Valuations

We are introducing a new set of fair value models for currencies. On a cyclical basis, the dollar is expensive. However, this is not enough of a reason to expect an imminent fall in the greenback. The yen is extremely cheap, and its fair value is rising on the back of a positive terms-of-trade shock. The yuan is fairly valued. Most commodity currencies are not yet cheap.

Sterling has come under intense pressure since PM Cameron announced date of the EU referendum. Our bearish view on the British pound has not been based on a forecast of U.K. succession from the EU.

The remarkable admission by OPEC's secretary-general, Salem el-Badri, earlier this week that with "any increase in (oil's) price, shale will come immediately and cover any reduction" in output only hints at the larger impact of light-tight-oil (LTO) going forward.

This month's Special Report reviews the main factors driving the "lower for longer" bond yield view. A key finding is that the demographically-driven portion of the expansion in world capital spending has come to a virtual standstill, representing a major hit to underlying demand growth.

Credit growth acceleration in China is a bearish development in the long run. Potential non-performing loans at Chinese banks could wipe out 40-55% of their equity capital. "Muddling through" for China, from its own internal standpoint, is possible. However, Chinese stocks and China-related equities worldwide will remain in a bear market. From the perspective of the rest of the world, China is now in recession.

A near-term rally in risk assets now appears very likely. But we expect it to be cut short when the Fed eventually reacts to easier financial conditions by returning to a more hawkish policy stance. Investors should maintain a defensive portfolio allocation on a 6-12 month horizon, and remain overweight TIPS versus nominal Treasuries.

The deeply negative momentum in oil prices is fading, setting up the possibility of a counter-trend rebound in global inflation expectations and perhaps even the beaten-up U.S. High-Yield bond market.

Lean against rally attempts until leading profit indicators improve. The conditions for a tradable oilfield services rebound remain elusive. Capital markets may bounce, but we would sell on strength.

The agreement to freeze oil production should reduce tail risks, even if it does not improve overall corporate sector health and profits.

The recovery in global risk assets and currencies is a temporary oversold bounce. It is not supported by signs that global growth is on the mend. Consequently, we are not willing to embrace more risk in our currency strategy just yet.