…indeed it has. But, of course, what we’ve seen over the last week has been the wrong sort of re-risking. The UK downgrade and the Italian election results were helpful reminders that the road to economic recovery remains a protracted and painful one and that political risks in the eurozone retain the capacity to surprise. Clearly, risk assets did not welcome these reminders, as government bonds took satisfaction.
But, is this a correction, or a reversal?
To investors with long memories, these moves are not unexpected but part of the risk on: risk off dynamic of the last few years. Central bankers are also alert to these issues and remain proactive in their attempts to deal with them. The Bank of Japan has been telegraphing a more aggressive and assertive easing campaign for a few months now, key Fed officials remain committed to easy policy, and even at the Bank of England, more officials are advocating more quantitative easing and other ways to ease monetary policy.
Perhaps the key questions are around the European Central Bank (ECB). We’ve already seen the ‘Draghi put’ in action a few times: the Long Term Refinancing Operations (LTRO) back in December 2011 and the Outright Monetary Transactions (OMT) policy in July of last year. As the Italian saga unfolds further, and if markets continue to deteriorate, we could well see another iteration of the put. As ever, the real question is around the ‘strike price’ of the option. How bad do things really have to get? Or, is the ECB reaction function now so well known and the threat of action so well understood, that markets won’t be tempted to find out?
We’ll see, but in the meantime we’re comfortable with our exposures to risk assets and will add on any weakness.