This year started with an unprecedented backdrop. The pandemic has led to an increase in global debt of roughly USD 20tn, due mainly to central bank monetary responses. During its December meeting, the Fed communicated very clearly about the evolution of its asset purchase programme, intending to do more for longer. The continuation of the monetisation process is a necessary element for the continuation of the still-early recovery: macro data has shown an improving trend recently but also volatility as pockets of weakness and uncertainties remain. Consequently, yesterday’s meeting was key, as the Fed needed to weigh the better macro data on one hand against the ongoing spread of the pandemic on the other. The New York Fed’s nowcaster expects 6% growth (annualised) over Q1 – but does the FOMC agree with this improving trend?
Apparently not. This time again, the Fed confirmed its accommodative stance, keeping interest rates unchanged, indicating no rate hikes for the foreseeable future and confirming that it will continue asset purchases as indicated in December. The improving macro situation was not referred to at all in its statement, which highlights instead how “the pace of the recovery in economic activity and employment has moderated in recent months”. Having said that, the Fed made its focus clear: the pandemic is the source of “considerable risks to the economic outlook over the medium term”. This means that with the recent pandemic figures – notwithstanding the fact that the US government needs low rates – the Fed sees a very small chance of changing the course of its policy. It now explicitly mentions the evolution of the vaccination programme as a trigger to its policy. The Fed has never been so “data dependent” in its century-long history.
Was the message dovish enough? This time, the only thing the Fed had to offer were words instead of deeds, a significant change from December. Given the exuberance of December and January, this could lead to an acceleration in the bearish trends seen of late. In the wake of this bearish evolution, the USD gained significantly: the now considerably more attractive carry of US bonds should cushion any future drop in the dollar’s value.
Markets were under pressure yesterday with deleveraging taking place. Following the statement’s release, the market reaction was muted across equities, rates and FX markets. During the press conference, equity markets continued to be under pressure and the USD was better bid as the message was seen as slightly more hawkish, notably around the 2021 outlook.
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 the current global dovish tone of central banks is here to stay. The Fed is ahead of its peers with its balance sheet now nearing USD 7.5tn and yesterday’s meeting leaves little prospect of seeing this number drop. Between its forward guidance and its asset purchase programme, its communications have been a boon for investors. This marginally more dovish statement does not eliminate the threat of a burst of market stress. With this in mind, our current dynamic assessment articulates around three dimensions:
Macro: Growth remains solid and inflation is on the rise. The longer-term picture is supportive for growth assets but also for inflation assets.
Market Sentiment: Sentiment is now very high for growth assets broadly, and this exuberance could lead to bursts of stress.
Valuation: Growth assets are expensive, while inflation assets have solidly repriced a reflation scenario.
From these three elements, our current dynamic allocation highlights that we should remain positive on growth-oriented assets, but not as much as in December because of stretched valuations and higher positioning. We have also reduced a portion of our inflation asset allocation as a temporary profit take.
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