Want to see something scary? Look no further than SocGen’s latest black swan chart, which the bank updates on a fairly regular basis.
The thing that’s particularly interesting about the “outliers” the bank says pose the most realistic threat in 2017 is that in my mind, they’re virtually all almost certain to play out. Does that mean we shouldn’t call them “black swans” anymore? I don’t know but I think you’ll agree that political uncertainty, a sharp rise in bond yields, a Chinese hard landing, and a shift towards protectionism in the US are all virtually certain to manifest themselves.
Why do I say that? Well, because they already have…
China tops “pure” economics risks amongst the G5, with a 20% hard landing risk: To identify where the “pure” economic risks are the most acute we look for signs of excess, be it in debt, real asset values, NPL and/or capacity, across all sectors of the economies. Amongst the major economies, China is where we see the most significant risks with pockets of significant excess in housing, high debt levels and a burgeoning NPL problem. At the same time, the fact that the financial system remains largely closed and the authorities have regained a fair amount of control over the capital account means that we set China “hard landing” risks at 20%. Insufficient structural reform, however, leaves the economy at very significant risk of a lost decade, which we set at a 40% probability.
Upside risks on the real economy: Business investment has remained lacklustre compared to historical patterns and we consider the risks to be biased to the upside on this front, not least in the advanced economies that, contrary to China and a number of commodity producers, are still dealing with a capacity overhang.
Europe tops “political” risks: With a very busy political agenda ahead, Europe tops the political event tails risks. On our SG Swan Chart below, we have opted for a broader view of political risks, taking into account potential spillovers from European policy uncertainty and recognising also that significant uncertainty remains on the future shape of US policy. We also see risks for Asia as we discuss in this GEO. We have opted this time to add a swan describing the risk of isolationism and trade wars, and set this as a 15% risk.
Bond yields are the Achilles heel of global markets: Since the US election, higher bond yields and stronger equity markets have come fairly much hand in hand. Market pricing on Fed rate hikes, however, remains modest and there is to our minds significant risk of a more disorderly repricing of global bond yields. Such a scenario could have very negative spillover, not least to emerging markets.
Reform and better fiscal policies: In our previous SG Swan Chart we included a 15% upside risk from fiscal spending. This has been lowered to 5% reflecting that we have moved much of this to the central scenario with the upgrade to our US fiscal stance.