1. ASSESSING INFLATION STATUS IN A TURNING POINT FOR CENTRAL BANKS
For Professional Investors
Marketing Communication
PATRICK BARBE
London, 2 October 2017

2. CONTENT Eurobond market performance Main themes concerning inflation
US case analysis
Growth and overall situation
FED policy changes
Focus on Euro situation
Growth outlook
ECB strategy
Outlook for Euro inflation
10/11/2018

3. The eurobond market: remarkable resilience
The ECB’s very accommodative policy has kept yields at their lowest level
Index
Universe
Performance 2015
in %
Performance 2016
Performance 2017
in % as at end August 2017
Barclays Euro Corporate
EMU Corporate Bonds All Maturities
-0.56
4.73
1.97
Barclays Euro Aggregate
EMU Bonds Aggregate All Maturities
1.00
3.32
0.51
Barclays Euro Treasury
EMU Government Bonds IG all maturities
1.65
3.23
0.08
Barclays Euro Treasury AAA
EMU Government Bonds AAA All Maturities
0.36
3.99
-0.60
Eurozone main bond indices: performance
Source: Barclays Capital as at end August 2017
Fading political risk (France, etc.) has led to eurobond country spread normalisation
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4. Structural inflation themes (follow-up since LED March)
The structural issues weighing on inflation:
It can take a long time, a decade, to recover from such a ‘once-in-a-century’ crisis:
The real estate bubble burst and affected housing and financial markets as well as households and banks
Reducing households’ and banks’ excess debt levels
Global disinflation due to excess industrial production capacity: a globalisation issue!
Pressure on margins and wages due to the ‘GAFA’* generation: the ‘uberisation’ world
Ageing population in many developed countries and/or a change in consumption behaviour
Wealth losses due to the crisis, impacting household confidence
* GAFA = Google, Apple, Facebook and Amazon
Source: Barclays Capital as at end of August 2017
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5. Synchronised global economic growth for the first time since the crisis
All regions and their main countries are experiencing growth at the same time
Source: Markit, BNP Paribas as at end August 2017
Red improving growth
Blue declining growth
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6. Economic activity was already accelerating before the US election
The US economic picture changed when the industrial soft patch ended in 2016
Step-by-step, all growth engines are contributing to increased activity in 2017:
Strong trend for both job creation… … and real-estate activity
Job openings reached a new high during the summer and leading indicators announced an acceleration:
The real-estate sector is again a pillar of US growth: prices are back to their pre-crisis levels
Source: BNPP AM, Bloomberg as at end of August 2017
Source: BNPP AM, Natixis as at end of August 2017
Economic activity was already accelerating before the US election
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7. The Trump reflation policy was so strongly expected that it became a ‘game changer’
Such a strong rebound in confidence lead to ‘animal spirits’ behaviour…
boosting activity by itself
Domestic companies expect a lot from Trump’s policies: capex rebound since Trump election
Jump in consumer confidence:
household perception of financial situation
Source: Census, Haver Analytics, DB Global market Research
Source: BNPP AM, Bloomberg as at end of August 2017
Such confidence can accelerate the pace of growth to a high level
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8. Thus the Fed should remove its accommodative policy
Since the election, the Fed and the market have been concerned about the declining rate of inflation…
This is temporary, as shown by leading indicators for wage increases:
Last year’s low productivity explained low wage increases: but unable-to-be-filled positions reached a new high
A key leading wage increase indicator is also back to a high level
Source: BLS, Macrobond, BNP Paribas as at end June 2017
Source: Census, Haver Analytics, DB Global market Research as at end August 2017
Scale in %
The Fed announced its balance sheet reduction to exit from a non-accommodative policy
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9. The new US policy for reflation is a game changer
Many uncertainties remain but an asset reflation objective is clear
The challenge for the new president is to get his Party’s agreement on each reform
The most probable measures would be focused on a consensual Republican topic: tax reform for corporates & the middle class, to boost domestic demand
Cutting taxes raises the funding issue without the revenues of the too-complex border tax on imports
The repatriation tax should bring some revenues to fund a small tax cut plan
A context of steady global growth implies increasing pressure on prices of goods, in turn implying a rise in the risk premium - which explains Fed cautiousness
The inflation rate should start to rise smoothly as the output gap closes:
Source: IMF / OECD Official figures as at end August 2017
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10. The Fed just announced its balance sheet reduction
The Fed recently announced its portfolio reduction process:
First three months: USD 6 billion of Treasury reimbursement non- reinvested and USD 4 billion of MBS
Then every three months, the cap should be increased by USD 6 billion of Treasury reimbursement non- reinvested and USD 4 billion of MBS
One year after activation, the maximum amount of Treasury reimbursement non-reinvested should be USD 30 billion, and for MBS, USD 20 billion
Source: CBO, Bloomberg, BNP Paribas Asset Management as at end August 2017
This should result in the yield curve steepening at more than a bearish trend level, as long as inflation is stable
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11. Improved eurozone growth (1)
Supported by: a weak currency, very low yields, the fall in commodity prices and the end of fiscal austerity…thanks primarily to household credit and consumption:
Private credit is now growing in most countries except Spain, thanks to consumption
Consumption rebounded as real wages increased… thanks to lower energy prices
Source: Deutsche Bank, ECB, Haver Analytics / Credit consistent with DB domestic growth
projections as at end March 2017
Source: Macrobond, Eurostat, BNP Paribas as at end March 2017
The ECB’s accommodative monetary policy is starting to work: it will take time to reverse the effects of the last six years, especially if energy prices or long-term yields rebound
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12. Improved eurozone growth (2)
Since the start of 2017, corporates in all sectors except construction have been contributing to the acceleration in economic growth
Corporate confidence is on a bullish trend thanks to the US and French elections
Strong rebound in investment: at risk by the year end?
GSK % Balance / diffusion index
Source: BNPP AM as at end of August 2017
Source: Eurostat, Bloomberg, BNP Paribas Asset Management, Juillet 2017
Eurozone growth acceleration would be at risk should EUR/USD rise back to 1.30
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13. The ECB is focused on currency and asset prices
The impact of QE on currency has ended, reducing inflation risk
Real exchange rate is back to its pre QE level despite a negative deposit rate:
Because of the large balance account surplus
Core inflation rate should stay around 1%-1.5%
Source: Bloomberg, BNP PAM as at end August 2017
Source: Bloomberg, BNP PAM, as at end August 2017
No issue for the ECB in terms of inflation: unchanged policy for 2017 and just tapering in 2018
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14. The ECB’s strategy: asset reflation
QE extension to Q to ensure protracted support for monetary policy transmission:
a ‘tapering’ process due to bond scarcity but conditional upon economic data
Risk of implicit tightening: currency rebound and then risk premium
No key rate increase soon
New rules could be implemented to be able to extend QE purchases up to 2018:
More flexibility in the capital key rules, maturity band or sector allocation
Its CSPP programme of EUR 5-7 billion per month supports credit market:
Corporate bonds offer negative returns on short-term maturities!
The ECB purchasing programme’s impact on the market should remain significant in 2018 because of bond reinvestment (EUR 10 billion a month), despite tapering:
Estimated net sovereign flows for 2017 of EUR -315 billion
Source: BNP Paribas CIB, as at end of December 2016
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15. The euro inflation outlook
A rise toward the ECB’s target in 2018
Euro inflation market expectations are stable, at around 1.6% (5Y/5Y forward rate)
Rising global growth and commodity prices should support a core CPI rate rising toward 1.5%-2%
The higher level should only be reached if wages increase toward 3%
So no reason for the ECB to exit its accommodative policy soon
Source: BNPPAM, Bloomberg end of August 2017
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