Japan

DM central banks are shifting back into easing mode, with the BoJ's surprise cut the most dramatic example. Japan's adoption of negative rates represents another deflation-fighting step, ultimately leading to a price-level targeting regime and debt monetization. While the real yen will ultimately decline, near-term strength would force more aggressive policy. Stay neutral global equities, preparing to decrease exposure on any sustained rebound. U.S. 10-year yields are still on track to reach our target of 1.5% by year-end.

Rising demand for U.S. dollars in EM and further yen depreciation, if it transpires, assures global exchange rate volatility will rise. Rising currency volatility, especially in the RMB, will push the global risk premium higher, weighing on global share prices. In Turkey, a wage-inflation spiral is unfolding and the central bank is behind the curve; the currency will plummet further.

Maintain an above-benchmark portfolio duration since, favoring markets with the highest real yields that stand out in a world where 65% of Developed Market government bonds trade with a negative yield.

It is highly unusual for equities to enter a bear market without the economy going into recession. Since we see the risk of recession as low, we recommend a neutral allocation between bonds and equities.

The setback in global financial markets has not been enough to persuade the FOMC to alter its stance. Although the Fed is signaling that the tightening cycle has further to run, the U.S. dollar is showing signs of fraying at the edges.