Markets: This is not the big risk sell-off - Nomura

Bilal Hafeez, Research Analyst at Nomura points out that we’ve now had the largest one-week drop in US stocks in over two years and such tremors shouldn’t be easily dismissed, and suggest that 2018 will likely be a much bumpier year than the remarkably smooth 2017.

Key Quotes

“The proximate trigger for the latest bout of risk aversion has been the rise in global bond yields. This was driven by a more hawkish Fed and higher US wage data. Most risk markets have entered “risk aversion” as we define it (a one standard-deviation move above its 3-month average). Equity volatilities have surged, FX volatility has picked up sharply and credit spreads have widened.”

“The one exception has been emerging markets, which have held in well so far. Given that we seem to have seen a cascading move into risk aversion from equities to FX to credit, we should keep an eye out for spikes in EM risk.”

“Stepping back, the US backdrop is not helping risk markets. US growth data surprises are falling, while inflation expectations are rising. Such a “stagflation” tilt is not helpful to risk markets. It is also notably different to the “Trumpflation” sell-off in rates in late-2016, when both growth surprises and inflation expectations were rising.”

“In the short term, this mix of US growth disappointment and inflation surprises could linger, but it’s unlikely to persist for too long. For one, the jump in average hourly earnings of US workers contained several idiosyncratic factors (hours worked fell on poor weather, and only managers seemed to get the wage gains). The global inflation picture is also more subdued (for now). Then, there is the activity cycle: China is slowing but not sharply, and euro area data remain elevated.”

“In FX then, we’d stick to our bearish dollar view (against euro and yen), stay short AUD (vs GBP) and NZD (vs JPY) and keep an eye on EM volatility.”