The folks at BNP Paribas provide a simple framework for looking at alternative risk premia trades based on the expected macro environment. There are three risk choices: The right tail risk of more inflation risk, the left tail event of deeper recession, and the main case of muddling through with the current environment. If the base case is muddling through, hold carry trades and add risk. The recession scenario requires defensive risk-off strategies, and a higher inflation environment requires rate production and a move to value.
Subjective probabilities concerning the macro environment will drive investment choices. The tough question is determining what those probabilities should be. We have moved from rates lower, slower growth, and lower inflation to a higher likelihood of muddling through over the last three months.
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