Strategy: Policy uncertainty takes over the baton amid global trade worries

Now underweight US high-yield bonds versus cash

23 Jan 2017

  • No imminent revival of global trade
  • Fed leaning towards three interest-rate rises
  • ECB will likely look through energy-driven inflation

In recent weeks financial markets have mostly looked at the expected positive impact of the incoming US administration: tax cuts, repatriation of company profits and more deregulation. This has now been discounted, we think. But policy uncertainty still reigns: President Trump has yet to present a cohesive economic plan. And there are still obvious differences of opinion between the president and the Republican-dominated Congress. Meanwhile, global trade could come under further pressure. Given the downside risks, we remain cautious, now implementing an underweight in US high-yield credit versus cash.


Ever since the financial crisis in 2008/09, global trade growth has been sluggish. According to the IMF the causes include overall weakness in economic activity, and particularly in business investment, the waning pace of trade liberalisation, growing political risks and the slower pace – and occasional reversal of – globalisation. We would add the reduced availability of trade credit due to financial regulation and China’s reduced competitiveness as a result of rising wages.

This is not something we see changing quickly. Sluggish growth in business investment is a truly global phenomenon. The number of restrictive measures on global trade has steadily risen in recent years. President Trump’s protectionist streak should not help either. Pressuring companies to invest in the US instead of abroad may benefit local employment, but it would also raise prices for US consumers. It would add to the slowdown in globalisation. Actual tariffs on imports, or a ‘border tax’ system for companies which would exempt exports from taxes and would no longer count imports as deductible costs, would further limit global trade. Obviously there is a risk of retaliation by other countries.

Brexit is also a risk to trade. UK Prime Minister May is leaning towards a hard Brexit: full control of immigration and an end to the jurisdiction of the European Court of Justice. This would cost it access to the EU’s common market and while the UK could negotiate trade deals with other countries and apparently this is on the agenda when May meets Trump, such deals take time to agree and furthermore the eurozone is the biggest importer of UK goods. Apart from a weak British pound, the consequences of Brexit have started to show up in higher inflation, a drop in consumer confidence and a slowdown in retail sales growth. The full impact is not visible yet.

Global trade has improved recently, but mostly in nominal terms, as price deflation has abated. But in real terms trade growth still looks sluggish, presenting a challenge for emerging markets. With advanced credit cycles slowing in some of these countries, we do not generally foresee a strong growth revival in these economies.


Above-trend growth in the US is clear from the low unemployment rate and emerging wage and inflation pressures. However, the increase in inflation has a flipside, limiting consumer spending to a somewhat modest growth rate unless optimism encourages consumers to dip into their savings. However, we doubt consumers are ready to do so as inflation and interest rates rise.

On the production side things look better at first sight with industrial production recording the first annual growth since August 2015. But manufacturing output, which is less volatile since mining and utilities are excluded, is stuck in the range of recent years. Confidence among homebuilders has weakened, but this is from a cyclical high. The slowing issuance of building permits has confirmed the downtrend and housing starts are essentially moving sideways.

Higher inflation could affect monetary policy. Several policymakers have argued for a couple of policy rate rises this year. It now looks like the consensus within the Federal Reserve is moving from two to three increases. A rate rise in June is now a given in the eyes of the markets, looking at the 74% probability priced into fed funds futures. Fed chair Yellen warned recently that it would be risky and unwise to allow the economy to run markedly and persistently hot. Waiting too long with removing accommodative monetary policy could cause inflation expectations and actual inflation to rise, making it harder to control. US equities dipped as Yellen spoke.

In the eurozone the ECB council meeting was keenly watched for signs of how the ECB would cope with relatively strong growth and rising inflation. Would the central bank wobble on its promise to maintain its asset purchases at EUR 60 billion until the end of the year? We had not thought it would as this measure had been announced only a month ago. Thus, the threshold for any changes or even tapering is high. For now, President Draghi has asked for patience. The euro fell as Draghi spoke, showing that markets took his remarks as dovish, but this was only temporary. We regard the ECB’s willingness to ignore rising inflation for now as important since it reduces the risk of a hawkish policy error.


In our Total Return strategies we have built in upward protection through option constructions. But in our broader asset allocation we have further lowered our exposure to risky assets, implementing an underweight in US high-yield credit versus cash. Fundamentals in this sector have worsened in recent years, especially leverage. Debt has risen and not just in the commodity sector. We think high-yield is overvalued and credit availability appears to be deteriorating.


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