From ANZ Sell Side Insights

Some markets and assets are starting to trade with a risk off tone. As the French election draws closer, French stocks are underperforming, while at the same time rising uncertainty in the US has drawn flows into gold funds. Emerging market currencies are starting to feel some pressure, but this has yet to filter into the performance of the AUD or NZD in a substantial way.

In the near term we expect that volatility could spike. Indeed, the gap between policy uncertainty and broad measures of volatility, like the VIX, is close to its historical wide. While this is not a perfect predictor of future volatility it should mean risks around the AUD become more balanced in the near term.

That said, we still think that any spikes will be short lived. While policy uncertainty is an important driver of markets, we think that it remains secondary to growth as a driver of sustained market volatility. This is because the growth pulse determines the importance of policy uncertainty. In a strong growth environment, an uncertain policy environment is less important to the performance of risk assets, and vice-versa. This is because, when growth is scarce, policy decisions arguably have a larger impact.

The impact of growth on volatility is also borne out in our ANZ Regime Identifier – which measures the correlation across FX, equities and bond markets. It has been steadily declining since mid-November 2016 and this suggests that we shifted from a highly correlated world –where assets are roughly split in risk-on/risk-off assets– to an uncorrelated environment where local drivers are starting to play a greater role. We believe this shift has been driven by the combination of rising global inflation and a more upbeat outlook for global growth. High cross-asset correlation is driven by elevated uncertainty over the growth outlook. In this ‘world’ each data release (or event which drives policy uncertainty) has a significant impact on the outlook and as a result, movements in assets prices tend to be synchronised and large. Indeed, our analysis shows that when global growth deteriorates (uncertainty rises) polarisation tends to rise.

For now, this is not the case. For as long as growth and inflation data remain upbeat, markets should remain unpolarised and local macro factors will once again emerge as more significant market drivers. This also suggests that although heightened policy uncertainty may impact on the currency concerned on a sustained basis, while global growth remains at current levels, it will not be an environment where these events can have a sustained negative impact on the broader currency performance.


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