Breakout for bonds and US dollar ahead, BofA-Merrill Lynch says
Investors continued to rotate towards so-called 'inflation trades', ahead of a likely break-out in bonds and the US dollar, according to the widely-followed weekly tally of fund flows by Bank of America-Merrill Lynch.
As an asset class, Equities took in $8.5bn worth of funds in the week ending 23 February and Commodities another $0.6bn.
However, Bonds also attracted heavy inflows, to the tune of $7.6bn.
Against the backdrop of the MSCI ACWI stock benchmark hitting all-time highs, BofA-ML strategists said actions by US president Donald Trump and Federal Reserve chair Janet Yellen on taxes and monetary policy would determine the direction of markets.
Key in that regard, Trump was set to adress Congress on 28 February.
Somewhat ironically, according to remarks by US Treasury Secretary Steve Mnuchin on 23 February, the same day BofA Merrill inked its report, the White House's tax reforms might not be ready before the August 2017 recess in Congress.
As regarded the Federal Reserve, at least 10 of its rate-setters were expected to take to the podium over the following week.
Looking out to March, "upside" for the S&P 500 and 10-year US Treasury yields required certainty from Trump on tax reform and Obamacare's future together with a Fed rate hike built on solid foundations.
"The Upsides of March: SPX 2450 & GT10 2.75% needs…Trump tax reform/Obamacare certainty (note just 23% investors expect tax reform passage by August) + credible Fed hike (following strong data, e.g. PCE >0.3/0.4%, payroll >275k)," the strategy team led by Michael Hartnett said.
Echoing that debate, the main argument of the so-called 'bears' in the markets was "look what happened after Apr 2015 high", whilst 'bulls' were retorting "stocks just 4% above their Oct'07 high", the strategist said.
For its part, BofA-ML chose to position itself via what it dubbed an 'Icarus' trade, remaining 'long-risk' with a target of 2,500 for the S&P 500, crude oil futures at $70.0 a barrel, the 30-year US Treasury yield at 3.5% and the US dollar spot index at 110.0, "in that order sequentially".
"Trump & Yellen = breakout time for bonds & FX: holding pattern in bonds & dollar set to end with Trump to Congress 28th, PCE on March 1st, Yellen speech 3rd, payroll 10th, FOMC 15th (note Fed hike probabilities…March 38%, May 61%, June 75%)."
On a more cautionary note, the investment bank did reference what it called the Rule of 10: (at least in the past) whenever the Fed hiked rates with the S&P 500 trading 10% above its 200-day moving average, as was then the case, and S&P realized volatility was at less than 11% (then at 6.0%), over the following month the S&P 500 would return -2.0%.