“Front-end yields declining further from here would likely reflect economic deterioration that would likely overwhelm any bullish impulses on risk assets,” said Naufal Sanaullah, chief macro strategist at EIA All Weather Alpha Partners. “The extent to which a more dovish Fed can boost risk assets from here is likely limited, because the market is already discounting a quite dovish 2019 Fed path.”
The Detroit-based hedge fund is staying long emerging markets, reckoning that the damaging feedback loops from U.S. dollar strength have dissipated. However, the flattening 2019 trajectory for Fed tightening offers a good opportunity to hedge this exposure in the event the market begins to discount two to three hikes next year, Sanaullah said.
Powell’s early October comments did more than just spark a re-evaluation of how high short rates might get this cycle. The pain was even larger at the long end of the yield curve, with 10-year Treasuries battered, alongside the swoon in stocks. Higher discount rates can weigh on equity valuations, contributing to a lowering in the S&P 500 Index’s forward multiple. However, 10-year yields are now back below their Oct. 2 closing levels.
Any further downside for yields might need to be linked to negative developments for equities, such as weak data, concerns about slowing Chinese growth, or an escalation of trade tensions, warned Mayank Seksaria, chief macro strategist at Macro Risk Advisors.
“Further dovishness past this resetting of expectations would probably be driven by a much weaker economic environment, and that’s unlikely to be a good backdrop for stocks,” he said. “As we move out of the QE era, the response function from Fed dovishness should not necessarily be good news for risk assets for any prolonged period of time.”
“A really good risk-on-trade” now would be betting that the Fed’s dots -- in other words, three rate hikes -- will be realized in 2019, Seksaria said. It offers a very attractive risk-reward proposition even if the central bank only lifts rates twice, he said.
This article was provided by Bloomberg News.