Sam Jacobs* says that as we approach the midpoint of 2018, one Australian economist has summarised the key risk themes facing global and domestic markets.
Photo: Roberto Júnior
Global markets came into this year with strong momentum, amid an environment of steady growth and low bond yields which saw US stocks reach an all-time high in late January.
But a heavy dose of volatility in early February showed it may not be smooth sailing for the rest of 2018.
And since then, an increasing number of analysts have begun to asses the key risks investors should be wary of.
In a timely research note last week, AMP economist Diana Mousina summarised the central risks facing markets in the US and Europe.
Closer to home, Mousina said the conditions in Australia’s housing market were still the dominant narrative when it came to domestic economic risks.
While more broadly, she assessed the risks posed by rising inflation as a result of higher oil prices.
European markets were something of a success story in 2017, as economic data continually beat to the upside while an element of political stability returned following the French election in 2017.
But Mousina noted that the European economy has hit a rough patch, while more recent political developments show challenges to a unified Europe remain.
First,the populist right-wing Social Democrat party gained traction in Germany’s 2017 election.
Now Italy’s tentative coalition government has unravelled.
Another election is on the cards, and it looks to be shaping up as a battleground for whether Italy remains a member of Europe’s currency union.
Asian markets responded by driving the euro back above US$1.17 last week, but global markets will be watching closely given the uncertainty has prompted a sharp rise in Italian Government bond yields.
Across the pond in the US, recent economic data suggest further strength in the American economy.
But Mousina highlighted debt risk as the primary factor to be wary of.
More specifically, corporate debt and government debt (unlike Australia, where the focus is on housing debt).
“Investors are probably too complacent around future risks in the corporate sector, particularly as debt and leverage has been rising,” Mousina said.
Last month, the Financial Times reported that so far in 2018, prices for US corporate bonds are off to their worst start to a year since the 1990s.
The cost of debt has been rising as US Government bond yields climb, but an unexpected number of US companies have still flooded the market seeking debt capital.
“Lending standards are something to watch,” Mousina said.
“Conditions for large and medium firms are still loose, and are around neutral for small firms, which means that lenders are not concerned about credit conditions yet.”
And Mousina expects US Government bond yields to stay in a higher range, due to budget pressures stemming from the Trump Administration’s tax cuts in December 2017 combined with an expected lift in Government spending later this year.
“A higher budget deficit will also put upward pressure on public debt which has been growing since 2009,” Mousina said.
“The anticipated increased debt burden will also keep US bond yields elevated.”
Closer to home, it’s all about housing.
With capital city house prices in decline since September, the focus has turned to stricter lending standards and whether that will add further downside pressure.
“Ultimately, more stringent lending standards are positive for financial stability in the long-run, but in the short-term, these developments in the housing market may exacerbate downside home price growth as credit growth eases,” Mousina said.
And last, Mousina highlighted the recent spike in oil, which saw Brent crude briefly hit a four-year high above US$80 barrel.
The complex web of supply and demand in oil markets was on display late last month, as prices dipped by more than 3 per cent amid reports the Organisation of Petroleum Exporting Countries (OPEC) would boost production to cover supply shortfalls in Iran and Venezuala.
But Mousina said the chief risk was whether prices stay elevated at their current levels above US$75 a barrel, which would put upward pressure on global inflation.
Such a scenario poses “a downside risk for global growth, as the negatives for consumer spending and profits are more than offset by the benefits of higher prices for oil-producing nations”, Mousina said.
“The strong global backdrop is positive for risk assets.”
“But the five risks highlighted should be watched as a warning sign of a deterioration in global conditions.”
* Sam Jacobs is markets and economics reporter for Business Insider Australia. He tweets at @Mr_SamJacobs.
This article first appeared at www.businessinsider.com.au.
