David Woo, Bank of America Merill Lynch’s well-respected FX and Rates strategist is out with his top trades for 2015.
Because of the markets he covers some of the trades are very nuanced. The 5 themes he highlights as the key drivers have a much broader, macro impact across a wide range of markets, from stocks to bonds, commodities and foreign exchange.
Here are Woo’s 5 themes:
Theme 1: Burden shifts from the Fed
The Fed, having exited QE, will be relying more on forward guidance in 2015. However, with the market already pricing an extremely slow tightening cycle and term premium at low levels, the scope of easing through forward guidance may be limited.
If we are right that the impact of the end of Fed QE has yet to be felt fully, then the ECB, the BoJ, and possibly other central banks may have to ease more to compensate. This should be bullish for the USD (we are looking for EUR/USD and USD/JPY to reach 1.20 and 123 by end-2105) and bullish for European and Japanese rates (we expect 5y German bond yields to fall to 0%).
Theme 2: China and the world diverge
The consensus is that global growth will accelerate in 2015. Forecasters are looking for even the Eurozone to grow faster next year. The only exception is China – Wall Street economists expect Chinese growth to moderate further to 7%.
What is clear is that the USD will be the prime beneficiary of a continued Chinese slowdown. US exports to China are only 1% of US GDP, versus 3% for Germany, 4% for Japan, and 6% for Australia.
Theme 3: It’s easier to trade the USD than US rates
The key lesson for us in 2014 is that the USD can rally without higher US rates, but a higher USD can cap upside of US rates. Another lesson is that US rates are increasingly driven by global factors. These lessons tell us that for the USD to do well, all we need is for the US to do better than other countries. However, for US rates to go up, we need the other countries to do well too.
Theme 4: It pays to be contrarian
If we learned anything at all in 2014 about investing, it is that the right trade, when it is crowded, often becomes the wrong trade. In other words, it sometimes pays to take the other side when positioning becomes too one-way. Identifying when a trend has gone too far and is set to reverse is not easy, but this is why understanding value and valuation has never been more important. Understanding positioning has never been more crucial as lower dealer risk appetite means markets are more prone to overshooting.
Theme 5: Oil volatility will drive global volatility
Year-to-date, Brent crude prices have declined nearly 30%. Without a significant recovery in the next month, this would be the second largest annual sell-off in 15 years (only behind 2008). A big decline in oil prices two years in a row is rare. In the past 25 years, this only happened once (1997-1998). Our commodity team believes oil prices will rebound next year, after production adjustment by OPEC and with lower prices shutting out marginal producers.
In general, we expect oil price volatility to be a key driver of volatility in the rates and FX markets in 2015. We believe the outlook for oil prices will have particularly profound impact on the US decoupling thesis and therefore the overall direction of the USD
And his trades – note the top one!
Best directional trades:
Selling AUD/USD spot (spot reference 0.8710), targeting 0.78 with a 0.90 stop.
Pay 5y US swap rates versus 5y offshore China swap rates at 119bp, targeting
60bp with a stop at 145bp.
Best European trade:
Receive Eonia 1y one year forward (entry -4 bp) with a -15 bp target and stop at
Sell CHF/NOK (spot reference 7.00) with a target at 6.25 and a 7.42 stop loss.
Best Vol trade:
Buy 1y-6m one-touch put spread in EUR/USD struck at 1.18 for 14.5% (spot
Best inflation trade:
Buy 30y US inflation versus 30y Euro inflation in swaps at a spread of +49bp,
targeting +80bp with a stop at 35bp.
Best contrarian trade:
Sell 3m USD/JPY ¥125 one-touch option to finance buying a 6m ¥125 one-touch
option in U$10m/U$13m ratio payout (spot reference 117.80).
Best regulation trade:
Buy $200mm T 0.625% 11/15/16 vs paying in matched-maturity swaps. Entry
17.5bp, target 28bp with a stop at 12bp.
Best relative value trade:
Buy 3y Portugal and 10y Bunds and sell 10y Spain (55%, 83% and -100%),
targeting 115bp, with a stop at 93bp.
Best tail risk trade:
1y USDCAD 1.27 digital call for 10.25% (spot reference 1.13)
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