Fed rate hike postponed

Signs of a pick-up in US growth are mixed and new doubts arose following the May job report. As a consequence, the probability of a Fed rate hike priced by the market has recently declined. In her speech on June 6th, Janet Yellen underscored that positive economic forces have outweighed the negative, implying a possible hike on July 27th. We keep our short duration bias on the US 2Y and US 10Y.

ECB’s dovish projections

At its June meeting, the ECB avoided a hawkish tilt and surprised with relatively dovish projections for both growth and inflation (only upgrading 2016 forecasts and leaving 2017 and 2018 broadly unchanged). It also left the door open for QE beyond March 2017.

The Eurozone is entrenched in a fragile expansion (economic momentum supported by economic sentiment and consumer confidence, rebound in oil) and the ECB should maintain a highly expansionary policy as long as the inflation target remains out-of-reach.

Firmer guidance should follow in September, when the ECB will present its new macro forecasts, which may show more clearly the effects of CSPP and TLTRO II. No decision was taken about reinstating the waiver, which would allow Greek banks to use Greek sovereign bonds again as collateral in ECB repo transactions.

EMU front-end core rates in expensive territory

We see limited value in 2 yr core rates, with German 2 year rates standing close to -0.6%. We therefore concentrated our underweight at the front-end, as stress surrounding Brexit could lead to further flattening of the curves in the short term. Fair values indicators continue to point to the expensiveness of core sovereign markets. Rates are close to historical lows despite a context of improving activity and inflation cycle.

Flow indicators (net negative flows) however are more supportive for sovereign debt in June, while investors positioning remains negative despite a reduction in long positioning.

A lower economic growth, deterioration of the fiscal position and credit rating downgrade by Moody’s (to Aa1) strengthen our negative view on Finland.

Neutral on peripheral debts except on Italy

Framework and flows dynamics are less positive for peripheral markets, even if these markets continue to be strongly supported by the accommodative monetary policy stance of the ECB. Carry remains a supportive factor. Moreover, we note that most investors have been net sellers of sovereign debts since the start of the QE (with the exception of the ECB) and have reduced their exposure to peripherals over the past three weeks. Recent widening in non-core spreads has raised some concerns about a repetition of the 2011 foreign investor exodus of non-core.

Among Non-core countries, liquidity dynamics deteriorated in Portugal (bid-ask spread widening).

We continue to reduce our overweight on non-core countries, with neutral positions in Spain, Ireland and Portugal.

Strong convictions on linkers

We still like the linkers asset class with a preference for the US. We have positions both on EUR and US linkers. The Central Banks monetary policy remains supportive (as both the ECB and the Federal Reserve keep their dovish bias) and the inflation cycle indicators turned more positive. In the UK market, linkers performance still continue to lag.

The ECB surprised with relatively dovish inflation projections (+0.2% in 2016 vs 0.1%, and +1.3% in 2017). Core CPI rebounded from a multi-year low seen in March. However, break-even inflation protection is less supportive for euro countries relative to the US.

In the US, the break-even inflation protection is firmly supportive (carry profile strongly positive on 3-month horizon) while multiple inflation indicators point to rising inflation. Lastly, we note an increased appetite for the inflation linked asset class since the beginning of the year.

Currency strategy

Neutral on EUR, USD & GBP

According to our internal model, the EUR is slightly undervalued against all major G10 currencies except the JPY. Market positioning is becoming neutral on the EUR and long-term drivers are supporting its appreciation.

However, we keep a neutral stance on EUR as well as on the GBP. The British pound remained under pressure following Brexit referendum.

Overall, we do not change our neutral position on the US dollar as our framework remains very negative. As of today, the US Dollar still appears overvalued vs all G10 currencies EUR, notably due to a high purchasing power parity.

In addition, we note more and more short positions on USD month after month in 2016.

Long JPY & NOK vs Short NZD

In Northern Europe, there should be room for a gradual appreciation of the Norwegian Krona, thanks to strong fundamentals and a rebound in oil.

Our cyclical & forex frameworks are very positive. We maintain our long position on NOK vs USD & EUR. Conversely, we remain neutral on the Swedish Krona, even if long term fundamentals are positive.

Long-term and tactical indicators (well-oriented purchasing power parity & investor positioning) point towards further JPY appreciation.

The Japanese Yen benefits from its safe haven status, also helped by a decision from Prime Minister Abe to delay the announced sales tax hike. We keep our positive bias on JPY.

The New Zealand kiwi is still penalized by the softness of the business cycle in China and long-term drivers indicate its overvaluation (high PPP). Our short position on the NZD is maintained.

This month, the Canadian dollar is well positioned, closed to its fair valuation and supported by a rebound in oil. We remain neutral on CAD as well as on AUD (overvalued).

Still aggressive on EM Forex

EMFX is the EM asset class with the highest sensitivity to global growth and external risks.

As near term EM risks have risen ahead of the EU referendum in the UK, EMFX volatility has increased in May and June and is likely to stay elevated until EM growth recovers decisively.

EMFX valuations are attractive on average and EM external risks (China, Commodity, Fed) have subsided.

As a resut, we are overweighted on the Argentinian peso as we believe Argentina rates and forex are supported by structural reform momentum and Central bank easing, and on the Brazilian real as the government is willing to implement structural reforms.

Conversely, we have a structural underweight on Asian forex.

Indeed, the Chinese yuan depreciated on a medium term horizon due to the liberalization of the capital account, forex regime and slower growth.

The Thai bath also depreciated because of the accomodatoive monetary policy and the deterioration in fundamentals.