Fixed Income
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.
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 Fed is sending signals that another rate hike is coming, despite sluggish U.S. growth and modest inflation, while both the ECB and BoJ are facing questions about the ability to maintain the pace of bond purchase programs. Amidst all this uncertainty, bond risk premiums can rise further in the near term.
The Treasury curve will bear-flatten between now and a likely December rate hike. Beyond December, our strategy will depend on how the dollar responds to increased rate hike expectations. For now, maintain below benchmark duration and favor convexity risk over credit risk.
Disappointing ISM surveys could signal a growth consolidation.
That, in turn, would spur a correction in risk assets.
With recent comments strongly hinting that the Fed is on track for a rate hike in December, the dy-namics of the Fed Policy Loop make spread product appear extremely vulnerable.
The August payrolls report did not change our view that a Fed rate hike is likely in December, but not before that.
We reveal what our most-trusted leading indicators are predicting about the major economies, and end with a provocative conclusion.
Recent shifts in the Fed's policy stance are bullish for the dollar, negative for commodities and emerging markets, and positive for assets with a yield. They also suggest risk assets will continue to perform decently.
Given the rising odds of another Fed move before year-end, and the uncertainty that additional easing can be delivered in Europe and Japan, we re-iterate our tactical call to maintain a below-benchmark duration stance.