Europe

Helicopter money is coming, and once deployed, will prove to be much more successful than most people imagine. Stay long Japanese and German inflation swaps. USD/JPY and EUR/USD are ultimately likely to reach 140 and 0.9, respectively, over the next two years. The U.S. economy will remain resilient enough to make helicopter money unnecessary but a strengthening dollar will greatly curtail the ability of the Fed to raise rates. Investors should overweight Treasurys relative to bunds and JGBs. Helicopter money will benefit gold as well as the beleaguered European and Japanese stock markets.

The Fed is accentuating bearish dynamics for the dollar over the next three to six months. The upcoming National Congress of the Communist Party of China provides Chinese authorities with an incentive to ramp up stimulus this year. The new Treasury semi-annual report pre-empts meaningful direct interventions to soften the yen. More than just Brexit risk is weighing on the pound.

Approaching the referendum on EU membership, what are the prospects for the U.K. economy and financial markets?

Special Report

The end of the Debt Supercycle will be a key theme influencing economic and financial trends for many years to come. Its hallmark will remain the inability of central banks to engineer a new credit cycle, despite extremely low interest rates. China is one of the few remaining countries where the Debt Supercycle has yet to end, and history suggests the catalyst for a turning point will be a financial crisis.

The reflation rally continues. Despite our bearish outlook for the year, we think the risks of the current rally lie to the upside given China's redoubling of stimulus at the expense of reform. Populist troubles are picking up in Europe, but we maintain our positive structural view and note that the migration crisis is slackening. Rather, the greatest risks of populism continue to flourish in the Anglo-Saxon world with Brexit and Trump.

Special Report

To cheaply hedge against a "Leave" vote, go long U.K. inflation protection, reduce exposure to U.K. corporate debt, and position for a steepening of the Gilt curve.

We discuss the technical and political problems with helicopter money, plus the near-term outlook for the euro area economy and markets.

The factors that drove the recent rally - Fed dovishness, China reflation, and a pickup in economic data - are largely over. 

Corporate earnings rarely shrink outside of economic contractions, so investors can be forgiven for worrying that we are on the brink of a global recession. Earnings-per-share (EPS) for the MSCI all-country world index are estimated to have fallen by 7% in the year to March, the fourth quarter in a row of annual decline (top panel). This is by far the worst performance since the Great Recession. EPS growth in both the U.S. and the U.K. (local currency) is deep in negative territory. Profit growth is still positive, albeit decelerating, in the Eurozone and Japan in local currencies (bottom panel). How much more downside is there? When will EPS bottom and how strong will the recovery be? These are obviously key questions for the appropriate equity weighting within balanced portfolios, especially given that stocks are not cheap, downside global growth risks abound and the FOMC is biased to lift rates. It is difficult to justify being overweight equities without seeing some profit relief on the horizon. In yesterday's Special Report, we took a top-down approach to projecting EPS for the global index, the U.S., the Eurozone and Japan. The rebound in oil prices and some positive economic signs out of China have raised hopes that the profit recession is close to the end. Indeed, the good news is that world EPS annual growth should bottom in the third quarter. However, the bad news is that the climb back into positive growth territory will take time. Barring very strong (and unrealistic) growth assumptions for the rest of 2016, investors should not expect positive year-on-year global EPS growth until early in 2017. Bottom-up earnings estimates currently are too optimistic. On a regional basis, U.S. earnings growth will likely trail both Japan and the Eurozone over the next two years, although much depends on currency movements (see the next Insight).

Absolute valuations on Euro Area corporates are not cheap, but there are relative value opportunities to take advantage of the ECB becoming a major buyer of corporates. Favor Euro Area High-Yield over Euro Area Investment Grade, and favor Euro Area corporates over U.S. corporates.