Global Outlook: Q4 2019 – Hey, Where’s My Yield?

Traders Magazine Online News, September 11, 2019

John D’Antona Jr.

BNP Paribas released their most recent global market outlook and Traders Magaziine is pleased to share their fourth quarter view of the markets.

Here is a brief summary:

 

• Trade tensions continue to weigh. We still think an escalation in the US–China trade tensions is more likely than a resolution, and expect this to weigh on global growth. While recent rhetoric has suggested more positive US–EU trade relations and the potential avoidance of the auto tariffs that are a key downside risk for the eurozone, we would not be too optimistic at this early stage.

• Our DM and EM growth forecasts remain below consensus, even though consensus has come down significantly this year. We forecast global growth to slow further below 3% in 2020. Countries more reliant on exports such as China, Germany and some emerging markets could be particularly hard-hit, and the eurozone is on the brink of recession. Brexit remains an area of uncertainty, with asymmetric risks to the downside.

 

• Rates to stay low or go lower. As a result, we expect global rates to drop or remain close to current lows. As developed economies face the prospect of ‘Japanisation’, we expect central banks to react with more easing: a package announcement including rate cuts (with tiering) and QE from the ECB, four more rate cuts by the Fed by mid-2020 and rate cuts by the majority of EM central banks.

 

• We see fledgling moves towards fiscal expansion. Policymakers seem to acknowledge that developed markets have reached the limits of monetary policy, and fiscal policy is starting to appear on the agenda. In our view, this will become more of a story in 2020 and implementation will take time, but we expect the idea to take root this year as exceptionally low funding costs make it increasingly attractive.

 

• We are positive on bonds, cautious on equities. We are positive on bond markets in general and peripheral spreads in particular. We also like IG credit in the US and Europe, and EM spreads at the long end of the curve (mainly in Mexico, Brazil, Russia, Hungary and Poland). We are defensive on equities, where negative earnings revisions are not fully priced in, in our view. In FX, we think the USD will stabilise and remain structurally bullish on the JPY.

DETAIL ON ASSET CLASSES

 

GLOBAL ECONOMY: On the brink (PG 7-10)

Luigi Speranza, Chief Global Economist

• Looking back, our long-held pessimism about the prospects for the global economy might not have been gloomy enough. The slowdown underway in trade and manufacturing has proved to be deeper and longer than even our below consensus forecasts envisaged

 

• We have cut our already sub-consensus forecasts sharply and now expect PPP-weighted global growth to be below 3% next year, amounting to a downturn.

 

• Germany is one of the hardest-hit economies due to its dependence on global trade. We expect its GDP to shrink again for Q3, signalling a technical recession. The greater resilience of the French economy should spare the overall eurozone from the same fate, but risks abound.

 

• Significant risk of recession: In our view, the global economy can still be pulled back from the brink of recession; there are no obvious signs of large global imbalances and the policy response is likely to be prompt

 

• Central banks to the rescue? A key concern, in our view, is inflation – specifically, the lack of it, which we attribute to a combination of unusually long lags and structural factors. Despite unprecedented monetary policy stimulus, inflation remains stubbornly low, even in economies that are operating close to full potential, such as the US. Even more unusually for this stage of the cycle, inflation expectations appear to be trending lower rather than higher

 

• Beyond monetary policy: We see a strong case for higher fiscal spending at a global level. The likely effectiveness of fiscal measures should be improved by the prevailing exceptionally low interest rates, as lower borrowing costs and less impact on debt sustainability should assuage worries that stimulus now means renewed consolidation in the future

UK: At a crossroads (Pg 19)

Paul Hollingsworth, Senior European & Chief UK Economist

• Forecasts assume unresolved Brexit: The biggest change to our UK forecasts in this Global Outlook is that we now attribute only a 20% probability to a Brexit deal being struck. We think there is a 50% chance of a ‘no deal’ Brexit and a 30% chance of a revocation whereby the UK remains a member of the EU.

COMMODITIES: Oil switches focus, gold glitters (pg 20)

Harry Tchilinguirian, Senior Oil Economist

• Oil shrugs off supportive supply fundamentals: Under normal market conditions, the recent tighter supply trends should have propelled oil prices higher. OPEC and its non-OPEC allies have committed to output restraint until Q1 2020 and so far have delivered on their pledges. Production is falling in Venezuela, while Iran’s crude exports have collapsed; the US is unlikely to lift its crippling sanctions on either anytime soon. At the same time, geopolitical concerns in the Middle East have risen. Yet oil has struggled to rally in Q3.
• In our view, the market focus has switched from supply trends to demand. With escalating US–China trade tensions and economic uncertainty, there is a fair hesitancy to go long oil. At the same time, supply dynamics are changing. Terminal and pipeline buildouts this year will allow the US to export more light oil, hampering OPEC supply management efforts.
• Gold glitters: Market pricing of Fed easing has sent gold up faster than we had expected. Falling nominal yields and contained inflation have reduced the opportunity cost of holding gold, while economic uncertainty has boosted safe-haven demand.

MACRO QUANT: Low is the new normal  (Pg 21-22)

Michael Sneyd, Head of Macro Quantitative & Derivatives Strategy & team

• BNP Paribas Cyclical-R indicates a fair value for the US 10y Treasury yield of 2.45%, indicating that yields are currently undershooting (top chart). The US 10y yield undershot its Cyclical-R fair value in a similar manner during the US Federal Reserve’s ‘insurance’ cutting cycles in 1995 and 1998. This is, in our view, probably due to market uncertainty before the rate cuts: whether only a few cuts will be delivered, or a full rate-cutting cycle.
• The undershoot of the US 10y yield can be interpreted as the market pricing in a more pessimistic economic outlook.
• Our long-term projections are for nominal R* to decline to 1.10% by 2030 as US trend growth slows and an ageing population saving for retirement increases demand for assets. Thus investors might, in our view, be prepared for yields to remain on a downward trajectory over the long term

G10 RATES: 10y US yield heading to 1.00% (Pg 23)

• We expect the 10y US yield to drop to 1.00% by the end of 2019, with a flattening bias on the 2s10s curve, before a recovery as the global outlook starts to improve. The increasing number of negative-yield bonds elsewhere in the world and the drop in FX hedging costs are likely to support demand for Treasuries even as yields decline. The BNPP US economic strength index (BNPP US ESI) and US real rates have fallen sharply in the current quarter.
• In our opinion, current economic and financial conditions do not support risky assets and bonds will benefit.

G10 FX: USD correction postponed (pg 24)

• We expect the US dollar to hold close to current levels, with the notable exception of USDJPY, on which we remain structurally bearish.
• The growth picture in the US is deteriorating at a pace similar to the rest of the world, but the scope for rates to fall is greater in the US than elsewhere. This, together with the USD’s strong starting point (top chart), prevents us from holding an outright bullish view. However, while a marked depreciation remains overdue, in our view, it now seems less likely to take place over our forecast horizon.

EMERGING MARKETS: Aim lower in rates (pg 25)

Marcelo Carvalho, Head of Global Emerging Markets Research & team

• We expect EM growth to continue to slow, with the risks to our below consensus forecasts lying to the downside. We now forecast real EM GDP excluding China to rise by just 2.7% this year, down from 3.3% in our May Global Outlook.
• Our more pessimistic views are based on a further deterioration in exports as trade tensions intensify and on a fall in investment in an increasingly uncertain global environment.
• We now expect the majority of EM central banks to cut rates by the end of 2019 (up from eight in May’s Global Outlook, when our EM rate forecasts were already below consensus). There has already been a robust policy response to the fall in growth and inflation.

EQUITIES: Earnings the driver, not valuation (pg 26)

Edmund Shing, Global Head of Equity & Derivative Strategy & team

• Equity outlook late in the game: We think the global economy has moved further into the late stage of the economic cycle. In this low-growth, low-inflation, low-rate world, we expect investor exposure to equities to have a defensive bias. Consider shifting from cyclicals to defensives.
• We expect increased dispersion of stock returns, with companies that have pricing power and low labour costs as a percentage of earnings likely to be more resilient. We view companies with higher balance sheet leverage and already-low margins as most at risk in a late-cycle environment.
• Lower margins are potentially a good gauge of a lack of pricing power and flag an inability to pass on price pressures.

CREDIT: Sluggish but dovish (Pg 27)

Viktor Hjort, Global Head of Credit Strategy & team

• Our base case is for tightening of investment grade credit spreads in both EUR and USD. We see vulnerabilities on the back of the weakening in growth, increased trade tensions and external factors (such as Brexit), but the US Federal Reserve’s and ECB’s more dovish stances are likely to compensate for these risks, in our view.
• We expect the impact of ECB QE to be significant and see EUR IG spreads narrowing by 15bp despite some expensive corporate bond valuations. CDS indices are also likely to tighten but lag the move in cash and we see the basis performing in European IG

SUSTAINABILITY: EU coordination driving real change (Pg 28-29)

Trevor Allen, Sustainability Analyst

• European outlook: The transition to low-carbon economies continues to spread across Europe, bolstered by three developments: 1. New EU legislation: The EU has announced its intention to reach carbon neutrality by 2050. Legislation is in progress on the back of the recent wave of success of green and populist parties in Europe and is set for ratification in 2020.
• Record low energy prices: Recent renewable energy auctions in the south of Europe have resulted in record low prices per MW generated
• Cars will produce fewer emissions: In 2021, the EU auto emissions law will require car manufacturers to ensure their entire fleet maintains an average of 95CO2 g/km for all new cars produced. Limits are now capped at 130CO2 g/km
• In our view, these policy developments, combined with new legislative proposals, such as the EU Taxonomy and Green Bond Standard, indicate that the EU will continue to push for stricter rules on carbon emissions.
• SUSTAINABILITY: US states leading in energy transition
• US outlook: Although policy from the executive is proving more supportive of fossil-fuel development, some state governments are driving change towards embracing a low-carbon policy shift in their economies, specifically in infrastructure.
• The Climate Alliance is a group of states that are breaking rank with the federal government and continuing to abide by the COP21 Paris Agreement. These states represent 50% of the population and 60% of US GDP
• The move away from coal will continue, in our view, as the US brings more natural gas online. The cost of electricity generation via natural gas is still lower than the cost of solar in the US, but is currently near parity with wind energy.
• The costs of both solar and wind energy are expected to move below natural gas costs by the middle of the next decade, according to Bloomberg, but with more natural gas investment being made, it may prove difficult for the US to move away from the natural gas infrastructure currently under construction. Making this transition profitable will be key in reducing emissions from heating and electricity in the US

Out-of-consensus calls for Q4 2019

Our out-of-consensus calls for Q4 2019:

• A sharp slowdown in US growth to 0.9% q/q annualised in Q4 2019 to catalyse monetary and fiscal easing beyond current expectations.
• US 10y yield to drop to 1.00% by Q4 2019, well below current levels of 1.50%, and the curve to flatten until central banks get ahead of market expectations of rate cuts.
• USDJPY to decline to 102 by the end of 2019 and to 96 by Q3 2020. Global risk aversion and the hedging of  long USDJPY positions by domestic Japanese investors to drive further JPY appreciation.
• Eurozone growth to fall to 0.7% and German growth to just 0.2% in 2020.
• Receiving rates in emerging markets, particularly in the long end of local yield curves.
• Fall in US, eurozone and Japanese equity markets. Focus to shift to earnings and away from valuations. Continued outperformance of late-cycle trades – long Real Estate, Health Care, Consumer Staples, Technology and short Industrials, Materials, Consumer Discretionary, Telecom and Energy.

 

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