Risk sentiment took a further big hit this week as geopolitical risks are on the rise and weak euro area data is raising concerns over the fragile euro recovery. The centre of the risk-off move is Europe where the German Dax index has now corrected 10% over the past month. Credit spreads are also widening and peripheral bond spreads have increased.
The extent of the moves we have seen corresponds very much to what we saw during summer last year when the focus of the risk-off sentiment was driven by Emerging Markets turmoil. If it is a repeat of this pattern, we should see a bottom in risk sentiment soon. The big question is whether there will be a further leg down in risk sentiment or whether it is time to ‘buy the dip’ in risk assets.
From a fundamental point of view, we are inclined to go for the latter. Global growth is accelerating and central banks continue to provide massive stimuli and promise very low rates for a long time. While the Ukraine crisis has escalated this week with the new sanctions from Russia (see EMEA Weekly), the direct effects through trade links are still fairly limited. There will probably be a small sentiment effect, which we may be seeing already, but in our view the crisis is not yet big enough to give a big hit to global activity. Inventories are likely to become a bit leaner due to the uncertainty which will have a short-term impact. But unless the crisis escalates further, we doubt it will have a big or long-lasting effect.
At the same time, though, uncertainty is on the rise and global politics are not very predictable and a tit-for-tat development can suddenly see things spin out of control. So we recommend caution in the short term. In our view, there are two key determinants that could lead to a bigger impact on the global economy:
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