Saxo Q4 Outlook: EM Asia is One of The Few Beacons Offering Positive Real Rates; China’s Crackdown Hurt The Market Confidence while Valuation was Still Comparably Low

Saxo Markets, the online trading and investment specialist, has today published its Q4 2021 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 investors and markets.

“The size and nature of the pandemic policy response will show that this time, inflation outcomes really will be very different from anything we have experienced in decades.” Steen Jakobsen, Chief Economist and CIO at Saxo says, in the introduction to the Quarterly Outlook:

“To avert an immediate crisis, the pandemic response brought fiscal stimulus on the scale of war mobilisation, supporting basic incomes and MMT-like direct transfers to nearly every sector of the economy. It was a massive demand stimulus at a time when the economy was shutting down the supply side to deal with the virus. And even as we open up from the pandemic, the new fiscal dominance will continue as we face three generational challenges simultaneously: inequality, infrastructure, and climate change policy, or the green transformation.” 

The economic results of this new focus will be: ever-bigger government, more intrusive regulations, supply chain disruptions, inflation, no price discovery, a general hard swing to the left in the western world and―not least―the increased “channeling of capital” into small pockets of investable resources and assets. This could be the 1970s all over again, except this time it’s all about the political imperative of the decarbonisation of the economy, whatever that means for real growth.

ESG is The Biggest Political Project Ever

“Decarbonisation is needed, absolutely, but the current palette of technologies doesn’t fit the bill, as solar and wind scale poorly because of intermittency.”

Steen Jakobsen, Chief Economist and CIO at Saxo, continues: “The ESG push, and related green transformation effort have so much political capital behind them that failure is simply not an option.”
“The ESG and green transformation is the single largest policy bet ever undertaken, and the main consequences will be inflation and ever lower real rates. We investors need to embrace, understand, and act on this. There are two major assets classes that will do well under this regime: Government-sanctioned assets, and assets with price discovery. This means green and, ironically, commodities have the best odds of producing long-term excess returns.”

China’s Crackdown Hurt The Market Confidence while Valuation was Still Comparably Low

“After the Technology sector crackdown in China in Q2-Q3, we are seeing another risk event coming for Chinese property markets. Evergrande, was one of the biggest property developers in China, faces serious financial stress that brought the global market under pressure. Some people regarded the Evergrande crash as similar to Lehman Brother’s crash, but it is a very exaggerated term. People understand the risk of Evergrande’s portfolio and it is why the bond market will regard Evergrande’s as high risk and high-yield bond." says Edison Pun, Senior Market Analyst at Saxo Markets.

"Another real estate market concern from the market now is Chinese government is asking local Hong Kong property developers to help fix the housing problem locally. Share prices of local property developers dropped more than 10% right after the news. Technology sector crackdown, property developers’ stress, Macau casino business crackdown are hurting the market confidence in both Hong Kong and Mainland China. However, the valuation of China market is still much lower than global equity markets, which did fuel some long-term investors' interest."

In a Global Black Hole of Negative Real Rates, Emerging Market Asia is One of The Few Beacons Offering Positive Real Rates for Investors

“Negative real rates seem to be a function of developed markets that have lost the ability to have true price discovery and are instead influenced by synthetic pricing as a result of extraordinary credit growth. After the 2008 financial crisis, the predominant response from the US and most of the world was one of monetary policy expansion but fiscal policy restraint.” says Kay Van-Petersen, Global Macro Strategist at Saxo Markets.

“In the US, inflation has more than doubled from +2.3% in December 2019 to +5.3% in August 2021. During the same period, the Fed rate went from 1.50% down to 0.00%, alongside the biggest ever expansion of monetary and fiscal policy that has ever been seen. Meanwhile in China, Indonesia and India, inflation has actually been falling from pre-Covid levels to the present. And in the case of China’s PBOC, they never cut rates during the Covid crisis.”

“EM Asia is host to some of the biggest real rates yielding bond markets in the world. These include Indonesia (+4.5%), China (+2.1%), and Malaysia (+1.1%); contrast this with the negative rates to be found in the USA (-4.0%) and the Eurozone (-3.7%)."

Crypto Traders Chasing High Returns in Decentralised Applications

Despite aggressive trading in parts of the crypto community, a recent survey shows that fewer crypto traders are buying cryptos as a gamble in 2021 than in 2020, and more see crypto as an alternative to mainstream investments. 

Anders Nysteen, Senior Quantitative Analyst at Saxo Bank, said: “With the rapidly evolving applications for smart contracts, Bitcoin is again challenged as the dominating cryptocurrency since it was challenged for the first time during the initial coin-offering boom in 2017. The market capitalisation fight has several combatants: Bitcoin as the first mover with its status of “digital gold” and renown as store of value; Ethereum as technically superior to Bitcoin and a first-mover among the cryptos with smart contracts, although with scalability limitations in its current version; and newer generations of cryptos as they are technically superior when it comes to scalability, the green agenda and interoperability-wise, although many of these are still in the rollout/development phase. It is way too early to call a winner in this battle, but the tendency this year has clearly been in favour of the new generations of cryptos.”

“As we see it, the rest of 2021 will be driven by the expectation of smart contract applications and decentralised protocols. We expect an increased risk appetite for decentralised protocols in the hunt for large returns, and this will add value to the amount locked in DeFi protocols. However, investors in the crypto market should keep an eye on several risks. The big moves in the crypto market and particularly in the minor cryptocurrencies may not be driven by an underlying boost of fundamentals; it may merely be bubble-like movements where traders are buying solely to ride the price uptrend. 

On the regulation side, the decentralised protocols are lacking a regulatory framework and there’s no lawful protection of the investor; a single hacker attack can wipe out the whole investment. Many government agencies are pushing for increased regulation of DeFi, and it may have a significant impact on Ethereum and other DeFi blockchains, while Bitcoin should be less affected. On the other hand, an additional focus on the global green agenda may prove a drawback for Bitcoin due to the large power demands for running the Bitcoin blockchain, whereas only a minor impact may be seen in the less power-demanding, “greener” cryptocurrencies.”

The Mysterious Dissonance in Equities

“The biggest risk to economies, financial markets, and equities is inflation. It holds the key to upset the entire structure in place since 2008. Policies are being implemented globally as if we have a demand shock, but we are currently facing a supply-side shock due to the pandemic, lack of investments in the physical world, and an accelerated decarbonisation through electrification and renewable energy. These forces are putting enormous pressure on commodity prices and our view is that the green transformation combined with the current policy trajectory will sow the seeds of a commodity super-cycle that will last for a decade.” says Peter Garnry, Head of Equity Strategy at Saxo Bank.

“Inflation and interest rates are the real risks now for equity investors and we recommend that equity portfolios think about equity duration and lower it now while equity markets are calm.”

Real Yields a Boon to Tightening Commodity Markets

After what has already been a strong year for commodities, we maintain a bullish outlook into Q4 and beyond. As the impact of government spending and handouts from governments in Europe, China and the US begins to taper off, the market has started to cool a bit. However, supply constraints will, in our opinion, continue to support prices despite a slower growth trajectory.

Ole Hansen, Head of Commodity Strategy at Saxo Bank, said: “Precious metals led by gold remain stuck in a range that by now has prevailed for more than a year. Gold currently is struggling to find a way out of its 200-dollar-wide range between $1700 and $1900. During the past quarter, one of the interesting developments was gold’s inability to shine despite a renewed drop in Treasury yields, not least ten-year real yields which at one point hit a record low at -1.2%."

“We maintain the view that the rising cost of everything will keep inflation levels elevated for longer, and with peak growth possibly already behind us. Add to this the prospect of less aggressive central bank action, and the foundation for another period of safe-haven and diversification demand could emerge. Gold needs to break above $1835 to reconnect with investors, and once it does this the signal for a return to an all-time high will have been given.”