Chief Investment Strategist
April 25, 2016
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Central-bank policy and crude oil’s stabilization are impacting financial markets and we are adjusting our stance accordingly.
Two powerful shifts are underway in global financial markets. First, leading central banks are taking yet more steps to keep their monetary policies accommodative and to reduce risks. Second, crude oil and assets linked to crude oil are bottoming out after cascading in price over the past couple of years. What might the implications of these shifts be for investors?
The central banks’ accommodative stance is having most impact for now in fixed income markets. Their policies have driven nearly one-third of investment-grade sovereign bonds worldwide to negative yields. This unprecedented situation demonstrates that central-bank asset purchases and other measures are still effective in influencing asset pricing, contrary to what many have come to believe. We expect this influence to be felt in equity markets too.
The US Federal Reserve is showing great near-term pragmatism in its monetary policy. When China’s currency came under pressure and triggered instability in the markets, the Fed quickly recoiled from its planned path of interest-rate rises. In the near term, this restraint should boost those emerging-market assets that are most vulnerable to rising US borrowing costs. However, it is also reminiscent of the fragility of periods that preceded bubbles, such as in the late 1990s. And it poses a problem for Japan, whose currency has risen 8.5% against the US dollar this year, which has in turn has weighed down on Japanese equities.
Meanwhile, crude oil has rallied in 2016 in a way that is highly reminiscent of early 2015. This time, though, the move could prove more sustainable. Forward-looking fundamentals for crude have improved rather dramatically. New drilling activity has fallen nearly 60% over the past two years, which should help address the supply-glut in due course. Asset prices and currencies linked to the oil price have suffered a deep bust. But we now see them as poised for a rocky recovery on the whole.
At our most recent meeting on 21 April 2016, the Citi Private Bank Global Investment Committee (GIC) left our tactical allocation to global equities unchanged at +1% relative to our strategic benchmark. But we raised our weighting to fixed income by 0.2% to -1.3%, lowering our overweight allocation to cash by 0.2% to +0.3%.
To reflect central-bank policy and crude oil’s stabilization, we’ve raised our allocation to Latin American fixed income to overweight, both in hard and local currency. While selectivity remains important, Latin American yield spreads over Treasuries appear sufficient for this small asset class to follow the strong, recent performance of US investment grade corporate debt, our largest overweight. To neutralize further our effectively underweight exposure to crude oil, we raised Canadian equities to neutral by reducing our other developed market equity overweights slightly. We expect to make similar, carefully targeted, portfolio changes over time.