HOUSE_OVERSIGHT_014439.jpg

Chart 9: USD breaks to new highs Chart 10: As Treasury yields open big gaps with Europe and Japan 105 27 US 10y veld —— y yle +00 ——DXY Curncy 25 === {(y Bund yield (RHS) , exe |(y JGB yield (RHS} 95 , 2.3 90 2.1 85 1.9 80 1.7 75 1.5 fy & & % x N x N > 13 Noa, Na: Ne, re F PTF VK WM Ww GK ww KX WW SLM LW LH M'-—' WS Source: Bloomberg Source: Bloomberg The USD is a case in point, with the higher US rates creating a significant gap to equivalent Euro and JPY rates. With the ECB likely to extend QE by the full current amount (despite the debate over timing) and the BO) committed to capping JGB yields at zero, a surge higher in the USD was the logical outcome. Given that the biggest gap in intentions was relative to Japan it is perhaps not surprising that the JPY has been the biggest victim, with the JPY falling some 10% against the USD since the election. The DXY has broken out of the top end of the trading range it has been in since early 2014. The stronger USD is not just reliant on higher yields, but also other factors such as the likely repatriation of money into the US under a new proposal for US corporates to return funds at a concessionary tax rate, generally referred to as HIA2. We had positioned long USD as well as short rates, not so much as an explicit play on a Trump victory but more against a more hawkish Fed in 2017. We were also of the view though that a Trump win would likely be positive for the USD and higher yields. Going back to our fixed income strategists’ point that the dot plot should now perhaps be the base case for the markets that does imply higher yields which should continue to be dollar supportive. Like their bond yield forecasts though our strategists call for a modest further appreciation of the USD rather than a huge surge. They have the USD peaking at 1.02 vs the EUR, 120 against the JPY and 1.43 vs the CAD. So the big violent move has likely happened even if we still see the USD strengthening further next year. Certainly our FX strategists are not calling for a surge in the USD similar to the one that happened in 2014/15. The reaction of the US economy to “Trumponomics” is key These two things are important for other asset classes. If we really thought 10Y Treasuries were heading to 3%, the Fed likely to tighten above the dot plot and the USD to surge another 10% in quick order, the impact on other asset classes would likely be more severe. That would undoubtedly exacerbate the trends we have seen out of EM and long duration equities. We also suspect it would make it much harder for commodities to perform. We see holding USD and short rates positions as necessary to hedge against such an outcome with limited downside risk if it does not happen. Oct-14. Feb-15 Oct-15 Feb-16 Jun-16 Oct-16 8 Global Cross Asset Strategy - Year Ahead | 30 November 2016 BankofAmerica <2” Merrill Lynch HOUSE_OVERSIGHT_014439