Bank of America Merrill Lynch FX Strategy Research notes that rates and equities are pricing two very different scenarios for the US and the world economy more generally.
"Rates are pricing a very slow pace of Fed hikes and the end of the tightening cycle after only one more hike next year, with a relatively high probability for a US recession. Equities, on the other hand, are the only Trump trade still alive and, at all-time highs, are pricing fast growth ahead. Implied market volatility is also at historic lows, suggesting no concern about a sharp adjustment. US data is mixed and do not give a clear indication of whether rates or equities will have to adjust. The FX market is more consistent with what the rates market is pricing, or the USD should have been stronger, in our view," BofAML notes.
However, BofAML thinks that this is clearly not sustainable, and expects a reality check in the months ahead, most likely after the summer.
"We have been warning that although market volatility could remain low this summer, it will increase right after, as this fall is packed with events-more Fed hikes (or not), unwinding Fed balance sheet, possible Yellen replacement, US tax reform, ECB QE tapering and policy sequence, German and possibly Italian elections, and Brexit negotiations. In a good case scenario, the USD will have to appreciate against the JPY and rates will sell off. In a bad case scenario, equities and EM assets will sell off," BofAML argues.
Source: Bank of America Merrill Lynch Rates and Currencies ResearchOriginal Article
