Investment Research — General Market Conditions
28 April 2017
Strategy
Focus on economics again (sort of)
Markets relieved after first round in France
In the first round of the French presidential election, the independent Emmanuel M acron
and the Front National candidate M arine Le Pen received the most votes, with 23.9% and
21.4%, respectively, and will now face each other in a second run-off on Sunday 7 M ay.
Although Le Pen still has the chance to become the next French President, markets rallied
following the election, as the markets had feared a second-round consisting of far left-wing
Jean-Luc M élenchon and Le Pen and Macron is the clear favourite over Le Pen
(approximately 60% versus 40% according to polls, see chart below). Also, M acron
has received the endorsement of important members of both the Socialist Party and the
Republican Party, whose voters still constitute a sizable share of the electorate. The main
event before the voting is the TV debate between M acron and Le Pen on Wednesday 3
M ay. With Macron so far ahead in the polls, markets seem less worried about France
and political uncertainty in Europe than they have done for a long time.
Don’t get overexcited about Trumponomics
As there was no major news in the Trump administration’s announcement on tax reform
this week, the announcement was a ‘marginal’ rather than a ‘big’ one as promised by
Trump. M ost of what was announced was known from either Trump’s economic plan stated
during the election campaign or Paul Ryan’s blueprint for tax reform and, in our view, this was
just a smokescreen ahead of Trump’s 100-day anniversary tomorrow. We still have to wait for
the full budget to be released, possibly next month, to get more details on Trumponomics.
Although all Republicans share the same goal to cut and simplify taxes, they disagree on the
financing. While moderate Republicans do not want to make big cuts in other parts of the
budget, fiscal hawks do not want to increase the government budget deficit/debt to finance this.
Thus, we may see a repetition of the Republicans’ failure to change Obamacare. We still
believe Trumponomics will come later and be smaller than previously pledged and feel a
deal is unlikely to be reached until after Congress’s August recess. There were no
comments on infrastructure in the announcement and we believe this is likely to be postponed
until 2018. Based on the market reaction following the announcement, it also seems as though
markets have become less optimistic about the prospects of large-scale tax reform.
Today’s key points
 Markets less worried about
France, as Macron is clear
favourite against Le Pen.
 Don’t get overexcited about
Trumponomics.
 With markets less worried about
political uncertainty in Europe,
focus may soon return to
economics.
 We do not expect much action at
next week’s Fed meeting.
 Rising risk from North Korea is a
joker.
Growth impact of Trumponomics in an
optimistic scenario
Macron win seems highly likely, according to polls
Source: Danske Bank
Source: Macrobond Financial
Important disclosures and certif ications are contained f rom page 4 of this report.
Senior Analyst
Mikael Olai Milhøj
+45 45 12 76 07
[email protected]
www.da ns ke re se arc h.c om
Strategy
Focus on economics again (sort of)
With markets less worried about political developments in Europe and a repricing of
the magnitude of Trumponomics, focus may soon return to economic development,
especially if the French election turns out as expected next week. While economic data
have stayed very strong in Europe, with economic confidence now at the highest level since
the last upturn, growth seems to be decelerating in the US and the US economic surprise
index is now back to neutral after rising sharply in H2 16. Our models still indicate
growth has peaked for now and we estimate the US ISM manufacturing index declined
in April. This is not the same as saying the economic recovery is set to pause but that growth
is no longer accelerating as it has over the past 6-9M . As we have pointed out previously,
it is whether or not growth is accelerating that is the key driver for a bond bear market, not
the level of growth. As PMIs seem to have peaked, we expect yields to be more or less
stable this year before moving higher next year (see also Yield Outlook: More or less
stable yields in 2017 – higher yields a 2018 story, 20 April).
Business cycle signal continues to
weaken across regions
The next Fed meeting takes place next week but we do not expect much action, as it is
only one meeting since the Fed’s previous hike (also it is one of the small meetings without
updated projections and a press conference). While consensus is that the Fed will hike at
the June meeting, we are more sceptical, because of both the weaker economic data and
still too low inflation in the US and the Fed’s desire to begin reducing the balance sheet
soon, which we call ‘quantitative tightening’ (QT). We think the Fed wants to send up a
trial balloon in June by announcing what conditions would trigger a change in its current
reinvestment strategy in order to avoid a new round of ‘taper tantrum’. We have written
extensively about the QT theme this year: Fed’s Quantitative Tightening: Fixed Income
Implications (6 April), FOMC Minutes: Quantitative tightening is moving closer (5 April)
and Research US: Fed’s regulatory hurdle for starting quantitative tightening (13 M arch).
Markets expect the Fed to hike three
more times before year-end 2018
As expected, the ECB kept its policy rates and its forward guidance on rates and QE
unchanged at this week’s meeting. Although the ECB still argued that measures of
underlying inflation remain subdued, markets reacted to the hawkish twist in the
introductory statement that downside risks to growth are diminishing. Focus in the market
is very much on whether the ECB will turn more hawkish this year but we still believe
the ECB will announce an extension of its EUR60bn monthly QE purchases at the
S eptember meeting. For more details, see also ECB Review: Less downside risk to growth
EUR/USD range-bound at 1.06-1.10
near-term before moving higher in 6M12M
Source: Danske Bank Markets
Source: Bloomberg, Federal Reserve
but no changes to inflation, 27 April.
EUR/US D still looks like a 1.06-1.10 range near term, as the Fed will be there to keep
some downside potential intact but, in our view, there is clearly a risk that we could stand
at the June meeting with an ECB that changes its forward guidance in a more hawkish
direction provided the cyclical situation looks good still and provided the inflation outlook
has not deteriorated markedly (beyond base effects falling out) – and EUR/USD would be
Source: Macrobond Financial
more sensitive to a signal on rates than to a possible extension of QE.
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Rising risk from North Korea is a joker
Although markets may soon begin to focus on economics again, there is one major
risk looming, as a dangerous game of chicken is going on between the US and North
Korea. The key driver behind the escalation is North Korea advancing fast in developing
an intercontinental ballistic missile that could reach the US with a nuclear warhead. The
new Trump administration has been clear that it will not allow this to happen and that the
‘era of strategic patience’ is over. While the US is currently exercising brinkmanship, the
bar for military intervention by the US is very high. A pre-emptive strike runs with a very
high risk of a retaliatory response from North Korea on South Korea and/or Japan, which
could lead to a significant loss of life. Nevertheless, further escalation in the conflict is still
likely. A trigger would be another nuclear test by North Korea and/or continued missile
tests with a rising success rate. If the US shoots down a North Korean missile, it would also
provoke North Korea and increase tensions. For more details, see The rising risk from North
Korea – and what it means for markets, 27 April.
Global market views
Asset class
Equities
Neutral po sitio ning o n sto cks sho rt and medium term
DM (UW), EM (OW)
DM : US (UW), Euro A rea (OW), Japan (N). EM : China/A sia (OW), LatA m (N),
Russia/Eastern Euro pe (OW)
Main factors
The reflatio n trade, which has been o ngo ing since A ugust/September 2016, is co ming to an end, with equities ho vering aro und alltime highs established in early M arch but having difficulty breaking o ut fro m there. Fo r equities to mo ve substantially higher, yields
needs to rise, as bo nd markets have no t yet bro ught the pro mise o f a no rmalisatio n o f gro wth and inflatio n. Ho wever, we do no t
think there is big co rrectio n ahead o f us, as gro wth data is still very upbeat. M o ving fo rward, we think equity markets will trade largely
in a range.
Bond market
German/Scandi yields – set to stay lo w fo r no w, higher o n a 12M ho rizo n
EU curve – set to steepen 2Y10Y when lo ng yields rise again
Fo r no w, German yields are being kept lo w by po litical uncertainty, lo w inflatio n pressure and ECB purchases. The o utlo o k fo r lo w
co re inflatio n and an apparent peak in the glo bal manufacturing cycle are set to keep yields lo w in 2017.
The ECB is set to keep a tight leash at the sho rt end o f the curve and with 10Y yields stable, the curve sho uld change little o n a 3-6M
ho rizo n.
US-euro spread – stable
P eripheral spreads – tightening but clear risk facto rs to watch
Eco no mic reco very, QE and better fundamentals, particularly in P o rtugal and Spain, po int to further tightening but po litics (French
presidential electio n), banking recapitalisatio n plans (Italy) and a fear o f a new mo ve higher in co re euro zo ne yields (ECB tapering
fears) remain clear risk facto rs. P eriphery spreads o ften widen when co re yields mo ve higher.
FX
EUR/USD – rangebo und near term, higher in 6-12M
EUR/GB P – slightly lo wer po st electio n, then rangebo und fo r extended perio d
Cro ss to stay in 1.06-1.10 range near term but set to edge higher lo nger term as the ECB gradully lo o ks to the exit.
If Theresa M ay stays in po wer po st the June electio n, the GB P co uld strengthen slightly, then be rangebo und (0.84-0.88) during B rexit
nego tiatio ns.
USD/JP Y – rangebo und no w, higher lo nger term
P air set to remain in the 1.08-1.12 range fo r no w but set to edge higher driven by 10Y US rates lo nger term.
EUR/SEK – range near term, then gradually lo wer
Gradually lo wer o n relative fundamentals and valuatio n in 2017 but near-term SEK po tential limited by the Riksbank.
EUR/NOK – range near term, then gradually lo wer
Cro ss set to mo ve lo wer o n valuatio n and gro wth, real-rate differentials no rmalising but NOK vulnerable to glo bal risk appetite.
Commodities
Oil price – range bo und
M etal prices – range bo und
OP EC cuts almo st fully implemented, do wnside risks fro m co ncerns abo ut extensio n o f cuts and hawkish central banks.
Underlying suppo rt fro m co nso lidatio n in mining industry, industrial cycle nearing a peak. Is the market lo sing patience with Do nald
Trump?
Go ld price – range bo und
Tug o f war between higher US rates and geo po litical risks.
A griculturals – rising again
Recent fall o n lo wer o il o nly tempo rary.
Source: Danske Bank
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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 Mikael Olai Milhøj, Senior Analyst.
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