Inflation/Deflation

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.

Most scenarios point towards higher Japanese bond yields with valuations overstretched. Maintain a maximum underweight stance on Japan in global hedged bond portfolios.

The question of how far central banks should go in their efforts to boost growth is becoming increasingly controversial. In this <i>Special Report</i>, BCA Chief Economist Martin Barnes outlines his personal view that monetary policy has done enough. He will debate this issue with Peter Berezin, BCA Chief Global Strategist at next month's BCA Conference in NY.

More aggressive monetary and fiscal stimulus will be necessary to resuscitate the Japanese economy. While the BoJ's forthcoming review is likely to endorse the current policy stance, there is a good chance that Kuroda will open the door to more radical measures. These measures will push down the yen, giving Japanese stocks a lift in the process. Sentiment on the U.K. economy has gotten too bearish. We are closing our short GBP/SEK trade and going long GBP/JPY.

The deepening interconnectedness of the "global eco-system" brought front-and-center by NY Fed President Dudley will keep inflation at the consumer level synchronized in the world's largest economies. The importance of global variables in the evolution of local inflation rates will remain elevated.

Last week's blowout jobs report had the beautiful combination of strong growth and flat/rising underemployment rates. This supports our expectation of a Fed hike in December rather than one in September.Accelerating growth when the economy is approaching full employment suggests that the equity bull market is not over, though we are entering a more volatile phase.

A two-speed economy requires selective portfolio construction, favoring consumer-oriented and mainly non-cyclical industries. Put communications equipment on the high-conviction overweight list, and stay clear of refiners.

While the BoE and the Fed are increasingly committed to letting inflation expectations rise, the BoJ disappointed once again. The dollar and the pound are likely to experience broad weaknesses, while gold, the euro and commodity currencies have upside. USD/ZAR will fall further in the short term, but the cyclical bull-market is not over.

With the Fed more sensitive to how its policy affects the global economy, and <i>vice versa</i>, we believe monetary policy will remain accommodative to encourage U.S. and EM growth.

Eventually the easing of financial conditions will strengthen the Fed's resolve to lift rates. Rate hike probabilities will rise and risk assets will struggle to cope with higher Treasury yields.