Emerging Markets

The RMB has been steadily depreciating versus the U.S. dollar and has dropped to a new cyclical low versus its trade-weighted basket. All the while, Chinese domestic interest rates have lately drifted higher. When global investors wake up to these dynamics, global share prices and EM risk assets will likely sell off anew. In Mexico, initiate a new yield curve trade: receive 10-year / pay 1-year swap rates.

Economic disappointment will become the key theme in the second half of the year, driving a return to non-cyclical market leadership and a recovery in the growth vs. value ratio.

DXY can test 98 by July, creating a shorting opportunity: it will be hard for the Fed to increase rates more than once without causing an accident. If, it can, it is because global growth is stronger, hampering the USD's prospects. There's some rays of sunshine in Japan and we are closing our long AUD/NZD trade. A few words on the yuan.

While the Fed's recent forward guidance leading markets to increase the odds of a policy-rate hike earlier than previously expected will restrain the recovery in crude oil prices, fundamentals will dominate price formation now that markets have rebalanced.

The Turkish central bank has almost exhausted its foreign exchange reserve. It has been printing money to keep interest rates lower, and sustain the credit boom in the economy. Such policies are unsustainable and the currency will plunge anew. Currency depreciation will push up market-based interest rates. Stay short/underweight Turkish risk assets. A new trade: Short 2-year local currency government bonds.

The window for "stealth" RMB depreciation is likely closed for now. The Chinese authorities are stepping up efforts to boost infrastructure construction with several major announcements last month. Capital spending on transportation infrastructure will likely accelerate at least through next year.

Markets will remain stuck in a trading range, driven by two policy feedback loops: the Fed's and China's.

Both hawks and doves at the Federal Reserve, including Chair Yellen, have stepped up efforts to condition financial markets for a rate hike as early as June.

Long-term fundamentals are often poor predictors of the outlook for currencies over the subsequent 12 months. For shorter time horizons, investors should focus on the medium- and short-term currency determinates introduced in this <i>Special Report</i>.

While it is impossible to time the stock market, even a system whose results are slightly better than a coin-flip can still generate significant <i>alpha</i>. Overweight equities when valuations are favorable, growth is advancing, and financial conditions are easing. Stocks tend to do best when sentiment is bearish but improving, and the market has started trending higher without yet going parabolic. The outlook for U.S. stocks is rather mixed; Europe, Japan and China should outperform (currency-hedged).