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FX: Sell EUR/GBP GBP remains a consensus short. Despite GBP appreciating following the High Court decision for a Parliamentary vote to activate Article 50 and the US elections, the market’s short GBP position remains stretched according to our positioning analysis (Chart 44}. Our Global Fund Manager Survey flags short GBP as the strongest consensus view in G10 FX. Our EX & Rates Sentiment survey also suggests that the majority of investors look for some type of hard Brexit. Although we have been arguing for upside GBP risks after the recent flash crash, our baseline projections expect GBP/USD to hit a new low of 1.15 in Q1 after the UK activates Article 50. However, we have argued that GBP tail risks are skewed to the upside. UK data have been strong post-referendum and could continue surprising to the upside. There is room for positive headlines at the political front, if the UK agrees on the transitional period that could extend the current regime until a final trader deal with the EU. A Parliamentary vote on Article 50 activation could reduce the chances of a hard Brexit. And Trump’s victory could lead to an early bilateral US-UK trade deal, while it increases the geopolitical importance of the UK for the rest of the EU. Moreover, we expect markets to become more concerned about political tail risks in the rest of Europe following Trump’s victory in the US elections. Political risks in Italy and France could question the sustainability of the Eurozone, thus weakening EUR/GBP. If Prime Minister Matteo Renzi loses the referendum on the constitutional reform in December, Italy could have a snap election, which the Five Star party could win based on the latest polls. Even if Italy avoids elections in 2017, the next election will take place by May 2018, and markets could become concerned about it earlier if Renzi loses the referendum. The 2017 French election is another concern. President of the far-right party and presidential candidate Marine Le Pen is ahead in the polls to win the first round. Winning the second round is much more difficult, as she will need more than 50% of the votes, but investors could start to expect the unexpected after being blindsided in the UK and the US. Other considerations also support selling EUR/GBP. Data are consistent with a weaker EUR/GBP (Chart 44). The market is short both EUR and GBP, but long EUR/GBP, with the latest flows pointing to more EUR downside and GBP upside. Using a spot reference of 0.8672, we recommend selling EUR/GBP via a 6M 0.84/0.80 put spread, to capture both the referendum in Italy and the French elections, but also give time for GBP to recover in case it weakens further following activation of Article 50 in Q1. The structure costs 1.07% EUR. Chart 44: Positioning is short EUR but even more so in GBP Chart 45: Data surprises suggest that EUR/GBP should be lower 50 40 30 20 0.0 .B4 -50.0 5 -100.0 + -150.0 ~ “Iasi AUD USD JPY NOK NZD EUR CAD GBP SEK CHF 77 07 7 p79 EN NS oh % %, eee wLatest Positioning © =Change in positioning eee F7-UK data surprises (RHS) === EURGBP (RHS) Source: BofA Merrill Lynch Global Research. Source: BofA Merrill Lynch Global Research. 24 Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 BankofAmerica <2” Merrill Lynch HOUSE_OVERSIGHT_014754