Multi-asset investments views - July 2019 - Will the Fed lose patience?
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US monetary policy outlook appears increasingly dependent on the medium-term outlook for US trade policy. We still expect negotiations to resume between the US and China after a meeting between their Presidents at the G20 summit on the 28-29th of June, despite recent hawkish rhetoric. However, the US is likely to continue to provoke further trade tensions over the coming 18 months with China, Europe and beyond, as part of the Trump’s political strategy. Given this uncertainty, it is not surprising that the Fed is providing no suggestion of an immediate cut ahead of its June meeting. Rather, Fed speakers and Fed Chair Jerome Powell stated that the Fed was monitoring trade developments very closely and would “act as appropriate to sustain the expansion”. We therefore expect the Fed to react to trade developments if necessary.
Markets have gone much further. The magnitude of rate cuts expected over the next 18 months is now quite aggressive and ranges from around 10bp for the ECB and 15bp for the Bank of England and Bank of Japan to around 50bp of rate cuts for Bank of Canada, the Reserve Bank of Australia and almost 100bp for the Fed, with nearly 3 cuts priced in by year-end. It is striking how the market backdrop has shifted from selective tightening to universal easing.
So much so that markets now strongly expect the Fed to cut interest rates as soon as July. Over the last 30 years the Fed has always cut when the market priced a cut on the day prior to a FOMC meeting. If the Fed does not intend to cut rates, it will have to drive market expectations for easing lower, and the previous instances suggest that equities and bonds react negatively as expectations for cuts moderate.
If the Fed does eventually cut rates, then history suggests that markets reaction will depend on the reason it is cutting rates.If the reason is weakening growth then this is not a good environment for equities overall (e.g. like in Jan 2001 or Sep 2007). If, on the other hand, the reason is to provide insurance against future downside risks even as the current growth backdrop remains resilient (e.g. like in Jul 1995 or Sep 1998), then these rate cuts would most likely bolster equity markets. Signs of a further deterioration of the global cycle are accumulating and the last employment report in the US, much weaker than expected, could be seen as another important signal in that direction.Therefore the margin of error for markets and the Fed appears now relatively narrow. In this context, we reiterate our preference for carry positions, essentially in High Yield credit and emerging debt, over equities. We don’t expect US Treasuries and the USD to move that much from current level given what is already priced-in.
Markets strongly expect the Fed to cut interest rates as soon as July
Source: Bloomberg, AXA IM Multi Asset Investments
Our key convictions:
· We remain prudent on developed equities given that risks have increased as trade negotiations between China and the US have taken a turn for the worse amid soggy economic data
· We remain positive on emerging debt and US High Yield as a more dovish Fed is supportive for carry positions
· We maintain Euro core government bonds at neutral: lower growth and falling inflation underpins prices
· Underweight EMU equities
· Positive EM debt and US High Yield
· Positive NOK versus AUD and CHF
· Long equity call options delta hedged to protect the portfolios where possible
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