Moments ago, just two days after it was closed out of its Top Trade for 2015 (“to be short EUR/$ via a 1.00 – 0.95 put spread (initially struck at 1.20-1.15 with spot at 1.25), which expires out of the money incurring a loss of premium”), Goldman released its first Top 6 Trades for 2016. For those who can’t wait to take the other side of Goldman’s clients, and thus the same side of Goldman’s prop desk, here they are.
Top Trade #1: Long USD vs short EUR and JPY
Go long USD against an equally-weighted basket of EUR and JPY at 100, with a spot target of 110 and a stop loss of 95. Annual carry is positive at around 1%.
The divergence between the Fed and both the ECB and BoJ will continue to be one of the more durable themes of 2016, in our view. In the US, we believe ongoing improvement in the labor market and resilience in domestic demand will ultimately drive a Fed tightening cycle that is more hawkish than the market is currently discounting. And in Europe and Japan, the fragility of their economic recoveries and lower starting point for inflation mean that the policy stance will remain dovish and will lean against the Fed. Currencies are particularly sensitive to this divergence pressure and, despite the strength we have seen so far, we believe the USD has more room to appreciate vs the EUR and JPY.
Top Trade #2: Long US 10-year ‘Breakeven’ Inflation
Stay long 10-year US break-even inflation (USGGBE10 Index), opened on 10 November 2015 at 1.60%, with an initial target of 2.0% and a stop on a close below 1.40%.
In the US, core CPI inflation is running just below 2%, and the more sticky service price components of the index are trending upwards, contributing more than 200bp to the headline reading. Yet, since the oil price crash in mid-2014, inflation expectations priced by the market have declined all the way out to 10-years. Currently, the inflation swap market prices that headline CPI will not reach 2% (the Fed’s inflation objective) until around 2020. Moreover, the option market assigns a 40% probability to CPI averaging less than 1% over the next 5 years. We think this represents an opportunity to take the other side of too pessimistic expectations by being long 10-year TIPS and short nominal Treasury bonds. Our view is predicated on the idea that continued above-trend growth will lead to a further build-up of wage and price pressures. In our central outlook, the drag to headline inflation from the energy complex should gradually reverse in the coming months.
Top Trade #3: Long MXN and RUB (equally weighted) versus short ZAR and CLP (equally weighted).
Go long an equally-weighted basket of MXN and RUB versus short an equally weighted basket of ZAR and CLP, with an entry level of 100, total return target of 110 and stops at 95. The expected return, including carry, is around 10%.
This EM relative value trade speaks to a number of our key themes in EM in 2016. It positions for (i) currencies where external balances have adjusted in recent years (RUB) versus those where more progress is required (ZAR); (ii) currencies (MXN and, again, RUB) that are exposed to crude oil where we see limited further downside under our central forecasts versus commodities tied to capital expenditure, such as industrial metals, where we see further downside (CLP, ZAR); and (iii) the short side is relatively more exposed to a slowing in China and the risk of a CNY depreciation. We expect a 10% total return including carry (about 1% on a 12-month basis).
