CIO & Head, Global Fixed Income, Currency & Commodities
5 REALISTIC Surprise Predictions for 2018
Posted on December 21, 2017
The Central Banks raise rates more aggressively The markets are pretty complacent that the Fed, ECB, BOJ, etc…are content to be behind the curve. That they will allow growth to continue to accelerate and look the other way on the expectation that inflation will remain muted. But what if the tightness in the US labor market (4.1% unemployment rate; lowest weekly claims data since 1973) leads to higher wage growth? What if German wages surprise to the upside? And, what if asset price inflation spills over into the cost of goods and services? Or tax reform leads to a wave of corporate and consumer consumption? It’s hard to believe that the Central Banks will be so comfortable with the sizes of their balance sheets, their negative real policy rates and the volume of outstanding ‘distorted’ bonds with negative real yields ($8-9T!). We could very easily see the Fed raise rates four times, not three, and the ECB start the journey toward positive rates from MINUS 0.40%. It might also be enough for the BOJ to target 0.20–0.40% on 10-year JGBs instead of 0%.
US High Yield appreciates I don’t just mean that US high yield will post a positive total return, I mean that the yield on high yield will drop from 5.75% to 5.25–5.50% at a minimum. That even as the Fed raises the fed funds rate toward 2%, pushing Treasury yields higher, the yield spread on high yield will narrow by more than that. For example, if 5-year Treasury yields rise by 75 bps, I would expect high yield spreads to narrow by 100 bps. Corporate fundamentals look terrific as earnings are strong and the top line is growing. Tax reform will not only improve the earnings of corporate America but also give companies more financial flexibility. I wouldn’t be a seller of high yield until it is clear that a recession is looming…and that’s not on the horizon for 2018. BTW: European high yield and bank Additional Tier 1 (AT1/Cocos) still have a pretty good rally left in them as well.
The yield curve bearishly steepens The yield curve flattening trend makes complete sense: the Fed is raising rates amid unusually low inflation expectations, all while inflows from foreign QE are weighing on the long end of the market. But it just doesn’t feel sustainable. As growth accelerates with investment spending increasing and tax reform taking hold, market expectations of the terminal fed funds rate will have to rise from 2–2.25% toward 3%. By the end of 2018, we should see what real investors demand to fund the government once the price-insensitive Central Bank buyers disappear from the market.
Emerging Market Foreign Exchange appreciates vs the US dollar It is just assumed that a ‘normalizing’ Fed will provide ongoing support to the greenback. Lost in all of that is that the emerging markets are performing well. China has deployed a platoon of policies designed to improve growth and increase financial stability. As the developed markets grow, exports out of the emerging markets should accelerate. We expect emerging market real growth to accelerate toward 5% in 2018 from 4.6% in 2017. CEEMA and growth/equity sensitive Asian currencies look particularly attractive.
Gold returns more than Bitcoin Forget about that dirty paper money, that fiat currency that everyone has been using since the Nixon era, this is all about old money versus new money. The momentum is in cryptocurrency and Bitcoin, while the need for a hard asset in a flight-to-quality appears distant. I still like blockchain/digital currency/store-of-value innovations for the future as concepts for medium of exchange. But the mania today is reminiscent of past bubbles. Once the excess liquidity in the system is drained away, gold will make a resurgence.
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