Market Insights – August 31, 2020

Each week, a team of experts shares its market views with you.

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Essentials

The US dollar is still under pressure. It is hovering just above its recent lows, particularly against the Swiss franc. The psychological threshold of 0.90 could be a support level, as investors remain extremely bearish on the greenback.

Shinzo Abe, Japan’s longest-serving prime minister, announced on Friday that he would be stepping down about a year earlier than planned because of his health. It’s unlikely that his successor, who will be chosen from within the Liberal Democratic Party, will change the country’s stimulus policies in the short term.

While Germany’s PMI lost ground in August, the country’s IFO Business Climate Index rose for the fourth month in a row. Companies’ assessment of the current business situation improved sharply, a sign that they are starting to feel the effects of the economic recovery. The improvement in business expectations, however, was slower than forecast, no doubt because of the increase in the number of COVID-19 infections.

Powell breaks a taboo

Paul Volcker, who was chair of the US Federal Reserve from 1979 to 1987, died at the end of 2019. He was a highly controversial choice when he first took office, but he is now widely credited with having brought runaway inflation under control after prices soared in the wake of the oil crisis. By raising interest rates sharply, he managed to rein in inflation, which was at 15% a year in the early 1980s, bringing it to below 5% by the middle of the decade. Jerome Powell, who’s currently at the Fed’s helm, could go down in history as the chair who triggered a rate of inflation not seen in more than 30 years by ending the policy of keeping inflation below 2%.

Actually, since 2008, central banks have mainly had to battle deflation during economic or financial crises. And because interest rates are at rock bottom, unconventional policy tools have been used, injecting liquidity into the economy and the financial system. Mr Powell is the first major central banker to consider the 2% threshold to be too low. The traditional annual meeting of central bankers at Jackson Hole was cancelled this year because of the pandemic, and so a virtual meeting was held, at which Mr Powell unveiled his new policy to his peers. Following the Fed’s strategic review, begun over a year ago, he concluded that the USA could withstand an inflation rate above the sacred 2% target. Priority has instead been given to growth and full employment. This is a major change of course – one that will have short-, medium- and long-term consequences.

For the time being, investors can rest assured that the Fed will maintain its ultra-loose monetary policy in order to offset the impacts of the public-health crisis and bring back economic growth. Interest rates are low and liquidity is abundant, which could mean that equities will continue to rise, even though valuations are already a little high for this point in the business cycle. Looking further out, a rise in inflation will push up US long-term interest rates, and bonds with longer maturities could suffer as a result. Our preference will be for lower-quality corporates and treasury inflation-protected securities (TIPS), which should be buoyed by the uptick in inflation expectations.

Alternative funds – the solid momen-tum should continue

Alternative funds have fared well during the summer, maintaining the solid momentum that began in late March. This trend can be seen across all types of strategy. It makes sense that directional funds have been lifted by the market momentum. And tech-based funds even seem to have been boosted by the pandemic. We think these products still represent good investment opportunities. Credit strategies, for instance, should do well because spreads remain appealing and can compensate investors for the current uncertainty.

In addition, more complex situations or those with limited liquidity have not yet fully reaped the benefits of the improving economic climate, although they should gradually make up for this lag. Current conditions are, for example, a boon for convertible bond arbitrage strategies. Volatility has been high and credit markets have rallied, which has helped to support managers active in these areas. But more than anything it is the record number of attractively priced new issues that makes us bullish in the longer term.

Although alternative funds have performed well since the spring, we are still finding good investment opportunities and recommend continuing to overweight these strategies.

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