Investment Research — General Market Conditions
3 February 2016
Strategy
Self-defence or protectionism? Depends on who you ask
The past week provided few surprises. Data continues to look robust globally. The Fed
stands pat as it awaits Trump’s fiscal policy plans. Most markets moved mainly sideways.
The main exception was the USD, which continued to weaken following comments
from Donald Trump and his new head of the National Trade Council Peter Navarro. Both
of them lashed out at China, Germany and Japan, claiming they are using devaluations to
boost exports. Trump mentioned China for the first time since his inauguration when
he said: ‘Every other country lives on devaluation. You look at what China’s doing, you
look at what Japan has done over the years….They play the money market, they play the
devaluation market and we sit there like a bunch of dummies’. Navarro accused Germany
of using a ‘grossly undervalued currency’ to gain a competitive advantage and called the
euro an ‘implicit Deutsche Mark’.
In a market that is very long the USD these comments raised fears that Trump will
aim for a weaker USD. Exactly how he would do that is not very clear. A fiscal expansion
could instead lead to higher rates and push in the direction of a stronger USD. However,
rather than a weaker USD the response from Trump may be an import border tax that
punishes countries he sees a ‘cheating’ in the global game of trade. Peter Navarro has been
very vocal that Germany not only has an undervalued currency but also cheats through its
taxation system because it puts VAT on US imports, whereas German companies can
deduct their VAT when exporting to the US. Having a current account surplus of 8% of
GDP in Germany is seen as reflecting a mercantilist and protectionist policy by the
Trump camp.
Key points
 USD weaker as Trump team
blames Germany, Japan and China
for devaluing currencies
 We still look for stronger USD on
1-3M horizon
 A trade war could be brewing –
self-defence if you ask Trump,
protectionism if you ask trade
partners
 More upside in yields and equities
in the medium term
Germany and Japan big net savers
Trump and his team very vocal about USD strength
Source: Danske Bank Markets
Source: Macrobond Financial
Important disclosures and certifications are contained from page 4 of this report.
Chief Analyst
Allan von Mehren
+45 45 12 80 55
[email protected]
www.danskeresearch.com
Strategy
On the issue of an import border tax Peter Navarro said recently in an interview that it’s
early days and that they are looking at several ways to protect US manufacturing.
Heading for a trade war?
The Trump camp sees weak US
manufacturing as a reflection of failed
US trade policies
While the rest of the world is accusing Trump of protectionism, the view from the US
administration is one of self-defence from other countries’ protectionist and
mercantilist policies. After the release of Navarro’s book ‘Death by China’ in 2012
Navarro said to Bloomberg: ‘There’s a big difference between self-defence against unfair
trade practices and protectionism. The biggest protectionist in the world now is China’
(link to Bloomberg interview, 22 August 2012).
Following Chinese president Xi Jinping’s speech at World Economic Forum in Davos in
which Xi Jinping defended free trade and globalisation, the incoming Secretary of
Commerce Wilbur Ross said that China speaks a lot about free trade but is the most
protectionist of large countries. In the same hearing he said that countries that do not
‘play by the rules’ should ‘get punished – and severely’.
It seems increasingly clear that the Trump team will take action to get what they call
a more fair deal for the US. They will likely talk to their trading partners first to find a
way to level the playing field – as they would see it. But if they do not see a change in
practice from trade partners in Europe and China we should expect Trump to implement
some kind of border tax. This could be flexible and be different for different countries and
goods. Regardless of how it is constructed, it could result in a trade war with retaliation
measures from Europe and/or China.
China is watching Trump with increasing anxiety. In a China Daily Editorial – which
tends to represent the Communist Party view – it said on Thursday: ‘Trump seems to have
proved that his campaign rhetoric was not just empty promises’ and ‘China needs to cast
aside any illusions it may have had that Trump was just mouthing off to attract votes and
instead be prepared for the worst’. China will wait to see what is coming, but it will not sit
back and watch if Trump ends up taxing Chinese goods.
Source: Danske Bank Markets
Manufacturing share much lower than
other high-tech nations
Source: Danske Bank Markets
EUR/USD lower – then higher
Still positive on the USD in the short term
As we wrote last week, our view on the USD is for it to strengthen over the coming 13 months as we get more details on Trump’s fiscal policy plans. In addition, if Trump’s
response to what he sees as undervalued currencies elsewhere is an import border tax, this
would be USD positive as it would support US exports and hurt imports. Hence the market
may be misinterpreting what Trump’s comments actually mean for the USD, when the USD
moves weaker in response to his remarks. The labour market in the US also seems to be
tightening faster in early 2017 and the market may start to price a higher probability of
three hikes rather than two. Our medium and long-term view remains one of USD
weakness, though. Gravitational forces should pull it weaker as current account flows
strongly favour the euro area and the USD is overvalued on our medium-term valuation
models.
Source: Danske Bank Markets
German yields catching up with US
More upside in bond yields and equities in medium term
In the bond market we still look for yields to move higher on a six-month horizon. A
stronger US job market, a further rise in inflation and more details on US fiscal plans,
should work in favour of higher yields. The sharp rise in euro area inflation from 1.1% in
Source: Danske Bank Markets
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3 February 2016
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December to 1.8% in January week may also give some fuel to a tapering discussion in the
euro area – even if it was driven by food and energy. Interestingly yields were lower this
week despite good economic news, which may reflect that the market is already positioned
for higher yields. Nevertheless eventually, we believe fundamentals will win and push bond
yields higher. Some patience may be needed, though.
Stock markets treading water
Similarly, stock markets are in a wait-and-see mode. The failure to show further increases
despite strong data (US ISM rose further this week) may also reflect that the market is
overweight equities. We may be in a waiting mode a bit longer but ultimately we expect
Trump’s tax plans and deregulation to give a boost to US equity markets.
Source: Danske Bank Markets
The big unknown is of course if and when we could see a trade war involving the US
and China – and possibly other nations. Judging from comments from the incoming
Treasury Secretary Steven Mnuchin the US will use the annual US-China Strategic and
Economic Dialogue (SED) to get a new deal with China. This normally takes place in June
or July. House Speaker and Republican Paul Ryan told Fox News that the focus will be on
overhauling health care ahead of fiscal budget planning during spring. The Trump
administration will probably have its hands full with these things and wait for the SED to
talk to China. Hence it may take some time before we are wiser in this area, but it should
be watched carefully.
Global market views
Asset class
Main factors
Equities
Overweight sto cks sho rt and medium term
Glo bal reco very and Trump's fiscal bo o st suppo rt equities.
Underweight DM , o verweight EM
Overweight US, Japan, No rdics and Russia/Eastern Euro pe; underweight Euro pe and LatA m; neutral o n
China
Bond market
Higher yields, further steepening 2Y10Y curve
M o re expansive fiscal po licy in the US and the Fed o utlo o k add to the steepening trend in Euro pe. Higher inflatio n prints in Q1, tapering
fears later in 2017 and a glo bal reco very also po int to a steeper curve. Ho wever, the ECB 's QE mitigates so me o f the effects.
US-euro spread: slightly wider in 2017
The US FI market is no w mo re o r less priced acco rding to o ur view fo r 2017 and after the recent spike in US yields the upside po tential fo r
the next three mo nths sho uld be limited. A s we mo ve further into 2017 we co uld in fact see a tightening o f the USD-EUR spread in the 10Y
segment as the stro ng USD caps the upside fo r lo nger US yields and as an end to ECB QE is co ming clo ser.
P eripheral spreads: tightening, but clear risk facto rs to watch
Eco no mic reco very and QE sho uld mean further tightening, but po litics, banking recapitalisatio n plans and a po tential new mo ve higher in
euro zo ne yields remain clear risk facto rs. P eriphery spreads o ften widen when co re yields mo ve higher.
Credit spreads: neutral
FX
EUR/USD – lo wer o ver co ming mo nths o n mo mentum, relative rates
USD set to remain suppo rted by Trump and the Fed in the near term. EUR/USD to head higher beyo nd 3M .
EUR/GB P – risk skewed o n the upside in run-up to when the UK is likely to trigger A rticle 50
Lo nger term, we expect EUR/GB P to settle in the 0.83-0.88 range. Sho rt-term risk skewed to the upside o n 'hard' B rexit risks.
USD/JP Y – sho rt-term risks skewed to upside o n higher US rates
USD/JP Y set to remain suppo rted near term by relative mo netary po licy and risk appetite.
EUR/SEK – range near term after recent decline, gradually lo wer medium term
Gradually lo wer o n relative fundamentals and valuatio n in 2017 but near-term po tential limited.
EUR/NOK – gradually lo wer, but technicals are near-term suppo rt facto rs
Cro ss set to mo ve lo wer o n valuatio n and gro wth, real rate differentials no rmalising.
Commodities
Oil price – OP EC hesitant abo ut extending deal thro ugh H2, crude sto cks remain high
Suppo rt fro m po sitive gro wth and inflatio n sentiment; near-term fo cus implementatio n o f OP EC deal, US crude sto cks.
M etal prices – fo cus turns to Trump's plans o n infrastructure and defence spending
Underlying suppo rt fro m co nso lidatio n in mining industry; reco very in glo bal manufacturing and US fiscal spending.
Go ld price – hawkish Fed weighing o n go ld price
Rising yields and USD pushing go ld price do wn.
A griculturals – abundant supply keeping a lid o n prices
A ttentio n has turned to La Niña weather risks o ver the winter, co nso lidatio n seen in so me parts o f the market.
Source: Danske Bank Markets
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Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’).
The author of the research report is Allan von Mehren, Chief Analyst.
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