- Were EM markets the first shoe to drop in the context of monetary policy normalization? That conclusion does not pass our test. But the poorer growth/inflation mix and central bank plans do make the financial envi-ronment more fragile. Lesson from the beach: pick assets more selectively, but diversify your hedges.
- There will be plenty of icebergs to navigate in Q4, such as the trade war (continued), the Italian ructions, US mid-term elections and final A50 negotiations. The world is a dangerous place, but sentiment and positioning lead us to re-weight slightly towards equities and credit, starting from our cautious allocation this summer.
- The next shoe to drop is maybe not where you think. We see only a modest rise in EUR core bond yields over Q4, but let us not forget that German Bunds have been the single biggest beneficiary of PSPP, which will end soon. We keep an underweight in EUR Govies. Stay defensive on BTPs into the May 2019 European election.
- We have seen enough decompression in EUR cash credit spreads for now. Investors have cut their long. We are moving from short to neutral, still preferring shorter but riskier credits. But the asset class will be a prime victim of policy normalization eventually, with sectors like US High Yield trading at very dear levels.
- We stay long cash but less so, and move back to small overweight in equities. Hard currency sovereign debt should be a target for those willing to bottom fish EM assets. Near-term dollar strength remains a drag in other EM sectors; G10 FX volatility has lagged EMFX volatility sharply, but may be about to catch up.
INVESTMENT VIEW Q4 2018 - THE NEXT SHOE TO DROP
There will be plenty of icebergs to navigate in Q4, such as the trade war (continued), the Italian ructions, US mid-term elections and final A50 negotiations.