Back to dovish

Long US Treasuries on the 10-year segment

Our interest rate framework turns more positive for the US Treasuries as the activity cycle is decelerating and the inflation is falling (Chart 2). As a result, in a process of normalisation of the rate environment, we consider that the Fed tightening could be a policy mistake. Thus we prefer to stay overweight on the long-term segment of the US curve. But the market has already strongly reacted since the beginning of the year. A mere 25-bp increase on the Fed Funds Futures markets is now expected for 2016. Thus, we are monitoring the level of the 10-year rates and could go back neutral in case of over-shooting.

Long New-Zealand rates

Among the developed countries with strong links to China and oil (Australia, Canada, N-Z), we think the Reserve Bank of New-Zealand Central is the most likely to ease its policy in the mid-term to face downward growth and inflation pressures. Indeed, the country is entering in recession and the Central Bank has room to further cut its cash rates (2.50%). According to our calculation of Taylor rule for different countries, the Central Bank rate is too high (Chart 3) . Thus, we diversify our global bonds portfolios with additional exposure to New- Zealand sovereign bonds.

Labour data are also improving with unemployment rate in the euro area declining to 10.7%. We however took partially profit on our non-core 

overweight. In Spain, volatility could increase as outcome of elections is unclear while market liquidity will be poor with general elections set a couple of days before Christmas. We remain prudent on Portugal as political instability would come back to the forefront in 2016. Additionally, we cut our overweight on France to the benefit of Latvia and Belgium given fiscal and valuation prospects.

CURRENCY STRATEGY

Long on CAD and SEK

The softness of the business cycle in China and the drop in oil prices have pressured commodities-linked currencies. In particular, the CAD suffered a lot and we decided to take advantage of the oversold levels to initiate a tactical long positioning on this currency versus the JPY (back to neutral from positive). Indeed, the oil markets initiated a tactical rebound which should benefit to the currency.

Less tactically, we maintain our long SEK. According to us, the RiksBank continues to adopt a too accommodative policy with a repo rate at -0.35% and aggressive quantitative easing program although the inflation is high relative to peers. We believe that the Central Bank will soon mitigate its easing tone leading to a strengthening of the Swedish Krona.

Still defensive on EM currencies

In a context of normalisation of the rate environment, EM currencies remain in their medium-term depreciation trend (Chart 4). Currencies of commodity exporting countries suffered the most with the temporary fall of oil prices below 30$ a barrel. Given this negative market sentiment, we remain negative overall on EM currencies and maintain a significant allocation to USD.

One of our biggest underweight is BRL with high idiosyncratic risks: the launch of impeachment proceedings against President Rousseff is a major issue slowing down the needed structural reforms. We remain negative on TRY as the currency appears expensive in a deteriorating external funding environment and high sensitivity to short-term portfolio flows. Political risks are also elevated and unlikely to fade completely in the short term.

We remain negative on many Asian currencies (MYR, THB for instance). Most Asian central banks have space to ease which can exert pressure on currencies. The hard landing of China also penalises its neighbours which are highly economically linked with China. We remain CNY underweight as we expect FX regime liberalization and slowing growth to usher further currency weakness. Yet, we favour other Asian currencies such as IDR and INR which benefit from the improvement of investor sentiment and an attractive valuation.