Policy

In recent travel, our clients remain focused on downside risks to today's range-bound markets. And for good reason. Uncertainty regarding Chinese reaction function is the biggest source of political risk in today's markets. We discuss it in detail in this month's report, along with an update on our views of Brazil, Russia, and Turkey. In addition, we examine the potential casualties of the European immigration crisis and the likelihood of Donald Trump becoming the president of the United States.

We still recommend a cautious stance on portfolio risk, for both credit and duration exposure, given that monetary policy expectations priced into Developed Market yield curves are already extremely dovish.

Over the coming two weeks, the G3 central banks will be holding key policy meetings that could prove instrumental in setting major FX trends for the next several months. What can currency traders expect?

Near-term, global yields will remain depressed, but the structural forces suppressing yields should abate and even reverse in the long-run. Slower potential GDP growth - and lower commodity prices - will eventually shift from tailwind to headwind for bonds. Stepped-up efforts to increase inflation will boost long-term nominal yields; populist politics and calls to curb income inequality will amplify this trend. Long-term investors should stay neutral global bonds for now, but prepare to shift to a structural underweight beyond this decade.

Are the arguments for overweighting European equities still valid? If so, overweighting relative to what?

Beyond the ongoing short-term rebound, EM currencies have more downside, and will depreciate by more than is implied by their forward rates on a 6-9 month horizon. This makes us reluctant to recommend buying local currency bonds to absolute-return investors. A new trade: Long Russian/short Malaysian equities. We also reiterate our short MYR/long RUB trade.

The Treasury market is now discounting too slow a pace of Fed tightening, while junk spreads are discounting too rapid an increase in the default rate. This week we examine the risk/reward proposition of temporarily leaning against some prevailing long-run macro trends.

Inflation expectations in the Developed Markets have been adjusting down to the lower trend of actual inflation, although the bulk of this adjustment now appears complete.

China will neither propose nor support any coordinated initiatives among central banks on the RMB issue in G20 meetings this year. RMB bonds will prove attractive to foreign investors, given their higher yields and lower exchange rate volatility.