Several changes at the top of central banks, rich stock valuations and a tightening of monetary policy in some countries pose enormous risks, Maya Bhandari writes in an essay for finews.first.
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As the tenth anniversary of the Global Financial Crisis passed in August, my thoughts turned to the ongoing muted volatility in financial markets. The «Goldilocks» conditions of improving growth without price pressures are something of a surprise, yet appear to be increasingly discounted in analysts’ and investors’ expectations.
This situation may appear to be benign, but with valuations across many asset classes appearing full (not to mention negative term premia in bonds) potential risks are mounting. Among the risks I see on the horizon are geo-politics, changes in central bank leadership, taper tantrums, and the dollar and emerging markets.
«However, the panic appears to be over, at least for now»
Political risk remains elevated in the United States, but had also been rising in Japan with polls indicating Prime Minister Shinzō Abe was falling out of favour with the Japanese electorate. Japan is a favoured equity allocation across many managed funds, so the possibility of Abe losing his position was of some concern.
However, the panic appears to be over, at least for now. Improved economic growth data and a less hostile attitude from the public following recent scandals looks to have headed off any political crisis for Abe.
Moreover, two recent cabinet appointments have been particularly encouraging, with two potential opponents of Abe given prominent positions within his Liberal Democratic Party, meaning neither are likely to pose a challenge to the Prime Minister. Our base case is that Abe survives this scare and political stability remains until at least 2021.
«Her position is, to a degree, dependent on President Donald Trump»
A change in central bank leadership could challenge the easy monetary policy conditions that have underpinned risk assets in recent years, threatening the «lower for longer» rate environment. In Europe, Mario Draghi’s term ends in October 2019, but he could bid for the Italian leadership next year; while in the US Janet Yellen’s tenure ends in January 2018 – although her position is, to a degree, dependent on President Donald Trump.
In Japan, Bank of Japan governor Haruhiko Kuroda’s term ends in April and he could be replaced by a Bank of Japan traditionalist who may be swift to normalise monetary policy. We are mindful that accelerated central bank normalisation could have serious repercussions for global risk assets.
«The dollar has been weak of late»
Taper tantrums are possible in Europe as the European Central Bank (EZB) turns less accommodative, especially as the ECB is the marginal buyer of bunds: Draghi has talked of a strengthening and broadening recovery in the euro area and has signalled further tapering of his QE programme as we go into 2018.
Ditto with the Fed, where term premia in US rates has turned negative once again. With share buybacks having slowed dramatically, equities may be vulnerable – although I do note that they price in greater risk premia than the likes of corporate bonds.
The dollar has been weak of late, which has helped emerging market rates in particular and risk assets more broadly. But if the dollar reverses course, there could be meaningful impacts on other asset markets. (Article in collaboration with Toby Nangle.)
Maya Bhandari joined Columbia Threadneedle in 2014 and is a portfolio manager and member of the Global Asset Allocation team. Before joining the company, she spent over 10 years advising buy-side companies on their multi-asset strategies. Most recently, she was a strategist and director at Citigroup.
Prior to that, she spent six years at Lombard Street Research, latterly as head of Emerging Markets Analysis. She started her career as an economist for the European Commission. She holds an MA (First Class Honours) in Economics from Edinburgh University, and a MPhil in International Relations from Cambridge University.
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