Article / Monday at 13:59 GMT

Navigating the market this summer

Head of Macro Analysis / Saxo Bank
France
  • Prospects for global economy and Eurozone seem brighter than in past three years
  • New narrative is about Eurozone momentum offset by credit risk in US and China
  • USD remains “king”; CNY’s market share could reach over 10% by 2019
  • Currency war is not on the agenda
  • Low volatility, market complacency, Trump failure to deliver reforms are key risks

Sailboat headed into sunset
 Here are some tips for navigating the financial markets 
this summer. Photo: Shutterstock

By Christopher Dembik

It is the first time in more than three years that I am so optimistic about the global economy and, especially, the fate of the euro area. Political risk was the main driver of market evolution in 2016, due to Brexit and the surprising election victory of Donald Trump.

But, as shown by the outcome of the French election, investors were mistaken by focusing so much on the European political agenda in 2017. The new narrative is based on positive growth momentum in the Eurozone (so far) and a credit cycle slowdown in the US and in China, but nothing to worry about. China is purposely fighting against shadow banking by tightening credit standards, whereas the US is heading towards the end of the business cycle, which is quite normal after so many years of GDP growth.

Main takeaways:

  • The US dollar remains “king”, with a market share of 88% against only 31% for the euro. The common currency has not managed to seduce investors and especially central banks due to the lack of economic integration. My main call is that the CNY’s market share could reach over 10% by 2019, exceeding that of GBP.

  • Currency war is not on the agenda. Some 99% of the time, Trump is wrong, but he clearly got it right regarding exchange-rate disequilibrium. Based on parity purchasing power, the USD is overvalued by 7% against the euro, by 11% versus the yen, and by 7% over the Canadian dollar. However, a new Plaza agreement is unlikely to happen, considering that there is no political incentive and that the USD is still 30% lower than in 1985. 


Picture 1  
  • In the US, inflation and wages are the most lagging economic indicators. Core CPI has been below the 2% target over the past five years, making harder for the Federal Reserve to hike interest rates substantially. Over the past few weeks, a key change of mind has happened: the fixed-income market has started to price in the risk of rate cut next year by the Fed.

  • Positive trend in the Eurozone (Eurocoin growth indicator +0.75%). Investors expect a successful “Merkcron” initiative to restart the European project after the German election in September. Optimism prevails, which has a significant positive impact on the euro exchange rate. For the first time in three years, EUR positioning is now back in absolute long territory.  

Picture 2
 
  • The UK will experience the “real” macroeconomic impact of Brexit. But I am positive towards the GBP for the second part of the year. Brexit has already been greatly priced in in the exchange rate and, based on parity purchasing power, the GBP is undervalued by 15% against the USD. A rebound, of course depending on the political situation, is quite likely from my viewpoint. 

Main identified risks:

  • Low volatility and market complacency (Yale survey March 2017: 99% of retail and institutional investors see stocks higher over the next year). There are increasing signals of financial tensions, such as the great divergence between the VIX volatility index and policy uncertainty, and also the US-Germany 5-year rate differential which stands at 28-year highs and which is usually considered an early sign of market correction. 

Picture 3
 
  • Trump does not deliver. This is certainly the highest risk, which is not completely priced in to the market. As a matter of fact, if Trump does not manage to provide more of a plan for lower taxation by September, the market may react quite badly, and it could be the trigger for a healthy correction in the US market (and therefore globally). Contrary to what Trump probably believed, it can take quite a long time to implement tax reduction on a large scale. It took almost five years for Reagan to draft and pass a bill for lower taxation. A correction would be short-lived considering that the macroeconomy and earnings are supportive of the market.

  • High risk of Trump impeachment. As a matter of fact, it is unlikely that impeachment would be carried out, but, as many Democrats have said, the purpose is to impose restraint on POTUS. It would certainly have a very negative impact on the market since it has not been fully priced in. 

President Donald Trump
 The highest risk not fully priced in is perhaps a Trump failure to 
deliver his economic and tax agenda. Photo: Shutterstock


— Edited by John Acher

Christopher Dembik is head of macro analysis at Saxo Bank

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At the end of the day, Draghi's going to be a star.
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He really has done a fine job...Imagine if Trichet would still be at the head of the ECB...
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