In last week’s commentary we covered mainly the initial outlook for equities. In today’s post we would like to present an initial outlook for other markets such as bonds, commodities, and foreign exchange.
Let’s start with the debt markets and the implications for fixed income instruments such as bonds:
– In the last six months of 2016 the yields started an upward trend. We anticipate that this trend may further push long term rates higher, but probably not beyond 2.80-2.90% . If that were to take place, Treasuries may not be very attractive since their prices move in opposite direction.
– Greater government spending and forthcoming higher deficits will result in greater issuance of Treasuries and subsequently lower bond prices and higher yields.
– As the economic outlook improves, businesses spend more on capital investments, incomes rise, unemployment drops, the Fed raises short term rates, and the government spends more money, a sense is built up that the headwinds become tailwinds, which in turn will push prices higher. In an environment of rising prices, bonds usually underperform.
– An investment implication of the above is that long dated TIPS (inflation protected bonds) are projected to outperform Treasuries.
– Another investment implication in the bond market is that as credit risks drops and businesses experience higher sales and profitability, some shifting between Treasuries and corporate bonds (in favor of corporate bonds) may be wise. Now regarding high yield bonds, while they become more attractive due to lower credit risk, their yields also drop. Consequently, it might be better to underweight them at least for now.
– As for municipal bonds we are of the opinion that they should be underweighted due to states’ finances and due to anticipated lower taxation that makes them less attractive.
– Regarding floating rate loans, we believe that given the current economic and financial circumstances, they may be one of the best instruments in the markets whose return could outpace that of many if not all fixed income holdings mainly because of a rising LIBOR.
– A more hawkish Fed (either due to new governors or due to economic developments) will lead to higher short term rates, which in turn will lead to tighter lending standards and ultimately to a reversal in corporate and investment sentiment, therefore
– Having said all of the above, we should also add that if policy uncertainty increases, the hat that reads “risk off” may be put on, which will shift capital from equities to bonds, driving yields down and bond prices up. Hence, vigilance is warranted.
Now, regarding metals and foreign exchange, here are our initial views at the start of 2017:
– The US dollar is in an upward momentum that is anticipated to last in the foreseeable future mainly because of rising rates in the US, higher spending and higher US growth, without of course neglecting that historically when the greenback is in an upward trajectory, that trend holds until the greenback is about 17-20% overvalued.
– The Euro on the other hand could be used as a growth redistributor. The interest rate differentials with the US tend to move it lower, the lower growth rate in the EU does the same, while politics cover it with a cloud of uncertainty.
– We also anticipate that the downward trajectory of the Japanese Yen will continue. This is due to expansionary policies in Japan, interest rate differentials, and rising inflationary expectations.
– The British pound is anticipated to face some headwinds in the beginning of the year due to the Brexit negotiations, but we expect that by year’s end it will recover and may even strengthen against the Euro and the US dollar.
– Finally regarding the Canadian and Australian dollars, our view is for some downward pressures. For the Canadian case, the excess capacity, excessive debts and declining exports are sufficient factors to hold the loonie down. The Australian case might be slightly different if metal prices recover, but overall we expect it to lose ground against the greenback.
– As far as commodities and industrial metals are concerned, our view is that oil prices should fluctuate between $44-58 per barrel while industrial metals may face some retrenchment in the beginning of the year (due to their significant strength lately) but could recover in the second half of the year, as Chinese reflation ignites again.
As a concluding remark, allow me to state that precious metals have intrinsic value and thus while being at the their current low prices should be viewed as anchors and hedges, therefore accumulation using dollar-cost average might be a wise tactic.
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