Reactions to the Fed’s “hawkish” dot plot shift are still trickling in from all over the sellside, as everyone weighs in on what spiking bond yields and a soaring dollar will mean as we head into the new year and plunge headlong into what promises to be the “greatest” (if that’s the right word) political experiment in history.
Some of the commentary is more useful than others, but like it or not, this is a moment in history when the more opinions we consider the better off we’ll likely be give the indeterminate nature of our situation. I’m generally a believer in the whole “signal to noise” argument but right now I’ll try and ferret out the “signals” wherever I can find them and I think you probably should as well.
In light of that, here’s some post-Fed commentary from SocGen:
No Christmas cheer for Treasuries. The biggest surprise came with the Summary of Economic Projections, with three hikes now seen for the 2017 median versus two previously. The backend of the curve lagged on the bearish move that followed the release. This makes sense in the context of the hawkish tilt and what it represents in terms of the Fed’s apparent willingness to react to outlook changes to the dual mandate (perhaps less keen to let the economy ‘run hot’ than the market had been anticipating). We see little impact on our 2017 rates outlook, and continue to target 2.90% for 10yT and 3.65% for 30yT by end-2017. In the near term, this release may cap somewhat the potential for steepening in a scenario in which data start to realise the reflation expectations created by the Trump victory. We maintain our short bias in the 5y sector of the curve.
The equity space should be able to withstand higher interest rates — for now. The prospect of higher US interest rates should not trigger an equity bear market as higher bond yields, accompanied by an improving growth outlook and upward earnings estimate revisions, should prove a good mix. While in absolute valuation terms equities are no longer ‘cheap’, on a relative basis they still offer better value than government bonds. We expect the negative correlation between equity and bond prices in the US to stand, with bonds yield levels close to our expected range levels over 2017. The ongoing rotation theme should continue within equities, with value style the likely major winner in our view, at the expense of growth and quality styles. We also think financials should do well versus consumer staples.
Waiting for better entry points in the EM space. In a scenario in which the Trump administration starts to deliver on reflation expectations via tax cuts and infrastructure spending, we could see the market converging to the Fed dots scenario for 2017. For now, SG’s US economist continues to look for two hikes next year. The current skewed pricing of EM assets on the pricing of an aggressive Fed could bring opportunities to add into this the space later on in the year as fundamentals move back into the driver’s seat, pushing aside the currently negative risk sentiment.
