Risk appetite: A local peak is nigh - Westpac

Research Team at Westpac, suggests that the negative interest rates across a substantial segment of the develop world bond market will continue to provide “structural support” for higher yielding assets for sometime to come.

Key Quotes

“But, the conditions for another decent multi-week leg up in risk appetite are not ideal right here. As the slide over shows Westpac’s global data surprise index is rolling over after hitting 4 1/2 yr peaks recently and our risk appetite index is in the zone where further gains are hard to come by. Back in early July we argued that there was room for risk appetite to recover in line with stronger global data. That horse has bolted.

Risk appetite and the complexion of the global data typically move in unison – softer data coincides with weaker risk appetite and vice versa. There are of course instances when weak data will lead to a repricing of interest rate expectations (i.e. Fed tightening expectations will ease on softer data) and that can boost risk assets, but over the long haul there is a stronger tendency for risk appetite to weaken in the wake of softer data and vice versa, as the slide over very clearly shows.

Scanning the key global releases due this week – China PMIs, the US ISM and US non-farm payrolls – one can certainly make a case that the incipient momentum toward a lower global data surprise index might build yet further. Most of the US regional PMIs and Markit’s nationwide US PMI eased back in August, signaling an easing in the ISM. After two consecutive strong monthly payrolls gains averaging +274k, substantially overstating the underlying strength of both the labour market and the real economy, US jobs growth surely eased back in August.

The backdrop for the Caixin and NBS PMIs is hardly constructive either - MNI’s China PMI edged lower in August from 55.5 to 54.3, underlying growth momentum in China remains questionable and there have been factory closures in and around Hangzhou ahead of the 4-5 Sep G20 Leaders Meeting. Beyond that asset markets need to navigate a number of potentially significant risks – Italy’s referendum on constitutional reforms for the Senate in October, the US Presidential election in November, which may yet carry a sting in its tail if polls tighten, while Chinese authorities are reportedly planning curbs on China’s property market.

Structural positives in favour of higher yielding assets, most notably negative rates across great swathes of the global bond market, won’t go away soon but the conditions do not appear ripe for a sharp leg up in risk assets right here.”