Labor Market

The Brexit vote has ended the reflation trade, but does not represent a "Lehman moment" either. Stick close to benchmark in terms of broad asset allocation, and watch European bank CDS for signs that another financial crisis is brewing.

At current levels, Treasury yields are consistent with our assessment of fair value. Further, the Fed's Labor Market Conditions Index does not suggest an imminent recession. Expect payrolls to stabilize above levels consistent with further progress on wage growth and inflation, allowing the Fed to hike rates later this year.

Risk assets will take their cues more from the dollar than the Fed if the euro rises above its 16-month range against the dollar. Retain exposure to energy equities and gold.

The disappointing May payroll report does not foreshadow an imminent economic downturn. The Japanese government's decision to postpone next year's VAT increase and introduce fresh fiscal stimulus should help jumpstart growth. On the flipside, the Fed is likely to restart its hiking cycle in September and the Chinese government will crack down later this year on what it regards as excessive credit growth. More worryingly, the odds of Brexit have increased over the past few weeks. Go tactically short European stocks (in dollar terms).

In this <i>Special Report</i>, we revisit our list of signpost economic indicators introduced two years ago to identify if the U.S. and Euro Area were falling into a "Secular Stagnation".

Weak employment will push out the timing of rate hikes to something closer to BCA's view of a September increase. It is also supportive of our asset allocation call two weeks ago to overweight Treasuries.

The Fed's statement underscored its 'go slow' approach, with a June hike increasingly unlikely, but September and December still in play. The BoJ stood pat, reluctant to admit that NIRP was a flop soon after it was launched. Nevertheless, we expect fresh easing this summer. Chinese stimulus should last a few more months, but commodities will resume their structural downtrend thereafter. Remain tactically bullish risk assets; be prepared to turn more cautious in Q2.

The balance of risks favors accelerating wages and stable core inflation during the next few months. This will result in a move higher in rate hike expectations, benefitting Treasury curve flatteners.

We are confident that the reward/risk tradeoff to holding equities and high-yield corporate bonds is deteriorating and that rallies in these assets are high-risk affairs.