Are markets legitimately fearful?
Last summer, the engine went out of whack. The financial markets have been gloomy, as everything has a pessimistic interpretation. How did we come to this? Do we have to significantly revise our economic and financial outlooks?
1. Why is the decline in oil prices so scary?
It weakens oil-producing countries, putting them into a vulnerable and maybe even extremely difficult position. It creates concerns over companies in the energy sector (see High Yield in the US) going into default or bankruptcy, with the implications that could have for banks. It also impacts the reserves of certain sovereign funds (oil funds and SWFs in general), which may have to sell off their portfolios to bring governmental liquidity back up again. We should not forget that, in the case of oil, two thirds of the decline is related to supply. It is hard to predict whether any decisions will be made to cut oil production. The next official OPEC meeting is not until June, and the fear that oil prices will remain in free-fall until then is predominant, affecting oil-producing governments, companies in the sector and banks.
2. Why are central banks unable to reassure financial markets?
Central banks seem to have lost their touch, and they no longer have the same credibility that they did before. The BoJ has adopted a negative interest rate for new funds deposited by banks with the central bank, implicitly recognising that QQE has not been effective. The ECB has stated that it will reconsider its monetary policy, given “new” phenomena such as energy prices and the return of volatility. Meanwhile, in the absence of inflation and faced with declining growth (GDP grew only 0.7% in the last quarter of 2015), the Fed will have a hard time actively pursuing any kind of monetary policy tightening cycle.
3. Why is China still causing concern for financial markets?
China undeniably represents the greatest systemic risk, and the events of the last few months (depreciation of the yuan, temporary closing of equity markets in August and January) have fuelled unease. We believe such fear is excessive: the Chinese economic slowdown isn’t news, and the country will not devalue the yuan. Furthermore, since the summer, China has been successfully managing the yuan’s value so it remains stable. Finally, there is no hard landing (or crash landing) on the horizon.
4. Should we be concerned about recession in the United States?
We have mentioned several times that the market consensus was too optimistic, and we are currently completely overhauling these forecasts. As for the United States, we must not forget that consumption (which represents more than 70% of GDP) continues to hold up well and that there is a big difference between the services sector (strong) and the manufacturing sector (weaker). All of this makes us thinkthat growth of approximately 2%, not a contraction, is in the offing. At this time, a recession in the United States is not a possibility, but what is worrying is the Fed’s lack of room to manoeuvre, as it has been unable to raise rates until now.
5. Should we revise our forecast for the dollar?
There are two complementary ways of explaining the euro’s appreciation:
- A new factor: what’s new is the downward revision of US growth forecasts and of expectations of monetary tightening, which are now both more in line with our own revisions.
- The foreign exchange policy: there is a real, explicit foreign exchange policy in Japan, China and the United States, which is not the case for the eurozone. As this has been the case since the single currency was introduced, the euro is adjusting and remains the system’s “relief currency”.
Overall, we are still keeping our fluctuation range at USD 1.05- USD 1.15, with a target of USD 1.05 in six months.
We still live in a world marked by:
- The slowdown of the global economy. This is related to the emerging markets, a clear decoupling between regions, and a lack of unified blocks of countries. There is no concrete economic reality in the European block, the emerging country block or the dollar block. In other words, investment opportunities can be found in the decoupling between advanced and emerging countries, or between countries (those with high domestic demand and others) and between the emerging countries themselves (those that produce commodities and those that consume them).
- Growth expectations that are still overly optimistic and fears that are definitely exaggerated over the medium term (they do not justify complete collapse), but are decidedly present in the short term. Such fears include the fear of a recession in the United States, the risks posed by the oil countershock (for countries, companies and banks), doubts over China’s ability to controls its situation, and finally the inability of central banks to reassure markets. In other words, these fears clearly justify the macro-hedging strategies developed at Amundi over the last six months (long on US Treasuries and German Bunds, long on the USD and JPY, long on USD cash and long on gold).