Taking Advantage of Higher US Interest Rates

Yields on US Treasuries with five year or more duration rose above 3.0% for the first time since May, when it touched a seven-year high. While interest rate pressure is likely to be lasting, last week’s sharp equity market decline looks to be in line with historic market stumbles which provided to be temporary.

The Federal Reserve has hiked interest rates three times this year – in March, June and September.  Citi analysts expect Treasury yields to reach 3.75% in 2019 which may rise further if growth endures and the Fed tightens in line with forecasts.

To take advantage of the growing opportunity created by higher US interest rates, Citi analysts are more positive on bonds. Citi analysts have added to overweight recommendations of short-duration US Treasuries, corporate debt and municipals – but remain underweight European and Japanese sovereign debt.

Citi’s underweight of US small- and mid-cap (SMID) equities reflect their greater volatility and largely higher debt burdens compared to large firms.

The broad US SMID asset class tends to underperform in a slowing US growth environment. Citi analysts continue neutral on large-cap US equities, as the rise in US interest rates and absence of new tax cuts may likely slow the US economy moderately in 2019.

Citi analysts have also spread their EM Asian overweight more broadly to include markets such as Thailand and Malaysia as likely beneficiaries of US-China trade tensions.

Despite its strained trade relationship with the US, Citi analysts continue to hold a modest overweight on China. Declines in Chinese equities seem consistent with severe domestic credit tightening, which the Chinese authorities are now reversing.