As global economic growth remains robust with the rise of sectors like artificial intelligence, defense and obesity drug manufacturing, Saxo Bank warns of several risks to the “sandcastle economy” in its latest quarterly outlook for Q3.
The bank’s outlook cites threats to economic growth including unsustainable U.S. fiscal spending, geopolitical risks and demographic trends that could destabilize the current economic momentum in the longer term.
In his macro note, “Sandcastle economics”, Peter Garnry, Saxo’s chief investment strategist, emphasizes the precarious nature of current economic growth, stating: “Economic growth will remain stable, but down the road, several factors can destroy our sandcastle economy.”
Garnry highlights the “two-lane economy,” where some sectors are thriving while others are struggling. This disparity complicates monetary policy, as aiding weaker sectors could prolong inflation, increasing economic costs. Meanwhile, inflation remains persistently high, prompting cautiousness from the Fed and delaying rate cuts until policymakers see a significant economic slowdown.
Robust demand to support commodities
Amid robust global economic growth, strong demand and production challenges should continue supporting commodities. The precious metals market, including gold and copper, now takes a breather after reaching record highs. However, the energy and grains are set for growth. Ole Hansen, Saxo’s head of commodity strategy, states that OPEC’s ‘line in the sand’ price and strong summer demand towards mobility and cooling will support crude oil.
Despite a second-quarter setback in energy due to a decline in the geopolitical risk premium, metals remain strong. However, Hansen notes that “industrial metals require a recovery in Chinese demand to justify higher prices at this stage”. While metals consolidate, energy and agriculture sectors will likely be the key drivers of growth in the coming quarter.
Tech boom propels equities
As the Q3 of 2024 begins, the current market rally shows signs reminiscent of 2021, driven by speculative tech growth, crypto, meme stocks, and high U.S. equity valuations, “which is higher than we saw during the dot-com bubble”, notes Garnry.
Extreme index concentration is evident, with the 10 largest stocks comprising 35 percent of the S&P 500 Index.
Despite the rally in U.S. markets, Saxo Bank remains overweight on European equities. We “believe European equities will be repriced higher relative to other markets on the ECB rate cut in June and a growth rebound in the third quarter”, added Garnry.
Fixed income amid persistent inflation
Saxo Bank expects U.S. and European sovereign bond yields to remain range-bound during the third quarter as the uncertain inflation outlook remains despite less aggressive monetary policies.
Saxo’s head of fixed income strategy, Althea Spinozzi, highlights that U.S. Treasury yields will likely remain higher until inflation trends decisively return towards the 2 percent target. Spinozzi notes that the divergence between U.S. and European rates “will keep bond volatility elevated, prompting us to overweight high-quality credit and short-term duration”.
Investment-grade corporate bonds will likely remain well-bid as direction on inflation remains uncertain. In addition, high-yield bonds that act as a hedge against inflation will likely maintain support despite tight spreads.
Saxo Bank adds that, in this environment, it makes sense to maintain a cautious stance and limit duration exposure. Investors can focus on quality and maturity up to five years while being cautious with longer durations. Hence, long-term rates remain vulnerable to inflation trends and potential rebounds in the term premium.
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Risk-on currencies to surge against havens
A bearish dollar trend could extend into Q3 if U.S. economic weakness broadens, although valuation and safe-haven appeal limit the downside. High-beta currencies like AUD and NZD are in a good position to outperform due to lagging central bank easing cycles and a stabilizing Chinese economy.
“Low-yielding currencies such as JPY and CHF are likely to underperform in a dollar-bear world due to negative carry,” stated Charu Chanana, head of FX strategy.
While the dollar may face downside risks, selective high-beta currencies and tactical emerging market carry trades present potential opportunities in the evolving FX landscape.
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