Markets are in the midst of a transition away from a world in which central bank liquidity boosted all assets, to a world of more limited policy support. The road back to ‘normality’ is likely to be bumpy as investors adjust to this new landscape. Here are three areas that we are currently watching for potential risks that could disrupt global markets.
Upside/downside surprises to US growth
The polar wave effects will soon work their way through US data, and with that we will start to get a much clearer picture of underlying economic growth in the US and what that may, or may not, mean for monetary policy. Undoubtedly, stronger US growth in 2014 would be a tailwind for risk assets in the long run. However, if data surprise strongly to the upside, this could produce a period of more significant market volatility in the short run as it would necessitate a rethinking of the profile for the federal funds rate, and inevitably other interest rates around the world. On the flip side, if it becomes evident that the weather was not to blame for economic weakness, we may once again see rallies in safe haven assets and vulnerability in cyclical regions and assets. Although our central scenario is that the US will resume a modest pick-up in growth this year, we remain alert to the possibilities of a different outcome.
China’s rebalancing act
China is in the midst of a tricky re-balancing act as it moves deliberately away from being an economy that is export-led towards one that is more domestically focused. China’s vast growth over the past couple of decades has been driven largely by the mass mobilisation of capital and labour, rather than growth in consumption. As the government undertakes unprecedented structural reforms and necessary financial deleveraging, the risks of a policy error are increasing. There is an outside chance that a financial crisis precipitates in China. A mistake in judgement in reigning credit, for example, could have dramatic knock-on effects not only locally in Asia, but in the worst case could trigger a global systemic shock.
Developments in Ukraine
News headlines have been dominated by the crisis developing across eastern Ukraine following Russia’s annexation of Crimea. At the moment, the immediate impact on the global economy of the crisis appears limited in that Ukraine accounts for only 0.2% of global GDP. A more genuine threat is posed, however, by the potential disruption of energy supplies to Europe and any retribution visited on Russia through trade embargoes. The conflict as it currently stands is not driving our positioning, but it does contribute to our wider sense of caution about risk assets and our preference for developed markets over emerging markets.
Column by Bill McQuaker and Paul O’Connor, Co-Heads of Multi-Asset, Henderson Global Investors