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The UniCredit
Macro & Markets
Weekly
Macro Research No. 179
Strategy Research 13 March 2020
Credit Research
“ 2020 outlook revisions: V-shape with downside risks
This week, major central banks, including the Fed, the ECB and the BoE, launched easing packages to soften the
economic damage from the COVID-19 outbreak. The expansion of strict containment measures by the Italian
government led to a complete lockdown of the entire country, while measures to support companies and households are
”
being stepped up. The German government announced an unlimited volume of federal guarantees to facilitate corporate
lending and tax deferrals. US President Donald Trump announced a 30-day ban on travel from Europe (excluding the
UK) to the US and a series of targeted fiscal measures. Not yet convinced by fiscal and monetary policy measures
adopted so far, financial markets entered a tailspin this week with major equity indices temporarily giving up about 20%.
Core bond yields fell by 20-40bp on Monday, but have risen since. BTPs experienced exceptional volatility with 10Y
yields, on balance, rising by 50bp. As the US dollar regained considerable strength, EUR-USD fell from a peak of 1.15
to 1.11 and GBP-USD from 1.32 to 1.25. In spite of the ECB’s decision to scale up the CSPP program, corporate bond
credit risk premiums widened further on the back of pressure from equity markets.
– Macro: We have revised our forecasts for 2020 in response to COVID-19. We now see the eurozone slipping into
a technical recession in 1H20, followed by a rebound in 2H20, with the yearly average at +0.1%; risks are to the
downside. If other countries were to implement the same restrictive measures as Italy, eurozone GDP would
contract by 1.5%. The Fed is likely to announce a 100bp rate cut next week and additional liquidity measures.
– FI: Given our expectations for a V-shape pattern in growth, we anticipate further yield declines in the next months,
although additional bond strength is likely be temporary and over by late in the second quarter. Beyond 2Q20, we
expect risk appetite to improve, driving yields up, with the UST curve and, more modestly, the Bund curve
steepening.
– FX: We confirm our 4Q20 target of 1.16 for EUR-USD, but volatility is set to remain high, especially in 2Q. The
JPY and CHF are likely to remain firm in the coming months.
– Equities: From a tactical point of view, we recommend continued investment caution going into 2Q20. We expect
an improved economic environment in 2H20, with positive equity market potential of some 30%.
– Credit: We moderately raise our 2Q European credit spread forecast, although we still expect levels to decline,
supported by the scaling up of the CSPP and potential fiscal stimulus.
Editor: Dr. Thomas Strobel, Economist (UniCredit Bank, Munich) Editorial deadline: 13 March 2020 12:30 CET13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Markets at a glance
Current Total return (%)
Equities Price 1M 3M 6M 12M YTD QTD
MSCI World (USD) 1777 -26.7 -23.0 -18.7 -13.1 -24.4 -24.4
MSCI EM (USD) 883 -20.0 -18.4 -13.2 -13.5 -20.6 -20.6
S&P 500 2481 -26.3 -21.4 -16.7 -10.0 -22.9 -22.9
Nasdaq Composite 7202 -25.8 -17.4 -11.5 -4.8 -19.6 -19.6
Euro STOXX 50 2707 -25.3 -21.7 -17.5 -11.5 -22.6 -22.6
DAX 9663 -29.7 -27.2 -22.5 -16.5 -27.1 -27.1
MSCI Italy 39.88 -40.0 -36.2 -33.5 -26.9 -36.8 -36.8
Rates (government bonds) Yield (%) 1M 3M 6M 12M YTD QTD
1-3Y US 0.52 1.6 2.2 3.0 5.1 2.1 2.1
7-10Y US 0.93 5.6 7.6 8.8 15.9 8.2 8.2
1-3Y Germany -0.91 0.5 0.4 0.0 0.0 0.5 0.5
7-10Y Germany -0.60 2.5 3.4 1.9 5.8 4.2 4.2
1-3Y Italy 0.55 -2.0 -1.7 -1.8 -0.1 -1.6 -1.6
7-10Y Italy 1.59 -6.5 -3.9 -5.7 7.4 -3.0 -3.0
Credit OAS (bp) 1M 3M 6M 12M YTD QTD
iBoxx Non-Financials (EUR) 116 -2.5 -1.6 -1.7 2.5 -1.4 -1.4
iBoxx Non-Financials Sen (EUR) 106 -2.3 -1.4 -1.5 2.5 -1.2 -1.2
iBoxx Non-Financials Sub (EUR) 318 -6.1 -5.1 -4.5 2.2 -5.3 -5.3
iBoxx Financials (EUR) 134 -3.0 -2.2 -2.1 1.6 -2.0 -2.0
iBoxx Financials Sen (EUR) 110 -2.4 -1.7 -1.8 1.5 -1.4 -1.4
iBoxx Financials Sub (EUR) 245 -5.4 -4.5 -3.8 1.8 -4.4 -4.4
iBoxx High Yield NFI (EUR) 547 -11.0 -10.1 -9.5 -5.7 -10.4 -10.4
EM hard currency* (USD) 500 -6.9 -4.4 -2.6 3.0 -5.1 -5.1
Current Price change (%)
Commodities Price 1M 3M 6M 12M YTD QTD
Oil (Brent, USD bbl) 35.0 -37.8 -46.3 -41.8 -48.1 -46.9 -46.9
Gold (USD oz) 1,586.1 0.6 7.4 6.6 21.2 4.5 4.5
Bloomberg Commodity Index 67.3 -10.6 -15.2 -14.4 -17.4 -16.7 -16.7
Exchange rates Price 1M 3M 6M 12M YTD QTD
EUR-USD 1.12 2.9 0.3 0.7 -1.5 -0.5 -0.5
EUR-GBP 0.89 -6.7 -6.3 -0.5 -4.7 -5.0 -5.0
EUR-CHF 1.06 0.3 3.4 3.6 7.5 2.6 2.6
EUR-JPY 119 0.0 2.1 0.6 5.8 2.3 2.3
EUR-NOK 11.10 -9.6 -9.5 -10.3 -12.6 -11.3 -11.3
EUR-SEK 10.85 -3.4 -3.7 -1.9 -3.1 -3.3 -3.3
EUR TWI 98.4 3.1 1.5 1.4 1.6 1.5 1.5
EUR-PLN 4.36 -2.7 -2.2 -0.9 -1.4 -2.5 -2.5
EUR-HUF 339 -0.5 -2.8 -2.3 -7.2 -2.4 -2.4
EUR-CZK 26.2 -4.9 -2.6 -1.2 -1.9 -2.8 -2.8
EUR-RON 4.82 -1.2 -0.9 -1.8 -1.0 -0.7 -0.7
EUR-TRY 6.99 -6.2 -7.6 -9.8 -11.5 -4.5 -4.5
EUR-RUB 81.1 -14.9 -13.9 -12.1 -8.6 -14.3 -14.3
Returns are shown in domestic currency *Bloomberg Barclays index Source: iBoxx, Bloomberg, UniCredit Research
Prices on 12:30 - 13 Mar 2020
UniCredit Research page 2 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Major data releases and economic events of the week ahead
Date Time Country Indicator/Event Period UniCredit Consensus Previous
14 - 20 Mar 2020 (CET) estimates (Bloomberg)
Sat, 14 Mar US Northern Marianas Democratic convention
US Guam Republican caucus
Mon, 16 Mar 03:00 CH Industrial production (% yoy) Feb -3.0 5.7
13:30 US NY Fed Empire State Manufacturing Survey Mar 5.1 12.9
Tue, 17 Mar US Primaries in several US states (OH, IL, FL, AZ)
US Northern Marianas Republican caucus
10:30 UK Avg. earnings (% yoy, 3M MA) Jan 3.0 3.0 2.9
10:30 UK Earnings ex. bonus (3M, % yoy) Jan 3.1 3.2 3.2
10:30 UK Employment change 3M (thous.) Jan 120 140 180
10:30 UK Unemployment rate (3M, %) Jan 3.8 3.8 3.8
11:00 GE ZEW Survey - Current situation (index) Mar -38.5 -25.0 -15.7
11:00 GE ZEW Survey - Expectations (index) Mar -45.5 -20.0 8.7
13:30 US Retail sales (% mom) Feb 0.2 0.2 0.3
14:15 US Capacity utilization (%) Feb 77.1 76.8
14:15 US Industrial production (% mom) Feb 0.3 0.4 -0.3
15:00 US Business inventories (% mom) Jan -0.1 0.1
Wed, 18 Mar 13:30 CA Consumer price index (% yoy) Feb 2.2 2.4
13:30 US Housing starts (thousands) Feb 1500 1567
13:30 US Building permits (thousands) Feb 1500 1550
19:00 US Federal funds target rate (upper bound, %) Mar 0.25 0.75 1.25
19:30 US Powell holds post-FOMC meeting press conference
22:45 NZ Real GDP (% qoq) 4Q 0.5 0.7
Thu, 19 Mar TW CBC benchmark interest rate Mar 1.38 1.38
0:30 JP Consumer price index (% yoy) Feb 0.5 0.7
1:30 AU Unemployment Rate (% sa) Feb 5.3 5.3
4:00 JP BOJ policy balance rate -0.10 -0.10 -0.10
8:00 SZ Imports (real, % mom) Feb -1.8
8:00 SZ Exports (real, % mom) Feb 1.7
9:30 SZ SNB target rate (%) Mar -0.75 -0.75 -0.75
10:00 PO Industrial production (% yoy) Feb 2.1 1.1
12:00 TR Repo rate announcement (%) Mar 10.75 10.25 10.75
13:30 US Current account balance (USD bn) 4Q -108 -124
13:30 US Philadelphia Fed business outlook survey Mar 10.0 36.7
15:00 US Leading indicators (Conference board, % mom) Feb 0.1 0.8
Fri, 20 Mar PT Portugal sovereign debt to be rated by DBRS
SP Spain sovereign debt to be rated by S&P
BE Belgium sovereign debt to be rated by S&P
SP Spain sovereign debt to be rated by Moody's
8:00 GE Producer price index (% yoy) Feb 0.2
10:00 EMU Current account balance (EUR bn) Jan 33
11:30 RU Bank of Russia key rate (%) Mar 6.00 6.00 6.00
*Asterisked releases are scheduled on or after the date shown; sa = seasonal adjusted, nsa = not seasonally adjusted, wda = working day adjusted
Source: Bloomberg, UniCredit Research
UniCredit Research page 3 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Macro overview
Outlook revisions: the impact of COVID-19
Marco Valli ■ We have lowered our global growth forecast for this year to 2.0% from 2.7% in response to
Head of Macro Research
Chief European Economist the spread of COVID-19. We now see real GDP growth of 4.2% in China (previously 5.9%),
+39 02 8862-0537 0.1% in the eurozone (previously 0.8%), and 0.9% in the US (previously 1.2%). Within the
marco.valli@unicredit.eu
eurozone, forecast revisions are largest for Italy, which we now expect to contract by 2.3%
Daniel Vernazza, PhD this year.
Chief International Economist
+44 207 826-7805
daniel.vernazza@unicredit.eu ■ We see the trough in economic activity in China in 1Q20, and in Europe and the US in
2Q20. The eurozone will likely enter a technical recession in 1H20, with a small contraction in
1Q followed by a deeper one in 2Q. A rebound is likely to follow in 2H20.
■ A loosening of monetary, regulatory and fiscal policy should support a V-shaped recovery.
The ECB might expand its asset purchases again, while we expect the Fed to hit the zero
lower bound very soon and leave rates there through 2021.
■ The risks to growth are skewed to the downside, since the coronavirus may take longer to
contain than we expect, and underwhelming action from policymakers would weaken the
expected recovery.
Global
Signs of recovery derailed by The global economy ended last year on a weak footing, although at the turn of the year there
COVID-19
were signs of a bottoming-out (or stabilization) of leading indicators. The spread of COVID-19
has certainly derailed any recovery for some time.
The epidemic curve In China, excluding Hubei, it took roughly a month from the time that the cumulative number of
confirmed cases reached a hundred (22 January) until the number of new daily cases fell to single-
digits (25 February, at which time the cumulative number of confirmed cases had reached 12,874),
thereby depicting a relatively normal epidemic curve for the total number of cases compared with
previous discoveries of viruses that jumped from animals to humans. Several other countries appear
to be following broadly-similar epidemic curves to China, with some further along the curve (such as
South Korea, Italy and Iran) than others that are only just approaching the steep part of the curve
(such as the US, Germany, France, Spain and the UK). There are now 24 countries in the world
with 100 or more confirmed cases, and almost no country without a single confirmed case.
Flattening the epidemic curve In the absence of a vaccine, the only way to control the spread of the virus is to reduce the
rate of infection, which necessarily means reducing person-to-person contact for a period of
several weeks (people that survive the virus remain infectious for around two weeks before
they recover, when they are no longer infectious). Some countries have banned travel,
prohibited large gatherings of people, closed schools and shops, and quarantined individuals,
among other measures. China was successful in flattening the epidemic curve, as was Hong
Kong and Singapore, seemingly as a result of imposing what may have initially appeared to
be extreme measures that ultimately proved successful in containing the spread.
A big hit to economic activity Containment measures can save lives, which are unquestionably the highest priority, but can
be extremely disruptive to economic activity, in terms of both demand and supply. Factory
shutdowns and the knock-on effects of supply-chain disruption weigh on the supply-side,
while people staying at home weighs on aggregate demand, particularly through reduced
household spending. Heightened uncertainty and the “economics of fear” lead consumers to
delay purchases (of durables) and firms to defer investment.
UniCredit Research page 4 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
The effects can be exacerbated – and the expected recovery weakened – if the policy
response falls short of what is required, including automatic fiscal stabilizers (such as sick pay
and payroll tax relief), and term liquidity for firms, particularly SMEs, to bridge a period of
weak demand and supply disruption, and to avoid layoffs and the building-up of bad loans.
Our base case In our base case scenario, we expect the spread of the virus outside of China to accelerate
until April-May. This means that, statistically, the global economy will likely have an appalling
first half of the year, followed by a strong rebound in the second half, starting in Asia, and then
rolling through Europe and the US – erasing a good chunk of the damage. Even in our
relatively benign V-shaped central forecast, significant economic activity will be lost
(for example, forgone travel, meals out, lost factory output etc.). We have lowered our global
GDP growth forecast to 2.0% for this year (previously 2.7%), down from 2.9% in 2019. The
risks are skewed to the downside, since the virus may take longer to contain than we expect,
and a lack of action from policymakers may weaken the expected recovery.
China
Improving but not back to China’s growth rate is likely to roughly halve to around 3% yoy in the first quarter, or around a
normality
5% annualized contraction, due to the impact of the extension of the Lunar New Year holiday,
factory shutdowns and other containment measures. PMIs slumped to record lows in
February. With daily new COVID-19 cases in China, excluding Hubei, now down to a trickle,
the worst is probably over for China. GDP will likely rebound in the second quarter, but
containment measures will continue to weigh on growth. While state-owned enterprises have
returned to normality, the Ministry of Industry and Information Technology said last week that
less than a third of SMEs are back to normal (although around 80% of exporters are back to
work). Daily activity trackers show that the disruption to labor migration following the Lunar
New Year has now been fully resolved, but other activity measures such as coal consumption
at the country’s six largest electricity producers, freight and traffic volumes, suggest that up to
a third of output is not back to normal. A stronger rebound in the second half of the year is
unlikely to fully make up for the weak first half – there will be some permanent loss of activity.
Overall, for 2020 we expect GDP growth of 4.2% – down from our previous forecast of 5.9%.
Policy measures will support On the policy front, Beijing has adopted a combination of monetary, regulatory and fiscal
the recovery
measures to support the economy. The PBoC has activated a number of targeted lending
facilities, lowered the reserve-requirement ratio and cut the loan prime rate (LPR) by 10bp.
A recent State Council meeting called on the central bank to inject more liquidity for small and
medium-sized companies, with a special focus on export-oriented firms. However, given the
supply-side nature of the shock, the most decisive action comes from fiscal policy and
regulation. On the regulatory side, banks are entitled not to classify overdue loans as non-
performing, and they are encouraged to roll-over lending to firms facing liquidity problems. On
the fiscal side, Beijing is accelerating payments of unemployment insurance benefits,
expanding social safety nets, easing the tax burden for firms in the most vulnerable regions
and sectors (such as transportation, tourism, and hotels), and allowing for a temporary
suspension of social security contributions for firms. This will support the expected rebound
later this year.
Eurozone
Technical recession in 1H20 The hit to Chinese activity and the spread of COVID-19 in Europe has led us to lower our 2020
growth forecast for the eurozone just when the first signs of reacceleration in economic activity
were emerging. We now expect the eurozone to slip into a technical recession in 1H20, with
average GDP growth of only 0.1% this year, down from our previous forecast of 0.8%.
UniCredit Research page 5 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
We assume that the two shocks began to weigh on growth at the end of the first quarter
through both the supply and demand channels, and that their drag will intensify in the second
quarter, when GDP might contract by almost 1% qoq. This is likely to be the trough.
Rebound in 2H20 Importantly, we assume that containment measures across the eurozone will peak around mid-
April and start to be relaxed progressively over the remainder of the second quarter as the
epidemic curve finally flattens. If this hypothesis proves correct and headwinds to growth fade in
2H20, a meaningful rebound in economic activity might materialize from the summer onwards,
supported by receding fears among households and firms. The GDP rebound in 3Q20 could be
particularly strong and erase most or all of the drop recorded in the first half of the year.
Downside risks Risks are tilted to the downside. Early signs of normalization in Chinese activity bring some
relief, but the main concern is the trajectory of the spread of the virus in Europe, and the
policy responses by governments that this will trigger. Apart from the confusing US travel ban
on European travelers (except the UK), the trade-off is clear: bold and timely containment
would weigh heavily on activity in the short term, but would create conditions for a prompt
rebound once the virus is brought under control.
Italy worst affected Our forecast revisions are largest for Italy, which is the country that has implemented by far
the toughest measures aimed at containing the coronavirus infection. The Italian government
has already shut down all non-essential activities nationwide and this will take a heavy toll on
the country’s economic performance in 1H20, leading to an annual GDP contraction of 2.3%
this year (followed by average growth of 2.5% in 2021).
Severe measures in the rest Reflecting the lower numbers of infected people so far, containment measures in Germany,
of Europe would generate
a sharper V France and Spain have been much milder than in Italy, and we assume that further tightening
of these measures will not take them to levels comparable to those of Italy. However, this is
more a working assumption than a conviction call, because the epidemic curves in these
three countries look similar to that of Italy, with a lag of one-to-two weeks. Therefore, there is
a high, and rising, risk that the rest of Europe will ultimately be forced to follow Italy in
implementing stringent measures within a short period of time. If this scenario were to
materialize, we estimate that eurozone GDP would contract by 1.5% on a yearly basis in
2020, with a decline of close to 1% qoq in 1Q20 and a massive drop of about 4% qoq in
2Q20, followed by a rebound of similar size in 3Q20. To some extent, this would resemble the
"Lehman shock", but more front-loaded and followed by a much quicker recovery.
Fiscal policy easing Fiscal policy is likely to play an important role in mitigating the shock, more so in countries
that experience the largest damage to economic activity. In Italy, the government has
earmarked EUR 20bn (1.1% of GDP, which includes contingent financing) for a wide range of
measures to support activity and employment over the coming months. In Germany,
Chancellor Angela Merkel vowed to do "whatever is necessary" to limit the impact of the virus.
Finance Minister Olaf Scholz and Economics Minister Altmaier announced an unlimited
volume of federal guarantees to facilitate corporate lending and tax deferrals to improve
liquidity of companies. While fiscal measures can probably do little to cushion the drop in
activity in the short term, they will be very important in containing the second-round effects of
the crisis. Together with monetary policy, targeted fiscal action should be aimed at preventing
liquidity crises at firms from turning into solvency crises, while temporary labor-protection
schemes would allow firms to retain their staff without incurring excessive costs. This would
help create the conditions for a quick rebound in activity after the virus is finally defeated.
Given its extraordinary nature, such expenditure would be excluded from the computation of
the fiscal stance that is used when assessing compliance with the Stability and Growth Pact.
The ECB will come under The ECB’s policy response to the coronavirus outbreak has so far been targeted, with their
pressure to provide more
stimulus focus on supporting the banking sector via liquidity and supervisory measures, and easing
credit conditions for the private sector.
UniCredit Research page 6 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
To a large extent, this strategy probably reflects the fact that the central bank is closer to the
effective lower bound than its rate guidance suggests. We think that the ECB will soon face
data pointing to a severe contraction in economic activity with the inflation rate likely to quickly
approach zero. The Governing Council (GC) has probably already partly accounted for such a
scenario, but a further intensification of financial market tensions that lead to tighter financial
conditions would likely force the GC to provide more stimulus. In this scenario, the ECB might
prefer asset purchases to a rate cut.
US
US cases accelerating In the US, the number of confirmed coronavirus cases is now approaching the steep part of
the typical epidemic curve seen in other countries. While measures to reduce person-to-
person contact in the US are still at an early stage, more-extreme steps are likely to follow in
the coming days and weeks. These will weigh on personal consumption and on economic
activity more generally.
Cyclical slowdown Even before the spread of the coronavirus, we had expected US GDP growth to slow
brought forward
materially below its potential rate (of around 1.9%) this year, to 1.2%, with weakness
concentrated in 2H20. The coronavirus outbreak has made the projected downturn
frontloaded and sharper.
A sharp contraction in 2Q Overall, we have revised down our projections for US GDP growth for 2020 by 0.3pp to 0.9%,
while we have revised up our projections for growth in 2021 by 0.3pp to 1.2%, in part thanks
to a statistical carry-over effect from a projected-stronger end to 2020. The first quarter is
largely already baked into the cake: new coronavirus cases in the US did not intensify until
late February, and business surveys mostly held up well in the first two months of the year.
We have revised down our projection for 1Q20 GDP growth only slightly to an annualized
1.1% from an already-weak 1.2% previously. Weakness will likely be concentrated in 2Q,
when we expect to see an annualized contraction of 1.5%, based on our assumption that the
epidemic curve will peak in April-May and that containment measures will weigh heavily on
consumer spending and on already-weak business investment (the latter is also likely to be hit
by much-lower oil prices in the shale-oil industry). Growth is likely to remain anemic in 3Q, as
containment measures continue. We expect to see a decent rebound in 4Q20, with GDP likely
to grow by an annualized 1.8%, thanks to pent-up demand and firms rebuilding inventories.
Looking through coronavirus-induced volatility in GDP growth, we still expect the US to enter
an underlying cyclical slowdown this year as the past fiscal stimulus fades and trade-policy
uncertainty continues. How 2021 turns out will depend on the outcome of the November 2020
US presidential election.
The fiscal response has so far Ultimately, we expect the economic impact of the coronavirus to be fairly short-lived, but risks
been lacking
are skewed to the downside, particularly if the policy response is not well-handled. In this
respect, the fiscal response has so far been lacking. US President Donald Trump has
announced plans for a series of targeted fiscal measures, including asking Congress to grant
immediate payroll tax relief, directing the Small Business Administration to provide cheap loan
financing to small businesses affected by the coronavirus and instructing the Treasury to defer
tax payments for impacted businesses and individuals. But details are still lacking, and House
Democrats have rejected the White House’s payroll-tax-relief plan in favor of its own plan.
UniCredit Research page 7 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Oil
Edoardo Campanella We expect Brent prices to remain within the USD 35-40/bbl range for the rest of the year. In just
Economist
+39 02 8862-0522 a matter of a few weeks, the global oil outlook has sharply deteriorated. Demand for crude is
edoardo.campanella@unicredit.eu dropping by the day as the coronavirus spreads across the globe. In its March update, the
International Energy Agency has revised down its demand forecast for a second consecutive
Brent prices likely to stay month, penciling in a contraction of 90k/bd for 2020 — the first annual decline since 2008. But
around USD 35-40/bbl for the the IEA has warned that this might still be a benign scenario as the Chinese recovery might be
rest of the year
partly impaired by the slowdown in economic activity in advanced economies.
Price war In the meantime, the failed OPEC+ meeting has triggered a price war between Saudi Arabia
and Russia, with the former offering aggressive discounts (up to USD 8/bbl) to its European,
Asian and American customers and promising to flood the market with more than 2m/bd when
the output curbs expire at the end of March. But, longer term, Brent prices below USD 40/bbl
are no equilibrium for anyone. Some production adjustment will arrive via the least
competitive US shale producers turning the tap off — with the most cash-strapped ones
facing the risk of bankruptcy. Also traditional producers will be forced to act. Riyadh, whose
fiscal breakeven price is above USD 80/bbl, is playing hardball to force Moscow to decide
where to stand: either it cooperates with OPEC through deeper production cuts or the OPEC+
alliance will collapse. In the latter case, OPEC will go it alone and remove barrels from the
market, while the price that Russia will have to pay is a loss of influence in the Middle East
from its OPEC+ membership.
UniCredit Research page 8 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Fed preview
Daniel Vernazza, PhD
Chief International Economist
■ We expect the Fed to announce both a 100bp cut to the target range for the federal funds
+44 207 826-7805 rate and additional liquidity measures next week. We now expect interest rates to stay at
daniel.vernazza@unicredit.eu the zero lower bound through 2021. We do not expect quantitative easing (QE) to be
resumed unless the economic situation deteriorates further.
The coronavirus outbreak is Although there are few signs so far of a coronavirus impact in US hard data – because the
likely to hit the US economy
hard spread of the coronavirus in the US did not intensify until late February – the Fed has rightly
judged that the economic impact of the outbreak is likely to be large. In the words of Fed
Chair Jerome Powell, it will surely weigh on economic activity “for some time”. Anecdotal
evidence from the Fed’s Beige Book and company warnings, as well as the sell-off in financial
markets, bolsters this view.
Emergency cut shows intent to On 3 March, the Fed announced a 50bp emergency rate cut in order to counter the tightening
act quickly
of financial conditions induced by the sell-off in financial markets, to support confidence and
ultimately to do what the Fed can within its mandate and toolkit to support economic activity.
While the Fed knows that rate cuts are unlikely to provide much of a boost to economic
activity in the near term, as containment measures disrupt demand and supply, rate cuts will
help support the recovery once the virus is brought under control. As Mr. Powell suggested
last week, the response to the coronavirus outbreak must be multifaceted, with healthcare
officials on the front line and (so-far-lacking) targeted fiscal measures.
We expect a 100bp cut next At the FOMC’s regular 17-18 March meeting next week, we expect the Fed to cut the target
week and additional liquidity
operations range for the federal funds rate by 100bp, to 0.00-0.25%. There are three main reasons behind
this forecast. First, financial markets are now almost fully pricing a 100bp rate cut, and the Fed
will not want to disappoint expectations, particularly given recent huge volatility in financial
markets. Going against expectations would have the opposite effect of what the Fed wants to
achieve: providing confidence and looser financial conditions. Second, there is evidence, which
several Fed officials have cited, that, as the key policy rate approaches the zero lower bound, the
central bank should move more quickly than it otherwise would to add monetary stimulus. In a
speech on 18 July 2019, New York Fed President John Williams said, “When you only have so
much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic
distress”. The third reason is related to risk management. The downside risks of cutting rates do
not seem to be that big right now. Inflation is subdued – the Fed’s preferred measure of inflation,
the core PCE deflator, has been below the 2% target for several years, possibly leading to a de-
anchoring of inflation expectations – and if things turn out fine, the Fed can always reverse rate
cuts later this year. The Fed is also likely to announce additional liquidity measures next week,
possibly including a term auction facility, a program used during the financial crisis to offer loans
for terms of 28 to 84 days to multiple counterparties against a wider range of collateral and swap
lines with foreign central banks. On Thursday, the New York Fed announced that it would
conduct huge additional liquidity operations for one month, purchasing USTs in a range of
maturities to “address temporary disruptions in Treasury financing markets”.
We see rates staying at the Our revised Fed forecast projects that rates will stay at the zero lower bound through 2021
zero lower bound through 2021,
no resumption of QE even if GDP growth recovers later in 2020, and after the coronavirus shock proves temporary.
The central bank will want to achieve “escape velocity” to sustainably move away from the
zero lower bound, justifying keeping interest rates lower for longer. Also, the Fed policy
review, which is due to end around mid-year, will likely result in the Fed adopting so-called
“flexible average inflation targeting”, and that would also justify keeping interest rates lower for
longer, given that inflation has been below target. We do not expect the Fed to formally
resume QE unless the economic situation deteriorates further and stress in bond markets
builds. Long-term UST yields and mortgage rates are near historical lows. To buy assets
other than USTs and agency debt would require congressional approval.
UniCredit Research page 9 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Major events and data releases of the week
SNB target-rate decision (19 March)
■ After the ECB’s decision to not cut rates, we expect the SNB to remain on hold. The SNB is likely to intervene further in FX
markets instead of preventing further appreciation of the Swiss franc against the euro.
■ A stronger Swiss franc has contributed to the headwinds faced by Swiss exporters as a result of the coronavirus. Exports to
China, which account for about 10% of total Swiss exports, already deteriorated significantly in January (the latest month for
which such data are available). Swiss internal demand is also likely to weaken, at least on a temporary basis, as the
coronavirus outbreak will probably dampen transportation activity, tourism, etc.
UK
Labor market likely deteriorated at the start of the year
Tue, 17 Feb, 10:30 CET UniCredit Consensus Last
Employment Vacancies - rs
Avg. earnings (% yoy, 3M MA) Jan 3.0 3.0 2.9
thous.,change yoy thous., change yoy
1,000 200 Earnings ex. bonus (3M, % yoy) Jan 3.1 3.2 3.2
800 150 Employment change 3M (thous.) Jan 120 140 180
600 100 Unemployment rate (3M, %) Jan 3.8 3.8 3.8
50
400
0
■ We expect the UK labor market to have deteriorated at
200 the turn of the year. Regular pay growth likely eased by
-50
0
-100
0.1pp to 3.1% yoy in the three months to January.
-200
-150 Employment gains likely slowed to 120k for the three
-400 -200 months to January. The unemployment rate probably held
-600 -250 at 3.8%.
-800
Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 Jan-19
-300 ■ Over the coming months, as the spread of the coronavirus
leads to disruptions in supply and demand – these are
likely to be particularly more acute in some sectors, such
as air travel, retail and manufacturing – it will be important
to monitor the likely reduction in average hours and pay
and the likely rise in jobless claims.
US
Retail sales likely rose modestly before the coronavirus outbreak
Tue, 17 Feb, 13:30 CET UniCredit Consensus Last
Retail sales total (% mom) Retail sales total (% yoy, rs)
Retail sales (% mom) Feb 0.2 0.2 0.3
2.0 8.0
1.5 6.0
■ Retail sales likely rose 0.2% mom in February. The
coronavirus did not intensify in the US until late February.
1.0 4.0
■ Lower gasoline prices likely weighed on retail sales, while
0.5 2.0
unit car sales were flat on the month. Sales of building
0.0 0.0 materials likely benefitted from mild weather. Aggregate
-0.5 -2.0 payroll income growth was a strong 0.8% mom in February.
-1.0 -4.0 ■ The spread of the coronavirus will likely affect
-1.5 -6.0 discretionary sales in March, and these are only likely to
-2.0 -8.0
be slightly offset by some household stockpiling of non-
Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 perishable food items.
Source: Bloomberg, UniCredit Research
UniCredit Research page 10 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Industrial production probably rebounded, but trouble lies ahead
Tue, 17 Feb, 14:15 CET UniCredit Consensus Last
Industrial production (% mom) Industrial production (% yoy, rs)
3.0 6.0 Industrial production (% mom) Feb 0.3 0.4 -0.3
■ Industrial production likely rebounded in February, rising
2.0 4.0
0.3% mom and reversing a fall in the previous month.
1.0 2.0
■ The payrolls report projected a 15k increase in
manufacturing employment after a 20k reduction in
January. Above-average temperatures likely weighed
0.0 0.0
again on energy production, while lower oil prices likely
dragged on mining activity.
-1.0 -2.0
■ The near-term outlook for industrial production is very
-2.0 -4.0
weak. The coronavirus will directly affect production.
Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Supply-chain disruption will amplify this, and demand for
durable goods is likely to wane amid high uncertainty.
Source: Bloomberg, UniCredit Research
Dr. Andreas Rees, Chief German Economist (UniCredit Bank, Frankfurt)
Daniel Vernazza, PhD, Chief International Economist (UniCredit Bank, London)
UniCredit Research page 11 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Strategy overview
Updating our strategy forecasts
Elia Lattuga ■ Global markets have reacted sharply to the global COVID-19 outbreak. Measures
Co-Head of Strategy Research
Cross Asset Strategist announced with regard to monetary and fiscal policy have so far failed to halt a
+44 207 826-1642 deterioration in risk appetite. In spite of drawdowns of over 25% among global equities,
elia.lattuga@unicredit.eu
weakness might persist in the coming months. We anticipate that volatility will be high and
that risks still be skewed to the downside among risky assets for most of 2Q20.
■ As the end of the quarter approaches, we expect confidence in global markets to return in
anticipation of a meaningful recovery in economic activity in the second half of the year.
Cheaper valuations, lower policy rates and fiscal action will be seen in the context of a
less-risk-averse market, paving the way for a strong rebound in equities and risky exposure
while pushing long-term yields higher. The main risk to our forecasts would come from
economic weakness lingering into 2H.
■ We continue to recommend cautious positioning for 2Q20 and that investors remain
vigilant and ready to increase exposure, as we project that the Euro STOXX 50 and DAX
will be at 3,500 and 13,000 (an increase of approximately 30% from current levels) by
year-end.
■ The CHF and JPY are likely to remain firm in the coming months. We expect EUR-USD to
drift higher throughout the forecast horizon and reach 1.16 by YE20.
■ Bond yields might slip lower in the short term on the back of monetary-policy action and
risk aversion. Downward pressure should however be temporary and over by late 2Q20.
We expect 10Y UST and Bund yields to be at 1.15% (+25bp) and -0.40% (+20bp) by year-
end. Italy’s sovereign spreads will be molded by ECB support and recovery in risk appetite
in 2H20, on the one side, and by deteriorating fiscal metrics on the other side. We forecast
that the 10Y BTP-Bund spread will be at 175bp by year-end.
■ Risks to corporate credit spreads are likely to remain to the upside in the short term.
Especially in HY, these are likely to be more correlated with equity developments.
However, by year-end, we expect European HY to be at 450bp (-90bp from current levels)
and IG NFI to be at 60bp (-45bp). CSPP-eligible bonds should benefit from ECB support,
also in the short term.
UniCredit Research page 12 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
FI Strategy
Yields close to bottoming out – after 2Q the only way is up
Luca Cazzulani ■ We are revising our yield forecasts to account for the effect of the COVID-19 outbreak.
Co-Head of Strategy
(UniCredit Bank, Milan) Given our expectation of a V-shaped pattern in growth, we see further yield declines as
+39 02 8862-0640 likely in the coming months, although additional bond strength should be temporary and
luca.cazzulani@unicredit.eu
over by late Q2.
■ Beyond 2Q20, we expect risk appetite to improve, driving yields up. With policy rates
remaining at record lows, the US curve and to a lesser extent the Bund curve should
steepen. We expect 10Y UST yields at 1.15% and Bunds at -0.40% by the end of the year.
A wild week on markets This week has seen extreme market moves as investors have progressively factored in the
effects of the COVID-19 outbreak and its implications for the global economy. A surge in risk
aversion has sent government bond yields to record lows, with the entire US curve trading below
1% at some point. While the mood remains strongly risk averse, yields have rebounded
somewhat from recent lows.
With forwards pricing zero In the US, expectations of bold action by the Fed mounted. OIS forwards are pricing in a
rates by the Fed, extra support
for USTs from monetary policy probability that Fed rates will hit zero virtually at its next meeting. The long end of the US
is extremely limited… curve has moved in sync with money-market forwards. Although it is tricky to disentangle the
term premium, the message from Chart 2 is that 10Y US yields have already moved to price
in a substantial amount of Fed easing. Barring expectations of even stronger Fed action (for
example a new round of QE) the effect of monetary policy on yields has most likely run its
course. In the short term, declines in yields will be possible, mainly in relation to deteriorating
…while deterioration in risk risk appetite and/or further compression in the term premium. Given the solidly negative
appetite or term premium
correlation between equities and bonds, pockets of weakness in equities could well be a
compression matter more
factor pushing US yields further south.
USTs are facing some pressure because, being a traditionally liquid asset, investors in need
of cash are selling them as a first option. The Fed has promptly announced some temporary
measures that should help to address the issue.
Beyond 2Q: improving risk Going forward, we expect that 2Q will be the weakest quarter in terms of GDP growth, with
appetite versus low Fed rates
sentiment indicators starting to turn around mid-year. Beyond the second quarter, we expect a
V-shaped recovery, which should lead to an improvement in risk appetite. Accordingly, we
expect UST yields to rise reaching 1.15% at the end of 2020. This implies that bonds will only
in partly reverse the gains related to the COVID-19 outbreak, mostly because of monetary
policy having become significantly easier. With the fed funds rate at 0.25% and the 2Y trading
with an only small spread, the curve will remain significantly flat.
CHART 1: MARKETS THROUGH THE COVID-19 STORM CHART 2: 10Y YIELDS, TERM PREMIUM AND MM FORWARDS
3.0 0
100
10Y US 1Y1M OIS 10Y US TP (rs)
80 21Jan/21Feb
-0.2
21Feb/12Mar 2.5
60
-0.4
40
2.0
20 -0.6
0
1.5 -0.8
-20
-40 -1
1.0
-60
-1.2
-80
0.5
-1.4
-100
10Y 10Y US 10Y US 10Y 10Y 10Y 10Y 10Y 5Y5Y EUR 2Y
UST (ry) BE Bund swap OAT SPGB BTP infl swapsp 0.0 -1.6
Jun-19 Sep-19 Dec-19 Mar-20
Source: Bloomberg, UniCredit Research
UniCredit Research page 13 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Bunds have marked Bund yields have declined sharply on the back of a flight to quality, marking new record lows.
new records
The strong Bund performance has led to widening in credit spreads, including the Bund-swap.
In most cases, the widening has occurred with yields falling; BTPs have been an exception.
Money-market forwards have plunged dramatically, beyond August levels. At its last meeting,
however, the ECB decided to leave rates unchanged. The decision not to match expectations
as well as to behave differently from other central banks is a strong signal that the bar for
cutting rates is very high. We expect the ECB to keep rates on hold but with some risks of a
cut in the coming quarters. The lack of significant further easing and the fact that additional
QE will mostly be geared towards private securities should structurally remove some strength
from Bunds.
In the short term, we see room for lower Bund yields if risk appetite deteriorates further.
Based on our fair value model for real yields and breakeven (BE), we may see Bund yields in
the -1%/-0.8% area. Over a longer horizon, 10Y Bund yields below the depo are a stretch.
10Y yields to rise to -0.40% Looking beyond the short term, we expect Bunds to behave similarly to USTs: as risk appetite
by year end
improves, yields should gradually rise. The main difference is that the 10Y Bund is likely to
remain closer to the policy rate than in the US due to the effect of QE. Based on our model for
real yields and BE, 10Y Bund yields should be around -0.40% at year end. The rise in yields
should extend in 2021, possibly moving back into slightly positive territory. With respect to the
end of 2021, there is a risk that yields may be much higher (if the ECB policy review, coupled
with fiscal easing in the eurozone, leads to a significant reduction of scarcity) or much lower (our
inflation forecasts remain well below the ECB’s target and growth remains below potential).
BTPs: weaker fundamentals BTPs have been under strong pressure after an unfortunate comment by ECB President
versus improving risk appetite
Christine Lagarde during the press conference, with the spread shooting to 270bp. BTPs have
also suffered reflecting investors’ disappointment about the strong focus on private assets in
the extra-QE envelope. But even before the ECB meeting, BTPs were under pressure. The
widening has gone hand in hand with the more general repricing of credit risk premiums,
although it has been stronger in Italy than for other sovereigns because of the bigger
expected impact of the outbreak on the Italian economy and its weaker fundamentals. Going
forward, we expect BTP spreads to benefit from the general improvement in risk appetite. At
the same time, we expect GDP growth to be extremely weak in the first half of this year, which
will weigh on fiscal variables, possibly keeping investors concerned about rating implications.
Assuming that the debt/GDP ratio moves towards 140%, our model suggests a fair value level
for BTP credit spread north of 200bp. Considering the low rates/high liquidity environment, we
think the spread may fall below this level, but only moderately, and we expect the 10Y BTP-
Bund spread to be 175bp at the end of 2020 and then to reach 160bp in 2021.
CHART 3: MONETARY POLICY EXPECTATIONS IN EUROZONE CHART4: BTPS GET INCREASINGLY CORRELATED TO RISK
0.00 0.0 1.0 -0.9
10Y Bund 1Y1M (r.s.)
-0.10 -0.1 Crop.bonds
-0.8
0.8
-0.20 HY
-0.2 -0.7
0.6 Domestic equity (rs, inverted)
-0.30
-0.3 -0.6
-0.40 0.4 -0.5
-0.4
-0.50
0.2 -0.4
-0.5
-0.60
-0.3
-0.6 0.0
-0.70
-0.2
-0.80 -0.7 -0.2
-0.1
-0.90 -0.8
-0.4 0.0
Jun-19 Sep-19 Dec-19 Mar-20
17-Sep-19 17-Oct-19 17-Nov-19 17-Dec-19 17-Jan-20 17-Feb-20
75-day rolling correlation of 10Y BTP yields against respective indices
Source: Bloomberg, UniCredit Research
UniCredit Research page 14 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
FX Strategy
Volatility is back and is here to stay
Roberto Mialich, ■ We confirm our 4Q20 target of 1.16 for the EUR-USD, but volatility is likely to remain high,
FX Strategist
(UniCredit Bank, Milan) especially in 2Q.
+392 88 62-0658
roberto.mialich@unicredit.eu ■ The yen is again the safe-haven currency of choice, but we see any scenario in which
USD-JPY shifts below 100 as quite challenging, primarily for the BoJ. We have also
lowered our 4Q20 EUR-CHF target to 1.08 given the franc’s strength. GBP looks set to
stay firm on a deal-Brexit compromise.
When volatility comes The equity-market turmoil has had a clear impact on the FX market: the USD has been
to town…
penalized overall; the JPY has returned to being the safe-haven currency of choice; and
importantly, volatility has finally resurged, jumping to multi-year highs as shown in Chart 1.
Implied volatility seems set to remain higher than the exceptionally low levels investors have
been accustomed to in the past few months. Hence, while we have not made substantial
changes to our FX forecast, we expect to see more see-sawing over the weeks to come.
EUR-USD: still slightly firmer We confirm our 4Q20 target of 1.16 for the EUR-USD. After all, the Fed is expected to ease
and below 1.20
monetary policy more than the ECB by way of another 100bp rate cut, and this is likely to
weaken the USD further. The main risk we see here is that our 4Q21 target of 1.18 may be
approached earlier than anticipated, but we remain skeptical about embracing a scenario in
which EUR-USD shifts above 1.20. In trade-weighted (TWI) terms, the EUR has already
strengthened by nearly 3% since 20 February, when the USD started losing ground across
the board. Further and more-sustained strengthening not backed by substantial improvements
in the eurozone’s economic picture is unlikely to be tolerated by Europe’s authorities.
USD-JPY: towards stabilization The BoJ, which meets on 19 March (one day after the upcoming FOMC meeting), is probably
around 105
facing an even harder task. The JPY has appreciated by more than 6% in TWI terms since
20 February, with USD-JPY in particular tumbling from above 112 to the edge of the 100
baseline, a nearly 10% change in less than three weeks. Indeed, that USD-JPY returned to
around 105 is a clear sign of how currency markets are likely to remain volatile and
dependent on swings in risk appetite and monetary policy action over the coming months. In
any case, with the Japanese economy contracting by 7.1% in annualized terms in 4Q19
(mainly due to a sales-tax hike early in October), we doubt that the BoJ will easily tolerate a
sustained and long-lasting USD-JPY fall below 100.
CHART 1: IMPLIED VOLATILITY HAS FINALLY SURGED CHART 2: RISK-OFF HAS LIFTED JPY AND CHF (TWI)
30 108
EUR-USD 3M implied volatility USD-JPY 3M implied volatility EUR USD JPY CHF
25 106
20 104
15 102
10 100
5 98
0 96
2008 2010 2012 2014 2016 2018 2020 Jan-20 Feb-20 Mar-20
01 January 2020=100
Source: Bloomberg, UniCredit Research
UniCredit Research page 15 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
In a world where coordination among major central banks has become less stringent, solo
moves – a new liquidity injection, policy rates being placed further into negative territory or
even open-market intervention – can be less difficult to implement. On balance, we are thus
keeping our 4Q20 target of USD-JPY 105.
EUR-CHF: a bit higher but still The major revision we have made to our FX outlook is to lower our 4Q20 target for EUR-CHF
capped below 1.10
to 1.08 from 1.13. The Swiss franc has further appreciated as a safe-haven currency, keeping
EUR-CHF stuck between 1.05 and 1.06, even in front of the EUR-USD rally back to 1.14. The
reasons why the Swiss franc remains structurally strong are well-known. However, at the
same time, the SNB is likely to intervene further on the currency should EUR-CHF slip further
and approach parity again. As we have also penciled in a slightly firmer EUR-USD with
respect to its current spot level, a gradual rebound by EUR-CHF back to 1.08 by year-end
seems possible – if stock markets eventually find a base and build up in the meantime.
GBP: firmer on a deal-Brexit The assumption that a deal will be reached by the end of the year between the UK
(and despite the BoE’s easing)
government and European authorities (to avoid tariff barriers) and a the view that the USD will
be weaker per se allow us to keep our 4Q20 target for GBP-USD at 1.35 – even if the BoE
cuts the bank rate to 0.10% by the end of 1H20, as we expect. Due to the slightly higher
EUR-USD, EUR-GBP will also likely fluctuate again between 0.87 and 0.86.
Commodity currencies and the The three commodity currencies and the two Nordic currencies are expected to remain very
two Nordic currencies should
become firmer if stock markets sensitive to global equity markets, concerns surrounding Chinese growth and oil-price
stabilize and oil prices bounce dynamics. The RBNZ (now at 1.00%) and the BoC (at 1.25%) have more room to cut rates
back
further than the RBA (at 0.50%), and we expect them to ease further if needed (especially the
BoC given more Fed easing is likely in the pipeline). However, on balance, we are sticking
with our current FX forecasts.
EUR-SEK and EUR-NOK have confirmed their high-beta status with early gains, respectively
of beyond 10.50 and towards 10.00 respectively, having fully reversed as a result of both
market turmoil and the oil-price plunge. However, both currencies remain undervalued with
respect to long-term fundamentals. We believe that the trajectories for both EUR-SEK and
EUR-NOK remain tilted to the downside. The NOK may get additional help as soon as oil
prices rebound from recent lows.
USD-CNY: still seesawing Lastly, we are keeping our USD-CNY forecasts roughly around the 7.00 threshold. The
around the 7.00 threshold
exchange rate looks to be an indirect barometer of the ongoing Chinese economic crisis.
Indeed, we doubt that past peaks for this pair – of close to USD-CNY 7.20, which was
reached in autumn – will be tested again, unless the impact of coronavirus on Chinese growth
proves to be deeper and ends up lasting beyond 1H20. On the other hand, a drop of USD-
CNY to below 6.90 appears quite challenging as well, as the PBoC is unlikely to easily
tolerate a strong currency, as long as the Chinese economy tries to recover from recent lows.
UniCredit Research page 16 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
Equity Strategy
Difficult second quarter but good chance of a rally in 2H20
Christian Stocker, CEFA, ■ From a tactical point of view, we recommend continued investment caution going into
Lead Equity Sector Strategist
(UniCredit Bank, Munich) 2Q20. We expect an improved economic environment in 2H20, with positive equity market
+49 89 378 18603 potential of some 30%.
christian.stocker@unicredit.de
■ We have revised our strategic 2020 year-end index targets down: Euro STOXX 50 to
3,500, DAX to 13,000.
From a strategic perspective, we see high performance potential of some 30% for the Euro
STOXX 50 and the DAX to year-end. This compares to our revised 2020 year-end index
targets: Euro STOXX 50 3,500 (down from 3,850), DAX 13,000 (down from 14,000). Going
into 2021, we expect to see further positive index potential (based on our GDP forecast) and
room for further valuation expansion. However, it is hard to predict when the low in equity
markets will be reached given the uncertainty surrounding the further spread of the
coronavirus and related distortions to the economy. We think that the next few months will be
characterized by ongoing weak risk appetite and persistently high volatility. Against this
background, we continue to recommend a strongly defensive allocation. We have revised our
half-year targets for the Euro STOXX 50 down to 2,900 (from 3,400) and for the DAX to
10,500 (from 12,000). These half-year targets are about 5% above current levels. This reflects
our expectation that a more constructive view might evolve towards the end of 2Q20, and
economic prospects could brighten significantly in the second half of this year. In 2H20, we
expect a new bull market to likely emerge with recovery back to levels achieved over most of
2H19. In light of our positive year-end forecasts, we think that equity markets will offer good
opportunities in the next few weeks.
The current drawdown is in the From a long-term perspective, the median and average drops in the S&P 500 that have been
range of past market declines
associated with drawdown phases (we considered only drawdowns of at least 15% within a
24-month period) back to 1975 have been 20% and 28%, respectively. This would take the
S&P 500 down to the 2,450-2,700 range (which is the current level). The Euro STOXX 50 has
already dropped by 34% to 2,545 (close 12 March) from the high it reached on 19 February.
Recoveries since the US recessions in the 1980s have resulted in an average and median
rebound of 29% on a 6M horizon and an average 12M rebound of 38% (median 34%).
Therefore, upside potential of some 30% by year-end would not be exceptional (see Table 1).
TABLE 1: MAXIMUM DRAWDOWN AND RECOVERY SINCE 1975 CHART 1: PATH OF GDP AND INDEX EARNINGS GROWTH
Maximum Before and after
drawdown this date 6M rebound 12M rebound 4 40
estimates
-57% 3 Sep 2009 52% 70%
-49% 10 Sep 2002 21% 34% 2 20
-34% 12 Apr 1987 21% 27%
-30% 10 Mar 2011 29% 33%
0 0
-27% 1
12 Mar 2020
-27% 8 Dec 1982 43% 67%
-2 -20
Eurozone GDP, yoy in %
-20% 10 Nov 1990 29% 34%
UniCredit GDP forecast
-20% 24 Dec 2018 26% 37%
-4 UCG Euro STOXX 50 12M fwd.
-40
-19% 3. Jun 1978 21% 23% earnings est., in % yoy (rs)
-19% 31 Aug 1998 34% 48%
-6 -60
-19% 3 Sep 2002 5% 5% 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
-17% 27 Mar 1980 33% 43%
Source: Datastream Refinitiv, UniCredit Research
1
current drawdown since 19 February 2020
UniCredit Research page 17 See last pages for disclaimer.13 March 2020 Macro & Strategy Research
Macro & Markets Weekly
We have updated our index earnings model for the Euro STOXX 50 according to our adjusted
eurozone GDP-growth path, which forecasts a strong recovery in GDP in 2H20 and into 2021.
Against this background, we have revised our 2020 year-end targets only slightly. We expect
Euro STOXX 50 12M forward index earnings to go up by 1.5% yoy by the end of 20202.
This is associated with an index EPS level of 267, which represents a decline of 4% versus
2019 and is almost 6% below current consensus estimates of 283. Chart 1 shows our
expectation of the eurozone GDP trend and the Euro STOXX 50 forward earnings estimates
growth trend going forward. Our year-end index forecasts targets are based on the
assumption that the P/E level will normalize at 13.5 again, where it was at the end of 2019
(see Chart 2).
The Euro STOXX 50 P/E has The Euro STOXX 50 P/E valuation (based on 12M forward earnings) dropped to 10 on
declined sharply from its
recent peak but will likely 13 March, down from 14.7 on 19 February. Chart 2 shows that a drop below two standard
recover in 2H20 deviations from the 52-week average within such a short timeframe is an extreme outlier. In
the past when equity markets were confronted with such strong declines, a recovery back to
previous levels was not exceptional.
High equity-risk premium With interest rates falling to record lows recently, the yield gap3 between equities and bonds
supports our strong
recovery assumptions has widened significantly, to 10.7% on 13 March, the highest level since 2012 (see Chart 3).
We assume the yield gap will have narrowed again by year-end to 8%, which indicates a P/E
ratio of 13.5 (which is our baseline assumption). Any stronger narrowing to more-long-term
averages would imply even higher P/E ratios. The average yield gap since 2006 is 7%
(recently reached in January), which suggests a Euro STOXX 50 P/E ratio of almost 16 based
on our year-end FI forecasts.
CHART 2: EURO STOXX 50 P/E RATIO AND AVERAGE CHART 3: EURO STOXX 50 EARNINGS YIELD GAP
18 18 12
Euro STOXX 50 earnings yield vs. 10Y
German government bonds
16 16 Average over displayed period
10
14 14
12 12 8
10 10
Euro STOXX 50 6
8 52W moving avg. +/- 2 8
standard deviations
6 52W moving avg. 6 4
4 4
2006 2008 2010 2012 2014 2016 2018 2020 2
2006 2008 2010 2012 2014 2016 2018 2020
Source: Datastream Refinitiv, UniCredit Research
Sector allocation remains We are not making any changes to our European sector allocation at this point. In fact, our
strongly defensive
recommended sector allocation has delivered strong relative outperformance this year thanks to
its defensive positioning. We continue to favor the Food & Beverage, Health Care, Utilities and
Telecommunications sectors, which should be least affected by the current market turmoil.
2
Our earnings-growth estimates are based on a regression model comparing past GDP growth and earnings growth estimates from 2003 to 4Q19. We included our
GDP forecasts for 2020-21. The model has a solid R2 of 0.76 over the period 2003-19.
3
The yield gap serves as a proxy for the equity risk premium and measures the difference between the Euro STOXX 50 earnings yield (inverse of P/E ratio) and 7-
10Y eurozone government bond yields.
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