Saxo Q2 Outlook: The End Game has Arrived

Gone are the days of ever-falling real interest rates and ever more financialisation, to be replaced by a new rise in productivity

HONG KONG, 6 April 2022 – Saxo Markets, the online trading and investment specialist, has today published its Q2 2022 Outlook for global markets, including trading ideas covering equities, FX, currencies, commodities and bonds, as well as a range of central macro themes impacting investors and markets.

Saxo’s Outlook for Q2 argues that we are witnessing nothing less than the arrival of the end game for the paradigm that has shaped markets since the advent of the Greenspan put in the wake of the LTCM crisis of 1998. The twin shocks of the pandemic and Russia’s invasion of Ukraine have shifted priorities on all policy fronts, including fiscal, monetary and geopolitical. In the US, the imperative for the Fed to grapple with spiraling inflation risks has disrupted the traditional rinse and repeat of bailing out financial markets and the economy at the first ripple of trouble. In Europe, the Russian invasion of Ukraine has seen Germany tossing decades of fiscal and defence policy out the window, ushering in a new era of investment that should drive a strong rise in productivity. EU existential risks have disappeared as defence priorities soar above all other considerations.

“This outlook addresses the tectonic shift already underway in global macro and politics. Gone are the days of ever-falling real interest rates and ever more financialisation, to be replaced by a new rise in productivity as we move the economic agenda to a better and more rational place, despite the gruesome humanitarian news we get day by day from the war in Ukraine,” says Steen Jakobsen, Chief Economist and CIO at Saxo, in the introduction to the Quarterly Outlook.

“We have three cycles simultaneously impacting the market:

1. The ongoing supply crunch from Covid and the war in Ukraine, but also from the world’s physical limits
2. The repricing of assets against a backdrop of rising inflation
3. The new Fed tightening cycle lifting off in March and set to continue

These will eventually lead to two key outcomes. Firstly, on a strategic macro level, an increased spending on energy and defence priorities, but also supply chain diversification to remove single points of failure for strategic industries. Secondly, negative real rates turning more positive as an indication that the global economy is set for a major productivity boost, away from short-term financial gains and rent seeking and toward tangible assets, infrastructure and a reaffirmation of the social contract.,” says Steen Jakobsen.

China: In response to the new paradigm, Chinese policies are set to turn more accommodative.

“With major economies in the world are entering into this high inflation, rising energy and commodity prices, monetary tightening and global supply chain reconfiguration new paradigm, export which was China’s key growth driver last year, is having difficulty to do the heavy lifting this year. The rise in energy and commodity prices has already substantially worsened China’s terms of trade and demand for its exports will likely decelerate as well in the coming quarters. These, plus the resurgence of Covid breakouts in major cities, in particular Shanghai have made China’s 5.5% growth target for 2022 challenging,” says Redmond Wong, Greater China Market Strategist at Saxo Markets.

“It was against this backdrop that Vice Premier Liu He, in a special meeting of the Financial Stability and Development Committee of the State Council last month, pledged to boost the economy with more accommodative policies and hinted to scale down regulatory pressures against e-commerce platforms and to turn more supportive towards the property sector.” Redmond Wong adds.

Equities: Productivity, innovation and pricing power have never been more important

“The war and subsequent severe sanctions against Russia have catapulted the world into an unpredictable and maximum uncertainty environment. When the future becomes more uncertain, the precautionary principle dictates that the equity risk premium should go up, with equity valuations going down as a consequence.” says  Peter Garnry, Head of Equity Strategy at Saxo.

“With a large-scale war back in Europe and commodity markets in upheaval, this has aggravated inflationary pressures and equities have entered an environment not seen since the 1970s. High inflation is essentially a tax on capital and raises the bar for return on capital, and thus inflation will filter out weaker and non-productive companies in a ruthless fashion. The days of low interest rates and excess capital keeping zombie companies alive longer than necessary are over.

The largest companies in the world are the last to get hit from tighter financial conditions, and they also have the pricing power to pass on inflation to their customers for a longer time than smaller companies,” says  Peter Garnry.

Commodities: War and sanctions turbocharging already tight commodity markets

“The prospect for a long-lasting cycle of rising commodity prices that we first wrote about at the start of 2021 continues to unfold. During the past quarter, the war in Ukraine and sanctions against Russia helped turbocharge a sector that was already witnessing a tightening supply outlook.” says Ole S. Hansen, Head of Commodity Strategy at Saxo.

“Multiple uncertainties will trigger another wide trading range during the second quarter—potentially between $90 and $120 per barrel. Ultimately the market should stabilise with an upside price risk from reduced spare capacity among key producers and continued supply disruptions related to Russia being partly offset by slowing demand as the global economy becomes increasingly challenged by inflation and rising interest rates. Add to this a temporary Covid-related drop in demand from China and the outlook for a revisit to the March high looks unlikely,” says Ole S. Hansen.

Industrial metals: “Current supply disruptions from Russia will continue to support the sector throughout 2022, not least considering the ongoing push towards a decarbonised future. At the same time increased defence budgets in response to the Russian threat will keep demand robust despite the current risk of an economic slowdown. In addition, and supportive for the sector, is the outlook for slowing capacity growth in China as the government steps up its efforts to combat pollution, and ex-China producers for the same reasons being very reluctant to invest in new capacity.

While the energy transformation towards a less carbon-intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizable portion of Chinese demand relates to the property sector. But considering a weak pipeline of new mining supply we believe the current macro headwinds from China’s property slowdown will moderate throughout 2022.”

Precious metals: “Heading into the second quarter we see gold eventually adjust to the US rate hike cycle and move higher. Our bullish outlook is based on the belief that inflation will remain elevated, with components such as rising input costs from commodities, wages and rentals not being lowered by rising interest rates. We believe gold is also increasingly being viewed as a hedge against the markets’ currently optimistic view that central banks will be successful in bringing down inflation before slowing growth forces a rethink of the pace of rate hikes and the resulting terminal rate.”

Fixed Income: A painful path to normalisation

“We have entered a bond bear market, where yields are destined to increase substantially. In this environment, traditional safe havens like US Treasuries will not protect investors looking to diversify portfolios. Duration will be even more toxic than at other times in history because we are starting off from record low interest rate levels and there is no higher income to fall back on. This is a result of years of accommodative monetary policies, which distorted risk perception and forced investors to take on more risk either through credit or duration,” says Althea Spinozzi, Senior Fixed Income Strategist at Saxo Bank.

Foreign exchange: The great EUR recovery and the difficulty of trading it

“The Russian invasion of Ukraine took the euro down just after the currency had begun mounting a significant recovery attempt in anticipation of a shift toward tightening from the ECB at its March 10 meeting. The ECB did make a reasonably hawkish shift given the uncertain backdrop, but more important still has been Germany—within days of the Ukraine invasion—promising massive fiscal outlays to address its energy and defence vulnerabilities. The EU has joined the call and will fund large new fiscal initiatives with joint debt issuance. All of these fiscal moves will profoundly deepen EU capital markets and could provide a long-term boost for the euro. If the terrible fog of war hopefully lifts soon, the conditions are promising for the euro to reprice significantly higher,“ says John J. Hardy, Head of FX Strategy at Saxo.

USD: “China, as the world’s largest holder of foreign reserves and in increasing rivalry with the US, will likely see the actions against Russia’s central bank as a massive wake-up call that will make it want to move as quickly as possible away from reliance on the US dollar. On top of that, with the explosion of commodity prices and the lack of US fiscal discipline, any major holders of USD and other fiat FX reserves may want to diversify out of holding negative-yielding fiat assets and invest in commodities and other hard assets and productive capacity instead, even if there is no immediate sanctions threat.These processes take time, and the US dollar will retain a premium as the world’s most liquid currency as we navigate the rocky road ahead.” says John J. Hardy.

To access Saxo Bank’s full Q2 2022 Outlook with more in-depth pieces from our analysts and strategists, please go to: https://www.home.saxo/insights/news-and-research/thought-leadership/quarterly-outlook