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Insight: Q2 Strategy

 

Global economy benefiting from supportive central banks and recovery in the Chinese construction sector.

By Danske Bank

  • A series of coordinated dovish central bank actions have helped improve global risk sentiment
  • and a further boost may come from an emerging recovery in the important Chinese construction sector
  • which will also lend support to the outlook for commodity prices, notably base metals

Aggressive ECB QE purchases will support euro-govies…

  • We see a strong case for lower yields in euro-govies over the next month for several reasons: (i) The ECB will start raising its monthly purchases from EUR60bn to EUR80bn in April
  • (ii) Net cash flow for April is very positive with redemption and coupons of some EUR144bn and an estimated issuance of EUR55-60bn. Hence, the positive net cash flow could be around EUR85-90bn
  • (iii) Inflation expectations in the euro area have continued to move slightly downward since the last ECB meeting (in sharp contrast with the rise in US inflation expectations and oil prices). This may increase market speculation of a further ECB easing

while the equity rally may lose some steam near-term, but still has further to go, notably in emerging markets.

  • as long as the Fed remains in a dovish mode, we continue to see further rises in equities, notably in emerging markets, which still appear relatively cheap given the heavy beating over the past couple of years

although the dollar weakness may have gone too far and could reverse near-term

  • In general, the soft Fed, rebound in the Chinese construction sector and stronger footing for commodity prices will continue to support commodity-dependent currencies.
  • Regarding the USD, we have been a bit surprised about the significant upward move in EURUSD despite the recent relatively strong US data. In our view this illustrates that the cross is increasingly giving in to fading policy divergence of the ECB vs. the Fed and fundamental factors in favour of the EUR. However, we still stress that time is not yet ripe for a move towards our 12M target of 1.18 and we may see a dip short-term, given that i) our short-term models suggest USD crosses are in general oversold, ii) USD positioning is now close to neutral (i.e. some scope for longs to be added again), iii) there is clearly room for more hikes to be priced on the Fed after Yellen’s retreat on rate hikes. Also, we think that the EUR/USD has gone somewhat ahead of the drop in EU inflation expectations, which could fuel ECB easing expectations yet again. In our view, the EUR/USD should still stay in a range 1-3M, albeit slightly higher than the 1.10-1.14 range.

Equities:

  • The Fed’s late dovish stance and the ECB’s action lead to another leg higher in the risk rally. Follow through in terms of easing should be expected from other central banks globally. The weakening of the USD makes the world a better place: commodities should stabilise further and it will be supportive of Chinese growth as it provides an opportunity for the PBoC to ease further. EM should outperform DM in this environment and in terms of sectors, parts of the cyclical space will generally outperform defensives.

Bond market

  • Higher QE and new TLTRO means that the ‘hunt for yield’ continues, but no more rate cuts and higher US yields.We still look for policy divergence in Q4, but for now ‘hunt for yield’ supports treasuries
  • QE, improving fundamentals and search for yield. But vulnerable to risk sentiment and political uncertainties.
  • Liquidity abundance and QE in corporate bonds

FX

  • EUR/USD – support gaining traction as policy divergence fading Fundamentals support cross in the medium to long term, but downside risks short term from Fed and Brexit risks.
  • USD/JPY – rangebound with risks skewed to the upside on BoJ USD/JPY set to head higher again on Fed-BoJ divide as BoJ set to fight further JPY appreciation with negative rates.
  • EUR/SEK – trapped in 9.10-9.50 range near term, lower medium term Riksbank loosening up on SEK appreciation aversion; EUR/SEK set to fall eventually on strong Swedish fundamentals.
  • EUR/NOK – settling in 9.30-9.50 interval now, then lower as cycle turns Limited room for more easing to be priced from Norges Bank, fundamentals point to lower EUR/NOK in H2 16.

Commodities

  • Oil pricesdovish Fed removes downside risk; subdued recovery in H2:  Production freeze no game changer; now awaiting non-OPEC supply cuts and further USD weakening
  • M etal prices anticipating recovery in Chinese construction Consolidation in mining industry puts a floor under prices, awaiting support from higher global economic growth
  • Gold pricesflat near term Short-term support from repricing of Fed rate hikes
  • Agriculturalsrisks remain on the upside Attention has turned to La Niña weather risks in H2 16.
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