A recurring theme for our forecasting model is not predicting the future but just identifying the current regime. It is more important to first know where you are before you determine where you might be going. If you have ever been lost, the best solution is to first figure out your current location.
There has been growing research work on the Global Financial Cycle or the fact that global growth is driven by a limited number of factors. These factors focus on long-term monetary or credit expansion and volatility. Specifically, the monetary expansion of the dollar as the reserve currency is a key to global growth and volatility determines where and how much this global dollar liquidity is used. Dollar liquidity supports global funding. Volatility changes the risk profile for this liquidity.
There are two major regimes in the global financial cycle: risk-on booms and risk-off busts. A global financial cycle boom occurs when there is monetary expansion in the dollar and low volatility. Under this regime, it makes sense to invest in emerging markets and higher levered economies. Follow the money flows that drive asset prices higher and enhance global leverage. A risk-off bust environment will see dollar monetary contraction and higher volatility. In this environment, there should be emphasis on holding lower risk safe assets. Lower liquidity will push risky asset prices lower and reduce funding for new projects. The retrenchment will be exacerbated by higher volatility.