The Fed has shifted the debate into new territory, Credit Suisse’s Keating says
Giles Keating, head of research for Private Banking and Wealth Management at Credit Suisse, presents the results of the company’s monthly research.
Possibly the most interesting part of the Fed statement that shocked markets in mid-June was not the determination to wind down QE, but rather the fact that this decision was built on an above-consensus forecast of 3.25% for US GDP next year.
With this projection, the Fed shifts the debate about the economy into new territory, which some forecasters were already testing, but most still reject.
The Fed outlook is based, among other things, on the strength in housing and on the economy’s resilience so far this year in the face of a one-off
major fiscal tightening, and implies a clear shift in the trading range of US Treasury yields to a (significantly) higher level than before.
Investors may not be convinced, but it is authoritative enough to be given weight when setting portfolios. Broadly speaking, the Fed’s view is good news for reasonably-valued equities (e.g. in the US), since the adverse impact of faster monetary tightening should be more than offset by the beneficial effect of better earnings growth.
So the current dip in their prices opens up an entry point. It is bad news for assets where fundamentals are weak and prices had been boosted by liquidity- driven funds flow (e.g. heavily indebted corporate and
sovereign credits), and these should still be avoided despite
the price decline.
In the middle, an opportunity can open for debt and equity in emerging and developed markets with good fundamentals, but where prices had become too rich, provided the current sell-off removes that richness. If the Fed is wrong and the consensus is right, implying a soft economy and an exit
from QE slower than implied by Mr. Bernanke, then lower-quality,
interest-sensitive assets should recover somewhat; but more interestingly, reasonably-valued equities should also perform, making them a portfolio choice that is fairly robust, whoever ultimately wins the growth debate.
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