Are We Headed Back to the Risk-Off Trade?
A sharp sell-off in equity markets and other risk assets on renewed jitters over Europe has investors scurrying for safe-haven assets once more. But don't bet on this being the start of a big "risk off" trade, analysts say.
European shares tumbled almost 1.5 percent on Monday, while Spanish 10-year government bond yields climbed to six-week highs and the euro tumbled as a corruption scandal in Spain and polls showing Italy's former prime minister Silvio Berlusconi regaining ground ahead of elections this month sparked fresh concern about the outlook for the euro zone economy.
The anxiety in Europe spread over into other markets from U.S. to Asia, which have enjoyed a bumper rally in recent months on growing confidence about global economic growth prospects. On Wall Street, stocks overnight posted their worst-day performance this year, while Asian equities opened broadly lower on Tuesday with Japan's benchmark Nikkei down more than 1 percent.
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Still, analysts say they are not perturbed by the volatile market moves, which should be viewed in terms of a correction after a several weeks of strong gains, rather than a return to a "risk off" trading environment.
"It's absolutely normal to have a pull back after three months of rallying. So it's normal for investors to take some profits, but we see this as an opportunity to get longer in risk assets going forward," Nick Maroutsos, managing director at Kapstream Capital told CNBC Asia's "Squawk Box."
"Equities have been depressed for such a long time it's good to see them in favor and I think that will continue to be the case as the economy recovers," he added.
In general, sentiment towards risk assets, including the euro, peripheral euro zone government debt and global equity markets has seen a turnaround in recent months as worries about U.S. fiscal woes eased, European officials took steps to put a floor under the euro zone debt crisis and signs of a rebound in China's, the world's second biggest economy, started to emerge.
Against this backdrop, analysts said the current market jitters were unlikely to last too long.
"It does look like we're back to political risk with worries about Spain and Italy, so there could be a fair bit of uncertainty over the next few weeks," said Westpac Bank's Senior Currency Strategist Sean Callow.
"The question is how serious do we take this? There is a set-back in the market and the fall in euro/Swiss franc suggests a flight to quality, but for the moment we are going to regard this as a blip in an otherwise improving trend," Callow told "Squawk Box."
The euro, which hit its highest level since late 2011 on Friday just above $1.37, is down about 1.5 percent from that peak. Its gains in recent weeks have come as investors sold safe-haven currencies such as the Swiss franc and the yen.
Clifford Bennett, chief economist with Orb Global Investments in Sydney, said on Twitter that he was standing by his bullish forecast for the euro to climb to $1.50.
"Spain will stay austere even if (Spanish Prime Minister Mariano) Rajoy goes and he may not. Italy's Berlusconi a worry but (he) won't get in [back into power]. Great Buy Opportunity," the tweet from Bennett read.
Andre de Silva, head of Asia-Pacific Rates at HSBC Global Research, said steps taken in the past year by European policymakers to contain a debt crisis in the euro zone favored a continuation of risk trades despite the pull-back in markets taking place now.
"The sell-off in markets overnight is a correction rather than the start of a trend and I understand the catalyst is the political problems in Spain and Italy," de Silva said.
"And this will continue, especially in the run up to Italian elections. But we now have a framework in place in terms of the ESM (European Stability Mechanism)," he said, referring to the European Union's permanent bailout fund that was officially launched late last year.
"Some people call it the Emergency Stability Mechanism; I call it the Emergency Spain Mechanism. That's still in place, so there will be a limit to how much of a correction we'll see in the (peripheral) bond market," de Silva added.