The rise in bond yields in developed economies in the past 6 weeks remains one of the over-riding themes as we head into the last seven days of the US presidential campaigns. Markets are now fretting about the implications for global growth and asset valuations and ultimately whether elevated global risk appetite will correct more forcefully. Higher international commodity prices, a pick-up in global GDP growth in Q3 and early Q4 and easing deflation fears suggest that interest rate policies in developed economies may have reached an important inflexion point – in line with the view I expressed six weeks ago. Developed central banks may refrain from loosening monetary policy further near-term, with the exception of the RBNZ and possibly ECB. At the very least, policy-makers will tweak a discourse which has largely focused on doing “whatever it takes”. Recent US data have paved the paved the way for a 14th December Fed hike, conditional on Democrat candidate Hilary Clinton wining the 8th November US presidential elections. But with the exception of the Fed and possibly a handful of EM central banks, rate hikes are a story for the latter part of 2017 (perhaps) while further rate cuts remain on the cards in Brazil, Russia, Indonesia and India. Higher global yields and still uncertain US election outcome are taming global equities and volatility has spiked but EM currencies have still managed to eek out modest gains. Assuming Hilary Clinton wins next week, I would expect the initial reaction to be a rally in global equities, EM currencies and Dollar and an underperformance of safe-haven assets. But I would also expect market pricing for a December Fed hike to rise a little further, which could in turn eventually curtail any rally in global equities and EM currencies. In this scenario, the Dollar would likely end the year stronger, as per my January forecast of a third consecutive year of albeit more modest Dollar gains. Whether global risk appetite avoids its early 2016 fate will depend on the interconnected factors of underlying macro data and the Fed’s credibility. In any case, market volatility could spike in the run-up to March 2017. The self-reinforcing sell-off in Sterling and UK bonds has only very recently abated, with markets seemingly taken some comfort from a number of factors including the only modest slowdown in UK GDP growth to 0.5% qoq in Q3. But optimism over UK GDP data is not warranted as growth has become more unbalanced and slowed in August-September despite a significant easing in UK monetary policy.

1. 1
Be careful what you wish for
The rise in bond yields in developed economies in the past 6 weeks remains one of the
over-riding themes as we head into the last seven days of the US presidential campaigns.
Markets are now fretting about the implications for global growth and asset valuations and
ultimately whether elevated global risk appetite will correct more forcefully.
Higher international commodity prices, a pick-up in global GDP growth in Q3 and early Q4
and easing deflation fears suggest that interest rate policies in developed economies may
have reached an important inflexion point – in line with the view I expressed six weeks ago.
Developed central banks may refrain from loosening monetary policy further near-term,
with the exception of the RBNZ and possibly ECB. At the very least, policy-makers will
tweak a discourse which has largely focused on doing “whatever it takes”.
Recent US data have paved the paved the way for a 14th December Fed hike, conditional on
Democrat candidate Hilary Clinton wining the 8th November US presidential elections.
But with the exception of the Fed and possibly a handful of EM central banks, rate hikes are
a story for the latter part of 2017 (perhaps) while further rate cuts remain on the cards in
Brazil, Russia, Indonesia and India.
Higher global yields and still uncertain US election outcome are taming global equities and
volatility has spiked but EM currencies have still managed to eek out modest gains.
Assuming Hilary Clinton wins next week, I would expect the initial reaction to be a rally in
global equities, EM currencies and Dollar and an underperformance of safe-haven assets.
But I would also expect market pricing for a December Fed hike to rise a little further, which
could in turn eventually curtail any rally in global equities and EM currencies.
In this scenario, the Dollar would likely end the year stronger, as per my January forecast
of a third consecutive year of albeit more modest Dollar gains.
Whether global risk appetite avoids its early 2016 fate will depend on the interconnected
factors of underlying macro data and the Fed’s credibility. In any case, market volatility
could spike in the run-up to March 2017.
The self-reinforcing sell-off in Sterling and UK bonds has only very recently abated, with
markets seemingly taken some comfort from a number of factors including the only modest
slowdown in UK GDP growth to 0.5% qoq in Q3.
But optimism over UK GDP data is not warranted as growth has become more unbalanced
and slowed in August-September despite a significant easing in UK monetary policy.

2. 2
A blast from a distant past – Rising yields
The rise in global government bond yields, particularly at the long-end of the maturity spectrum, remains
one of the over-riding themes as we head into the last seven days of the US presidential campaigns. Figure
1 shows that 2-year, 5-year and 10-yields yields have risen in the US, Germany and Australia by on
average 13bp, 8bp and 14bp, respectively, since mid-September. The rise in Japanese yields has been far
more timid, with 10-year rates actually a little lower in the past six weeks.
Figure 1: Government bond yields have risen across the maturity curve in US, Germany, UK and Australia
Source: investing.com
Policy-makers and markets for so long concerned about the threat of global deflation and depressed yields
are now fretting about the implications of higher yields for global growth and asset valuations and ultimately
whether elevated global risk appetite will correct more forcefully.
A number of common and interconnected factors have driven yields higher in most developed markets. The
(admittedly unsteady) rise international energy and commodity prices, including for crude oil, copper, iron
ore and Nickel, and signs that global GDP growth picked up slightly in Q3 have eased deflation fears –
fears which I had argued last year were overdone (see Deflation, what deflation?, 15 September 2015).
This has in turn shed greater light on signs that interest rate policies in developed economies may have
reached an important inflexion point – very much in line with the view I expressed six weeks ago (see
Global central bank easing nearing important inflexion point, 16 September 2016).
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Change in government bond yields since 16 September 2016 (basis points)

3. 3
Global GDP growth inching higher
My core view was, and still is, that eight years of ultra-low (and in some cases negative) central bank policy
rates and expansive bond-buying programs have helped stabilise global economic growth and inflation,
albeit at low levels, and there are early signs that both are inching higher. At the same time, the costs of
ultra-loose monetary policy, including asset price bubbles, distortions in bond markets, pressure on the
banking sector and even rising inequality, may be starting to outweigh the benefits.
Global GDP growth likely increased incrementally in Q3 2016 after having stabilised around 2.8% year-on-
year (yoy) in Q2. My estimate is derived from the rise in the global manufacturing PMI from 50.2 in Q2 to
50.9 in Q3 (see Figure 2) and preliminary GDP figures for the US, European Union, China, Korea and
Mexico which in aggregate account for two-thirds of world GDP (see Figure 3). This ties in with my
September forecast that “global GDP growth may have risen to around 2.9% yoy in Q3 based on global
manufacturing PMI data for July-August”.
Moreover, strong country PMI data for October, including in China (highest level since July 2014), Russia
(4-year high) and India (22-month high), provide an early sign that global GDP growth picked up further in
early Q4. Monthly global manufacturing PMI data, released months before official GDP figures, continue to
be a reliable forward indicator of global GDP growth yet receive only ephemeral market attention.
Figure 2: Manufacturing PMI data had pointed to
first increase in global growth since Q4 2013…
Figure 3: …and data for major economies further
confirm modest global growth pick-up
Source: IMF, national statistics offices, Markit Source: IMF, national statistics offices
Developed central banks at inflexion point
Therefore, developed central banks may refrain from loosening monetary policy further near-term, with the
exception of the Reserve Bank of New Zealand (RBNZ) which markets expect to deliver one final 25bp cut
at its policy meeting on 10th
November, and possibly the ECB.
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(figure in brackets is share of world GDP)

4. 4
Figure 4: Rate cutting cycles coming to an end in developed economies but still room for EM policy rate cuts
Source: National centralbanks
Since April, developed central banks have only delivered four 25bps policy rate cuts – the Reserve Bank of
Australia (RBA) in May and the RBA, RBNZ and Bank of England (BoE) in August. I would expect policy
rate cuts and expansions/extensions to QE current programs to become increasingly rare (see Figure 4). At
the very least, the world’s most influential central bankers may going forward tweak a discourse which has
in recent years largely focused on doing “whatever it takes”.
 Australia: The RBA at its policy meeting today was seemingly intent on making clear that it sees no
compelling reason to cut rates further given expectations of a pick-up in economic growth and
inflation medium-term.
 Eurozone: My core scenario since September has been that the ECB would keep it policy rates on
hold and the modalities of its current QE programs unchanged until its 8th
December policy meeting
and so far the ECB has stayed on script. Stable eurozone GDP growth of 1.6% yoy in Q3 and the
rise in CPI-inflation to a 27-month high of 0.5% yoy in October have, if anything, reduced the
probability of the ECB extending its QE program, which expires in March 2017, before end-year.
 UK: I am sticking to the view which I have held since late-August that there is little room or need for
the BoE to either cut or hike its policy rate or extend its current QE program (see UK economy post
referendum – for richer but mostly for poorer, 26 August 2016). Q3 GDP data did not provide a
compelling case for the BoE to change its current course of monetary policy. Moreover, with Sterling
and UK yields having stabilised for now, the already weak case for BoE intervention in the FX
market has now all but evaporated (see below for a more detailed discussion).
 Norway: The Norges Bank, which on 26th
October again kept its policy rate of 0.5% unchanged,
has adopted a neutral stance. It noted on the one hand the positive impact of higher oil prices on the
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Major central bank policy meeting interest rate decisions

5. 5
oil-exporting Norwegian economy and slight rise in expected policy rates among trading partners but
lower inflation on the other hand. The Norges Bank’s real policy rate – the policy rate deflated by
headline or core CPI-inflation – remains very low relative to history and to other developed central
banks. But with inflation on a downtrend and GDP growth of only 1.3% yoy in H1 2016, policy rate
hikes are probably not on the cards any time soon.
Fed will hike rates on 14th December…assuming Hilary Clinton wins presidential elections
The elephant in the room is still the US Federal Reserve policy meeting on 14th
December, with US macro
data in the past year having proved a major hurdle for the Fed to clear.
But the rebound in US GDP growth in Q3 to 2.9% annualised, decent September macro data and higher
international oil prices have in my view paved the way for a second consecutive December rate hike.
Importantly, growth in private sector aggregate weekly payrolls rebounded in September to 4.3% yoy from
a multi-year low of 3.5% yoy in August and retail sales, ISM manufacturing and non-manufacturing and
most measures of inflation measures also bounced back (see FX update: Dollar, Sterling and EM, 17
October 2016).
My forecast of a 25bp hike remains conditional on Hilary Clinton wining the 8th
November US presidential
elections (see Federal Reserve – the Father Christmas of central banks, 23 September 2016). Her victory
is a necessary, if not sufficient condition for the Fed to hike in my view, despite Fed Chairperson Yellen’s
assertion that the Fed is apolitical. Perhaps it is not totally coincidental that the market’s current pricing of a
75% probability of a 25bp hike in December is similar to the estimated probability of Clinton winning next
week’s presidential elections according to FiveThirtyEight (which accurately forecast the voting outcome of
all 50 states in the 2012 US presidential elections).
Rate hikes still very much the exception, not the norm
To be clear, bar the Fed and possibly a handful of EM central banks still fighting weak currencies and/or
high inflation, no major central bank is likely to hike policy rates or tighten monetary policy in coming
months, in my view. That’s a story for the latter part of 2017 (perhaps). Even the Fed has repeatedly
stressed that any future rate hikes would be modest and gradual, a point it will likely reaffirm regardless of
whether it decides to hike rates in December.
Since April 2016 only two major central banks have hiked their policy rates – Nigeria (in July) and Mexico
(in June and September). Banco de Mexico could opt to stay on hold if the peso nominal effective
exchange rate (NEER), which has appreciated 4.3% in the past six weeks, benefits from a Clinton victory
and survives a December Fed hike.
During that period, emerging market central banks have delivered 14 policy rate cuts, in line with my
forecast last year that EM central banks would continue cutting their policy rates (see More EM central
banks to join rate-cutting party, 30 September 2015). Even since August 2016, major EM central banks
have delivered five rate cuts, broadly as I had expected (see Right or wrong further central bank rate cuts
still on the cards, 19 August 2016).

6. 6
With central banks’ real policy rates still high in Brazil, Russia, Indonesia and India, further rate cuts remain
on the cards, particularly in Brazil and Russia where GDP growth is weak. These countries’ central banks
may admittedly want to first gage the impact of the US elections and a possible Fed hike on their currencies
before cutting rates further.
Dollar hat-trick, EM currencies choppy
Higher global yields and the still uncertain US presidential election outcome have perhaps unsurprisingly
been a headwind for global equities unchanged from six weeks ago (see Figure 5) while volatility has again
spiked (see Figure 6) – a pattern which has so far matched my expectation that “In this context higher
volatility is likely to prevail and global risk appetite may struggle to forcefully regain traction for now”.
Figure 5: Global equities are unchanged since
mid-September
Figure 6: After a brief respite, VIX has again
spiked higher as US elections loom
Source: investing.com Source: investing.com
A GDP-weighted basket of emerging market currencies has been treading water versus the US Dollar and
has depreciated slightly if the weaker Chinese Renminbi is included (see Figure 7). But this partly reflects
the Dollar’s strength and a basket of emerging market NEERs (excluding the CNY) has appreciated about
1.5% since mid-September (see Figure 8). Commodity and high-yielding emerging currencies, including the
Brazilian Real, Mexican Peso, Russian Rouble and South African Rand, have outperformed other
currencies by significant margins – understandably given the backdrop of higher international commodity
prices and rising developed market yields.
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CBOE S&P 500 Volatility Index (VIX)

7. 7
Figure 7: EM currencies struggling to make gains
versus robust Dollar…
Figure 8: …but stronger against their trading
partners’ currencies
Source: investing.com, BIS Source: investing.com, BIS
But the next six weeks could prove pivotal for global equities and EM currencies. Let’s assume that Hilary
Clinton wins the 8th
November US presidential elections – a reasonable assumption given her still modest
lead over Donald Trump in the majority of polls. I would expect the initial reaction to be:
 A rally in global equities;
 US Dollar appreciation, particularly against other majors including the Euro and Sterling. This would
likely suit the ECB and BoE just fine, with both central banks seemingly intent on at least keeping
their currencies near current levels in order to support domestic economic growth;
 An appreciation in the currencies of EM economies reliant on trade with the US, including the
Mexican Peso and Brazilian Real, given concerns that Donald Trump would opt for a less open US
economy, and;
 An underperformance of safe-haven assets, including gold.
But I would also expect market pricing for a December Fed rate hike to rise a little further (from 21bp
currently), which could in turn eventually curtail any rally in global equities and EM currencies. Assuming no
exogenous shocks between the US elections and 14th
December and that the Fed hikes its policy rate
25bp, I would expect:
 Broad-based USD appreciation;
 Other major central banks to be more inclined to maintain their stance on monetary policy and policy
rate cuts to be less frequent;
 EM currencies and global equities to struggle to hold onto post-US election gains.
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Including CNY, left scale
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GDP-weighted basket of Emerging Market
nominal effective exchange rates (April 2010 =

8. 8
Figure 9: Higher US yields and stronger Dollar
moving in tandem…
Figure 10: …while inverse relationship in UK is
more akin to an emerging market
Source: investing.com, Federal Reserve Source: investing.com, Bank of England
Volatility will key metric in Q1 2017
Net-net, in this scenario, the Dollar NEER – which is now up 0.2% on the year for the first time since March
based on Federal Reserve currency weights (see Figure 9) – would likely end the year stronger, as per my
January forecast of a third consecutive year of albeit more modest Dollar gains (see What to expect in 2016
– same, same but worse, 19 January 2016).
The Fed will certainly want to avoid a repeat of Q1 2016 when global equities and EM currencies sold off
and the Dollar appreciated sharply following the Fed’s December 2015 hike. The probability of this scenario
materialising once again will, in my view, depend on two sets of interconnected factors: underlying macro
data and the Fed’s credibility.
If US macro data in early 2017 take a turn for the worse, markets may query the suitability of the Fed’s hike
in December 2016 and global risk appetite could come under pressure. Even if US and global data prove
resilient, markets will look to the Fed for reassurance that the Fed’s hiking cycle will continue to be slow
and gradual. I would therefore expect FOMC members at the 14th
December meeting to further revise down
their estimates of the appropriate policy rate as they did at their December 2015 meeting. Their success in
communicating this message to a market sensitive to even the most benign Fed utterance will be a key
determinant of whether global appetite risk appetite corrects in the weeks following 14th
December.
Volatility in Fed fund futures and market pricing is thus likely to remain fluid in early 2017 and, in any case,
market volatility could spike in the run-up to March 2017 as this will mark:
 The Federal Reserve’s policy meeting on 15th
March with Q&A session hosted by Chairperson
Yellen and updated FOMC forecasts;
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Average of 2, 5 & 10yr UK bond yields, %
(right scale)

9. 9
 The end of the ECB’s QE program, assuming it is not extended in December; and
 British Prime Minister Theresa May’s self-imposed deadline to trigger Article 50 which officially sets
in motion the 2-year timeframe for the UK to leave the EU.
UK bond prices and Sterling finding their footing after multi-week pounding
The case of the UK is somewhat unique as the far larger jump in yields (than in other developed
economies) has gone hand in hand a collapse in Sterling, as per Figure 10 (See Sterling: The lady’s not for
turning (yet!), 14 October 2016), a co-existence one would normally associate with emerging markets. A
large UK account deficit allied to concerns about the UK’s future relationship with the EU have seen
investors shy away from long-Sterling positions, with Sterling’s depreciation in turn raising fears of imported
inflation and acting as a headwind to foreigners’ gilt purchases, putting further pressure on the currency.
This self-reinforcing sell-off in Sterling and UK bonds has only very recently abated (see Figure 10).
Markets have seemingly taken some comfort from a number of factors, including:
 Mark Carney’s announcement yesterday that he would extend his stay as BoE Governor until June
2019, easing speculation as to whether government criticism of his tenure would see him stay only
until 2018;
 Nissan’s decision to maintain its UK car plant, in exchange for somewhat opaque government
promises regarding the future of the UK’s automotive industry and the UK’s broader relationship
with the EU; and
 The only modest slowdown in UK GDP growth to 0.5% quarter-on-quarter in Q3 from 0.7% in Q2
(seasonally adjusted), as shown in Figure 11.
Optimism over UK GDP growth not warranted
However, I would argue that the positive spin surrounding these GDP data is not fully justified, for a number
of reasons:
1. This is the first estimate of Q3 GDP growth (data content is less than half of the total required for the
final output estimate) and will likely be subject to (albeit usually minor) revisions. The second and
final estimates are due to be published on 25th
November and in late-December, respectively.
2. Growth, if anything, became even more imbalanced in Q3. All of the growth came from services,
which account for 79% of national GDP and rose 0.8% qoq in Q3. The index of production (15% of
national GDP) contracted 0.4% qoq and thus subtracted 0.05 percentage points (pp) to headline
GDP growth (see Figure 12). In comparison, in the previous six quarters production had on average
added 0.07pp to headline growth. Similarly construction output (6% of national GDP) fell 1.4% qoq
and subtracted 0.09pp to headline GDP. In the previous six quarters it had added 0.04pp (I omit
from these calculations the agricultural sector which accounts for only 0.7% of UK GDP).

10. 10
3. About 70% of the GDP growth in Q3 materialised in July when presumably the effects of the
referendum result had yet to kick in, according to my estimates using monthly Office for National
Statistics data. As Figure 13 shows, in July the index of services was up 0.4% mom, the index of
production was flat on the previous month and construction output was up 0.5% mom. But growth in
all three sectors slowed sharply in August and only rebounded marginally in September based on
ONS forecasts and early responses to its September Monthly Business Survey. If growth rates in
these three sectors did not pick up in October and do not pick up in November and December, real
GDP growth in Q4 will likely be far slower than in Q3.
Figure 11: UK GDP growth in Q3 did not slow as
much as had been feared…
Figure 12: …but economic growth if anything has
become more imbalanced…
Source: Office for National Statistics Source: Office for National Statistics
4. Even if we assume GDP growth remains stable at 0.5% qoq for the next four quarters, which I would
in itself query (see below), the UK’s real GDP will be 1% lower in a year’s time than if the economy
had continued to grow at 0.7% qoq.
5. It is conceivable that GDP growth could have picked up in Q3 had the British electorate voted to
stay in the EU. After all global GDP growth rose in Q3 to around 2.9% yoy from 2.8% yoy in Q2
according to my estimates.
6. UK GDP growth slowed despite the BoE cutting its policy rate 25bp, introducing a new term-funding
scheme and re-launching quantitative easing at its policy meeting on 4th
August 2016.
7. But most importantly UK GDP growth slowed despite a significantly more competitive currency.
While September trade data will only be released on 9 November, Figure 14 suggests that while the
Sterling NEER depreciated about 17% between November 2015 and end-September 2016 the UK’s
goods and services trade deficit is unlikely to have narrowed much in Q3 (see Barbarians at the
Sterling gate, 7 October 2016). If true, net trade will have made only a small positive contribution to
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11. 11
GDP growth in Q3, the extent of which will be revealed when second and third estimates of Q3 GDP
are released.
At the same time a weaker Sterling is driving domestic inflation higher. So UK households have borne
the costs of a weaker currency, including higher inflation (which is eating into already tepid real wage
growth) and a significant haircut to their wealth (when expressed in foreign-currency terms) but have yet
to see the potential benefits as GDP growth has slowed, not accelerated. Moreover, the outlook for UK
growth is not particularly encouraging in my view. Uncertainty over the UK’s future relationship with the
EU is likely to continue weighing on domestic and foreign investment in the UK while the scope for
interest rate and fiscal policy easing is limited.
Figure 13: …and July accounted for about 70% of
UK GDP growth in Q3 2016
Figure 14: UK GDP growth slowed in Q3 despite
significantly more competitive Sterling
Source: Office for National Statistics (Table 2)
Note: * Monthly growth rates for production,
construction and services are weighted according to
these three sectors’ size relative to national GDP.
Source: Office for National Statistics, Bank of England
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