(08 JUNE 2019)THE thought of weekend:Fed open to rate cuts, CIO holds no-change view

The negative market reaction following the escalation of the US-China trade tensions has yet to prompt either side to rush back to the negotiation table, but the US Fed signaled its willingness to cut interest rates if the economy gets hurt.

Speaking at a conference hosted by the Federal Reserve Bank of Chicago, Jay Powell said the Fed would "act as appropriate to sustain the expansion".

He added that the Fed is "closely monitoring the implications" of escalating trade war for the US economic outlook.

Powell's remark followed a more dovish comment by his colleague James Bullard a day earlier. Bullard reportedly said a rate cut might be "warranted soon" and that current interest rates might be "inappropriately high".

Markets welcome these statements – the S&P 500 index was up over 2% last night, and the CSI 300 Index was up slightly at the time of writing.

UBS CIO Global Wealth Management maintains its base case view that the Fed will hold rates steady this year, while acknowledging a significant escalation in trade tensions could increase the chances for a rate cut later this year.

Currently, the federal funds futures market is pricing in almost three 25bps rate cuts this year, and the 3-month/10-year US Treasury yield curve has inverted again as the latter has fallen by almost 50 basis points since mid-April.

Some see the inverted yield curve a precursor to a recession, but CIO believes that it has been easier for the curve to invert due to a prolonged period of accommodative central bank policy, institutional demand for bonds and lower term premiums.

CIO's base case posits long-term yields to move higher.

"That said, we shouldn't ignore the signal from the fixed income market. The plunge in yields signals that risks have risen and that rate cuts are likelier than hikes. It reflects the recent escalation in trade tensions. We estimate a 30% probability of US-China talks breaking down," CIO added.

Given the combination of a positive base case but elevated risks, CIO's overall six- to 12-month tactical positioning continues to overweight equities but with a regionally selective approach. It also recommends countercyclical positions to help protect portfolios from downside risks, including exposure to the Japanese yen.

An emerging market foreign exchange basket (INR, IDR, ZAR), high-quality dividend stocks and green bonds are also some of CIO's preferred strategies.

(BY UBS)