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Nomura Has 10 'Gray Swan' Risks That Could Roil Markets in 2017

Nomura Has 10 'Gray Swan' Risks That Could Roil Markets in 2017

(AFP/AWC Ltd.)

Thursday, 08 December 2016 04:44 PM

Markets' black swans are rapidly turning gray.

Brexit, the election of Donald Trump, and a faltering bull market in bonds have all helped elevate analysts' 2017 tail risk predictions from the status of colorful festive reading to a cause for sleepless nights.

Analysts at Nomura are the latest to throw their hat in the ring — warning investors to be prepared for "unlikely but impactful events" including the possibility of capital controls in emerging markets, a long-elusive pick-up in Japanese inflation, and a Federal Reserve at loggerheads with the U.S. government.

"Needless to say, none of them are our base case," the analysts caveat. Of course, investors scarred by the turmoil of 2016 know that doesn't necessarily mean that they won't happen.

Here are Nomura's 10 events that could end up roiling your 2017.

1. Russia on the warpath

A staple of gray swan lists since Vladimir Putin's annexation of Crimea two years ago, Russian military aggression in eastern Europe remains one of the big risks for 2017. While an actual military invasion is unlikely, the foundations may be laid next year through anything from changes to U.S. foreign policy to the election of populist leaders in Europe, according to Nomura. Position for risk by going long credit-default swaps of any of the Baltic nations, shorting credit and trading Poland as a negative proxy.

2. A surge in U.S. productivity

As Fed officials make the case that the president-elect's fiscal stimulus should be targeted at increasing productivity, Nomura says a pick-up in research and development investment could already be laying the groundwork. Like the tech boom of the 1990s it would catch forecasters unaware, but could have implications ranging from a faster series of rate hikes to a sustained boost to equities if it materializes.

3. China floats the yuan

As recent outflows suggest, a balance-of-payments shock could follow hasty moves to liberalize the currency regime of the world's second-largest economy. The probability China gets to that goal in the next 12 months is "very low," Nomura analysts assert, but prepare for yuan weakness if it happens.

4. An exit from Brexit

U.K. Prime Minister Theresa May said she'll trigger the process of leaving by March of next year, and her favored "Brexit means Brexit" catchphrase makes it sound like she means it. But there are two big upsets that could appease the 48 percent: the case being heard by the U.K.'s Supreme Court might trigger a general election, were it to galvanize pro-EU sections of parliament, while — in an attempt to assuage further break-up — the EU could also grant the country face-saving concessions.

5. Capital controls in emerging markets

Emerging markets may face "pronounced outflows" in 2017 if Trump's planned stimulus spending sends U.S. yields higher and further strengthens the dollar. That could prompt policy makers to take action, and they might even coordinate in a collective rebellion against the U.S. Countries most at risk are those with volatile currencies, low currency reserves and relatively low rates.

6. Japanese inflation jumps

What if the market is wrong to price in a moderate pick-up in Japanese inflation next year? A sharp rise — potentially triggered by the collision of higher oil prices and a weaker yen — could prompt the Bank of Japan to take action by lifting its 10-year yield target of zero percent. Such a shift could have a global impact because both inflation and global core bond yields are highly correlated.

7. A clearing house crisis

The systemic risks that stem from the clearing houses that were themselves introduced to contain systemic risks aren't new to regulators: financial stability watchdogs are already taking measures to deal with any potential fallouts. "The interplay between struggling banks, collateral squeezes, sharp market moves in an overpriced market with central counterparties at the center" could potentially lead to a crisis, in Nomura's worst-case scenario.

8. Trump takes fight to the Fed

The Fed chair has indicated that she'll stay her term. Yet Janet Yellen was on the receiving end of some harsh invective during the future president's campaign, and Nomura considers a change to the bank's mandate to be among 2017's outlying risks. More likely is that Trump could name sympathetic board members when present appointments expire. Higher policy rates could ensue.

9. Abenomics comes unstuck

The most likely outcome of a general election in Japan is that Prime Minister Abe's support will be solidified. That means that anything fracturing this stability will come as a big shock to the market. A weakening of Abe's hold on power could cause Abenomics trades to be unwound, with Japenese equities bearing the brunt of the pullback.

10. The end of cash

It seems inevitable that electronic payments will replace notes and coins at some point, but Nomura picks up on one reason why it might happen sooner rather than later: negative yields. Electronic money would prevent potential savers stashing money under their mattresses to avoid sub-zero interest rates. The risk to this scenario is of course that savers get hurt and consumers start inventing new hard currencies.


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Markets' black swans are rapidly turning gray.
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Thursday, 08 December 2016 04:44 PM
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