Marvin Loh – Managing Director, BNY Mellon Capital Markets, LLC
Chairman Bernanke spoke this week and essentially confirmed that he intended to let the tapering genie out of the bottle at last month’s Senate testimony. This caught us and the market off guard, as we were expecting a more dovish or, at worst, highly neutral tone. Instead, we got a hawkish view that tapering could begin as soon as the end of this year and be wound down by mid-2014 if economic conditions warrant. What we find difficult to understand is that the economy is far from stable, with the inflation expectations of the market, Fed and economists inconsistent with strong GDP growth. Instead we are going down the minority road that the chairman is asking the market to adjust the risk premia on assets, as he works on the legacy that he will take with him when he leaves at the end of the year. We also remain skeptical on any significant tapering, given that most of the world remains in an easing mode, an event that we think will accelerate later this year. To a certain extent, the market is reacting by adjusting risk premia, with practically all major asset classes selling off this week. If a stronger economy is in the cards, as the Fed is trying to convince us, we expect the riskiest assets of HY and equities to quickly find a floor as they are most leveraged to economic gains. However, we do not think we have capitulated to the downside yet, and expect volatility to continue throughout the summer. While real returns, fair value and relative values point to many cheap assets, we remain most concerned with unintended consequences in a highly interconnected financial system with low liquidity that seems highly susceptible to fund flows. From that perspective, we think caution is prudent until flows begin to show signs of stability. Read the full commentary now.
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