Credit Suisse is out with its top 10 trades for 2016. Ric Deverell, global head of research, and the members of his fixed income and economics research team aren’t mincing words about the year ahead.
“The coming year is likely to prove to be a watershed in global economic history,” Deverell wrote as his opening to the global outlook released today.
The reason for this momentous year ahead is that the Federal Reserve will begin “the process of normalizing US interest rates, after seven years of historically unprecedented accommodation,” he said.
That’s important, Deverell says, because:
This attempt at tightening will occur in a global economy experiencing historically large divergences among the major players, as structural issues intersect with normal cyclical dynamics. Rather than following the Fed, as has occurred in previous cycles, the ECB and BoJ are likely to ease further, while the Chinese authorities continue to battle the excesses of investment past.
The words “historically large divergences” are cause for anyone with an interest in markets and economics to get excited about the possibilities that will throw up for the year ahead.
Deverell notes the “intersection of the cyclical and the structural is likely to result in further substantial changes in the flow of capital around the globe.“
That’s another huge statement but the bank is not thinking its expectation that the Fed will hike rates four times in 2016, and the divergent economic outlook across the globe, will lead to year of global economic weakness. Rather, they say, their base case is “a modest rebound in global growth powered by steady developed market consumption. We expect the Fed to hike four times by the end of 2016, while the ECB and BOJ maintain their easing bias.”
On China, Deverell’s team believes the economy is going to respond to recent policy measures by the nation’s central bank. But they do highlight that a “deepening slump in Chinese investment is a major risk to our outlook.” But the potential for this to have a high impact but is a “low-probability outcome”, they say.
Key to the outlook and the trades is that Deverell’s team believe there is going to be a “drift higher in US core inflation that triggers higher interest rates and tighter financial conditions.”
Here are their top 10 trade ideas.
- 1. Buy USD versus EUR and CHF
Rationale: We expect the impact of monetary policy divergence between the Fed and ECB to increase as 2016 starts. The SNB is likely to remain committed to preventing Swiss franc strength versus the euro even as EURUSD declines.
- 2. Long European stocks
Rationale: Given our view that the Fed will tighten, the euro depreciate toward parity, and the ECB extend its QE program, we expect that a catch-up in European corporate earnings will allow European equities to outperform US equities.
- 3. Sell Aussie dollars against the US dollar again
Rationale: The policy divergence stretches well beyond Europe. Our structural expectations for slowing in China and ongoing weakness in Australia’s core commodities leave us bearish on the Aussie dollar.
- 4. Buy 2-year Germany
Rationale: We expect the ECB to cut the deposit rate in December. This should lead to further rate cuts being priced into the curve.
- 5. Sell 5-year US Treasuries
Rationale: Our technical analysts see scope for a range break in US 5-year yields.
- 6. Overweight European versus US credit
Rationale: Relative monetary policy and the much-lagged stage of the European corporate profit cycle make European credit attractive relative to the US, in our view.
- 7. Overweight local-currency EM bonds
Rationale: Selected EM markets offer value in a rising US yield environment.
- 8. Overweight credit-oriented SP versus Agency MBS
Rationale: We see the pick-up in volatility related to a potential Fed hiking cycle as structurally negative for Agency. Parts of the non-Agency MBS and CMBS markets appear relatively cheap as they have lagged the recent tightening of macro-markets.
- 9. Add a USD rates bear flattener
Rationale: We think that the market is under-pricing the medium-term potential for Fed hikes.
- 10. Protect against risk of dollar surge
Rationale: Higher US rates may trigger a new surge in the dollar, dominating other capital flows. EURMXN downside exposure has cheapened EURUSD/USDMXN implied correlation.
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