Fed emergency lending levels, while still elevated, have come off their peak. But confidence remains delicate, and we think market volatility may remain high in the near term. We recently moved bonds to most preferred, and lowered equities and the US dollar to least preferred.
Market confidence took a hit in March on sudden financial sector stress.
- Acute banking sector stress—punctuated by the failure of Silicon Valley Bank on 10 March—had sparked broader concerns over solvency, liquidity, and profitability.
- At the time, US Treasury yields fell sharply and bond futures shifted to price fairly sharp Fed rate cuts on worst-case expectations that a recession could be imminent.
But fears of a systemic crisis or credit crunch have since eased.
- US and European policymakers have acted swiftly to contain risks in the global banking sector, with coordinated liquidity measures and quick bank rescue deals.
- While we aren't fully past it, recent Fed data on bank deposits and the use of its liquidity facilities suggest the worst is over.
- The BofA MOVE index of bond volatility fell to 128 as of 11 May, down from a peak of 198.7 in mid-March.
Investors should also consider diverging outlooks for equities, bonds, and other asset classes.
- With all-in yields still high, we rate bonds as most preferred, and suggest investors lock in attractive yields now, with a tilt to quality bonds.
- We now rate equities as least preferred, with global stocks likely to deliver limited returns and high volatility over the rest of the year.
- We have moved the USD to least preferred, and instead favor the Aussie dollar, Swiss franc, euro, British pound, Japanese yen, and gold.
Did you know?
- In response to banking sector pressure, the Fed announced a new Bank Term Funding Program (BTFP), offering banks the possibility of taking loans of up to one year against US Treasuries and other collateral.
- Investors tempted to sit on the sidelines during periods of market volatility should know that this often results in being under-invested when a new sustainable bull market begins.
We have raised bonds to most preferred and lowered equities to least preferred. We think investors should lock in yield now, with a tilt to IG and HG bonds, while also considering more selective equity exposure in EMs (like China) or via sectors like consumer staples, industrials, and utilities. We expect USD weakness to continue, and suggest investors consider real assets like commodities and infrastructure, or alternatives like hedge funds and private markets.
Main contributors - Patricia Lui, Crystal Zhao, Eva Lee, Yifan Hu
Content is a product of the Chief Investment Office (CIO).
Original report - How do I position amid tighter credit conditions?, 12 May 2023.