Gov Sovereigns/Treasurys

We reveal what our most-trusted leading indicators are predicting about the major economies, and end with a provocative conclusion.

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.

Chair Janet Yellen's comments at Jackson Hole reinforce our view that a Fed rate hike is highly unlikely until December. The risk is that overbought equity and junk bond markets correct as an oversold dollar prices in a December move.

In August, the model outperformed the S&P 500 and global equities in both USD and local-currency terms. For September, the model increased its allocation to cash and trimmed its exposure to equities.

Investors are being forced into riskier asset classes by the TINA effect, but the gaping macro disequilibria makes it difficult for investors to see how we move back to equilibrium in a benign way. Monetary policy on its own is limited in its ability to soften the adjustment, but the good news is that the political pendulum is swinging toward fiscal stimulus.

Our primary argument for continued EM/China growth disappointments is that their credit growth is set to decelerate further and credit impulses will remain negative, depressing economic growth. Rising LIBOR could lead to a stronger U.S. dollar versus EM currencies. In Venezuela, the economic and financial situation will continue deteriorating hindering any further rally in its sovereign and corporate credit.

We put the odds of a Fed rate hike this year at slightly better than 50/50. But in the event of a rate hike, any sell-off in risk assets will be relatively short-lived and not as severe as the sell-off that followed the initial rate increase last December.

True inflation rates in the euro area and in the U.S. are actually not that different, making the polarized divergence in expected monetary policy very difficult to justify.

The global search for yield, not an improvement in EM fundamentals, has been driving the EM rally. EM/China growth conditions have stabilized but not recovered. Barring a full-fledged cyclical profit upsurge in EM EPS, EM stocks are not cheap at all. EM/China final demand for commodities will disappoint and will likely produce a major reversal in EM risk assets.