(BLOG) Morning Brief: Aug 24, 2018

Real Fed Funds Rate

1. Real Fed Fund Rate

For the first time in more than a decade, the overnight real rate (Fed target rate minus PCE core rate) in the US is positive. The real rate should rise as the Fed continues to raise interest rates.

Why it Matters

A positive real rate on cash alleviates the need for investors to chase yield in riskier asset classes. A growing positive real return for cash makes it a viable asset class again. This could be one factor behind the recent cheapening of gold as a store of value.

2. Investor Sentiment

Despite the turmoil in emerging market debt and equities, investor sentiment remains strong. According to Morgan Stanley data, most indicators point a little more toward “exuberance” than “fear”.

Investor Sentiment

Why it Matters

Everybody is looking for the catalyst to signal the top in US equities; whether it is from peak earnings, tight monetary policy, or a slowdown in global growth. Regardless of the source, most tops are also associated with excessive levels of euphoria. We are not there yet.


The JP Morgan LACI Index of LATAM currencies hit a new low yesterday. Once again, Brazil led the way down. Brazil has the largest weight in the index (ARS 10%, BRL 33%, CLP 12%, COP 7%, MXN 33% PEN 5%).

EM FX and USDBRL Option Vol

Why it Matters

Investor focus on EM currencies has moved from Turkey to Brazil. 1-month volatility on USDBRL has spiked. We have to watch for spillover effects into developed market risk assets.

4. Small Caps

The small-cap outperformance is largely attributed to the strength in the USD and exposure to a potential trade disruption. There may be additional return sensitivity to the eventual turn of the credit cycle when investors shun weaker balance sheets.

Russell 2000 Credit Composition

Why it Matters

Small cap equities (Russell 2000) made a new all-time high yesterday, with the index up almost 12% YTD. The index composition from a credit quality perspective, however, is much worse than the S&P: 60% of the Russell 2000 is below IG vs 10% for the S&P 500.

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