By Vishwanath Tirupattur, global head of Quantitative Research at Morgan Stanley
The prospect of foreign investors reducing exposure to US assets amid concerns about the continued predominance of US Treasuries as a safe haven has been at the center of market debate over the last few weeks. Significant shifts in cross-asset correlations, particularly between US equities and USD, are adding to concerns. The correlations between US equities and FX are nearly two standard deviations above their average over the last five years (see Are Cross-Asset Correlations Broken?), with USD weakening as equities have sold off – a pattern more associated with emerging than developed markets. In our view, evolving market perceptions of the trajectory of the US economy and policymaking are taking the global economy and markets to unprecedented levels of uncertainty and challenging long-held assumptions about cross-asset relationships.
Over the last 20 years, US markets have had a terrific run, and for good reason. US growth has consistently outperformed much of the rest of the developed markets. Furthermore, US policymaking has been consistent if not infallible, with clear lines of demarcation between the executive branch and the central bank. US markets have attracted abundant capital flows during periods of stability as well as stress, and USD has remained entrenched as the global reserve currency. While capital inflows during periods of relative normalcy driven by the persistent relative outperformance of US equities are not surprising, it is noteworthy that even during periods of stress in risk markets, much of the world turned to US Treasuries and other high-quality US fixed income instruments as safe-haven assets. This held true even when market stress emanated from the US, as during the global financial crisis. USD’s dominance and global influence are evident across multiple metrics – central bank reserve allocations, global trade financing, foreign exchange activity, cross-border lending, and debt issuance.
