We believe global risk appetite will remain healthy during 2018 notwithstanding the sharp, technically-driven equity market correction in February.
However, the risk of additional spikes in market volatility has increased.
While the exaggerated swings in equity markets can be disconcerting, they are likely a result of investors grappling with too much complacency, rather than a reflection of any dramatic deterioration in economic fundamentals.
The hunt for portfolio diversifiers is set to intensify as investors adjust to a return to the “old normal” from an extended period of extremely low market volatility.
Long Japanese Yen exposure has proven to be a good hedge in helping to mitigate a drawdown of risky assets.
JPY outperforms in times of strong risk aversion
Being most sensitive to risk aversion among the G10 currencies, the JPY has been the clear winner from defensive financial markets.
Bank of Japan (BoJ) governor Kuroda’s miscommunication has also kept USDJPY under pressure.
We have lowered the 12M USDJPY forecast to 108 from 111 to reflect rising tensions between, on the one hand, the support for JPY from the hunt for diversifiers and currency undervaluation versus, on the other hand, our belief that BoJ will remain dovish and be the last to exit from ultra-loose monetary policy.
Financial markets are facing new challenges: rising US inflation, slightly softer global growth, more Fed hawkishness and rising trade tensions.
However, rising inflation is not unusual for an economy such as the US, where solid growth is using up spare capacity.
Market expectations have moved to fully pricing in three hikes for 2018, edging closer to our forecast of four hikes.
Global manufacturing, meanwhile, seems to be coming off the boil. Global PMIs have stopped surprising on the upside but are merely likely to be falling back to more normal levels.
‘Inflation up, PMIs down’ is typical of late business cycle environments, which is also typically associated with higher market volatility but should not be a major threat to equity markets, as discussed in the Monthly Investment Guide.
Our base case remains ‘no trade war, no trade peace’.
However, concerns over retaliation by other countries in response to the Trump Administration's proposals for steel and aluminum tariffs, potentially triggering a trade war, are likely to add to market unease.
Gold is higher even though US 10-year real rates have also gone up since January 2018.
The "normal" relationship would postulate that gold has to go lower as real rates rise, since as a non-yielding asset, there is less reason to hold gold in a higher rate environment.
Gold's resilience to higher rates can be explained by portfolio hedge demand and softening USD outlook.
Gold has often acted as a portfolio hedge in market downturns and the recent equity market pullback was no exception.
Cryptocurrencies are no substitute for gold as a safe haven, especially if the behaviour of bitcoin and other cryptocurrencies during the recent equity market selloff was any indication.
Unlike the JPY, which is more of an ‘all weather’ diversifier, gold is primarily more of a hedge against systemic risk.
We do not see convincing catalysts for a further gold rally above $1,380 against a broadly stable global macro backdrop with low recession risk.
We retain a view that gold price is poised to hover between $1,200-$1,380 for the most part of this year, as the tug-of-war between bearish and bullish factors calls for neither a strong rally nor an aggressive sell-off.Disclaimer applicable to recommendation
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