"Sell everything but high-quality bonds"

The risk of global contagion is higher than ever, argue market strategists, with UK bank RBS suggesting the only safe place to be is high-grade bonds.
"Sell everything but high-quality bonds"

The risk of a global market panic caused by China's equity and currency market volatility is increasing, say market strategists, with UK bank RBS advising clients to offload “everything except high-quality bonds”.

As investors try to figure out how to position themselves after one of the worst starts to the year in history, they are focusing on what they perceive as toxic effects being caused by structural weakness in China’s equity and currency markets.

In an environment where negative sentiment overrides reason, “market psychology can itself become an economic fundamental”, said RBS in a note this week.

Andrew Roberts, the bank’s global head of credit markets, warned: “China has set off a major correction and it is going to snowball. Equities and credit have become very dangerous.”

While China may not be to blame for all global market ills, Hong Kong and Shanghai equities -- down at some 10% and 14%, respectively, in 2016 -- are certainly not providing reassurance. Negative sentiment and continued weakness in commodity markets are also weighing down Australian stocks, which have lost 7% since January 4.

China’s equity and currency volatility seem to be behind much of the jitters. Sean Yokota, head of Asia strategy at Swedish bank SEB, said: “Allowing the currency to reflect economic fundamentals means the rest of the world feels more of what China is feeling.”

Global investors fear that China is now willing to let the currency weaken naturally, preferring to focus on managing domestic monetary policy, as AsianInvestor reported last week.

Under the old regime of a semi-peg to the dollar, the world was insulated from China’s domestic dramas. “That is no longer case,” said Yokota. “For those of you outside of Asia, get ready for more contagion. China is getting more attention than US payroll figures."

Roberts added: “We are deeply skeptical of the consensus that the [Chinese] authorities can buy time by their heavy-handed intervention in cutting reserve-ratio requirements, rate cuts and easing in fiscal policy.”

He sees plenty of risk in the US market as well, suggesting the Fed is “playing with fire” by raising rates when, according to RBS, growth slowed to an annualised 0.5% in the fourth quarter of 2015.

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