There had been a massive inflow into bonds and gold for the past three weeks, mainly because financial companies and retail investors had started to price in a worse global economic outcome for 2020. Risk sentiment had deteriorated dramatically and markets had been dominated by fear.
In such an environment, the natural reaction is to take money out of “risk assets” like stocks, ETFs, or mutual funds, and put it into safe-haven assets like bonds and gold. That’s exactly what happened during the past few weeks and now the big question is if things will continue at the same pace?
The main problem
Most of the analysts put the market reaction on the back of the coronavirus outbreak. The epidemic continues to spread around the world and that could lead to weaker global economic growth this year. To stimulate the economy, central banks and governments will have to use both monetary policy and fiscal policy measures, but this time the main problem hasn’t anything to do with the economy.
Companies and retail investors rushing into gold and bonds communicate how severely the outlook had changed, but even with interest rates at very low levels, the epidemic will depend on other factors.
How will financial markets respond in the near term?
The initial selloff had been followed by a strong rebound but given the situation around the world is not improving, we should expect stocks to continue to move lower. At the same time, central banks will be pressured to lower short-term interest rates, so banks and financial institutions won’t have to deal with any liquidity shortages.
Deflationary pressures are the main concern moving ahead and unfortunately, central banks are in a bad position, due to their limited ability to stimulate economic activity via interest rate cuts or monetary easing. We should expect volatility to remain elevated and as a result, CFD traders will need to keep risk under control by adjusting position size and diversifying with a broad portfolio of assets.
As we move forward, the bottom line is that the outcome will depend not on financial conditions, but on the public authorities’ ability to contain the virus, until a proper treatment will be created. Given the already loose financial conditions and oversold market conditions, any positive sign regarding the outbreak could turn things the other way around and as a result, bonds and gold will start to lose ground against stocks. This isn’t the first time we have an epidemic and sooner or later, the market will start to look past it.