FINANCIAL MARKETS TODAY

FINANCIAL MARKETS TODAY North American edition Tuesday 18 December 2018 INSIDE TODAY'S EDITION: NEWS & RUMOURS -- The UK Times carried a story citing that the UK PM Theresa May is likely to present three Brexit countdown options to the Cabinet. -Bloomberg. -- The UK Government has taken secret legal advice on extending Article 50 which it argues effectively rules out a second referendum, The Telegraph reported. -- China's President Xi at the 40th reform anniversary event said that the country might face unimaginable difficulties ahead. FOREX MARKET ROUNDUP USD sentiment seen weaker ahead of the 2-day FOMC meeting that begins today with market players wary of the possibility for a more dovish statement from the Fed going into 2019 following an expected 25bps hike. BOND MARKET STRATEGY Treasuries resumed their push higher to open the week on Monday, alongside further equity market weakness as markets look ahead to the FOMC statement/rate decision (accompanied by updated economic projections and followed by a post-statement press conference with Fed Chai Powell). GERMANY: IFO SURVEY CONFIRMS WEAKENING GROWTH The 101.0 reading on the Dec German headline Ifo business climate indicator is a full point below the 102.0 chalked up in Nov and moderately weaker than the market consensus prediction of 101.8. It follows a long line of recent surveys that have been revealing weakening business conditions in the Eurozone s largest economy. US PREVIEW: HOUSING STARTS/BUILDING PERMITS ON TAP The November US Commerce Department housing starts and building permits report will be released Tuesday at 08:30EST (13:30GMT). We expect an overall increase in the housing starts measure to 1235k in November, versus the 1228k result that occurred in October. UK: PM MAY DISMISSES CALLS FOR A PEOPLE S VOTE /2 ND REFERENDUM UK PM May s dismissal of a second referendum and her insistence that the govt s Brexit Withdrawal Agreement is the only deal available, is increasing the chances of a no deal Brexit, given that Parliament will likely be voting it down next month. DAILY ECONOMIC DIARY DD/MM GMT R* CTRY DATA RELEASE FOR ACTUAL IDEA MEDIAN LAST ----- ----- - -- -------------- --- ----- ---- ---- ---- 18/12 13:30 4 US HOUSING STARTS NOV 1235 1233 1228K 18/12 13:30 3 US BUILDING PERMITS NOV 1275 1265 1265K 18/12 13:30 3 CA MANUF SLS OCT 0.3 N/A 0.2% 18/12 23:50 3 JP TRADE BALANCE Y NOV N/A 630.0 449.3B *R=Market Significance rating, on scale 0-5 Source: Reuters/Bloomberg -----------------------------------------------------------------------

Financial Markets Today 18 December 2018 page 2 DD/MM GMT CTRY EVENT ----- ----- -- ----- 18/12 NO MAJOR IMPORTANT EVENTS SCHEDULED FOR TODAY NEWS & RUMOURS Ifo economist Wohlrabe says the German economy is cooling down but sees no recession. Says uncertainty has increased further with Brexit at the top of the agenda. Norges Bank gov Olsen repeats the CB's plan remains to gradually increase key policy interest rates in the years ahead, adding that rates will be hiked in Mar 2019 if developments proceed as projected by the Bank. He acknowledges that the uncertainty surrounding 'Brexit' is extremely high. - Reuters. The latest German Ifo business climate index reading came in weaker at 101.0 vs an expected 101.8 print. EU Commissioner Moscovici says the EU is working hard to ensure Italy can carry out the policies it wants without breaking the EU fiscal rules, but adds that France's likely overshoot of the EU's 3.0% of GDP ceiling in 2019 would be allowable if it's just a temporary measure, and would not entail punitive fines - Reuters. IDEA: The Italian govt will not be happy with this even though the country's dizzying debtto-gdp ratio of just over 131% of GDP means that it cannot really afford to have even moderate-sized budget deficit/gdp ratios, and should in theory be generating fiscal surpluses to get that debt ratio down. France's debt-to-gdp ratio on the other hand is reportedly on course to reach 98.7% this year, still a problem, but not as bad as Italy's. UK Communities secretary Brokenshire says preparing for a no-deal Brexit is the right thing to do even if the scenario is not one the govt would like. Reuters. In the latest budget proposal the Italian govt has reportedly slashed its GDP growth estimate for 2019 to 0.9%-1.0%, down from 1.5% previously, according to Italian newspaper Il Sole. Some short covering noted in cable in early trading seen lifting the pair to 1.2660 while EUR/GBP dips lower to 0.8980. Traders note a break above the 200-hour ma around 1.2635/40 as a possible shortterm catalyst. According to the daily Corriere della Sera, the EU Commission has asked Italy for a further EUR2.5-3.0bn in structural savings before approving the 2019 budget - Reuters. USD sentiment is a little weaker ahead of the 2-day FOMC meeting that begins today with market players wary of the possibility for a more dovish statement from the Fed going into 2019 following an expected 25bps hike. USD/JPY has slipped to 112.50 weighed by 10-year U.S treasury yields falling below 2.85%, both 8-day lows. However, the key fx mover overnight has been the NZD/USD, up 0.8%, driven by a sharp rise in December business confidence. Elsewhere, equity market sentiment remained weaker, along with oil prices, prompting some safe haven JPY demand. In Europe traders await the release of the latest German Ifo report during an otherwise quiet data and event session. The UK Times carried a story earlier, citing that the UK PM Theresa May is likely to present three Brexit countdown options to the Cabinet. -Bloomberg. The UK Government has taken secret legal advice on extending Article 50 which it argues effectively rules out a second referendum, The Telegraph reported. The advice states that Britain will be legally obliged to take part in European Parliament elections in May of next year if it extends Article 50 and subsequently send British MEPs to Brussels. It warns that there will be a "high risk of a successful legal challenge" if the UK refuses to take part in the elections because doing so will be breaching people's rights as EU citizens.

Financial Markets Today 18 December 2018 page 3 The latest comments from the BoC Governor Poloz, speaking during a CTV interview: Rates need to be more neutral with economy near capacity. Is not expecting a recession in 2019. Canada's economic fundamentals quite solid. China's President Xi at the 40th reform anniversary event said, that the country might face unimaginable difficulties ahead. The government opposes hegemonism and Taiwan's independence. The country's development poses no threat to any country and the country's defensive national security policy will be upheld. On the domestic front: Anti-corruption battle has achieved results while democracy will be improved to ensure people's democratic rights. The communist party should promote its governance ability he said, and the authorities will promote trade convenience and continue to play the role of a responsible major nation. The government will stick to supply-side reforms. China plans to unveil more major tax cuts. The individual income tax reduction will be at the top of the list next year and upcoming policies will also include tax exemptions for SMEs and high-tech enterprises, reports the China Daily citing an unidentified tax administration official. China vehicle sales printed -13.9% y/y in November after -12.0% y/y in October; vehicle production came in at -18.9% y/y in November after -10.3% y/y in October. China's central bank injected CNY 180bn liquidity in repos, including CNY 40bn in 14-day repos. The Nikkei 225 witnessed a plunge on US equities dipping and Xi's comments, to fall -391 pts (- 1.82%) and close at 21,115. The Japanese FinMin Aso comments: Will reduce tax on buying cars - The government will extend housing loan tax exemptions (this to ease the sales tax hike due ahead) - The US rate hikes are not a bad thing as they help to sustain economic growth. Japan's government, Cabinet Office issued revised economic forecasts citing natural disasters and weakening export demand due to trade tensions. GDP: Economy to grow 0.9% in fiscal 2018 (ends in March), down from previous projection of 1.5% - Fiscal 2019 +1.3% down from previous +1.5%. Capital expenditure: +3.6% in fiscal 2018, +2.7% growth in fiscal 2019. CPI: +1.0% this fiscal year, down from 1.1% forecast previously - fiscal 2019 +1.1% from +1.5%. The minutes of the RBA December 2018 meeting: Board agreed next move in rates more likely to be up than down but saw no strong case for a near-term change in policy. Rates to remain the same. Steady policy allowed RBA to be a source of stability and confidence - Sluggish household incomes, high debt and falling home prices "posed downside risks" - Had expected Q3 GDP growth to be above 3% for the year (vs actual 2.8%) - Expected GDP growth to run above potential this year and next - Leading indicators pointed to above average jobs growth for next couple of quarters - Further fall in the unemployment rate likely - Banks had slowed lending for housing investment and to small business - There had been a "generalised tightening of credit availability" - Noted a pick up in business lending by major banks to large businesses. Trade-weighted A$ remained within range of recent years - Recent sharp fall in oil prices likely to curb headline inflation globally - Board noted difficult to gauge underlying growth in Chinese economy - Growth had slowed in number of economies globally, in part due to trade tensions. Australia (ANZ Roy Morgan) weekly consumer confidence up a notch at 117.8 with prior being 117.7. ANZ's Head of Australian Economics, Plank, comments: Consumer sentiment was basically unchanged over the past week. The upward movement in the time to buy a household item was a good sign considering the holiday season, though still below its long-run average.

Financial Markets Today 18 December 2018 page 4 ANZ's monthly NZ Business Outlook Survey for December: Business Confidence, an 8 month high at -24.1 versus a prior of -37.1 - Activity Outlook up also at 13.6, its highest in 7 months, versus a prior of 7.6. Key points: Expected profitability and employment, investment and export intentions rose, and perceived availability of credit jumped sharply. - Marring the picture a little, most indicators for the agriculture sector deteriorated. Additionally: Employment intentions improved - investment intentions improved - profitability still negative. ANZ comments: Business confidence lifted meaningfully. That said, it remains in the red, with a net 24% of respondents reporting they expect general business conditions to deteriorate in the year ahead. More importantly, firms' perceptions of their own activity rose 6 points to a net 14% expecting a lift. US equities saw downward pressure on Monday with the S&P 500 decreasing -53.99 to 2545.96 (- 2.08%). Meanwhile, the 10Yr US Treasury yield decreased -3bps to around 2.86%. This came alongside downward pressure for crude prices with January crude decreasing -$1.32 to $49.88/bbl. -- Recap from Monday's North American session -- The US Dec Federal Reserve Bank of New York manufacturing activity index saw a decrease in the general business conditions measure to +10.9, versus the unrevised +23.3 reading seen in November. This comes in well below market expectations for a +20.0 result. Meanwhile, prices paid decreased to +39.7 in December (from +44.5). Alongside the decrease seen in the headline reading, weaker readings were seen across most key underlying components. This was characterized by decreased readings seen from new orders (+14.5, from +20.4), shipments (+21.0, from +28.0 and the average workweek (+8.0, from +9.2), partially offset by upward pressure seen from the number of employees (+26.1, from +14.1). Meanwhile, looking forward the six-month business conditions decreased to +30.6 (from +33.6). The NAHB US Housing Market Index decreased to 56 in December, versus the unrevised 60 reading seen in November (lowest since May 2015), well below expectations for a 60 result. According to the release, prospective buyer traffic decreased to 43 in December (from 45). Meanwhile, the index of current single-family sales decreased to 61 (from 67), alongside an decrease in the six-month sales outlook to 61 (from 65). The Canada international securities transactions report revealed a net CAD +3.98bln increase in foreign holdings of Canadian securities in October, versus the revised CAD +7.76bln increase seen in September (prev. CAD +7.70bln). Canada existing home sales were report down -2.3% m/m in November, versus the -1.6% m/m increase seen in October. FOREX MARKET ROUNDUP USD sentiment seen weaker ahead of the 2-day US FOMC meeting that begins Tuesday with market players wary of the possibility for a more dovish statement from the Fed going into 2019, following an expected 25bps hike. USD/JPY opened in Europe around 112.50 weighed by 10- year U.S treasury yields falling below 2.85%, both 8-day lows, however, the key fx mover overnight in Asia was the NZD/USD, up 1.0%, driven by a sharp rise in December business confidence. Elsewhere, equity market sentiment remained weaker, along with oil prices, prompting some safe haven JPY demand.

Financial Markets Today 18 December 2018 page 5 During the course of the European morning session further weight was seen on the USD from 10-year U.S treasury yields (2.82% low) with some short covering noted in Cable lifting the pair to 1.2660 while EUR/GBP dipped lower to 0.8980. Traders noted a break above the 200-hour ma around 1.2635/40 as a possible short-term catalyst. EUR/USD also saw some short covering to 1.1385 despite the latest German Ifo business climate index reading coming in weaker at 101.0 vs an expected 101.8 print. BOND MARKET STRATEGY US: Treasuries resumed their push higher to open the week on Monday, alongside further equity market weakness as markets look ahead to the FOMC statement/rate decision (accompanied by updated economic projections and followed by a post-statement press conference with Fed Chai Powell). On the data front, markets were greeted by weaker than expected Empire manufacturing (decreasing to +10.9 in December, lowest reading since May 2017) and further downward pressure in the NAHB housing market index (decreasing to +56, lowest reading since May 2015). Despite remaining backdrop issues ahead of the FOMC, further volatility from manufacturer and homebuilder sentiment clearly provides another layer of concern, alongside increased focus on weaker global demand and general economic slowing. Overall, these issues are likely to see a more cautious Fed as we move into 2019, unlikely to continue their current pace of 25bps per quarter (likely to shift towards 25bps per half, alongside increased data dependence). Markets now look ahead to a relatively light flow of data on Tuesday, highlighted by housing starts/building permits. GERMANY: IFO SURVEY CONFIRMS WEAKENING GROWTH The 101.0 reading on the Dec German headline Ifo business climate indicator is a full point below the 102.0 chalked up in Nov and moderately weaker than the market consensus prediction of 101.8. This latest development takes the headline reading closer to its l-r average of 97.6 and the Q4 quarterly average of 102.0 falls from 103.2 in Q3. This Ifo latest follows a long line of recent surveys that have been revealing weakening business conditions in the Eurozone s largest economy, which is likely to impinge on the region s economy as a whole. German ZEW current conditions sub-index & Ifo business sentiment 150 110 100 50 0-50 -100-150 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 l-t contemporaneous correlation of 0.9131 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 ZEW current conditions sub-index, lhs Ifo business climate index, rhs Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 105 100 95 90 85 80

Financial Markets Today 18 December 2018 page 6 The latest Ifo survey rubberstamps the view that after the shock 0.2% q/q decline in German GDP growth in Q3, the kind of previously hoped-for rebound in economic growth in Q4 could prove elusive. It would seem that the car industry has not quite managed to pull itself out of the torpor that has been created by the vehicle emissions scandal, while it is clear that it is taking a lengthy period for German auto companies to restructure and adapt to the changing demand environment for car types. The uncertainty surrounding Brexit is also intensifying as Mar 2019 draws closer and no Withdrawal/Future Relationship Brexit deal, although signed by the EU and the UK govt, has been ratified as yet by the UK parliament. Then there are also the effects of the ongoing US trade protectionist policies against the EU as well as China that are occurring on top of the slowdown that would normally be expected to occur as the economic growth phase matures. % 8.0 German GDP & Ifo headline business climate indicator 110 6.0 4.0 2.0 0.0-2.0-4.0-6.0-8.0 Q1 1992 Q4 1992 Q3 1993 Q2 1994 GDP y/y grow th, lhs Ifo headline business climate, rhs Q1 1995 Q4 1995 Q3 1996 Q2 1997 Q1 1998 Q4 1998 Q3 1999 Q2 2000 Q1 2001 Q4 2001 contemporaneous correlation of 0.7808 Q3 2002 Q2 2003 Q1 2004 Q4 2004 Q3 2005 Q2 2006 Q1 2007 Q4 2007 Q3 2008 Q2 2009 Q1 2010 Q4 2010 Q3 2011 Q2 2012 Q1 2013 Q4 2013 Q3 2014 Q2 2015 Q1 2016 Q4 2016 Q3 2017 Q2 2018 What is disappointing though is the fact that the domestic economy is not taking up as much of the slack released from weakening exports as one would like, despite evidence of a tightening labour market, job gains and indeed accelerating wage growth. So although it is clear that the economy is easing, the chances of another negative quarter for growth cannot be ruled out in the quarters ahead. This would be the more so should the UK s departure from the EU prove to be a hard, disorderly Brexit and the car industry fails to recover properly. The slowing of the German economy, the weakness in Italy that has caused the country s official growth forecast to be cut to 1% from 1.5% for 2019 and civil strife in France and Belgium that are taking significant tolls on sectoral output there are factors that are likely to undermine overall Eurozone growth. This could well delay the ECB s start to its interest rate normalisation programme, the more so as market inflation expectations are easing and global oil prices are tamer. The upside for EURUSD is thus fairly limited unless the outlook for US Fed monetary policy changes dramatically. 105 100 95 90 85 80 US PREVIEW: HOUSING STARTS/BUILDING PERMITS ON TAP The November US Commerce Department housing starts and building permits report will be released Tuesday at 08:30EST (13:30GMT). We expect an overall increase in the housing starts measure to 1235k in November, versus the 1228k result that occurred in October. Meanwhile, we anticipate building permits will increase to around 1275k in November, versus the 1265k result seen in October. On balance, weakness in single-family housing starts,

Financial Markets Today 18 December 2018 page 7 coupled with more volatile results seen in multi-family starts, should keep the overall measure at historically weak levels, despite budding improvement. Looking back at the October results, housing starts increased +1.5% m/m to 1228k, versus the revised 1210k reading seen in September. Meanwhile, building permits decreased to 1263k in October (-0.6% m/m), versus the revised 1270k reading that occurred in September. Alongside the increase seen from starts, we expect broader improvement is likely to be seen in the months ahead as production gradually improves, despite any lingering headwinds. In terms of 3-month moving averages, housing starts increased to 1239k (from 1224k), while building permits pushed lower to 1261k (from 1274k). Overall, there is clearly some chance that demand for new starts could remain dampened in the near-term, highlighted by volatility in recent reports. However, we anticipate broader gains will likely be seen in the months ahead. As weakness erodes, we anticipate further traction to be seen moving forward. UK: PM MAY DISMISSES CALLS FOR A PEOPLE S VOTE /SECOND EU REFERENDUM Ahead of UK PM May s statement to the House of Commons on Mon afternoon about her failure to win last minute legally-binding assurances from the EU on the Brexit Irish backstop, there had been a growing number of Cabinet ministers who were floating the idea of MPs being given the opportunity to vote on what alternative options/approach (Plan B) should be established in the event that PM May s Withdrawal Agreement fails the meaningful vote in Parliament next month. But against the backdrop of a rising number of voices asking for a People s Vote/Second referendum, PM May once again signalled her refusal to acquiesce to such an idea, and urged MPs not to go down that route. This, along with opposition Labour Party leader Corbyn s threat to call a no confidence motion on PM May s leadership if she didn t name a date for the Meaningful Vote, as well as Fitch s threat to downgrade UK sovereign debt in the event of a no deal Brexit, undermined Cable, sending it back below 1.2600 briefly. Although it has recovered some poise and pushed above 1.2700 on short-covering the m-t risk to the exchange rate remains to the downside. As it stands, Parliament on balance does not have the stomach for a no-deal Brexit, even though there are now suggestions in some ministerial quarters of a managed no deal Brexit, but what seems to be gaining traction now is the suggestion that MPs should be allowed a free vote on the Withdrawal Deal when it reaches Parliament next year. By so doing, it would enable MPs the freedom to chose which way to vote without having to be whipped into toeing the party line by the Whips. This could mean the prospect of several Labour Party MPs and other opposition party members voting of their own free will and perhaps backing the Agreement, rather than have a no deal Brexit scenario. However May s utterances in Parliament confirm that she is seeking no alternatives whatsoever and will stay the course and continue to work towards getting her deal through parliament. She continues to aim to wrest legally binding assurances from EU officials, but we think this is wishful thinking on her part. But at this juncture it still is more likely than not that the Withdrawal Agreement will fail in parliament, free vote or otherwise, and Monday s statement from PM May in Parliament provide very little real clues on the possible next steps if a deal is voted down. Cabinet ministers calls for a series of votes in parliament as soon as possible to test support for alternatives to the prime minister s deal, should the latter be voted down, have clearly been eschewed. This confirmed an earlier statement from a Downing Street spokesperson stating that there were no plans to offer an indicative vote in parliament on Brexit options, with the PM

Financial Markets Today 18 December 2018 page 8 being focused on securing the extra assurances required to get her Withdrawal Deal through Parliament. So, May s dogged determination to pursue her way means that the risk of a no deal Brexit has risen once again, given that her deal will likely be voted down in Parliament in Jan and the more so as Cabinet talks on no deal preparations are continuing as usual and are in fact being stepped up. Contributors: L. Abisogun, E. Brown, M. Clarke, E. Holmberg, J. Karasin, M. Loader, F. Nazareth Tel.: (Ldn) +44 207 664 0200 / (N.Y.) +1 646-759-3653 / (Sing.) +65 6332 0700 E-mail: research@ideaglobal.com 2018 IDEAglobal TM Limited *** NO DISTRIBUTION INTERNALLY OR EXTERNALLY WITHOUT PERMISSION. *** DISCLAIMER: IDEAglobal products are supplied on IDEAglobal s standard terms and conditions, a copy of which is available on request. Without prejudice to any provisions contained, in such terms, IDEAglobal and all identified data suppliers obtain information for their analysis and forecasts from sources they consider reliable but neither IDEAglobal nor any identified data supplier guarantees its accuracy or completeness. All conditions, warranties and representations expressed or implied by statute, common law or otherwise in relation IDEAglobal services are excluded and in no event shall IDEAglobal or any identified data supplier be liable for any losses or damages, whether indirect or consequential foreseen or unforeseen including loss of profit or other economic loss arising out of any IDEAglobal service. The liability of IDEAglobal and any identified data supplier shall be limited as set out in subscription agreements (or shall be nil if there is no subscription agreement).