What it means
Markets do not always move on company-specific news. Often a single feeling, either confidence or fear, drives money from one group of assets to another.
Analysts use the labels "risk-on" and "risk-off" to describe which feeling is in charge. During risk-on periods investors buy assets that offer higher returns and higher risk, such as shares, high-yield corporate bonds, emerging market currencies and commodities.
In risk-off periods they sell those assets and move into government bonds, cash and sometimes currencies considered safe harbours. Gold also tends to attract money when fear rises, and the dollar, the Swiss franc and the Japanese yen are often described as safe-harbour currencies.
For businesses, the swings have practical effects. When markets turn risk-off, borrowing costs for weaker companies can jump, share issues get postponed, and currencies of exporting countries can fall.
A finance team that plans a bond issue or a share sale will often watch the mood closely. Investors use simple signals to judge the mood.
Rising share prices, narrow credit spreads and a low volatility index suggest risk-on, while falling shares, wider credit spreads and a spike in volatility suggest risk-off. These indicators are never exact, but together they give a useful picture.
The nuance is that the pattern is not fixed. Correlations (how closely assets move together) that hold in one phase can break in another, and in some crises even supposedly safe assets fall.
The labels describe a tendency in market behaviour, not a law. Central banks and governments also influence the mood.
Interest rate decisions, large stimulus programmes or sudden policy surprises can switch investors from one state to the other within hours. Many strategists therefore treat policy announcements as the main triggers for large shifts.
In practice
Real-world examples.
Example
After a surprise bank failure, a global investor sells emerging market shares and buys short-term government bills. Analysts describe the day as a risk-off move, noting that shares, commodity prices and several smaller currencies all fell together while government bond prices rose.
Example
A central bank announces support measures, and share prices and corporate bond prices rise together. A strategist at a brokerage calls it a risk-on rally, pointing out that investors were selling safe government bonds to buy higher-yielding assets.
Example
A manufacturer planning a bond issue sees credit spreads widen and decides to delay the sale for a month. The treasurer explains to the board that markets have turned risk-off and borrowing would be too costly, and she sets a trigger to revisit the plan when spreads narrow.
Case study
Seen in the real world.
Cobalt Freight is a fictional shipping company that planned to refinance $50 million of debt. In this illustrative scenario, the treasurer prepared the paperwork but noticed that market indicators had flipped to risk-off just before the planned launch date.
Spreads on comparable corporate bonds had widened by roughly one percentage point, which would have added about $500,000 a year in interest on $50 million. Over a seven-year bond, that extra cost would have totalled about $3,500,000. The treasurer postponed the issue by six weeks, and when conditions improved the company completed the refinancing at a lower rate. She reported to the board that the delay had saved the company hundreds of thousands of dollars in interest over the life of the bonds.
The episode led the board to adopt a simple dashboard, with credit spreads, a volatility index and the company's own share price, to check the market mood before any financing decision. The dashboard was updated weekly by the treasury team and reviewed at every board meeting, so that directors saw the same picture of the funding climate.
Watch out
Common mistakes.
- Assuming risk-off always means shares fall and bonds rise. Sometimes both fall together, particularly when inflation or interest rates are the cause of the fear.
- Treating the labels as precise predictions. They describe a broad tendency, not a guaranteed pattern.
- Thinking only professional investors need to care. Borrowing costs, exchange rates and funding availability for ordinary companies move with the mood too.
Questions
People also ask.
What are typical risk-on assets?
Shares, high-yield bonds, emerging market assets and commodities often rise in confident markets. Currencies of commodity-exporting countries are also commonly bought.
What are typical risk-off assets?
Government bonds, cash and certain safe-haven currencies tend to attract money in nervous markets. Their prices rise when demand for safety grows, which pushes their yields down.
How can a company use this idea?
It can time debt issues, review currency hedges and stress test budgets for periods when funding becomes harder or more expensive. It can also keep a standby credit line so that a risk-off period does not leave it short of cash.
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