A most a remarkable and unexpected risk appetite reversal

GLOBAL MARKETS 

European equities were stronger Monday, with Stoxx600 up 0.5%. US markets closed for Martin Luther King day. However, US futures traded relatively passively as market leadership has shifted to non-US markets for the time being.

Global investors have staged a remarkable and unexpected risk appetite reversal, especially given that “The Street” has been entirely consumed by when central bank rate hikes might exact a sharper toll on growth and trigger a recession.

Sure, a good chunk of applause should be directed to the China reopening bounce, but there are reasons beyond China’s borders why investors are more optimistic.

European natural gas prices have fallen to their lowest level in 16 months, with a decline of more than -80% from their August peak. That’s been partly driven by warmer-than-expected weather, but another factor has been considerable efforts to reduce demand across the continent.

A reassessment of Europe’s near-term outlook is echoed in asset price action. The Euro has moved above $1.08 for the first time since April; the STOXX 600 is also at its highest since April.

A more optimistic inflation picture has led investors to reappraise how aggressive central banks will be this year—and providing a zap to equity markets.

Traders expect the Fed to slow the pace of hikes again at its next meeting. This apparent desire to slow things down tends to ease financial conditions, which are now at their most accommodative since last February before the Fed even began to hike rates.

Hence, investors are now questioning what was once a given only weeks ago: whether policy tightening will severely affect growth and cause a recession in major economies.

Oil prices have been on a downward trajectory since mid-June and are now down over -30% in that time; although currently supported by China reopening, they continue to trade in well-worn ranges as unseasonally warm weather in Europe continues to weigh on the energy complex.

And importantly for Asian risk sentiment, The US dollar index, which benefited greatly as a “safe haven” through 2022, is now around its weakest level since June.

That said, a more rosy economic outcome does point to some risk that central banks may be forced to keep growth below potential via further policy tightening if more resilient growth prompts inflation or commodity prices surprise to the upsi­­­de significantly forcing the Fed to snuff out the China rally inflation effects. For now, however, provided inflation continues to decelerate and central banks maintain a more orthodox policy setting, global growth may have further to run.

OVERNIGHT UPDATES

Interestingly the Euro has not reacted significantly to the domestic equity markets ramp, suggesting either inflow is not that big so far, the 16 bp decline in the peak ECB terminal rate, which is now priced for the July 2023 meeting, is providing a bit of overhang, or markets are showing some respect to the Fed ahead of the Feb meeting.

Oil is trading lower ahead of agency outlooks amid concerns central banks might have to temper China’s bounce after the hawkish tone from BoE’s Bailey hinting that “China’s reopening could fan inflation” But it’s not much of a stretch to assume similar conversations are happening behind the Feds closed doors.