Axi | Jan 04, 2018 13:06
Originally published by here to read part one of this analysis.
h2 WHAT'S IT ALL MEAN FOR MARKETS?/h2The biggest risk is this theme coalesces into a narrative which sees pressure on, and thus losses in, a number of markets from stocks, to high yield bonds, European sovereigns - in fact anything with a negative or near negative rate or a bond spread flat to Treasuries.
As I highlight, should growth see inflation lift and central banks accelerate the withdrawal of monetary accommodation valuation measures across many markets will be affected.
Indeed the top 10 of Deutsche Bank (DE:DBKGn)'s "30 risks to markets in 2018" are all in some way related to the theme and outlook I have articulated above (my annotation via the red box).
More directly though here are some potential impacts on specific markets.
h2 FOREX/h2Commodity currencies like the Aussie, Canadian dollar, and kiwi stand to be the primary beneficiaries among the G10 from what could become a strong narrative around global reflation in 2018.
Of course, the US dollar should also benefit in that narrative because it suggests the Fed will continue to tighten while the ECB and BoJ are well behind in terms of timing given they have not even halted their balance sheet operations and quantitative easing let alone begun to raise rates or shrink their balance sheet.
But in 2017 the forex pain trade has been long dollars and it seems the US dollar can't take a trick this year when it comes to the euro, and in many ways even the yen and other pairs. That's because in the absence of wages pressure or inflation in the US, traders are discounting what the Fed says it is going to do by not pricing to the dot-plot. At the same time more weight has been given to the uptick in growth across the Eurozone and the implications that will have for the ECB.
Interest rate differentials and bond spreads haven't really been big influences on the majors in 2017. But that may change in 2018.
As a result, the dollar should find its feet eventually and start to make headway once again. The question is from what level and when.
It speaks to continued forex market ranges.
h2 STOCKS/h2Both the MSCI All-Country Index and the S&P 500 are about to complete their first year ever where each calendar month saw a positive return for the indexes.
That's a remarkable result. So it's no surprise that observed volatility and the price of same via the VIX has been low across the course of 2017.
But if bonds rates spike, or if any one of the many geopolitical risks manifests, then volatility both implied and realised could rise. That would not only harm the many sellers of vol - picking up pennies in front of a steamroller - but may lead to liquidation in other markets.
What's important here is that with such low levels in volatility and in bond rates it does not take much of a move to make a material move in the capital price - a capital loss. recently, and in fact for many years, spikes in vol, or rates, have been opportunities to fade the moves.
And while Wall Street analysts currently believe that the S&P 500 will end 2018 around 5% higher than where it is today there is an expectation of higher volatility in the year ahead as the Fed raises rates.
Higher volatility and its knock on effects is my base case for stocks in 2018.
But let's face it after such a quiet year of solid gains and no real or material pullback that's probably one of the easiest forecasts me or other strategists/traders/investors could make.
h2 COMMODITIES /h2Commodity prices have had a solid rally in 2017.
But whether it is commodity prices relative to stocks or metals and mining shares relative to the overall market commodities and stocks associated with them have underperformed the overall market.
Of course, arguments of resource utilisation in an increasingly service-based global economy and the emergence of the tech giants - the FAANGS - who have been integral in fuelling this US and global stock market rally in 2017 can be made to suggest Commodities have lifted as much as they might.
But many markets are tighter than realised.
And with OPEC tightening supply in oil markets at a time of synchronised global growth for the first time in a decade there is a real chance oil prices, and further gains, are a real part of this global reflation, bond, central bank story.
Inventories have been drawn down materially and US EIA data suggests there is a surfeit of demand over supply in global "liquid fuels markets" over the first half of 2018. That will further tighten the market and support prices.
h2 KEY MARKETS I'M WATCHING AS A RESULT OF ALL THIS/h2One thing worth noting about this outlook is that there are many self-reinforcing or dampening interconnections throughout the global economy and markets. Indeed at the first sign of ructions, there is every chance central banks will revert to type and back off. Just like as the Fed did after the taper tantrum a few years back.
So when looking forward there are, by necessity, "degrees of maybe" in any outlook.
For me, those "degrees of maybe" evolve and shift probabilities on a daily, weekly, and monthly basis. A degree here, a hald a degree there. It's these subtle shifts and what they mean for markets which drives my reasearch for and is reflected in my daily note "Market Mornings". It's these subtle shifts which end up moving the the outlook as the global economy and markets evolve.
You are welcome to join me in this fascinating journey that 2018 promises by reading my daily note each morning. It's the first and best thing I do each day.
Have a great year's trading.
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