Photo: Bloomberg TV
Société Générale FX strategist Sebastien Galy thinks the second half of 2013 will be very interesting for markets.In a note titled “Asset rotation or something more sinister? Pre-Lehman vs now,” Galy writes that once the market is able to anticipate a Fed tightening, which he thinks will happen “most probably” in the second half of this year, “we will see a rising U.S. Treasury 10-year yield drive all before it, leading to a brutal reallocation of risk.”
Galy says bonds are in a bubble, but the market isn’t collapsing as funds rotate into equities. He warns that “the pace of that rotation may be enough to create this collapse,” but he says the conditions for a collapse don’t appear to be set, at least in the short-term, with global economic data on an upswing.
“The difference with the last crisis is that the leverage is lower and different,” writes Galy. “It is in fixed income and hence credit.”
The SocGen strategist expands a bit on just where the leverage may be hiding this time:
Leverage is now most probably at the level of retail investors or hidden in balance sheets (e.g. swaps of collateral done for pension funds and insurance companies on the balance sheet of banks). It seems that we are seeing investors reduce their concentration of positions in fixed income and credit.
Sovereign wealth funds first moved to very low durations to avoid the risk and are presumably in the process of rotating their credit risk away from areas that would be hit by a repricing of risk. That means a translation up in the quality spectrum and away from deep concentration of risks (e.g. U.S.). It suggests a demand for T-bills rather than financial paper in the U.S., for example.
Galy predicts that the “brutal reallocation” he foresees later this year “will be a strange event with some side casualties on the credit side,” but a supportive economic environment and attractive valuations following a selloff should bring investors back to markets quickly once the dust settles.
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