Financial Markets
The secular bond bull market is over. Safety is in a bubble. The shift from monetary to fiscal easing is the most likely candidate to prick the bubble in safety.
In this piece we revise our yield portfolio to increase its resilience to interest rate shocks.
We extracted the key factors driving currency returns; these variables approximate the dollar, EM spreads, and commodities. Any currency's sensitivity to these factors can be estimated, offering a great degree of flexibility for investors to generate trade ideas. Based on our macro views, this approach recommends being short commodity currencies and being long the dollar. The BoJ, BoE, and Riksbank are also covered.
A looming Fed rate hike will weigh on stocks over the coming weeks. One of the reasons cited for raising rates is the possibility that continued low interest rates are endangering financial stability. Historical evidence suggests that excessive financial deregulation, rather than lower interest rates, has been the primary cause of financial crises. In fact, easy monetary policy - to the extent that it leads to higher inflation and higher nominal interest rates - can actually enhance financial stability.
Fed policy - and, importantly, policy expectations' effect on the broad trade-weighted USD (TWI) - will dominate price evolution over the short term, as markets puzzle out if and when a rate hike is coming this year.
China's industrial sector is showing signs of regained strength. Odds of immediate fresh stimulus measures have declined, but Fed tightening will not become a serious policy constraint for the PBoC. Chinese stocks will not be immune in a broader global selloff, but the risk-return profile of this asset class is still favorable. Expect H shares to grind higher, albeit with increased volatility.
While we expect both direct and indirect exposure to generate solid risk-adjusted returns, favor direct given its overall portfolio impact, lower correlation to financial assets and better inflation protection.
Today's dangerous distortion does not result from credit excesses. It results from an irrational mispricing of risk caused by a protracted period of ultra-loose monetary policy. In turn, the ultra-loose monetary policy results from the dangerous dogma of the 2% inflation target. How should investors position short-term and long-term?
EM corporate credit spreads are too tight according to our fair value model. Such expensive valuations in conjunction with a strong sell signal from our Corporate Financial Health (CFH) Monitor signify that the EM corporate credit market is very vulnerable. The CFH Monitor currently heralds a major relapse in EM risk assets. A new relative value recommendation: long Russian and Chilean / short off-shore China corporate credit.
The median voter moving to the left has spurred paradigm shifts. These new regimes are giving way to transformational leaders who seek change by breaking convention. As they test their constraints and pursue their preferences, a cautious stance towards risk assets is warranted. In this Monthly Report, BCA's Geopolitical Strategy discusses Trump's recent comeback, rising EM political risk, and Italy's upcoming constitutional referendum.