SocGen’s Big Call: It’s Time To “Make Reflation Great Again!”

Don’t tell Albert Edwards, but his colleagues at SocGen are ready to “make reflation great again.”

If you’re the type who doesn’t give a shit about the details and therefore prefers as high a “visuals-to-words” ratio as absolutely possible, allow us to save you some time by simply showing you the first page of the bank’s latest Global Asset Allocation piece:

MakeReflationGreat

There you go. The “scenario” and the “strategy” all communicated in one handy graphic, set against a pleasing hue of royal-ish blue.

For those readers who like a little nuance with their giant spoke-and-wheel charts, below, find the general thrust of the piece condensed into two headlines and a few bullet points.

As you’ll see, one of the key assumptions here is that growth needs to remain just shitty enough to keep the Fed cautious and just good enough to keep the faith alive. That’s a common refrain these days and ultimately, I’m not sure it says anything good about the extent to which we’re all hooked on central bank liquidity…

Via SocGen

Overall stance

  • Our reading of the US situation is that, while persistently worrying at the political and diplomatic levels, it is close to Goldilocks at the economic level. The sub-2.5% GDP growth allows the Fed to tighten “only” moderately, and this is a clear burden to the US dollar and a trigger for risk-taking elsewhere.
  • This comes at a time when economic growth in the euro area and Japan continues to accelerate, and when China’s policies remain supportive ahead of their all-important Politburo gathering in the fall.
  • We advise keeping a strong overweight position in equities and a strong underweight in bonds.
  • The expected reacceleration of the US economy before the summer should also act as a boost to commodity prices, especially oil, where supply is controlled by OPEC and Russia.
  • One could also start preparing for some Brexit pain after the UK general elections: negotiations might prove much tougher than envisaged by the yes-vote, consumer confidence could be dented and UK assets, especially sterling, could come under renewed pressure.

Prepare for a tactical rebound of the US

  • The markets’ response to the prospect of reflation was probably too fast and too sharp in the second half of last year. Some of the optimism has unwound in the initial months of this year, as overly optimistic soft data has finally converged to the reasonably good hard data.
  • Despite the failure of the first attempt to repeal Obamacare and the controversies around Trump, we think that parts of his economic agenda will get through Congress, notably the proposed tax cuts for individuals and businesses. With the November 2018 mid-term elections on the horizon, there will be considerable pressure to approve the tax cuts by early 2018.
  • The likely failure of US structural reforms over the four-year presidential mandate is a strong incentive to diversify into regions where structural reforms have already been implemented and which are starting to bear fruit: the euro area and Japan, and to some degree, those many emerging markets which are seeing a recovery in their balance of payments.
  • After the large USD selloff, we have temporarily stopped being shy of the USD (especially versus EUR), although our long-held view of a structurally fragile US currency remains firmly in place (SGe EUR/USD target of 1.18 for 4Q17 and 1.16 for 2018). After excessive pessimism, we expect reflation trade to return to the forefront of successful strategies, leading 10-year treasury yields up to around 2.7% at the end of this year (3.1% in 2018).
  • We expect the S&P to reach 2450 at the end of 2017 with an even more positive impact on global equity markets. On top of our cautious view on Treasuries, our best investment ideas to gear to this reacceleration of the US economy are the Japan automobile sector, Global Value style and eurozone dividends.
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