buy alongside the ECB at low spreads. Towards the end of 2017, tapering concerns could become a crucial driving force for credit investors, resulting in rising spreads and therefore higher funding costs.

Winning strategy: prefer risky assets over safe haven; in terms of sectors, financial subs looks most attractive

What could be a winning strategy for credit investors in 2017? Given the complex technical environment, which could easily result in negative total returns due to the steepening of the yield curve, the hunt for strategies to avoid losses will be key for credit investors in 2017. In general, we recommend avoiding safe havens, such as low spread names, particularly those with long durations, which are prone to large losses from the interest-rate side. As a consequence, risky assets are king. But which sectors to choose? Among the risky sectors that may perform well are those that could benefit from a Trump boom, i.e. Construction & Materials, Basic Resources, Industrials, but also Oil & Gas (depending on how the oil price will evolve if US explorers will increase supply). But the prospects for these sectors crucially depends on policies of the incoming Trump administration. Excessive hopes for reflationary programs could easily be disappointed. Hence, we recommend remaining more critical in this respect.

However, there is another sector – Financials – that is set to benefit from potential Trump policies, but for which the positive prospects are going far beyond being pure Trump reflation hopes. In particular European financials are set to see improved fundamentals, on the back of improving macroeconomic conditions, but also because of the steepening yield curve. As our Chief Economist Erik Nielsen recently argued, the ECB version of Operation Twist (reducing the overall purchasing volume alongside removing the limitation of buying bonds only if yields are higher than the deposit rate) could be seen as a deliberate step to offer financials, which are impacted by the low yield and the negative deposit rate, some fundamental relief. This would support bank capital instruments, such as equities and AT1.

Summary In summary, we think that risky credit exposure – hybrids and high yield – will outperform safe havens. The latter is at risk of resulting in negative total returns on the back of rising risk-free yields. In terms of sectors, we prefer financials, which will benefit fundamentally from steeper yield curves. Overall, technical factors, such as the CSPP, issuance activity and the correlation pattern between spreads and yields should be the dominant drivers for credit markets over the course of 2017. Credit fundamentals will remain sound, given an anticipated growth environment of about 1.5%.


2017 Outlook


Commodity OPEC decision to cut production leads to higher oil prices

Jochen Hitzfeld, Commodity Strategist (UniCredit Bank) +49 89 378-18709 [email protected]

Oil demand will grow further, but at a slightly slower pace

2016 has been characterized by various actions by OPEC. In the first quarter, the oil price rose by 50% after Saudi Arabia, Russia, Qatar and Venezuela agreed to freeze their output at January 2016 levels on the condition that other producers follow suit. During the summer, the market remained extremely jittery in an ongoing rebalancing process. On 30 November 2016, OPEC surprisingly agreed to cut supply by 1.2mn b/d to the new official target of 32.5mn b/d. Interestingly, non-OPEC countries also took part in the deal and agreed to cut oil production by 600kb/d, with 300kb/d from Russia alone. The coordinated commitment was further strengthened by signals from Saudi Arabia that it is even prepared to cut output to below the level agreed with OPEC. The deal will start in January 2017 and will last for six months, with option to extend. The deal should move the oil price (Brent) to a new level firmly above the USD 50 mark in 2017, with USD 60 as a possible target mark. We think this will be achieved as an average price in the fourth quarter of 2017 and that it will be maintained throughout 2018. A fast supply reaction from the US fracking industry is rather unlikely, as the OPEC deal only has a short initial duration of six months and cheap oil could come back to the market thereafter. Meanwhile, US fracking production has continued to decline, from 4.8mb/d in March 2015 to 3.96 mb/d in December 2016, despite rising rig count numbers. From the three major areas, only the Permian Basin has shown further increases, while Eagle Ford and Bakken remain in deep decline. So, overall we think that the oil price will firmly establish itself slightly above the USD 60 mark in 2018. There are even some upside risks, as inventories should be considerably lower than they are currently and OPEC’s spare capacity will fall significantly below historic averages. So our price target for 2018 is USD 62 as an average.

According to the International Energy Agency (IEA), global oil demand will likely increase by 1.2mn b/d in 2017 to 97.5mn b/d after having peaked at a five-year growth rate high of 1.6mn b/d in 2015. For 2018, we expect a growth rate similar to 2017. Non-OECD countries will continue to dominate the global demand picture. Two countries stand out: China and India (both +400kb/d). However, demand growth rates in OPEC countries should also not be underestimated: the more demand there grows, the less there is available to export. Despite increasing numbers of electric vehicles on the road and ongoing improvements in the efficiency of cars, we expect global oil demand to grow, mostly because of the lack of easy alternatives to oil in road freight, aviation and petrochemicals. However, demand growth rates will not be as high as in previous years.

Global crude oil inventories to turn lower due to supply deficit

There is no doubt that the OPEC deal will heavily influence the global oil supply/demand balance in 2017. Saudi Arabia will deliver the lion’s share of OPEC’S production cut with a reduction of almost 500kb/d. Other substantial cuts will come from Iraq (-210kb/d), U.A.E. (-139kb/d) and Kuwait (-131kb/d). Iran basically accepted a freeze of its oil production at around 3.8mn b/d (vs. previous plans to increase its oil production to around 4mn b/d). Moreover, the OPEC agreement to cut oil production also includes a reduction of 600kb/d by non-OPEC producers. Russia is contributing to the deal with a 300kb/d cut. The only countries that are exempt from the cuts are Libya and Nigeria.

If the supply cuts are implemented in the first quarter of 2017, every quarter of the year will show a high (and rising) supply deficit (see chart on next page). Especially in the fourth quarter of 2017, when the supply deficit reaches 1.3mn b/d, inventories will drop strongly. According to the IEA, global industrial crude oil (and crude oil products) inventories increased from 2.57bn barrels in January 2014 to 3.10bn barrels in June 2016. Afterwards, they fell by 34mn bbl – the strongest two-month decline in nearly three years. Thus, the global inventory cycle seems to have finally turned lower in the summer of 2016. Taken the expected supply deficits of 2017 into consideration, global inventories could decline by approximately 300-400mn bbl and could thus quickly approach their five-year average in 2017.


2017 Outlook


The expected supply deficits could be even higher due to the decline in investment that has occurred. According to Wood Mackenzie, oil and gas companies will spend USD 1tn less on finding and developing reserves between 2015 and 2020. Global capex was down in 2015 and 2016, the first time since the 1980s that capex has declined for two consecutive years This lays the foundation for tighter markets and rising prices in subsequent years. However, a more short-term effect of lower investment could be an acceleration in natural decline rates of existing oil fields already in 2017 and 2018. Wood Mackenzie estimates that the investment slowdown could cut 2017 global oil and gas production by 4%. The impact is only partly offset by falling costs for oilfield services and equipment.

A recovery of oil production in Libya and Nigeria would be positive. In both countries, oil production is suffering greatly from political tension. In Libya, oil production has dropped from 1.8mn b/d to 0.5mn b/d and, in Nigeria, it has gone down from 2.0mn b/d to 1.7mn bbl/d. Any recovery here would clearly soften the effect of the outcome of the OPEC meeting. Moreover, the new US administration is clearly more focused on domestic production. An increase in the price level and a similar cut in production costs due to lower regulatory burdens could also lead to an increase in US production. Currently we do not expect a fast rebound of US shale output, as many producers are still seeking to strengthen their balance sheets. Nevertheless, the EIA is only expecting a slight increase of US crude oil and liquid fuel supply

Risks to our forecast In the past, commodity prices have recorded a particularly sharp rise whenever a supply shortage could not be covered from inventories and OPEC's available production capacity was low. This situation might materialize again in 2018 for the following two reasons: 1. the inventory cycle turned lower in 2H16 and the decline in inventories will considerably accelerate in 2017, mainly due to OPEC’s production cut. Inventories might become too low again in 2018, 2. OPEC's spare production capacity was at a reassuring level of 7mn b/d in October 2014. However, just before the decisive OPEC meeting, it had already halved to 3.0mn b/d. The OPEC decision to cut oil production will increase that figure back to 4.2mn b/d again. Using the average figures, demand in 2018 is likely to grow by a further 1.2mn b/d. At that level, OPEC is likely to restore unlimited production again. Should geopolitical tensions persist, the oil market will probably start to price in a significant risk premium. An extremely exciting constellation is thus emerging for the crude oil market in 2018.

HUGE SUPPLY DEFICIT IN THE GLOBAL CRUDE OIL MARKET IN 2017 AFTER THE OPEC DEAL TO CUT PRODUCTION

INVENTORY CYCLE HAS ALREADY TURNED LOWER AND WILL ACCELERATE IN 2017

Source: Based on IEA data from the Monthly Oil Market Report © OECD/IEA 2015, www.iea.org/statistics. License: www.iea.org/t&c; as modified by UniCredit Bank AG, UniCredit Research

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

OPEC crude oil: supply minus demandmbd

2,300

2,400

2,500

2,600

2,700

2,800

2,900

3,000

3,100

3,200

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

OECD industry inventories of crude oil and products

mn barrels


2017 Outlook


Table 1: Annual macroeconomics forecasts

GDP (%)

CPI inflation (%)

Central Bank Rate (EoP) Government budget balance

(% GDP) Government gross debt

(% GDP) Current account balance

(% GDP) 2016 2017 2018 2016 2017 2018 2016 2017 2018 2016 2017 2018 2016 2017 2018 2016 2017 2018 US 1.6 2.4 2.7 1.3 2.5 2.6 0.75 1.25 2.00 -4.1 -4.1 -5.1 108.2 108.6 109.1 -2.7 -2.7 -3.0 Eurozone 1.6 1.5 1.4 0.2 1.5 1.4 0.00 0.00 0.00 -1.8 -1.8 -1.6 91.6 90.9 89.5 3.5 3.3 3.1 Germany 1.8* 1.5* 1.6* 0.4 1.8 1.9 - - - 0.6 0.0 0.0 69.0 67.0 65.3 8.9 8.5 8.0 France 1.2 1.2 1.1 0.2 1.3 1.3 - - - -3.3 -3.1 -3.0 96.2 96.1 95.8 -1.9 -2.1 -2.0 Italy 0.9 0.8 0.9 -0.1 1.1 1.1 - - - -2.4 -2.4 -2.0 132.9 133.2 132.8 2.7 2.6 2.4 Spain 3.2 2.4 2.0 -0.4 1.3 1.7 - - - -4.8 -3.8 -3.2 99.5 100.0 100.2 1.5 1.5 1.5 Austria 1.5 1.6 1.4 0.9 1.8 1.9 - - - -1.5 -1.3 -0.9 84.4 82.2 80.2 2.0 2.1 1.9 Greece 0.1 0.9 1.4 0.0 0.6 0.7 - - - -3.1 -2.0 -1.8 183.1 181.3 181.0 0.0 0.2 0.3 Portugal 1.2 1.2 1.1 0.6 1.0 0.9 - - - -2.6 -2.1 -1.9 131.0 130.0 128.0 0.1 0.3 0.2 Other EU UK 2.1 1.2 0.8 0.6 2.3 2.8 0.25 0.25 0.25 -3.7 -3.5 -3.0 87.8 91.5 92.0 -4.0 -3.5 -3.0 Sweden 3.2 2.5 2.6 0.9 1.7 1.8 -0.50 -0.65 -0.50 -0.3 -0.3 0.8 42.0 41.0 40.5 5.5 5.3 5.5 Poland 2.7 3.0 3.4 -0.6 1.6 2.0 1.50 1.50 2.25 -2.6 -2.8 -2.8 53.8 56.1 55.8 -0.7 -0.7 -1.7 Czech Rep. 2.4 2.4 2.5 0.6 2.0 2.2 0.05 0.05 0.50 0.3 -0.4 -0.5 38.6 37.9 36.8 2.3 1.8 1.8 Hungary 2.2 3.0 3.1 0.5 3.0 3.0 0.90 0.90 0.90 -1.2 -2.4 -2 73.2 72.7 70.2 4.8 4.0 4.1 Others Switzerland 1.4 1.5 1.7 -0.4 0.5 0.9 -0.75 -0.75 -0.75 -0.1 0.1 0.3 34.1 33.4 32.0 9.3 8.8 8.8 Russia -0.8 0.9 1.1 7.1 4.8 4.2 10.00 8.00 6.50 -3.8 -3.6 -3.1 11.0 10.4 11.2 1.9 1.2 0.8 Turkey 1.5 3.4 3.3 8.1 9.1 7.9 8.00 8.50 8.00 -2.6 -2.8 -2.5 33.1 33.6 33.1 -5.1 -5.6 -6.0 China 6.7 6.3 6.2 2.1 2.2 2.5 4.35 4.10 3.85 -3.1 -3.5 -3.5 46.0 50.0 53.0 2.5 2.4 2.4 Japan 0.8 1.0 0.9 -0.2 0.6 0.9 -0.10 -0.10 -0.10 -5.3 -5.2 -5.0 250.0 253.0 255.0 3.7 3.5 3.5

*non-wda figures. Adjusted for working days: 1.7% (2016), 1.8% (2017) and 1.6% (2018). Source: UniCredit Research


Economics & FI/FX Research

2017 Outlook December 2016

Table 2: Quarterly GDP and CPI forecasts REAL GDP (% QOQ, SA)

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 US (annualized) 3.2 2.3 2.2 2.3 2.8 2.9 2.9 2.7 2.5 2.3 Eurozone 0.3 0.3 0.4 0.4 0.4 0.4 0.3 0.3 0.3 0.3 Germany 0.2 0.3 0.5 0.5 0.5 0.5 0.4 0.4 0.4 0.4 France 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2 Italy 0.3 0.0 0.2 0.3 0.3 0.2 0.2 0.2 0.2 0.2 Spain 0.7 0.6 0.6 0.6 0.6 0.5 0.5 0.4 0.4 0.4 Austria 0.5 0.6 0.4 0.3 0.3 0.3 0.4 0.4 0.4 0.4 Other EU UK 0.5 0.4 0.3 0.1 0.2 0.2 0.2 0.2 0.2 0.2 Sweden 0.5 0.8 0.4 0.8 0.4 1.0 0.4 0.8 0.4 0.8 Poland (% yoy) 2.5 2.0 2.2 2.3 3.4 3.8 3.1 3.3 3.2 3.8 Czech Republic 0.2 0.4 0.6 0.7 0.6 0.7 0.6 0.6 0.6 0.6 Hungary 0.3 2.0 0.4 0.4 0.5 0.5 1.1 0.8 0.8 0.8 Others Switzerland 0.0 0.4 0.4 0.4 0.4 0.5 0.5 0.4 0.4 0.4 Russia -0.1 0.2 0.3 0.3 0.5 0.5 0.3 0.2 0.1 0.1 Turkey (% yoy) -1.8 -1.3 0.4 1.1 7.7 4.6 3.6 2.6 3.6 3.4

CPI INFLATION (% YOY)

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 US 1.1 1.8 2.5 2.5 2.7 2.4 2.5 2.5 2.6 2.7 Eurozone 0.3 0.7 1.6 1.5 1.6 1.5 1.4 1.4 1.5 1.5 Germany 0.5 0.9 1.5 1.8 1.9 1.9 1.9 1.8 1.8 2.0 France 0.3 0.5 1.2 1.2 1.4 1.5 1.3 1.3 1.3 1.3 Italy 0.0 0.0 0.7 1.1 1.3 1.4 1.2 1.1 1.1 1.2 Spain -0.3 0.6 1.2 1.2 1.3 1.3 1.6 1.6 1.7 1.7 Austria 0.7 1.4 1.9 1.9 1.7 1.7 1.9 1.9 1.9 1.9 Other EU UK 0.7 1.2 1.8 2.1 2.5 2.7 2.8 3.0 2.9 2.7 Sweden 1.0 1.3 1.6 1.6 1.8 1.8 1.8 1.7 1.8 1.9 Poland -0.8 0.0 1.1 1.4 1.9 2.0 2.1 2.2 1.9 1.9 Czech Republic 0.5 1.3 1.7 1.8 2.2 2.1 2.2 2.2 2.2 2.2 Hungary 0.6 1.7 3.3 2.6 3.3 3.1 2.9 2.9 2.7 2.6 Others Switzerland -0.2 0.1 0.3 0.4 0.6 0.8 0.8 0.9 0.9 1.0 Russia 6.4 5.7 5.0 4.7 4.6 4.5 4.3 4.2 4.1 4.0 Turkey 7.3 8.1 11.3 10.3 10.1 9.1 7.9 7.6 7.7 7.9

Source: UniCredit Research




Table 3: Comparison of annual GDP and CPI forecasts GDP (%)

UniCredit

IMF (Oct-16)

European Commission (Nov-16)

OECD (Nov-16)

2016 2017 2018 2016 2017 2018 2016 2017 2018 2016 2017 2018 US 1.6 2.4 2.7 1.6 2.2 2.1 1.6 2.1 1.9 1.5 2.3 3.0 Eurozone 1.6 1.5 1.4 1.7 1.5 1.6 1.7 1.5 1.7 1.7 1.6 1.7 Germany 1.8* 1.5* 1.6* 1.7 1.4 1.4 1.9 1.5 1.7 1.7 1.7 1.7 France 1.2 1.2 1.1 1.3 1.3 1.6 1.3 1.4 1.7 1.2 1.3 1.6 Italy 0.9 0.8 0.9 0.8 0.9 1.1 0.7 0.9 1.0 0.8 0.9 1.0 Spain 3.2 2.4 2.0 3.1 2.2 1.9 3.2 2.3 2.1 3.2 2.3 2.2 Austria 1.5 1.6 1.4 1.4 1.2 1.2 1.5 1.6 1.6 1.5 1.5 1.3 Greece 0.1 0.9 1.4 0.1 2.8 3.1 -0.3 2.7 3.1 0.0 1.3 1.9 Portugal 1.2 1.2 1.1 1.0 1.1 1.2 0.9 1.2 1.4 1.2 1.2 1.3 Other EU UK 2.1 1.2 0.8 1.8 1.1 1.7 1.9 1.0 1.2 2.0 1.2 1.0 Sweden 3.2 2.5 2.6 3.6 2.6 2.2 3.4 2.4 2.1 3.3 2.7 2.2 Poland 2.7 3.0 3.4 3.1 3.4 3.3 3.1 3.4 3.2 2.6 3.2 3.1 Czech Rep. 2.4 2.4 2.5 2.5 2.7 2.4 2.2 2.6 2.7 2.4 2.5 2.6 Hungary 2.2 3.0 3.1 2.0 2.5 2.4 2.1 2.6 2.8 1.7 2.5 2.2 Others Switzerland 1.4 1.5 1.7 1.0 1.3 1.5 1.2 1.5 1.7 1.6 1.7 1.9 Russia -0.8 0.9 1.1 -0.8 1.1 1.2 -1.0 0.6 0.8 -0.8 0.8 1.0 Turkey 1.5 3.4 3.3 3.3 3.0 3.2 2.7 3.0 3.3 2.9 3.3 3.8 China 6.7 6.3 6.2 6.6 6.2 6.0 6.6 6.2 6.0 6.7 6.4 6.1 Japan 0.8 1.0 0.9 0.5 0.6 0.5 0.7 0.8 0.4 0.8 1.0 0.8

CPI INFLATION (%)**

UniCredit

IMF (Oct-16)

European Commission (Nov-16)

OECD (Nov-16)

2016 2017 2018 2016 2017 2018 2016 2017 2018 2016 2017 2018 US 1.3 2.5 2.6 1.2 2.3 2.6 1.2 2.0 2.1 1.2 1.9 2.2 Eurozone 0.2 1.5 1.4 0.3 1.1 1.3 0.3 1.4 1.4 0.2 1.2 1.4 Germany 0.4 1.8 1.9 0.4 1.5 1.7 0.4 1.5 1.5 0.3 1.4 1.7 France 0.2 1.3 1.3 0.3 1.0 1.1 0.3 1.3 1.4 0.3 1.2 1.2 Italy -0.1 1.1 1.1 -0.1 0.5 0.8 0.0 1.2 1.4 -0.1 0.8 1.2 Spain -0.4 1.3 1.7 -0.3 1.0 1.1 -0.4 1.6 1.5 -0.3 1.5 1.3 Austria 0.9 1.8 1.9 0.9 1.5 1.8 1.0 1.8 1.6 0.9 1.7 1.8 Greece 0.0 0.6 0.7 -0.1 0.6 1.0 0.1 1.1 1.0 0.1 1.1 1.4 Portugal 0.6 1.0 0.9 0.7 1.1 1.4 0.7 1.2 1.4 0.7 1.1 1.1 Other EU UK 0.6 2.3 2.8 0.7 2.5 2.6 0.7 2.5 2.6 0.6 2.4 2.9 Sweden 0.9 1.7 1.8 1.1 1.4 1.7 1.1 1.6 2.0 0.9 1.5 2.0 Poland -0.6 1.6 2.0 -0.6 1.1 1.9 -0.2 1.3 1.8 -0.8 1.1 1.7 Czech Rep. 0.6 2.0 2.2 0.6 1.9 2.0 0.5 1.2 1.6 0.6 1.8 2.2 Hungary 0.5 3.0 3.0 0.4 1.9 2.6 0.4 2.3 2.7 0.1 1.4 2.5 Others Switzerland -0.4 0.5 0.9 -0.4 0.0 0.5 -0.4 0.0 0.2 -0.4 0.3 0.5 Russia 7.1 4.8 4.2 7.2 5.0 4.5 7.3 5.2 4.2 7.2 5.9 5.0 Turkey 8.1 9.1 7.9 8.4 8.2 6.8 7.8 8.0 7.6 7.9 7.7 7.3 China 2.1 2.2 2.5 2.1 2.3 2.4 - - - 2.1 2.2 2.9 Japan -0.2 0.6 0.9 -0.2 0.5 0.6 -0.3 0.0 0.1 -0.3 0.3 1.0

*non-wda figures. Adjusted for working days: 1.7% (2016), 1.8% (2017) and 1.6% (2018). **UniCredit forecasts refer to CPI with the exception of Spain, where HICP is used. IMF and OECD inflation forecasts refer to the CPI except for eurozone countries, where HICP is used. EC inflation forecasts refer to the HICP, except for the US, where CPI is used. Please note that in the UK, CPI and HICP coincide.

Source: IMF, European Commission, OECD, UniCredit Research




Table 4: FI forecasts INTEREST RATE AND YIELD FORECASTS (%)

Current Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 EMU Refi rate 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Depo -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 3M EUR -0.32 -0.35 -0.35 -0.35 -0.35 -0.35 -0.35 -0.35 -0.35 2Y Schatz -0.80 -0.70 -0.60 -0.55 -0.55 -0.45 -0.40 -0.35 -0.30 5Y Obl -0.46 -0.40 -0.30 -0.20 -0.10 0.05 0.10 0.15 0.20 10Y Bund 0.34 0.40 0.50 0.65 0.80 0.95 1.10 1.15 1.20 fwd 0.44 0.50 0.56 0.62 0.68 0.74 0.80 0.86 30Y Bund 1.09 1.15 1.30 1.45 1.60 1.80 1.90 2.00 2.10 2/10 113 110 110 120 135 140 150 150 150 2/5/10 -46 -50 -50 -50 -45 -40 -50 -50 -50 10/30 75 75 80 80 80 85 80 85 90 2Y EUR swap -0.16 -0.10 -0.05 -0.05 -0.10 0.00 0.00 0.05 0.10 5Y EUR swap 0.14 0.20 0.25 0.30 0.35 0.50 0.50 0.55 0.60 10Y EUR swap 0.77 0.80 0.90 1.00 1.15 1.30 1.40 1.45 1.50 US FedFunds 0.75 0.75 1.00 1.00 1.25 1.25 1.50 1.75 2.00 3M Libor 0.97 1.00 1.30 1.30 1.55 1.55 1.80 2.05 2.30 2Y UST 1.26 1.35 1.45 1.60 1.75 1.95 2.10 2.25 2.40 5Y UST 2.07 2.20 2.30 2.40 2.45 2.55 2.60 2.65 2.65 10Y UST 2.58 2.70 2.85 2.95 3.00 3.00 3.00 3.00 3.00 fwd 2.66 2.73 2.80 2.86 2.91 2.96 3.01 3.06 30Y UST 3.13 3.35 3.55 3.60 3.60 3.60 3.60 3.60 3.60 2/10 131 135 140 135 125 105 90 75 60 2/5/10 31 35 30 25 15 15 10 5 -10 10/30 55 65 70 65 60 60 60 60 60 2Y USD swap 1.52 1.60 1.70 1.85 2.00 2.20 2.35 2.50 2.65 10Y USD swap 2.51 2.60 2.80 2.90 2.95 2.95 3.00 3.00 3.00 UK Key rate 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 10Y Gilt 1.46 1.60 1.85 1.95 2.00 2.10 2.10 2.10 2.10 fwd 1.59 1.66 1.73 1.80 1.87 1.93 2.00 2.06

Spreads Current Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Apr-18 May-18 Jun-18 10Y UST-Bund 224 230 235 230 220 205 190 185 180 10Y UST-Gilt 111 110 100 100 100 90 90 90 90 10Y Gilt-Bund 113 120 135 130 120 115 100 95 90 10Y BTP-Bund 151 130 140 150 150 140 135 135 135 10Y EUR swap-Bund 41 40 40 35 35 35 30 30 30 10Y USD swap-UST -10 -10 -5 -5 -5 -5 0 0 0





Table 5: FX forecasts G10 & CEEMEA EXCHANGE RATES VS USD

USD Current 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 3M 6M 12M BEER* Deviation** G10 EUR-USD 1.04 1.05 1.08 1.09 1.10 1.12 1.14 1.15 1.16 1.05 1.08 1.10 1.20 -13.3% USD-CHF 1.03 1.04 1.02 1.01 1.02 1.00 0.98 0.98 0.98 1.04 1.02 1.02 0.98 5.1% GBP-USD 1.24 1.23 1.21 1.23 1.25 1.26 1.27 1.29 1.30 1.23 1.21 1.25 1.67 -25.7% USD-JPY 118 116 115 113 112 110 108 106 104 116 115 112 93.8 25.8% USD-NOK 8.66 8.38 8.06 7.89 7.73 7.50 7.28 7.13 6.98 8.38 8.06 7.73 6.05 43.1% USD-SEK 9.39 9.14 8.80 8.62 8.45 8.21 7.98 7.83 7.67 9.14 8.80 8.45 5.97 57.3% AUD-USD 0.74 0.75 0.76 0.77 0.78 0.79 0.80 0.80 0.80 0.75 0.76 0.78 0.69 7.2% NZD-USD 0.70 0.72 0.74 0.75 0.76 0.77 0.77 0.78 0.78 0.72 0.74 0.76 0.69 1.4% USD-CAD 1.33 1.30 1.26 1.23 1.22 1.22 1.21 1.20 1.18 1.30 1.26 1.22 1.19 11.8% USTW$ 94.9 93.8 92 90.7 89.8 88.6 87.2 86.2 85.1 93.8 92 89.8 82.6 14.9% USD-DXY 103 102 99.9 98.6 97.7 96.2 94.6 93.6 92.6 102 99.9 97.7 CEEMEA & CHINA USD-PLN 4.25 4.19 3.98 3.93 3.86 3.81 3.73 3.69 3.62 4.19 3.98 3.86 3.31 28.4% USD-HUF 300 297 292 289 291 279 275 273 276 297 292 291 284 5.6% USD-CZK 25.9 25.8 24.3 24.2 24.1 23.6 23.1 22.7 22.4 25.8 24.3 24.1 25.2 2.8% USD-RON 4.33 4.29 4.18 4.10 4.09 4.02 3.96 3.89 3.88 4.29 4.18 4.09 USD-TRY 3.52 3.60 3.48 3.45 3.65 3.70 3.65 3.60 3.80 3.60 3.48 3.65 USD-RUB 61.8 61.5 62.0 59.9 59.7 60.0 59.7 60.3 60.5 61.5 62.0 59.7 USD-ZAR 13.9 13.3 14.0 14.7 14.4 14.2 14.1 13.9 13.9 13.3 14.0 14.4 USD-CNY 6.95 6.98 7.08 7.11 7.25 7.27 7.38 7.40 7.50 6.98 7.08 7.25

G10 & CEEMEA EXCHANGE RATES VS EUR

EUR Current 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 3M 6M 12M BEER* Deviation** G10 EUR-USD 1.04 1.05 1.08 1.09 1.10 1.12 1.14 1.15 1.16 1.05 1.08 1.10 1.20 -13.3% EUR-CHF 1.07 1.09 1.10 1.10 1.12 1.12 1.12 1.13 1.14 1.09 1.10 1.12 1.18 -9.3% EUR-GBP 0.84 0.85 0.89 0.89 0.88 0.89 0.90 0.89 0.89 0.85 0.89 0.88 0.72 16.7% EUR-JPY 123 122 124 123 123 123 123 122 121 122 124 123 113 8.8% EUR-NOK 9.04 8.80 8.70 8.60 8.50 8.40 8.30 8.20 8.10 8.80 8.70 8.50 7.26 24.5% EUR-SEK 9.81 9.60 9.50 9.40 9.30 9.20 9.10 9.00 8.90 9.60 9.50 9.30 7.17 36.8% EUR-AUD 1.42 1.40 1.42 1.42 1.41 1.42 1.43 1.44 1.45 1.40 1.42 1.41 1.78 -20.2% EUR-NZD 1.48 1.46 1.46 1.45 1.45 1.45 1.48 1.47 1.49 1.46 1.46 1.45 1.74 -14.9% EUR-CAD 1.39 1.37 1.36 1.34 1.34 1.37 1.38 1.38 1.37 1.37 1.36 1.34 1.43 -2.8% EUR-TWI 94.4 94.9 96.8 97.2 98.1 99.1 100.3 100.5 101.2 94.9 96.8 98.1 CEEMEA & CHINA EUR-PLN 4.43 4.40 4.30 4.28 4.25 4.27 4.25 4.24 4.20 4.40 4.30 4.25 3.97 11.5% EUR-HUF 313 312 315 315 320 312 313 314 320 312 315 320 341 -8.2% EUR-CZK 27.0 27.1 26.2 26.4 26.5 26.4 26.3 26.1 26.0 27.1 26.2 26.5 30.2 -10.7% EUR-RON 4.52 4.50 4.51 4.47 4.50 4.50 4.52 4.47 4.50 4.50 4.51 4.50 EUR-TRY 3.67 3.78 3.76 3.76 4.02 4.14 4.16 4.14 4.41 3.78 3.76 4.02 EUR-RUB 64.6 64.6 67.0 65.3 65.7 67.2 68.1 69.3 70.2 64.6 67.0 65.7 EUR-ZAR 14.5 14.0 15.1 16.0 15.8 15.9 16.1 16.0 16.1 14.0 15.1 15.8 EUR-CNY 7.26 7.33 7.65 7.75 7.98 8.14 8.41 8.51 8.70 7.33 7.65 7.98

*BEER values are fair value estimates based on our Behavioral Equilibrium Exchange Rate model "BEER by UniCredit” **Deviation between current value of the exchange rate and the fair value estimate Source: Bloomberg, UniCredit Research




Table 6: Commodities forecasts Current 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 Brent (USD/bbl) 54.08 52 55 59 60 60 63 65 60


Table 7: Risky assets forecasts EQUITY AND CREDIT FORECASTS

Current Mid-2017 End-2017 Equities Euro STOXX 50 3240 3300 3300 DAX 11360 12000 12000 FTSE MIB 19000 18000 18000 Credit** iBoxx Non-Financials Senior 48 53 85 iBoxx Financials Sen 48 48 55 iBoxx High Yield NFI 338 400 450




UniCredit Research page 54

Disclaimer Our recommendations are based on information obtained from, or are based upon public information sources that we consider to be reliable but for the completeness and accuracy of which we assume no liability. All estimates and opinions included in the report represent the independent judgment of the analysts as of the date of the issue. This report may contain links to websites of third parties, the content of which is not controlled by UniCredit Bank. No liability is assumed for the content of these third-party websites. We reserve the right to modify the views expressed herein at any time without notice. Moreover, we reserve the right not to update this information or to discontinue it altogether without notice. This analysis is for information purposes only and (i) does not constitute or form part of any offer for sale or subscription of or solicitation of any offer to buy or subscribe for any financial, money market or investment instrument or any security, (ii) is neither intended as such an offer for sale or subscription of or solicitation of an offer to buy or subscribe for any financial, money market or investment instrument or any security nor (iii) as an advertisement thereof. The investment possibilities discussed in this report may not be suitable for certain investors depending on their specific investment objectives and time horizon or in the context of their overall financial situation. The investments discussed may fluctuate in price or value. Investors may get back less than they invested. Changes in rates of exchange may have an adverse effect on the value of investments. Furthermore, past performance is not necessarily indicative of future results. In particular, the risks associated with an investment in the financial, money market or investment instrument or security under discussion are not explained in their entirety. This information is given without any warranty on an "as is" basis and should not be regarded as a substitute for obtaining individual advice. Investors must make their own determination of the appropriateness of an investment in any instruments referred to herein based on the merits and risks involved, their own investment strategy and their legal, fiscal and financial position. As this document does not qualify as an investment recommendation or as a direct investment recommendation, neither this document nor any part of it shall form the basis of, or be relied on in connection with or act as an inducement to enter into, any contract or commitment whatsoever. Investors are urged to contact their bank's investment advisor for individual explanations and advice. Neither UniCredit Bank nor any of their respective directors, officers or employees nor any other person accepts any liability whatsoever (in negligence or otherwise) for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection therewith. This analysis is being distributed by electronic and ordinary mail to professional investors, who are expected to make their own investment decisions without undue reliance on this publication, and may not be redistributed, reproduced or published in whole or in part for any purpose. Responsibility for the content of this publication lies with: UniCredit Group and its subsidiaries are subject to regulation by the European Central Bank a) UniCredit Bank AG (UniCredit Bank), Am Tucherpark 16, 80538 Munich, Germany, (also responsible for the distribution pursuant to §34b WpHG). The company belongs to UniCredit Group. Regulatory authority: “BaFin“ – Bundesanstalt für Finanzdienstleistungsaufsicht, Lurgiallee 12, 60439 Frankfurt, Germany. b) UniCredit Bank AG London Branch (UniCredit Bank London), Moor House, 120 London Wall, London EC2Y 5ET, United Kingdom. Regulatory authority: “BaFin“ – Bundesanstalt für Finanzdienstleistungsaufsicht, Lurgiallee 12, 60439 Frankfurt, Germany and subject to limited regulation by the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS, United Kingdom and Prudential Regulation Authority 20 Moorgate, London, EC2R 6DA, United Kingdom. Further details regarding our regulatory status are available on request. c) UniCredit Bank AG Hong Kong Branch (UniCredit Bank Hong Kong), 25/F Man Yee Building, 68 Des Voeux Road Central, Hong Kong. Regulatory authority: Hong Kong Monetary Authority, 55th Floor, Two International Financial Centre, 8 Finance Street, Central, Hong Kong d) UniCredit Bank AG Singapore Branch (UniCredit Bank Singapore), Prudential Tower, 30 Cecil Street, #25-01, Singapore 049712 Regulatory authority: Monetary Authority of Singapore, 10 Shenton Way MAS Building, Singapore 079117 e) UniCredit Bank AG Tokyo Branch (UniCredit Tokyo), Otemachi 1st Square East Tower 18/F, 1-5-1 Otemachi, Chiyoda-ku, 100-0004 Tokyo, Japan Regulatory authority: Financial Services Agency, The Japanese Government, 3-2-1 Kasumigaseki Chiyoda-ku Tokyo, 100-8967 Japan, The Central Common Government Offices No. 7.

POTENTIAL CONFLICTS OF INTERESTS Company Key – –

Key 1a: UniCredit Bank AG and/or any related legal person owns at least 2% of the capital stock of the analyzed company. Key 1b: The analyzed company owns at least 2% of the capital stock of UniCredit Bank AG and/or any related legal person. Key 2: UniCredit Bank AG and/or any related legal person has been lead manager or co-lead manager over the previous 12 months of any publicly disclosed offer of financial instruments of the analyzed company, or in any related derivatives. Key 3: UniCredit Bank AG and/or any related legal person administers the securities issued by the analyzed company on the stock exchange or on the market by quoting bid and ask prices (i.e. acts as a market maker or liquidity provider in the securities of the analyzed company or in any related derivatives). Key 5: The analyzed company and UniCredit Bank AG and/or any related legal person have concluded an agreement on the preparation of analyses. Key 6a: Employees or members of the Board of Directors of UniCredit Bank AG and/or any other employee that works for UniCredit Research (i.e. the joint research department of the UniCredit Group) and/or members of the Group Board (pursuant to relevant domestic law) are members of the Board of Directors of the analyzed company. Members of the Board of Directors of the analyzed company hold office in the Board of Directors of UniCredit Bank AG (pursuant to relevant domestic law). The application of this Key 6a is limited to persons who, although not involved in the preparation of the analysis, had or could reasonably be expected to have access to the analysis prior to its dissemination to customers or the public. Key 6b: The analyst is on the Supervisory Board/Board of Directors of the company they cover. Key 8a: UniCredit Bank AG and/or any related legal person hold a net long position exceeding 0.5% of the total issued share capital of the issuer. Key 8b: UniCredit Bank AG and/or any related legal person hold a net short position exceeding 0.5% of the total issued share capital of the issuer.

RECOMMENDATIONS, RATINGS AND EVALUATION METHODOLOGY Company Date Rating Currency Target price – – – – –

Overview of our ratings You will find the history of rating regarding recommendation changes as well as an overview of the breakdown in absolute and relative terms of our investment ratings on our website www.disclaimer.unicreditmib.eu/credit-research-rd/Recommendations_CR_e.pdf. Note on the evaluation basis for interest-bearing securities: Recommendations relative to an index: For high grade names the recommendations are relative to the "iBoxx EUR Benchmark" index family, for sub investment grade names the recommendations are relative to the "iBoxx EUR High Yield" index family. Marketweight: We recommend having the same portfolio exposure in the name as the respective iBoxx index. We expect that the average total return of the instruments of the issuer is equal to the total return of the index. Overweight: We recommend having a higher portfolio exposure in the name as the respective iBoxx index. We expect that the average total return of the instruments of the issuer is greater than the total return of the index. Underweight: We recommend having a lower portfolio exposure in the name as the respective iBoxx index. We expect that the average total return of the instruments of the issuer is less than the total return of the index. Outright recommendations: Hold: We recommend holding the respective instrument for investors who already have exposure. We expect that the total return of the instruments of the issuer is equal to the yield. Buy: We recommend buying the respective instrument for investors who already have exposure. We expect that the total return of the instruments of the issuer is greater than the yield. Sell: We recommend selling the respective instrument for investors who already have exposure. We expect that the total return of the instruments of the issuer is less than the yield. We employ three further categorizations for interest-bearing securities in our coverage:




Restricted: A recommendation and/or financial forecast is not disclosed owing to compliance or other regulatory considerations such as a blackout period or a conflict of interest. Coverage in transition: Due to changes in the research team, the disclosure of a recommendation and/or financial information are temporarily suspended. The interest-bearing security remains in the research universe and disclosures of relevant information will be resumed in due course. Not rated: Suspension of coverage. Trading recommendations for fixed-interest securities mostly focus on the credit spread (yield difference between the fixed-interest security and the relevant government bond or swap rate) and on the rating views and methodologies of recognized agencies (S&P, Moody’s, Fitch). Depending on the type of investor, investment ratings may refer to a short period or to a 6 to 9-month horizon. Please note that the provision of securities services may be subject to restrictions in certain jurisdictions. You are required to acquaint yourself with local laws and restrictions on the usage and the availability of any services described herein. The information is not intended for distribution to or use by any person or entity in any jurisdiction where such distribution would be contrary to the applicable law or provisions. If not otherwise stated daily price data refers to pre-day closing levels and iBoxx bond index characteristics refer to the previous month-end index characteristics. Coverage Policy A list of the companies covered by UniCredit Bank is available upon request. Frequency of reports and updates It is intended that each of these companies be covered at least once a year, in the event of key operations and/or changes in the recommendation.

SIGNIFICANT FINANCIAL INTEREST UniCredit Bank AG and/or other related legal persons with them regularly trade shares of the analyzed company. UniCredit Bank AG and/or other related legal persons may hold significant open derivative positions on the stocks of the company which are not delta-neutral. UniCredit Bank AG and/or other related legal persons have a significant financial interest relating to the analyzed company or may have such at any future point of time. Due to the fact that UniCredit Bank AG and/or any related legal person are entitled, subject to applicable law, to perform such actions at any future point in time which may lead to the existence of a significant financial interest, it should be assumed for the purposes of this information that UniCredit Bank AG and/or any related legal person will in fact perform such actions which may lead to the existence of a significant financial interest relating to the analyzed company. Analyses may refer to one or several companies and to the securities issued by them. In some cases, the analyzed companies have actively supplied information for this analysis.

INVESTMENT SERVICES The analyzed company and UniCredit Bank AG and/or any related legal person concluded an agreement on the provision of investment services in the previous 12 months, in return for which the Bank and/or such related legal person received a consideration or promise of consideration or intends to do so. Due to the fact that UniCredit Bank AG and/or any related legal person are entitled to conclude, subject to applicable law, an agreement on the provision of investment services with the analyzed company at any future point in time and may receive a consideration or promise of consideration, it should be assumed for the purposes of this information that UniCredit Bank AG and/or any related legal person will in fact conclude such agreements and will in fact receive such consideration or promise of consideration.

ANALYST DECLARATION The author’s remuneration has not been, and will not be, geared to the recommendations or views expressed in this study, neither directly nor indirectly.

ORGANIZATIONAL AND ADMINISTRATIVE ARRANGEMENTS TO AVOID AND PREVENT CONFLICTS OF INTEREST To prevent or remedy conflicts of interest, UniCredit Bank has established the organizational arrangements required from a legal and supervisory aspect, adherence to which is monitored by its compliance department. Conflicts of interest arising are managed by legal and physical and non-physical barriers (collectively referred to as “Chinese Walls”) designed to restrict the flow of information between one area/department of UniCredit Bank and another. In particular, Investment Banking units, including corporate finance, capital market activities, financial advisory and other capital raising activities, are segregated by physical and non-physical boundaries from Markets Units, as well as the research department. Disclosure of publicly available conflicts of interest and other material interests is made in the research. Analysts are supervised and managed on a day-to-day basis by line managers who do not have responsibility for Investment Banking activities, including corporate finance activities, or other activities other than the sale of securities to clients.

ADDITIONAL REQUIRED DISCLOSURES UNDER THE LAWS AND REGULATIONS OF JURISDICTIONS INDICATED You will find a list of further additional required disclosures under the laws and regulations of the jurisdictions indicated on our website www.cib-unicredit.com/research-disclaimer. Notice to Austrian investors: This analysis is only for distribution to professional clients (Professionelle Kunden) as defined in article 58 of the Securities Supervision Act. Notice to investors in Bosnia and Herzegovina: This report is intended only for clients of UniCredit in Bosnia and Herzegovina who are institutional investors (Institucionalni investitori) in accordance with Article 2 of the Law on Securities Market of the Federation of Bosnia and Herzegovina and Article 2 of the Law on Securities Markets of the Republic of Srpska, respectively, and may not be used by or distributed to any other person. This document does not constitute or form part of any offer for sale or subscription for or solicitation of any offer to buy or subscribe for any securities and neither this document nor any part of it shall form the basis of, or be relied on in connection with or act as an inducement to enter into, any contract or commitment whatsoever. Notice to Brazilian investors: The individual analyst(s) responsible for issuing this report represent(s) that: (a) the recommendations herein reflect exclusively the personal views of the analysts and have been prepared in an independent manner, including in relation to UniCredit Group; and (b) except for the potential conflicts of interest listed under the heading “Potential Conflicts of Interest” above, the analysts are not in a position that may impact on the impartiality of this report or that may constitute a conflict of interest, including but not limited to the following: (i) the analysts do not have a relationship of any nature with any person who works for any of the companies that are the object of this report; (ii) the analysts and their respective spouses or partners do not hold, either directly or indirectly, on their behalf or for the account of third parties, securities issued by any of the companies that are the object of this report; (iii) the analysts and their respective spouses or partners are not involved, directly or indirectly, in the acquisition, sale and/or trading in the market of the securities issued by any of the companies that are the object of this report; (iv) the analysts and their respective spouses or partners do not have any financial interest in the companies that are the object of this report; and (v) the compensation of the analysts is not, directly or indirectly, affected by UniCredit’s revenues arising out of its businesses and financial transactions. UniCredit represents that: except for the potential conflicts of interest listed under the heading “Potential Conflicts of Interest” above, UniCredit, its controlled companies, controlling companies or companies under common control (the “UniCredit Group”) are not in a condition that may impact on the impartiality of this report or that may constitute a conflict of interest, including but not limited to the following: (i) the UniCredit Group does not hold material equity interests in the companies that are the object of this report; (ii) the companies that are the object of this report do not hold material equity interests in the UniCredit Group; (iii) the UniCredit Group does not have material financial or commercial interests in the companies or the securities that are the object of this report; (iv) the UniCredit Group is not involved in the acquisition, sale and/or trading of the securities that are the object of this report; and (v) the UniCredit Group does not receive compensation for services rendered to the companies that are the object of this report or to any related parties of such companies. Notice to Canadian investors: This communication has been prepared by UniCredit Bank AG, which does not have a registered business presence in Canada. This communication is a general discussion of the merits and risks of a security or securities only, and is not in any way meant to be tailored to the needs and circumstances of any recipient. The contents of this communication are for information purposes only, therefore should not be construed as advice and do not constitute an offer to sell, nor a solicitation to buy any securities. Notice to Cyprus investors: This document is directed only at clients of UniCredit Bank who are persons falling within the Second Appendix (Section 2, Professional Clients) of the law for the Provision of Investment Services, the Exercise of Investment Activities, the Operation of Regulated Markets and other Related Matters, Law 144(I)/2007 and persons to whom it may otherwise lawfully be communicated who possess the experience, knowledge and expertise to make their own investment decisions and properly assess the risks that they incur (all such persons together being referred to as “relevant persons”). This document must not be acted on or relied on by persons who are not relevant persons or relevant persons who have requested to be treated as retail clients. Any investment or investment activity to which this communication related is available only to relevant persons and will be engaged in only with relevant persons. This document does not constitute an offer or solicitation to any person to whom it is unlawful to make such an offer or solicitation. Notice to Hong Kong investors: This report is for distribution only to “professional investors” within the meaning of Schedule 1 to the Securities and Futures Ordinance (Chapter 571, Laws of Hong Kong) and any rules made thereunder, and may not be reproduced, or used by or further distributed to any other person, in whole or in part, for any purpose. This report does not constitute or form part of an offer or solicitation of any offer to buy or sell any securities, nor should it or any part of it form the basis of, or be relied upon in connection with, any contract or commitment whatsoever. By accepting this report, the recipient represents and warrants that it is entitled to receive such report in accordance with, and on the basis of, the restrictions set out in this “Disclaimer” section, and agrees to be bound by those restrictions. Notice to investors in Ivory Coast: The information contained in the present report have been obtained by Unicredit Bank AG from sources believed to be reliable, however, no express or implied representation or warranty is made by Unicredit Bank AG or any other person as to the completeness or accuracy of such information. All opinions and estimates contained in the present report constitute a judgement of Unicredit Bank AG as of the date of the present report and are subject to change without notice. They are provided in good faith but without assuming legal responsibility. This report is not an offer to sell or solicitation of an offer to buy or invest in securities. Past performance is not an indicator of future performance and future returns cannot be guaranteed, and there is a risk of loss of the initial capital invested. No matter contained in this document may be reproduced or copied by any means without the prior consent of Unicredit Bank AG.




Notice to New Zealand investors: This report is intended for distribution only to persons who are “wholesale clients” within the meaning of the Financial Advisers Act 2008 (“FAA”) and by receiving this report you represent and agree that (i) you are a “wholesale client” under the FAA (ii) you will not distribute this report to any other person, including (in particular) any person who is not a “wholesale client” under the FAA. This report does not constitute or form part of, in relation to any of the securities or products covered by this report, either (i) an offer of securities for subscription or sale under the Securities Act 1978 or (ii) an offer of financial products for issue or sale under the Financial Markets Conduct Act 2013. Notice to Omani investors: This communication has been prepared by UniCredit Bank AG. UniCredit Bank AG does not have a registered business presence in Oman and does not undertake banking business or provide financial services in Oman and no advice in relation to, or subscription for, any securities, products or financial services may or will be consummated within Oman. The contents of this communication are for the information purposes of sophisticated clients, who are aware of the risks associated with investments in foreign securities and neither constitutes an offer of securities in Oman as contemplated by the Commercial Companies Law of Oman (Royal Decree 4/74) or the Capital Market Law of Oman (Royal Decree 80/98), nor does it constitute an offer to sell, or the solicitation of any offer to buy non-Omani securities in Oman as contemplated by Article 139 of the Executive Regulations to the Capital Market Law (issued vide CMA Decision 1/2009). This communication has not been approved by and UniCredit Bank AG is not regulated by either the Central Bank of Oman or Oman’s Capital Market Authority. Notice to Pakistani investors: Investment information, comments and recommendations stated herein are not within the scope of investment advisory activities as defined in sub-section I, Section 2 of the Securities and Exchange Ordinance, 1969 of Pakistan. Investment advisory services are provided in accordance with a contract of engagement on investment advisory services concluded with brokerage houses, portfolio management companies, non-deposit banks and the clients. The distribution of this report is intended only for informational purposes for the use of professional investors and the information and opinions contained herein, or any part of it shall not form the basis of, or be relied on in connection with or act as an inducement to enter into, any contract or commitment whatsoever. Notice to Polish Investors: This document is intended solely for professional clients as defined in Art. 3.39b of the Trading in Financial Instruments Act of 29 July 2005 (as amended). The publisher and distributor of the document certifies that it has acted with due care and diligence in preparing it, however, assumes no liability for its completeness and accuracy. This document is not an advertisement. It should not be used in substitution for the exercise of independent judgment. Notice to Serbian investors: This analysis is only for distribution to professional clients (profesionalni klijenti) as defined in article 172 of the Law on Capital Markets. Notice to UK investors: This communication is directed only at clients of UniCredit Bank who (i) have professional experience in matters relating to investments or (ii) are persons falling within Article 49(2)(a) to (d) (“high net worth companies, unincorporated associations, etc.”) of the United Kingdom Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 or (iii) to whom it may otherwise lawfully be communicated (all such persons together being referred to as “relevant persons”). This communication must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this communication relates is available only to relevant persons and will be engaged in only with relevant persons. CR e 10




UniCredit Research* Erik F. Nielsen Group Chief Economist Global Head of CIB Research +44 207 826-1765 [email protected]

Dr. Ingo Heimig Head of Research Operations +49 89 378-13952 [email protected]

Cross Asset Research

Economics & FI/FX Research European Economics Marco Valli, Chief Eurozone Economist +39 02 8862-0537 [email protected] Dr. Andreas Rees, Chief German Economist +49 69 2717-2074 [email protected] Stefan Bruckbauer, Chief Austrian Economist +43 50505-41951 [email protected] Tullia Bucco, Economist +39 02 8862-0532 [email protected] Edoardo Campanella, Economist +39 02 8862-0522 [email protected] Dr. Loredana Federico, Lead Italy Economist +39 02 8862-0534 [email protected] Dr. Tobias Rühl, Economist +49 89 378-12560 [email protected] Chiara Silvestre, Economist [email protected] Dr. Thomas Strobel, Economist +49 89 378-13013 [email protected] Daniel Vernazza, Ph.D., Lead UK Economist +44 207 826-7805 [email protected]

US Economics Dr. Harm Bandholz, CFA, Chief US Economist +1 212 672-5957 [email protected]

EEMEA Economics & FI/FX Strategy Lubomir Mitov, Chief CEE Economist +44 207 826-1772 [email protected] Dan Bucşa, Lead CEE Economist +44 207 826-7954 [email protected] Javier Sánchez, CFA, CEE Fixed Income Strategist +44 207 826-6077 [email protected] Dumitru Vicol, Economist +44 207 826-6081 [email protected]

Global FI Strategy Michael Rottmann, Head, FI Strategy +49 89 378-15121 [email protected] Dr. Luca Cazzulani, Deputy Head, FI Strategy +39 02 8862-0640 [email protected] Chiara Cremonesi, FI Strategy +44 207 826-1771 [email protected] Alessandro Giongo, FI Strategy +39 02 8862-0538 [email protected] Elia Lattuga, FI Strategy +44 207 826-1642 [email protected] Kornelius Purps, FI Strategy +49 89 378-12753 [email protected] Herbert Stocker, Technical Analysis +49 89 378-14305 [email protected]

Global FX Strategy Dr. Vasileios Gkionakis, Global Head, FX Strategy +44 207 826-7951 [email protected] Kathrin Goretzki, CFA, FX Strategy +44 207 826-6076 [email protected] Kiran Kowshik, EM FX Strategy +44 207 826-6080 [email protected] Roberto Mialich, FX Strategy +39 02 8862-0658 [email protected]

Cross Asset Strategy Dr. Philip Gisdakis, Head +49 89 378-13228 [email protected] Marino Bucher, Technical Analysis +49 89 378-18148 [email protected] Dr. Tammo Greetfeld, Equity Strategy +49 89 378-18361 [email protected] Jochen Hitzfeld, Commodity Strategy +49 89 378-18709 [email protected] Christian Stocker, CEFA, Equity Strategy +49 89 378-18603 [email protected]

Credit Strategy & Structured Credit Research Dr. Philip Gisdakis, Head Credit Strategy +49 89 378-13228 [email protected] Dr. Christian Weber, CFA, Deputy Head Credit Strategy +49 89 378-12250 [email protected] Dr. Tim Brunne Quantitative Credit Strategy +49 89 378-13521 [email protected] Holger Kapitza Credit Strategy & Structured Credit +49 89 378-28745 [email protected] Dr. Stefan Kolek EEMEA Corporate Credits & Strategy +49 89 378-12495 [email protected] Manuel Trojovsky Credit Strategy & Structured Credit +49 89 378-14145 [email protected]

Publication Address

UniCredit Research Corporate & Investment Banking UniCredit Bank AG Arabellastrasse 12 D-81925 Munich [email protected]

Bloomberg UCGR Internet www.research.unicredit.eu

*UniCredit Research is the joint research department of UniCredit Bank AG (UniCredit Bank), UniCredit Bank AG London Branch (UniCredit Bank London), UniCredit Bank AG Milan Branch (UniCredit Bank Milan), UniCredit Bank New York (UniCredit Bank NY), UniCredit Bulbank, Zagrebačka banka d.d., UniCredit Bank Czech Republic and Slovakia, Bank Pekao, ZAO UniCredit Bank Russia (UniCredit Russia), UniCredit Bank Romania. XA 32

The UniCredit Macro & Markets 2017 Outlook

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