What has taken most market participants by surprise is the resilience of the US economy and labor market despite real rates being as high as they are at present.

Until earlier this week it seemed like rate cuts were on the horizon, but the latest January CPI print indicates that the progress on inflation could be stalling and that return to the Fed’s 2% inflation target could take longer.

Markets have already pared back expectations of rate cuts and in a big way. A month ago, the market was pricing in a 90% chance of the Fed rate being below 4% by the end of 2024 which was akin to expecting at least 6 cuts.

The probability for the same now stands at a mere 8%. One of the reasons why it is taking longer for tight monetary policy to have an impact is that aggressive US government spending has negated its effect.

The question is how one should position oneself in various asset classes given current dynamics. The answer to it depends on what you see happening with the US yield curve.

We see two distinct scenarios. If we get evidence of disinflation in the Feb and March prints, we could see a parallel shift lower in US yields and maybe eventually even some bull steepening.However, if inflation continues to remain sticky, we could see further yield curve inversion as elevated rates for longer would eventually result in a recession or crisis to which the Fed may have to respond by cutting rates quickly.The curve would therefore bear flattening in this case. One of our high conviction views therefore for this year is to own duration as it could benefit under both scenarios.

We see the yield on the US 10y move towards 3% by the end of the year. In the former scenario, we would most probably see a weak Dollar, resilient equities, higher commodity prices, and gold prices remaining supported.

In the latter scenario, we would most likely see a stronger Dollar, a sell-off in equities, weak commodities, and higher gold prices. Gold is also therefore an asset we have a favorable view on as it benefits from lower US real rates as well as risk aversion.

Until before the most recent CPI print, we were leaning towards the first scenario. However, we prefer to remain neutral as of now and await the next couple of US CPI prints.

We believe if the Fed is not in a position to cut rates by May, we could see the risk sentiment turning around and that would tilt the scales in favor of the second scenario.

(The author is Founder and CEO IFA Global)

(Disclaimer: Recommendations, suggestions, views and opinions given by experts are their own. These do not represent the views of Economic Times)

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