Overview - Recovery Risks
SG MARKET RISK OUTLOOK
Downside COVID scenario less probable and less severe:
implications for asset classes
65
%
probability
for the base case
economic outlook
probability
for downside scenario
probability
for upside scenario
20
%
15
%
Our economists present forecast for each asset class
(Click on each asset class to learn more)
The COVID-19 pandemic is still a considerable source of uncertainty. Therefore, in this edition of the SG Market Risk
Outlook our economists once again trace out the implications of alternative scenarios for the economic outlook across asset classes. In the base-case scenario, the virus continues to circulate but the gradual opening up of economies progresses. Three months ago, our economists ascribed a 55% probability to this scenario; now it is 65%. In the upside scenario, a highly effective treatment or treatments are found or better yet a vaccine is developed in the near term, meaning in around three months or so. This probability is left unchanged at 15%. The downside scenario remains one in which severe restrictions on movements and business activity have to be reintroduced because the virus spread accelerates again and threatens to overwhelm medical systems. This scenario has become much less likely, and the probability has been reduced to 20% from 30%. 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 scenario: equity markets globally should be essentially flat as fairly rich valuations, central bank ammunition running short and a spike in defaults will put pressure risk assets.
Downside scenario: Russell 2000, which is full of leveraged companies, will be worst hit. Europe indices would drop as recovery is already partly priced in. HSCEI should resist thanks to its exposure to Chinese consumption.
US rates - 10YT and 2s10s
EUR rates - Bund 10Y and BTP/Bund 10Y
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Upside scenario: diversification out of US equities in favour of eurozone and EM equities. Cyclicals and Value should overperform Growth. HSCEI harbours substantial upside potential.
Focus on equity volatility:
Base case scenario: US will remain elevated. Our economists expect other regional volatilities to closely follow the trajectory of US volatility.
Downside scenario: the stress in credit markets induced by a “second wave” of credit defaults should feed into equity volatility.
Upside scenario: strong return of volatility selling flows. Volatility selling pressure in Europe is in general less severe and V2X should remain slightly above VIX.
Base case scenario: the counterbalance to the status quo of stagnant yields is improving fundamentals, increasing Treasury supply and stimulus (both monetary and fiscal). Our economists expect modestly higher yields.
Downside scenario: lower-for-longer Fed policy, persistent global disinflationary forces, and a could keep interest rates low.
Upside scenario: effective vaccines and therapeutics would lead to a faster recovery but volatile data prints could keep a lid on the rise in rates.
Base case scenario: COVID-19 second wave and a deteriorated inflation outlook will cap yields.
Downside scenario: further ECB easing and rate cuts. For BTPs, renewed fear of a negative rating action would be harmful.
Upside scenario: normalisation toward higher rates but sluggish inflation and central banks’ aim to be more rather than less dovish should limit the sell-off potential.
Euro and US Investment Grade Credit
Base case scenario: USD and EUR IG recovered well from the March sell-off. Correlation between the two markets may weaken as technical bids for EUR assets remain strong while US default rate is expected to rise.
Downside scenario: risks of rating downgrades on lower-rated companies especially in the US but central banks and governments proactivity should give some support.
Upside scenario: while better economics should give some respite to the weaker companies, our economists could see less support from the Fed and the ECB.
EUR and US High Yield Credit
Base case scenario: HY spread should tighten by year-end given the ongoing hunt for yield due to expensive IG markets. However, default rates should rise and peak in 2021 widening the spread again, especially in the US.
Downside scenario: further government and central bank support only partly mitigate higher default. US spreads go even wider as it has a larger proportion of low-rated companies.
Upside scenario: a stronger recovery should keep defaults rates from rising too much but higher sovereign bond yields and a less aggressive hunt for yields could temper appetite for High Yield.
Base case scenario: the convergence of global monetary policy should continue to drag the EUR/USD towards long-term averages. JPY appreciates on higher Japanese GDP relative to the US.
Downside scenario: Euro drops as Europe is more open to emerging markets, is expected to suffer, and has more scope to cut rates relative to the US. Sterling’s only defence scenario is the all-time low for its real value.
Upside scenario: Euro could rise as ECB would, in the market’s view, be quicker to start talking about rate hikes than the Federal Reserve.
Base case scenario: capital flows into EM are likely to remain weak due to insufficient yield compensation, an already large allocation into EM bonds and a lack of dry powder on falling AUM.
Downside scenario: EM FX falls by only twice as much as in our base case as policy response would be quick and the post-COVID recovery was weak as some capital already exited.
Upside scenario: the positive surprise could have a meaningful impact on sentiment and lead to some recovery in EM currencies.
EM FX
Oil
Base case: slow supply-and-demand.
Downside scenario: OPEC+ tries to mitigate demand destruction.
Upside scenario: stronger demand recovery on path to normalisation.
Copper
Base case: industrial delusion, positive surprises are behind us.
Downside scenario: find a floor on cost curve.
Upside scenario: remain at current level on greener stimulus.
Gold
Base case: still some upside potential on rates and uncertainties.
Downside scenario: rally on persistent ETPs inflows.
Upside scenario: gold price normalisation on investors liquidation.
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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.
© Societe Generale 2020
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#contentwithimpact
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.
© Societe Generale 2020
Cookies Policy
Legal Information
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