It’s that time again – time for an update on SocGen’s “swans” chart.
For the uninitiated, the SG swans chart is an effort on the bank’s part to quantify the inherently unquantifiable; to attach percentages to “shock” events.
The last update on the swans came in June, and it probably goes without saying that most of the downside risks have intensified or otherwise become more likely to materialize.
It is of course true that U.S. equities eventually recouped losses incurred in February and March on the way to summiting new peaks, but one of the key points to consider when you think about 2018’s macro narrative is this: The same policies that served to insulate U.S. equities from the turmoil abroad were in large part responsible for the malaise in ex-U.S. assets. Late-cycle stimulus stateside forced the Fed to lean hawkish and that lean led directly to dollar strength, which in turn put enormous pressure on emerging markets. The sugar high from the stimulus combined with trade war jitters transformed 2017’s synchronous global growth narrative into a U.S.-centric story, and the consequent economic divergence perpetuated the preference for U.S. assets. That culminated in a historic divergence between U.S. stocks and their international counterparts.
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Given that, it is not at all surprising that downside risks have grown in tandem with rising U.S. stocks.
Meanwhile, the Trump administration has openly stated that the President is inclined to view the rally in U.S. equities as a cushion when it comes to fighting the trade war. We’re “playing with the bank’s money”, Trump claims. While there’s some truth to that, the President’s recent comments about the Fed suggest he’s perhaps not as happy to squander that cushion in the interest of pushing the envelope on trade as he suggested back in July when he told CNBC that the rally affords him the opportunity to turn the screws on Beijing.
It’s with all of the above in mind that SocGen says the following in the introduction to their latest market risk outlook:
When we published the second edition of SG Market Risk Outlook in June, we warned that the largest risks for financial markets stemmed from rising protectionism, slower global trade and souring trade relations. Since then, a hawkish Fed and a global dollar scarcity has added fuel to the fire for EM assets.
In the updated version of the swans chart, SocGen ups the risk associated with an all-out U.S.-China trade war to a “quite subjective” 25%, from 20% three months ago.
(SocGen)
As you can see, the subjective probability assigned to “China hard landing” is now 20% versus 15% in the June update and that’s a direct consequence of the increased trade frictions.
“If the risk of a trade war is greater, it follows that the risk also increases of China experiencing a hard landing, which we define as growth slowing by 2pp or more over a year, meaning 2019 GDP growth of less than 5%”, SocGen writes, adding that “given China’s weight in the global economy of around 20%, this would imply a downside shock to global growth of 0.4pp or more.”
Clearly “European policy shock” is still a risk whether that means some kind of overtly hawkish lean from the ECB or else a fiscal policy “mistake” in Italy. SocGen also notes that “a sharp market repricing to the downside has been a risk for some time, but it too has grown over the past three months”. If you need evidence to support that contention, just ask last Wednesday.
On the “upside” swans list, you’ll note that “surprise in fiscal accommodation” is assigned a 15% probability. On that point, we would remind you that back in July, JPMorgan’s Marko Kolanovic suggested that a coordinated push into fiscal stimulus could be one mitigating factor for the global economy going forward at a time when trade jitters and an assumed waning of the sugar high in the U.S. are causing consternation. To wit, from Marko’s July 30 note:
The US often sets global trends, such as the introduction of QE in the aftermath of the 2008 financial crisis. QE was later replicated (and taken to another level) in Europe and Asia. At the end of his term, chairman Bernanke said that there are limits to monetary policy and that pro-growth fiscal measures need to play a bigger role. Trump fully on-boarded this as a part of his platform. Corporate tax cuts can also be viewed as a part of the trade war. Corporate tax cuts outside of the US might be a necessary step in order to compete in trade, especially after the massive reduction in US tax rates. Fiscal measures are also popular with voters and can help reduce various political tensions, e.g., exposed by the recent rise in populist movements in Europe. For this reason, we think that is quite possible that in coming quarters Europe and Asia will move towards fiscal easing. Instead of a 2019/2020 recession, we may see a boost to the global cycle driven by Trump-style fiscal measures outside of the US.
Late last month, our good buddy Kevin Muir reiterated those sentiments in a post called “Things Have Changed” over at his popular MacroTourist site.
That said, SocGen reminds you that the percentages assigned to the upside risks in the swan chart have not changed since June, which means there is “no offset to the higher downside” probabilities.
[Insert generic doomsday prediction to close post]
I’m just kidding, that’s somebody else’s shtick.
