Will risk appetite weaken further in Q3?

Brexit uncertainty and the threat of withdrawal without a trade deal has placed pressure on the pound

Lukman Otunuga, OpinionIndustry Expert
Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

June 18, 2019

Global risk sentiment swung back and forth during the second quarter of 2019 as investors tussled with a basket of fundamental themes influencing the market mood.

The never-ending Brexit drama, persistent uncertainty over the progress of trade talks and geopolitical tensions among many others are only a handful of themes straining appetite for risk. On the other side of the equation, investor confidence was boosted by speculation over the Federal Reserve potentially easing monetary policy to counter a global slowdown.

At the time of writing in the final trading month of Q2, Brexit uncertainty still lingers, affecting the British pound and market expectations towards the UK’s economic performance. The uncertainty has been amplified by the changes in the UK’s political landscape after Prime Minister Theresa May resigned. Market concerns over the leading candidate Boris Johnson steering Britain towards the path of a no-deal Brexit should he become Prime Minister continues to haunt investor attraction towards the pound. With the clock ticking on Brexit and little clarity to reassure the markets about what’s going to happen next, this is poised to weigh on investor sentiment as we enter the third trading quarter of 2019.

Another heavyweight drag on risk appetite can be seen in ongoing trade tensions between the United States and China, and flagging negotiations which have reached a standstill, if not a stalemate, for the time being. All eyes are currently on economic data coming from China and the U.S. as investors nervously look for signs of a regional slowdown which could in turn, lead to a global slowdown.

The risk-off sentiment has boosted appetite for gold, which has gained 4.16 percent quarter-to-date (QTD), also benefiting gold mining stocks in major producers like South Africa and Australia, while adding to the attraction of other gold-linked instruments. Concerns over slowing global growth and fears over the European economy are set to keep investors on edge.

In another ‘side effect’ of trade tensions, investors should pay close attention to emerging markets and oil prices, which are poised to be impacted by ongoing issues between the U.S. and China. We have already seen volatility hit emerging market currencies and stock markets, as well as oil prices pressured by fears over global demand, so unless trade tensions subside or are resolved, risk appetite could be similarly affected in the third quarter.

Among the most prudent of risk takers are central banks like the Federal Reserve, which is holding a red light against interest rate hikes amid the prospect of worsening global conditions. The more dovish the Federal Reserve becomes, the more risk sentiment has the potential to diminish further in a flight to safety, at least in short-term bursts.

While speculation over a Fed rate cut may weaken the U.S. dollar and support equity markets and other risky assets such as emerging market currencies, global growth fears are seen limiting the upside gains. While there are strong headwinds facing risk appetite, some support could be seen in the form of central banks boosting stimulus measures to reinforce their respective economies. An unexpected resolution to trade talks could also boost risk appetite and lift fears over global growth.

Sentiment is nonetheless cautious and easily rattled, so should markets receive further confirmation that trade disputes are crippling global growth, risk aversion is set to remain a major theme in Q3.

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