Hartnett says: “In 1994 cash was the best performing US asset. This was because the US economy surged, catching an easy Fed off guard and sent the US bond market and leveraged fixed income investors into a tailspin (think Orange County and Mexico). Should macro activity or inflation data in coming months question the wisdom of zero rates and forward guidance look for 5-year, 10-year and 30-year Treasury yields to slice through 2 per cent, 3 per cent and 4 per cent respectively and ‘risk assets’ to take a temporary hit. Investors worried about such a scenario should either short 2015 Eurodollar contracts, put on curve flatteners or, buy consumer staples stocks (which are defensive and currently the largest underweight in global portfolios since August 2003).
“The best lead indicator for this scenario is the UK. Unlike in the US, the drop in the UK unemployment rate is not stemming from a lower participation rate but is driven by very strong employment. UK Economist Nick Bate thinks this week’s 7.1 per cent UK unemployment print (the lowest since Mar’2009) was equivalent to a US payrolls number of 450K. UK short rate expectations jumping towards 2 per cent would be a warning sign.”