While US and European markets have largely recovered from the latest round of tariff announcements and delays rolled out this July, Mabrouk Chetouane at Natixis Investment Managers, warns of key risks ahead. The head of market strategy shares his views on persistent US inflation and the impact on Federal Reserve cuts this year, he talks uncertainty over the Fed’s leadership, and discusses the threat of currency wars and the wider implications this could have on outflows, hedging costs, and market volatility.
Chetouane also unpacks how his team calculates volatility and adapts his investment models in unpredictable markets using Markov techniques and inputting monetary policy factors.
Interview
Jo Gallagher Give us a temperature check on global markets, how have they been reacting to the latest tariff news and policy changes?
Mabrouk Chetouane Well, the markets stayed quite calm after the recent announcement made by the White House. We haven’t seen them in the prices derailing like we have seen, for example, after Liberation Day. The market’s not immune against the new paradigm, but they want to see the roadmap of the White House in terms of tariffs. When we look, for examples, at let’s take the implied volatility on the stock market in the US, you take, I mean, the short maturities, the medium maturities and the long maturities. I mean, they came back immediately to their pre-new tariffs level. So the market is ready to take risk, investors are ready take risk again, and the mood is pretty good, actually and the temperature of the market is fine.
Jo Gallagher There is so much market unpredictability; how do you calculate volatility and manage investment models in times like these?
Mabrouk Chetouane The calculation of the volatility is quite simple. It is based on returns, of course, but after that, we are clustering this volatility in order to identify market regimes. I mean, we can have models with two, three, four regimes, for example, and in our approach, we have even decided to have, I mean four regimes in order to characterize the market sentiment. We are updating these models on a daily basis, and our goal is to identify if we are in a bull regime or in a bear regime. But even in the bear market, we have episodes of positive returns with high volatility. And we need to be extremely accurate in order to identify these episodes of recovery, which could be extremely violent as well. So we are using Markov switching approaches in order to calculate these probabilities and in order to have. Let’s say, a dynamic approach of asset allocation. The data that we are using is only equity prices or bond prices available on the capital market. But in order to disentangle, I mean, noise from the signal, we need to add other factors. And one of them, which is extremely important, is monetary policy factors based on real interest rates and all the maturities available. In a monetary policy, it could be accommodative or aggressive, hawkish or dovish. And depending on this question, of course, we can add more information into our signals in order to say, OK, now the signal go in that direction and not in the other one. So combining a market regime approach plus a monetary policy approach bring more value to the asset allocation decision.
Jo Gallagher While there’s been a lot of positive momentum behind risk assets, how are you preparing for any potential market swings? What risks would you advise trading desks to be mindful of?
Mabrouk Chetouane In our opinion, there are two or three risks that we need to monitor closely because they could have a serious impact on the capital market. The first one is inflation. If the inflation is too persistent in the US., it can clearly pose a problem for the Fed, and the Fed could decide, I mean, to postpone their rate cuts that are awaited by the markets and by the investors. Second risk. Is the appointment of a new chairman, and clearly it could create also some noises, some disturbances on the capital market, because the credibility of the Fed could be challenged by the market. So, this could create another episode of stress. And third risk is a currency war if the U.S. Administration is disappointed by the outcome of the negotiations for the tariffs and for the trade flows. They can force countries to manipulate their currency to the benefit of the USD. It creates definitely an environment of stress and a lack of visibility for investors. Currency war, for example, could have two key consequences. The first one is outflows. I mean, if you are an international investor and you are seeing the currency is depreciating, you will be forced to exit from one capital market or the other one. This would create massive outflows, which in turn feed the stressful environment. And the second consequence is an increase of implied volatility, meaning that the cost of the hedging will increase as well. So we can enter into a situation that could be completely out of control because it is creating a kind of loop of stress. It is extremely negative for the market and for the investors and this could create a very bad environment for all the capital markets, bond equities and FX as well.
Jo Gallagher Thank you Mabrouk for your insight, and of course, you’ve been watching, this has been Trader TV This Week.
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