Market and policy dislocations could peak in Q1 of 2015, warns Saxo Bank

The global economy and policy mix is about as out-of-synch as it has ever been and we are faced with major geopolitical risks that could deepen with the advent of sub-60 dollar oil prices, according to Saxo Bank’s latest outlook. Inflation is at multi-decade lows even as monetary policy is extremely loose in most of the developed economies and tight in emerging economies, with the US Federal Reserve the lone developed economy central bank expected to begin a tightening cycle soon - likely around mid-year. Meanwhile, credit spreads trade below default rates and yields and volatility is still near historic lows.

Balancing the global economy in 2015 will require countering the slowdown in emerging markets, combating deflation and confronting rising debt to GDP ratios. Steen Jakobsen, Saxo Bank’s Chief Economist, says that eventually “the path of least resistance in 2015 is a lower dollar, stable to slightly higher energy prices and unchanged interest rates.” Though the point of maximum dislocation, based on an extension of the trends we saw building in 2014, will be seen in the first quarter, as the ECB risks making a terrible decision by hitching its wagon to a new QE programme.

Currency markets will see considerable volatility in 2015. The most likely trend is not so much a stronger US dollar but a weaker dollar although Saxo Bank expects the greenback will continue to strengthen in Q1 with the prospects of currency wars emerging, particularly in Asia. Saxo Bank’s key FX trade recommendations for Q1 2015 are to go long USD/CHF to position for possible punitive negative rates from the Swiss National Bank in March. We’re also looking at selling the Chinese yuan versus the US dollar and eventually against the Japanese yen to position for a possible Chinese currency devaluation which could see China exporting deflation to the rest of the world.

Saxo Bank expects the global economy to grow by 3% in 2015, compared to 2.2% in 2014, driven by low energy prices, less austerity in advanced economies and higher trade growth, with the major downside risk to global growth in 2015 coming from geopolitical tensions. More specifically:

• The US economy will continue to grow at a robust pace driven by consumption and lower energy prices. Saxo Bank expects the US economy to grow around 3% in 2015.
• Outlook for the euro area remains challenging, with structural reforms remaining sporadic while the private sector continues to pursue deleveraging, suppressing both growth and inflation. Saxo Bank expects the euro area economy to grow by 1% in 2015.
• The UK economy will grow by 2.5% in 2015, driven by strong private sector growth and supportive government policies, with the main downside being a material slowdown in the housing sector.
• Saxo Bank remains sceptical of the impact on the real economy of China’s central bank efforts to arrest the decline in growth through easing policies. The bank’s forecast for Chinese growth in 2015 is a below consensus 6.7%.

Despite the relatively low growth rate in the eurozone in 2015, Saxo Bank predicts that Club Med and Eastern European member countries will lead growth in 2015, as comparative gains enjoyed by the likes of Germany come to an end and low unit labour costs in the periphery drive growth. “The upshot of this is that Europe’s economy will finally transform itself to one fuelled by small, innovative and agile companies. This is excellent news for Europe’s future.” adds Jakobsen.

FX

Saxo Bank predicts that Q1 could see the US dollar strengthen further, but warns to expect an uneven path as leveraged traders are already heavily long on US dollar and significant risks to that view as the year wears on if asset markets destabilize on the anticipated withdrawal of Fed liquidity. Further afield, economic and political tensions between China and Japan over Japan’s radical monetary policy and JPY weakening could lead to a fresh Asian currency war.

Equities

Saxo Bank expects Spanish equities to outperform global equity markets in Q1 2015, boosted by the inevitable easing policies pursued by the European Central Bank, as inflation runs low and economic growth is slow. On the other hand, the Chinese equity market remains overheated and is due for a correction, while the oil and energy slump will cast a long shadow over Russian equities too.

Commodities

Rising supply at a time of weak demand growth and a stronger dollar will keep a raft of key commodities under pressure at the beginning of 2015 with the first half most likely yielding the lowest prices. In oil markets Saxo Bank expects Brent crude to average $62/bbl during the first quarter. A stronger dollar remains the key risk to precious metals while higher US interest rates are already priced in. This leaves positive drivers for commodities such as geo-politics under-priced and with this in mind, the first quarter could see a low point for gold.

To access the full list of trade ideas produced by Saxo Bank analysts which accompany the 2015 outlook, please click here: https://www.tradingfloor.com/publications/essential-trades