Donay said the rebound in equity markets had largely been driven by a reversal in the excessive pessimism about the global economy, notably China, but further gains will be limited for as long as downwards revisions to earnings forecasts continue. However, a major reversal remains unlikely, given broadly robust global economic fundamentals,
In contrast, he said, bond yields are likely to move higher: “Sovereign bonds lagged the (recent) equity market rebound, with yields on 10-year US Treasuries initially rising only gently. Until recently, fears about deflation, linked in part to lower oil prices, were still dampening long-term interest rates. But this changed with very strong job creation data in the US last week, which, in conjunction with hawkish comments from Janet Yellen, considerably increased the likelihood of a Fed rate rise in December. “
The group expects long-term interest rates in the US to rise gradually to around 2.7% by the end of 2016 with only three interest rate rises between now and the end of 2016. Donay adds: “10-year treasuries are on track for a poor year in terms of returns in 2015 (only around 2%), but will likely remain attractive to protect portfolios against shocks to equity markets, given their negative correlation with equities.”
Donay also said that monetary policy divergence is likely to strengthen the dollar against the euro. He added: “The EUR/USD is now testing 1.07; a combination of Fed rate rise and ECB loosening in December could well push it below 1.05.”
