The economic and investment strategy boffins at Swiss investment banking giant UBS have bashed their heads together to come up with their eight key macro trades for the coming 12 months, despite admitting that it's likely to be another year of sticky wickets for investors. 'After a difficult 2015 for macro investors, 2016 is unlikely to get easier,' says the UBS global strategy team.
'Increased volatility, slowing emerging market (EM) growth, fluctuating quarterly US growth rates, and persistent uncertainty regarding US monetary policy have made 2015 a tricky year for macro trading. 2016 is unlikely to be much easier. Even after the first Fed hike, volatility should remain high as clarity on the Fed's future path will be limited, and EM continues to face a challenging growth environment.
Top cross-asset macro trades for 2016
Long Eurostoxx 50, currency unhedgedSell EUR/USD puts, long USD/JPYLong DM FX (EUR and USD) versus short EM FX (SGD, TRY, TWD, and ZAR)Short Bunds versus long 10-year TreasuriesReceive 5yr5yr rates in Australia versus pay 1yr1yr rates in UKLong US large cap versus short US small capLong CAD/MXN and long GBP/AUDLong DM financials versus short EM financialsThe UBS team, including strategy analysts Daniel Waldman, Themos Fiotakis and Yianos Kontopoulos, explains its decisions:
Macro backdrop to remain tricky in 2016
'2015 has been a tricky year for macro investors, defined by persistent monetary policy uncertainty in the US and slowing growth in the emerging world. This has translated into higher market volatility and lower returns across asset classes, with the Sharpe ratio to being long both US equities and Treasuries falling to the lowest of the past five years. In FX, carry trades have been a particularly poor strategy, with both negative returns and significantly higher volatility.'
The team goes on to explain that, in its base case, 'we see another year of moderate global growth, with headline inflation edging slightly higher due to base effects, but core inflation remaining low as disinflationary forces persist.'
The Fed lift-off against such a backdrop should keep monetary policy uncertainty high and market volatility elevated, says UBS. 'Even after the first hike, the future path of rates will remain data dependent, and feedback effects from higher US rates to tighter financial conditions will further
complicate the Fed's task. EM growth may stabilize, but will be doing so at weak levels, as China?s deceleration extends and pressure on EM balance sheets rises.
Three big ideas
From a thematic lens, the UBS team's year-ahead trades are predicated on three main ideas:
Any pick-up in core inflation will be modest
With global growth remaining moderate, and fears around EM growth risks high, this is key to avoiding a global risk sell-off. Despite scepticism from many investors, easy monetary policy still benefits asset markets, and if core inflation remains low, equity performance can remain part of central bank reaction functions.
Of the four possible combinations of equity and 10-year rate outcomes, modestly lower 10-year yields and modestly higher equities is our base case over the coming months. Higher yields and lower equities should be the lowest likelihood combination, as low core inflation allows central banks to lean against any equity shock with marginally less restrictive policy.
European growth will accelerate in 2016
We have been arguing that markets are over-pricing the degree of future divergence between the US and Euro area, and a further improvement to European growth in 2016 is key to this view.
Our European Economics team forecasts growth rising from 1.5% in 2015 to 1.8% next year. Policy in Europe is supportive, with both fiscal and monetary policy set to loosen, and the ongoing easing in credit conditions is pointing to acceleration in private sector demand.
Growth in China will continue to slow
Policymakers should be able to manage this slowing (see China Outlook), and tail risks from a sharper growth slowdown are a relatively low probability event, in our view. Nonetheless, further slowing in Chinese growth is tradable, particularly through Australian and EM Asia assets, FX in particular. Against this backdrop, we also see pressure on EM balance sheets continuing to rise.
Where we can be wrong
But illustrating the lack of guarantees, UBS also details areas where real events could deviate from these predictions. 'Given the degree to which our year-ahead trades are driven by the three assumptions above, the main risks to our trades revolve around them,' explains UBS' strategists.
'A sharp rise in core inflation that called into question the ability of central banks to keep policy loose or retain their 'equity put' would be negative for risk markets. However, keeping in mind our view that having offsetting risk in portfolios is key in 2016, our short EM FX positions should perform very well in such a scenario, compensating for some of the equity exposure in the portfolio.'
The second risk, as the analysts see it, include an 'idiosyncratic slowdown in European growth.' This would likely be the worst for the team's overall portfolio of recommended trades, UBS admits, since it would negatively impact pro-cyclical European trades, including Eurostoxx, EUR/USD, and German rates, with little overall offset in the portfolio.
Finally, if Chinese growth were to accelerate significantly, the short-Australia risk positions (AUD and Australian rates) would perform poorly, UBS says, as would the short EM FX exposure. 'Long Eurostoxx would likely do well in such an environment, but not well enough to offset the other positions.'
'Although we are not forecasting a sharp slowdown in China, if a tail scenario were to occur, the overall portfolio should perform well. Long equity exposure would perform poorly, but short EM FX and long duration positions should more than compensate,' the UBS strategy team concludes.
