The rising yield and inflation story is back again as the main focus for investors. Recently various other events where in centre stage - such as concerns about protectionism - but rising commodity prices have been intensifying lately.
Two weeks ago the price of oil (Brent) was trading at USD67 per barrel and 10Y Treasuries were at around 2.78%. 10 days later oil reached USD73 per barrel and treasuries broke the 2.90% level. Oil is at its highest price since December 2014 and the US 10Y bond yields are within shouting distance of their mid-February highs, a peak since late 2013/early 2014. In the meantime, the probability (92%) of a June Fed rate hike is now almost certain.
In this context, we keep our short duration positioning and remain vigilant on an unexpected acceleration in inflation. At this stage, however, we do not expect the ECB to tighten its communication at the upcoming meeting but rather adopt a “wait and see” attitude until mid June.
Our current investment strategy on traditional funds:
grey : no change
blue : change
EQUITIES VERSUS BONDS
We have kept our exposure to equities unchanged.
- Global monetary tightening is progressive, but the US are tightening first given the accommodative fiscal policy.
- The Federal Reserve started its balance sheet reduction in October 2017, hiked in December 2017 and in March 2018.
- The ECB has recalibrated its programme, buying less bonds as of January. A rate hike should not occur before 2019.
- The escalation of tensions on global trade represent a new development and a major uncertainty.
REGIONAL EQUITY STRATEGY
- We are neutral on the euro zone region. The region still displays a robust economic expansion but activity indicators show some signs of weariness. The ECB remains accommodative, and is not in a hurry to become hawkish.
- We are underweight on Europe ex-EMU equities. The Bank of England’s more hawkish monetary policy stance has put a barrier to GBP depreciation, challenging overseas profit growth. “Brexit” negotiations remain a risk, while negotiations on new trade relations don’t seem to progress much. Britain also has a lower expected earnings growth and thus lower expected returns, this justify our negative stance.
- We have a neutral stance on US equities.
- We have trimmed our Japanese exposure towards neutral. Visibility on an accommodative policy mix and an above-potential expansion remain positive for Japan. But, the stock market is highly correlated with the JPY performance, which, currently fulfils a safe-haven role and appears disconnected from the accommodative Bank of Japan.
- We have become neutral on emerging markets equities. They are impacted by a tightening Fed and the geopolitical noise around the budding trade war between the USA and China. In addition, the high weighting of the tech sector (28%) is adding volatility.
- We are underweight on bonds and keep a short duration
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to show an uptrend towards 3% on the 10Y US government debt. In addition to rising producer prices, rising wages, fiscal stimulus and tariffs on trade could push inflation higher. The Fed will continue its hiking cycle beyond March.
- The overall improvement in the European economy could also lead EMU yields higher over the medium term (towards 0.9% on the Bund). The ECB remains dovish in its Quantitative Easing plans and is opposed to a strong euro.
- We have a neutral view on credit as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
- The on-going monetary easing represents an important support for emerging market debt.