Global expansion is positive for risk – Danske Bank

Analysts at Danske Bank expect global growth to remain relatively robust, as strong fundamentals in developed markets point to ongoing expansion as investments seem to pick up.

Key Quotes

“With global expansion set to continue in coming years, the cyclical environment is likely to remain supportive for risk markets. This year has generally been a very good year for FX carry trades and implied FX volatility has declined significantly. From a risk/reward perspective, FX carry trades still look attractive, with high yielding currencies, such as RUB, TRY and ZAR, offering very attractive risk-adjusted carry and the currencies are not significantly overvalued from a fundamental point of view. Moreover, we expect growth momentum to pick up in some of the major emerging economies with, for example, Brazil, South Africa and Russia continuing to show a modest economic recovery after years of subpar economic growth.”

“But acceleration phase is over

While the global business cycle is set to remain robust and constructive for risk assets, we believe the acceleration in growth we saw in 2017 is behind us as we expect a moderation in Chinese growth to weigh on global growth and tailwinds from monetary stimulus to ease in 2018. Moreover, we note that our quantitative business cycle model indicates a relatively high probability of the global business cycle moving into a deceleration phase (red quadrant) in 2018. Usually, a move into the red quadrant tends to be negative for carry trades (left skewed returns) and FX volatility tends to increase (right skewed distribution).”

“Downside risks are likely to increase in 2018

Hence, while risk assets are likely to perform going into 2018, we could see downside risks increasing, as positioning and risk premiums become even more stretched. Implied FX volatility is very low and volatility curves are generally flat as the FX option market prices a continuation of the low volatility environment. In the G10 space, our FX volatility valuation monitor indicates that buying volatility at longer-dated tenors in USD crosses in general looks attractive from a risk/reward perspective. Thus, we see value in building in a long vega exposure in FX positions with a +6M expiry given the generally low risk premia priced in FX options.”