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Mere 25 bps rate cut by Fed will disappoint bond market: Julian Brigden

ET Now|
Jul 22, 2019, 04.08 PM IST
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Julian Brigden-1200

Highlights

  • Below 50 bp cut to make bond market wobble and may force the Fed to deliver in Sept.
  • I am not a big fan of the long end of the US bond market.
  • G-7 may have just agreed on a deal on how to tax global tech cos.
In certain sectors in the US, equity markets definitively have bubble like conditions and in those growth-oriented stocks, which are growing only because money is cheap, there is no real growth. It is just revenue growth, says Julian Brigden, Co-founder & President, Macro Intelligence 2 Partners. Excerpts for an interview with ETNOW.

It seems like the markets have already priced in a 25 bps rate cut by the US Fed. What do you think is going to be the likely impact of that now on asset classes?
Yes, you are absolutely right. In fact, the market has priced in more than 25 bps cut. If you look at the odds over 50 bps rate cut, particularly after we had some comments on the Fed today, we are pricing closer 40% chance of a 50 bps rate cut. I am a little concerned but I will be honest with you, if they only were to deliver a 25 bps then there is actually some risk of disappointment in the bond market, unless it comes along with a very dovish commentary that almost guarantees a rate cut again in September.

The bond market is betting on 50 bps cut and it would be a slight disappointment if we only got 25. Coming to the equity market, particularly some of those very high flying FANG type stocks which seems to leave off super cheap money and would obviously be pretty bullish with the dollar set for a setback.

Do you see two more cuts in next year?
This is the fundamental question. The markets concept of what the rate cuts necessary to should we say extend the economic cycle a very different from the Fed’s concept. If you look back to say 1994-1995, when the Fed punted the cycle, they extended the cycle by giving an interim cycle rate cut. We got a total of 75 bps and I think that 50 to 75 bps cut is probably realistic. We have seen time and again, the market betting on considerably more than that and so if you get 25 bps cut, there is a risk of a bit of a wobble in risk markets, a back up in bond yields. I suspect that probably forces the Fed to deliver in September, unless the data gets very much better.

So do you see a risk of a bubble in the US equity markets?
In certain sectors, you could absolutely argue about that. We flagged off back in September-October what we refer to as classic bubble charts and they led to the technical trading pattern that we use based upon historical patterns from everything from the crash of the Dow in 1929 through to the Nikkei that we saw and the NASDAQ in 2000.

We flagged some of the FANG stocks -- Amazon, Netflix, Nvidia -- in those patterns which suggest extreme overvaluation. If you look at the broad S&P growth versus the S&P value, we have actually pushed that ratio back to the highs of 2000. It is possible to argue that in certain sectors in the US, equity markets definitively have bubble like conditions and in those growth- oriented stocks, which are growing only because money is cheap, there is no real growth. It is just revenue growth.

But what about bond markets? Given the kind of inverted yield curve it is showing, is that overblown as well?
Here is quite a difficult situation. You have got some tactical concerns about the yield curve and we did see an inversion in the forward curve though we never actually saw it in the cash curve. We skirted with those source of levels. At the end of last year, we were betting on rate cuts in the US. We are going to get those rate cuts and I am just worried as to how much the markets think it is necessary to do that. They may be over exaggerating how much the Fed will cut. There are risks of a spike and a steepening of the yield curve. It would be the best steepening at this point, led by selloff at potentially the long end.

The bigger picture is if the Fed is determined, which is what Powell told us at the last FOMC meeting to extend the cycle and that is ultimately reflationary which is resource a back in 2016 when Janet Yellen did exactly the same thing ultimately became inflationary and in that environment I am not a big fan of the long end of the US bond market.

What is the outlook when it comes to the dollar?
We were big dollar bulls right until the end of last year and we have been sitting on our hands since then, but one of the things that I have started to notice in the precious metal market -- which we have recommended to our clients to be long on for a week now -- is that you are starting to see nascent signs of dollar weakness. The problem is there is a lot of clients and a lot of people tend to look at these baskets of dollar and things like the DXY.

The DXY is very heavily euro orientated. But once you strip the euro away and look at some of the individual pairs, you are starting to see signs of a clearly dollar topping pattern. As I said,if the Fed messes up this messaging around the next FOMC, you could get a bit of a chop but generally we are starting to see signs of the dollar move rolling over.

If you look at a very long term cyclical pattern, the dollar tends to trade in very clear cycles. It falls very aggressively if it is reflationary, and bounces if it is deflationary. We have come to the end of what historically should be one of those patterns and we should be entering a multiyear down cycle in the dollar.

I do not think we are quite there yet but I am seeing nascent signs of that which would be tremendously good for the world. It is generally reflationary as the dollar falls and it is great for emerging markets and commodities. It is not great for the long end of the bull market.

Do you see more money moving into emerging markets in the current environment or will we continue to see safe haven demand?
It is early days yet but if you look at the Emerging Market Index, we have started to see that push up towards 45 level which has really been a cap for quite a considerable period of time.

I am a little nervous about how the Fed handles this next FOMC but generally, I am looking for opportunities to buy emerging markets. I have been looking at Brazil very closely. Southeast Asia is a little bit more complicated at this stage.

I would be looking at some of those commodity orientated emerging markets but generally if we are about to enter a down cycle in dollar, it takes a bit of time to get there to that defined trend. I am positive on emerging markets.
What is the outlook on FAANG stocks? A lot of interest is on what is happening there and whether or not it is another big bubble just waiting to burst?
They have been a fantastic trade. They benefitted from a number of factors; super cheap financing is one of them. These growth stocks grow when nothing else is growing and they just borrow huge amounts of money either from the equity market or from the bond market directly to fund all that revenue growth. If we are entering a period of a little choppy steep yield curve and higher longer- end bond yield, that is generally not good for these guys.

There is certainly significant regulatory risk around some of these names, some of these names are also highly inflated on a relative basis to value stocks in the broad economy and finally, if what I am hearing is correct, it came out of the G-7 meeting today that we may have just agreed on a deal on how to tax these global tech companies and it is not a good one for them.

What it appears to be is we may have agreed to tax them on the basis of where revenue is derived and not where they are domiciled. And that means significantly higher tax rates for these guys for revenue that they derive in many countries in Asia or particularly in Europe.
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