WEEKLY CROSS-ASSET MARKET OUTLOOK

21 SEPTEMBER 2016

ROBERT MCADIE

Global Markets Head of Research and Strategy

Non Independent Research – Marketing Communication www.GlobalMarkets.bnpparibas.com

Please refer to important information at the end of the report. This document is classified as non-objective research.

BNP PARIBAS MARKETS CALL

Complacency all around, in rates and FX markets

Market outlook

Source: BNP Paribas, Bloomberg

Federal Reserve: Today. The Fed has clearly signalled a rate hike for this

year.

� On top of strong labour markets and improving wage growth, core CPI data

have been at or above 2.3% since November 2015. Headline CPI is

climbing now, at 1.1%.

� Inventories that weighed on GDP growth last quarter are likely to provide a

boost to output for the rest of the year. As such, near-term risks to the

economic outlook have ‘diminished’, paving the way for the Fed to hike.

� Current market expectations (less than 20% chance of a hike) are too

low. We think the Fed has a clear window to raise rates at this

September meeting.

Bank of Japan: Shift in policy Price level targeting (yield curve control)

� The BoJ, will shift its monetary base with flexible purchasing policy until

inflation is above 2% and stable.(provide additional freedom to maintain the

current policy track indefinitely)

� The BoJ has scrapped average maturity target with no rate cut

� Should drive a steeper curve, good for financials, equities and slightly

weaker Yen

Markets, both risk free and risky, are complacent and are not ready

for higher rates after a strong performance in 2016.

� The recent violent repricing in some ‘risk free’ bonds is creating a volatility

jump normally associated with equity markets (around 20%). This will make

these long-dated assets less attractive, as their Sharpe ratio will drop. Safe

haven assets may not be that safe after all.

� The complacency in the FX market has reduced over the week, but there is

still lots of room for a reaction to a rate hike from the Fed, or even a

‘hawkish hold’.

20/09/2016 LDN close 1 Month prognosis Current vs prognosis

EURUSD 1.116 1.090 -2.36 %

GBPUSD 1.298 1.280 -1.39 %

USDJPY 101.67 106.00 4.26 %

10yr Gilts 81 bp 75 -6 bp

10yr Bunds -2 bp 5 7 bp

10 Tsys 1.67% 1.8% 13bp

10yr JGBs -6 bp 0 – 5bps 11 bp

S&P 2,143 2,070 -3.42 %

SX5E 2,965 2,900 -2.19 %

SX7E 92 90 -1.68 %

FTSE 100 6,831 6,650 -2.65 %

Nikkei 225 16,492 16,800 1.87 %

GOLD 1,315 1,320 0.37 %

Oil (CL1) 44 45 3.45 %

Itraxx Main S24 70bp 75 5 bp

Itraxx Xover S24 329bp 345 16bp

CDX S26 75bp 77 2 bp

Please Note: Underlining denotes a change in target

2

Fed and BoJ outcome scenarios and likely market impact

Fed

Dovish on hold

(US 2s10s flatter, US 10yr aTSY 1.5%)

Hawkish on hold

(US 2s10s steepening, US 10yr aTSY 1.75-

1.8%)

Rate hike

(US 2s10s intital flattening then

steepening, US 10yr aTSY 1.8-1.9%)

USDJPY lower (<100) USDJPY slightly lower (102-103) USDJPY higher (105)

Nikkei down vs other equities Nikkei lower Nikkei lower

Global equity mkts & risk ccys supported Global equities and risky ccy steady Global equities and risky ccy under

pressure

USDJPY (102) USDJPY (104) USDJPY higher (108)

NKY rebound but inline with global equities NKY outperform global equity NKY outperform global equities

Global risk appetite to be supported Neutral impact on global risk taking Global risk taking underpressure

USDJPY higher (105) USDJPY higher (107) USDJPY substantially higher (110)

Strong rally of risky assets Support to risky assets NKY outperforms other equity mkts

NKY to rise, overperformance of Banks Strong outperformance of NKY Global risk underpressure

No policy change

(JGB 2s10s unchanged

and 10yr at -6bps)

Moderate easing:

Change to purchase

program (price level

targeting), no rate cut,

no increase in ETF

(JGB 2s10s steeper, 10yr

@ 0-5bps)

Big Change: Major

change to their QE

program, allow banks to

fund at neg rates,

Indication of further

policy changes

(JGB 2s10s steeper, 10yr

@ 5-10bps)

BOJ

Sources: BNP Paribas, Bloomberg

3

When ‘safe haven’ asset prices drop, the rest should follow

Chart 2: So far Duration vol has not filtered into credit risk

Sources: BNP Paribas, Bloomberg

Chart 1: Repricing in Tsys has not yet filtered into spread product

Table 1: How many months of carry compensate for 1bp rise

90

100

110

120

130

140

Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16

Short dated usd EM bonds(rebased at 100 in 2011)

Long dated USD bonds(rebased at 100 in 2011)

Chart 3: 3m realised vols are going up faster in bonds than equities

5%

10%

15%

20%

25%

30%

Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16

US TBond vol

Long Bund vol

S&P vol

150

175

200

225

250

275

300

85

100

115

130

145

Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16

Long dated IG bondsOAS spread (rhs)

Long dated USD Tsy Price

(rebased at 100 in 2011 lhs)

Bonds Rating YTMPrice move in cts for 1bp

move in yield

Mths of carry for

10bp

Tnote 2026 Aaa 1.70 -9.3 6.6

DBR 2026 Aaa - 0.00 -10.1 N/A

UKT 2026 Aa1 0.82 -9.3 13.5

JGB 2026 A1 - 0.03 -10.0 N/A

US HG A- 2.88 -6.4 2.7

US HY B+ 6.44 -4.4 0.8

EU HG A- 0.66 -6.5 11.9

EU HY BB- 4.05 -4.9 1.5

4

FX market unprepared for a hawkish Fed

FX Positioning for USD FX market has scaled back its risk taking in recent days

� The complacency in the FX market has reduced over the

week, but there is still lots of room for a reaction to a ratehike from the Fed, or even a ‘hawkish hold’.

� The size of the market’s short USD position has been

reduced, but the position is still a short with a score of

-9.

� Positions in the risky G10 currencies (the AUD, NZD,

NOK) have also been reduced, but there is still a net

long position.

� These ‘risky’ currencies continue to appearvulnerable to higher US yields.

FX market has reduced its long AUD and NZD positions, but there is

room for shorts to be entered on a Fed surprise

-37

-21

-12

-9

3

5

5

5

13

23

-50 -30 -10 10 30 50

GBP

SEK

CAD

USD

NZD

EUR

AUD

CHF

NOK

JPY

19-Sep-2016

12-Sep-2016

BNP Paribas FX Positioning Analysis

Source: BNP Paribas

5

Introducing BNP Paribas Market Factor Analysis (MarFa™)

75 assets across equities, rates, credit, FX and commodities

MarFAMarFAMarFAMarFA™™™™MarFAMarFAMarFAMarFA™™™™

1. Monitors correlations

across asset classes 2. Identifies ‘market’ and

‘macro’ factors driving

assets

3. Signals when an asset is overbought or

oversold, using strategies:

i) MarFA™ Trading: 1-2 week horizon

ii) MarFA™ Macro: 1-2 month horizon

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

-20

-15

-10

-5

0

5

10

Jun-16 Jul-16 Aug-16

1st Market Factor (lhs)

EM credit (normalised, reversed rhs)

SP500 (normalised rhs)

9

9.5

10

10.5

11

11.5

12

12.5

13

13.5

14-15

-10

-5

0

5

10

Jun-16 Jul-16 Aug-16

1st Market Factor (lhs) G4 FX vol, average

1st Market Factor is currently correlated with equites and credit

1st Market Factor corresponds with implied FX vols

The Mexican equity index is one asset that appears mispriced vs its Macro Factors

Source: BNP Paribas

6

MarFA™ - Current themes & signals

Key outcomes:

� There is a high degree of correlation between

equities and credit market across the globe.

� The outperformance of risk-assets is identified as corresponding with the decline in vol (implied in equity

and rates) over the summer months.

� Looking forward, in a scenario of higher vol, equities and credit are vulnerable to a sell-off, with EM equities

and credit most at risk.

MarFA™ valuations:

� UK assets appear too expensive vs the Market

Factors: The FTSE 100 appears overvalued, while

investment grade and HY credit spreads are too narrow.

� Mexican assets (ccy and equities) are cheap vs their

Macro Factors.

� Curves appear too steep, especially in France, Japan and the UK.

See Introducing MarFA™: BNP Paribas Market Factor Analysis for further details.

5800

6000

6200

6400

6600

6800

7000

7200

Jun-16 Jul-16 Aug-16 Sep-16

MarFA Trading FTSE100

MarFA™ Trading indicates that the FTSE 100 is overvalued by around 3% vs the Market Factors

The most mispriced assets according to MarFA™

AssetZ-score

deviationFair value Asset

Z-score

deviationFair value

FTSE100 2.0 6677.6 USDMXN 3.2 18.6JP Invt credit, spread 1.9 36.2 France 2s10s 2.9 -Australia 10yr yield 1.8 2.04 JP 2s10s 2.5 -USDMXN 1.8 19.10 UK 2s10s 2.2 -SBX (Sweden) 1.3 825.46 MSCI China

22.1 106.7

Sweden 2yr yield -2.3 -0.6 MSCI Mexico2

-3.8 7779UK HY, spread -2.1 484.9 MSCI Norway

2-1.8 4774

UK Invt credit, spread -2.0 130.5 Australia 10yr , generic price-1.7 127MSCI Mexico -1.8 5101 Canada 10yr , generic price-1.5 137France 2yr yield -1.8 -0.6 USDJPY -1.4 104Notes:

1 Price index,

2 Total return index,

3 represented as a normalised relative bond index

MarFA™ Trading MarFA™ Macro

Most overvalued

Most Undervalued

Source: BNP Paribas

7

Trade of the week: Buy 1m 25 delta USDTRY

Chart 1: Amid increased uncertainty, the USDTRY vol curve

remains steep whilst the RR remains low

In relatively benign USD funding conditions, USDMXN and USDZAR

have been through a significant period of stress. We expect the USDcurve to start to price in tighter financial conditions as 10y real rates push

higher with steeper curves, at least in the near term.

In contrast to the MXN and ZAR, USDTRY implied volatility remains low,

while the volatility curve remains relatively steep.

� The USDTRY vs USDZAR 1m vol spread has reached 11 vols, an

extreme value (Chart 2).

� Short risk reversals in USDTRY are at low levels.

� Pricing of USDTRY volatility reflects rather a past period of FX

stability rather than any possible tightening of USD liquidity.

In addition, Moody's is expected to review Turkey’s sovereign rating no

later than 10 October; we think there is a significant chance of adowngrade.

Trade: Buy 1m USDTRY call, at spot 2.97 with strike of 3.05,for 70bp of the notional amount.

Chart 2:USDZAR, USDMXN have already reacted to tighter G2

liquidity; TRY is likely to follow

Source: Bloomberg, BNP Paribas

-5

-4

-3

-2

-1

0

1

2

3

4

5

60

1

2

3

4

5

6

7

Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16

TRY 1m 25d risk reversal

1m vs 1y TRY implied volatility (inverted), rhs

-5

-3

-1

1

3

5

7

9

11

13

Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16

1m implied volatility ZAR vs TRY

8

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DISCLAIMER - Credit

This Commentary is prepared by persons within the Trading function (which includes Sector Specialists) within the BNP Paribas group of companies(collectively “BNPP”). This is not a research report nor prepared by the BNPP Research Department and the views expressed herein may differ from

those of the Research Department. This Commentary should not be considered objective or unbiased. BNPP may engage in transactions in a mannerinconsistent with the views expressed in this material. BNPP trades as principal in the instruments (or related derivatives), does have proprietary

positions in the instruments (or related derivatives), and will likely make markets in the instruments (or related derivatives) discussed herein. The authorof this Commentary will know the nature of firm trading positions and strategies. Marketing and Trading personnel are indirectly compensated based on

the size and volume of their transactions. This material is based upon information that BNPP considers reliable as of the date hereof, but BNPP does notrepresent that it is accurate and complete. This material is for the general information of BNPP’s clients and is a general solicitation of derivatives

business for the purposes of, and to the extent it is subject to, §§ 1.71 of the U.S. Commodity Exchange Act. This material should not be construed asan offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. This material does

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any of the subject securities, issuers, or markets; and that no part of their compensation was/is/will be directly or indirectly related to the expressedrecommendation or views.

11

DISCLAIMER

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DISCLAIMER

Japan: This publication is being distributed to Japanese based firms by BNP Paribas Securities (Japan) Limited or by a subsidiary or affiliate of BNP Paribas not registered as a financial instruments firm in Japan, to certain financial institutions defined by article 17-3, item 1 of the Financial Instruments and Exchange Law Enforcement Order. BNP Paribas Securities (Japan) Limited is a financial instruments firm registered according to the Financial Instruments and Exchange Law of Japan and a member of the Japan Securities Dealers Association and the Financial Futures Association of Japan. BNP Paribas Securities (Japan) Limited accepts responsibility for the content of a publication prepared by another non-Japan affiliate only when distributed to Japanese based firms by BNP Paribas Securities (Japan) Limited. Some of the foreign securities stated on this publication are not disclosed according to the Financial Instruments and Exchange Law of Japan.

Hong Kong: This document is prepared for professional investors and is being distributed in Hong Kong by BNP Paribas Hong Kong Branch, a branch of BNP Paribas whose head office is in Paris, France. BNP Paribas Hong Kong Branch is registered as a Licensed Bank under the Banking Ordinance and regulated by the Hong Kong Monetary Authority. BNP Paribas Hong Kong Branch is also a Registered Institution regulated by the Securities and Futures Commission for the conduct of Regulated Activity Types 1, 4 and 6 under the Securities and Futures Ordinance. This document may not be circulated, distributed, reproduced or disclosed (in whole or in part and in any manner whatsoever) to any other person without the prior written consent of BNP Paribas Hong Kong Branch. For the professional investors in Hong Kong, please contact BNP Paribas Hong Kong Branch for all matters and queries relating to this report.

Singapore: BNP Paribas Singapore Branch is regulated in Singapore by the Monetary Authority of Singapore under the Banking Act, the Securities and Futures Act and the Financial Advisers Act. This publication may not be circulated or distributed, whether directly or indirectly, to any person in Singapore other than (i) to an institutional investor pursuant to Section 274 of the Securities and Futures Act, Chapter 289 of Singapore ("SFA"), (ii) to an accredited investor or other relevant person, or any person under Section 275(1A) of the SFA, pursuant to and in accordance with the conditions specified in Section 275 of the SFA or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provisions of the SFA.

South Korea: BNP Paribas Securities Korea is registered as a Licensed Financial Investment Business Entity under the FINANCIAL INVESTMENT SERVICES AND CAPITAL MARKETS ACT and regulated by the Financial Supervisory Service and Financial Services Commission. This publication does not constitute an offer to sell to or the solicitation of an offer to buy from any person any financial products where it is unlawful to make the offer or solicitation in South Korea.

Taiwan: BNP Paribas Taipei Branch is registered as a licensed bank under the Banking Act and regulated by the Financial Supervisory Commission, R.O.C. This publication is directed only at Taiwanese counterparties who are licensed or who have the capacities to purchase or transact in such products. This publication does not constitute an offer to sell to or the solicitation of an offer to buy from any person any financial products where it is unlawful to make the offer or solicitation in Taiwan.

Australia: This material, and any information in related marketing presentations (the Material), is being distributed in Australia by BNP Paribas ABN 23 000 000 117, a branch of BNP Paribas 662 042 449 R.C.S., a licensed bank whose head office is in Paris, France. BNP Paribas is licensed in Australia as a Foreign Approved Deposit-taking Institution by the Australian Prudential Regulation Authority (APRA) and delivers financial services to Wholesale clients under its Australian Financial Services Licence (AFSL) No. 238043 which is regulated by the Australian Securities & Investments Commission (ASIC).The Material is directed to Wholesale clients only and is not intended for Retail clients (as both terms are defined by the Corporations Act 2001, sections 761G and 761GA). The Material is subject to change without notice and BNP Paribas is under no obligation to update the information or correct any inaccuracy that may appear at a later date.

Some or all of the information contained in this publication may already have been published on https://globalmarkets.bnpparibas.com

© BNP Paribas (2016). All rights reserved.

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