The Bojo and Trump show is exhausting. The good news is that Sharpie-scribbled weather maps and fainting police have ensured our ribcages are now incapable of further shock and comic torture. The serious market risks associated with trade wars and a chaotic Brexit will receive more media coverage this weekend but not much will surprise.
In fact, the sheer incompetence of the protagonists has resulted in more positive developments in both the US-China trade dialogue and Westminster. A check of the price charts for the S&P 500 and Sterling (GBP) for the past week will confirm increasing optimism. However, shocks are by definition events not yet considered by market participants. Looking past trade wars and Brexit there are five potential risks which probably won’t get headlines in the coming days but might genuinely surprise.
- A Dollar Shortage
- European Banks
- Saudi Turmoil
It might sound strange that a currency which accounts for 62% of global central bank reserves would be in short supply. However, companies(ex banks) in emerging markets had borrowed $3.7 trillion US dollars by the end of last year according to the Bank for International Settlements. That’s double the levels in 2010 and as the economic cycle slows the US dollar is unhelpfully climbing to new valuation highs versus it’s trading partners’ currencies in emerging markets. Suffice to say debtors are struggling to find/earn the dollars to service debts. The default worries surrounding borrowers like Argentina and China’s Evergrande Group are real-time illustrations of distress in funding markets. To add to these worries there are reports that in recent days an unidentified bank requested a $870m facility from the Federal Reserve. That’s not normal.
Negative rates are crushing European banks already struggling with challenged balance sheets. A German economy slipping into recession as data suggested this week could be the final nail in Deutsche Bank’s coffin. Not surprisingly the CEOs of both Deutsche Bank and UBS have pleaded with banking authorities to consider alternatives to negative interest rates as monetary stimuli. European banks are into the ICU phase and it’s possible some won’t make it into 2020.
There has been more intrigue this week within the royal House of Saud. Ahead of the IPO of the state oil company, Aramco, Mohammed Bin Bonesaw has removed the chairman of the company which will only increase tensions between various factions within the royal family. Growing awareness of climate change and pressure on oil prices won’t help IPO valuations and the royal family’s ability to bribe its citizens and pay protection money to the US. The Saudi story has “coup” written all over it.
The Brexit story had its own “coup” this week as the move to prorogue Westminster resulted in a counter-coup by the opposition, potentially removing by law the ability of the government to leave Europe without a deal. Interestingly, there has been market chat in recent days that Europe has given up on the UK and possibly could cut and run. Yes, the reality TV show “Brexit” could have a “EurFired!” punchline with Europe refusing any extension, citing the need for certainty and the paralysing effect of Brexit on investment and policy decisions across the trading bloc.
The headlines keep highlighting the $16 trillion worth of sovereign bonds currently trading with negative yields. The consensus view is that this is signaling lower growth, or worse, in the future. Implicit in that scenario is very low inflation. But, but there is another scenario. Check out the latest data in the US. Job growth and manufacturing activity has materially weakened. Well, there’s your low growth scenario. Now here’s the twist. Trump Tariffs(yes, they must be branded) are pushing inflation(CPI data) to 6-month highs and wage inflation is now cruising along at a 4.2% annualized rate! If Fed Chair, Jay Powell, thinks he has problems with the Orange Toddler right now we shudder to think what he will make of a dreaded stagflation scenario.
None of the above events are high probability forecasts. In the investment world, they would be considered “tail risks”. However, for pure devilment this writer would hazard one strong long odds tip for the weekend. Prepare for the possibility for Boris de Pfeffel Johnson’s resignation on Monday morning and his place in history as Great Britain’s shortest-serving Prime Minister; the previous record was George Canning who served for just 115 days. By George, that would be a story!
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