The pentagon of fear - Nomura

Bilal Hafeez, Research Analyst at Nomura, suggests that the recent bond sell-off is clearly weighing on risk sentiment, and it is something Nomura thinks will continue.

Key Quotes

“Another obvious market risk factor is a Trump victory in the US elections, though the likelihood of that has fallen in recent days. But these are not the only risks that keep us awake. Indeed, there are five larger macro risks that would constitute an (irregular) pentagon of fear:

A. De-globalisation. Whatever the outcome of the US election, there has been a clear shift away from policies supporting global trade. The lack of cross-party support for the Trans-Pacific Partnership agreement is one such example. This comes at a time when the steady increase in US trade openness appears to have peaked. With the US being the engine for liberalising global trade and markets, a reversal could have far-reaching consequences from countries enacting protectionist measures to countries being unable to run large current account imbalances.

B. Euro area has a leverage problem. The woes of the euro area’s banking sector have dominated headlines at various points this year. A big factor behind this is the very large German current account surplus, which results in large financial outflows – much of it in the form of lending to residents abroad. Consequently, German financial institutions’ balance sheets have come under particular scrutiny. Related to that is the deeper problem of a continued increase in leverage in the euro non-financial sector. Credit is being extended, but it is not resulting in much growth. This suggests that lending could be propping up failing investments or firms. The contrast with the US is stark.

C. Can China’s global growth engine go into second gear? The bounce in Chinese growth this year has baffled many, but it is perhaps too early to call an end to the trend decline in growth (and import demand). The Chinese authorities are in the midst of an incredibly complex balancing act between supply-side reform and short-term demand management. Any mistakes could see growth roll over once again with its attendant negative consequences for Asian economies and commodity markets.

D. BOJ’s 10yr rate peg – can it last? We have all been scarred by the break in the EUR/CHF peg in early 2015. So there is no guarantee that pegs can last or indeed that policymakers will flag a change. Therefore, the Bank of Japan’s commitment to keep JGB 10yr yields around 0% needs to be watched closely. It’s too early to question the peg, but the time we stop questioning will be the time we need to worry. By then, investors would likely have borrowed significantly out to 10 years in Japanese markets, and so a painful unwind would likely ensue.

E. Oil matters. The ups-and-downs in oil prices have wrought havoc for price indices around the world and have rebalanced growth between oil exporters and importers. This would not be as much of a problem had the oil price moves been moderate, but the volatility has surged to its highest level since 2008. It is not clear whether the volatility will end any time soon.”