Investment Research General Market Conditions 18 October 2013 Strategy US stalls while China and Europe strengthen Once again US politicians struck a last-minute deal and once again fears were running high as the deadline got nearer. However, markets kept their cool and were buying the rumour of a deal more than trading on fear of a breach of the deadline. So where do we go from here? Below an overview of how we see the situation and what we expect from US in the coming quarters. Some damage to US activity has been done even though the disaster scenario was avoided. The government shutdown is expected to subtract 0.2-0.4 percentage points from Q4 growth and the indirect effect of weaker sentiment among households and businesses will weigh on activity. It adds to this year s double whammy of a) the sharp fiscal tightening and b) the significant rise in bond yields that has already eaten into Q3 growth, which is now tracking only 1.5-2%. We saw further evidence of the effect on housing this week with a decline in the NAHB housing index, which fell from 57 to 55, the second monthly decline. It looks increasingly likely that growth will be stuck in the 1.5-2% range also in Q4. This would leave H2 clearly weaker than expected and as the debt ceiling deal is only a case of kicking the can down the road, it does not give the much needed lift to uncertainty. This may keep businesses hesitant to invest and hire. In terms of key data we expect ISM manufacturing to correct a bit lower in coming months. The ISM new orders index fell in September and ISM non-manufacturing took a nosedive. Hard data have also failed to show the strength of ISM manufacturing and given the government shutdown the risk of a move lower is quite high. Consumer confidence is also likely to decline due to widespread frustration with Washington. While the headwinds have dragged out we expect growth in the US economy to gather pace in 2014. Firstly, the drag from fiscal policy will peter out, which will significantly lift growth. Secondly, the sharp negative impulse from the rise in bond yields will also fade as bond markets take a breather. Thirdly, the housing market is still in a structural recovery phase even if it is halted temporarily by the bond yield shock this year. Wealth effects from rising house prices will underpin consumer confidence and there is still substantial pent-up demand in housing, as both sales and activity are still running at very low levels from a historical perspective. Fed tapering is now likely pushed into next year and our baseline scenario is now the 29 January meeting. Uncertainty is clearly high, though, as the short-term economic outlook is foggy. The Fed likely needs to see the recovery on a stronger footing before it will start to taper. Hence hard data on private consumption, capex and job growth should improve in order for the Fed to move. However, since the September decision was a borderline one we may not need a very big improvement in hard data. The tapering probability distribution in our view: 15% at December meeting, 40% at January meeting, 30% at March meeting and 15% later. Today s key points We are still positive about risk assets on a medium-term horizon. Fed to delay tapering but bond market is already pricing this we look for range-trading. US recovery stalls short term but gains traction in 2014 as headwinds fade. Europe and China continue to deliver good news securing momentum in global recovery. Risk of ISM correcting lower hard data likely to stay soft short term 65 Index 12.5 US ISM manufacturing >> 15.0 % 3m/3m, AR 1 60 7.5 5.0 55 2.5 50-2.5 << US domestic demand indicator 45-5.0 (core retail sales+core capex orders) 40-7.5-1 35-12.5-15.0 30 08 09 10 11 12 13 Headwind from rise in mortgage rates to linger rest of the year 1.0 0.5-0.5-1.0 % points % points -1.5 US 30y mortgage yield, 6m change -2.0 00 02 04 06 08 10 12 1.0 0.5-0.5-1.0-1.5-2.0 Chief Analyst Allan von Mehren +45 45 12 80 55 alvo@danskebank.dk Important disclosures and certifications are contained from page 4 of this report.
Where does this leave the markets? In the bond markets we expect US yields to trade in a 2.5-3% range the rest of the year and probably in the lower end until the fog clears a bit. A later tapering is already pretty much priced in our view. Money markets now look for the first hike in October 2015, a bit later than current Fed guidance, which is mid-2015. By end-2016 the market now expects a rate of just above 1.5%, quite a bit lower than the median estimate of Fed projections at 2.0%. US bonds have outperformed Germany recently and we expect this to continue as the euro area continues to recover while the US is stuck at a low growth track in the short term. For risk markets we still have a positive view on a medium-term horizon. While US growth is stalling, we continue to see positive signs from both Europe and China (see below). At the same time, the postponement of Fed tapering gives support to risk sentiment. In stock markets we see the most value in Europe as valuation is more attractive here and the change in growth is going to be the strongest as it moves from recession into positive growth of 1-1.5%. US 10y nearing 2.5% - market now prices end-16 Fed rate at 1.5% Global stock market continues bull trend In the bond markets we look for continued credit spread compression and believe peripheral bonds will outperform in euro government bond space. The combination of a) global recovery, b) large slack in the economies and c) very low inflation will keep a continued bid in credit markets. Central banks are going to keep rates low for a very long time underpinning search for yield. In the short term peripheral bonds will also be supported by large redemptions. We especially like Italian bonds in the euro space see also Government Bonds Weekly: Here come the redemptions, 17 October. With US now being the weak link in the global recovery (in the sense that it is showing the least change in growth) and Fed tapering being pushed into next year, the USD is expected to be under pressure in the short term. We look for more upside in EUR/USD as the cross is also underpinned by continued peripheral spread compression and strengthening euro data. That said, we are not far from our 1m forecast at 1.37 and we look for a move lower in EUR/USD to 1.30 on a six-month horizon. European recovery continues unabated While US growth is stalling the news coming out of Europe is still quite encouraging. The German ZEW index surprised to the upside rising to the highest level since 2010. Euro area industrial production also posted a positive surprise in August and the big decline seen in July was revised higher. The trend in industrial production is thus still up and data overall now point to growth in Q3 at a similar pace as in Q2 leaving annualised growth running around 1.25%. While it is far from a boom, it is a clear improvement compared with the recession in the early part of the year and it is a higher level than what consensus is looking for in 2014 at 1%. We continue to see clear upside risk to euro area growth relative to the consensus expectations. Still positive news out of UK as well. Jobless claims for September fell at the fastest pace in over 15 years suggesting that the upbeat growth indicators are translating into stronger job growth. Retail sales for September also surprised to the upside and point to continued decent consumption growth. Overall the domestic UK economy seems to be recovering fast with all sectors participating. Consumption is gaining strength, housing has picked up speed and sentiment data point to a very sharp rise this year. It leaves Bank of England with a challenging task in its forward guidance but for now it will continue to try to calm down markets and stick to the guidance. Given how strong UK data have been it may be difficult to continue to surprise to the upside. The UK economy has had a strong take-off and we expect growth to stay at a robust level over the coming years. Source: Macrobond UK labour market gaining strength Source: Macrobond 2 18 October 2013
UK growth is strong but the markets are also pricing this. Money markets are pricing Bank of England to be the first of the big central bank to hike rates currently in mid- 2015. As the euro area is gaining strength the relative surprise may become more neutral and we look for a bottom in EUR/GPB close to current levels. On the other hand, we do not see a big rise and have a one-year forecast of 0.86 (currently 0.845). China recovering Another factor supporting risk assets and Emerging Markets comes from the recovery of Chinese growth. Q3 data this morning showed a pick-up in growth to 7.8% y/y from 7.5% y/y in Q2 see Flash Comment China Moderate recovery in Q3, 18 October. On an annualised q/q basis GDP growth was close to 9%. While one should always be a bit sceptical about Chinese growth data, the current picture is supported by a rise in industrial production as well as development in electricity production. Interestingly, the current activity data are stronger than the PMIs suggest. This is not the first time this has happened, though, and it may indicate some upside risk to PMI in coming months. We look for growth to keep a robust pace in coming quarters but to lose steam during 2014. Investment growth should slow down again next year but a pick-up in export growth will underpin activity as the European recovery keeps going and the US growth rises a notch to 2.5-3% from the current 2%-level. Chinese industrial production still strongest since 2010 Source: Macrobond, Danske Bank Chinese GDP growth 12 11 10 9 8 7 6 5 4 % China GDP % y/y Forecast % q/q SAAR. 10 11 12 13 14 % 12 11 10 9 8 7 6 5 4 Global market views 3-6 months horizon Asset class Equities Higher on 6-12M horizon Bond market Core bond yields range-bound short-term, higher medium term Germany to underperform US in 10-year bonds Peripheral spreads to tighten gradually Credit spread to tighten gradually FX EUR/USD - more upside short term. Lower on 6M horizon USD/JPY - near term range but higher in long run EUR/SEK - higher short term, medium term lower EUR/NOK - gradual move lower Main factors While US recovery stalls short term, global medium-term outlook is strengthening Earnings growth to pick up. Fed tapering postponed as US recovery delayed Dovish Fed keeps yields anchored short term, global recovery gives upward pressure longer term German bonds have lagged in this year s sell-off, Fed tapering postponed, Euro area recovering Ample liquidity, search for yield, improving fundamentals Ample liquidity, search for yield, strong corporate fundamentals Re-pricing of Fed tapering has postponed USD strength but this will materialise in 2014. ECB committed to low rates Bank of Japan to continue monetary easing and Fed to eventually start tapering. Slower Japanese growth next year Soft growth short term but strong fundamentals and no rate cut from the Riksbank positive in long term Strong fundamentals, but short-term picture is soft and still risk from dovish rhetoric from Norges Bank Commodities Oil prices - short term sideways, lower price in 2014 Significant supply shock from US shale and OPEC over-production to weigh in 2014 Metal prices - downside risk fading as China rebounds Copper to stay volatile, aluminium to head lower as energy costs come under pressure Gold prices to correct lower still Part of the bubble now eliminated but more declines in store on Fed tapering Agricultural risks remain on the upside Stabilisation in the near term but extreme weather events remain a key challenge Source: Danske Bank Markets 3 18 October 2013
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