Despite every effort by The Fed to convince the world that everything is awesome, it's not. From China growth risks to concerns about tightening financial conditions, Goldman warns so-called 'grey swan' fears are rising with Brexit, Trumpe elected, widening terrorist threats, and increased protectionism the most impactful.
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Many of the risks that sprung up in 2015, as Goldman details, look set to continue in 2016 (or worsen)...
Greece has avoided the worst, but challenges remain. Greece and its official creditors agreed on a new adjustment program and financial support package in July, and Alexis Tsipras was re-elected as Prime Minister in snap September elections. The inflow of liquidity from initial financial disbursements has staved off the immediate threat of default and/or exit from the Euro area, but implementation of necessary governance and economic reforms remains challenging. Both within and outside Greece, much skepticism remains about the economic and political viability of the proposed adjustment, against the background of a renewed downturn in the Greek economy triggered by the mid-year threat of Grexit. Parliamentary support for adjustment measures has been diminishing and austerity and reform fatigue is intense among the Greek public.
Concerns about extreme Chinese equity market volatility have given way to growth worries. A series of administrative measures launched over the summer calmed the Chinese equity market, allowing for a recovery in China A- and H-share markets from their Q3 lows. These measures included: tightening rules on margin trading by lowering the loan-to-value (LTV) ratios for brokers’ financing and by restricting OTC leverage products such as umbrella trusts; suspending domestic IPOs (resumed in November); banning major shareholders from selling their shares; restricting trading on index futures, and directly purchasing stocks in the secondary market (which amounted to an estimated RMB1.8tn from June to November). However, while equity market volatility has diminished, lingering concerns about policy implementation difficulties against a broadly less friendly backdrop for economic growth have left China risks front and center for many market participants.
Tensions between Russia and NATO members have persisted and arguably escalated. While fighting in eastern Ukraine has continued with varying levels of intensity, Russia has shifted its focus to the conflict in Syria, launching airstrikes there at the end of September. Despite a common pursuit with Western powers of combatting the Islamic State, the US and others have criticized the Kremlin’s approach for targeting primarily Syrian rebels. More recently, tensions flared after Turkey shot down a Russian military aircraft accused of breaching Turkish airspace on November 24. News that NATO had extended a membership invitation to Montenegro in early December also prompted a negative reaction from Russian officials.
Cybersecurity issues continue to affect government agencies and private companies alike. US officials revealed in July that data breaches of Office of Personnel Management’s (OPM) computer networks had exposed security clearance data and other personal information for over 20 million people (from a prior estimate of 4.2 million). Other notable cyber incidents in 2H2015 included a breach of the information services company Experian, which compromised personal data of an estimated 15 million T-Mobile customers. However, cyber concerns gave way somewhat in the public eye to a renewed focus on “conventional” threats after high-profile terrorist attacks in Beirut, Paris, and San Bernardino (California), among others.
Rate volatility has declined, but unjustifiably so. Volatility of US short- and long-dated interest rates remained elevated through mid-November. But, over the past month both realized and implied vol for maturities longer than 2-years has sharply declined, which we don’t think is warranted and is unusual in a rate hiking cycle.
In retrospect, two key grey swans missed: SNB cap abolished and the magnitude of the European refugee influx.
And what to look for in 2016:
- Risk of relapse in Greece. Unpopular changes to the Greek pension system may undermine the government’s parliamentary majority, leading to another round of political uncertainty and delays in the disbursement of official financial support. However, Greece is unlikely to become such a central focus again because (1) markets have become less concerned about contagion, (2) the immediate cash flow needs of the Greek government have diminished, and (3) Greece’s geographically and politically crucial role in the European refugee crisis has reduced the appetite to allow deeper economic stress in the country.
- Ongoing concerns about the intersection of Chinese policy, politics, and growth, and CNY-related risks.
- Continuation of tensions between Russia and the West, from one-off incidents or strategic differences.
- Debate in the public and private sphere over the treatment of encryption software in combatting terrorism.
- Increased rate volatility, at least until more clarity on the pace and predictability of further US rate hikes emerges.
- Other potential grey swans: (1) Brexit, (2) Trump elected, (3) widening terrorist threat, (4) a rise in protectionism.
Source: Goldman Sachs
