Eleanor Creagh

Saxo Bank, the online trading and investment specialist, has published its Q3 2019 Quarterly Outlook for global markets, including trading ideas covering equities, FX, currencies, commodities, and bonds, as well as a range of central macro themes impacting client portfolios.

“Central banks’ response to the looming economic slowdown and trade war has been panic cutting interest rates and signaling new extremes of easing, while politicians are warming to the idea of Modern Monetary Theory. Our model indicates that the low point in the economic cycles lies in the third quarter for China, and in the first to second quarter for the US, UK and Europe. Furthermore, we could be headed for a massive repeat of the 1970s global supply shock,” says Steen Jakobsen, Chief Economist and CIO, Saxo Bank.

“Companies globally are scrambling to make sense of the trade war, Brexit and the disintermediation of a multilateral system in a world where environmental costs are about to explode, driven by consumer concerns and a wave of Green politicians getting into the political driving seats.

“The credit impulses globally continue to indicate that the economic low point is ahead of us, not behind us. Our model indicates that it lies in the third quarter for China, and in the first to second quarter for the US, UK and Europe.

“Today globalisation has reached its maximum, even without the trade spat. China produces everything, so the “making things cheaper” process has run out of room. Add to that the potential trade war and massive focus on the environmental impact of all facets of consumption, from plastics to packaging, airline and sea transport pollution, and, with central banks wrongly focused on excessively low inflation, you get a perfect storm brewing that will turn the tide back toward inflationary outcomes. From anti-globalisation, higher unit cost of production due to environmental considerations, a fiscal push into infrastructure and shoring up injured global supply chains — all that creates a massive repeat of the 1970s global supply shock.

“The shock this time will come sometime after the global fiscal expansion set to arrive in the third and fourth quarter. In this situation, the markets that stand to benefit the most will be commodities and real resources, infrastructure plays, wages and gold. By the summer of 2020 – one year from now – we will have seen the end of any belief in monetary policy moving the needle, and will be witnessing extravagant spending driving inflation to levels beyond anyone’s expectations, just a couple of quarters after inflation, once again, has been pronounced dead.”

Against this uncertain backdrop, Saxo’s main trading ideas and themes for Q3 include:

Global equities show the biggest disconnect since 2007

Society has reached an important inflection point on several fronts which will have profound implications for global equities and investors. We have reached the end of globalization as we have known it since the early 1980s. Large imbalances can be seen across the environment, inequality, credit and the global supply chain.

Peter Garnry, Head of Equity Strategy, said “OECD’s leading indicators on the global economy is still declining with April’s number marking the 17th consecutive monthly decline. The global economy at its weakest point since July 2008 and the probability of a recession is still elevated and not fully reflected in equity valuations. South Korea, one of the world’s economies most tuned globalisation, is showing significant weakness with its leading indicators declining for 23 straight months in April and to levels not seen since early 2012. The South Korean economy has historically been one of the best indicators on the global economy, so we expect more pain to come in the second half of the year.”

“The recession probability is much higher than what global equities are currently reflecting with the yield curve and leading indicators sending the strongest warning signals to investors. But history has often showed a final bullish move in equities despite clear evidence of an incoming recession. This is exactly what we are witnessing today. The Fed put is used as an excuse to buy equities as it presumably increases the equity risk premium, but history shows that the first rate-cut is often a reliable signal that a recession is coming which reduces short-term cash flows and rises return expectations as investors get more risk-averse. The short-term is not correctly discounted in equities based on our forecast of the future, but it is the long-term expectations that we believe make the disconnect between equities and reality the biggest.”

It’s finally time for the USD to weaken

The US Federal Reserve is playing catch-up, and, if we see material signs of weakening in the third quarter, the Fed will axe rates to the effective zero bound instantly and could even restart quantitative easing before year-end. All this points to a weakening of the US dollar in the second half of 2019.

John Hardy, Head of FX Strategy, said: “The most remarkable development in currencies over the first several months of 2019 was the resilience of the US dollar despite the whiplash-inducing reversal in Fed expectations from hawkish in late to December to dovish and then more dovish with each subsequent Fed appearance in 2019.

“Given the risks of a growth slowdown in the US already baked into the cake, from the weak credit impulse to the rolling off of the impact of Trump’s tax reforms, we should expect clearer signs of a weaker US economy to emerge. For the second half of 2019 we will be looking for a transition to a weaker US dollar as the Fed is set to deliver strong easing.

“The collapsing rate outlook from the Fed and its willingness to bring back the policy punchbowl will make the rest of the world look less bad, though there are residual risks that any ugly episodes of general market deleveraging could drive bouts of USD strength against the most vulnerable currencies, the Turkish lira, for example. Elsewhere, the world doesn’t look great, but the lack of room to move further on the monetary policy front will encourage a more rapid transition to fiscal policy options.”

Commodities are set to benefit

The global fiscal panic, which is likely to result in governments spending money they don’t have, has the potential to drive a boom in commodities, not least gold as inflation looks likely to come roaring back. And a weaker US dollar could give gold and commodities overall the boost that has been lacking in recent years.

Ole Hansen, Head of Commodity Strategy, “Five years of range-bound gold trading look set to come to an end over the coming months as the yellow metal takes aim at $1,483/oz, the 50% reversal of the 2011 to 2015 sell-off. Driving the initial move higher are expectations that global central banks will cut rates to spur growth, which has proven increasingly difficult to achieve with trade wars disrupting global supply chains.  While US Federal Reserve easing cycles in the past have coincided with a strong dollar, we may already have seen the maximum potential for USD strength early in the Fed’s shift. On that basis, we ask if it is finally time for the USD to weaken? That would give gold and commodities in general the tailwind that has been missing in recent years.

“The biggest risk to our scenario of rising commodity prices is the potential for a major trade deal between the US and China reducing the markets’ expectations for how much US rates will have to fall.

”With silver trading at a 26-year low relative to gold, we see some additional upside, not least due to investors having preferred to trade silver from the short side for a while. In copper, we may already have seen the low point around $2.60/lb in high grade and $5,750/tonne in LME. Crude oil’s gyrations during the past six months look set to persist, with multiple drivers creating a very difficult market to navigate.

We expect that Opec and Russia will reaffirm their commitments to keeping oil production capped for the remainder of the year.

”Agriculture commodities will be keeping a close eye on the clouds – or lack of them – in the sky. The problems that farmers in Europe and the Black Sea region faced last year due to drought have moved to the US this past quarter. Torrential rain and flooding have sharply reduced the prospect for US corn production, while the quality of wheat has also been called into question. Soybeans, while also rallying, have struggled to gain momentum amid the trade war and the outbreak of African swine fewer reducing demand from China.”

Global policy panic to boost bonds

European government bonds have rallied powerfully since the end of 2018, with periphery issuers, such as Greece, benefiting the most. European sovereign debt valuations are likely to be well supported throughout the summer, and a further rally could be ahead if the unfolding economic slowdown triggers a new loosening of monetary policy.

Althea Spinozzi, Bonds Specialist, added: “We believe that European sovereign debt valuations will continue to be supported throughout the summer, and they may tighten a little further as monetary policies remain extremely dovish. European Central Bank president Mario Draghi’s last speech made clear that the ECB is ready to increase monetary stimulus if the economy does not improve. At this point, not only inflation is disappointing, but the data show weakness in the biggest EU economy, Germany, as economic sentiment plummeted in June, while uncertainty over US foreign policy is weighing on economic forecasts.

“The market is too dovish in pricing three US interest rate cuts this year, starting in July. The Federal Reserve just finished hiking rates four times last December, reaching a “comfortable” level at the moment.

“European and US corporate bonds have been rallying since the beginning of the year, reaching levels previously seen at the end of 2016, at a time when economic conditions were robust and well before the Fed and the ECB started to talk about raising interest rates. Now the economic backdrop is weaker amid slowing growth and escalation of trade war, so it is hard to justify low yields on corporate bonds.

“Since the resignation of British prime minister Theresa May last month, we have seen 10-year gilt yields inevitably fall below 1%, exactly as was seen in 2016 after the Brexit referendum. The message that the bond market is sending is clear: things are going to get worse before they get any better. This has serious implications for investors with sterling as a base currency as it means that they need to pay up for good-quality assets, but if they venture into the junk space, yields are so high that they may be irresistible.”

Fiscal policy to the rescue in the Eurozone

Growth in the Eurozone could be derailed in the coming quarters, and such a slowdown would trigger a new phase of expansionist fiscal policy. The size and the effectiveness of the next round of stimulus, however, remain uncertain, and some European governments will have little incentive to act.

Christopher Dembik, Head of Macroeconomic Analysis, said: “Interest rates are structurally extremely low. In other words, the cost of debt is low so it reduces the urgency to reduce debt. Recently, for the first time ever, the 10-year government bond interest rates of Austria, France and Sweden have fallen below zero. For some Eurozone countries, up to 88% of the total outstanding public debt is with negative yields for maturity up to 2032. This is the new normal in the Eurozone. Consequently, in major European countries, the cost of debt is totally manageable.

“There is little room left for monetary policy. The European Central Bank is confined to the zero lower bound, which means that lower rates have less positive effect than in the past, as they are already very low or negative. The ECB could resort to a new round of quantitative easing, in case of an economic downturn or de-anchoring of inflation expectations, as early as 2020, but to be effective, it will need to wield a more massive bazooka than in 2015, and the effects are still uncertain. What we know with more certainty is that QE tends to be associated with negative distributional effects (exacerbation of wealth inequality) that can only be mitigated by fiscal redistribution.”

Monetary madness in the ‘miracle’ economy

With the global economic outlook weakening and the Australian economy losing momentum, the Reserve Bank of Australia already in June began what is likely to be a series of cuts to its cash rate, which will probably land at 0.5% next year or even by year-end. Easier monetary policy will be required to deal with slackness in the labour market, weakness in the housing sector and falling consumption.

Eleanor Creagh, Market Strategist, commented: “Australia’s near 30-year recession-free run, the envy of central bankers around the globe, is now at risk as economic malaise grips. The “wonder, down under” that escaped zero interest-rate policy, negative interest-rate policy and quantitative easing has not managed to vanquish the business cycle and will not be so lucky this time around. Easier monetary policy will be required given the sizeable spare capacity remaining in the economy which continues to lose momentum and is running well below potential. The weakness is likely to lead to a further rise in unemployment and persistent disinflationary pressures, even before a potential global shock appears.

”In the current low-rate environment and for the foreseeable future, fiscal policy therefore has a far more active role to play. So, what is the bigger problem? Governments shirking their responsibilities to focus on infighting instead of policy reform. Monetary stimulus is ineffective for the challenges we face, and bureaucrats in Canberra must have realistic expectations about what central banks can achieve to stimulate the economy. Monetary policy will never replace sound economic policy. So, rather than relying on central bankers to clean up the mess, the government must deliver productivity-enhancing reforms, infrastructure spending and other fiscal measures to restore confidence and start a self-sustaining recovery in economic growth.

”Where there is a policy power vacuum, the RBA must be ready to step in and do the heavy lifting in case of an enduring threat to growth and employment. Although the RBA hopes it will not need to resort to unorthodox measures, once the conventional policy toolkit has been exhausted, the RBA would probably turn to quantitative easing if the economic outlook were to deteriorate further. Asset purchase programmes could take several forms, depending on the objective.”

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While these predictions do not constitute Saxo’s official market forecasts for 2018, they represent a warning of a potential misallocation of risk among investors who typically see just a one percent likelihood to these events materialising.

Commenting on this year’s Outrageous Predictions, Chief Economist at Saxo Bank, Steen Jakobsen said: “We have published Outrageous Predictions for more than 10 years and think this year’s list is one of the best we ever had, encouraging everyone to think outside the consensus box. It is important to underline that the Outrageous Predictions should not be considered Saxo’s official market outlook, it is instead the events and market moves deemed outliers with huge potentials for upsetting consensus views.”

Head of FX Strategy, John J. Hardy, who lead the project this year, commented: “A year ago, many thought 2017 would prove a volatile year, given the seemingly impossible rise of Trump and the shock of Brexit. Instead, we got a year of outrageously smooth sailing that inflated risky assets the world around with nary a storm. But in 2018 we see the pendulum swinging back in favour of pronounced volatility risks as the irony of long periods of quiet and complacency in asset markets is that they sow the seeds for future volatility as investors underestimate tail risks and overleverage their bets on a continuation of the cycle.”

“That being said, our predictions this year aren’t just about market crash concerns. We wax outrageous on everything from major central banks losing their policy mojo and a new political crisis in the EU, to China eroding the US dollar’s reserve currency status and a new political spring welling up in southern Africa. We may or may not get any of these right but that isn’t the point. Rather, our task here is to stimulate debate and thought on what outrageous direction things may head at major inflection points like those that 2018 will inevitably bring. “

1. The Fed loses independence as the US Treasury takes charge

Both the Republicans and Democrats vie for an increased share of the populist vote as we head into 2018 mid-term elections, with budget discipline entirely absent and GOP tax cuts bringing a massive revenue shortfall which will worsen as US heads into recession. The weak economy and the higher interest rates and inflation will leave the Fed with no answer on monetary policy. The Fed becomes a scapegoat for the economy’s weak performance, a bond market in turmoil and worsening inequality. The Treasury takes on emergency powers and forces the central bank to cap US government yields to 2.5% on long bonds to prevent a bond market meltdown, a policy which was last in place in the immediate aftermath of World War II.

2. Bank of Japan forced to abandon yield curve control

The Bank of Japan’s policy of yield curve control depends on soft global interest rates and low yields, and in 2018 this centre will simply not hold. As inflation rises, yields too will spike, and the result will be a fantastical plunge in the yen. Ultimately, the central bank will need to resort to QE-style measures, but not before USDJPY hits 150, after which it rapidly devalues to 100.

3. China rolls out the Petro-Renminbi

China is by far the largest oil importer, and many producer nations are already more than happy to transact in yuan terms. With the US’ global power and reach waning, and given the success of CNY-based commodity futures in general, the Shanghai International Energy Exchange’s decision to launch a yuan-based crude oil future is a runaway success. The introduction of the petro-yuan sees CNY appreciate more than 10% versus the dollar, taking the USDCNY rate below 6.0 for the first time ever.

4. Volatility spikes after flash crash in stock markets

World markets are increasingly full of signs and wonders, and the collapse of volatility seen across asset classes in 2017 was no exception. The historic lows in the VIX and MOVE indices are matched by record highs in stocks and real estate, and the result is a powder keg that is set to blow sky-high as the S&P 500 loses 25% of its value in a rapid, spectacular, one-off move reminiscent of 1987. A whole swathe of short volatility funds are completely wiped out and a formerly unknown long volatility trader realises a 1000% gain and instantly becomes a legend.

5. US voters go hard left in 2018 election

Changing demographics in the US which already has the under-35 millennials in place as a larger cohort than the post-war baby boomers will have a dramatic impact on politics in 2018. The general revulsion of younger voters for Trump’s persona, the widening inequality gap aggravated even further by the Republicans’ cynical tax reform, and a new breed of Democratic candidates who are unafraid to tap into Sanders-style populism from the left sees millennials turning out in droves at the polls in November. The Democrats pull the debate away from tax reform to spending stimulus for the masses. True populism means breaking out the chequebook for the 90%, and that means fiscal stimulus, deficits be damned. US 30-year Treasury yields rip beyond 5%.

6. Austro-Hungarian empire threatens EU takeover

The divide between old core EU members and the more sceptical and newer members of the bloc will widen to an impassable chasm in 2018 and for the first time since 1951, Europe’s political centre of gravity will shift from the Franco-German couple to CEE. The EU’s institutional blockage does not take long to worry financial markets. After spiking to new highs versus the G10 and many EM currencies by late in 2018, the euro rapidly weakens towards parity with USD.

7. Bitcoin is thrown to the wolves

Bitcoin peaks in 2018 above $60,000 and with a market capitalisation of over $1 trillion as the advent of the Bitcoin futures contract in December 2017 leads to a groundswell of involvement by investors and funds that are more comfortable trading futures than tying up funds on cryptocurrency exchanges. Before long, however, the Bitcoin phenomenon finds the rug torn out from under it as Russia and China move deftly to sideline and even prohibit non-sanctioned cryptocurrencies domestically. After its spectacular peak in 2018, Bitcoin crashes and limps into 2019 close to its fundamental “production cost” of $1,000.

8. Southern African Spring sees South Africa blossom

In 2018, after a surprising turn of events, a wave of democratic transition spreads across sub-Saharan Africa. The forced resignation of Zimbabwe’s long-term president Robert Mugabe at the end of 2017 triggers a wave of political change in other African countries. South Africa’s Jacob Zuma is forced out of power and Congo’s Joseph Kabila faces unprecedented demonstrations pushing him to flee the country. South Africa, however, is the main winner as the ZAR becomes the EM darling and returns 30% against the G3 currencies. It brings the world’s strongest rates of growth in South Africa and satellite frontier economies of the region.

9. Tencent topples Apple as market cap king

China, still the world’s most populous country and one with a rapidly rising standard of living, is opening up its capital markets and its reform programmes are driving a rise in investor sentiment. This is particularly evident in Chinese technology stocks with market leader Tencent’s shares rocketing 120% higher in 2017. In late 2017, Tencent moved into the global top five in market cap terms, nearing $500 billion and even eclipsing Facebook at one point. In 2018, though, Tencent leaves the other giants in the dust with its shares advancing another 100% despite the company’s already enormous size , stealing the world market cap crown from Apple at well above $1 trillion.

10. It’s their time – women crash the glass ceiling

Over the last generation, women have started achieving higher education levels than men, with US universities now graduating some 50% more women than men at the bachelor’s degree level. Women also now comprise nearly half of all business graduates. And yet in 2017, only 6.4% of the CEOs in the Fortune 500 list are women – though on average they earn more than their male peers.

Change is coming – not because it is “fair”, but for the practical reason that women realising their desired potential is the last way left to grow the pie without growing the population in our low-productivity and aging developed economies. In 2018, the chauvinist old boys’ clubs are shaken to their core by shareholders and a woman occupies the top spot at more than 60 Fortune 500 companies by the end of the year.

Read the full publication of Outrageous Predictions for 2018.

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What’s in store for Q2?

Saxo Bank, parent company of Saxo Capital Markets, the online multi-asset trading and investment specialist, has published its quarterly outlook for global markets and key trading ideas Q2 2017.

Europe to outperform the United States

European assets, with the exception of German fixed income, enter the second quarter of 2017 with small or large discounts, based on nervousness about the French and German elections, and expectations over the end outcome of Brexit. With the base scenario that the European economy will outperform the US economy over the next four years, Saxo sees a wide gap between perception and reality when it comes to European assets, which will present significant buying opportunities for investors in Q2 2017.

Commenting on the outlook, Steen Jakobsen, Chief Economist and CIO, Saxo Bank, says: “As we head into the second quarter of 2017, it is increasingly apparent that the European instability narrative may be overblown as the continent prepares to outperform the US which is overly dependent on the Trump-trade.

“What non-Europeans often fail to add to their assessment is the massive amount of political capital invested in Europe and the euro. With little or no chance of France leaving the euro – regardless of whether Marine Le Pen wins or not – we expect a significant move in the euro’s value once the elections are done in Q3.

“Europe runs a big current account surplus, the ECB is moving towards a less accommodative policy stance and the CEE region continues to outperform with average growth levels above 3%. However, while all this points to the fact that Europe will do better than the US in Q2, we maintain that recession is still likely in the 12-18 month period as we see the credit pulse peak simultaneously with the global inflation,” adds Jakobsen.

France could become ungovernable

With the French Presidential election likely to be one of the most closely watched events of Q2 2017, Saxo Bank urges traders and investors to look at the legislative elections in June which will provide a more accurate view of the future direction of France.

Christopher Dembik, Head of Macro Analysis, says: “There are essentially two possible outcomes here. Either Le Pen is elected President but she is deprived of real powers by not winning the legislative elections, or Macron is elected President but he has difficulty dealing with his overly-heterogeneous majority.

“For the first time since 1958, parliamentarians could make their great return which, given the experiences of the Third and Fourth Republic, is not a positive signal. In the end, France could become ungovernable,” added Dembik.

European equities will outperform US and Japanese equities

The reflation trade that started before Donald Trump’s victory in the US presidential elections accelerated in Q1 as global economic data improved and surprised against expectations. Saxo Bank points out that the reflation trade could end in Q2 with a healthy correction in global equities.

Peter Garnry, Head of Equity Strategy, says: “While investors are focusing on Europe’s political landscape with upcoming elections in France and Germany, they seem to have missed the fact that Europe’s GDP growth has surged to almost 3% annualised, estimated by the euro-coin indicator from Bank of Italy.

“The drivers are improving financial conditions, upward pressure on prices and increasing business confidence. This improved economic picture and outlook is at odds with the valuation discount to US equities and one of the main reasons behind our overweight Europe and underweight US theme. If Macron wins the French election we believe French equities will outperform in Q2 against other European equity markets.”

A more volatile FX market

Q2 could well see much of the uncertainty lifting on the EU political front and greater sense on whether Trump can rally the rare majority he holds in the House and Senate to pass policies that could boost the US dollar. In any case, the remarkable lull in volatility in Q1 could yield a more volatile market as we sort through important themes and after global complacency levels reached extremes in Q1.

John Hardy, Head of FX Strategy, says: “Risks are two-way for the USD in Q2, mostly depending on Trump, thought the upside potential has increased due to the market’s growing scepticism. We expect the euro will continue to be supported by the strength of incoming data from across Europe and the ECB eases off on fretting the downside risks. An important caveat though beyond the Q2 is how the weakest peripheral countries, most importantly Italy, will deal with an ECB taper.

“A discounted sterling may be justified given the UK’s still large twin-deficits and the overhanging Brexit uncertainty, although as the process could take many years to unfold, this could see the market gradually unwind the uncertainty discount. Lastly, Chinese liquidity withdrawal could weigh on the outlook for EM currencies in Q2 and beyond, likewise tempering enthusiasm for the reflation trade. “

Relative stability in the bond market

With the largest proportion of political risk disappearing after the French election, we expect a relief rally in riskier assets, but also an elimination of safe-haven premium in core markets like the German, Dutch or Danish bond markets, sending the overall core-yield levels higher. In September, the German election can restart another round of moderate risk-off, although we do not see the same market concerns regarding this election, at this point in time.

Simon Fasdal, Head of Fixed Income Trading, says: “This could be the quarter that sees relative stability in global bond markets, with inflation and yields moving higher, but a dive in the oil price or geopolitical risk could be the rock on which the steady ship founders.“

Sharp reality check for oil, and a bonus for gold

Commodities bulls may have entered Q1 on a wave of enthusiasm spurred by the great reflation trade, but there has been a sharp reality check that looks like being a bonus for gold and negative for oil.

Ole Hansen, Head of Commodity Strategy, says: “When it comes to oil, what became increasingly apparent during the first quarter was the lack of price momentum to justify this bullish build-up in speculative bets. We believe the best the market can hope for in Q2 is for Brent crude to stabilise around $50/b but cannot rule out a temporary drop to $45/b. We lower our year-end forecast to $58/b in the belief that demand growth and supply cuts eventually will positively impact the price.”

“Gold, where investors have maintained a lukewarm attitude with rapid build-ups of speculative longs reflating quickly ahead of FOMC, needs to see the bullish dollar and bond yield expectations face more that they have already. We maintain our end of year forecast at $1,325/oz and based on a pick-up in industrial metals, we could see silver reaching $19/oz. “

Read Saxo Bank’s full Q2 2017 outlook.

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Saxo Bank, parent company of Saxo Capital Markets, the online multi-asset trading and investment specialist, has today released its annual set of ‘Outrageous Predictions’ for the year ahead. These are 10 unlikely, yet perhaps underappreciated, events that could have significant consequences on the financial landscape as we venture into 2016.

As ever, the predictions span the length and breadth of markets and geographies; ranging from oil making a drastic return to $100 a barrel to Silicon Valley’s much vaunted unicorns returning to myth. Other claims include the Russian rouble rising 20% versus the US dollar/euro basket, the Olympics turbo-charging a Brazilian recovery and a meltdown in corporate bonds.

Steen Jakobsen, Chief Economist at Saxo Bank, commented: “We are nearing the end of the paradigm paralysis that has dominated the policy response to the global financial crisis. Quantitative easing and other forms of intervention have failed. China is transitioning, and geopolitical tensions are as complex as ever. The marginal cost of money is rising, and so is volatility and uncertainty. It is against this backdrop we have set this year’s predictions.”

“Saxo Bank’s Outrageous Predictions remain an exercise in finding ten relatively controversial and unrelated ideas which could turn your investment world upside down. It is rewarding to see how the outrageous predictions catch our clients’ imagination and fuel ongoing debate; it is this process of discussion and anti-herd thinking that is at the heart of Saxo’s now established tradition of attempting to draw attention to the unfathomable”.

See below for Saxo Bank’s Outrageous Predictions 2016

1. EURUSD direction? It’s 1.23…

Europe is running a massive current account surplus and its weaker inflation should, in macroeconomic logic, mean a stronger currency, not a weaker one. The race to the bottom has gone full circle, meaning we are back to a weaker US dollar again as the direct outcome of US interest rates policy.

2. Russia’s rouble rises 20% by end-2016

By the end of 2016, a surge in oil demand and the Fed raising rates at an inappropriately slow pace causes the Russian rouble to rise some 20% versus the US dollar/euro basket in 2016.

3. Silicon Valley’s unicorns brought back down to earth

2016 will resemble 2000 in Silicon Valley with more startups delaying monetisation and tangible business models in exchange for adding users and trying to achieve critical mass.

4. Olympics to turbo-charge EM’s Brazil-led recovery

Stabilisation, investment spending on the Olympics, and modest reforms will see sentiment rebound in Brazil, with EM exports helped by cheaper local currencies. The result: EM equities to have a great year – outperforming bonds and other equities.

5. Democrats retain presidency, retake Congress in 2016 landslide

The Republican Party goes from strength to dramatic weakness as the rifts from an internal struggle on its future direction play out. This leads to a landslide victory for the Democratic Party as they successfully execute a get-out-the-vote campaign with Millennials coming out in droves having been frustrated by the political stalemate and weak job prospects of the last eight years.

6. OPEC turmoil triggers brief return to $100/b oil

OPEC’s crude oil basket price drops to the lowest since 2009 and unease among weaker as well as wealthier members of the cartel over the supply-and-rule strategy continues to grow. The long awaited sign of an accelerated slowdown in non-OPEC production finally begins to flicker. Suitably buoyed, OPEC catches the market on the hop with a downward adjustment in output. The price mounts a quick recovery with investors scrambling to re-enter the market to the long side – once again bringing $100/barrel prices onto the horizon.

7. Silver breaks golden shackles to rally 33%

2016 will see a renewed confidence in silver. The political drive towards reducing carbon dioxide emissions by supporting renewable energy will add to increased industrial demand for the metal, given its use in solar cells. As such, silver will rally by a third, leaving other metals behind.

8. Aggressive Fed sees meltdown in global corporate bonds

Late 2016 will see Fed chief Janet Yellen embark down a hawkish path with a series of aggressive rate hikes, triggering a huge selloff in all major bond markets as yields start to rise. As the portions of bank and broker balance sheets allotted to bond trading and market making have almost disappeared, one of the vital parts of a functioning market is simply not there. This realisation sinks in too late and the entire buy-side flee into a panic selling one-way street, as highly advanced risk models lurch into a symmetric red alert.

9. El Niño sparks inflation surge

Next year’s El Niño will be the strongest on record and will cause moisture deficits in many areas of southeast Asia and droughts in Australia. Lower yields across agricultural commodities will curb supply at a time when demand is still increasing on the back of global economic expansion. The outcome will be a 40% surge in the Bloomberg Agriculture Spot Index, adding some much-needed inflationary pressure.

10. Inequality has last laugh on luxury

Faced with rising inequality and unemployment of over 10%, Europe is considering the introduction of a basic universal income to ensure that all citizens can afford to meet their basic needs. In a more egalitarian society where other values are promoted, demand for luxury goods decreases sharply – the sector collapses.

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Outlook for Europe

Saxo Bank, the online multi-asset trading and investment specialist and parent company of Saxo Capital Markets, has published its second quarterly insight for 2014, focusing on the outlook for Europe.

European outlook: A United States of Europe?

Following an abundance of false starts, the European economy is likely to encounter further challenges in Q2, Saxo Bank writes in its second quarterly insight for 2014. By the end of the second quarter, the European Central Bank is likely to grow increasingly concerned about deflation and the lack of growth and signal new quantitative easing and yet another set of unconventional measures.

As well, Europe faces its biggest electoral challenge since the 1970s, as the reality gap between Europe’s voters and their EU-friendly politicians is wider than ever. At the May EU parliamentary elections, look for EU sceptic parties to form one of the largest overall blocs in the new European Parliament. If Brussels listens to voters, it could mark a decisive turning point for the failing EU experiment, even if for now, the political status quo is more likely to maintain the upper hand.

While the economic outlook appears to be improving for Spain, Portugal and Greece, this is really part of an internal transfer of problems from these ‘Club Med’ countries to France and soon Germany, which is likely to flirt with recession by the end of the year. France and Germany are also likely to suffer from reduced exports, particularly in the luxury goods sector, as Asian growth cools.

Steen Jakobsen, Chief Economist and CIO for Saxo Bank, commented: “The EU member countries have surprised with their political solidarity over the last few years of the EU crisis, but the electorate is growing restless and EU-sceptic parties are making huge inroads that the establishment must recognise. Beside this we have the eternal problem that the EU entirely lacks an economic foundation that is sound and long term. Here in early 2014, EU complacency has never been higher, just as real political and popular entropy is about to make its presence felt.”

Global outlook: a ‘state of flux’

The ‘Fragile Five” (South Africa, Brazil, India, Indonesia, Turkey), which with the recent additions of Argentina, Russia and Chile have become the “Fragile Eight”, are now in the process of rebalancing, as the Fed tapering has forced their currencies weaker and required policy tightening that will crimp growth and right the structural imbalances that have grown in recent years. This “state of flux” is a positive development overall, but too many countries and economies are trying to do the same thing simultaneously – devalue and increase exports – so growth is likely to weaken structurally and cyclically due to prior credit excesses.

As Jakobsen points outs, “We have been so focused on saving the world, the banks and the political system that we have underinvested in people, education, infrastructure, innovation and technology.

“It will not be the European Parliamentary elections that make or break the EU, but how the policymakers and their trusted mandarins respond to the slowdown and subsequent rebalancing of the world.”

Key points on investments for 2014:

Fixed income: core government bonds will be the only asset that is up Q1 2014 versus Q1 2015 (rebalancing and lack of productivity).

Foreign exchange: EURUSD will peak at about 1.4000/1.4050and then turn down to 1.2500 (the ECB should get active on deflation over the summer). USDJPY could see 95.00 on a VAT hike and initial signs of Abenomics failing. The “Fragile Eight” will drop another 5 percent.

Commodities: will do well through Q2 as real rates will drop, but could fall again heading into H1 2015.Will take profit in Q3 2014.

Equity: The S&P 500 will peak at about 1,900-1,950, then a 30 percent correction. Equities are the only asset not yet hurt by the changing economic cycle.

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Outlook is positive for Q4: Saxo Bank

With or without the support of further quantitative easing from the major central banks, global growth is headed for a slowdown, say analysts at Saxo Bank, the parent company of Saxo Capital Markets, in the Bank’s financial outlook for Q4.

They don’t expect a sustainable comeback for growth until policymakers stop supporting the parts of the economy that don’t need or deserve support and start supporting the most important engine of job and economic growth: small and medium-sized enterprises (SMEs).

With the intensifying need to reset interest rate expectations after the Fed’s non-tapering of its asset-buying programme, there is a perfect storm brewing on the economic horizon. This would be good news, Saxo Bank pointed out in the Quarterly Outlook published on 8 October. The only way to stop the unprecedented monetary experiment is for it to fail to show that it is generating what should always be the number one priority: more jobs and rising incomes.

Saxo Bank argues that a weak economy and in particular the struggling labour market will force the Fed’s hand, and instead of tapering it will have to increase its QE next year as the economy is too weak to weather a pullback in Fed support. As the markets adjust to the prospect of more QE rather than less, we may see another bout of hope that extend and pretend will continue to pump asset valuations ever higher. However, further ahead, likely sometime early in 2014, the QE cycle – or at least the markets response to it – will begin to falter as Fed policy will increasingly risk losing credibility. In the end, all major historic shifts in policy have only come as a result of massive stock market declines or unemployment rates becoming too high and painful to ignore. In other words, QE will only be threatened as a policy tool when the markets roundly reject it, rather than celebrating it.

Steen Jakobsen, Chief Economist, Saxo Bank, comments: “The global economy is running on empty. 2014 will see a bigger discussion on what is the real exit strategy from the current ‘extend and pretend’. Right now the market only sees two paths: Inflating the economy to reduce the burden of debt, or writing off the debt between treasuries and central banks. But I believe there is a third way: A repeat of the 1940s – the last time fed was this involved in so-called helping the market. Back then, the Fed got saved by disinflation and a recession brought on by the very same policy which today slows the path towards recovery too much easy money. History is about to repeat itself only because we fail to learn and to embrace the need for change”

Saxo Bank advises to prepare for a good start to Q4, but for headwinds in asset markets to build as we roll in to 2014. Steen Jakobsen added: “2014 will be the year to clean up and prepare for a world that is increasingly more balanced, less leveraged and more proactively helping the one part of the economy we have kept outside the loop throughout this cycle: the SME.”

The full report can be downloaded here: http://storage.saxosoft.net/au/q4-outlook.pdf

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