'Signs of deterioration': 5 risk factors to watch in global markets

(Andy Lewis / Barcroft Media via Getty Images)
  • Approaching the mid-point of 2018, AMP Capital Diana Mousina has summarised the key risk themes facing global and domestic markets.
  • She said investors have been too complacent about the buildup of US corporate debt.
  • Negative developments in any of the themes highlighted could be a warning sign of deterioration in global markets.

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 in 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 this morning, 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.

Firstly,the populist right-wing Social Democrat party gained traction in Germany’s 2017 election.

Now Italy’s tentative coalition government has unraveled. 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 have responded by driving the euro back above $US1.17 this morning, 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 points 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 week, 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. The anticipated increased debt burden will also keep US bond yields elevated,” Mousina said.

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 lastly, Mousina highlighted the recent spike in oil which saw Brent crude briefly hit a four-year high above $US80 barrel.

The complex web of supply and demand in oil markets was on display on Friday night, as prices dipped by more than 3% amid reports 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 $US75 barrels, 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.”

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