Forecast Summary

Forecast Summary (averages)
Actual 2014
Oct
Sep
October 10, 2014
Nov
Dec
2015
Q1
Q2
Q3
Q4
Michael Gregory, CFA
Deputy Chief Economist
Benjamin Reitzes
Senior Economist
U.S. Rates
BoC overnight
10-yr Canadas
Fed funds
10-yr Treasuries
1.00
2.18
0.13
2.53
1.00
2.04
0.13
2.35
1.00
2.12
0.13
2.45
1.00
2.20
0.13
2.50
1.00
2.34
0.13
2.64
1.00
2.55
0.21
2.85
1.00
2.82
0.46
3.12
1.25
3.09
0.71
3.40
C$ per US$
US$/€
US$/£
¥/US$
1.101
1.29
1.63
107
1.110
1.26
1.61
109
1.113
1.26
1.62
110
1.115
1.27
1.63
110
1.122
1.27
1.65
111
1.133
1.26
1.64
112
1.143
1.25
1.62
113
1.150
1.23
1.61
115


QE done this month; Fed cautious about changing forward guidance
Treasury yields slide as global economic and geopolitical risks weigh
 Greenback hits 5-year high, helped by capital
inflows
UNITED STATES
(percent)
1.50
3.50%
(Year-end ’15)
1.25
(lhs)
0.75
Fed policy…The FOMC’s policy announcement on September
17 contained few changes, apart from another reduction of
asset purchases and another member joining the dissention
Fed
Funds
1.00
4
3
10-Year
Treasury
2.50%
(Year-end ’14)
(rhs)
0.50
bandwagon. Treasury and MBS purchases were each cut by $5
billion (for the seventh consecutive meeting) to $10 billion and
2
0.25
$5 billion, respectively. The Fed said it would end QE in October
(upping the Treasury taper to $10 billion). Dallas President
forecast
0.00
12
13
14
15
Sources: U.S. Federal Reserve Board, U.S. Treasury, Haver Analytics, BMO Capital Markets Economics forecasts
1
Fisher joined Philadelphia’s Plosser in not supporting the policy
statement. Mr. Fisher took issue with the forward guidance,
U.S. BROAD TRADE-WEIGHTED DOLLAR
that the policy rate would remain unchanged for a
(January 1997 = 100)
“considerable time” after QE ends. The Minutes subsequently
108
revealed that “several” participants were similarly concerned
106
this language “suggested a longer period before liftoff, and
104
perhaps also a more gradual increase in the federal funds rate
102
thereafter” than will likely be appropriate and “could be
100
misunderstood as a commitment rather than as data
dependent.” However, the consensus view was that the market
98
forecast
96
12
13
14
15
understood this guidance was data dependent (and, if not,
Chair Yellen made sure of it in her post-meeting presser).
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
DOUGLAS PORTER, CFA, CHIEF ECONOMIST · www.bmonesbittburns.com/economics
One reason why the Fed opted to keep the current language, as a “number” of participants
noted, was that any change “might be misinterpreted as a signal of a fundamental shift in the
stance of policy that could result in an unintended tightening of financial conditions.” It was
“generally agreed” that alterations pose “communication challenges, and that caution will be
needed to avoid sending unintended signals about the Committee's policy outlook.” This
suggests language changes are likely to occur only if they are major (no minor tweaking) and in
meetings followed with the Chair’s presser (for communications effectiveness). Thus, the
announced end of QE on October 29 is unlikely to be accompanied with altered forward
guidance.
Through H2 and into 2015, we look for U.S. economic growth to average 3.0%, sufficient for
continuing payroll gains near 200k per month. With the participation rate stabilizing, the jobless
rate should continue drifting down to 5.8% by the end of this year and to 5.0% by the end of
next year. FOMC participants project the longer-run unemployment rate in a 5.2%-to-5.5%
central tendency range. This should be hit by mid-2015. From a risk management perspective,
this would be a key juncture for rate hikes to begin (if they haven’t done so already). We are
forecasting the first formal rate hike in June 2015 and a gradual quarter-per-quarter cadence
during the first year of tightening. This should raise the range for fed funds to 0.75%-to-1.00% by
2015-end and 2.00%-to-2.25% by 2016-end (both are at least 50 bps below the FOMC’s latest
median projections).
There are offsetting risks of a sooner or later tightening profile. The sooner scenario reflects the
case in which wage pressures build more rapidly owing to a 5-handle jobless rate or global
forces continue pulling down Treasury yields as domestic economic and inflation prospects
prove resilient to global headwinds (the Fed would, in effect, be taking advantage of the
situation to start/continue the normalization process, which we dub “opportunistic
normalization”). The later scenario reflects the opposite case: continued subdued wage inflation
(bolstering the “secular stagnation” argument) or domestic prospects being dimmed by global
headwinds.
Treasuries…Once again, 10-year Treasury yields took a stab at cracking the 2.60%-to-2.65%
range through mid-September (a range held since April despite several attempts), but they
backed off as pre-FOMC-meeting concerns that the Fed could turn less dovish were not
realized. Meantime, dimmer global economic prospects (e.g., Euro Area, China, Japan and
Brazil) and mounting geopolitical risks (e.g., Hong Kong, ISIS and Ukraine), not to mention
Ebola fears, helped pull yields down to their lowest levels in 16 months (under 2.35%). Indeed,
given the above prospects/risks/fears, the market is betting, apart from QE ending this month,
that the next less-dovish policy turn and the first rate hike have been pushed back (fed funds
futures are now pricing in a 25-bp higher average by September 2015, having moved away
from June). We still judge U.S. economic performance will stay resilient amid all the global
turmoil, probably imparting a bit of upward pressure on yields through the turn of the year.
PAGE 2
But, recent ranges should hold. We look for 10-year yields to average around 2.50% by yearend.
Heading into 2015, continued sturdy (3%-ish) real GDP growth and Fed policy shifting from
neutral to tightening should apply additional upward pressure on yields. But, if recent history
is any guide, this uptrend will be occasionally interrupted by indications of weaker
growth/slower inflation, further flare-ups of global economic/geopolitical concern and bouts
of buying as yields start hitting multi-year highs. We expect to see a ratcheting pattern, as 10year yields head to 3.50% by 2016-end. The uptrend in shorter-term yields should be
smoother as policy rate hikes approach. We see 2-year yields around 0.60% by the end of this
year and above 2.10% by 2015-end.
Greenback… The U.S. dollar (trade weighted against the majors) hit its highest level since
April 2009 in the wake of the employment report on October 3. Although it drifted a bit
weaker in subsequent days, since early July (which was an eight-month low at the time), the
greenback has appreciated some 6.3%, as it continues to garner strength from both sets of
FX drivers. First, relative economic performance/monetary policy prospects (U.S. economy
strengthening, Fed stopping QE while the ECB and BoJ are still in balance sheet expansion
mode). Second, “risk on”/“risk off” (USD-boosting “off” owing to escalating geopolitical
concerns). Even if the second driver calms, a glance at the economic and policy prospects in
the major markets that make up the index suggests the greenback should gain even more
ground in the months ahead. Among the U.K., Canada, Australia, Sweden, the Euro Area,
Switzerland and Japan, only the U.K. appears to be ahead of the U.S. in terms of policy
tightening prospects.
Canadian Rates



BoC in no hurry to hike rates, even if the Fed moves
10-year Canada yields keep pace with Treasuries
Loonie hits 5-year weak spot to start October
BoC Policy…The Bank is officially “neutral with respect to the next change to the policy rate,”
meaning an equal chance of a rate cut or rate hike. But the odds of any action, any time soon,
are very low. A resilient housing sector (the BoC said it was “stronger than anticipated” in its
September policy announcement) and household debt dynamics (the Bank also said the risks
associated with household imbalances have “not diminished”) are keeping the odds low on the
rate-cut side. Keeping the odds low on the rate-hike side, the expansion-critical export-capex
nexus is just starting to kick in (and still needs nurturing) and policy rates are already at 1%
(recall Governor Poloz: “In this world, that’s a high number when everything is starting at
zero.”).
Through H2 and into 2015, we look for economic growth to average around 2.5% as the
“rotation in demand” from consumer spending/housing-led growth to export/capex-led activity
PAGE 3
continues to unfold. We judge that the Bank will be reticent to
CANADA
raise an already “high number” until the pull of U.S. economic
(percent)
3.0
4
BoC
Overnight
Rate
2.5
3.20%
(Year-end ’15)
(lhs)
2.0
in turn, business investment. As this reticence subsidies and the
3
10-Year
GoC
1.5
performance is unequivocally evident in Canadian exports and,
output gap steadily closes (and inflation risks rise), we look for
the Bank to hike rates in October 2015. With the Fed expected
(rhs)
2.20%
(Year-end ’14)
2
to begin hiking in June, the prospects for narrower Canada-U.S.
overnight spreads should add to the factors weighing on the
1.0
forecast
0.5
12
13
14
1
15
loonie.
Canadas…Canada-U.S. 10-year spreads hit their most
Sources: Bank of Canada, Haver Analytics, BMO Capital Markets Economics forecasts
CANADIAN DOLLAR
negative levels since mid-2008 to end July (-42 bps). After a
(C$/US$)
few days of deterioration (profit taking), spreads have been
1.20
relatively stable in the vicinity of -35 bps. Even as Treasury
1.15
yields rose nearly 30 bps from late August until midSeptember, only to rally back as much through early October,
1.10
spreads have moved no more than 2 or 3 bps around the -351.05
bp level. We see this stability continuing as the inclination for
spreads to deteriorate owing to loonie depreciation is being
1.00
0.95
12
13
14
forecast
mitigated by the prospects for Fed-lagged BoC tightening
15
actions and news that the federal government is well ahead
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
of schedule to balance its budget (leaner supply is looming).
Looking ahead, amid the general rise in yields, we see
Canadas outperforming a bit at the short-end (where monetary policy prospects have more
influence) and holding their own at the long end. We expect 2- and 10-year Canadas to
average above 1.10% and around 2.20% by year-end, respectively, and above 2.20% and
3.15% by 2015-end.
Loonie… As decent employment data were released south of the border on October 3, the
Canadian dollar hit $1.1259 (Bank of Canada closing quotes), the weakest level since July
2009. The milestone reflected the combination of the greenback’s recent strengthening trend
(against nearly everybody) and speculation the Bank will lag the Fed when it comes to raising
policy rates (stoked by official comments). The Bank asserts that it does not actively promote
a weaker currency, either via policy or pronouncement. However, the fact that export
expansion is the critical ingredient in the “rotation of demand” scenario, the Bank is likely very
“welcoming” of a weaker loonie. Although the currency has rebounded since its five-year
extreme, we judge the depreciation trend will resume (for the same factors cited above),
hitting $1.15 next autumn, just before we project the Bank will follow the Fed into tightening
mode.
PAGE 4
Euro


ECB asset purchase plan details underwhelm
Economic developments troubling
Following up September’s surprisingly aggressive action—rate cuts and announcing asset
purchases—the ECB unveiled the details of its ABS and covered bond buying programs, which
will last at least two years. Purchases of the latter will commence in the second half of the
month, while the ABS will start at some point in Q4. While
EURO
President Draghi reiterated that the ECB is targeting expanding
(US$/€)
its balance sheet back to mid-2012 peak levels (about 1 trillion
1.45
euros above current levels), he failed to specify the size of the
1.40
purchases. Indeed, the TLTROs will also play a role in
1.35
expanding the Bank’s balance sheet. The QE era has finally
1.30
begun in Europe—only five years after the Fed and Bank of
England—but the ECB is still holding back sovereign bond
1.25
forecast
1.20
12
13
14
15
buying for now.
There’s massive easing coming from the ECB over the next few
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
months with asset purchases, TLTROs and the latest rate cuts
feeding through. In addition, the completion of the Asset Quality Review on commercial banks
should give the sector confidence to increase lending, boosting economic activity. But all that
stimulus can’t come soon enough for the region, with the latest German data suggesting GDP
will be lucky to see any growth in Q3. France and Italy, both of which are lagging badly on
much-needed reforms, are struggling mightily as well. Spain and Ireland are performing well,
while Greece is finally growing after a multi-year recession, but that won’t be enough to lift
the region. Another downward revision to growth and inflation forecasts could prompt the
ECB to take further action.
Diverging monetary policy, with the ECB on course for at least two years of QE (meaning rates
aren’t going anywhere) versus likely Fed rate hikes by mid-2015, is expected to weaken the
euro consistently through next year. Other than bottom-fishing, there are few compelling
reasons to buy euros over the next year or two.
U.K. Pound


BoE inching toward rate hike, but not until early 2015
Housing cooling; Euro Area weakness weighs
The U.K. economy remains in robust health, with GDP growing solidly in Q2 and on pace for a
decent gain in Q3. The Bank of England has suggested that an early 2015 timeline for the start
of tightening is reasonable, though it has also cautioned that there is no rush to move. That’s
especially the case with housing showing signs of cooling and the Euro Area struggling
mightily. Indeed, given below-target inflation, weakness across the Channel, and no sign of
wage pressure, the risk is that the BoE will delay hiking rates until further into 2015.
PAGE 5
Note that the U.K. holds national elections in May 2015, which could constrain the timing of
policy changes. Carney has said that the Bank ignores politics, but waiting an extra month or
two to tighten in order to avoid the appearance of being
BRITISH POUND
political would do little harm.
(US$/£)
1.75
Sterling rallied into the Scotland referendum, but saw little
1.70
follow through after the “no” vote. Indeed, a weaker euro is
1.65
pulling the pound lower, but an early 2015 hike by Carney
1.60
would provide a big, though temporary, lift for the currency.
1.55
However, once it becomes clear that the Fed will be more
1.50
forecast
1.45
12
13
14
15
aggressive when it starts tightening by mid-year, look for
Sterling to trend lower.
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
Japanese Yen


BoJ downgrades economic assessment
More easing possible, but likely not until 2015
The Bank of Japan has stayed on the sidelines following April 2013’s aggressive easing
announcement. Since then, officials have consistently voiced confidence that inflation
remains on a path to the 2% target. However, the lack of rebound following this past April’s 3
ppt sales tax hike prompted the BoJ to downgrade its economic assessment in October. The
BoJ meets again at the end of the month when it will release new forecasts, but policymakers
are unlikely to make a decision on further easing until they are certain activity won’t gain
momentum and more stimulus is needed.
Given the weakness in activity, it looks as though the 2% inflation target probably isn't
achievable in 2015, which leans toward more action from the BoJ. And, the government has
to decide shortly on whether to raise the sales tax again in October 2015, creating yet another
potential hurdle for the economy. A weaker yen is helping exporters, but it does no favours
for the domestic economy, hitting consumers and service
JAPANESE YEN
providers with higher import costs.
(¥/US$)
120
The yen weakened sharply through September, briefly
110
breaching 110 versus the US$ for the first time since 2008. The
100
yen retraced some of those losses early in October, but is
90
expected to continue weakening through the end of 2015, as
the U.S. economy outperforms and the Fed tightens policy
80
forecast
70
12
13
14
15
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
PAGE 6
while the BoJ contemplates further easing.
Australian Dollar


RBA remains neutral
Concerns about high A$ persist
The Reserve Bank of Australia held rates steady at a record-low 2.5% in October, maintaining a
neutral stance and leaving policy unchanged for over a year. The Bank continues to believe that
"monetary policy is appropriately configured" and "the most prudent course is likely to be a
period of stability in interest rates.” A strengthening housing market, driven by low rates and
Asian inflows, is being offset by declining business investment as large commodity-related
AUSTRALIAN DOLLAR
capital projects are completed. This backdrop suggests the RBA
(US$/A$)
is comfortable holding rates steady for some time yet. The
1.10
October statement added some concern about the housing
1.05
market, but that’s unlikely to push rates higher and precludes
1.00
any rate cuts.
0.95
The statement again noted that even with the recent weakness
0.90
the A$ “remains high by historical standards.” Look for those
0.85
forecast
0.80
12
13
14
15
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
Chinese Yuan


currency worries to ebb over the coming year, as the risks are
tilted toward the RBA lagging the Fed’s tightening cycle,
suggesting the A$ will face downward pressure.
August economic data point to decelerating growth in Q3
Yuan little changed in September
Worries about China’s economic growth have returned following a sharp deterioration in the
August data. Industrial production growth was the weakest since 2009, fixed asset investment
gains were the slowest in nearly 14 years, and retail sales disappointed as well. Part of the
softness in the first two indicators could be at least partially explained by a shift toward more
services-driven growth, but the dip in retail sales suggests troubles are deeper. If the September
figures don’t show a sizeable rebound, Q3 GDP growth will probably come in well shy of Q2’s
7.5% (which is also the government growth target). And, while policymakers have introduced
some minor stimulus measures to boost activity, they’ve repeatedly said that more significant
action is not forthcoming.
CHINESE YUAN
The Chinese yuan stabilized in September, ending an
(CNY/US$)
6.40
appreciating trend which retraced about half of the losses seen
6.30
from February to June. China’s trade surplus remains
extraordinarily large which should give authorities confidence
6.20
that the currency can strengthen without harming activity
6.10
significantly. Look for the yuan to strengthen at a modest pace,
6.00
reflecting the recent record trade surpluses and an ongoing push
forecast
5.90
12
13
14
15
Sources: U.S. Federal Reserve Board, Haver Analytics, BMO Capital Markets Economics forecasts
PAGE 7
to boost domestic demand.
Foreign Exchange Forecasts
Local Currency per U.S. Dollar (averages)
Actual
Sep
2014
Oct
Nov
Dec
2015
Q1
Q2
Q3
Q4
Canadian Dollar
C$ per US$
US$ per C$
Trade-Weighted
1.101
0.908
110.5
1.110
0.901
110.0
1.113
0.898
109.8
1.115
0.897
109.5
1.122
0.891
108.8
1.133
0.883
107.9
1.143
0.875
107.2
1.150
0.870
106.7
U.S. Dollar
Trade-Weighted*
104.8
105.5
105.7
105.7
106.0
106.7
107.4
108.1
European Currencies
Euro**
Danish Krone
Norwegian Krone
Swedish Krona
Swiss Franc
U.K. Pound**
1.29
5.78
6.35
7.13
0.94
1.63
1.26
5.90
6.35
7.30
0.94
1.61
1.26
5.90
6.40
7.30
0.95
1.62
1.27
5.90
6.45
7.30
0.96
1.63
1.27
5.85
6.45
7.30
0.97
1.65
1.26
5.90
6.40
7.25
0.98
1.64
1.25
6.00
6.40
7.25
1.00
1.62
1.23
6.05
6.35
7.20
1.01
1.61
Asian Currencies
Chinese Yuan
Japanese Yen
Korean Won
Indian Rupee
Singapore Dollar
Malaysian Ringgit
Thai Baht
Philippine Peso
Taiwan Dollar
Indonesian Rupiah
6.14
107
1036
60.9
1.26
3.22
32.2
44.2
30.1
11921
6.12
109
1040
61.5
1.26
3.21
32.5
44.3
30.1
12000
6.11
110
1045
61.8
1.27
3.22
32.6
44.5
30.2
12075
6.10
110
1050
62.1
1.27
3.24
32.6
44.7
30.3
12150
6.08
111
1070
62.7
1.28
3.27
32.7
44.9
30.4
12250
6.05
112
1085
63.7
1.28
3.30
33.0
45.3
30.7
12400
6.02
113
1100
64.7
1.29
3.33
33.2
45.8
30.9
12550
5.99
115
1110
65.7
1.30
3.36
33.5
46.3
31.2
12700
Other Currencies
Australian Dollar**
N.Z. Dollar**
Mexican Peso
Brazilian Real
Russian Ruble
South African Rand
0.904
0.813
13.24
2.34
38.0
11.0
0.880
0.780
13.25
2.35
38.7
11.0
0.874
0.770
13.30
2.36
39.3
11.3
0.868
0.760
13.30
2.37
40.0
11.6
0.855
0.770
13.35
2.39
39.1
11.7
0.836
0.768
13.45
2.41
38.4
11.7
0.821
0.757
13.55
2.42
38.0
11.9
0.808
0.746
13.65
2.44
37.5
12.0
* Federal Reserve Broad Index
** (US$ per local currency)
Cross Rates
Versus Canadian Dollar
Euro (C$/€)
U.K. Pound (C$/£)
Japanese Yen (¥/C$)
Australian Dollar (C$/A$)
1.42
1.79
98
0.996
1.40
1.79
98
0.977
1.40
1.80
99
0.973
1.41
1.82
99
0.968
1.43
1.85
99
0.959
1.43
1.86
99
0.947
1.42
1.85
99
0.938
1.42
1.85
100
0.929
Versus Euro
U.K. Pound (£/€)
Japanese Yen (¥/€)
0.79
138
0.78
137
0.78
139
0.78
139
0.77
141
0.77
141
0.77
141
0.77
142
PAGE 8
Interest Rate Forecasts
Percent (averages)
Actual
Sep
2014
Oct
Nov
Dec
2015
Q1
Q2
Q3
Q4
1.00
0.92
0.95
1.00
1.14
1.16
1.65
1.80
2.18
2.71
1.00
0.90
0.93
1.00
1.09
1.11
1.53
1.68
2.04
2.56
1.00
0.90
0.93
1.01
1.10
1.13
1.58
1.74
2.12
2.63
1.00
0.90
0.93
1.02
1.13
1.16
1.63
1.80
2.20
2.71
1.00
0.90
0.93
1.07
1.22
1.26
1.74
1.92
2.34
2.84
1.00
0.90
0.93
1.19
1.46
1.50
1.98
2.15
2.55
3.05
1.00
0.90
0.93
1.37
1.82
1.90
2.29
2.47
2.82
3.29
1.25
1.16
1.19
1.67
2.17
2.35
2.62
2.86
3.09
3.55
1.24
1.28
1.37
1.48
1.25
1.27
1.37
1.47
1.25
1.27
1.37
1.48
1.25
1.27
1.37
1.49
1.25
1.27
1.37
1.54
1.25
1.27
1.37
1.66
1.25
1.27
1.37
1.84
1.49
1.52
1.62
2.13
Prime Rate
U.S. Yield Curve
Fed funds
3 month
6 month
1 year
2 year
3 year
5 year
7 year
10 year
30 year
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.25
0.13
0.02
0.04
0.11
0.57
1.05
1.77
2.22
2.53
3.26
0.13
0.02
0.04
0.10
0.52
0.99
1.65
2.07
2.35
3.07
0.13
0.02
0.04
0.11
0.55
1.02
1.70
2.13
2.45
3.13
0.13
0.02
0.04
0.14
0.60
1.07
1.76
2.19
2.50
3.20
0.13
0.02
0.04
0.23
0.78
1.24
1.91
2.34
2.64
3.30
0.21
0.10
0.12
0.49
1.22
1.63
2.22
2.60
2.85
3.49
0.46
0.33
0.36
0.82
1.65
1.99
2.49
2.82
3.12
3.72
0.71
0.56
0.60
1.12
2.01
2.32
2.78
3.09
3.40
3.97
1m LIBOR
3m LIBOR
6m LIBOR
12m LIBOR
0.15
0.23
0.33
0.58
0.15
0.23
0.33
0.57
0.15
0.23
0.33
0.58
0.15
0.23
0.33
0.61
0.15
0.23
0.33
0.70
0.24
0.32
0.41
0.96
0.50
0.58
0.67
1.31
0.77
0.85
0.92
1.63
Prime Rate
Other G7 Yields
ECB Refi
10yr Bund
3.25
3.25
3.25
3.25
3.25
3.35
3.60
3.85
0.05
1.00
0.05
0.95
0.05
0.95
0.05
1.00
0.05
1.10
0.05
1.20
0.05
1.35
0.05
1.45
BoE Repo
10yr Gilt
0.50
2.48
0.50
2.30
0.50
2.40
0.50
2.50
0.65
2.65
0.75
2.90
0.90
3.15
1.15
3.40
BoJ O/N
10yr JGB
0.06
0.53
0.05
0.50
0.05
0.60
0.05
0.65
0.05
0.75
0.05
0.85
0.05
0.95
0.05
1.05
Cdn. Yield Curve
Overnight
3 month
6 month
1 year
2 year
3 year
5 year
7 year
10 year
30 year
1m BA
3m BA
6m BA
12m BA
PAGE 9
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