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12.01.2021 69

Market Scenarios and Risks - January 2021


12 January, 2021

5 to 10 minutes
Market Scenarios and Risks - January 2021

12 January, 2021

5 to 10 minutes

Central & Alternative Scenarios

Monthly update

This month, we update the probabilities and narrative of our central and alternative scenarios, taking into account 4Q20 developments in vaccinations, fiscal and monetary policies, and (geo)politics. We have a higher conviction on our central scenario and we are raising its probability from 65% to 75%. We are lowering the probability of our downside scenario from 25% to 15%, which remains above historical levels. We confirm our constructive medium-term view on the “financial recovery regime”, with more caution in the short-term on financial markets, given the virus-dependent news flow.

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Top Risk

Monthly update

Risks are clustered to ease the detection of hedging strategies, but they are obviously linked. We maintain the overall narrative and change the probabilities of risks in light of the recent developments.

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CROSS ASSET DISPATCH: Detecting markets turning points

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Global Research Clips

1.  Hidden YCC by the ECB

  • Technical factors will continue to play a major role in the euro fixed-income market.
  • Unused PEPP + additional QE will more than cover 2021 net new issuance, due to higher deficits. The ECB will buy 70% of 2021 Gross Sovereign Supply.
  • This is the end of Bund’s volatility. Marketable on overall sovereign debt is lower for Germany than for other major European countries: 73% vs ratios between 83% and 87%. This is the first factor supporting Bund scarcity.
  • The extended PEPP can be re-calibrated at any point in time. This is YCC (Yield Curve Control) without saying it.

2.  How far the “great rotation” can go

  • After the strong rally in risky assets, we see more opportunities in lagging sectors and styles, rather than in regional allocation.
  • While Europe usually performs in line with US equities during a recovery phase, this unusual recovery favours European cyclicals and its financials. The same applies to Japan (Value and Growth) relative to the US.
  • Value vs. Growth mean reversion is just starting and has room to expand further. The positive signal is that the correction of the valuation gap between the two is materializing, with Value catching up, and not through a burst of a Growth bubble, which is a positive signal for pro-cyclicality.
  • Until bond yields are below the average nominal growth expectations over the course of the cycle, it will mainly be the speed of adjustment of the bond market that matters. Provided that CBs don’t allow rates to move quickly, and corporate earnings growth keep rising, there is enough time for the rotation to play out.
  • Georgia’s Senate runoffs results should further boost the rotation out of USA into RoW, once markets digest the potential of higher tax and regulatory implications from a full Democratic government.

3. FX matters

  • On the USD, the expectation of stronger growth in 2021, fueled by vaccine hopes, spurred risk sentiment and almost filled the undervaluation gap, while the Fed removed almost entirely the USD rates advantage that made the greenback a profitable opportunity on top of a defensive play.
  • The ECB will also continue to monitor developments in the exchange rate. It’s not the current level of the EUR but the pace of its appreciation looking ahead that is likely to worry the ECB (with a stronger pass-through to prices at a time when inflation is already in negative territory).
  • Global determinants remain the key factor to watch. We see commodities performing in line with nominal GDP, a mild steepening of the curve and Value outperforming Growth: NOK, AUD, SEK and CAD show the highest risk /reward profiles. There’s too little to squeeze from NZD, EUR and GBP.

4. EM equities as the recovery play

  • EM Central banks remain accommodative, but the pace of yield compression is going to decelerate, and inflation is expected to normalize to higher levels.
  • EM FX is still undervalued on average. We see +0.5% upside on a three-month horizon. The potential EM FX upside is higher in GBI-weighted terms (+0.8%). We remain positive on some Latam countries like MXN and PEN, as well as for IDR, RUB and some Asian FX, such as CNY, which are more advanced in the economic recovery and in controlling Covid.
  • HC bonds show limited room for further spread compression in 2021 even if we expect lower volatility in 2021 compared with 2020. We still see more room in H12021 for HY. Our scenario for USD depreciation is not supportive.
  • EM equity earnings growth is being driven by the rebound in world trade, emerging exports and a mild but positive increase in commodities prices. Profits growth in the first half of 2021 will be more concentrated in Emerging Asia, which is much more advanced in the recovery and more linked to booming e-commerce profits and the secular trend of technology. The region remains safer and should continue to outperform, involving laggards such as Indonesia. We see room in the next months for some rotation into laggards and value places like Mexico and Russia.
Covid-19 update by David Brecht, Fixed Income Analyst, CFA

As the rollout of approved vaccine is under way across the globe, two more vaccines from J&J and Novavax have near term chances of approval. If approved, the J&J vaccine would massively increase the supply with one billion dose targeted in 2021. There is a lot of concern around two new variants of the coronavirus, one in the UK (B.1.1.7) and the other in South Africa (B.1.351). Both variants have mutations in the receptor-binding domain, which is where the virus binds to the host cell. Both variants are much more contagious, which just could be because a person exposed to the variant is more likely to get infected or because a person sick with this variant sheds and therefore spreads more virus. The South African variant also has some additional mutations that could negatively affect vaccine efficacy. These mutations are on the virus’ spike protein, which is also the target of the vaccines and antibody therapies.
The UK variant does not appear more lethal but supports the hypothesis of Covid being endemic. Moreover, vaccines in development are all polyclonal and there is no evidence that any mutations so far make a vaccine ineffective. Vaccines can also be updated (6 weeks according to BioNTech) and most vaccines should continue to be effective.


Amundi Asset Class Views

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