Inflation Protected
Some near-term upside in Treasury yields is very likely as flight to safety flows begin to unwind. However, given that global growth divergences remain in place, we will continue to look for an opportunity to increase duration on any meaningful back-up in yields.
Post-Brexit uncertainty will continue for some time. But we were already cautiously positioned, and would not go any more defensive.
Increasing uncertainty over the Brexit vote will keep the Fed from raising its overnight policy rate at this week's FOMC meeting, but it may not keep the USD from rallying in the event of a decisive win for Brexit advocates on June 23.
Assuming last month's weak employment report is not the start of a trend, the market is still discounting too low a probability that the Fed will lift rates this year. This means the Treasury curve should bear-flatten in the coming months, providing an opportunity to move to above-benchmark duration.
A Fed rate hike in June, July or September is likely to send our 12-month fed funds discounter toward 70bps by the date of the next hike. This re-rating of rate expectations will cause significant flattening at the long-end of the curve. Investors should enter a 5/30 flattener to profit.
There is a risk that global bond yields move higher in the near term, although we prefer to position for that move <i>via</i> cross-market spread, yield curve and inflation trades.
The U.S. dollar has fallen to almost 5% below its 2016 peak. In this <i>Special Report</i> we explore the impact of a weaker dollar on key U.S. fixed income markets.
To cheaply hedge against a "Leave" vote, go long U.K. inflation protection, reduce exposure to U.K. corporate debt, and position for a steepening of the Gilt curve.
Financial conditions will continue to ease during the next few months, and the Fed will use its June statement to prepare the markets for a rate hike in September.
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.