The danger of the Fed’s presumed US exceptionalism: real yields, “illusory alpha”, declining neutral rates and the need for core “received” positions.

The US interest rate market is maintaining longer-term path to lower trading ranges in terms of yields. This is under-pinned by a lower “neutral” real Fed Funds rate. It also reflects an underlying weakness in the US economy, which reduces the resilience of the expansion to domestic and external shocks and which also questions the Fed’s presumed exceptionalism – it’s view that it can tighten policy while the rest of the world is looking to ease. Indeed, despite yet another ratcheting lower of it’s presumed path of policy tightening at its June FOMC meeting, the Fed still appears overly optimistic on the path of rate hikes. Once the Brexit-related gyrations in global risk premia have passed, the underlying trend of lower yields in term-US interest rates is expected to continue. Investors will continue to be rewarded for retaining core “received” positions. Meanwhile, one trend which is supporting the declining trend in UST and US IRS yields – falling real yields – is also serving to preclude a source of “illusory” alpha which benefitted the asset management industry pre-crisis, and which is now supporting the rise of lower cost passive investment strategies.

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Avoiding the “Big Crunch” – policies to prevent a deflationary world

The policymaker response to the slow burning growth crisis of the global economy remains uncoordinated across geographies and reflationary levers. It is a path that leads to mounting non-linear risks for global markets and growth. The global economy needs a more effective and coordinated policy response, one that can raise aggregate demand but also prevent some of the increasingly persistent, cyclical restraints to economic growth becoming structural. While there are growing signs that some key countries may switch to more effective reflationary policies, in all too many cases the political barrier to appropriate policy remains high, and may first require a period of pronounced market and economic dislocation which could mean a pyrrhic victory for investor portfolios positioned for a switch to reflation. However, short-of a sufficiently bold policy reflation, there are a number of policies which could meaningfully improve cyclical and secular global growth and which may face a lower political barrier to implementation. Some of these are already emerging onto the global policy agenda, and have the potential to provide a much needed upside risk to growth and market performance.

US worker productivity – An example of how insufficient and misdirected reflationary policies can lad to a cyclical restraint to growth becoming a structural one


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