- Top Trade #1: EUR/$ downside via a one-year EUR/$ put spread.
- Top Trade #2: 10-year US Treasuries above 3% but not below 2% in mid-2015, through cap and floor spreads at zero cost.
- Top Trade #3: Long a Dec-2015 Eurostoxx 50 ‘bull’ call spread.
- Top Trade #4: Long US High Yield credit risk via 5-year CDX HY junior mezzanine tranches.
- Top Trade #5: Long an equity basket of EM crude oil importers (Taiwan, Turkey and India).
- Top Trade #6: Short CHF/SEK.
- Top Trade #7: Bearish Copper relative to Nickel, on supply divergence.
- Top Trade #8: Long US Dollar against a basket of ZAR and HUF.
Some more detail:
Top Trade #1: EUR/$ downside via a one-year EUR/$ put spread
Position for EUR/$ downside via a one-year 1.20/1.15 put spread for around a 4.5 to 1 potential maximum payout.
We forecast that EUR/$ will fall to 1.15 over the next 12 months, in equal parts a reflection of our Dollar bullish view and Euro bearish outlook. In particular, given that HICP inflation is unlikely to rebound in coming months, there is a chance that additional ECB easing, including possibly sovereign QE, comes sooner rather than later, setting the stage for EUR/$ to move meaningfully lower in the short term.
Top Trade #2: 10-year US Treasuries above 3% but not below 2% in mid-2015, through cap and floor spreads at zero cost
Buy a constant maturity 10-year US Treasury 3.00-3.50% ‘cap spread’ at zero cost by selling a corresponding 2.24-1.75% ‘floor spread’, both expiring on June 30, 2015.
We expect 10-year US Treasuries (TY10), currently yielding around 2.3%, to trade at or above 3.0% next June – one quarter ahead of the market-implied lift-off date for the Federal Funds rate. Our Sudoku model indicates that TY10 are already trading ‘expensive’ relative to our Economics team’s global macro outlook, and puts yields in a 3.10-3.50% range in the second half of next year. TY10 outcomes higher than 3.5%, implying a 5-year 5-year forward rate of over 4.0%, are unlikely over this horizon, especially considering that German Bund and JGB yields are still capped by the respective central banks.
Top Trade #3: Long a Dec-2015 Eurostoxx 50 ‘bull’ call spread
Go long Dec-2015 Eurostoxx 50 3150/3450 ‘bull’ call spread (buying the Dec-2015 3150 strike call and selling the Dec-2015 3450 strike call), currently at 101.5 (Bloomberg: SX5E 12/15 C3100 Index vs. SX5E 12/15 C3400 Index).
The (nearly) at-the-money 3150 call costs 170.6, while selling the 3450 call costs 69.10 (both priced as of the close on November 19), giving this position a maximum potential 2-to-1 payout. There are two routes by which European equities could move higher. In our central case, we see scope for a pick-up in Euro area growth in 2015, which we think is not reflected in market prices. At the same time, our European economists see a significant risk of a downside case in which activity and inflation disappoint. And, in that case, the ECB would move to more forceful QE, so initial asset market pressure would subsequently be reversed.
Top Trade #4: Long US High Yield credit risk via 5-year CDX HY junior mezzanine tranches
Go long risk (sell credit protection) on the 5-year CDX HY Series 23 junior mezzanine tranche (the 15-25% portion of the loss distribution), at a running spread of roughly 495bp per year for a target of 440bp (implying a potential return of over 700bp) and a stop at 580bp.
We think the recent underperformance of the US High Yield (HY) market should prove transitory. Our current best understanding for this underperformance is that a portion of the HY investor base remains burdened by recent losses on a number of crowded trades. Our choice of the junior mezzanine tranche, which provides a reasonable level of subordination for default losses, is partly informed by our long-standing ‘up-in-quality’ view on the HY market.
Top Trade #5: Long an equity basket of EM crude oil importers (Taiwan, Turkey and India)
Buy an equally-weighted basket of Taiwan (TWSE), Turkey (XU030) and India (NIFTY) stock market indices, priced at 100, with an initial target of 115 and a stop at 93.
The decline in crude oil prices has the potential to boost activity growth, particularly for oilimporting countries in Emerging Markets (EM). We propose an equally-weighted basket of several of the biggest EM petroleum importers. Each of the basket’s constituent countries adds elements that, in our view, fit with our global baseline macro outlook. Taiwan is an exporting economy that is exposed to a growing US, and has lagged the recent move higher in US equities along with the broader EM complex.
Top Trade #6: Short CHF/SEK
Go short CHF/SEK at the current spot of around 7.70 with a target of 7.00 and a stop at 8.10.
Euro weakness has been reflected in EUR/$ and EUR/GBP this year, to name just two Euro crosses, but EUR/SEK is a notable exception. In large part, this reflects the fact that inflation in Sweden is almost as low as in the Euro area, with recent dovish surprises from the Riksbank reinforcing the view that Sweden and the Euro area are suffering from the same ‘lowflation’ problem. We do not agree with this. After all, low inflation in the Euro area has a heavy structural component, as the internal rebalancing in the monetary union involves lower prices/wages in the periphery and the opposite dynamics in the core markets. In contrast, we see low inflation in Sweden as temporary and think it will move higher in coming months, in line with the Riksbank's October forecast.
Top Trade #7: Bearish Copper relative to Nickel, on supply divergence
Position for Copper underperformance relative to Nickel via Dec-15 LME futures, using equal notional amounts, for a potential 20% upside.
The short Copper/long Nickel trade highlights some important features of our set of market views for 2015 in the commodities space, particularly the theme of ‘supply differentiation’. Copper has entered a once-in-20-year supply cycle, resulting in above-trend supply growth, while Nickel supply continues to be constrained by the Indonesian export ban. This should result in rising (falling) visible inventories of Copper (Nickel) in 2015.
Top Trade #8: Long US Dollar against a basket of ZAR and HUF
Go long USD against a basket of HUF and ZAR at 100, with a spot target of 113 and a stop at 94. The ‘cost-of-carry’ for the basket is around 3.75% per annum, which we will account for in terms of our stop-loss throughout the year.
Our global outlook is consistent with USD strength against EM currencies. The strengthening US recovery should see US yields pushing higher from current levels, while EM rates stay suppressed due to the broader commodity-driven disinflation trends in the first half of the year. The compression in interest rate differentials should ultimately result in USD/EM strength. Two buckets of EM currencies are most exposed. The first bucket includes countries facing persistent imbalances. South Africa stands out: its external imbalance has remained large despite a weaker currency, higher yields and softer activity performance.
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To summarize: short bonds (this time will be different), go long a decoupling America, short Europe because Draghi will do "whatever it takes" to crush Europe's political capital, er, artificial currency, and then go long risk on both inflation and deflation because as showed yesterday, in the current idiotic period which historians will laugh at one day, both inflation and deflation are bullish.
The only thing that prevents us from issuing a "do just the opposite" recommendation is that unlike previous years, Tom Stolper is not part of the recommending crew, thus there is some risk Goldman may actually get some of these right...