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Risk-Off Sentiment to Continue but Beware of a Correction First

Risk-Off Sentiment to Continue but Beware of a Correction First

2017-08-11 09:23:00
Martin Essex, MSTA, Analyst
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Talking Points

- While the confrontation between the US and North Korea continues, the flight to safety will likely pick up speed.

- But beware of a correction in the markets before current trends return.

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Assets seen as boltholes for risk-averse investors, such as the Japanese Yen, Swiss Franc and gold, remained in demand in Europe Friday, while “risk-on” assets such as stock markets and the Australian Dollar were sold. However, the key question for traders now is whether these trends will continue as the US and North Korea ramp up the aggressive language or whether profit-taking will soon begin.

Truth is, the move towards safe havens has been relatively small so far. The S&P 500 index of US stocks closed down just 1.4% Wednesday and is still above where it traded a month ago. The gold price is no higher than it was in early June.

The VIX measure of US stock volatility is still lower than it was late last year and positions in VIX futures are now net short. Even high-yield bonds, which have led the way lower for stocks and fallen sharply, are only back to where they were in April – and the spreads between emerging-market bond yields and those of the developed countries remain historically low.

Chart: SPDR Barclays High-Yield Bond ETF Daily Timeframe (Feb 2017 to Date)

Risk-Off Sentiment to Continue but Beware of a Correction First

Chart by IG

This implies that the current “risk-off” sentiment could continue for a while yet even though there could be some profit-taking, dip-buying and bottom-fishing before the current trends resume – particularly if the two combatants tone down their belligerent rhetoric.

However, one haven currency, the Japanese Yen, looks to have been mispriced. As I explained here, buying the Yen when Japan lies on the direct route from North Korea to the threatened US island territory of Guam makes little sense – yet so far it has kept pace with the Swiss Franc.

Chart: CHF/JPY Daily Timeframe (May 2017 to Date)

Risk-Off Sentiment to Continue but Beware of a Correction First

Chart by IG

Traders should therefore be wary of market corrections but the current trends look set to continue, particularly if the talk of “bubbles” in some assets like credit begins to grow louder.

--- Written by Martin Essex, Analyst and Editor

To contact Martin, email him at martin.essex@ig.com

Follow Martin on Twitter @MartinSEssex

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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