Against this backdrop, we believe there is an opportunity for risk assets to move modestly higher, but we do not want to take too much cyclical risk. As a consequence, we are emphasising carry in our strategies – US high yield, European investment grade, and currency carry.
The US 10-year Treasury yield has rallied and is close to our target of 2.5%, so we have reduced our portfolio positions in US bonds. We still like having interest rate sensitivity in our portfolios given the ongoing risks to growth, but are now favouring positions which offer better carry, such as Korean rates versus Japanese rates.
In Q4, we judged that the US dollar was too expensive, and established positions that are negatively correlated with the US dollar, namely gold and emerging equities versus European equities. Within the US, we believed that small caps looked oversold, and added exposure to US small caps versus US large caps.
After the fall in US Treasury yields in December and January, we now see limited opportunity for further rate convergence between the US and the rest of the world. This leaves us more neutral on the US dollar. We are reducing portfolio sensitivity to a weaker US dollar by increasing our exposure to Japanese and European equities at the expense of the US and the UK.
The key risks to our view are:
A) World ex-US continues to decelerate
and / or
B) US rate tightening in Q2 as the US remains at full employment.
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