In the near-term, we believe upward pressure on rates from better growth and loosening fiscal policy could be balanced by uncertainty around the Trump agenda and political risks events in Europe, keeping risk-free rates in a range. In this environment, we think focusing on yield enhancement strategies makes sense.
Without a realization of better economic data, we see current levels for 10-year U.S. Treasuries as approximately fair. Better-than-expected growth, which hinges partly on the new policy mix under Trump, would drive “fair value” higher. We expect economies to continue to perform well in 2017 and will look to position for further rises in risk-free yields later in the year as the direction of regulatory reform and fiscal stimulus become clearer.
Geopolitical tail risks, such as a reversal of the U.S.’ one China policy and lack of support of NATO has been much reduced, as well as the most pessimistic scenarios of a sharp trade protectionist escalation. However, a renewed push towards trade protectionism or a 20 percent border-adjustment tariff would have a material impact on the USD and EM outlook, with Mexico and EM Asia likely to bear the brunt of any negative reaction.
On Mexico, despite a near 10 percent appreciation since its peak, we note that the Mexican peso remains the most undervalued currency in EM and is still pricing in a significant risk premium with regards to protectionist policies out of the U.S.
We expect that barring any news to the contrary, U.S. investment-grade and high-yield credit should continue to tighten as technicals remain supportive of the asset classes and macro fundamentals stay firm. In Europe, if anti-euro risks fade with European elections, we believe spreads still have the potential to tighten further.
We remain cautiously overweight CMBS. Most sectors of the CMBS market are performing well with record high occupancy rates and increasing rental rate but remain wary of retail shopping centers.
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