The rates market at June-August period is right to price in as a base case this year, with some risk of three. A little argument is seen with the 10-year yield in the 4.25% to 4.5% range, which is where we see fair value – we are neutral on bonds.
Equities and credit should benefit from some degree of a ‘Fed put:’ more easing if the labor market weakens, and slower or halted easing if the labor market stabilizes or financial conditions prove too easy for getting inflation back to 2% sustainably. Pricing out future cuts because the economy holds up should not be a major problem for risk assets; solid nominal growth is consistent with solid earnings.
The primary near-term threat to risk assets is that the Fed is already behind the curve and the economy deteriorates faster than the Fed eases. With initial jobless claims down year-over-year and consumer spending holding up, we see this as a relatively low probability. Still, upcoming jobs reports are critical, and our short USD position vs. the euro helps hedge a sharper US slowdown.
The Fed has shifted more dovish in response to increased downside risks to the labor market; this is positive for the economic outlook and supportive of risk assets. Global equities remain overweighted with a preference for the US and emerging markets. Government bonds are fairly valued, in our view, and remain an effective hedge if the economy deteriorates further, forcing additional Fed easing. Lower rates can increase foreign-investor demand to hedge US exposures, likely putting downward pressure on the USD. At the same time exposure to silver will retain stable, expected to continue catching up to gold amid tight deficits.
