Weekly View – Yields inverted!

The CIO office’s view of the week ahead.

Last week, the 10-year US Treasury yield dipped below the yield on the 3-month bill for the first time since 2007, a year before the last recession. Should we be worried? Not excessively. Yes, the Federal Reserve has lowered its rates and growth forecast (just like the European Central Bank – ECB – before it), German manufacturing has slumped, and the Chinese economy is still in a funk. Yet we think that the signals sent by the yield curve have been distorted by central banks’ asset purchases of recent years. Rising inflation expectations point to some renewed upward pressure on rates and current market pricing of rate cuts is too extreme. But prolonged rate flattening is bad news for some equity sectors, notably banks. The clock is ticking, so we were happy to have booked some profits on equities, and equally glad to stay neutral on US Treasuries, in spite of the low yield.

And yet an important reason for not panicking over the yield curve is our forecast for a rebound in both the euro area and China in the second half of this year. To be true, the negative momentum in German manufacturing hurt equities at the end of last week. But we prefer to see the bright side of things. The IFO survey this morning on German business confidence was stronger than expected, increasing for the first time in six months. In addition, consumer confidence in Europe is also slowly rebounding as wages rise.

This week will be yet another ‘decisive’ week for Brexit. Parliament is set to vote on different Brexit options and Teresa May’s premiership hangs in the balance. The risk of a ‘hard Brexit’ (on 12 April, if May cannot get parliament to agree on her divorce deal) has definitely risen. But we believe that the closer we move to the end-point, the greater the possibility of some workable solution for all sides, possibly involving one or more extensions to the UK’s EU membership. But in the meantime, we remain underweight UK assets.

César Pérez Ruiz, Head of Investments & CIO

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