FICC
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With recent comments strongly hinting that the Fed is on track for a rate hike in December, the dy-namics of the Fed Policy Loop make spread product appear extremely vulnerable.
The dollar is likely to enter the bubbly stage of its bull market within the next 12 months. The key culprit for this move will not be the Fed, but easing by non-U.S. central banks. The euro area economy could enter a temporary soft patch, but this will not result in an imminent easing by the ECB.
If the Fed convinces markets it is on track to lift rates this year and a couple of times next year, we expect a 10% appreciation of the USD over the next 12 months. This would be extremely bearish for commodities.
Given the rising odds of another Fed move before year-end, and the uncertainty that additional easing can be delivered in Europe and Japan, we re-iterate our tactical call to maintain a below-benchmark duration stance.
A Fed rate hike by December could erode the slowly evolving fundamentals favoring base metals.
We put the odds of a Fed rate hike this year at slightly better than 50/50. But in the event of a rate hike, any sell-off in risk assets will be relatively short-lived and not as severe as the sell-off that followed the initial rate increase last December.
The evolution of oil demand will be far more important for prices than the outcome of next month's International Energy Forum meeting in Algiers. The supply destruction brought on by lower prices is increasingly shifting to OPEC producers outside the Persian Gulf, which keeps the odds of a large-scale unplanned outage - in Venezuela or Nigeria, in particular - elevated.
