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The End Of Easing
What to expect as policy makers reverse
Risk assets are in the sweet spot. Investors see looming recovery but
policy remains at recession-combating levels. The focus will soon turn to the
end of easing and, beyond that, the policy tightening phase.
We expect a below-par recovery. So while easing may soon end,
tightening will probably not start until 2010 – well into 2010 for many
developed economies. Markets, however, look ahead, and when the focus
turns to a prospective tightening, we think investors should:
• Sell equities as the strong relief rally is partly reversed. We expect
developed equities to settle into a wide range-trading environment for an
extended period. Emerging market equities will likely remain high beta, but
we expect medium-term structural outperformance to continue.
• Rotate into late cyclicals and quality defensives. Also expect market
performance to increasingly reflect the divergent outlook for domestic growth
in various regions.
• Buy forward volatility in rates, and expect still-steep curves. End of
easing increases volatility for rates, while the curve is likely to be structurally
steeper than in the prior cycle. In equity derivatives, we like positioning this
view directly via variance swaps, and directionally via diagonal put spreads.
• Buy EM currencies and reflation laggards (SEK in G10, KRW in EM).
Currency markets will focus on fiscal strength and high beta/high rate
currencies that have lagged to date.
• Stay long credit, but expect lower returns. The big risk to credit is
double-dip, not the end of easing.
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