BNP Paribas AM: Rising US yields support USD

Summary

• As in February, US Treasury yields rose to the point where they ended up rocking markets, but this time the disruption was more visible in the US dollar and emerging markets than in equity markets.

• We see several factors for the rise: (i) US inflation and crude oil prices hit 2018 highs in April, (ii) US macroeconomic data have been robust enough for the US Federal Reserve to continue normalising its interest-rate policy, and (iii) rates markets have become more concerned about US Treasury debt issuance.

• The bar is quite high for further interest-rate increases in the near term, but when policy tightening does resume, we think this will not keep equity markets from rallying as long as the growth backdrop remains solid.

• The stronger USD reflects disappointing economic activity data in the G10 and emerging markets compared to the US. This is consistent with markets pricing in reduced expectations of central bank policy normalisation in Europe and Japan.

• Further USD strength is possible, but we doubt it can persist in the medium term unless the prospects for growth in the US continue to decouple from those for the rest of the world.

Asset allocation

• Our key asset allocation views have not changed. We remain long European equities, where we see more attractive valuations and good earnings fundamentals, while we remain underweight government bonds, mainly by being short German Bunds.

• In April, we took a long position in US bank equities versus the overall US index. This relative value trade should do well as banks typically benefit as interest income rises and as the economic recovery matures.

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