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What it can take to tip the balance on risk? - Nomura

Analysts at Nomura point out that over the past 17 years, there have been 21 risk-off episodes that persisted for over two weeks and it has been almost two years since a major risk episode – on average we get one every nine months. It seems on that basis, a risk-off episode is overdue, but of course, it would need a catalyst, they further add.

Key Quotes

What historically has driven these risk-off episodes?

First, we note that high growth rates are not a guarantor of continued risk-seeking behaviour. The extent of equity market declines around risk-off episodes is not particularly well correlated to the level of the ISM. Even though growth rates are currently running high in developed market economies, this does not make equity markets immune to periods of risk-aversion.

Of course, slowing growth and elevated recession risk helps to explain some periods of risk aversion. The frequency of risk-off episodes is much higher when recession risks increase, explaining the high concentration of risk-off episodes in the 2000-01, 2007-08 and 2010-12 crises. 

However, there are other noteworthy drivers of risk aversion. The Fed’s hiking cycle through 2004-06 drove two periods of risk-aversion, not to mention the taper tantrum in 2013. The China devaluation in the summer of 2015, and renewed concerns in Q1 2016 were drivers of the most recent risk-off episodes. The Enron accounting scandal fallout in 2002 was also important at a time where equity markets were fragile.  

“Three factors that could weigh on risk markets: the recent sharp jump in Fed expectations, China growth risks and a plethora of upcoming event risks. It doesn’t always take a recession to tip the balance for risk markets. Given this backdrop, we expect commodity currencies such as AUD and NZD to continue to underperform, while the yen should remain supported.”

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