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Reflation and uncertainty

Steven Wieting

By Steven Wieting

Chief Investment Strategist

November 18, 2016Posted InForeign Exchange, Investment Strategy, Investments and Fixed Income

At its 17 November meeting, the Citi Private Bank Global Investment Committee reduced its allocation to global equities from neutral to -1.0% adding to a tactical cash overweight position now at +1.5%. The GIC left its allocation to global fixed income at -1.0%, but reduced the duration of US dollar fixed income portfolios to neutral with several changes to sub-sectors. The GIC left its allocation to US equities at neutral, but cut its allocation to European equities (ex-UK) to underweight. In anticipation of some further US dollar appreciation and interest rate pressures, we also reduced some Southeast Asian equity weightings

The election of Donald Trump with Republican control in the US Congress creates a significantly less certain US policy outlook compared to the gridlock that prevailed in recent years. While not certain, the unified government appears likely to succeed in passing sizeable US corporate and personal income tax cuts. Increased US infrastructure spending is also possible. These policies would represent a significant boost to US growth, though likely no sooner than the second half of 2017. In contrast, possible disruptions to US trade relationships, as discussed by then-candidate Trump, remain a downside risk for the world economy.

Fixed income markets have already moved to price in stronger US growth, higher inflation and greater US borrowing from the world. The US dollar has risen sharply to a 13-year high. So-called “announcement effects” have often accounted for the bulk of asset market movements on significant changes in expected policies. However, in our view, the probability of further increases in the US dollar and concurrent global interest rate pressures has risen looking ahead.

With this in mind, we lowered the duration of US investment grade corporate debt to neutral, while maintaining a significant overweight. We also reduced our allocation to US municipal debt to neutral from overweight and added further to our overweight in short-term US Treasuries as an alternative to cash. We maintain large underweights in government bonds in Europe and Japan.

US interest rate and currency pressures shocked emerging markets, with the largest hit to Latin America. However, we see valuations in the region as compelling and maintained overweights. The oil sector is likely to see no more than a temporary setback in its recovery. Conversely, we believe the U.K. referendum and US presidential election highlight ongoing political risks in Europe, where inter-country cooperation is of greater financial importance than elsewhere. The long list of political hurdles over the coming year led us to reduce our equity allocation to underweight in the region.