Financial markets appear to be caught up again in the risk-on, risk-off (RORO) phenomenon.
When risk-on is back, a large number of investors flood into risk assets like equities, commodities and precious metals.
But when sentiment turns, investors would dump the assets and buy US dollar, Treasuries and other safe-haven instruments.
HSBC came up with a so-called RORO index in 2010 to monitor relative change among different asset classes and help gauge market risk appetite.
The market is deemed to be in a risk-on mode when stocks, raw materials, precious metals are increasingly positively correlated.
By contrast, when US dollar and American government bonds are positively correlated, it means investors are ready to flow into low-risk assets and the market is in risk-off mode.
Risk-on assets have negative correlation with risk-off assets.
People should consider the overall market sentiment and capital flows when making investment decisions instead of just relying on fundamentals of a specific company.
Currently, it seems the RORO phenomenon is back after the Fed ended the QE stimulus. More importantly, there are signs that the market is heading towards risk-off mode, and investors would face various challenges including the Brexit vote, FOMC meeting and US presidential election.
RORO index is likely to pick up when the US rate hike comes on horizon.
Undoubtedly, market fears over a rate hike will intensify, exerting pressure on equities and emerging market currencies. And it will trigger a new wave of risk-averse actions, in particular in emerging markets. Capital might flow back into safe-haven assets like the Japanese yen.
The RORO index surged to an all-time high during the 2008 financial crisis, when all assets fell back.
The global market has returned to the risk-off mode, as risk assets like equities, commodities have all slumped this year, while safe-haven assets like US Treasuries, precious metals, Japanese yen have risen. It’s very hard to reverse the RORO mode.
The US dollar is likely to stay strong amid increasing expectations for a US rate hike in June. Amid this situation, China’s renminbi could lose some ground.
This article appeared in the Hong Kong Economic Journal on May 23.
Translation by Julie Zhu
[Chinese version 中文版]
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