Navigating a murky risk landscape
Better readings on US Chicago PMI/ISM held the promise that Q3/H2 might deliver a better tone for risk markets. A lack of confidence in the ’kick the can down the road’ strategy from the Eurozone and continued monetary tightening from China suggests that a more cautious stance toward risk could give way to more in the way of sideways trading.
Things were starting to look up as we approached the end of what was a very difficult second quarter. Europe had seemed to avoided an imminent Greek default, China might stop hiking rates and focus on growth risks and US data was adding weight to the soft patch thesis with strong gains on Chicago PMI/ISM.
Since then we have seen the second bailout for Greece come into difficulties related to involving the private sector and now Portugal has entered the risk radar screen following Moody’s decision to downgrade its rating below investment grade. This has now been followed by a rate hike from China at a time when their (and Europe’s) PMIs are close to entering into contraction territory and markets are focused on ’hidden’ local government debt. Even the IEA’s release of oil stocks has seen oil bounce back from its lows and providing only temporary relief.
With the positive sentiment boosters turning around we are left with the uncomfortable question of whether the US confidence indicator could prove to be an outlier. While we wait for more US data to help resolve this uncertainty the market is reacting to the growth risks related to the Eurozone (debt crisis) and China (monetary tightening). This is a positive environment for the USD especially as the market is focused on QE2 risks from the BoE and backdoor QE from the ECB (see “ECB - Backdoor QE or monetization?”; Jul 5). For bond and equity markets expect to see sideways trading dominate as the pendulum of market sentiment shifts between “risk-on” and “risk-off”.
The best strategy in this environment is to trim exposure to risk and wait for greater clarity as to the economic and policy outlook. Without such clarity the current market seems more like a crapshoot.