Market Insights

October 2018

Global Economyo Ten years after the collapse of Lehman Brothers and the major financial crisis, the US stock markets continue to break

records. A combination of strong growth and accommodative monetary and fiscal conditions support the US stock

markets to reach record highs while the rest of the world remains behind and has to face rising dollar interest rates

and the strengthening of the dollar

o The era of cheap money and high liquidity is coming to an end, as more and more central banks, led by the US Fed

and the ECB in Europe, are returning to normal policy

o The trade war continues to challenge the resilience of the global economy. Trump’s administration has imposed a new

round of tariffs on Chinese goods. Further actions are expected as the real intentions of the war between the

superpowers is much more than a trade war, it is a war on hegemony of the 21st century

o Although a lull in the emerging markets has occurred lately, the increase in the dollar interest rate alongside the

continued contraction of the Fed’s balance sheet are expected to keep pressuring the emerging markets

o The price of Brent Crude Oil jumped last month to more than $80 a barrel, a four-year level high due to the collapse of

Venezuela and the sanctions on Iran. Trump's demand to lower prices has for the time being received only a

indifferent response from OPEC

•

•

United Stateso The US economy continues to grow strongly due to accommodative economic policy. In Q2, the economy grew

at an annual rate of 4.2% led by private consumption, which rose by 3.8%

o Consumer confidence reached a 14-year high, while the small business confidence has climbed to a 45-year

high. According to corporate surveys, both manufacturing and services sectors continue to expand rapidly

o Hourly wages rose by 2.9% YOY, further evidence of the labor market strength. The unemployment rate

remained stable at 3.9% and the economy generated 201K new jobs

o Inflation rose to 2.7% in the past year, a decrease of 0.2% from the previous month. However, the Core PCE

Deflator remained stable at a level of 2%, meeting the Fed's inflation target

o The yield spread between 2 and 10 year bonds rose to 0.3%, reflecting the investors' understanding that the

economy remains strong, and the interest rate is expected to keep rising into 2019

o The Fed raised the interest rate by 0.25% (to 2%-2.25%). For the first time, the base rate rose above the

inflation target, and is expected to increase again by the end of 2018 and at least three additional times in the

upcoming year

Core Economic IndicatorUSA

Economic Indicator Latest Figure Reference Period

Growth Rate (YoY) 4.2% Q2-2018

Unemployment Rate 3.9% Aug-2018

Inflation Rate (Core, YoY) 2.0% Aug-2018

Fed Funds Target Range 2.25%-2% Oct-2018

10 Year Treasury 3.04% Oct-2018

Ratio of Surplus in Current Account to GDP 2.17%- Q2-2018

Ratio of Public Debt to GDP 105.68% Q1-2018

Economic GrowthGDP (Annualized)

-2.3

2.1

-2.1

-8.4

-4.4

-0.6

1.5

4.5

1.5

3.7

3

2

-1

2.9

-0.1

4.7

3.2

1.7

0.5 0.5

3.6

0.5

3.2 3.2

-1

5.1 4.9

1.9

3.3 3.3

1

0.4

1.5

2.31.9 1.8 1.8

3 2.82.3 2.2

4.2

-9.0

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Economic SentimentManufacturing and Non-Manufacturing PMI

30

35

40

45

50

55

60

65

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Manufacturing Non- Manufacturing

Labor MarketUnemployment Rate (Left) and Under Unemployment Rate, U6 (Right)

6

8

10

12

14

16

18

3.5

4.5

5.5

6.5

7.5

8.5

9.5

10.5

12-07 06-08 12-08 06-09 12-09 06-10 12-10 06-11 12-11 06-12 12-12 06-13 12-13 06-14 12-14 06-15 12-15 06-16 12-16 06-17 12-17 06-18

Unemployment U6- Unemployment

InflationCore PCE (YoY) and 5Y Inflation Forecast

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

12-07 06-08 12-08 06-09 12-09 06-10 12-10 06-11 12-11 06-12 12-12 06-13 12-13 06-14 12-14 06-15 12-15 06-16 12-16 06-17 12-17 06-18

US Breakeven 5 Year Inflation Core PCE Rate (YoY)

Fed Inflation Target

10YR Treasury Yield to Maturity

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

12-07 06-08 12-08 06-09 12-09 06-10 12-10 06-11 12-11 06-12 12-12 06-13 12-13 06-14 12-14 06-15 12-15 06-16 12-16 06-17 12-17 06-18

US Treasury Yield Curve

0

0.5

1

1.5

2

2.5

3

3.5

0Y 2Y 4Y 6Y 8Y 10Y

Current 3-Months Ago 6-Months Ago

Fed Funds Projection

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

2018 2019 2020

FED Projection Market Projection

US Dollar Index (DXY)

75.0

80.0

85.0

90.0

95.0

100.0

105.0

12-12 06-13 12-13 06-14 12-14 06-15 12-15 06-16 12-16 06-17 12-17 06-18

Citi Economic Surprise

-100

-80

-60

-40

-20

0

20

40

60

80

100

12-12 03-13 06-13 09-13 12-13 03-14 06-14 09-14 12-14 03-15 06-15 09-15 12-15 03-16 06-16 09-16 12-16 03-17 06-17 09-17 12-17 03-18 06-18

Eurozoneo Q2 GDP grew by 1.5% in annual terms. The data indicates a decline in consumption, while on the other hand, an increase

in public expenditure and capital investments

o Net foreign trade subtracted 0.2% in both Q1 and Q2 growth, in evidence of the crisis in emerging markets and the

slowdown of international trade. Industrial production continues to decrease, when in fact, in six of the last eight months

it fell and does not appear to be a positive contribution to Q3 growth

o Despite the slowdown in growth, the labor market continues to recover. The unemployment rate fell to 8.1% in August, a

record-low rate since November 2008. The continuing decline in unemployment led to 2.3% increase in wages

o Forward-looking indices, including the Purchasing Managers’ Index, indicate continued expansion, albeit at a slow pace

o Although headline inflation edged up from 0.1% to 2.1% in September, the core inflation decreased slightly to 0.9%,

remaining far below the inflation target of 2%

o The ECB is expected to end its bond purchases at the end of the year and raise interest rates in the fall of 2019

o The chances of an orderly exit agreement between Britain and the EU diminished. The position of the British Prime

Minister has been eroded and the chances that it will be overturned or that elections will be held are increasing

Core Economic IndicatorEurozone

Economic Indicator Latest Figure Reference Period

Growth Rate (YoY) 1.5% Q2-2018

Unemployment Rate 8.1% May-2018

Inflation Rate (Core, YoY) 0.9% May-2018

Central Bank deposit rate 0.00% June-2018

10 Year Government Bond Yield (Germany) 0.45% June-2018

Ratio of Surplus in Current Account to GDP 3.57% Q1-2018

Ratio of Public Debt to GDP 86.7% Q4-2017

Economic GrowthGDP (Annualized)

2.2

-1.5

-2.2

-6.6

-11.4

-1

1.3

2.21.7

3.7

1.82.4

3.4

0 0

-1.2-0.7

-1.3

-0.5

-1.7-1.4

21.4

1

1.9

0.8

1.72

2.9

1.6 1.41.9

2.7

1.1 1.3

3.12.7 2.8 2.7 2.6

1.61.5

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Economic SentimentManufacturing and Non-Manufacturing PMI

48.0

50.0

52.0

54.0

56.0

58.0

60.0

62.0

11-15 02-16 05-16 08-16 11-16 02-17 05-17 08-17 11-17 02-18 05-18 08-18

Manufacturing Non-Manufacturing

Labor MarketUnemployment Rate

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

12.0

12.5

12-07 06-08 12-08 06-09 12-09 06-10 12-10 06-11 12-11 06-12 12-12 06-13 12-13 06-14 12-14 06-15 12-15 06-16 12-16 06-17 12-17 06-18

InflationCPI and Core CPI (YoY)

-1

0

1

2

3

4

5

01/08 01/09 01/10 01/11 01/12 01/13 01/14 01/15 01/16 01/17 01/18

Core CPI CPI

Money Supply and CreditGrowth in Money Supply, Loans to Real Sector

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

04/12 10/12 04/13 10/13 04/14 10/14 04/15 10/15 04/16 10/16 04/17 10/17 04/18

Change in Lending to Non Financial Institutions Change in Lending to Households M3 Money Supply Growth

10YR Government Bond Yield

-0.5

0.5

1.5

2.5

3.5

4.5

12-13 03-14 06-14 09-14 12-14 03-15 06-15 09-15 12-15 03-16 06-16 09-16 12-16 03-17 06-17 09-17 12-17 03-18 06-18

Germany Italy France Spain

Current Account BalanceEUR Billion

-2.29 -1.47-0.20

-5.41

-2.64

1.05 0.86

5.30 5.33

19.46

13.85

17.84

24.74

22.34

17.38

19.48 18.84

11.72

27.2625.18

19.18

4.34

28.34

32.66

30.20

25.61

31.44

28.69

34.29

27.99

40.24

28.61

38.37

28.91

21.31

-10

0

10

20

30

40

50

03/2010 09/2010 03/2011 09/2011 03/2012 09/2012 03/2013 09/2013 03/2014 09/2014 03/2015 09/2015 03/2016 09/2016 03/2017 09/2017 03/2018 09/2018

Exchange RateEuro Index (Left) EURUSD (Right)

1

1.05

1.1

1.15

1.2

1.25

1.3

1.35

1.4

1.45

75

80

85

90

95

100

31/12/2012 30/06/2013 31/12/2013 30/06/2014 31/12/2014 30/06/2015 31/12/2015 30/06/2016 31/12/2016 30/06/2017 31/12/2017 30/06/2018

Euro Index EURUSD

Citi Economic Surprise

-150

-100

-50

0

50

100

12-12 03-13 06-13 09-13 12-13 03-14 06-14 09-14 12-14 03-15 06-15 09-15 12-15 03-16 06-16 09-16 12-16 03-17 06-17 09-17 12-17 03-18 06-18 09-18

Israelo Q2 GDP grew only by 1.8% in annual terms, after increasing by 5.1% in Q1

o The headline inflation rose only by 1.2% YOY, close to the lower end of the inflation target (1%-3%). The

inflation expectation for the upcoming year decreased recently to 1.3%. However, it is too early to declare that

the inflation is established within the target range

o Despite the last increase in the unemployment rate, the labor market conditions are still tight

o The deterioration in the balance of payments continues: the current account surplus of H1 2018 was only

$2.27 billion, compared to a surplus of $4.76 billion in H1 2017. The decrease is derived from a deterioration in

the trade account, the continuous strengthening of the shekel and the slowdown in international trade

o The probability of an interest rate increase in 2018 reduced lately, due to moderate inflation and shekel

appreciation

o On the back of the interest rate differential between Israel and the US (2.8% per year), institutional and retail

investors continue to increase their exposure to US assets

Core Economic IndicatorIsrael

Economic Indicator Latest Figure Reference Period

Growth Rate 1.8% Q2-2018

Unemployment Rate 4.2% July-2018

Inflation Rate (YoY) 1.2% Aug-2018

Central Bank Interest Rate 0.1% Sep-2018

10 Year Government Bond Yield 2.01% Sep-2018

Ratio of Surplus in Current Account to GDP 2.06% Q2-2018

Ratio of Public Debt to GDP 61% Q4-2017

Economic Growth GDP (Annualized)

3.6

0.8 0.7

-2.6

0.4

3.5

4.9

5.86.1 6

4

6

6.9

4.1

8

1.7

-0.4

0.1

4.44

4.3

7.1

4.2

2

3.9 4

2.6

6.3

1.4

0.91.1

4

4.5

5.2

4.6 4.6

0.8

3.6

4.44.7 5.1

1.8

5.1

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

03-08 09-08 03-09 09-09 03-10 09-10 03-11 09-11 03-12 09-12 03-13 09-13 03-14 09-14 03-15 09-15 03-16 09-16 03-17 09-17 03-18

Labor MarketUnemployment Rate

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

2012 2013 2014 2015 2016 2017 2018

InflationCPI (YoY)

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

10YR Government Bond Yield

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

03-11 06-11 09-11 12-11 03-12 06-12 09-12 12-12 03-13 06-13 09-13 12-13 03-14 06-14 09-14 12-14 03-15 06-15 09-15 12-15 03-16 06-16 09-16 12-16 03-17 06-17 09-17 12-17 03-18 06-18 09-18

Government Bond Yield Curve

0

0.5

1

1.5

2

2.5

0Y 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y

Current 3-Months Ago 6-Months Ago

Hedging CostsUSDILS 1YR Forward Premium

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

Current Account BalanceUSD Million

951

101211

948

1,820

1,2691,051

2,611

2,9933,002

2,236

835

1,986

1,453

556

1,262

-1,406

1,0401,227

633

2,406

1,992

892

3,439

3,174

4,226

2,213

3,702

3,158

4,278

4,612

3,816

2,924

3,579

1,965

3,441

2,4052,3542,413

2,091

1,473

795

000000000000000000000000000000000000000000000000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

Exchange RateUSDILS (Left) BoI Nominal Effective Rate (Right)

75

80

85

90

95

100

105

01-13 07-13 01-14 07-14 01-15 07-15 01-16 07-16 01-17 07-17 01-18 07-18

3

3.2

3.4

3.6

3.8

4

4.2

USDILS BoI Nominal Effective Exchange Rate