US: Outlook for global asset prices rests on Fed’s next move - ING

In view of Viraj Patel, Foreign Exchange Strategist at ING, the flatness of the US yield curve has now got to an ‘eyebrow raising’ stage – with St. Louis Fed President Jimmy Bullard claiming that the yield curve could become inverted within the next 6 months.

Key Quotes

“Such a phenomenon would likely be taken by investors as a recessionary signal for the US economy – irrespective of whether that is a true reflection of the underlying economic reality. Equally, it would likely trigger a broader flight-to-safety within global markets – assuming that such dynamics were not already in play during the transition from a flat to inverted yield curve.”

“The sharp flattening of the curve – and clear lack of interaction between short-term and long-term US rates – leads us to posit that either one of two market dynamics are occurring: (a) investors are pricing in growing risks of a Fed policy mistake – such that the narrative of a growing US economy within the backdrop of short-term policy rate adjustments is no longer credible; or (b) the market is completely mispricing the strength of the US economy – as well as the current stage of the economic cycle that we’re in.”

“Both the economic and financial evidence lends greater support to the former; as we’ve pointed out before, markets have begun to price in the peak for the Fed tightening cycle – with the 3-year short-term OIS forward rates lower than their 2-year equivalent. Moreover, the extremely low US unemployment rate – and general length of the current economic expansion – would suggest that the cycle is nearing its end (fiscal stimulus is merely a shot of adrenaline to extend the cycle by a year or two). While we have been arguing that the USD will take its cue from the US economic cycle – irrespective of what the Fed does – we do believe that the outlook for global asset prices in general now rests on what US monetary officials choose to do next.”

“Tightening into a highly-leveraged late-cycle US economy could be a toxic combination for risky assets – one that should keep global risk appetite on the back-burner should the US curve remain as flat as it is. As a side note, yesterday’s news that the Iran will switch from the US dollar to the euro as its official reporting currency makes for interesting US-Iran nuclear deal talks (with President Trump set to make a decision on May 12).”