Market Sentiment. Risk on/off
Market sentiment is a generalized indicator of financial market participants' mood regarding risk-taking or risk avoidance. It reflects whether investors are willing to put capital into more profitable but risky assets, or, conversely, move into defensive instruments to preserve capital.
Unlike a single specific indicator, sentiment is not calculated by a single formula. It is determined through a set of market signals that show where capital is moving in the global financial system.
Professional macro analysts assess the state of sentiment through several key groups of indicators:
Stock index dynamics
The growth of global indices (S&P 500, Nasdaq, DAX) usually signals Risk-On. Mass sell-offs of stocks often mean a shift to Risk-Off.
Bond market
Increased demand for US, German, or Japanese government bonds indicates a search for safe assets, i.e., Risk-Off. If bond yields rise due to bond sales and capital flowing into risky assets, this is more often a sign of Risk-On.
Gold and other safe-haven assets
Gold traditionally reacts to increased uncertainty. A sharp rise in gold prices often signals Risk-Off, while its decline may indicate an improved appetite for risk.
Currency market
Forex is one of the fastest indicators of sentiment change. Currencies can be conditionally divided into risky and safe-haven.
Risky currencies usually include:
AUD
NZD
CAD
Safe-haven currencies:
USD
JPY
CHF
If capital flows into risky currencies, a Risk-On environment forms. If investors buy safe-haven currencies, it's a Risk-Off signal.
Commodity markets
Industrial metals and energy resources often rise during periods of economic optimism, while demand for them falls during a fear phase.
Thus, market sentiment is determined not by a single indicator, but by the overall behavior of different asset classes that reflect the movement of global capital.
Risk-On is a market condition where investors demonstrate a willingness to take on more risk in search of higher returns. During such periods, economic expectations improve, and the fear of systemic risks decreases.
In this mode, capital moves into risky assets: stocks, cyclical commodities, corporate bonds, and currency markets of countries dependent on global trade.
Typical market manifestations of Risk-On:
stock indices rise
gold declines or consolidates
bond yields rise
risky currencies strengthen
Typical movements on Forex:
AUD/USD rises
NZD/USD rises
EUR/USD tends to rise
USD/JPY often rises due to yen weakening
GBP/USD may strengthen along with global optimism
Hypothetical Risk-On example
Imagine a situation where China and the US publish strong industrial production and business activity data. Markets begin to expect an acceleration of global economic growth.
Investors assume that demand for energy and raw materials will increase. Due to this, oil prices rise as the economy will require more energy.
Increased global trade means greater demand for Australian and New Zealand resources, so AUD and NZD strengthen.
As fear in the market decreases, investors sell safe-haven assets. Gold may decline, and demand for the Japanese yen falls.
Capital moves into stock markets, and the S&P 500 or Nasdaq rise, reflecting optimistic sentiment.
Risk-Off is a market regime where investors try to reduce risk in their portfolios and shift capital to more stable and liquid assets.
This condition usually arises during financial crises, geopolitical conflicts, or a sharp deterioration in economic prospects.
In Risk-Off mode, investors buy safe-haven assets: government bonds, gold, the US dollar, the Japanese yen, and the Swiss franc.
Typical market manifestations of Risk-Off:
falling stock indices
rising gold prices
increased demand for government bonds
strengthening of safe-haven currencies
Typical movements on Forex:
AUD/USD declines
NZD/USD declines
USD/JPY falls due to yen strengthening
EUR/USD often declines due to dollar demand
GBP/USD also tends to decline
USD/CHF may fall due to Swiss franc strengthening
Hypothetical Risk-Off example
Suppose news of a major banking crisis or a sharp escalation of geopolitical conflict emerges in the market.
Investors begin to avoid risk and quickly reduce positions in stock markets. Stocks fall as market participants try to preserve capital.
Capital moves into safe assets. Gold begins to rise, as it is traditionally used as a safe-haven asset during periods of uncertainty.
Investors buy US government bonds, which increases their price and lowers yields.
In the currency market, demand for the US dollar, Japanese yen, and Swiss franc rises, while risky currencies, such as the Australian and New Zealand dollars, decline.
At the same time, oil prices may fall, as expectations of an economic slowdown mean less demand for energy.
Understanding the mechanics of Risk-On and Risk-Off allows traders to assess the global direction of capital flows and better interpret the movements of currency pairs, commodity markets, and stock indices. It is the change in market sentiment that often becomes the main driver of short- and medium-term trends in the global financial system.