Q3: Saxo Bank warns of a false start to the Fed’s rate hike cycle

Greece’s seeming hour-by-hour descent into chaos at the end of the second quarter has fashioned an intensely uncertain framework casting markets at the mercy of headline risk.

It is with that ever-changing caveat that Saxo Bank publishes its Q3 Outlook ahead of the Greek referendum on EU membership which, as things stand, will take place July 5.

The outlook for Q3, therefore hangs in the balance, depending on the degree of fallout and EU peripheral contagion should Greece vote ‘No’. On the one hand, optimists say that the European Central Bank can simply print more money to cover the enormous debts to creditors. But on the other, a Greek ‘No’ vote presents the significant risk of contagion across the EU periphery and even global uncertainty that could send markets into a tailspin on the usual trajectory of global risk-off events.

The Bank therefore stresses that much of what follows is contingent on the Greek “fire" burning out quickly and warns of a false start to the Fed’s rate hike cycle:

• We are entering the final phase of the multi-decade lows in yield and inflation, but a rise in both this year may prove a false start before the real deal in 2016.
• All eyes are on Janet Yellen Fed’s slow march to policy normalisation. Will Fed rate hikes be a case of “one-and-done” or the start of a “normal rate hike cycle”?

Saxo Bank says that while current economic data is not supportive of proposed rate hikes by the U.S. Federal Reserve, the Yellen Fed could hike anyway, a move that it may eventually regret.

Saxo Bank Chief Economist Steen Jakobsen believes the prospect of a Federal Reserve interest rate hike represents the most significant market event in Q3 and expects the Fed will take a “minimal pain” approach in the form of a “one and done” rate rise in September. Steen Jakobsen says,

“If this approach is taken the dollar will weaken as the market sees the Fed as being done for now and this will be supported by a rising marginal cost of capital which will kill the nascent acceleration of growth expected by the consensus in H2 2015. We will then expect commodities and gold/silver to outperform as asset classes.”

Steen Jakobsen views this approach as far more likely than the expected scenario in which the Fed hikes rates to 2% or higher by 2018. Further out over the horizon, Saxo Bank’s Chief Economist is refreshingly upbeat as he sees the global economy pivoting for the better.

”We are in the final stages of this multi-decade cycle of ever lower yields and inflation. At zero policy rates, and even beyond, in some cases, nothing works. Water freezes to ice at zero degrees, and economies do as well. The warning reads: We are about to enter a major secular change in yields. The path will most likely be through higher interest rates into year-end, and this higher capital cost, combined with rising input costs to the economies – commodities, energy and capital – will slow growth in Europe and the US back toward zero growth again.

From that point onwards, however, we will see real improvements to the economy as well as the micro-economy: small and medium-sized companies will be borrowing again, monetary aggregates will be rising, and wages will be grinding slowly higher again for the first time in this cycle. It will be a false start in the second half of 2015 based on hope, and then in 2016 we will begin to see the economy improving from the bottom-up”.

Against this backdrop, Saxo Bank key trading ideas for the next quarter are:

• Commodities
  Oil prices and gold have settled into a range of late. But oil bears are hoping that rising Opec output and rising US inventories after the peak demand season will allow prices to move lower, while a rate hike in the US could be a buying opportunity for gold says Ole Hansen, Saxo’s Head of Commodity Strategy.
  
  Hansen expects the third quarter will be when the Fed’s chair Janet Yellen begins to turn off the liquidity tap and maintains his call for gold to finish the year at $1,275/oz., somewhat above the current consensus.
  
  
• Macro
  The US economy is slowly but steadily getting back on track after the Q1 doldrums and the question is no longer if the Fed will hike rates, but when. The answer to that question depends on who you ask. The market seems to stand on two legs, more or less split between September and December says Mads Koefoed, Saxo Bank’s Head of Macro Strategy.
  
  
• Koefoed also considers Europe saying the European Central Bank president Mario Draghi also has a handful on his plate in Q3, but it is of a different nature as a Greek euro exit looms large while sovereign bond yields have surged with the German 10-year rising to more than 0.8% from less than 0.2% in Q2. He sees growth in the region staying robust in the second half of 2015 albeit without much pickup.
  
  
• FX
  Head of Saxo Bank’s FX Strategy John Hardy says with the Eurozone still embroiled in difficulty, the USD may resume its upwards track – but this hinges on the numbers and whether the US recovery really is here to stay. After a quarter mostly spent consolidating previous heady gains, the US dollar will demand the market’s full attention in the third quarter of this year. It may rally afresh, provided US economic data and Federal Reserve rhetoric point towards a September rate move – in what would be the first rate hike in more than nine years.
  
  
• Fixed Income
  Saxo Bank’s Head of Fixed Income Trading Simon Fasdal says the recent rise in global bond yields has already established itself as a major theme in financial markets. He also considers what could go wrong this quarter. Besides Greece, there are no real signs of any critical market triggers, and now with the holy trinity for Europe – a lower oil price, a weaker euro and ECB bond-buying – this should boost the economy and send inflation expectations and yields into an upwards spiral in Q3.

To access the full list of trade ideas produced by Saxo Bank analysts which accompany the Q3 2015 outlook, please click here: https://www.tradingfloor.com/publications/essential-trades