Macro backdrop, key themes and risks for 2016 – Goldman Sachs

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Dec 24, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Delhi) – Research Team at Goldman Sachs, suggests the key themes and risks associated with the US economy in 2016.

    Key Quotes

    Growth/inflation: Moderate pick-up in global growth, but US slowing; inflation to rise

    • Our economists expect a moderate pick-up in global growth from 3.2% in 2015 to 3.5% to 2016 driven by a stabilisation of hard-hit EM economies and a small acceleration in Europe and Japan. US growth is forecast to decelerate from 2.5% to 2.3%. China should continue its deceleration – we expect growth of 6.4% (2015: 6.9%).

    • Even if oil prices remain low, headline inflation is likely to rebound to more normal levels. Core inflation should remain below central bank targets almost everywhere, but is likely to rise gradually as energy pass-through abates and some economies – especially the US and UK – are now close to full employment.

    Policy: Dovish Fed rate hike cycle near-term; ECB easing to be followed by BOJ

    • US and UK monetary policy is expected to tighten. Strong labor market data increased our confidence in a Fed lift-off on December 16. Our economists expect 75-100 bp cumulative Fed hikes during 2016 and a further 100 bp during 2017. The market discounts a less steep Fed Funds rate path. We believe the BOE will follow closely and raise rates in 2Q2016. Again, we expect an earlier and faster increase than the forwards discount.

    • We expect more monetary easing in Europe and Japan. The ECB cut rates and extended its QE program, which might grow if inflation disappoints. And we expect further fiscal and monetary stimulus in Japan in 2016. The BOJ may announce more QE at its January 29, 2016 meeting which could include: longer-duration JGBs, expanded purchases of ETFs, and a broader range of assets including municipal bonds, zaito bonds and RMBs.

    • For China our economists expect further easing from the PBoC (two benchmark rate cuts and RRR cuts of 300 bp to alleviate capital outflows) and more expansionary fiscal policy. They expect the RMB to moderately weaken against the US$ to 6.6 by end 2016 and 6.8 by end 2017 (3%/6% depreciation over 12/24 months).

    Asset allocation: Flatter and fatter – still pro-risk, but near-term neutral

    • We have a pro-risk asset allocation (Overweight equities and credit, Underweight bonds) over 12 months, but see a flattening return trajectory and more risks. As a result, we focus on relative value and introduce hedges.

    • We expect bond yields to increase and weigh on returns for fixed income. In the near term we see limited downside to bonds and remain Neutral and also remain Neutral on equities due to elevated volatility and risks of lower oil prices. We remain Underweight commodities on a 3-month basis, mainly due to downside for oil.

    Key themes: Late-cycle concerns, rising rates and divergence

    • Late-cycle concerns are growing for equities with elevated valuations and limited earnings growth potential in most DM markets. As a result we see the risk of drawdowns increasing. We prefer non-US markets since the US is already in the ‘Optimism’-phase, in our view, and recommend call overwriting strategies.

    • Fixed income returns are shrinking in function of low yields and gradually rising rates which is likely to weigh on multi-asset portfolio returns. Prospective returns have dropped by more than 50%. We would avoid ‘bond proxies’ within equities that have benefitted from the search for yield and like US HY credit, where elevated spreads can help buffer higher rates (once oil prices have stabilised).

    • With limited return potential across asset classes our focus shifts to relative value. Monetary policy divergence is likely to remain a key driver of cross-asset performance in 2016. We would position for a decline in inter-equity correlations and like buying calls on Europe and Japan equities financed by the US.

    Risks: Bond/ equity correlations, commodities and China

    • We are in one of the longest periods of positive equity/bond yield correlations since 1870. As a result, long duration bonds have been good diversifiers for equities in case of growth shocks. A pick-up in inflation and monetary policy uncertainty can drive rate shocks and less stable bond/equity correlations. Long breakeven inflation can hedge against higher inflation expectations and we like equity collar hedges.

    • For oil there are high risks near term that the supply adjustment proves too slow as inventories continue to build and storage utilization nears high levels in the face of a mild winter, slowing EM growth and a potential lift of international sanctions on Iran. If surpluses breach capacity we see risk of oil prices reaching cash costs at US$20/bbl. We recommend selling 3-month calls on oil equities and buying CDX HY calls.

    • China growth and policy concerns are likely to continue in 2016. Sharp dollar appreciation and decelerating growth in China can increase pressure for another CNY devaluation. We like selective EM FX hedges (long $/CNH, long $/KRW & $/MYR and short commodity currencies) and MSCI EM puts.
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