While many were panicking about a 2008-style bank crisis, we cautioned against such predictions. So far, our view has been right.
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While many were panicking about a 2008-style bank crisis, we cautioned against such predictions. So far, our view has been right. US equities have bounced back from the declines following Silicon Valley Bank’s failure, credit spreads have started to narrow, and US banks are using less of the Fed support facilities than a few weeks ago.
But it is not all smooth sailing…
Rates markets appear to believe a credit crunch is underway that will force the Fed into easing later this year. So, markets appear to be pricing the perfect outcome: a credit crunch big enough to lower inflation but not big enough to lower earnings. The big debate in markets is therefore who is right: equities or rates?
We see two potential outcomes, both bearish equities. Either the market pricing is wrong, and the Fed does not cut, which means higher yields and a hit to tech stocks and hence lower equities. Or the Fed does cut, which means a recession, an earnings hit, and weaker stocks. Therefore, we continue to underweight equities.
Elsewhere, we stay underweight bonds. The market appears to price a too-dovish Fed, and long-term yields could rise as US regional banks offload treasury holdings as their balance sheets shrink. Moreover, we still think the euro area has inflationary pressures, keeping pressure on the European Central Bank (ECB), while the Bank of Japan (BoJ) could exit its yield curve control (YCC) policy in its upcoming meetings.
For now, we stay neutral commodities. But we see potential for upside soon given more restrained oil supply in the Middle East, the upcoming maintenance period for Russian oil production and solid China demand.
Crypto has had a great start to the year. Bitcoin recently breached $30,000, and ethereum’s Shapella upgrade went smoothly. But given our view on risk, we are neutral on crypto.
Finally, we still favour an overweight in cash – our favourite asset in a world transitioning from low rates to high rates.
In terms of market themes, we continue to focus on these five:
- US and global banking risks. Rather than an acute banking crisis, we are likely seeing a chronic one. This suggests that deposits will leave regional banks, which means these banks will sell Treasuries (bearish rates) and reduce lending to commercial real estate (bearish CRE).
- Investors expect the end of Fed hiking cycle soon. We think inflation is still in the system, which suggests the markets are pricing too many cuts for this year. This could put upward pressure on front-end yields.
- Recovering China. Authorities are allowing more credit easing and exports have risen. This should support China equities and commodity markets.
- Broadening inflationary pressures in Europe. This should allow the European Central Bank (ECB) to continue to hike.
- The BoJ could adjust its YCC bands. New BoJ Governor Kazuo Ueda has not signalled an imminent change to YCC, but he could lay out a framework for an exit at this first meeting in late April.
What Is the Consensus on Asset Allocation?
As for consensus, we find many asset allocators have gone from underweight US equities to neutral and reduced their overweights on credit. In aggregate, they are overweight bonds, neutral US equities, overweight European and EM equities, and neutral credit.