Investors responding to a growth scare are shifting into the safe harbor of bonds and money markets and away from equities just over a fortnight before the Federal Reserve's QE2 bond buying program ends.
Investors sold stocks — the MSCI index was set for a fifth weekly loss out of the past six — and chased benchmark U.S. Treasury yields below 3 percent as a stream of disappointing data raised concerns that economic weakness could drag on, instead of being a temporary affair as anticipated.
Data from Lipper shows all U.S.-domiciled equity funds suffered $6.45 billion in net redemptions in the week ended June 8 while money market funds recorded inflows of $14.3 billion.
Ten-year U.S. Treasury yields fell as low as 2.92 percent on Thursday, their lowest since December, while the cost of protecting U.S. high-yield bonds from default hit a six-month peak.
"It looks like there's a bit of deja vu feeling if you go back to what we saw last year. Investors are gripped by a double dip scare," said William De Vijlder, chief investment officer at BNP Paribas Investment Partners.
"That's fueling taking money off table and an increase in risk aversion. The ending of QE2 means money will be pulled towards government bonds and that will be detrimental for high yields or emerging markets. That's the risk."
He recommended investors position for a pick-up in the second half as monetary conditions remain loose, expecting a 10 percent rise in the S&P 500 index.
The Federal Reserve brings its $600 billion of Treasury purchases to a close at the end of June. Its chief Ben Bernanke has offered no hint whether the central bank might embark on a third round of monetary stimulus, but it is unlikely to rush into raising interest rates.
Indeed the market has pushed back the timing of the first rate hike from the Fed towards 2012, especially given benign inflation expectations.
Also positive for risky assets in the long term, Morgan Stanley expects the trajectory of rate hikes in the next tightening cycle to be flatter than previously assumed as the Fed seems committed to asset sales as part of the exit process.
"A summer low will be again with us. It will take a couple of weeks. But if you go into the latter part of the year, people will say monetary conditions are still very easy and the scare about slowdown will be exaggerated and you will have a pickup in risk appetite," De Vijlder said.
The risk asset retreat comes as the global economy moves into the middle stage of an economic cycle that started sometime around September 2009.
"The current pattern of asset markets is consistent with the way mid-cycle slowdowns are often priced. Cyclical assets underperform broad equity indices, bonds rally as the market adjusts its views of policy and that dynamic in turn partially cushions the hit to risk assets overall," Goldman Sachs said.
"A weakening dollar is not uncommon in an environment where the global cycle is showing positive but declining growth."
The dollar has fallen almost 6 percent since January.
According to a Stone and McCarthy survey cited by Barclays, U.S. bond managers moved to more neutral levels versus their benchmarks from short duration positions.
This reflects increased uncertainty as their duration has been closely correlated with the 10-year Treasury yield over the past two years.
Interest rate decisions from various emerging market central banks in the coming week may reinforce concerns about monetary tightening that would curb growth and investor risk tolerance.
Chile and India are expected to raise the cost of borrowing by 25 basis points at their meetings in the coming week, on top of interest rate hikes from Brazil and South Korea in the past week.
Persistent worries about China's efforts to restrain credit growth have already shaved nearly 13 percent off Shanghai stocks since mid-April.
"Many emerging central banks are behind the curve. We believe China is around 400-450 basis points behind the curve... We would prefer bonds in emerging markets. We are very shy of emerging equities," said Alain Bokobza, head of global asset allocation at Societe Generale.
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