Risk trade yet to show signs of fatigue
A month or so ago, there was a lot of talk that risk appetite would be pared back over the coming months. This talk was built around relatively cautious expectations for economic growth in most of the G-10 next year.
These cautious projections still stand. However, it is interesting that the risk trade suffered only a brief decline following the shock rise in the U.S. unemployment rate to 10.2 percent and the surprisingly strong fall in the University of Michigan confidence index.
Comments this week from Fed Chairman Ben Bernanke warning about “headwinds” that still face the U.S. economy have led to some paring back of risk but with poor economic data unable to cause a reversal of the uptrend in equities it seems that the risk trade is yet to exhibit many signs of tiredness.
The ability of markets to cast aside weak U.S. economic data centres on the outlook for Fed rates. Weak data is feeding the notion that Fed rates will stay lower for longer and this, it seems, is feeding appetite for risk.
The ability of the risk trade to remain undeterred by weak U.S. data feeds the accusation that the Fed is facilitating the risk trade and the dollar remains a preferred funding currency.
While the USD may be acting as the preferred funding currency, low interest rates are affecting investment decisions everywhere. Latest data from the UK’s Investment Management Association (IMA) confirm a bias away from cash into higher yielding assets.
In each of the 6 months to September 2009, private investors have ploughed more than 2 billion pounds into funds. Not only that, but in September this year equity fund purchases overtook corporate bond fund purchases for the first time since 2007.
This highlights that despite fears that economic growth rates in the US, UK and Eurozone will remain below trend for the next couple of years, that the lack of return on cash is spurring savers to take more risk.
Savings rates in the U.S., UK and the Eurozone are on the rise. Individuals are saving more in response to fear of unemployment and also to make up for wealth lost during the economic crisis. While bond markets have benefitted a great deal this year from flows diverted from cash due to lack of return, the data from the IMA suggests that a trend that favours equities could be emerging.
The healthy recovery this year in major stock markets and gains in some commodity prices is no guarantee of future performance. Even so, it is feasible that these rises could be contributing to the decisions of many savers to increase the amount of risk in their portfolios (the Standard & Poor’s 500 Index has rallied 61 percent in dollar terms from its March low).
If this is correct, then it is right to consider at what stage persistent low rates by the Fed and other central banks can be linked with the beginnings of asset price bubbles.