A World Out of Balance – Saxo Bank’s Q2 2020 Outlook

CIO Steen Jakobsen looks at a fragile financial system and global economy impacted by the COVID-19 crisis

The outbreak of COVID-19 has set three major impulses in motion, a global demand shock, a global supply shock, and an oil war that has forced prices to multi-year lows, according to Steen Jakobsen, CIO at Saxo Bank.

This final development will result in enormous destruction of capital and, soon, structural unemployment, the bank states in its Q2 2020 outlook.

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“In over 30 years of doing this job I have never seen three simultaneous blows to the economy,” Steen Jakobsen said.

“I am again reminded of 2008, where small events like BNP Paribas closing their high-yield fund, Bear Stearns closing redemptions on its hedge funds in 2007 and ultimately the failure of Lehman Brothers catapulted markets into a fitful, systemic meltdown that quickly disrupted the economic backdrop as well,” he noted.

“The markets were extremely difficult to trade in this period, just as it was difficult to comprehend all of the moving parts of the broader economic fallout,” he continued.

Jakobsen believes that this current disruption has already eclipsed the 2008 chaos in some markets, as the world suddenly finds itself in a period in which some markets can move up and down more in one day than they did in an entire year.

“A bull and bear market can happen inside of a week. The behavior of markets this year is completely without precedent and reflects how illiquid markets are,” he said.

In an environment of panic deleveraging, the ‘cash is king’ mantra arises, in his view.

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“Funds, banks, investors, and even companies suddenly see not only a dramatic mark-down of asset prices but wild swings in correlations across portfolios and swings in P&L,” he added.

Markets always become most vulnerable when we are operating with discontinuous price structures, according to Jakobsen.

“The shakeup we are seeing here in Q1 will change the landscape of investment and risk tolerance going into 2021. But it will also change the long-term allocation model away from a 60/40 bond/equity allocation – or similarly heavy-fixed income-weighted risk parity principles – to proper hedging through commodity exposure (inflation protection) and long volatility (fat tail-discounted price action protection),” he said.

2020, a financial year lost

The triple whammy to the global economy almost guarantees that 2020 as a financial year is lost, with policymakers needing to pull out all of the stops to address a real, global recession, Jakobsen says in his outlook.

“The market is on the brink of spinning out of control as credit, which is everything in today’s market, has dried up — such that US mortgage yields are rising even though 30-year US treasury yields have collapsed. In other words, the market is tightening terms on credit even as the Fed tries to ease by cutting rates,” he said.

He says that the question of if the system is so broken, or unbalanced, that it needs to get worse before it gets better, can only be speculated on.

Saxo Bank has full confidence that after 2020 the policy measures taken will prompt strong inflationary forces that even point to the risk of stagflation.

“The global bull market of 2009-2020, the longest in history, just died of coronavirus. In its wake, we have the weakest economic and political structures since the 1930s,” Jakobsen said.

“Buckle up, it’s going to be quite an adventure — one like none (save perhaps for the very oldest of us) have seen in our lifetimes,” he concluded.

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