Equities are still doing great, and vol-sellers remain in charge, driving the VIX steadily towards single-digit territory. In fixed income, a war of attrition is at play. The front-end is locked, but the long end can’t decide whether to sell-off. In preview, I think it will in due course, delivering the bear-steepener needed to sustain the burgeoning outperformance of value over growth—and cyclicals versus defensives—in equities. HSBC’s bond bull extraordinaire, Steven Major, is sceptical, but even he admits that the long bond might be in for a bit of pain in the near term. I’ll take that insofar as goes an endorsement for a self-proclaimed perma bond-bull. The devil as ever, however, is in the detail. Markets can probably be fairly certain that they have central banks exactly where they want them. Last week’s performance by Powell suggests that the Fed is kicking back from the table, with a dovish bias. Apparently, the Fed now wants to see a “persistent” and “significant” increase in inflation before hiking rates. This sounds an awful lot like the message from the ECB and the BOJ, and while I concede the BOE is in a different situation, but I’d imagine that Carney’s response to the facing the economy next year will be to do nothing. He seems to be quite good at that.
Read MoreIn a nutshell, this is what my models are telling at the moment: the three-month stock-to-bond ratios in the U.S. and Europe have soared, indicating that equities should lose momentum in Q2 at the expense of a further decline in bond yields. That said, the three-month ratios currently are boosted by base effects from the plunge in equities at the end of last year. They’ll roll over almost no matter what happens next. Moreover, the six-month return ratios are still favourable for further outperformance of stocks relative to fixed income. Looking beyond relative returns, my equity valuation models indicate that the upside in U.S. and EM equities is now limited through Q2 and Q3, but they are teasing with the probability of outperformance in Europe. Finally, my fixed income models are emitting grave warnings for the long bond bulls, a message only counterbalanced by the fact that speculators remain net short across both 2y and 10y futures. This mixed message from my home-cooked asset allocation models is complemented by a mixed message from the economy. The majority of global growth indicators still warn of weaker momentum, but markets trade at the margin of these data, and the green shoots have been clear enough recently. Chinese money supply and PMIs showed tentative signs of a pick-up at the end of Q1, a boost reinforced by data last week revealing that total social financing jumped 10.7% y/y in March.
Read MoreThe new year has started like the old one ended; volatile and with confusion among punters and analysts with respect to the notional Narrative™. The volte-face in expectations for U.S. interest rates is a good example. In October, eurodollars were implying a Fed funds rate of just under 3.3% in December 2019 and 2020. At the beginning of the year, they had collapsed to 2.6% and 2.4%, respectively, effectively pricing in an imminent recession, and Fed rate cuts in 2020 to counteract that. Indeed, at some point, the Fed fund futures were even pricing cuts this year, a position that was stung badly on Friday by the hilariously bullish NFP report. Although neither the Fed nor markets know where the terminal/neutral rate—not to mention that this is a moving target—I reckon that the past six months have given us a decent clue. Anything close to 3.5% probably is too high, while sub-2.5% is too low, at least as long as the economy remains in a more-or-less stable expansion. Looking beyond the navel-gazing that is U.S. monetary policy, I am warming to the idea that (equity) markets will pivot towards cyclicals at some point this year, but we are not there yet. Over Christmas, I toyed with the idea that the next shoe to drop would be a downturn in the (hard) global economic data. The numbers have already deteriorated, but I reckon that they could slip further.
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