What prospects for riskier assets?

Steve Barrow, Head of Standard Bank G10 Strategy, said there would be a number of global factors that would seem to suggest that riskier assets are on the cusp of a substantial rally. The most important of these is the global monetary easing cycle and, in particular, the start of Fed rate cuts. The Fed has made the first 50-bps downpayment on this easing cycle and the market is priced for a further 200-bps of cuts, or so, before the cycle has finished. Lower US rates – and a lower US dollar – drive the global financial cycle through the dominance of the US dollar in international finance.

In recent years, higher US rates and a strong US dollar have limit ed international US dollar finance with annual falls in US dollar credit to non-bank borrowers. The yen has taken up some of the slack given low Japanese rates, but yen loans are a tiny fraction of US dollar lending. The key now is that falling US rates start to lift global credit growth, and there are already some signs of this even before the first Fed rate cut.

The second key ingredient in this positive backdrop for risk assets is that the world, and particularly the US, looks as if it could achieve the soft landing that seemed almost impossible a year, or more ago, for such an outlook, reinforces the positive credit cycle.

The third factor that we’d mention is that investment in riskier assets, particularly emerging markets, appears to have been quite cautious in recent years. This, of course, is hardly surprising given that returns for investors have been high in advanced countries, notably the US, leaving little reason to take on unnecessary risks on assets with significantly weaker credit profiles.

For instance, in the US, we’ve seen the amount of money parked in money market funds roughly double over the past five years but as some of this USD 6tr-plus likely departs to other assets as the Fed cut rates, so some seems likely to be channelled into riskier global assets. So, could this triple boost from global policy easing, soft landings, and re-directed asset flows lead to a strong and sustainable rally in riskier assets? Steve Barrow thinks it will but, undoubtedly there are risks to consider as well.

One risk, of course, is that these assumptions prove incorrect; that the Fed and others can’t ease policy, soft-landing hopes are replaced by hard-landing disaster, or that global investors still steer clear of risky assets. But this is not our base case. Other risks to consider relate mainly to geopolitical threats.

One is that the two areas of military conflict, between Russia and Ukraine, and between Israel and all-comers, escalate into something that seriously impairs riskier assets. While we are sceptical that the situation in the Middle East will escalate to a level that weighs on financial market sentiment materially, the situation between Russia and Ukraine could be different. For we have mentioned before that if, or more to the point, when, the US and UK grant Ukraine the license to fire US and UK-supplied long-range missiles into Russia, there could be retaliation from Russia that spooks market sentiment.

What about other threats to this rosy risk-asset backdrop? The US election could be another should former president Trump win a second term on November 5^th, or perhaps even if he were to narrowly lose the election and provoke civil disobedience as we saw in January 2021.

In short, threats to a positive performance of riskier assets are clearly evident. But are they sufficiently worrisome to mean that global investors should sit on their hands and ignore the allure of riskier assets that comes from rate cuts, a soft landing, and the lack of risk exposure amongst investors? In Steve Barrow’s view, the answer is ‘no’. He believes that Fed easing, in particular, will drive improvement in risk assets and so usurp the threats to asset price strength that undoubtedly exist.