Hiccup or more?
A build-up of risk is driving stresses in markets. We have seen many such episodes in the post-Covid market and rising risk premia is certainly not something new. However, it is always prudent to question whether stresses in markets are the start of something greater. Risk premia in FX has built up around two main factors. Firstly, major elections, some of which in the notable cases of the UK and France had been unexpected until recently, have raised volatility. In the case of GBP and EUR, the estimated size of the premium versus a fair value model remains limited.
Monetary policy also continues to be a driver of risk. There have been few occasions over 2023/4 where the market had priced a scenario close to that which is now playing out in rates. Particularly within US policy, the lack of policy adjustment but the volume of speculation is driving USD risk. Despite its own election later this year and uncertainty surrounding rates, the Dollar is still one of the favoured safe havens in FX today. Due to the forecasted decline in the Yen, despite policy maker’s pledges to intervene in the face of persistent weakness, the Yen remains unattractive as a safehaven choice. Cuts at consecutive SNB meetings also leave CHF as an unsuitable choice for a safehaven bid.
The build-up of financial risk at this moment is widespread. The equity market has shown vulnerability particularly in the correction of what was briefly the most valuable company in the world, Nvidia. The stock alone that has driven much of the headline US equity gains has lost more than half a trillion Dollars in market capitalisation in recent sessions. Despite some underperformance in benchmark indices, equity market risk has largely played out within overvalued AI trend stocks. However, vulnerabilities in other markets, even within popular crypto assets, can be seen as indicative of wider market risk. If markets fail to keep risks contained within their current venues, a reappraisal of forecasts could be in order.
Discussion and Analysis by Charles Porter
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