Policy
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.
The Chinese manufacturing sector has remained under downward pressure, but the stress level has alleviated compared to a few months ago. The Chinese labor market will likely continue to deteriorate, which will force policymakers to stay accommodative. Despite the recent rally, Chinese investable stocks remain exceptionally cheap.
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.
Government bond markets have likely overestimated the degree of policy dovishness that is likely to be delivered by the major central banks in the next few months.
The odds of an inflation "mini-scare" are rising, although deflationary tail risks from abroad cannot be dismissed.
The U.S. and the global economies are improving. A synchronized upswing normally trumps the Fed in determining the path for the dollar. U.S. inflation expectations are likely to rise relative to the rest of the world, weighing on the dollar. The risks for EUR/USD have risen. We are hedging our long EUR/USD position by shorting the euro on some crosses. Buy CHF/JPY.
The contours of a deal to solve Italy's banking problems are starting to emerge. This is good news for European risk assets. Nevertheless, reviving Italian growth will require even more ECB easing. The appetite for radical measures is low at present, but this will change if euro area growth remains lackluster and efforts by Japan to introduce helicopter money policies prove successful.
The recent rally in risk assets is walking a very fine line. If the Fed turns more hawkish, or U.S. growth slows, it could fall over.
The 35-year bond bull market is coming to an end and the downward sloping trend channel for yields is changing to flat. Asset allocators should trim duration and fixed income exposure.