US stock market

In some ways, the global economic and political situation resembles that of a swan. On the surface, things seem quite smooth, at least in an economic sense, as policymakers pinch themselves that they might be achieving a relatively soft landing after all. But, under the surface, there’s a lot of thrashing around given the various domestic political and geopolitical threats that could easily rise to the surface this year. If investors want safety from these risks, how can they find it?

This is clearly not an easy question to answer, but, for a number of reasons, we’d argue that it is the yen. If we take the currency space first, then alternatives to the yen are largely restricted to the Swiss franc and the dollar. The Swiss franc is clearly an option but there are a couple of concerns here.

The first is that one obvious geopolitical risk is that the conflict in Ukraine develops into something more serious, perhaps because Russia manages to take the country and/or because it shows its military ambitions extend further into Europe. Japan is clearly far away from such conflicts; Switzerland is not.

A second issue is that the SNB’s surreptitious acceptance of a stronger franc seems to have ended. When inflation was soaring, the SNB saw franc strength as a useful deflationary tool. But now it does not, and it could intervene again given that inflation has declined and rate cuts seem to be just around the corner. In Japan, the risks of intervention lie on the other side, as the BoJ could act again, as it did in September 2022, to raise the value of the yen. But what about the dollar? Surely it is bound to outperform the yen if global risk aversion soars for whatever reason?

One problem with this argument is that it could be the US that’s at the centre of the tensions if, for instance, the conflict in the Red Sea escalates and pulls Iran into the fray. Or it could be domestic politics, should the prospect of a second term for Donald Trump in November increase geopolitical tension and damage asset prices.

But would the yen be a better asset to hold than bonds, particularly treasuries, in the event that one or more of the myriad of risks looming in 2024 develops into a serious constraint on asset price performance? One issue here is that the more the US enters into conflict situations with other countries, the more those countries seem to shed their treasuries. Examples here include Russia and China. A second issue is that the treasury market has often been a magnet for safe-haven demand in the past because crisis situations have spurred treasury purchases by the Fed alongside aggressive rate cuts.

However, right now, the Fed is still winding down its stock of treasuries, and, while it might stop this early if global risk aversion suddenly rises, Mr. Steve Barrow, Head of Standard Bank G10 Strategy doubts that it will volte-face straight away and restart quantitative easing. As far as Fed rate cuts are concerned, there are already a good deal of rate cuts baked into the curve—almost twice as many as the median forecast by FOMC members for 2024. Hence, it might be difficult for even an accelerated pace of easing to make treasuries a better bet than the yen in any risk-off scenario.

Another point is that not all increases in global risk aversion spur lower inflation and hence the scope to cut rates. Adverse supply shocks can create much higher inflation, as we’ve seen and if this actually cuts down the room for the Fed to cut rates, then treasuries might not attract the usual safe-asset demand. None of this is to suggest that treasury yields would rise sharply in a risk-off environment; all we are suggesting is that a better asset of choice in this situation is the yen.

Undoubtedly there are other non-financial assets that investors would put forward as their favourite should global risk aversion rise this year for whatever reason. Gold usually stands out, and other physical commodities might gain a mention.

”We are not going to disagree with this either, but we still believe that the yen is the asset of choice this year should investors take a very pessimistic view of the global economic and political landscape”, said Mr. Steve Barrow.