On Tuesday, we brought you [39] Bloomberg’s top 10 “worst case scenarios” for 2016. The list, compiled by polling "dozens of former and current diplomats, geopolitical strategists, security consultants, and economists" included everything from devastating cyber attacks by Iranian and Russian hackers to a military coup in China.
They even threw in a Trump victory in the national elections for good measure.
Bloomberg’s “pessimist’s guide” to 2016 was just the latest in a number of outlook pieces by pundits, journalists and sellside macro strategists who are all engaged in a black swan spotting expedition. We've laid out a number of risk factors both for capital markets and on the geopolitical front that are worth paying attention to as we head into the new year. Here are a few notable flashpoints:
- soaring junk bond redemptions;
- rising investment grade (and high yield) yields pressuring corporate buybacks;
- record corporate leverage and sliding cash flows;
- Chinese devaluation back with a vengeance;
- capital outflows from EM accelerating as dollar strength returns;
- corporate profits and revenues in recession;
- CEOs most pessimistic since 2012,
- the Fed's first rate hike in 9 years expected to soak up as much as $800 billion in excess liquidity
- Syria’s seemingly intractable civil war
- the still simmering conflict in Ukraine
- Brazil’s political crisis which threatens to keep one of the world’s most important emerging markets mired in a stagflationary nightmare
- a migrant crisis that threatens to tear Europe apart at the seams
- the resurgence of the far left and far right as voters lose faith in the political status quo
For their part, Saxo Bank has taken a unique approach by presenting [40] ten "outrageous" and in some cases counterintuitive predictions that could play out over the course of the next 12 months.
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From Saxo Bank
Intro by Steen Jakobsen
The irony in this year’s batch of outrageous predictions is that some of them are “outrageous” merely because they run counter to overwhelming market consensus. In fact, many would not look particularly outrageous at all in more “normal” times – if there even is such a thing!
In other words, it has become outrageous to suggest that emerging markets will outperform, that the Russian rouble will be the best-performing currency of 2016, and that the credit market will collapse under the weight of yet more issuance. We have been stuck in a zero-bound, forward-guidance lowering state for so long that there exists a whole generation of traders who have never seen a rate hike from the Federal Reserve.
As we close out 2015, it has been nearly 12 years (early 2004) since the US economy was seen as recovering strongly enough to warrant starting a series of hikes - and that series ended in early 2006, nearly ten years ago.
Mind you, I have been trading for over 25 years and I have only seen three Fed rate hike cycles in my entire career: 1994, 1998 and 2004.
We are truly entering a new paradigm for many market participants and the new reality is that the marginal cost of money will rise, and thus so will volatility and uncertainty.
All of this is embedded in this year’s Outrageous Predictions.
EURUSD direction? It’s 1.23…
Many years ago back in 1989 I wrote one of my first research reports and I made the call that USDDEM should trade all the way down to 1.23. It was an outrageous call and colleagues from back then still remind me when we meet (the dollar to the deutsche mark was trading in the high 1.60s at the time). Now it’s again time to call for 1.23 but this time in EURUSD. In four of the last five Fed rate hike cycles, the US dollar has peaked around the first hike indicating that the direction of the US dollar is inversely correlated to the Fed rate cycle. A higher EURUSD will not only make the European Central Bank lose face but also catch the consensus out as most investors and traders believe parity between the EUR and USD is only a matter of time.
Russia’s rouble rises 20% by end-2016
By late 2015, the combination of collapsing oil prices and financial sanctions against Russia over the situation in Ukraine saw a rough ride for Russian assets and its currency, the rouble. But in 2016, oil prices surge again as demand growth in the US and especially China outstrip overly pessimistic estimates, just as US oil production growth is slowing and even reversing on a financial debacle linked to shale oil companies. This is a boon to Russia’s energy dependent economy. Meanwhile, in 2016, the US Federal Reserve allows the US economy to run a little bit hot as the strong USD sees the Fed raising rates at perhaps an inappropriately slow pace. This represents a bonanza for emerging markets and their currencies, in particular Russia as commodity bears are left out in the cold in 2016.
Silicon Valley’s unicorns brought back down to earth
The first half of 2015 had the lowest number of venture capital deals in 25 years as VC firms rushed to plough money into so-called unicorns – startups valued above $1 billion each. This rush to capture everything that might have blockbuster potential inflated the bubble in unlisted US tech firms. 2016 will smell a little like 2000 in Silicon Valley with more startups delaying monetisation and tangible business models in exchange for adding users and trying to achieve critical mass. Remember the dotcom gospel of clicks and page views instead of focusing on revenue and profits?
Olympics to turbo-charge EM’s Brazil-led recovery
The poster child for emerging market weakness is Brazil with its recession, collapsing consumer confidence, skyrocketing unemployment and plunging currency. USDBRL has nearly doubled so far this year while confidence is at a decade low and unemployment is at a five-year high. Oh, and lest we forget; yearly GDP growth has been negative for five straight quarters – and this count could turn double-digit before it is over. A poster child, maybe, but Brazil is hardly alone in struggling to come to terms with the end of the commodity super-cycle, which has morphed into a full-scale oil price meltdown, a weakening China-led global manufacturing cycle and a run-up in dollar-denominated debt. Add uncertainty about the Federal Reserve’s first rate hike in more than a decade to the mix and the picture is bleak. Against this disturbing backdrop we look for the host of the 2016 Olympics to lead EM out of the current malaise with equities outperforming. Leading indicators are stabilising in China and climbing in India, and recent policy easing furthermore helps the outlook for the former.
Democrats retain presidency, retake Congress in 2016 landslide
In 2016, the Republican primaries descend into chaos after the party’s voters narrowly manage to nominate another weak, centrist candidate after the long self-destructive process of the nomination process. Donald Trump goes down in flames, taking the Republican Party with him and leaving its voters demoralised with their weak options in the presidential and congressional elections. In Congress, the Republican Party goes from strength to dramatic weakness as the rifts from its civil war on its future direction play out over the next four years. This leads to a landslide victory for the Democratic Party as the Democrats successfully execute a successful get-outthe-vote campaign. That campaign gains traction among the US’ now largest generation: the younger, more diverse, more liberal, overeducated and underemployed Millennials, who come out to vote in droves in favour of the Democratic ticket as they have been frustrated by the political stalemate and weak job prospects of the last eight years.
Opec turmoil triggers brief return to $100/b oil
The oil market remains under pressure as we enter 2016 with oversupply and the imminent increase in exports from Iran adding some additional downside pressure. During the first quarter, Brent crude reaches and breaches the 2009 recession low as US tight oil producers continue to show resilience. The selling is driven by capitulation from investors in exchange-traded products while hedge funds build a new record short position in the futures market. Opec’s crude oil basket price drops to the lowest since 2009 and the unease among weaker as well as wealthier members of the cartel over the supply-and-rule strategy continues to grow as the economic pain spreads across the 12-member group. The long awaited sign of an accelerated slowdown in non-Opec production finally begins to flicker. Suitably buoyed, Opec catches the market on the hop with a downward adjustment in output.That move breaks the downward price spiral and price mounts a quick recovery with investors scrambling to re-enter the market to the long side.
Silver breaks golden shackles to rally 33%
Semi-precious metal silver’s price direction is driven by movements in both gold and industrial metals. Its third consecutive annual decline in 2015 was driven by worries about demand (industrials) and tightening US monetary policy (gold). However, towards the end of 2015, mining companies began responding to falling prices by announcing production cutbacks of key metals such as copper and zinc. Silver is often mined as a by-product from the extraction of other metals including copper, zinc and gold with primary production only accounting for a third. With copper and zinc both hitting six-year lows at the end of 2015 as the outlook for Chinese demand deteriorated, the only way to support prices was to cut production even more. During 2016, this will add to production cuts already in place from major producers such as Glencore and BHP Billiton. While production of silver from these reductions slows economic activity and demand in key markets such as China, both Europe and the US strengthen, helping to boost confidence in silver.
Aggressive Fed sees meltdown in global corporate bonds
When Bridgewater Associates founder Ray Dalio told markets last August that the next big Fed monetary policy move would be to ease and not to tighten, it was a clear message that a tightening path will not be common sense as long as strong secular disinflationary forces are at play. More importantly, he argued that ending the long-term debt cycle with a series of rate hikes would inevitably cause turmoil, because ever-declining interest rates have encouraged endless borrowing and leverage, growing the cycle into a monstrous supercycle. In other words: the bubble is simply too big to burst. But late in 2016 the Fed will come to believe that there is no way out, and growing evidence of overheating markets – affecting labour, housing, equities and bonds – will propel Fed chief Janet Yellen down a hawkish path with a series of aggressive rate hikes.Although expected for years, this action triggers huge selloffs in all major bond markets as global bond yields start to rise, quickly magnifying the risk premium investors demand on riskier assets, when the risk free rate is not zero anymore. All of this is expected and normal in a rate hike scenario. But what happens next is so unusual and scary that it’s eerily reminiscent of the bond market apocalypse after the Lehman collapse. As the portions of bank and broker balance sheets allotted to bond trading and market making have almost disappeared, one of the vital parts of a functioning market is simply not there.
El Niño sparks inflation surge
According to many climate forecasters, 2015 and 2016 will likely be the hottest two years on record, adding to the growing number of droughts around the world. The volatile weather we’ve experienced in recent years has also increased the number of floods and other devastating weather extremes. On top of this, next year’s El Niño will be the strongest on record and will cause moisture deficits in many areas of southeast Asia and droughts in Australia. Global agricultural production will be affected negatively. Lower yields across agricultural commodities will curb supply at a time when demand is still increasing on the back of global economic expansion. The outcome will be a 40% surge in the Bloomberg Agriculture Spot Index, adding some much-needed inflationary pressure.
Inequality has last laugh on luxury
Luxury is the reflection of an unequal society. The conspicuous consumption of luxury goods and services is a way of demonstrating membership of the elite. The elite is ready to pay extra just for the privilege of it and to differentiate themselves from the rest of society. It is what we call the snob effect. The money spent on luxury cars, jewellery and clothing items could have been used for better infrastructure, education or for poverty alleviation. In that sense, luxury is a net economic loss. Since the global financial crisis, poverty has increased in Europe because of the economic downturn and austerity measures. The International Labour Organization estimates that 123 million people are at risk of poverty in the EU, which represents a quarter of the European population. This total has risen from 116 million in 2008. Faced with rising inequality and unemployment of over 10%, Europe is considering the introduction of a basic universal income to ensure that all citizens, regardless of whether they work, can afford to meet their basic needs. In a more egalitarian society where other values are promoted, demand for luxury goods decrease sharply.
