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London - The remarkable calm in global financial markets in the face of tensions over Crimea and the prospect of an early US rate hike may reflect investors' lack of appetite for deploying their cash, rather than their complacency.
Geopolitical risks have moved to the top of investors' worry list as the West extended sanctions on Russia. Federal Reserve chief Janet Yellen also dampened risk sentiment by suggesting the first rate hike could come in the first half of 2015.
But investors have barely blinked. The MSCI world equity index is trading not so far away from a recent six-year peak while the S&P 500 index is also near a recent record high.
Various volatility gauges in equity, fixed income and FX markets also show no sign of distress.
At the same time, however, investors are reluctant to commit their money in markets, so they are keeping unusually high cash balances in their portfolio. Hedge fund managers' leverage level also stands at a 19-month low.
This neutral stance also stems from their optimism that the U.S. economic recovery will accelerate into mid-2014 after a harsh winter.
A little complacent
"The market may be a little bit complacent about the tail risk, but there's an awful lot of cash in the balance sheet... They are simply holding back on fully investing their portfolios today," said John Bilton, head of European investment strategy at Bank of America Merrill Lynch.
"Ultimately the big axis of growth comes from the United States ... They are assuming the US will have quite a strong bounce back. That overall is helpful."
Fund managers polled by Bank of America Merrill Lynch had 4.8% of their holdings in cash in March, the highest since July 2012.
Hedge fund managers in the same survey pushed their leverage ratio - the weighted average ratio of gross assets to capital - down to 1.34 this month from 1.49 in February.
Some 31% of hedge funds have a leverage ratio of less than 1 in March, compared with 19% of funds in January.
No panic
US government bond prices plunged this week after Yellen's rate hike signal, with the 2-year US Treasury yield hitting a six-month high of 0.432%.
In the week ended March 12, foreign central banks dumped a record amount of the Treasuries they had parked at the Fed, underscoring the appetite of emerging countries like Russia for holding cash to defend their currencies.
Yet BofA's MOVE index, which measures implied one-month volatility in Treasuries, is holding calm at 66.8, near a historic low around 50 and compared with a crisis peak of 217.
Wall Street's Volatility Index - dubbed the "fear gauge" - and one-month euro/dollar volatility also remain at relatively low levels.
Even as the Fed withdraws monetary stimulus, global aggregate liquidity remains above average levels. CrossBorder Capital's monthly Global Liquidity Index ticked up to 52.4 at end-February from 47.9 in the previous month, although it stayed below its recent 61.9 peak in June.
The index measures liquidity data from central banks, the private sector, cross-border flows and financial conditions.
Emerging economies
Excluding emerging economies, where much of the tightening has taken place, the liquidity picture improved, with the index rebounding to 75.3, close to December 2012 peak.
Dirk Wiedmann, head of investments at Rothschild Wealth Management, says ample liquidity creates buying opportunities.
"Over the past two years, any equity market corrections have been rare and limited in their magnitude. Notably, they were followed closely by a rebound, which often pushed up indices to new highs. As a result, investors that followed a disciplined strategy of buying on the dips were well rewarded," he said.
"Financial repression has been behind this pattern and continues to encourage investors into risky asset classes because the yields available from safer investments remain depressed."
