On Tuesday, everyone’s first order of business upon returning to the desk after the holiday was finding a narrative to latch onto.
Of course given that the new year wasn’t even 48 hours old, that was a tall order. To the extent the dynamics that drove markets in 2017 are set to shift in the new year, we’re probably going to need to wait longer than two days for that shift to take place.
On top of that, the consensus seems to be that no shift in the prevailing narrative (i.e. “Goldilocks”) is imminent.
Part and parcel of Goldilocks is an overriding sense of complacency. Synchronous global growth lends credence to the risk-on trade and subdued DM inflation gives central banks the cover they need to stick with a gradualistic approach to normalization thus ensuring that the policymaker “put” remains ever-present even if it’s now running primarily on autopilot (i.e. intervention through jawboning is no longer necessary as every dip is bought on the assumption that any lasting weakness will be met with dovish communication).
Needless to say, that’s conducive to the build up of risk. “2018 starts with a general mood of complacency and excessive exposure to momentum-based and yield-seeking strategies,” SocGen notes in a piece out Wednesday.
It’s going to take more than Donald Trump bragging about the size of his “bigly” nuclear “button” to break the spell, so for the time being, cruise control is the default setting.
But for those interested in trying to “DO SOMETHING” (as opposed to just kicking back and being “actively” passive), SocGen is out with “7 key calls” along with the risk scenarios for each. Here they are…
- Exit strategies gaining momentum in 2018 We expect the main central banks to move further away from superaccommodative monetary policies in 2018. Illiquid assets trading at expensive valuations may suffer the most in this context. We prefer sovereign bonds to equity, especially in the US. 10-year US Treasury bonds continue to provide a safe haven in this environment. Risks: Fed, ECB, BoJ and BoE not normalising policy on the back of a growth slowdown.
- Fall in US dollar to resume in 2018 The tax cuts enacted by the US Congress are unlikely to provide significant support for the USD. The Fed should tighten only very gradually, 10y bond yields should remain capped by strong demand for Treasuries and low inflation, and valuations show that the currency is in expensive territory. Risks: Fed accelerates the pace of tightening.
- US: late economic cycle and perceived poor political management The US economic cycle has advanced considerably and is getting closer to its peak, while perceived poor political management means there will likely be little support from economic policies in the coming years, beyond the recently enacted tax cuts. Risks: Trump delivering more than expected, boosting the US economy further. Chinese growth surprising to the upside.
- Protect against global debt complacency Leverage has increased in both the US and Europe. Debt growth has been outpacing GDP, and the most leveraged non-financial companies are those with the least cash. In our view, a slowdown in growth in the US and Europe – SG economists forecast the peak in 2018 – would have negative implications and trigger a widening of credit spreads in the second half of 2018. Risks: lack of inflation momentum forcing G4 central banks to keep a dovish stance.
- Euro area: strong growth momentum and fading political fears The euro area growth outlook – especially domestic demand – is supported by a looser fiscal stance and the very gradual ECB move towards less accommodation. On top of the supportive economic backdrop, extreme risks are subsiding, including banking sector risks. Risks: acceleration of global growth beyond expectations.
- Buy oil on dips US supply growth should be the biggest single contributor to meeting global demand growth, which is currently picking up. Meanwhile, OPEC compliance with production cuts limits any durable downside in oil prices. We believe that oil prices should remain range-bound at $50- 60/b over the next two years. However, there is upside risk, with geopolitical tensions and winter weather being the main potential catalysts which could propel the oil price to $80/b. Risks: managed money stretched net long positioning, weaker macroeconomics and oil demand growth.
- Wild card scenarios for 2018 In this key call we present low-probability events gaining momentum in 2018: 1/ the Bank of Japan raising its target on 10-year Japanese government bonds from 0% on the back of strong growth momentum and rising inflation; 2/ no Brexit and/or Labour coming into power and Jeremy Corbyn becoming PM..