Institutional investors’ risk appetite declined in January as they recalibrated hopes for early interest rate cuts and recovery of Chinese markets, State Street Global Markets says.

The State Street Risk Appetite Index fell to -0.09 from 0.18, revealing a slight risk-off bias at the start of the year. “The ongoing woes in China’s real estate and equity markets along with more cautious commentary from the Fed on the timing of rate cuts sent institutional investors back to cash,” says Michael Metcalfe, head of macro strategy at State Street Global Markets. Investors’ allocation to cash rose 0.6 percentage points in January, reversing half of the fall seen in November and December last year.

“More defensive behaviour on the part of institutional investors was seen in weaker demand for emerging market currencies, equities and bonds in aggregate. There were, however, still some pockets of improvement and strength. Most notably, foreign demand for Chinese equities showed tentative signs of recovering, while inflows into Indonesian equities remained robust ahead of the elections this month,” Metcalfe says.

Long-term investor allocations to equities fell by 0.2 percentage points to 51.6%, while cash holdings rose 0.6 percentage points to 20.5%, State Street Risk Holdings indicators showed. The allocation to fixed income fell by 0.4 percentage points to 27.9%.

“Less robust risk appetite combined with reduced chances of imminent rate cuts have also changed investor sentiment on the US dollar. The sharp unwind of institutional investors’ US dollar overweight seen in November and December paused in January and is showing signs of reversing. Institutional investors are buying the US dollar again, even as the news cycle on the US presidential election gathers pace,” Metcalfe adds.

The institutional investor indicators, developed at State Street Global Markets, measure investor confidence or risk appetite quantitatively by analyzing the actual buying and selling patterns of institutional investors derived from State Street’s US$41.8 trillion in assets under custody and administration.

The Risk Appetite Index is derived from measuring investor flows in 22 different dimensions of risk across equities, FX, fixed income, commodity-linked assets, and asset allocation trends.  The Risk Holdings indicators capture the share of investor portfolios allocated towards equity, fixed income, and cash going back to 1998.