Markets take global risks in their stride

Investors brush aside bad news to stay focussed on positive macro-economic cues

Simmering fears of a global trade war. An embarrassing political scandal in Japan. Rapid job-turnover inside the White House and the threat of faster interest rate hikes in the United States.

In any other era, this concoction would be a perfect recipe for heightened market volatility. But in recent months, markets have brushed aside risks and recurring bad news on geopolitics to stay focussed on positive macro-economic cues.

And Guy Debelle, the Australian central banker who oversaw a review of global foreign exchange standards, says it doesn’t make sense.

The Reserve Bank of Australia deputy governor said in Sydney yesterday that he found it “puzzling that measures of volatility do not seem to embody much uncertainty”.

“I have expected that volatility would move higher structurally in the past and this has turned out to be wrong,” Debelle said. “But I think there is a higher probability of being proven correct this time.”

For Paul Dales, Sydney-based chief economist at Capital Economics, markets are “taking all of this in their stride as the global economy is fairly strong and is expected to stay strong both this year and next... it is probably right that the recent events shouldn’t derail that.”

Investors got a taste of what the spike in volatility might look like when in early February fears of faster US rate hikes hammered world shares. That sell-off was shortlived, though, and equity prices are now not too far from their February highs.

A gauge of market volatility is near all-time lows, while most estimates of the term premium for 10-year Treasuries are around zero, or even negative, despite projections of multiple rate rises by the US Federal Reserve this year and next.

This comes at a time the world is seeing the first synchronised global growth since 2007, with strong corporate earnings and blistering job-creation.

Higher interest rates could all but dampen the optimism, and that is just one of the many risks.

The danger of a global trade war looms after US President Donald Trump slapped duties on imported steel and aluminium and has threatened further tariffs on Chinese goods.

In Japan, a cronyism scandal has engulfed Prime Minister Shinzo Abe and Finance Minister Taro Aso, causing uncertainty around political stability.

Yet the market response so far: Stay calm and look away.

Despite shock events like Britain’s vote to leave Europe, the threat of a euro-zone break-up and the potential for a nuclear war with North Korea, market volatility spiked only temporarily.

In fact, equity returns last year were among the highest since the 2008 global financial crisis. Emerging markets did well too, and the Australian dollar, considered a barometer for global risk, jumped 8.7% in 2017, its best performance in seven years.

For Shane Oliver, Sydney-based head of investment strategy at AMP Capital, risks can create chances to buy.

“It’s hard to quantify geopolitical risks,” he said. “It often makes more sense for investors to focus on the opportunities they throw up, rather than taking long-term shelter from them in low returning cash.”