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Forget the Fed, Capital Flows May Be the Real Threat to Markets

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“Safe” assets are at risk of turning dangerous.

The major risk in global financial markets right now is that traditional safe-haven assets in the U.S. such as Treasuries are expensive, and that creates the danger that global liquidity flows out of the country at a rapid pace, CrossBorder Capital wrote in a report.

Too many investors are focused on risks from developed-market central banks unwinding their quantitative-easing policies this year. “Instead, we put far more weight on the threat from a too rapid reversal of cross-border capital flows,” the report said. “The asset bubbles are migrating eastward.”

The worries for 2018 include a Chinese economy that exceeds too-pessimistic consensus expectations, weaker global bonds and a stronger euro. The latest liquidity data show a boom in Europe, Asia accelerating and improving, and the U.S. with a “subpar outlook,” CrossBorder said, and that’s moving capital into non-U.S. markets from the U.S. Also, market volatility has a positive link to the rapidity with which global liquidity leaves the U.S., “much like 1987.”

“Sterling and the euro will be the major beneficiaries, while the yen will flat-line because of the implicit replacement of Japan’s previous liquidity-targeting policy by a new exchange rate target that includes the Chinese yuan,” the report said. “Japanese bonds will react negatively to this regime, forcing yields higher and reinforcing rising term premia and steepening yield curves worldwide.”

—With assistance from Luke Kawa.

—Read Global Markets Are Less Stable Than They Appear on ThinkAdvisor.

— Connect with ThinkAdvisor Life/Health on Facebook and Twitter.


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