Overview - Recovery Risks
SG MARKET RISK OUTLOOK
The consequences of recovery scenarios across asset classes
With the pandemic dominating almost everything, our economists detail far more thoroughly just one upside and one downside scenario to the base case. These are directly linked to how the pandemic develops over the coming months. They ascribe twice as high a risk to the downside scenario as to the upside one, and they judge the magnitude of the potential deviation from the base case to be twice as large in the downside scenario. Hence, we judge the risks to be highly asymmetrically skewed to the downside.
Accordingly, for each asset class our economists trace out the impact of several scenarios,
with a conviction level associated to each scenario:
55
%
base case economic outlook
(tilted V-shaped recovery)
downside
(L-shaped recovery)
upside
(V-shaped recovery)
30
%
15
%
Our economists present forecast for each asset class
(Click on each asset class to learn more)
With the pandemic dominating almost everything, our economists detail far more thoroughly just one upside and one downside scenario to the base case. These are directly linked to how the pandemic develops over the coming months. They ascribe twice as high a risk to the downside scenario as to the upside one, and they judge the magnitude of the potential deviation from the base case to be twice as large in the downside scenario. Hence, we judge the risks to be highly asymmetrically skewed to the downside.
Accordingly, for each asset class our economists trace out the impact of several scenarios,
with a conviction level associated to each scenario:
Equity
Rates
Credit
Commodities
FX
Base case growth scenario: equities have single digit upside into 2Q21: they appear to be pricing higher PMIs, but not a full V-shape recovery yet.
Downside growth scenario: China equities should be the least impacted. Leverage becomes a major widow- maker: US small caps most at risk.
US rates
EUR rates - Bund 10Y and BTP/Bund 10Y
FIND OUT MORE
Download the full publication
(for existing clients)
#contentwithimpact
Upside growth scenario: Asia equities have most upside. In Europe, small caps are best positioned for higher PMI + ECB injections EM Europe (ex-Russia) and FTSE MIB favoured as well.
Equity volatility is unlikely to return to pre pandemic level in the short term:
Among the factors a weaker gamma peak (because of high volatility and reluctance to sell volatility), high earnings uncertainty (higher than volatility), a busy political agenda (US elections, roll over of US stimulus program) and lack of liquidity (algo trading liquidity is an inverse function of volatility).
Credit is one of the key medium term risk following the pandemic some equity volatilities are underpricing that risk (IBEX vs CAC).
Long term perspective: volatility nature has changed (from a measure to a tradable asset and now a
target). It is no longer unimodal but bi modal (two way risks). The 2nd moment of return (volatility) has flatten while the third and fourth moments have increased (skew and convexity respectively).
Base case growth scenario: in the context of an L-shaped recovery in the US, we expect yields to rise gradually. While they expect Treasury yields to rise as conditions improve, the road to recovery will be bumpy, and the rise in yields is likely to be gradual.
Downside growth scenario: downside scenario - not revisiting the historical low.
Upside growth scenario: we believe the risks to the bond market are asymmetrically skewed toward higher yields.
Extraordinary monetary and fiscal stimulus is skewing the outlook towards higher yields, especially
so at very long maturities.
Progress on the EU Recovery Fund, ECB support and reduced risk of rating downgrades are narrowing BTP/Bund spread.
Euro and US Investment Grade Credit
Range-trading in July and early August. The summer will see less supply but fewer ECB purchases.
Liquidity ratios matter most in Q2 earnings.
We expect the Q4 squeeze to reappear this year (as it has done for the past three). The ECB will buy more credit as it runs out of CP to buy.
Excess supply is not an issue: supply has never choked off a rally. Supply follows spreads, not the other way around.
EUR and US High Yield Credit
More compression: HY/IG spreads are too wide and BBB has lagged the Single A rally in percentage terms.
UK to underperform: locally focused UK names are generally in the HY index.
Risk is that distressed debt could pull high yield lower: but over the past 10 years the IG/HY correlation has been consistently higher than the HY/distressed correlation.
Fed policies are undermining the dollar (and helping gold). Broad trade weighted dollar has peaked and EUR/USD has bottomed but a significant move higher in EUR/USD can be delayed until EM outlook has improved.
Base case growth scenario: EUR/USD continues slow turn higher, Asia outperforms US/Americas and USD/JPY trades (slowly) lower.
Downside growth scenario: USD/JPY trades (slowly) lower. Downside scenario: GBP/USD falls as UK is hit hard, EUR/USD bumps along range bottom for longer.
Upside growth scenario: AUD top G10 currency, but from current levels, and barring turnaround in monetary policy, USD/JPY probably remains in current range, so long AUD/JPY may not gain much more that AUD/USD.
Base case growth scenario: Historically, EM currencies perform well when global growth momentum is improving and poorly when it is weakening. Our strategists think the negative influence of a weaker growth level in this recovery phase will overwhelm the positive impact of improving growth momentum.
Downside growth scenario: EM FX down by end-2020. Exacerbation of base case scenario.
Upside growth scenario: Stronger growth momentum and the possibility that lost output is minimal would help EM currency performance to be more aligned with past cycles.
EM FX
Oil
Base case: tilted V-shaped pattern. Severe upward pressure will likely be very limited, as inventories are still three days above the five-year average.
Downside growth scenario: bearish for the oil markets.
Upside growth scenario: faster recovery in demand.
Copper
Base case: prices to correct but to remain resilient.
Downside growth scenario: long period of subdued income for both households and companies would likely dent private investment and dramatically reduce demand for copper.
Upside growth scenario: the refocusing of fiscal stimulus towards renewable energy should support copper demand.
Gold
Base case: bullish on the current high levels and expect gold to peak in 4Q20.
Downside growth scenario: very bullish for gold. Further economic damage would push average prices.
Upside growth scenario: bearish for gold, as it would ease fears of further equity turmoil and reduce the need for dovish monetary policies: gold prices would gradually lose ground, amid low gold volatility.
Watch the replay
(for existing clients)
This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
Contact
By continuing to use our website, you are accepting our use of cookies. The cookies we use are "analytical" cookies. They allow us to recognise and count the number of visitors and to see how visitors move around the site when they are using it. To find out more or to change your cookie preferences, please refer to our cookies policy.
This page contains financial analysis which reflects the opinion of the Cross-Asset Research department of Societe Generale, at the date of its publication. It does not necessarily reflect the views of the other departments of Societe Generale nor the official opinion of the Societe Generale group. This content has been prepared for use by institutional and professional investors and is not intended for retail investors. Investors should consider this report as only a single factor in making their investment decision.
Cookies Policy
Legal Information
© Societe Generale 2020