Equities rallied and bond yields fell on Tuesday after the European Central Bank (ECB) held out the prospect of fresh rate cuts. President Donald Trump provided additional fuel for the rally, announcing US-China trade talks would resume and that he would meet with China’s President Xi Jinping at this month’s G20 summit.

The Stoxx Europe 600 gained 1.7% and 10-year bund yields fell to a new record low of -32bps after ECB President Mario Draghi said that additional stimulus would be required if inflation didn’t improve towards the central bank’s 2% target. He said that “further cuts in policy interest rates” remain part of the ECB’s toolkit. US markets followed Europe higher with President Trump’s comments helping the S&P 500 close up 1%. Hong Kong’s Hang Seng index jumped 2.6% on Wednesday, and European equities held onto most of their gains in morning trade.

Both sets of statements are positive for risk assets and our overall six to 12-month tactical positioning continues to overweight equities with a regionally selective approach. But we also think that investors need to take into account that:

* Ahead of today’s FOMC meeting, equity markets have risen back close to record highs and the fall in bond yields has taken some markets to record low yields. Scope exists for market disappointment with the extent to which the Fed endorses dovish market pricing.

* Disappointment on the US-China trade dispute is also possible. Getting both leaders back to the negotiating table at this month’s G20 summit is an incremental improvement. However, subsequent comments from officials from both sides shows the gulf on expectations remains, with Washington reiterating its demand for structural changes in China, and Beijing seeking the immediate removal of all US tariffs. There appears another gulf on trust – with US Trade Representative Robert Lighthizer telling Congress he wasn’t sure whether tariffs on China “will get them to stop cheating”.

* While we think the Fed will remain on hold for now, central banks have clearly communicated that they remain accommodative and would provide additional stimulus if economic conditions deteriorate. We believe this is a favorable backdrop for carry trades. So in addition to equity exposure, we recommend counter-cyclical positions to protect against the risk of a breakdown in trade talks. And with yields on 2-, 5-, and 10-year US Treasuries now lower than 3-month T-bill yields, we think markets have gone too far in pricing rate cuts, and prefer stocks and cash over shorter-maturity US government bonds. To benefit from carry, in our FX strategy we overweight a basket of equally weighted high-yielding emerging market currencies (Indonesian rupiah, Indian rupee, South African rand) against a basket of G10 currencies (Australian, New Zealand, and Taiwanese dollars).