From risk to liquidity - key financial market themes

One main theme in the past few years is risk-on/risk-off. This idea relies on the correlation between assets – which meant that their movements were often related to each other.
One group of risk-on assets benefited from investor confidence – including commodity-based currencies (such as the Australian dollar), emerging-market currencies (particularly in Asia), and global equities. Thai assets and the baht also fall into this group.
On the opposite end, there were risk-off assets such as sovereign bonds (especially from developed countries), volatility-linked derivatives, and safe-haven currencies (primarily the US dollar and the Japanese yen).
The observant reader will |have noticed that this theme no longer explains recent market movements.
Under the basic risk-on/risk-off concept, good economic data from the United States would have led to a weaker US dollar, and higher US stocks. More recently, however, good data have had the opposite effect – the dollar has strengthened, while US stocks have been muted (or have even fallen).
The theme over the past few months has shifted away from risk and to liquidity.
This new theme has actually |been building over the past few |years, and reflects a fear about |the power of central banks. There have been many examples of central banks using monetary or exchange-rate policy more effectively than expected.
One example is from 2011, when the Swiss National Bank (SNB) was trying to fight the excessive strength of its currency. As investors panicked about the euro zone, they poured into the Swiss franc instead. Within one year, the euro-franc exchange rate moved from 1.39 to 1.03 (a Swiss appreciation of 35 per cent).
In response the SNB announced a currency floor – at all costs, it would prevent euro from moving below 1.200. Markets were initially sceptical, but the floor has indeed been maintained through drastic market interventions (Swiss foreign reserves have more than doubled as the SNB bought euros).
This important concept – that the major central banks would truly do whatever it takes to achieve policy goals – has also been seen elsewhere. It is apparent in the US Federal Reserve’s efforts to stimulate growth via huge bond purchases. It is also clear in the devout pledges from the European Central Bank to maintaining the euro.
The ability of central banks to make big commitments is also supported by the benign environment. Low inflation has given authorities the flexibility to use policy for other objectives.
The market’s recent movements represent investors trying to understand or pre-empt the big shifts in global central-bank policies that will occur this year. It is these expectations about upcoming liquidity conditions that are driving prices and currencies. With no clear resolutions likely any time soon, this theme will probably continue.
One key variable is the Federal Reserve, which has begun to signal it will slow down bond purchases if the economic recovery gathers pace. Such a move would be very positive for the dollar, but could also lead to much-reduced liquidity in financial markets.
The other key is Japan, where authorities have launched aggressive new easing measures to stimulate growth and inflation. While these plans were initially well received, markets are now looking for signs |of success. They are also monitoring the Bank of Japan, to see if it is indeed fully committed to these new policies.
Uncertainty about prospects at these two major economies is (at least in the short term) leading to more interest in the euro, where policies are suddenly seen as comparatively more conservative.

Parson Singha, chief markets strategist/global markets, HSBC Thailand. contributed this article.