Accordingly, we continue to favour carry strategies via high yield debt, European investment grade, Italian bonds and emerging market currencies. This month we also upgrade equities, reflecting the stabilisation in earnings revisions and the fact that the rally so far has been under-owned. This view is tactical, however, as we have yet to see clear signs of a cyclical pick-up that would justify a more medium term uptrend. Indeed, we are still concerned that signs of a more pronounced slowdown could emerge later this year.
Reflecting the cyclical risks, we continue to balance our risk exposures with some exposure to rates given our view that inflationary pressures are under control; albeit we have trimmed duration and we could see US 10-year yields rise towards 3%. Having shifted into US 10/30 steepeners earlier this year, we also see value in gilts vs. Bunds as the gilt market has not rallied as strongly as German Bunds.
From a currency standpoint, we continue to like long USD vs EUR as a positive carry hedge against further cyclical deterioration in the rest of the world.
To the extent that there is potential for cyclical surprise, we view the US (where the Federal Reserve has moved to a proactively dovish stance in spite of a tight labour market) and China (where there has been some evidence of looser liquidity) as being the most likely sources. This leads us to favour banks in the US and China within emerging markets.
At this point, the biggest risk to our portfolios is that the US economy proves to be weaker than expected, as the US has been the main locomotive of global growth.
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