Saxo Q3 Outlook: the runaway train

HONG KONG, 5 July 2022 – Saxo Capital Markets HK Limited (“Saxo Markets”), the online trading and investment specialist, published its Q3 2022 Quarterly Outlook for global markets, including trading ideas covering equities, FX, currencies, commodities and bonds, as well as a range of central macro themes impacting client portfolios.

“Inflation will prove a runaway train that central banks can only chase from behind until the inflationary dynamics result in a crash into a hard recession.”

Steen Jakobsen, Chief Investment Officer at Saxo Bank, says: “The risk is that inflation expectations are rising fast and driving second-round inflationary effects that will require central banks to tighten even more than they or the market currently conceives until the runaway train is controlled, likely sending us into a deep recession. 

This creates the next macro policy change and response we will need to look for in Q3 2022. Given a policy choice of either higher inflation or a deep recession, the political answer will likely be to instruct central banks, directly or indirectly, to move the inflation target up from 2 percent. The optics of this would hopefully mean requiring a bit less tightening, but also that negative real rates, or financial repression, are a real embedded policy objective now. It’s also a risky bet that there is some Goldilocks-level of demand destruction from a higher policy rate that will start to force inflation lower, all while demand is subsidised for the most vulnerable with support schemes for power, heating, petrol and food. The holes in this policy argument are that none of this addresses the imbalances in the economy. Whether the Fed has a 2 or 3 percent inflation target does not create more cheap energy.

What is clear is that the political system will favor the ‘soft option’ for inflation in which the chief imperative is financial repression to keep the sovereign funded and a reduction of the real value of public debt via inflation. This is exactly why inflation will continue to rise structurally. Q3 and beyond will make it clearer that political dominance pulls far more rank in the new cycle than monetary tightening, which will forever chase from behind.”

China: the train of new development paradigm left the station two years ago

The road ahead for China may be likely bumpy through this winter and into early next year, as it appears intent on stopping any widespread resurgence of the Covid-19 virus, with only hesitant offsetting stimulus measures. The secular bull market in energy, industrial metals and grains is worsening China’s terms of trade and is set to put negative pressures on China’s trade balance, GDP growth and companies’ operating margins.  Still, long- term perspectives for China are in order as we look at the country’s huge initiative in transforming its economy away from the factory-of-the-world era to a new ‘“dual-circulation’” paradigm led by high-tech prowess and increased self-reliance.

Redmond Wong, Greater China Market Strategist at Saxo Markets remarked: “Stimulus measures have been rolled out and will continue to come in monetary policies, fiscal policies, relaxation of crackdown on the property sector and better visibility of regulations over the internet sector, but their magnitudes and paces will be measured. The Chinese authorities will probably bring about more visibility and guidelines and remove some uncertainties hanging over regulations on the internet and ecommerce giants. However, rolling back regulations in a meaningful sense will be quite unlikely. The path of least resistance for China to take in order to stabilise its economy and keep unemployment in check is infrastructure spending.

Policy divergence, light position and undemanding valuation may mean potentials for outperformance for Chinese equities in Q3 versus other major markets. There may be tradable rallies for traders to benefit from in the coming months. However, China is still in the process of transitioning to a new development paradigm, being hit by deteriorating terms of trade,  increasingly tight global financial conditions and a slower global economy, and facing uncertain development in pandemic control. Chinese equities may still be in a bear market and long-term investors should be patient in accumulating positions.” 

Equities: Tangible assets and profitable growth are the winners

“The V-shaped recovery is dead this time. The past six months have seen the biggest shift in market sentiment in a lifetime and in Q3 the outlook for global companies’ earnings is not good. Given the current outlook and interest rates level, the equity valuation on MSCI World should be below average. Earnings for global companies are already down 10 percent from their peak in Q2 2021 and the outlook is not looking rosy.” 

Peter Garnry, Head of Equity Strategy at Saxo Bank, said: “US equities are officially in a bear market, but the big question is: Where and when is the bottom in the current drawdown? 

“Our best guess is that the S&P 500 will correct around 35 percent from its peak, and it could take somewhere between 12 and 18 months to hit the trough, which means sometime later this year or in the first half of 2023. The bear market will likely not exhaust itself until the new generation of investors that went all-in on speculative growth stocks, Ark Invest funds, Tesla and cryptocurrencies have fully capitulated.

Commodities and defence stocks are the only theme baskets that are up. We expect these themes to continue doing well until equities hit bottom in the current drawdown. The only exception to tangible assets winning is real estate. Low interest rates combined with tight supply in many urban areas in the US and Europe have pushed real estate into a position where it is quite vulnerable to rising interest rates in the short term.”

Commodities: Understanding the lack of investment appetite among oil majors

In Q3, Russia’s willingness to stop the war in Ukraine, China’s slowing economic growth, the strength and speed of US rate hikes, as well as the potential for demand destruction from rising prices, will help set the tone during the second half of 2022.

“We maintain a bullish outlook for gold, considering the risk of continued turmoil in global financial markets as the transition towards a higher interest rate environment takes its toll on companies and individuals. We stick to our forecast in Q2 that gold—and silver—following a period of consolidation in the second quarter, will move higher during the second half of the year, with gold eventually reaching a fresh record high.” says Ole Hansen, Head of Commodity Strategy at Saxo Bank.

“Oil majors swamped with cash, and investors in general, showing little appetite for investing in new discoveries is the long-term reason for the cost of energy likely remaining elevated for years to come. We suspect corrections in the energy market during the second quarter may end up being short-lived, with the risk of a prolonged period of high prices the most likely outcome. A brief return to the 2008 record high cannot be ruled out, but in general we believe that some emerging demand weakness on the other side of the peak summer demand season should keep prices capped within a wide $100-to-$125 range.”

”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. Copper, rangebound for more than a year, risks breaking lower before eventually reasserting its long-term bullish credentials. With this in mind, we are neutral heading into the third quarter, meaning that existing exposure to the sector should be maintained but not added to until the price action either signals renewed upside, potentially on a break back above $4.65 or alternatively around $3.5 on additional weakness. ” 

FX: Why can the Fed never catch up and what turns the US dollar lower?

The US dollar has surged in correlation with the steady repricing of ever more Fed tightening. It will likely only find its peak and begin a notable retreat once either the economy lurches into a disinflationary demand-induced recession or the market realises that the Fed can never catch up with the curve, because if it did, it would threaten the stability of the US treasury market.

“We believe that the dominant strong US dollar driver in this cycle is the US dollar’s global reserve status and the simple directional fact of US inflationary pressure requiring the Fed to continue to tighten. This wears on sentiment and global financial conditions. If that is the case, then the USD will only begin turning once economic reality finally flounders, sufficiently reversing inflation via a demand-induced recession.” says John Hardy, Head of FX Strategy at Saxo Bank.

“The euro will have a hard time rebounding if Chinese demand for its exports remains sidelined, the war in Ukraine grinds on and the US tightening on global liquidity continues. Sterling is in the same boat, and it remains difficult to conjure an upside scenario for that currency, given the country’s extreme supply side limitations and the enormous external deficits aggravated by high import prices for energy. “

“CNH could prove the most important currency to watch as a significant potential new source of market volatility if China makes a move to weaken it this quarter or the next - possibly also helping set up the end of a stronger US dollar.”

To access Saxo Bank’s full Q3 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