CMO BofA 09-25-2023 Ada
CMO BofA 09-25-2023 Ada
CMO BofA 09-25-2023 Ada
All data, projections and opinions are as of the date of this report and subject to change.
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Please see last page for important disclosure information. 5966108 9/2023
MACRO STRATEGY
Rates, Dollar, and Oil Raise Downside Risks
Irene L. Peters, CFA®, Director and Senior Macro Strategy Analyst
Seemingly insensitive to the Fed’s aggressive interest rate hiking cycle, incoming data, on
balance, have remained “not too hot, not too cold,” raising hopes of a successful “soft
landing” of the U.S. economy. The latter entails moving from unsustainably high growth and Portfolio Implications
inflation to a moderate growth and inflation environment without major economic and/or New risks to the outlook from
financial sector turbulence. There is an emerging Wall Street consensus that the U.S. will surging oil prices, appreciating
avoid recession, although that said, the S&P 500 Index rally has stalled as of late. Behind the dollar and “higher for longer
drag: 1) seasonality, i.e., September is historically a tough month for Equities, and 2) the interest rates” suggest that a
emergence of some new bumps in the road, namely, the rise in bond yields, the dollar and oil balanced tactical portfolio strategy
prices. with a high-quality bias remains
In this context, expectations for “higher for longer” interest rates to bring inflation prudent.
sustainably down to the Fed’s 2% target—confirmed by the Fed’s recent upside revisions to
its interest rate projections through 2024—have further weighed on the narrow market
index rally off the October 2022 lows. The sharp rise in 10-year Treasury yields to new cycle
highs will continue to spread throughout the economy, increasing mortgage rates further, for
example. Rising mortgage rates have already caused a renewed downturn in housing-related
sentiment, as reflected in the large August drop in the National Association of Homebuilders’
survey back below breakeven after an encouraging first-half recovery.
Also, higher energy costs have reignited consumer price inflation in August. Rising gasoline
prices reduce consumer discretionary incomes and, thus, could weigh on the outlook for real
consumer spending growth. That said, a key offset to rising energy prices lies with a tight
labor market and rising worker incomes.
Beyond the consumer, rising transportation costs could also create upside risks to goods and
services inflation, weighing on near-term growth prospects. At the same time, dollar
appreciation dampens the dollar value of corporate profits from overseas and restrains
exports, but also serves as a dampener to inflation. A strong dollar is the Fed’s friend, in
other words. The key to all the above: There are multiple crosscurrents working through the
economy, which, as we have highlighted in the past, is a $26 trillion hydra-headed beast that
remains the most competitive and dynamic in the world. Yes, it is too early to declare “all
clear” to the risks of recession; but by the same token, bumps in the road are not uncommon,
and hence our balanced approach when it comes to portfolio construction.
Keeping a sharp eye on the yield curveThe debate about the ultimate effect of all these
speed bumps to growth remains intense, with the recession predictive power of the yield
curve inversion particularly doubted. As discussed in past Chief Investment Office (CIO)
Capital Market Outlook reports, researchers have long determined that the spread between
long- and short-term interest rates contains useful information about the economic outlook,
with negative term spreads (higher short-term rates than long-term interest rates) for
decades providing accurate early warnings about incoming recessions and steep curves
precursors of strong early-cycle rebounds in economic activity.
That makes sense, since the yield curve tends to not only reflect investors’ views about the
future state of the economy (as embedded in their aggregate long-term interest rates
expectations), but these views also feed back to affect economic activity. For example, the
link between the yield curve spread and subsequent economic activity is apparent in the
correlation between the yield curve spread and bank lending appetite five quarters later.
Despite a temporary desynchronization caused by the pandemic shock, their co-movement
appears restored, suggesting that bank lending is likely to remain strained into 2024,
typically an economic headwind.
The transmission channel from the monetary policy stance, as reflected in the yield curve
spread, to economic growth has most recently been documented in a July 2023, Federal
Exhibit 1: Bank Willingness To Lend Followed By Changes Exhibit 2: The Yield Curve Spread’s Correlation With Bank
In The Unemployment Rate One Year Later. Lending Appetite Helps Explain Its Recession Prediction Record.
6 Standard Deviation from Mean Standard Deviation from Mean -6 5 Standard Deviation from Mean Standard Deviation from Mean -5
5 Y-to-Y Change in the Unemployment rate -5
(L. Scale) 4 % of Banks tightening commercial and -4
4 -4
3 Industrial loans to small firms (L. Scale) -3
3 -3
2 -2 2 -2
1 -1
1 -1
0 0
-1 1 0 0
-2 2 -1 1
-3 Bank willingness to lend to consumers 3
-4 4 -2 Yield curve spread (10-Year Treasury minus Fed funds 2
(Advanced 3 quarters, R. Scale, Inverted)
-5 5 rate, advanced 5 quarters, R. Scale, Inverted)
-3 3
1967 - Q1
1971 - Q1
1975 - Q1
1979 - Q1
1983 - Q1
1987 - Q1
1991 - Q1
1995 - Q1
1999 - Q1
2003 - Q1
2007 - Q1
2011 - Q1
2015 - Q1
2019 - Q1
2023 - Q1
1990 - Q1
1993 - Q1
1996 - Q1
1999 - Q1
2002 - Q1
2005 - Q1
2008 - Q1
2011 - Q1
2014 - Q1
2017 - Q1
2020 - Q1
2023 - Q1
Gray bars represent recession periods for both charts. Standard deviation is a statistical measurement of how far a variable, such as an investment’s return, moves above or below its average
(mean) return. Exhibit 1: Sources: Federal Reserve Board; The Conference Board/Haver Analytics. Data as of September 21, 2023. Exhibit 2: Sources: Federal Reserve Board; Bureau of Labor
Statistics/Haver Analytics. Data as of September 1, 2023.
In sum, U.S. economic growth has surprised to the upside, and the unemployment rate has
increased only modestly to just 3.8%, mainly because of a surge in the labor force
participation rate (that is, for a good reason). However, government spending is expected
to swing from significantly contributing to growth in 2023 to a more neutral factor on
growth in 2024 and beyond. The outlook for consumer spending hangs in the balance:
excess savings have been depleted, and the personal saving rate has dropped to rock-
bottom levels. Bank willingness to lend to consumers is very low, typically a headwind to
growth. The offset, however, remains a historically tight labor market.
Heading into the final quarter of the year, we continue to expect a “grind it out’ market,
punctuated by periodic bouts of volatility and risk-off moves. Current bumps in the road—
notably the optics around the United Auto Workers strike, a potential government
shutdown, and rise in oil prices—will weigh on investor sentiment near-term. However, we
maintain a balanced, high-quality approach to portfolio construction given the structural
competitive strengths of the U.S. economy.
1
Camelia Minoiu, Andres Schneider, Min Wei, "Why Does the Yield Curve Predict GDP Growth? The Role of Banks,"
Board of Governors of the Federal Reserve System, July 2023.
So memo to the decouplers—curb your enthusiasm. Don’t hang your hat on the headline
trade figures that are misleadingly screaming that the U.S. and China are inexorably on a
path of disengagement. And don’t bite on the false narrative that as America reduces its
import dependence on China, the upshot is more U.S. leverage over Beijing in setting bi-
lateral trade and investment policies. Nothing could be further from the truth.
And attention investors: The good news is that despite all the chatter about decoupling,
U.S.-Sino trade and investment ties remain relatively thick across various strategic
industries. That is bullish for U.S. assets, in our opinion. That said, however, the risks of a
market-rattling divorce between the world’s two largest economies remain real. The
footprints of decoupling are plain to see—if they multiply, the risks to Corporate America
also multiply.
Decoupling: The first cuts were not the deepest Owing to the punishing tariffs of the Trump Exhibit 3: Decoupling from China The
administration, and even tighter restrictions on trade and investment under the Biden Factory: Goods Imports From China
administration, U.S.-China bilateral commerce has downshifted over the past few years, As A Percent of Total.
and has continued to decline in 2023. Both trade and foreign direct investment flows are
2016 2023 through July
moving to the downside.
Total Goods
As Exhibit 3 underscores, quintessential “Made in China” imports like toys, furniture,
footwear and apparel have all plummeted since 2016, with the downturn reflecting rising
Electric Machinery
wage costs in China and the start of the U.S.-China trade war in 2018. The latter spurred a
number of rounds of tit-for-tat of tariffs on a variety of goods. Rising trade tensions also
Toys and Games
triggered a massive rethink of global supply chain vulnerabilities among suppliers, with the
pandemic and ensuing supply chain bottlenecks in China giving the diversification narrative Furniture
even more credence.
Footwear
As part of the decoupling theme, U.S. importers, at the urging of Washington, have
diversified away from China in recent years, boosting production in Vietnam, India, Mexico,
Apparel
Korea and Taiwan. Hence the massive shift in trade. Based on figures from the U.S.
Census Bureau, U.S. electrical machinery imports from China—as a percent of total 0% 25% 50% 75% 100%
imports—dropped by nearly 15 percentage points between 2016 and 2023; the Source: U.S. Census Bureau. Data as of September 2023.
percentage decline in toys wasn’t as great (10 percentage points), but the declines in
But here’s the rub: Thus far, U.S.-China decoupling has been relatively painless for the U.S.
economy and nonthreatening to the capital markets because finding alternative suppliers
for dolls, hoodies, sandals and mother boards hasn’t been that difficult or disruptive. These
products can be produced virtually anywhere in the world. As goods import from China
have gone down, imports from Vietnam, Taiwan and other nations have gone up.
America: Decoupling from China the factory, not China the refinery Yes, China’s role as the
“factory to the world” is being recast as more firms diversify and derisk their global supply
chains. And yes, as the media seems to harp on daily, the percentage of imports to the
U.S. from China is declining. But China does more than make “stuff”; it also refines “stuff”.
Indeed, when it comes to refining iron ore into steel or pulverizing cobalt into fine purity
particles for batteries, most roads lead through China. The nation’s processing
infrastructure—think smelters, refiners, cracking activities, chemicals and related
capabilities—is second to none on a global scale, and a potentially dangerous set up for a
country like the U.S., which according to the U.S. Geological Survey, is 100% reliant on
graphite and manganese imports, 70% per cobalt, and 50% net import reliant on lithium
and nickel. The U.S. is also significantly dependent on imports of metals/minerals like
antimony, rare earth minerals, barite, bismuth, gallium, germanium, tantalum, yttrium and
many other minerals. The list goes on—indeed, according to the U.S. Geological Survey’s
“Mineral Commodities Summaries 2023” report, the U.S. is now more than 50% reliant on
51 foreign minerals, up from 47 from the prior report. Importantly, 43 of these 51
minterals are categorized as “critical” by both the U.S. Geological Survey and the
Department of Energy.
From this list, China ranks as the number one supplier of 12 critical materials: antimony,
Exhibit 4: No Decoupling from China
arsenic, barite, bismuth, gallium, germanium, graphite, magnesium, rare earths, tantalum,
The Refinery: Critical Materials
tungsten and yttrium. Seven of these commodities are depicted in Exhibit 4, which shows
Imports From China As A Percent of
that from 2016 to 2022, America’s import reliance on China for these critical commodities
actually went up, not down. Take graphite, for example. Essential for batteries used for Total.
electric vehicles, graphite imports from China as a percent of total more than doubled 2016 2022
between 2016 and 2022, according to the U.S. International Trade Commission. In other Germanium
words, when it comes to critical materials to power America’s green transition, and to
support the U.S. semiconductor and defense sectors, think more, not less dependence on Graphite
China.
Magnesium*
Decoupling? Sure, that’s possible for garments but not graphite; monitors not magnesium;
Rare Earths
athletic shoes not arsenic; rattan furniture not rare earth minerals; Toys not tantalum. The
inconvenient truth is that the U.S. remains wedded—coupled—to the refining champion of Tantalum
the world. And while the U.S. and its allies are serious about diversifying its mineral/metals
supply chain, efforts to diversify and derisk mineral supply chains won’t be cheap and Tungsten
won’t happen overnight. These transitions will take time and require a great deal of capital
Yttrium
and the political will to overcome environmental concerns.
0% 20% 40% 60% 80% 100%
Investment takeaway For investors, all of the above is a reminder that geopolitical risks—
namely souring U.S.-China relations—remain a key concern and consideration when it *Magnesium compounds. Sources: U.S. International Trade
Commission DataWeb, U.S. Geological Survey Mineral
comes to portfolio construction and expected market returns. There is a great deal at Commodity Summaries 2023. Data as of January 31, 2023.
stake as the decoupling debate swirls and gathers more traction as the 2024 election
approaches. An all-out, full-blown decoupling of the U.S. and China is not our base case—it
would be too ruinous for both parties. That said, we suggest investors take a more
nuanced view of the decoupling headlines. Reality, or the world we live in, is far more
complex than the headlines suggest.
Sources: Bloomberg Indexes; Bureau of Labor Statistics; CIO Calculations. Data as of August 2023. Past performance is no
guarantee of future results. Please refer to index definitions at the end of this report. It is not possible to invest directly in
an index.
Equities
Total Return in USD (%) Economic Forecasts (as of 9/22/2023)
Current WTD MTD YTD 2022A Q1 2023A Q2 2023A Q3 2023E Q4 2023E 2023E
DJIA 33,963.84 -1.9 -2.1 4.1 Real global GDP (% y/y annualized) 3.6 - - - - 3.0
NASDAQ 13,211.81 -3.6 -5.8 27.0 Real U.S. GDP (% q/q annualized) 2.1 2.0 2.1 2.0 1.5 2.1
S&P 500 4,320.06 -2.9 -4.1 13.9 CPI inflation (% y/y) 8.0 5.8 4.0 3.5 3.5 4.2
S&P 400 Mid Cap 2,495.51 -2.8 -5.6 3.9 Core CPI inflation (% y/y) 6.1 5.6 5.2 4.4 3.9 4.8
Russell 2000 1,776.50 -3.8 -6.4 2.0 Unemployment rate (%) 3.6 3.5 3.5 3.7 3.8 3.6
MSCI World 2,879.85 -2.7 -3.5 12.1 Fed funds rate, end period (%) 4.33 4.83 5.08 5.38 5.63 5.63
MSCI EAFE 2,064.71 -2.0 -2.0 8.6
MSCI Emerging Markets 964.24 -2.1 -1.5 3.0 The forecasts in the table above are the base line view from BofA Global Research. The Global Wealth & Investment
Management (GWIM) Investment Strategy Committee (ISC) may make adjustments to this view over the course of the
Fixed Income† year and can express upside/downside to these forecasts. Historical data is sourced from Bloomberg, FactSet, and
Haver Analytics. There can be no assurance that the forecasts will be achieved. Economic or financial forecasts are
Total Return in USD (%)
inherently limited and should not be relied on as indicators of future investment performance.
Current WTD MTD YTD A = Actual. E/* = Estimate.
Corporate & Government 5.20 -0.44 -1.54 -0.04 Sources: BofA Global Research; GWIM ISC as of September 22, 2023.
Agencies 5.17 -0.15 -0.52 1.50
Municipals 4.06 -1.07 -1.42 0.15
U.S. Investment Grade Credit 5.26 -0.50 -1.59 -0.24 Asset Class Weightings (as of 9/5/2023) CIO Equity Sector Views
International 5.88 -0.34 -1.51 1.21 CIO View CIO View
High Yield 8.73 -0.65 -0.76 6.31 Asset Class Underweight Neutral Overweight Sector Underweight Neutral Overweight
90 Day Yield 5.47 5.45 5.44 4.34
neutral yellow
Equities
Over weight green
Healthcare
2 Year Yield 5.11 5.03 4.86 4.43
Slight over weight green
Energy
10 Year Yield 4.43 4.33 4.11 3.87 U.S. Mid Cap
Slight over weight green
Slight over weight green
International Developed Staples
Commodities & Currencies Emerging Markets
Neutral yellow
Total Return in USD (%) Neutral yellow
Technology
Fixed Income
Commodities Current WTD MTD YTD
U.S. Investment- slight over weight green
Communication Neutral yellow
Bloomberg Commodity 240.31 -1.1 0.5 -2.3
grade Taxable Services
WTI Crude $/Barrel†† 90.03 -0.8 7.7 12.2 International
neutral yellow
Industrials
Neutral yellow
Gold Spot $/Ounce†† 1925.23 0.1 -0.8 5.5 Slight underweig ht orange
Financials
Total Return in USD (%) U.S. Investment Grade Slight underweig ht orange
Materials
slight underweig ht orange
Prior Prior 2022 Tax Exempt slight underweig ht orange
Real Estate
Currencies Current Week End Month End Year End
EUR/USD 1.07 1.07 1.08 1.07 Alternative Investments* Consumer Underweight red
Discretionary
USD/JPY 148.37 147.85 145.54 131.12 Hedge Funds
USD/CNH 7.30 7.28 7.28 6.92 Private Equity
Real Estate
S&P Sector Returns Tangible Assets /
Commodities
Healthcare -1.2% Cash
Utilities -1.7%
*Many products that pursue Alternative Investment strategies, specifically Private Equity and Hedge Funds, are available
Consumer Staples -1.8% only to qualified investors. CIO asset class views are relative to the CIO Strategic Asset Allocation (SAA) of a multi-asset
Energy -2.3% portfolio. Source: Chief Investment Office as of September 5, 2023. All sector and asset allocation recommendations
Information Technology -2.6% must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all
Industrials -2.7% recommendations will be in the best interest of all investors.
Financials -2.8%
Communication Services -3.2%
Materials -3.6%
Real Estate -5.3%
Consumer Discretionary -6.3%
-7% -6% -5% -4% -3% -2% -1% 0%
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