BNP Paribas: Beware the risks of a fragile goldilocks

Summary

Goldilocks firmly in place

• Markets continue to price in a Goldilocks environment with equities making further gains
• Environment underpinned by more stable, but generally moderate growth, contained inflation and dovish central banks.

But this remains a ‘fragile’ Goldilocks: two plausible scenarios could cause disruption

• Global economic slowdown, which would hurt equities, but support government bonds
• Overheating US economy, forcing the Federal Reserve to resume tightening and likely causing both bonds and equities to suffer

Asset markets currently reflect Goldilocks, but not its fragile nature

• Equities rallied again in April and are now up by roughly 15% so far this year
• 10-year US Treasury bond yield is close to 20bp lower

The US economy is still a bright spot

Despite growth stabilising in major economies, markets are now more comfortable with the notion that more stable US growth is ‘safer’ than the tentative European or Chinese stabilisation

Asset allocation

Neutral developed equities and government bonds, but tactically short both

• Central banks are supporting markets, but this year’s rally calls for caution in the face of prevailing risks
• We are tactically short DM equities and ‘core’ EMU bonds

Still favour being long carry

• The dovish tilt of the Fed and other major central banks continues to suppress market volatility, lower real yields and fuel investors’ search for yield
• We are currently long emerging market hard currency debt, which enjoys a high carry and is protected against EM currency weakness

Exploiting asymmetries and building robust portfolios

• Given the uncertain macroeconomic backdrop, we favour building robust portfolios via diversification trades at this point in the cycle
• We hold several positions/RV trades with interesting asymmetries such as long 5-year US Treasury vs. German bonds and long the French CAC vs. the German DAX

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