Wednesday, December 19, 2012

Economies & Markets in 2013

This is a shortened version of my macro and markets outlook for 2013 

The so-called developed economies remain in a low nominal growth environment where the private sector deleveraging and the over-indebtedness of the public sector act as structural growth headwinds. Historically, the public sector successfully deleveraged via default or via a long-lasting combination of relatively tight fiscal policy (to slowly move to a primary surplus) with an ultra-loose monetary policy (to get low/negative real yields, accompanied by other elements of financial repression). Between 2010 to late 2011 the handling of the Eurozone debt crisis (ultra-tight fiscal policy & limited support from monetary policy, Greek PSI) increased the probability of the default option and hence meant high and rising systemic risks. However, in 2012 governments and more importantly the ECB changed the trajectory via the introduction of OMTs (whereby the ECB has assumed the lender-of-last-resort role for governments), the start of the ESM and steps towards a banking union as well as a weakening political support for ever more fiscal austerity. In turn, the Eurozone has been moving towards the second option for debt reduction, substantially reducing systemic risks.
Moreover, also policy makers in the UK and US have been moving towards a tighter fiscal but looser monetary policy stance. Finally, following two years of ever weakening growth, the global economy is in a bottoming process and real growth should increase moderately going forward, lead by an improvement in Asia ex Japan. On the other side, amid the ongoing deleveraging and the high level of unused capacity, inflation pressures in general remain low and hence nominal growth should remain low as well. 
Eurozone real growth should slowly bottom out and move slightly above 1% in H2 2013. Germany should lead the rebound on the back of increased export demand and as record low real rates as well as rising immigration support the domestic economy. Moreover, Italy might be surprising with a growth pick-up. On the other side, due to the ongoing substantial fiscal tightening, France and Spain should lag in this recovery. Overall, the necessary rebalancing of the Eurozone economies should take a major step forward.  While real growth should improve, inflation pressures will drop further. Roughly half of the current core inflation rate of 1.4% stems from the effects of the restrictive fiscal environment. As the impact of fiscal tightening slowly wears off, inflation rates should fall. Furthermore, excess capacity remains at very high levels, preventing inflation from rising even if growth improves. As a result, nominal growth will remain low for a long time
Global real growth is in a bottoming process and should improve gradually during 2013. The outlook for inflation is mixed, with falling inflation pressures in the Eurozone and gradually rising core inflation pressures in the US while Japanese deflation can abate if the BOJ goes down the proposed policy route. Furthermore, systemic risks should remain at the now lower levels. This is an environment where risk appetite can improve, safe-haven assets should come increasingly under pressure, assets linked to real growth will be supported but assets linked to inflation should face a mixed outlook. Importantly, it will mainly be the safe-haven currencies central banks (BOJ & FED, BOE) which will provide an increasing dose of monetary accommodation. This should undermine the safe-haven status of their currencies exactly at a time where risk appetite improves.

Sell safe-havens, buy pick-up & real growth assets and take a mixed approach on inflation:
  • Long carry products with a focus on steep curve areas. Move outright longs in higher-yielding semi-cores into spread trades vs. Bunds. Outright longs in peripheral bonds and spread tighteners vs. Bunds across the curve. Start the year with Bund shorts spread trades and add outright shorts as the year progresses.
  • Short safe-haven currencies (JPY, USD, GBP). Long growth currencies & Euro.
  • Outright shorts in safe-haven bonds, mostly from safe-haven currencies - i.e. USTs, JGBs - but also to a lesser extent Bunds.
  • Safe-haven curve steepeners & credit curve flatteners.
  • Short inflation protection in the Eurozone vs. long inflation protection in the US & Japan.

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