Market expectations ahead of yesterday’s FOMC meeting were lower than for previous meetings. The Fed, as well as other central banks around the world, have done so much this year to cushion the significant macro and liquidity shocks that it has become hard to expect much more now that growth has normalised.
The current situation is delicate. First, considering the recent evolution of our Growth Nowcaster, the macroeconomic picture for the US economy has markedly improved since its trough in March 2020. Even since the September meeting, our US Growth Nowcaster has remained high and so has its media newsflow-based counterpart (our US Newscaster).
Of equal importance, Q4 has been a period of improvement or stabilisation for most countries. In the meantime, the pandemic’s second wave has been hitting Europe and now the US: the Fed had to balance both elements in its assessment of monetary policy. No one was expecting the Fed to become more hawkish, but the revision of its forecasts and dot plot was due to be scrutinised.
The overall still-dovish tone was well received by risky markets, while the US dollar and inflation breakeven edged higher. Following the statement’s release, the 10-year yield rose, reaching about 95 bps, while stocks remained steady. The 2y10y curve steepened to 82bps, the highest level since October 2017. All-in-all, the statement and projection seemed well anticipated by markets.
Asset Allocation Consequences
Monetary and fiscal responses following the COVID-19 crisis have been unprecedented in size and scale. Yesterday’s Fed meeting was further evidence that central banks will continue to do “whatever it takes,” supporting risk premia broadly. The Fed is ahead of its peers with its balance sheet now in excess of USD 7tn, paving the way for other central banks. The “qualitative outcome-based guidance” announced yesterday is another indication that, in spite of the apparent recovery in macro numbers, the Fed is firmly acting as a risk manager. With this in mind, our current dynamic assessment articulates around three dimensions:
Macro: Growth remains solid and inflation has now started to recover. The longer-term picture is supportive for growth assets while being increasingly more positive for inflation assets.
Market Sentiment: Sentiment remains positive for growth assets broadly. In the shorter term, we see this sentiment potentially at risk. For the medium term and given the level of the VIX, we are still of the opinion that the sentiment recovery is far from over.
Valuation: Valuations reflect lower rates and ongoing macro trends. We now need earnings to recover strongly to justify the expensive levels reached by equities.
From these three elements, our current dynamic allocation highlights that we should remain positive on growth-oriented assets while adding inflation assets and becoming cautious on duration.
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