Despite recent China concerns and related commodity weakness, we do not see a sustained negative impact on risky assets

ROBERT MCADIE Global Markets Head of Strategy Research Please refer to important information and authors at the end of the report. www.GlobalMarkets.bnpparibas.com New York London Brussels Hong Kong Tokyo 09:00 14:00 15:00 21:00 22:00 PASSWORD 'The BNP Paribas Markets Call' 10 MAY 2017 EVERY WEDNESDAY LIVE All the dial-in details are available at the back of this document Despite recent China concerns and related commodity weakness, we do not see a sustained negative impact on risky assets Sources: Bloomberg, BNP Paribas Our view: xx denotes a change from previous call 2 We retain our positive view on risky assets over the next month, as we do not see immediate risks to the current picture despite the recent commodity weakness. Low and stable yields, strong earnings and greatly reduced European political risk continue to provide a supportive backdrop. We are moderately bearish on commodities, as buoyant supply and a build-up in inventories maintain downward pressure on prices, despite the global upswing. Strong US earnings, with EPS growth above 15.4% (for 432 companies reporting out of 498), are very supportive for US equities. European earnings growth has been even stronger at 23% for 182 companies out of 267 (financials still to report). On a valuations basis we continue to favour European stocks vs US stocks. Volatility across asset classes continues to remain at record low levels. We view this as unsustainable. The catalyst for higher volatility is unclear at the moment, but a shift in Fed rate expectations is likely to be one of the drivers. Global rates remain too low and should start to rise from current levels. We expect the Fed to stick to its current profile of two additional rate hikes for 2017. We continue to like the USD, as US real yields should rise into the end of 2017. We expect the broad trade-weighted dollar to climb by at least 10%. Commodity weakness is likely to weigh on emerging markets, but the improving economic data, strong investor inflows and currently low rates will continue to support this asset class in the short term. Trade of the week: Buy NZD vs JPY. We view that NZD has been oversold in the recent commodity-driven unwind. 09/05/2017 LDN close1-m onth prognosisPrognosis vs currentEURUSD1.0881.070-1.68%GBPUSD1.2941.3000.5%USDJPY114.17115.000.73%10y Gilt1.20%1.25%0.05%10y Bund43bp452bp10y Tsy2.40%2.50%0.1%10y JGB4bp95bpS&P2,3992,4000.04%SX5E3,6493,6500.03%SX7E 1371402.09%FTSE 1007,3427,260-1.12%Nikkei 22519,84319,300-2.74%Gold1,2171,200-1.36%Oil (CL1)4645-1.34%Itraxx Main S2762bp58-4bpItraxx Xover S27253bp240-13bpCDX IG S28 62bp60-2bp Chart 3: Alternative China activity series suggest China’s economic growth remains firm China: Should markets be worried about the second derivative of the economy when growth has been robust? 3 Chart 2: Tightening money supply and lower velocity of money have triggered growth concerns Table 1: Risky assets in China have corrected in recent weeks, driven by a combination of lending restrictions and commodities Chart 1: PMIs decline in April, from a high level, while hard data remain robust All sources: Bloomberg, BNP Paribas Monetary data for April released on 10-15 May Last1 month3 months6 months1 yearChina equity3079-5.8%-2.8%-2.2%8.7%MSCI EM9852.8%6.9%9.2%23.0%MSCI Latam2604-1.5%2.3%0.2%22.4%China local bonds159-1.1%-0.2%-3.7%-0.4%Copper prices7783.5%9.5%16.9%11.0%Oil prices46.43-12.5%-11.3%3.2%6.9%Iron-ore60.15-19.5%-28.0%-11.9%9.4% Chart 3: The CNY has weakened on a nominal trade weighted basis, reducing the risk of a sharp devaluation from here Chart 4: The drop of about USD 1trn in FX reserves shows that China is committed to keeping its currency stable Chart 1: CPI has not followed PPI, but this is due to sharp declines in China’s food prices China is not likely to export deflation, in our view Chart 2: PPI inflation is above the pace of CNY depreciation, meaning that China is exporting inflation All sources: Bloomberg, BNP Paribas 4 -15-10-5051015Jan-10Jan-12Jan-14Jan-16% y/yCNY CEFTSbasket % y/y depreciationChina PPIChina exportinginflation when PPI % y/y > CNY depreciation (grey area)Decline driven by 4.4% y/y decline in Food prices CEFTS basket introduced at 100 05001,0001,5002,0002,5003,0003,5004,0004,500-6,000-4,000-2,00002,0004,0006,0008,00010,00012,000RHS ChinaFX reserves in million USDLHS Chinac/a inmillion RMB Chart 4: Global copper production was strong in H2 16, but has started to decline Swings in supply explain a large amount of the price action 5 Chart 2: Supply of iron ore declined in Q1 2017 due to weather impact Chart 3: Coal price rise in H2 16 encouraged higher production in China and Australia Chart 1: Prices of coal and iron ore have declined (albeit after large increases) All sources: Bloomberg, BNP Paribas Rise in coal price after US election due to Trump’s positive stance on coal Oil market is now more balanced but US production is rising, OPEC compliance may fall and inventories are h