FICC

Special Report

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 Special Report 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.

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.

Oil markets will continue to be buffeted by Russian overtures to OPEC suggesting a desire to orchestrate a production cut-back, while uncertainty over the Fed's next move keeps markets on edge.

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.

Spread product performance has been foreshadowing changes in market rate hike expectations since early last year, and the recent bout of weakness means it is probably time for the Fed to temper its hawkishness.

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.

The Fed will upset the rebalancing of oil markets if it misreads the current sell-off as weakness in oil demand.

The declining correlation between risk assets and Treasury yields suggests that the market perceives monetary policy to be overly restrictive. Historically, this has led the FOMC to adopt a more dovish policy stance.

With inflation expectations declining alongside asset prices in almost every major economy, central banks can at least not make things worse by being more hawkish than necessary.