Refer to important disclosures at the end of the report

Taimur Baig Chief Economist taimurbaig@dbs.com

Duncan Tan Strategist duncantan@dbs.com

Please direct distribution queries to Violet Lee +65 68785281 violetleeyh@dbs.com

Recession risks

COVID-19 and a Russia-Saudi Arabia war of

attrition over oil have tipped the global

economy at a higher risk of recession than any

other period since the 2008-09 global financial

crisis. China’s measures to shut down factories

from mid-January onward will likely push down

production and cause supply side disruptions.

Even as infection rates fall and factories resume

work in China, the recovery will be sluggish,

unlike the V-shaped recovery expected by many

during the early phase of the outbreak. Services

make a majority of China’s GDP; loss of

activities in that area will be very difficult to

recover. Also, as the outbreak spreads

worldwide through March (and possibly

beyond), a new wave of negative shocks will

percolate through the global economy.

Our risk dashboard shows rapidly rising stress

across asset classes. The extent of stress is still

well below 2008/09, but the pace with which

stocks have sold off, credit spreads have

widened, and safe-haven trades have rallied

has been striking. This reflects how quickly

sentiments have had to adjust, and the amount

of lingering uncertainty about where all this is

going in the near term.

Our key focus is on EM and DM credit. As

commodity prices correct and growth outlook

dims, bonds from energy, transportation, and

tourism sectors are coming under pressure.

Despite lower interest rates, a credit crunch is

very much on the cards. Policy intervention

(liquidity injection and tax cuts, for instance)

may soften the blow, but is unlikely to backstop

credit risks until economies bottom.

Taimur Baig and Duncan Tan

DBS Group Research March 11, 2020

Economics & Strategy DBS Focus

Macro risk dashboard: downsides galore Economics/Strategy/Rates/FX/Equities/Credit/Commodities

• Our composite macro risk dashboard needle has decisively moved to red

• Downside risks to growth have spiked, reflected in the full spectrum of asset classes already

• The extent of stress is still well below what was seen in 2008/09

• Well capitalised banks are not at risk, in our view. But lower rates and rising credit risk are major headwinds to the financial sector

• The pace with which stocks have sold off, credit spreads have widened, and safe-haven trades have rallied has been striking.

• Global financial market dislocation could stem from credit, given the large debt overhang

Macro risk dashboard: downsides galore March 11, 2020

Page 2

Note: The three-coloured speedometers above represent our conclusions on the outlook prevailing in various markets, as reflected in growth data, pricing, spread, and valuation metrics charted in the rest of this publication. The composite score is an unweighted aggregation of the nine sub-categories highlighted above. Note that bullish fixed income sentiments do not necessarily imply a positive outlook, although periodically they do. At the current juncture, negative government debt yields in Europe and very low yields in the US reflect very comfortable borrowing conditions, but they are likely in response to a weakening growth outlook (i.e. the outlook is red).

Macro risk dashboard: downsides galore March 11, 2020

Page 3

Global Macro Landscape

A dramatic downward shift of the yield curve

as growth and deflation concerns mount

China’s policy easing has been swift but not

very large so far

A sharp rebound in recession risk

Note: Model uses the difference between 10-year and 3-month Treasury rates to calculate the probability of a recession in the United States twelve months ahead.

Poor data not out yet in the US and EU, but China’s dataflow foreshadows what’s coming

Note: Indices measure data surprises relative to market expectations. A positive reading means that data releases have been stronger than expected and a negative reading means that data releases have been worse than expected.

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

2.75

3.00

3.25

0 5 10 15 20 25 30

Years

US Treasury Curve% pa

Spot

End-2018

End-2019

Source: Bloomberg

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

Mar-19 Sep-19 Mar-20

China: Funding Rates for Banks

%

Source: Bloomberg

7D Repo - Interbank, 20D MA

3M NCD (AAA)

1Y MLF

7D Repo - PBOC

0

5

10

15

20

25

30

35

40

2018 2019 2020 2021

Recession Probability (New York Fed)%

Source: Bloomberg

-125

-100

-75

-50

-25

0

25

50

75

100

Mar-19 Jun-19 Sep-19 Dec-19 Mar-20

Economic Surprise Indices

Source: Bloomberg

US

Euro-zone

China

Macro risk dashboard: downsides galore March 11, 2020

Page 4

Macro Landscape (continued)

Fed is purchasing T-bills for reserve

management; ECB could increase QE size

Volatility in markets and pockets of funding

stress have tightened financial conditions

Note: Indices track the overall level of financial stress in money, bond, and equity markets to help assess the availability and cost of credit. A positive value indicates accommodative financial conditions, while a negative value indicates tighter conditions relative to pre-crisis norms.

China’s factories are operating well below capacity due to containment measures

Note: Movements in the Baltic Dry Freight Index gives insights into the demand for metals, minerals, grains and building material. Index acts as a leading indicator of global industrial production and economic activity. Market’s inflation expectations are plunging on shocks to oil prices and global demand

Note: Market-based expectation of long-term inflation based on 5Y forward 5Y inflation swaps.

Macro risk dashboard: downsides galore March 11, 2020

Page 5

China

Number of confirmed cases have levelled off

Shock absorption has shifted from FX (during

US-China tensions) to bonds (COVID-19)

Coal demand from major coastal power

generators, a widely tracked gauge of

industrial production, has started to stabilize.

PPI deflation worries appear to be easing.

Macro risk dashboard: downsides galore March 11, 2020

Page 6

Interest rates

Fed is priced to cut to the zero bound to boost

sentiments and buy time for fiscal response

Note: 2019 pricing is calculated as the spread between Jan19 and Jan20 Fed Fund futures. 2020 pricing takes the spread between Jan20 and Jan21 futures.

10Y real yields are at historic lows, signalling

much pessimism over the global outlook

Note: 10Y real yield is calculated as the spread between 10Y US Treasury nominal yields and 10Y breakeven. Breakevens are expected future inflation rates implied from Treasury Inflation-Protected Securities (TIPS).

ECB has less room to cut, needs to get more

creative with any incremental easing

Note: 12M ahead pricing is calculated as the spread between 1M forward 1M Euro overnight index average (Eonia) and 12M forward 1M Eonia. Extended for 18M and 24M.

BTP spreads are under pressure from COVID-19

outbreak in Italy and risks of fiscal slippage

Note: BTPs are treasury bonds issued by the Italian

government.

Macro risk dashboard: downsides galore March 11, 2020

Page 7

Currencies

USD has sold off lately, but traders’ positioning

is still constructive

Based on CFTC Commitment of Traders report.

Amongst major funding markets, cross

currency is seeing the most stress

Note: Measures USD liquidity relative to key funding currencies in FX swap markets.

FX vols have spiked after a long period of

dormancy

Different modes of COVID-19 impact - KRW via economic shock, IDR via financial volatility

Macro risk dashboard: downsides galore March 11, 2020

Page 8

Equities

US equity market appears to be expensive by historical standards

Note: Shiller PE ratio for the S&P 500 is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE).

SPX narrowly avoided entering a bear market (20% peak-to-trough). The pace of the decline has seen VIX spike to above 50.

Risk aversion is extremely elevated

Vol skew acts as a risk-aversion measure by comparing

demand for protective puts relative to bullish calls.

Macro risk dashboard: downsides galore March 11, 2020

Page 9

Credit

US credit spreads continue to surge, now wider

than in 4Q2018 when credit markets froze

Bank unsecured funding costs have jumped

Note: Measures USD liquidity in CD/CP markets.

EM credit spreads (USD) have jumped

Macro risk dashboard: downsides galore March 11, 2020

Page 10

Commodities

Commodities prices have softened on weaker

global economic outlook

Gold is being heavily bid as a safe haven,

especially when peers like Bunds or JPY are

yielding negative.

Price war amongst OPEC+ members have

driven up vols

Industrial metals prices have held up despite

the decline in China’s production

Macro risk dashboard: downsides galore March 11, 2020

Page 11

Sources: Data for all charts and tables are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations)

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