I have long argued that the risk of a collapse in global economic growth and inflation was over-stated and more recently that major central banks had likely reached an important inflexion point. A global recession and global deflation have seemingly been averted and central bank policy rate cuts and extensions of quantitative easing programs have become rarer occurrences. Donald Trump’s election has turbo-charged expectations that reflationary US-centric policies will drive global, and in particular US growth and inflation in 2017, that the Fed’s hiking cycle will step up a gear and that US yields and equities and the dollar will climb further, heaping pressure on emerging economies and asset prices. But analysts and markets may now be getting ahead of themselves. My core reasoning is that US inflation may not rise as fast expected, due to lags in the implementation of Trump’s planned fiscal policy loosening and immigration curbs, residual slack in the US labour market and disinflationary impact of higher US yields and a stronger dollar. As a result, the FOMC, which will see important personnel changes in early 2017, may argue that the market has already done some its work and not be as hawkish as expected. In this scenario, US short-end rates could lose ground while long-end rates continue to push higher, resulting in a steepening of a still not very steep US rates curve. One corollary is that factors which have wakened the euro may lose traction as 2017 progresses.

1. 1
Hawkish pendulum may have swung too far
I have long argued that the risk of a collapse in global economic growth and inflation was
over-stated and more recently that major central banks had likely reached an important
inflexion point.
A global recession and global deflation have seemingly been averted and central bank
policy rate cuts and extensions of quantitative easing programs have become rarer
occurrences.
Donald Trump’s election has turbo-charged expectations that reflationary US-centric
policies will drive global, and in particular US growth and inflation in 2017, that the Fed’s
hiking cycle will step up a gear and that US yields and equities and the dollar will climb
further, heaping pressure on emerging economies and asset prices.
But analysts and markets may now be getting ahead of themselves.
My core reasoning is that US inflation may not rise as fast expected, due to lags in the
implementation of Trump’s planned fiscal policy loosening and immigration curbs, residual
slack in the US labour market and disinflationary impact of higher US yields and a stronger
dollar.
As a result, the FOMC, which will see important personnel changes in early 2017, may
argue that the market has already done some its work and not be as hawkish as expected.
In this scenario, US short-end rates could lose ground while long-end rates continue to
push higher, resulting in a steepening of a still not very steep US rates curve.
One corollary is that factors which have wakened the euro may lose traction as 2017
progresses.
Two years ago I started to argue that analysts and markets were over-estimating the risk of a collapse in
global economic growth, pointing to the reflationary impact of years of monetary easing by the world’s
major central banks (see The global growth story – cause for concern, not panic, 17 December 2014). This
led me to conclude that concerns about global deflation were overdone (see Deflation, what deflation?, 25
September 2015) and a year later that central banks had likely reached an important inflexion point, with
policy rate cuts and expansions of QE programs to become increasingly rare (see Global central bank
easing nearing important inflexion point, 15 September 2016). The corollary was that the fall in global
yields, to which we had all become accustomed for so long, may not extend further.
A global recession was indeed averted. GDP growth bottomed out in H1 2016 at around 2.8% year-on-year
and rebounded to around 2.9% yoy in Q3 2016. Moreover, the latest indicators, including the up-tick in
global manufacturing PMI, suggest that global GDP growth may hit or even slightly exceed 3.0% yoy in Q4
2016 (see Figure 1), broadly line with my expectations (see Be careful what you wish for, 1 November

2. 2
2016). While global inflation remains low by historical standards, headline and core CPI-inflation have been
broadly stable around 1.5% yoy and 2% yoy, respectively, for the past two years (see Figure 2).
Figure 1: Global manufacturing PMI points to
global GDP growth of 3% yoy or more in Q4 2016
Figure 2: Global deflation avoided
Source: IMF, national statistics offices Source: World Bank
Finally, central bank monetary easing has become an increasingly rare occurrence. Since early November,
only two major central banks – in New Zealand and Brazil – have cut their policy rates and global yields,
bar Japanese yields, slowly inched higher from mid-September to 8th
November (see Figure 3).
Figure 3: Global yields, bar in Japan, rose between
mid-September and US elections…
Figure 4: …and jumped higher, particularly in US
and Australia, post Trump’s election victory.
Source: investing.com Source: investing.com
2.0
2.5
3.0
3.5
4.0
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Global real GDP, % year-on-year
(IMF methodology)
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Change in government bond yields since 8
November 2016 (bps)

3. 3
Donald Trump’s election to US president on 8th
November and his promise to boost infrastructural spending
and cut taxes have arguably given greater weight to the argument that the US may export inflation to the
rest of the world, that global deflation is no longer a risk and that major central banks may consider
eventual policy rate hikes. Fund managers and markets did not stay on the sidelines for long. Global yields,
with the notable exception of German yields, have risen further, particularly at the long-end of the curve
(see Figure 4). US yields have surged by about 60bp and the US rates market, which for the past two years
has correctly priced in a far slower pace of rate hikes than assumed by FOMC members, is now almost
perfectly aligned with the Fed’s latest dot-chart in assuming three rates hikes in 2017 (see Figure 5).
Figure 5: Markets, analysts and FOMC members now broadly on the same page
Source: US Federal Reserve,CME,CNBC, Financial Times, Reuters
Note: FOMC median/weighted average: Seventeen FOMC members' median/weighted estimate of the appropriate policy
rate by the end of the following year
Hawkish pendulum may have swung too far
The expectation that reflationary US-centric policies will drive global, and in particular US growth and
inflation in 2017 and that the Fed’s hiking cycle will step up a gear may well provide further momentum to
US yields, the dollar and US equities and continue to heap pressure on emerging economies and asset
prices in coming months.
But analysts and markets may now have got ahead of themselves in expecting a sustained and rapid
increase in global, and in particular US growth and inflation, unfettered dollar appreciation and the start of
central bank rate-hiking cycles in major economies. Put differently, in the space of a few months markets
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Analysts
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Actual
Dec 2014 (forecast for 2015) Dec 2015 (forecast for 2016) Dec 2016 (forecast for 2017)
?
FOMC and analyst forecasts and market pricing of Federal Reserve rate hikes for full-year (bps)

4. 4
may have gone from being too dovish to being too hawkish. If this proves correct, US and more broadly
short-end rates and the US dollar may stabilise and eventually correct lower.
My core reasoning is that US inflation may not rise as fast expected, due to lags in the implementation of
Trump’s planned fiscal policy loosening and immigration curbs, residual slack in the US labour market and
disinflationary impact of higher US yields and a stronger US dollar. As a result, the US Federal Open
Market Committee (FOMC), which will see personnel changes in early 2017, may argue that the market
has already done some its work and not be as hawkish as expected. In any case, forecasting the number of
hikes a changing FOMC will deliver in 2017 in response to a US and global macro environment pray to ill-
defined policies set by a president with no political experience will stretch the even the most skilled rate-
forecasters.
US fiscal policy – Devil in the detail and timing
What we don’t know or can only guess about US policy going forward still dwarfs what we know. The
nebulous panoply of pseudo-policies which Donald Trump announced during his presidential campaign and
since his election is admittedly slowly starting to come into focus; he has already u-turned or downplayed a
number of policy-ideas previously espoused (including the building of a wall between the US and Mexico)
while seemingly giving greater weight to areas of policy he had until now only touched on (including the
United States’ relationship with China). Moreover, Trump has appointed all of his senior cabinet members,
partly answering the key question of who will be pulling the strings in his inner circle.
However, Trump’s policies remain very fluid and many of the newly appointed cabinet members have little
real political experience which we can draw on to predict which policies they will prioritise. Greater
spending on infrastructure, immigration curbs and tax cuts are seemingly central to Trump’s doctrine but it
is still unclear whether and when they will become law, either via executive order or the more traditional
route of congressional approval. Trump, who will only be inaugurated president on 20th
January, and/or
Congress may realistically only pass the bulk of these policies in 2018.
Moreover, while tax cuts can quickly translate into consumption and investment and feed through to the
broader economy in the form of faster growth and inflation, costly and complex infrastructural projects are
usually prey to significant leads and lags. Various levels of government often need to green-light these
projects, funding earmarked and contracts put to tender. Assuming these projects get off the ground, it can
be months or years before the economic benefits are felt at a local, state let alone national level. In the
meantime, the US labour market may continue to struggle to provide a significant inflationary stimulus.
US labour market strong but large pool of available workers keeping wage growth in check
Despite the apparent tightness of the US labour market, growth in disposable income and wages has flat-
lined around 4% yoy (see Figure 6), which has in turn likely held back a more rapid increase in measures of
year-on-year core inflation in the past year (see Figure 7). There is evidence to suggest that there is still
some slack in the US labour market, a point voting FOMC member Brainard has made repeatedly – and
that people are being employed in low-pay sectors.

5. 5
Figure 6: Nominal wage growth stuck around 4%
per annum
Figure 7: Core US inflation measures rising at
slow pace
Source: US Bureau of Economic Analysis Source: US Bureau of Labour Statistics, US Bureau of
Economic Analysis
Markets tend to focus on the US unemployment rate, which has plummeted to 4.6%, but it is a crude and
incomplete measure of the labour market. Three variables drive total wages: 1) the number of people
working, 2) the number of hours they are working and 3) the wage/per hour they are getting paid.
Figure 8: Ratio of employed to working age
population still low by historical standards
Figure 9: Share of full-time workers has risen but
still low by historical standards
Source: US Bureau of Labour Statistics Source: US Bureau of Labour Statistics
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US wages & salaries, year-on-year % change in
$-value, 3mma
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Jan-15 Aug-15 Mar-16 Oct-16
Core CPI-inflation
Core PCE inflation
Market-based core PCE-inflation
Measures of US inflation excluding energy and
food prices, year-on-year % change
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scale
Wages & salaries (nominal) % year-on-year
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1994 1997 2001 2005 2009 2012 2016
US full-time employed as % of total employed

6. 6
The number of people working has risen but the number of people of working age has gone up even faster,
resulting in a still low employed-to-working-age-population ratio (see Figure 8). Hours worked per week
have stagnated at around 34.4 in the private sector, because the share of full-time workers is still quite low
(see Figure 9) and the number of hours these full-time workers are working is not going up much. Finally,
wage growth is not rising very fast, partly because there is still a large pool of potentially available workers.
From late-1997 to mid-2001 there were 10-11 million unemployed people and people not in the labour force
but ready to work and wage growth averaged nearly 8% yoy. Similarly, from late 2006 to late 2007 there
were fewer than 12 million such people and wage growth exceeded 7% yoy (see figure 10). That number
peaked at 21.3m million in October 2009 at the height of the financial crisis and has gradually come down
since. But it is still above 13 million, i.e. a couple of million more than when the labour market was really
tight. Still, one would expect wage growth to be a little higher than it currently is. There are a number of
reasons for this, including a large number of part-time workers.
Figure 10: Pool of unemployed/wanting a job has
fallen but still higher than during boom times
Figure 11: If part-time workers are added, potential
supply of labour remains quite high
Source: US Bureau of Labour Statistics Source: US Bureau of Labour Statistics
The number of unemployed, those not in the labour force but want a job and part-time workers (i.e.
potential labour supply) is, at about 41 million, still far higher than during boom times when it was a low as
33 million (figure 11). So, despite decent employment growth, employers still have a decent pool of
potential workers to fall back on and that is probably helping to keep wage growth in check.
It would be a stretch to argue that the US labour market is weak or that wage growth and core inflation will
not rise. They probably will. But in order for the pool of available labour to shrink and wage and inflation
growth to rise rapidly, the labour market may need a boost from large-scale infrastructural projects, curbs in
immigration and broad-based tax cuts. If these policies are delayed or mothballed, aggregate wage growth
may struggle to accelerate and inflation continue to rise only slowly, which the Fed would likely have to take
into account.
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Year-on-year % change in $-value of wages
& salaries (right scale)

7. 7
Federal Reserve monetary policy – Compounded uncertainty
The seventeen members of the Federal Open Market Committee (FOMC), of which ten are voters, estimate
that three 25bp rate hikes will be appropriate in 2017. This is seemingly more credible than their estimate of
four hikes in 2016 and there has been much focus on the possibility of a more pronounced pace of hikes in
2017 than in 2105 or 2016.
The US rates and FX markets have already priced in that the Fed will have to react more hawkishly to
potentially higher US inflation – US yields have surged (see Figure 12) and the dollar nominal effective
exchange rate (NEER) has appreciated 5% since Trump’s election and nearly 30% over the past three
years according to my estimates (see Figure 13). Markets have in effect already done at least part of the
Fed’s work. The risk is that the Fed decides that US monetary policy has for now tightened sufficiently
relative to the fiscal policies which Trump’s administration could conceivably deliver over the next twelve
months. Put differently, the Fed may not want to see further tightening of monetary policy until approved
and enacted policies start feeding through to macro variables.
Figure 12: Tightening of US monetary policy via
higher US government yields…
Figure 13: …and US dollar appreciation
Source: investing.com Source: investing.com, US Federal Reserve
This uncertainty, which Chairperson Janet Yellen has acknowledged and is endemic to any central bank’s
policy outlook, is compounded by the forthcoming changes in the FOMC.
0.6
1.0
1.4
1.8
2.2
2.6
Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16
2s-10s
Average of 2yr, 5yr and 10yr yields
US government bond yields, %
118
120
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130
Apr 16 Jun 16 Aug 16 Oct 16 Dec 16
USD nominal effective exchange rate
(23 April 2010 = 100)

8. 8
Figure 14: FOMC changing of the guard likely to usher in four somewhat more dovish voting members
Source: US Federal Reserve,various
FOMC member Background Bias Note
Esther George Kansas City Fed President Very hawkish Arguably one of the FOMC’s most, if not most hawkish
members, having dissented in favour of 25bp rate hikes
at the Fed’s policy meetings in July, Sept and Nov 2016.
Loretta Mester Cleveland Fed President Hawkish Dissented in favour of 25bp hikes at the Fed’s meetings
in September and November 2016.
Eric Rosengren Boston Fed President Dovish turned modestly
hawkish
Typically regarded as dovish but he dissented in favour of
a 25bp hike at the Fed’s September 2016 meeting.
James Bullard St Louis Fed President Hawkish turned dovish Harder to categorise, given his swings in outlook. He did
not dissent in 2016 but reportedly said that, had he had
been a voter in 2015, he would have dissented in favour of
a 25bp hike at the Sept 2015 meeting. However, he
acknowledged that in the Fed’s June 2016 dot-plot he
had called for just one hike by end-2018 – the most
dovish of all the seventeen dots.
Charles Evans Chicago Fed President
since Sept 2007
Very dovish One of the most dovish regional Federal Reserve
presidents.
Neel Kashkari Minneapolis Fed President
since 1 Jan 2016, replaced
Narayana.
Dovish Kashkari may not be as dovish as Kocherlakota but said
in early August that he did not see much inflationary
pressure and that the Fed had "the luxury of time" in
raising rates. On 12 Sept 2016, he said “There doesn’t
appear to be a huge urgency to do anything" . Following
the Fed's decision to hike rates on 21 Sept 2016, he said
“It’s also a question of when the broader economy can
sustain a higher interest rate environment" and on 29
Sept he said "There does not appear to be any urgency
to raise rates when inflation is coming up low [...] waiting
too long is less of a risk than moving too soon”.
Robert Kaplan Dallas Fed President since
8 Sept 2015, replaced
Richard Fisher
Neutral / modestly
hawkish
He has so far sounded less hawkish than Fisher who
consistently called for withdrawal of Fed stimulus. But
Kaplan's tone has become somewhat more hawkish in
the past 12 months. He delivered a dovish debut speech
on 18 Nov 2015, saying the FOMC had been "prudent" in
not hiking to that point. On 13 Jan 2016 he said he
expects to be a centrist in his time at the Fed. On 26
Sept 2016, he said: “I would like to see some removal of
accommodation. I would have been comfortable seeing
that accommodation removed in September [2016]...I
am concerned about distortions rates this low are
creating. ” On 18 Nov he said “we’re at the point where
we’re ready to remove some accommodation in the near-
future. I still feel that way heading into December ”.
Patrick Harker Philadelphia Fed President
since 1 July 2015, replaced
Charles Plosser
Hawk His tone has been hawkish, but he is likely to be less
hawkish than Plosser who was a consistent critic of the
Fed’s loose monetary policy and who dissented in three
of his last four votes on the FOMC. In Dec 2015, he said
the Fed should raise rates "sooner rather than later" and
that the economy was approaching "normalcy". In July
2016, Harker said it may be appropriate to raise rates
twice in 2016 and projected the funds rate to "approach"
3% by end-2018. On 16 Nov 2016 he said “we may need
to have a steeper path of rate increases.”
OUTIN

9. 9
At the Fed’s first scheduled meeting of 2017 meeting, on 1st
February, the four voting regional bank
presidents will be replaced as per the FOMC’s policy of one-year term rotating terms1
. Regional Reserve
Bank presidents Charles Evans, Patrick Harker, Robert Kaplan and Neel Kashkari will replace James
Bullard, Esther George, Loretta Mester and Eric Rosengren. This is significant as, historically, regional
bank presidents have had more contrasting viewpoints and been more willing to dissent then members of
the Board of Governors.
While Charles Evans was a voting FOMC member in 2008, 2011 and 2014, it will be first time that
Kashkari, Kaplan and Harker are voting FOMC members and they have yet to earn a cast-in-stone hawkish
or dovish label. However, in aggregate, the four new voting FOMC members are arguably more dovish than
the members they will replace (see Figure 14).
Moreover, appointments to the two empty seats on the board of governors could change dynamics further
(see Figure 15). President Barack Obama announced in early 2015 Allan Landon and Kathryn Dominquez
as his nominations but they are still awaiting confirmation from the US Senate and could conceivably be
derailed by Trump.
Finally, Atlanta Federal Reserve Bank president Dennis Lockhart – a non-voting FOMC member in 2017 –
will step down on 28 February 2017. There is no set timetable for naming a new president and Marie
Gooding, first vice president and chief operating officer of the Atlanta Fed, would serve as interim president
if a successor is not chosen before 28 February. Therefore, at the 1st
February policy meeting, either
Lockhart or his successor will be one of the seven non-voting FOMC members. From March onwards,
either Lockhart’s successor or Marie Gooding (if no successor has yet been appointed) will be one of the
seven non-voting FOMC members.
1 According to the US Federal Reserve, “The Federal Open Market Committee (FOMC) typically consists of twelve
members – the seven members of the Board of Governors of the Federal Reserve System; the president of the
Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year
terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president
from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and
Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the
Committee, participate in the discussions, and contribute to the Committee's assessment of the economy and policy
options.” However, two of the Board of Governor seats are currently unfilled and therefore there are only ten voting
members on the FOMC.

10. 10
Figure 15: Four new regional presidents, two empty seats and one soon-to-step-down non-voting member
Source: US Federal Reserve,various
A more dovish FOMC, faced with still modest inflation, residual slack in the labour market and uncertain
fiscal policy program, could conceivably hike fewer than three times next year, capping or reversing the rise
in US front-end yields (incidentally the last time the Fed hiked three times in a calendar year was in 1999).
At the same time US long-end rates could continue to push up, as i) delayed Fed rate hikes in H1 2017
could result in a greater need for hikes down the line, particularly if Congress/Trump start to push through
and enact reflationary policies in 2018; ii) hawks fill the two currently vacant FOMC seats and iii) the four
voting FOMC members who take their seats in 2018 are more hawkish than the outgoing ones. The net
result would be a steepening of the US yield curve, which is still pretty flat by historical standards (see
Figure 12).
Board of Governors Janet Yellen, Chairperson
Lael Brainard
Stanley Fischer
Jerome Powell
Daniel Tarullo
Vacant seat
Vacant seat
President of New York
Federal Reserve
William Dudley, Vice Chairman
Charles Evans (Chicago)
Neel Kashkari (Minneapolis) Never been voting FOMC member
Robert Kaplan (Dallas) Never been voting FOMC member
Patrick Harker (Philadelphia) Never been voting FOMC member
James Bullard (St. Louis)
Esther George (Kansas City)
Jeffrey Lacker (Richmond)
Dennis Lockhart (Atlanta) Due to step down on 28 Feb 2017.
Marie Gooding, first VP to serve
as interim president if successor
is not chosen before 28 Feb.
Loretta Mester (Cleveland)
Eric Rosengren (Boston)
John Williams (San Fransisco)
Composition of the Federal Opean Market Committee in 2017 (as of now)
Regional Fed Presidents,
voting
Regional Fed Presidents,
non-voting
Obama's appointments still
awaiting Senate confirmation
VOTINGNON-VOTING

11. 11
Factors which have driven euro weaker may lose traction as 2017 progresses
The German yield curve has followed a somewhat different dynamic, with short-end rates falling following
the ECB’s decision on 8th
December to extend its QE program by nine months until December 2017 with
planned bond purchases of €540bn (see Figure 4). However, its decision to cut its monthly bond purchases
from €80bn to €60bn as of March has likely contributed to fears that inflation may pick up in the long-term
and to higher long-end Bund yields. This “hawkish easing” or “dovish tapering” has ultimately led to a
steepening of the German yield curve.
Figure 16: EUR/USD approaching parity and Euro
NEER at one-year low
Source: investing.com, ECB
A number of factors have pushed the EUR/IUSD cross lower towards parity, in line with my January
forecast (see What to expect in 2016 – same, same but worst, 19 January 2016), and the euro NEER to a
one-year low according to my estimates (see Figure 16). These include i) the widening spread between US
and eurozone yields, ii) concerns that immigration and terrorism issues are fuelling European nationalism’s
ascendancy and in turn political risk which could ultimately lead to a break-up of the eurozone and/or
European Union, and iii) the weakness of the Italian economy.
The 2017 calendar is certainly peppered with European event risk. There are planned elections in Germany
(parliamentary) and France (presidential and parliamentary) – the EU’s two largest economies. The
Netherlands and Norway will hold legislative elections on 15th
March and 11th
September, respectively.
There could also be potential parliamentary elections in Italy, the eurozone’s third largest economy.
But if, as I expect, the eurozone economy starts to benefits from the euro’s depreciation and US yields
stabilise or fall, this yield spread may no longer be sufficient to push the EUR/USD cross lower. Moreover,
while posturing between European and Italian leaders may delay any agreement and implementation of a
comprehensive rescue package for the Italian banking sector, history suggests that a fudged compromise
will eventually be reached (see Renzi referendum – storm in a brittle tea cup, 2 December 2016).
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Aug 15 Nov 15 Feb 16 May 16 Aug 16 Nov 16
Euro nominal effective
exchange rate
EURUSD (right scale)
Euro indices (23 April 2010 = 100)

12. 12
European political risk is real but probably exaggerated
Finally, the risk of European nationalist parties acceding to the highest echelons of power has been over-
stated, in my view (see Black swans and white doves, 8 December 2016). Specifically, the probability of the
euro-sceptic leader of the French right-wing Front National party, Marine Le Pen, upsetting the status quo
and being elected president in the April-May elections is still low (see EM currencies, Fed, French
elections, UK reflation “lite”, 25 November 2016).
Italian elections could trump French presidential elections if President Sergio Mattarella brings forward
general election currently scheduled no later than 23rd
May 2018 and markets are forced to consider the
early departure of Paolo Gentiloni’s technocratic government. But again the odds of the populist Five Star
Movement securing the greatest number of seats in parliament and premiership are modest rather than
high. Germany is due to hold legislative elections in August-October but a credible challenge to Chancellor
Merkel being re-elected for a fourth term remains elusive.
Of course a number of economic and political events could throw off course this sanguine outlook for the
eurozone and I am cognisant that opinion polls have proved of little use in forecasting the British general
elections in 2015, British referendum in June 2016 and US elections in November 2016. It may be
premature to go long EUR/USD but this may well be the trade to consider, particularly in the run-up to the
French presidential elections in April-May 2017.