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in 2011 called the law a calamity that increases business uncertainty and undermines growth. Under Atkins, the transition team posted a statement that it will be “working to dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation." At this point there are no details on what parts of Dodd-Frank are most likely to be repealed, but Republican financial policy leaders appear pro- markets and have flagged free movement of capital via open markets as the best policy for economic growth and risk transparency. There are several dislocations across markets today that we think have a chance of normalizing in the tail-risk event that deregulation results in increased availability of leverage and ability to take more risk. We have discussed these dislocations as resulting in part from the lack of ability of hedge funds and other relative-value traders to access enough balance sheet at a low enough cost to help these trades normalize. The top trades we could see benefitting from the return of leverage would be: e Normalization of swap spreads; balance-sheet intensive Treasuries, both nominal and TIPS, are very cheap versus OIS and Libor swap rates. « Normalization of cross-currency basis swaps, which currently allow USD-based investors the ability to buy very cheap EUR- and JPY-denominated assets via the basis swap. ¢ Normalization of coupon STRIPS versus principal STRIPS as these yield differentials are near their all-time wides, particularly in the 2030-38 maturity bucket. As a tail risk for deregulation, we like buying 30y swap spreads, a credit-risk-free floating-rate US Treasury asset that provides 3m Libor + 56bp annually, which is about 100bp cheap to pre-crisis levels. Swap spreads could also benefit from deregulation that removes cash and Treasury bonds from the leverage ratio requirements, which would provide the ability of the dealer community to more easily absorb Treasury supply in the primary and secondary markets. The main risk is that policy changes retain strict capital requirements, which would continue to limit the availability of leverage. For example, the Financial Choice Act, a product of Texas Representative Jeb Hensarling's team, would provide banks an off- ramp option to all Basel 3 requirements as long as banks hold a 10% capital ratio. This plan would probably decrease the availability of leverage, and could also result in reduced demand for short-dated Treasuries in HQLA portfolios. Another risk to 30y swap spread normalization in particular would be a material increase in deficit spending as part of a fiscal stimulus package. This would likely further cheapen Treasuries versus swaps and other benchmark interest rates. Trade recommendation: Buy 30y Treasuries versus 30y matched Libor swap at 3mL+56bp. Target 3mL + Obp, stop loss 3mL+75bp. Tail risk 2: Comeback of Eurozone risk premia EZ risk hedges: 30s50s flatteners in BTPs, buy EUR/HUF vol In Europe, the biggest market risk for 2017 is arguably a comeback of stress on peripheral sovereigns. The next 12 months provide plenty of triggers, with increasing concerns about the ability of ECB to continue with QE, and an intense political season ahead (referendum in Italy on 4 Dec, and elections in France and Germany in 2017). As hedges to Eurozone risks, we recommend buying 30s50s flatteners in BTPs as the cheapest way to express a bearish view on the periphery, and buying EUR/HUF vol as a proxy for Euro instability with better pricing than EUR/USD vol. Concerns on EU politics and the ECB would likely lead to a switch of market focus from monetary policy to fundamentals. The periphery would be hurt by this new focus: public debt to GDP remains very high, and the low debt service costs enjoyed in the past five years favored debt accumulation, rather than debt reduction (Chart 73). The cyclical Bank of America Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 43 Merrill Lynch HOUSE_OVERSIGHT_014773