As the Brexit effect continues to ripple through markets this week, sovereign bond yields have rallied to fresh lows and the US Treasury curve continues to flatten. Historically such aggressive falls in yields and the extent to which the US curve has flattened have indicated an approaching recession; we think it is a bit too early to call for a recession at this stage as moves have been amplified by global financial market uncertainty. However, we do not see any upside pressures in the short-term as concerns over global stagnation and further weak to mixed economic data will no doubt dampen already fragile market sentiment. In fact, the relatively cautious minutes from the June FOMC meeting released yesterday indicate a further delay in rate hikes and an even more gradual pace to future rate rises, with repeated reference to the “uncertainty”.
After a couple weeks of hawkish comments from Fed members, Fed Chair Yellen stepped out for the first time since the last FOMC meeting mid-month and remained true to herself; maintaining her dovish credentials. A cautious approach in adjusting policy was the theme of her speech which she delivered at the Economic Club of New York yesterday. She highlighted that a cautious stance is “warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric”. Like us, she noted that domestic inflation is “somewhat more uncertain” adding that although there have been signs of pick-up, US economic indicators remain “somewhat mixed”. With increasing global uncertainty, Yellen even discussed the central bank’s “considerable scope” to ease if the economy falters, “we used them effectively to strengthen the recovery from the Great Recession” and would do so again, adding that “only a modest degree of additional stimulus” can be provided.
In portfolio management, risk is a key element; too much risk and you end up with volatility which will concern clients and with too little risk, you tend to underperform which equally upsets investors. So where is the happy medium? We believe it is where you take adequate positions and balance a portfolio to smooth the risks whilst adding to performance over and above a given target or benchmark.