Goldman Sachs has six trades designed to capitalise on its forecast for faster economic growth and a stronger dollar, coupled with more uncertainty.
According to a Goldman note issued on Friday, global economic growth will likely accelerate, spurred by fiscal stimulus across the world and continued quantitative easing from the European Central Bank (ECB) and the Bank of Japan (BOJ), but offset by more uncertainty in politics and on Federal Reserve tightening.
That was likely to spur a stronger dollar and higher inflation across developed markets, as well as better fundamental support for select emerging markets, the bank said, adding that European dividends were set to outperform.
Goldman suggested six trades to play those themes.
1. Go long the dollar against the euro and the pound to play the divergence in economic performance as well as the political risks on both sides of the pond.
“While the solid shape of the U.S. economy and the prospect of some fiscal stimulus make a more compelling case for a tighter stance of monetary policy and a stronger dollar over the coming months, the recent political gyrations in Europe will continue to weigh on euro and sterling,” the bank said. “Brexit negotiations in the U.K. have not yet started and uncertainty around the outcome remains elevated.”
Goldman said it did not believe sterling was cheap yet, with a 25-40 percent drop from pre-Brexit levels needed to rebalance the U.K.’s external position. The U.K. has a large current account deficit of around 6 percent of gross domestic product (GDP); that must be financed with money from overseas, which may further pressure sterling.
At the same time, uncertainty over upcoming elections in euro-area countries will weigh on the single-currency, according to the note.
In a separate note dated Sunday, Goldman lowered its sterling forecasts to 1.20, 1.18 and 1.14 on a three-, six- and 12-month basis respectively. The sterling was fetching $1.2349 at 9:27 a.m. HK/SIN.
It also set its 12-month target for the euro at $1.00. At 9:28 a.m. HK/SIN, the euro was fetching $1.0602.
2. Go long the dollar/yuan to play a weakening Chinese currency, Goldman said, advising using the 12-month non-deliverable forward contract with an initial target of 7.30, compared with current levels around 7.07.
Goldman said that with dollar appreciation set to continue through 2017, the dollar/yuan would need to rise to keep the yuan’s level against its trade basket stable, carrying a risk of re-igniting capital outflows from the mainland.
It raised its three-, six- and 12-month dollar/yuan forecasts to 7.00, 7.15 and 7.30 respectively, from 6.70, 6.80 and 7.00 previously. It also now expected the pair at 7.60 at end-2018, compared with its forecast of 7.30 previously.
3. Goldman advised earning “good carry” in emerging markets and hedging the risk from China and a declining yuan.
To play that theme, it said to go long an equally weighted basket of Brazil’s real, Russia’s ruble, India’s rupee and South Africa’s rand, while at the same time shorting an equally weighted basket of South Korea’s won and the Singapore dollar.
The “good carry” candidates – the real, ruble, rupee and rand – offer generous yields and fundamentals were improving, according to the note.
“The ‘Trump tantrum’ of the past week put meaningful pressure on the four currencies, creating more attractive entry points, and – given that both India and South Africa were net oil importers, while Russia and Brazil were net oil exporters – the basket limited exposure to oil risk,” it said.
“On the short side, the won and Singapore dollar feature low carry, subdued inflation and – given both their high exposure to Chinese demand and their direct competition with China in the export market – allow us to hedge against the left tail risk that a build-up in Chinese debt results in a sharp depreciation of the yuan.”
4. Go long emerging market equities with insulated exposure to growth, specifically Brazil, India and Poland, without hedging currencies, Goldman suggested.
“We remain positive on the emerging market ex-China growth recovery story heading into 2017 and see a good entry point in expressing this view via emerging market equities,” the bank said. “Brazil, Poland and India offer an ‘insulated exposure’ to the emerging market growth recovery story, without being particularly exposed to China growth or U.S. trade policy.”
5. Play the “reflation” theme by going long U.S. 10-year TIPS, or Treasury Inflation-Protected Securities, “break-even” inflation and long euro 10-year inflation via swaps, it said.
Goldman expected that low base-effects from commodity markets would push up headline consumer inflation figures across the major advanced economies. At the same time, inflationary pressures would get stoked by large public sector spending in Japan, China, the U.S. and Europe, it wrote.
Higher inflation was likely to push up bond yields, a factor that would push up the value of inflation-protection related securities.
6. Go long Euro Stoxx 50 2018 dividends via a swap trade, it said.
“Equities may not benefit from the reflation as much as we would like, owing to already elevated valuations and rising rates capping upside,” the Goldman note advised. “In addition, equities have been, and are likely to stay, volatile owing to political risk and elevated uncertainty,” it said. “Dividends swaps are less high beta than equities but also have some sensitivity to better growth.”
It expected more than 10 percent potential return from its swap play, higher than the likely upside for the equity market.
—By CNBC.Com’s Leslie Shaffer; Follow her on Twitter @LeslieShaffer1