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lows suggesting this will be a source of pressure on the Won given the greater trade linkages (Table 2). Our current account forecasts for 2017 anticipate deterioration in Korea’s current account surplus compared to marginal improvement in Russia’s. Recent issues at Samsung and Hanjin pose risks for the goods and service balances, respectively. Electronics account for 30% of Korea’s exports. While a stronger dollar and energy de- regulation in the US could dampen the oil market, our energy strategists continue to expect further modest gains in Brent over 2017. The RUB/KRW cross has a modest positive beta to oil at 25% since the beginning of 2014. Risks to the trade are mainly material downside to oil prices vs our baseline scenario. Sell German 2y vs OIS, buy 10y vs OIS In H2 2016, we saw an impressive richening of short-maturity German govies and repo: we like fading the move by selling 2y Bund vs OIS and buying the 10y vs OIS. German 2y is pricing-in structurally high demand and low supply The German 2y trades at the richest against OIS since the peak in 2011 due mainly to demand/supply dynamics driven by: 1} European regulation on mandatory central clearing and minimum initial margin requirements generating €350bn in extra collateral needs in 2016-19; 2} LCR regulation and negative rates having pushed cash-rich corporates into holding short-end German bonds/bills in order to store liquidity; and 3) net bill issuance having been cut to negative in Q4 because falling yields created €42bn of excess cash for governments. Supply pressures are expected to ease in 2017E Bubill auctions will resume after more than two months of absence while more treasuries may be the answer to an excessive rise in yields by increasing net issuance in the front-end. The ECB may also be concerned by the richness of front-end German govies (see Couré’s speech on 3 November). If the Eurozone fails to create enough safe/low-volatility securities for the market to work efficiently, then the central bank could compensate by lending more collateral, by adjusting counterparty frameworks and running higher balance sheets or even by issuing bills to satisfy safe asset demand in the non-bank system. ECB QE and potential periphery stress supports 10y outperformance Given the tail risks in 2017 and our call of ECB QE extension to September 2017, we prefer to add a 10y DBR long vs OIS — we expect 10s to outperform in such a scenario. In Chart 38 we show that ECB tapering expectations have now pushed 2510s vs OIS to levels before the announcement of ECB QE on 22 January 2015. However, we see even more reasons for the ECB to extend the €80bn per month in QE to September 2017. Chart 37: Return to a different time Table 2: Russia vs S. Korea factors 45 3.5 40 RUB KRW 3.0 Real rate* 42 09 38 25 CA change forecast, '17 vs '16 1.2 -{ 30 Growth delta forecast, '17 vs '16 1.6 0.2 25 - 2.0 NFA / GDP+ 1 5 20 15 Pvt credit (% GDP) 50 80 . Foreign holdings of local debt (USD bn) 20 67 15 - 1.0 FX reserves / ST debt 6 3 10 Share of US in exports 2 13 5 0.5 Share of China in exports 10 25 0 0.0 . ; a Jan-10 Oct-14 Juk413 Apr-15 Jan-17 1y fwd 5y yield vs inflation forecast +Countries net external position vs BIS-reporting banks ——RUB/KRW (LHS) ——=US 5y5y breakeven (RHS) Source: BofA Merrill Lynch Global Research, Bloomberg Source: BofA Merrill Lynch Global Research, Bloomberg 20 _ Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 Bankof America Merrill Lynch HOUSE_OVERSIGHT_014750