Monetary
Value in the U.S. Treasury market is rapidly deteriorating, and the 10-year Treasury yield is now consistent with our fair value projections. Investors should shift from an above-benchmark to a benchmark duration stance.
Reduce portfolio duration to neutral, while also cutting exposure to European bonds (both in the core and Periphery) and Canadian government bonds.
Somewhat like 1998, the dilemma for the Fed is that the labor market is approaching full employment and may justify eventual interest rate hikes.
Central bankers fail to grasp that in a non-linear world, it can be futile and dangerous to set an over-precise target for inflation. Today, European banks are the victims of such misguided linear-thinking.
Despite its substantial decline, the 10-year Treasury yield still appears reasonably valued relative to our base case scenario of a flat or slightly weaker U.S. dollar. In this <i>Special Report</i> we outline our Treasury valuation framework, in which the dollar plays a key role.
With global bond yields converging toward the lower levels of the NIRP countries, it still makes sense to favor markets with higher nominal and real yields and steeper curves, like U.S. Treasuries (especially U.S. TIPS) and U.K. Gilts.
Stay cautious. The Fed is only beginning to acknowledge what markets already realize. Eventually, they will back off, which reduces the odds of a further sustained equity decline. So far, however, the central bank is lagging deflationary forces acting on the U.S. economy, markets and profits. The weak ISM surveys are consistent with this. The risk is that employment follows suit.
The BoJ's latest rate cut will not have much impact on the Japanese economy or currency. The BoJ and ECB are closer to the end rather than the beginning of their unconventional policies. The biggest policy event of the year will be a 180-degree reversal from the Fed. The divergence in monetary policies that drove the euro and yen lower is largely over.
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.