Christian Gattiker, chief strategist and head of Research at Julius Baer, said:
“The US Fed will finally update tonight on its rate decision and economic outlook. The Fed was always the saviour of distressed investors and banks; that is why apart from the performance around Fed decision days, some claim the S&P 500 would rather trade around 1200 than near 2000. And when looking at past tightening cycles this was always the time to pick up emerging market and real assets. Yet, this assumes that a major tightening is around the corner, which we seriously doubt.
“Reiterating the view that this will be a very muted one – if there will be one at all, see 1997 – implies that it is not time to chase beaten-down emerging market assets and commodities. This is a trade, but no investment, and in energy we are already halfway through from the August lows, according to our commodity analysts.
“A bounce in beaten-down assets, but no major reversal as this is not a likely start for a major tightening cycle. We continue to prefer US consumer-related assets as well as European domestic exposure to emerging markets and real assets.”
Emerging markets – to hike or not to hike
Heinz Ruettimann, Strategy Research Analyst Emerging Markets at Julius Baer, said:
“The question for investors and emerging markets (EM) is not whether the Fed is going to hike rates or not. The question over the next 12 months is whether there will be negative surprises (more hikes than expected) and which emerging markets are the most vulnerable. First, the Fed is not independent in its interest rate decisions. More hikes are unlikely as long as the European and Japanese quantitative easing programs have not ended. Second, EMs most vulnerable to higher rates run a current account as well as a budget deficit, have negative real rates and are dependent on commodity revenues. These are Brazil, Turkey, South Africa, Malaysia and Colombia.
“The Fed is not independent in its interest rate decisions and the first hike is already priced in. Generally speaking emerging Asia is less vulnerable to rate hikes.”
Foreign selling of US Treasuries continues
Markus Allenspach, head Fixed Income Research at Julius Baer, said:
“The big topic today is the Fed’s rate decision to be published at 2 p.m. local time. Looking beyond the Fed ‘noise’, we see two main themes emerging. Number one is the lack of a budget deal to prevent sequestration or even a government shutdown. A deal must be reached by the end of this month. The other topic is the net selling of Treasuries by foreign central banks.
“The chart depicts the 6-month rolling change in foreign holdings of US Treasuries. In July alone, China is said to have reduced its holding of US Treasuries by $83bn alone. Total foreign holdings of US Treasuries declined by USD 99 pressure on Treasuries have reduced the spread between government bonds and the swap rate to 1.3 basis points. To compare: the so-called swap spread is 34 basis points for German Bunds and Swiss government bonds, respectively.
“The collapse of the swap spread supports our view that ‘safety’ has become a relative term for bond holders in these days and that it is time to move back into segments that offer a higher yield.”