Wow, what a week. We all expected volatility was coming, but the thing about volatility is that you never know exactly when it will rear its ugly head. Given the past two days, I would like to share my thoughts on where we go from here and what Structured Notes we can look at to take advantage.
Budding wage pressure, higher oil prices, low unemployment, the rise in leverage across the board, and frothy housing are a few of the economic variables we should be paying attention to. Moreover, the economy is doing well which has caused more demand for money (to pay for this growth) but with less money supply, showing up in a stronger dollar and pain for highly dollar-leveraged Emerging Market economies. Overall, this spells an inflationary trend that I believe will be here to stay for another 12 months; the question will be what does this do to interest rates?
I have been saying for 11 months now that yields will rise to 3.25% by the end of 2018, which will cause turmoil in the market. It certainly did, and I believe we’re not done yet. The end of QE inside many of the world’s largest Central Banks may cause 10-year rates to stay in the 3.25-3.75% level (or higher) over the next year. This is because the end of QE in Europe may lead to a gradual rise in rates within the Region, and when paired with US inflationary pressures, Fed tightening and massive US Treasury issuance, investors will want to be paid more for the risk. That being said, this may be offset with a slowdown in US growth, ultimately keeping long-end rates rising just gradually. What concerns me is the continued rise in the 2-year Treasury, causing the yield curve to flatten and eventually invert, potentially due to factors outside the broader economy’s control. In sum, I would expect rates to rise across the curve, but the curve to flatten, which will make it challenging for bonds to provide sufficient protection in portfolios.
Taking a look at equities, tariffs, inflation and a late-cycle slowdown could cramp corporate earnings. US Equities continue to be priced for perfection, and while Europe looks more attractive by the day from a valuation standpoint, volatility in the US can hurt all equities around the world. The upcoming earnings season could be one of the most interesting to watch in some time to see how these macro events play out, and if CFOs use the “macro blips” as an excuse to readjust the market’s expectations. Bottom line is that there is more uncertainty in the broader markets than I have seen in a very long time.