Asset Allocation
How big a problem are the non-performing loans in Italy and Greece? And what is the solution?
The near-term (next month or two) market dynamics in EM risk assets remain a coin toss. Beyond that the outlook for EM risk assets remains downbeat. EM financial markets are complacent and there are many potential negative EM/China developments that could derail the current EM rally. A new trade: go long the KOSPI / short EM overall equity index.
Most financial assets are trading within the confines of the feedback loop between markets and Fed policy. Investors should avoid expensive assets such as spread product, and hold positions with attractive long-term value such as U.S. TIPS over nominal Treasuries and U.S. Treasuries over German bunds.
Most financial assets are trading within the confines of the feedback loop between markets and Fed policy. Investors should avoid expensive assets such as spread product, and hold positions with attractive long-term value such as U.S. TIPS over nominal Treasuries and U.S. Treasuries over German bunds.
Like the economy, banks show no major imbalances. But the "glide path" for credit is slower than in previous cycles.
The dollar countertrend move has more downside, but beyond the next few months, the dollar remains in a cyclical bull market. Improvements in global growth, even if temporary, are likely to lift non-U.S. rates more than U.S. ones. The euro will benefit from that move as investors still have deep negative feelings toward EUR/USD, exactly as economic momentum has moved in favor of Europe. The SEK should outperform.
Saudi oil policy, like its defense policy, will be more aggressive and less predictable, following Deputy Crown Prince Mohammed bin Salman's apparent nullification of a production "freeze" deal at Doha.
The euro area's nominal GDP and wage bill are growing at 3%, suggesting that fears of deflation are overdone. But a higher wage bill has implications for profits growth.
EM/China growth improvements and the associated rally will falter on their own without tightening by policymakers. The short duration of these mini-cycles and a lack of observable catalysts make it impossible to precisely time selling out of EM positions. This makes us reluctant to chase the rally. Regardless how the impeachment process proceeds, Brazil is heading into a fiscal/public debt crisis.
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.