Financial Markets

It has been the perfect storm for a sharp appreciation in the Japanese yen. The immediate catalyst for the strengthening yen was the sell-off in global risk assets. However, the fundamental case for a stronger yen had been building for some time.

A rebalancing of oil supply and demand will lead to higher crude prices later this year. The Canadian dollar and Norwegian krone will benefit, but it is still too soon to buy these currencies versus the U.S. dollar. For now, we prefer to play the long side in the CAD and NOK <i>via</i> cross trades.

Plunging commodities have been driven by increased supply and falling investor demand, not a major downshift in physical demand. Stay neutral global equities. The earnings outlook remains uninspiring, but bottoming oil prices and continued monetary stimulus support valuations. The selloff in global bank shares reflects NIRP-related "income statement worries", not "balance sheet concerns" linked to deteriorating credit quality. Downgrade Treasury notes to neutral. The rally in bonds has brought 10-year yields near our long-standing, out-of-consensus target of 1.5%. 

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.

Rebalancing in the oil market later this year will arrest the negative feed-back loop driving markets' inflation, interest-rate and FX expectations, particularly for non-OPEC oil-exporting countries.

The Fed backing off from rate hikes is a necessary but not sufficient step toward putting a floor under global risk assets. Equity market breadth measures are still very weak, suggesting the selloff remains broad-based. The bear market in commodities/EM/China will likely culminate in a credit event. Downgrade Mexican stocks from overweight to neutral within an EM equity portfolio.

Global trade is plummeting as commodity prices remain depressed and emerging markets unravel. Even if oil were not plumbing new lows, we would remain bearish on EM economies, where poor governance and low efficiency suggest that more crises will rear their heads. Above all, we are watching China for policy clarity. After seizing 14% of global exports in recent years, it is now exporting surplus goods into an already deflationary world. Protectionism - not a coordinated response among leading countries - is the likely result. In essence, we reiterate our theme that globalization has peaked. Along the way, we call attention to five geopolitical "Black Swans" that <i>no one</i> is talking about.

This week we are publishing a new thematic chartpack <i>The BCA China Industry Watch</i> in an effort to monitor the growth profiles, balance sheet strength and stock market performances of major Chinese industrial sectors.

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.