Citi Research analyst Mark Schofield takes a look at four substantial risks for the markets on the horizon in his report dated September 16, 2013.
Global macro facing risks
These risks are geo-political (Syria), political (German elections), policy related (Fed meetings), and economic (China and emerging markets). According to Citi’s Global Macro Strategy weekly, Three Fat Tails, these risks are becoming “increasingly significant.”
A tail risk, in simple terms, is an event that is highly improbable by statistical standards, but happens nevertheless. Examples are the single-day crash of 1987, and the Japanese tsunami’s impact on the financial markets of the country.
Can the four risks mentioned above balloon into a tail risk? Citi says we might actually be in the eye of a storm caused by the confluence of these factors.
Syria’s political risks
The de-escalation caused by a withdrawal of the military option in Syria does not imply that the region’s geo-political risks have subsided. Citi apprehend that in the longer term the governments involved in the ‘ceding’ of chemical weapons in Syria could be faced with serious political and diplomatic challenges.
Germany is the dominant country in the Eurozone, and Sunday’s elections matter not only for Germans but that entire region. Financially troubled countries in the southern periphery will watch the results of the German elections with plenty of trepidation. According to current reckoning, the Christian democratic CDU-CSU alliance led by Angela Merkel will win another term. However, the jury is out on the composition of the coalition that might ultimately assume office. But a poor performance by the FDP might lead to the risk of a Grand Coalition, and all the uncertainties that brings.
China and the emerging markets
The recent encouraging data out of China, and the impact of the currency turmoil in emerging countries would need to be viewed closely for signals of improvement or deterioration going forward. The region is globally significant and could yet be the source of risk from economic de-stability.
Citi feels that policy could remain “accommodative to some degree, which should continue to underpin risk assets, and that emphasis will shift towards guidance as the primary policy tool.” Since the date of their report, the Fed has held off from their tapering initiative and maintained the status quo regarding the monthly bond purchase target of $85B.
Yet, the global risk from the rollback of a monetary easing conducted on an unprecedented, ‘whatever it takes’ scale still lurks.