Strategy With fading EU political risks, global business cycle back in focus

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1 Investment Research General Market Conditions 5 May 2017 Strategy With fading EU political risks, global business cycle back in focus Political risks in Europe fading for now Political risks in Europe have been a significant market theme for the past six months, with investors fearing populist parties would get their hands on power in the Netherland and France. With Emmanuel Macron appearing set to win solidly on Sunday and the first polls showing strong support for his party in the upcoming parliamentary elections, these risks are starting to abate. Indeed, getting a pro-reform and pro-european French president, who seems prepared to tackle the woes of the French economy, would, in our view, be beneficial not only for the French economy but also for Europe as a whole, as EU history shows that a strong and vibrant France is vital for Europe. With the European political risk behind us for now (Italy may be a concern later this year or next year) and a possible US-North Korean conflict still a simmering tail risk, the market is looking for the next theme on which to focus. This week may have brought a candidate slowing momentum in the global economy. But signs of the global business cycle losing momentum We have for some time been highlighting that signals from our leading business cycle model point to a peak in the global business cycle (see for example Research: Global reflation set to lose steam, 3 April). This week data provided actual evidence of a possible softening in economic growth ahead, as both China PMI and ISM manufacturing fell (see charts below). Key points Political risks are fading in Europe with Macron likely to become the next president of France. Economic momentum looks strong in the euro area. However, PMI indicators are pointing to a softening of the economic cycles in the US and China. Chinese financial markets are seeing increasing stress and commodity prices have also come under pressure. The impact on equity prices of a softer global business cycle is likely to be mitigated by strong earnings growth. Corporate confidence turning in US and China, while the Euro area is holding up well Macron is a solid favourite to become the next French president Source: Danske Bank Markets Chief Analyst Jakob Ekholdt Christensen akc@danskebank.dk Important disclosures and certifications are contained from page 4 of this report.

2 Although the PMI indicators are still above 50, they are falling closer to the level that could point to a more cautious spending plan ahead. The story in China is clear: China has moved its foot from the gas pedal to the brake and the two key engines of growth in 2016 housing and infrastructure are set to slow down and, in our view, be a drag to economic growth for the remainder of In the US, Q1 real GDP growth plunged to an annualised growth rate of just 0.7%, the lowest level since Q1 14. However, quarterly GDP data should be treated with caution due to volatile components (and the Fed certainly stressed after its policy meeting this week that it viewed the slowdown as temporary, as investment is likely to rebound and private consumption remains high). In contrast, euro area PMI still shows an upward trend, probably reflecting still strong external and domestic demand. However, looking forward, the euro area may not be immune to a slowdown in key US and Chinese export markets. Furthermore, we believe private consumption is likely to come under some pressure from lower real wages due to higher inflation. Stress is rising in Chinese financial markets are starting to take their toll on market confidence As we have pointed out, a softening in the global business cycle tends to lead to higher market volatility and downward pressure on equity prices. The weakening momentum in the Chinese economy has led to a new bout of rising financial stress, with bond yields climbing to levels last seen in December 2016, when we had the last bout of market stress (see China: Financial stress on the rise again, 4 May). Commodities prices have also been a clear casualty of signs of weakening momentum in the Chinese and US economies. Iron ore prices, which are closely tied to the activity in the Chinese construction sector, have seen a sharp downward adjustment over the past few months. Copper prices have also been hit but not to the same extent. Over the past few weeks, oil prices have also taken a nosedive, accelerating overnight after the oil price fell below the important USD50/bl benchmark. Apart from the concern about global demand, uncertainty about prolonging the OPEC and non-opec deal, which is set to expire at the end of May. Furthermore, US oil production has been rising since late In our view, we think the OPEC/non-OPEC deal will be prolonged, which should add support to oil prices from the current level later in May. With the plunge in commodity prices, we have seen commodity dependent currencies falling significantly. However, more broadly as the global business cycle softens carrytrade induced strategies tend to underperform, so high-yield emerging market currencies more broadly are likely to remain under pressure. On the other hand, EUR, JPN, CHF and USD are typically supported in this environment. Stock markets have held up surprisingly well so far. Typically, we see a weakening in stock markets following softer signs on the global business cycle. However, one mitigating factor for equities is the very strong earnings growth, which was 16% on average among S&P 500 companies in the first quarter. European markets have clearly outperformed US markets, as the political risk premium in Europe has faded as the French political risk subsided and economic activity still looks to be strong in the euro area. We see a fairly stable outlook for equity prices. And oil prices not immune to the state of the Chinese economy US Equity markets have not reacted to weakening surprise indicators 2 5 May

3 Global market views Asset class Equities Neutral positioning on stocks short and medium term DM (UW), EM (OW) DM : US (UW), Euro Area (OW), Japan (N). EM : China/Asia (OW), LatAm (N), Russia/Eastern Europe (OW) Bond market German/Scandi yields set to stay low for now, higher on a 12M horizon EU curve set to steepen 2Y10Y when long yields rise again US-euro spread stable Peripheral spreads tightening but clear risk factors to watch Main factors The reflation trade, which has been ongoing since August/September 2016, is coming to an end, with equities hovering around alltime highs established in early M arch, but having difficulty breaking out from there. For equities to move substantially higher, yields need to rise, as bond markets have not yet brought the promise of a normalisation of growth and inflation. However, we do not think there is big correction ahead of us as growth data is still very upbeat. M oving forward, we think equity markets will trade largely in a range. For now, German yields are being kept low by political uncertainty, low inflation pressure and ECB purchases. The outlook for low core inflation and an apparent peak in the global manufacturing cycle to keep yields low in The ECB is set to keep a tight leash at the short end of the curve and with 10Y yields stable the curve should change little on a 3 to 6M horizon. Economic recovery, QE and better fundamentals in especially Portugal and Spain point to further tightening, but politics (French presidential election), banking recapitalisation plans (Italy) and a fear of a new move higher in core eurozone yields (ECB tapering fears) remain clear risk factors. Periphery spreads often widen when core yields move higher. FX EUR/USD rangebound near term, higher in 6-12M EUR/USD ranges higher and while Fed-ECB policies should cap upside near term, the cross is set to test new year highs in H2. EUR/GBP slightly lower post election, then rangebound for extended period If May stays in power post June election GBP could strengthen slightly, then rangebound ( ) during Brexit negotiations. USD/JPY rangebound now, higher longer term Pair seen falling back to range near term but set to edge higher driven by 10Y US rates longer term further out. EUR/SEK range near term, then gradually lower Gradually lower on relative fundamentals and valuation this year but near-term SEK potential limited by the Riksbank. EUR/NOK range near term, then gradually lower Cross set to move lower on valuation, growth and real-rate differentials normalising but NOK vulnerable to global risk appetite. Commodities Oil price range bound, downside risk Metal prices range bound, downside risk Gold price range bound Agriculturals rising again OPEC cuts almost fully implemented, downside risks from concerns about extension of cuts and hawkish central banks Underlying support from consolidation in mining industry, industrial cycle nearing a peak. Downside risk from financial stress in China Tug of war between higher US rates and geopolitical risks. Recent drop on lower oil only temporary. Source: Danske Bank Markets 3 5 May

4 Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of the research report is Jakob Christensen, Chief Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Expected updates None. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. This research report is not intended for, and may not be redistributed to, retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. 4 5 May

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