As summer draws to an end and asset price volatility rises, investor appetite for risk in the short-run has climbed. US-China trade optimism and expectations of central bank easing from developed economies have been the main drivers for the shift. However, a sustained rally in risk assets is uncertain, as are the drivers behind these capital flows.
Earlier this month, optimism grew around a potential US-China trade resolution as news emerged that senior officials from both nations would meet sometime in October. While a date hadn’t even been announced, the news was enough to help stock markets in Asia, Europe, and the US climb. Equity markets had been stuck in a tight range in August—for instance, the S&P 500 Index hit support around the 2825 level and resistance around the 2940 level four times over the month. The news helped equities break out of this range, and since last week, the S&P 500 has climbed almost 3.5% while the trade-weighted US Dollar Index has fallen over 1.0% as of Monday morning.
Capital flows were also aided by key central bank policy announcements inching nearer, as the European Central Bank (ECB) is expected to introduce looser monetary policy this Thursday (click here to read more). Following that, the Federal Reserve will update interest rates next week along with central banks in the UK, Japan, and Switzerland. A range of stimulus packages are expected, including interest rate cuts and other more unconventional tools such as quantitative easing and credit easing. Looser monetary policy has been widely anticipated this year amid deteriorating global economic data, although central banks have become increasingly divided in recent weeks. The last meeting from the Federal Open Market Committee (FOMC) showed split opinions on US monetary policy and the European Central Bank (ECB) faces conflicting preferences from various members of the Eurozone.
The latest rally in risk assets demonstrates how sensitive investor sentiment is to expectations of central bank policy as well as global trade issues. Now that we’re into September, trading volumes are expected to pick up, and a shift in market sentiment is likely to manifest in larger movements in asset prices. The main underlying drivers of the uptick in risk appetite are also still uncertain – Donald Trump can wipe out hopes of a US-China trade solution in a single tweet, and a divided central bank risks losing its credibility as well the ability to deliver surprising policy moves.
Bottom line: Don’t be fooled into believing economic conditions are improving based on market sentiment. The underlying conditions and recent data releases don’t justify an increased appetite for risk.
The Pound has begun the week on a buoyant note thanks to easing sentiment over a no-deal Brexit and Boris Johnson’s inability to find support for a general election. Far from testing 2017’s low’s last week, we’re now seeing a bounce towards July’s levels above 1.24.
The trade-weighted Dollar Index is firmly off the top of its one-year trading range but remains perched in the upper bound. There’s scope for a further sell-off for the Greenback if the data this week disappoints. This would leave the Federal Reserve inching closer to a significant interest-rate cut next week.
The European Central Bank’s latest monetary policy meeting and subsequent press conference will be the highlight of the coming week. Markets have ramped up expectations of a significant package of stimulus, including a 10-basis point interest rate cut and the resumption of their asset purchase programme.
All content is written by the Global Reach Trading Desk. The opinions expressed are not the view of Global Reach Group and are not intended as investment advice.