FYI | Dec 08 2016
A summary of Saxo Bank's annual report on its ten "outrageous" predictions for 2017. Are they that outrageous?
-Trump sends US yields soaring
-Brexit doesn't happen
-EU banks buckle
By Eva Brocklehurst
It is that time of year when Saxo Bank delivers its ten outrageous predictions for 2017. As usual, the selection aims to provoke discussion on what might surprise or shock investors in the year ahead. The predictions are not an official market outlook but are deemed possible events which have the potential to upset consensus views.
2016 will become known as the year where reality managed to surpass even seemingly unlikely calls, such as the UK vote to leave the European Union (Brexit) and the election of Donald Trump as the US president.
Saxo Bank's chief economist, Steen Jakobsen, believes 2017 could be a wake-up call, with a departure from business as usual, both in terms of expansionary policies by central banks and austerity policies from governments which have characterised the period post the global financial crisis. In this spirit the following are offered as the most outrageous predictions for 2017.
Number one involves China's GDP. China comprehends it has reached the end of its manufacturing and infrastructure growth phase and, through a massive stimulus of fiscal and monetary policies, opens up capital markets to steer a transition to consumption-led growth. This results in 8% growth in 2017. Euphoria over private consumption-led growth pushes the Shanghai Composite index to double its 2016 levels and surpass 5,000.
US Federal Reserve
As US dollar and interest rates rise, the fiscal policies of President Donald Trump cause the US 10-year bond yields to reach 3%, creating market panic. In this second outrageous prediction , on the verge of disaster, the US Federal Reserve limits 10-year yields to 1.5%, effectively introducing an endless quantitative easing. This provokes a sell-off in global equity and bond markets, leading to the biggest gain for bond prices in seven years.
At number three, long-term average default rates for high-yield bonds rise as high as 25%. As the limits of central-bank intervention are reached, governments around the world move towards fiscal stimulus and yield curves dramatically steepen. As trillions of corporate bonds are trashed, the problem is exacerbated by rotation away from bond funds, which widens spreads and makes refinancing of low-grade debt impossible.
The fall-out from Brexit creates a more disciplined EU leadership and a more cooperative stance towards the UK. In the fourth prediction, the EU makes key concessions on immigration and passport rights for the UK-based financial services firms. By the time Article 50 is triggered, Brexit is turned down in favour of the new deal. The UK stays within the EU and the Bank of England raises its rate to 0.5%. The EUR/GBP slumps to 0.7300.
Number five is about copper. Copper was a clear commodity winner following the US election and in 2017 the market begins to realise the new president will struggle to deliver promised investments and the increased demand expected for copper fails to materialise. President Trump turns up the volume on protectionism as a result and introduces trade barriers, spelling trouble for emerging markets as well as Europe.
Global growth weakens and China's demand for industrial metal slows, as it moves towards more consumption-led growth. Having breached trend line support, copper descends all the way back to 2002 prices of US$2/lb and a wave of speculative selling then sends it down to the 2009 financial crisis low of US$1.25/lb.
President Trump spending increases the US budget deficit to US$1.2-1.8 trillion and this causes growth and inflation to skyrocket. The Federal Reserve accelerates its rate hike agenda and the US dollar reaches new highs. China starts looking for alternatives to a system dominated by the US dollar and its over-reliance on US monetary policy.
This leads to an increased popularity of currency alternatives and Bitcoin benefits the most, as leading banking systems move to accept Bitcoin as a part alternative to the US dollar. It triples in value to US$2100 from US$700.
US Health Care
Seventh on the list is healthcare expenditure in the US, at around 17% of GDP versus the world average of 10%. An initial relief rally in health care stocks after President Trump's victory quickly fades in 2017, as investors realise the administration will not go easy on health care and lodges sweeping reforms of the unproductive system. The healthcare sector plunges, ending the most spectacular bull market in US equities since the financial crisis.
Mexico and Canada
The market has drastically overestimated President Trump's true intention, or ability to crackdown on trade with Mexico, allowing the beaten down peso to surge. Meanwhile, Canada's higher interest rates initiate a credit crunch in the housing market and the banks buckle, forcing Bank of Canada into quantitative easing and injecting capital into the financial system.
Additionally, the Canadian dollar underperforms as Canadians enjoy far less of the US growth resurgence than they would have had in the past, because of the long-standing decay in the manufacturing base, as a result of globalisation and an excessively strong currency. The CAD/MXN corrects as much as 30% from 2016 highs.
German banks are caught up in the spiral of negative interest rates and flat yield curves and cannot access capital markets. In the EU framework a German bank bail-out inevitably means an EU bank bail-out. This is not a moment too soon for Italian banks which are saddled with non-performing loans and a stagnant local economy. A new guarantee allows the banking system to recapitalise and a European bad debt bank is established to clean up the balance sheet of the eurozone. Italian bank stocks rally more than 100%.
EU Stimulus Bonds
Finally number ten, where faced with success of populist parties in Europe and a dramatic victory for Geert Wilders far-right party in the Netherlands, traditional political parties begin moving away from austerity policies and favour Keynesian policies similar to those launched by US President Roosevelt post the 1929 crisis.
The EU lodges a stimulus package but to avoid dilution resulting from an increase in imports announces the issuance of EU bonds, at first geared towards EUR1 trillion of infrastructure investment, reinforcing the integration of the region and putting capital flows back into the EU.
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