US Fiscal Dispute: Problem Far From Solved

The US may have averted a debt default, and the government is open for business again, but the compromise is far from a long term solution. Global Chief Investment Officer of Credit Suisse’s Private Banking & Wealth Management division, Michael Strobaek, says that while risks have been abated in the short term investors should not chase rising prices.

Cushla Sherlock: The disputes in the US were resolved just before the deadline. Have the risks now been reduced in the short term?

Michael Strobaek: Yes. Risks have been reduced in the short term. Uncertainty disappeared and we saw markets move slightly higher as a consequence. However, whether the compromise can really be called a 'solution' is questionable. Therefore, uncertainty may come back again. For now, we have three new deadlines: The debt ceiling has been raised until February 7, 2014, the budget is now financed through January 15, 2014 and Congress has set up a Special Committee to report back on a broader budget plan as early as mid-December. If you compare this 'solution' with investors' expectations, then both the result and the course of the discussion can only be described as disappointing. The fundamental question about the US budget will continue to keep us busy in the coming weeks.

The equity and bond markets reacted to the compromise with relief. How do you explain this reaction, given that it is not a true 'solution' at all?

No investor seriously doubted that an agreement would not be reached in time. On the one hand, we noted that some investors began to hedge their positions in the final stage of the discussion. These hedges were all reversed the moment a compromise became apparent. This helped the US equity market to make a great surge forward. Furthermore, we are now in the earnings season and that has also slowly pushed markets higher. Continuing uncertainty surrounding the final US budget as well as the temporary government shutdown have led the Fed to continue its purchases of government bonds unabated for the time being, and not to start reducing stimuli until a later date. Only a few weeks ago, the consensus expected that the Fed would start tapering in September and completely stop buying bonds by mid-March 2014. This shift has now resulted in an easing on the equity and bond markets.

Does this mean we should be increasing equity exposure again?

As an investor, you must always be very cautious about chasing after rising prices. Yes, short term uncertainty has abated somewhat. But the problem has not completely disappeared, and investors have perhaps gone a bit overboard in response to the tapering deferment. This applies to the bond market too. In the coming weeks we will be keeping a very close eye on potential entry opportunities on the equity market. For now, though, we have decided to maintain an underweight position.

You say that investors should be careful about 'enjoying' the tapering delay – does that mean that the upswing on the bond market is also overstated?

We think it is. But, of course, it depends on the segment and the maturities. Yields on US government bonds with a residual maturity of 10 years dropped significantly, for example, due to the extension of the tapering debate. Furthermore, we still expect US growth to continue to recover in the coming months – even if this growth is not very dynamic. However, this also means that the Fed will start pulling back on its very expansive monetary policy sooner or later. But it may be too optimistic for investors to think that the Fed will start tapering in March 2014 or later – we believe it may begin sooner. In any case, interest rates will also rise over the medium term – nothing will change for this very recent trend. We therefore see the most recent decrease in yields as a good opportunity to reduce the interest-rate risk in our mandates somewhat.

Summing up, you recommend a tactical underweight position on equities, and a tactical and strategic underweight position on bonds. Where do we stand on commodities and currencies?

On the commodities side, we have been somewhat skeptical recently, particularly with regard to energy commodities. We were cautious on oil and the falling prices meant that this positioning worked out well. At the same time, we were more bullish on base metals. In general, we now recommend a neutral allocation toward commodities and we believe this is the right position for investors over the coming months.

When it comes to currencies, the weakness of the USD is striking – it has taken the greatest battering from the discussion surrounding the budget, the debt ceiling and the possible deferment of tapering. The USD is trading against the EUR and CHF at the lowest level in the past two years. We believe that the European Central Bank, in particular, is not pleased about this and we would not rule out a reaction from them if USD weakness continues. At the current level we therefore do not see much potential for a further weakening of the USD – it should strengthen in the coming months.