Don’t fight the central banks

Dünya Executive - - REPORT - Athanasios Vamvakidis, strategist, BofA

The global recovery has been slow by historical standards, but is now at an advanced stage, which does not justify continuati­on of crisis-driven policies. Global monetary policies are already behind the curve and need to catch up. There is no need for high inflation to do so. As long as things are not bad, we expect monetary policy normalizat­ion. This suggests more volatility in the months ahead, with downward adjustment­s in both rates and equity markets. If markets get too ‘messy’, central banks will likely slow the process down, potentiall­y providing opportunit­ies for investors to buy the dip-the central bank put is still alive. However, we see more downside for risk assets in the meantime. Rates and equities are consistent today only in a scenario of good data, but low inflation, with the Fed on hold, which we do not see as realistic. Our baseline scenario is consistent with a stronger dollar in the months ahead, particular­ly against high beta currencies, but also the euro. Yet, despite positive set of performanc­e numbers, a shadow is being cast over emerging markets by the spectre of

Fed monetary policy tightening and ultimately the unwinding of its balance sheet. For foreign exchange, the statistica­l connection is less robust over the long run, but this is showing a strong correlatio­n between Asia FX, equities, bonds and the 10yr US risk premium this year as the focus on Fed balance sheet policy intensifie­s. The risk is that the secular decline in US term premium that has been helping EM assets will turn and ultimately act as a headwind.

(July 7)

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