Overweight USD Vs. Euro, CAD, Other Export-Driven FX - TD Asset Management

While the Federal Reserve is expected to perform "the loosest tightening on record," the normalization policy will nonetheless put "some upward pressure on bond yields," leading Christopher Case, Vice President and Director at TD Asset Management, to seek protection in U.S. real return bonds, one of his key investment convictions.

"We have established a position in US Treasury Real Return Bonds (TIPS), which provide cheap insurance against inflation and protection against an upward movement in the low absolute level of interest rates," Case told MNI.

While the Fed will follow a "low and slow path", making sure to communicate any rate move clearly and avoiding any monetary shock, which it knows the U.S. and global economy cannot withstand, its tightening will still lift yields, even if modestly, so that Treasury Inflation Protected Securities are "offering good value," said Case, who manages the TD Global Bond Fund.

Case also likes Canadian bonds, which he expects to outperform on the back of an accommodative Bank of Canada. Following two rate cuts of 25 basis points each in 2015, the BOC left its policy rate unchanged at 0.50% Wednesday, surprising economists with a more upbeat-than-expected tone given the recent drop in oil prices and the central bank's downward revisions to its Canadian growth outlook.

It now sees real GDP growth at 1.4% this year (revised from 2.0% last October), picking up to 2.4% in 2017. The outlook, however, does not factor in the federal government stimulus package, the details of which will be known in the next budget by this spring.

Going forward, case expects the BOC to remain on hold for the remainder of this year, which is still an "accommodative" stance that will support Canada's fixed income.

For similar reasons, Case is also "favorable" on Australia and New Zealand debt.

The two AAA-rated high yielding dollar block issuers are likely to benefit from supportive monetary policies as the countries' reliance on Asian growth, hence exposure to China's slowdown, will keep pressure on the central banks to "continue perusing an easing campaign or at worst maintaining steady accommodative policy."

That being said, he does not favor all advanced economies where the central bank is conducting an accommodative policy. Europe and Japan, for instance, "suffer poor structural fiscal positioning and represent poor valuation from a credit perspective," he commented.

The European Central Bank on Thursday left its main refinancing rate unchanged at 0.05%, while also maintaining its deposit and marginal lending rates unchanged. However, ECB President Mario Draghi said the central bank will "review and possibly reconsider" its monetary policy stance "when the new staff macroeconomic projections become available which will also cover the year 2018," raising expectations of more easing measures as soon as March.

On the currency side, policy divergence vis-a-vis the U.S. means the greenback has further upside room, Case believes, maintaining as a result an overweight in U.S. dollar against the euro, the loonie, as well as "other export driven countries."

"With the U.S. Fed embarking on the loosest Fed tightening on record, while other major central banks pursue easing monetary policy or remain accommodative, the USD has room for further appreciation vs. the majors," he argued.

According to the BofA Merrill Lynch Fund Manager Survey for January released Wednesday, "long U.S. dollar remains the most crowded trade, but bullishness on the currency is waning."

The survey also showed a decline in net overweights in equities as well a retreat in bond underweights amid growing concerns over China's growth slowdown and the global economic outlook.

When it comes to rotation between asset classes, Case doesn't expect any "substantial rotation out of bonds" this year even as the Fed tightens policy.

"We believe in 2016 we will see stocks generate mid-single digit returns, while fixed income generates low single digit returns," he predicted.

While the Fed tightening will put upward pressure on yields, the U.S. 10-year yield is unlikely to break above 3.0% in his view, in light of the downward pressure "on global deflation from slow global growth, declining commodity prices and a strong U.S. dollar."

In fact, the International Monetary Fund this week downgraded its global growth projections, with the world output now seen growing 3.4% in 2016 and 3.6% in 2017, a 0.2-point cut from October's estimates, with risks still tilted to the downside.

"The slowdown and rebalancing of the Chinese economy, lower commodity prices, and strains in some large emerging market economies will continue to weigh on growth prospects in 2016-17," the IMF said.