Saxo’s outlook for Q3 says Covid-19 will amplify the unravelling of globalisation

Online trading and investment specialist Saxo Bank published its third quarter outlook for global markets and trading ideas for equities, FX, currencies, commodities, bonds, and a range of central macro themes impacting client portfolios.

Steen Jakobsen, Chief Economist and CIO at Saxo Bank said:

Starting with the Trump presidency – and with a breathtaking acceleration over the space of just a few months thanks to the Covid-19 pandemic – the world is being driven by self-interest, distrust and a game of us versus them in political circles as well as companies’ supply chains.

This great turning away from world-spanning supply chains, plus an impulse shading towards autarky, will bring widespread reshoring and incentive programmes to produce domestically. The first areas in focus will be medical supplies, after the embarrassingly dire lack of preparedness nearly everywhere for what was arguably an inevitable pandemic. But the new need to measure political accountability in terms of national self-sufficiency in pivotal industries will mean that energy, food supplies and technology will all be declared “mission critical”. Potential higher marginal costs for producing locally will prove less important than the political imperative to prove robust self-sufficiency. In short, prices will rise for nearly everything – and in real terms, not just through price inflation.

Jakobsen added:

The great irony is that although Covid-19 brings massive human and economic impacts, the even bigger risk is our response to the crisis. At best we are suspending market-based economies, at worst we are replacing them with state capitalism. That model can never ever win, as open markets are required to best drive price discovery, allocation of goods, innovation and even democracy.”

As the world resets after the pandemic, Saxo Bank expects more pain to lie ahead for equities. Supportive monetary polices have brought fiscal and monetary institutions closer and the unprecedented stimulus has fostered speculation on a scale we have not seen since 2000. However, the S&P 500 recently had its worst session since March and the VIX has exploded higher, so the impact from Covid-19 is far from over.

Peter Garnry, Head of Equity Strategy, commented:

Peter Garnry

Peter Garnry

As we enter Q3, markets remain fragile. The VIX is indicating a very volatile summer, where Q2 earnings releases will finally reveal the real damage to the corporate sector and potentially give us a rough sketch of what’s ahead.

Valuations have bounced back to levels where the risk-reward ratio is not attractive in a historical context. History suggests that there is a 33% probability, at current valuation levels, that the international equity investor will experience negative real rate return over the next ten years.

Strategy continued:

US equities generally have lower financial leverage than European companies, which is a positive in an uncertain macro environment. However, valuation is the key factor in explaining future returns, so with the historic outperformance of US equities combined with rich valuations we believe investors should begin to be overweight European equities – despite the political risks in the EU.


Saxo Bank office

The US dollar still has a steady position. The Fed has been mobilizing enormous quantities of liquidity, asset purchases and loan programmes to stop the firestorm of contagion, and the USD has returned to its trading range in the period leading up to the crisis. Despite these actions, Saxo Bank does not believe the market will return to normality in the near future as central banks’ response to the pandemic and shifts in international government policies pushes markets toward deglobalisation.

John Hardy, Head of FX Strategy, said:

John Hardy Saxo Bank

John Hardy, Saxo Bank

Q3 may yet prove too early, but the US dollar must roll over eventually. If nothing else, because we live in a world drowning in USD-denominated debt, both onshore in the US and globally – and any durable recovery has to see a devaluation of the US dollar in real terms in the US and in relative as well as real terms in the rest of the world. The risk of widening insolvencies and defaults will encourage an outright devaluation unlike anything seen since the post-World War II debt devaluation.

In FX, the losers will be the currencies with the worst financial repression and most aggressive MMT programmes. The relative winners will be economies with significant commodity potential. Current account considerations will also loom larger than they have in the past due to deglobalisation, slower trade and possibly reduced capital flows.

Saxo Bank’s outlook for precious metals for Q3 remains positive. However, the pandemic still threatens to derail the recent rallies witnessed in energy and industrials, and any additional growth in Q3 will be challenged.

Ole Hansen, Head of Commodity Strategy for Saxo, commented:

Ole Hansen

Ole Hansen

Gold remains the only key commodity to show a positive return so far in 2020. Following April’s rollercoaster ride it has settled into a range around $1700/oz. Gold’s ability to frustrate, then eventually reward, the patient investor is likely to be on full display during the third quarter. Multiple positive tailwinds are currently being offset by what we believe will be a short-lived decline in inflation.

The lack of market momentum since April and the disinflationary environment currently playing out have driven a 55% reduction in bullish gold futures bets since the early 2020 peak. A positive change in the fundamental or technical outlook are likely to force traders off the fence and back into the market. This development could also see gold break higher.

The outlook for crude oil demand remains challenged by the not-yet-under-control Covid-19 pandemic. While OPEC+ have made a gigantic effort to support the global market through record production cuts and high compliance, the potential for crude oil to reclaim further ground will be limited during the second half of 2020.

The coronavirus crisis has brought up Europe’s dependency on Asia and China in particular for the production of medical equipment, devices and the essential active of commonly used drugs.

Christopher Dembik, Head of Macro Analysis for Saxo, said:

Christopher Dembik

Christopher Dembik

The crisis served as a wake-up call to European governments and society on the urgent need to diminish economic and health dependence on the rest of the world. Reshoring of value chains is not a new idea; it is as old as globalisation itself. But it has swung back into fashion in recent years on the back of rising protectionism – and it has gained more ground over the past few months due to the outbreak.

In theory, relocation is a very attractive idea – the question is whether Europe has the means to realise its ambitions and become more self-reliant. The euro-area balance of trade provides us with initial answers. The Euro-area trade is characterised by a massive surplus, mostly due to Germany reaching a EUR 338-billion surplus in the twelve-month period to March 2020, which represents roughly 2.8% of euro-area GDP. This is the second biggest trade surplus in the world, behind China.

During the pandemic it also became obvious that businesses have to focus on adding resiliency to supply chains via localisation and regional ties.

Eleanor Creagh, Australian Market Strategist for Saxo, noted:

Eleanor Creagh

Eleanor Creagh Source: Twitter

Australia – as a small open economy with high energy and labour costs and an obsolete manufacturing sector – is in many ways swimming naked as the tide goes out on globalisation. Much will depend on the resultant policy response following a new Federal Government manufacturing task force that has been engaged on this issue.

When we talk about deglobalisation and reshoring, the concept of comparative advantage is often lost. However, Australia has a clear comparative advantage when it comes to renewables, and nowhere has the devastating impact of climate change been more obvious than Australia this year. This provides a clear impetus for investment and fiscal stimulus targeting not just the economic crisis but also the climate crisis.

The coronavirus pandemic has posed significant economic challenges in front of China, however the country also faces international pressures from the deterioration of relations with the US and unrest in Hong Kong.

Kay Van-Petersen, Global Macro Strategist for Saxo, commented:

Kay Van-Petersen

Kay Van-Petersen

China is facing the perfect storm of adversity and challenges, including the costs of Covid-19, US-China relations deteriorating, the west backing Hong Kong over Beijing and, still to come, a global backlash that is only set to increase once the Covid dust settles on who is to blame for all this.

Adversity, though, will only make a country more resilient and innovative, forcing it to tap into its true potential. Trump and Covid-19 are going to be the best things that have happened to China – a function of which will spill net positive to the rest of the world – in that it will accelerate Beijing’s plans to go from being export dependent to domestic-consumer driven. It will take China’s 2025-2035 plans, which are all about technology, moving up the value chain and developing tech infrastructure, and bring them forward. Finally, it will open China’s markets and accelerate reform which has been held back by export dependency.

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