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10 Grey Swan events for 2018

Focused thinking: 972 words
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December 2017
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    Although we would like to be able to predict black swan events, they are inherently unpredictable. Grey swan events-unlikely but high impact market events-on the contrary can be anticipated to a certain degree.

    We have put on our creative hats and came up with 10 grey swan events for 2018. Needless to say, none of them are our base case, but we think it is better to be prepared than not.

    Here are the 10 grey swan events that could end up disrupting markets in 2018:


    1. The “Amazonification” of inflation

    The long-term decline of US inflation has been caused by the sharp decline in goods price inflation and perhaps the “Amazon effect” won’t stop there. The impressive rise in smartphone ownership in the developing world compounded with the ease of outsourcing services abroad, the development of the gig economy and the rise of AI could mean the technological dampening of inflation may be more persistent than ever before.

    2. Two per cent inflation targeting goes out of style

    Inflation targets of around two per cent are a relatively new phenomenon. A longer view could reveal it to be nothing more than an economic fad. There are two key reasons for lowering the inflation target-a lack of success in hitting inflation targets in recent years and ageing demographics. So whilst central banks will (for now) likely retain their independence on the means to hit inflation targets, the executive and legislative powers in some countries could see political benefits in lowering this to one per cent.

    3. A United States of Europe

    2018 presents a unique political opportunity for countries within the euro area to forge closer ties and perhaps embark upon a political journey that will end with the creation of a ‘United States of Europe’. In fact, European politicians may embark on a treaty change that leads to increased mutualisation of debts and sharing of risks.

    4. Another UK political turnaround

    Even if the REAL grey swan for UK politics in 2018 will be for nothing interesting to happen, the tail risk will be for political instability to get so bad that another general election or a second Brexit referendum occurs in 2018. Over recent months we have seen a slim majority in the polls saying in hindsight it was wrong for Britain to vote to leave the EU. If this trend continues, Remain MPs on all sides of the house may push for a second referendum, on the outline of the actual deal with the EU.

    5. Bitcoin starts moving other markets

    The arrival of Bitcoin futures will likely see Bitcoin exchange traded funds expand in 2018. It may be too early for Bitcoin to have a global impact on other asset markets at this stage, but it is already making a dent with its energy consumption. So perhaps the grey swan of next year is not Bitcoin’s bubble bursting, but the continued rise and surging demand for coal.

    6. Housing market decline = rate cuts?

    Solid growth, low interest rates and hot money inflows from overseas have fuelled rapid house price gains in Australia, Canada, New Zealand, Norway and Sweden. As these growing imbalances cannot be ignored by policymakers, investors have been calling for a downturn for some time in these markets. Under extreme scenarios, rates markets may move to price cuts rather than hikes and the respective bond yields and currencies will depreciate versus the majors.

    7. A bigger proxy war in the Middle East 

    In 2018, the tensions in the Middle East may intensify and oil prices and global inflation might be impacted. If Brent oil price increases 30 per cent from its current price level to $80, it will add 0.4 and 0.9 percentage points to 2018 headline inflation in the US and eurozone, respectively and winners and losers of an oil price shock will emerge in emerging markets. With output gaps in major economies dwindling, an energy price shock may more easily lead to second-round effects on inflation, which may require a monetary policy response with knock-on effects on risk assets.

    8. “Get to the chopper!” 

    The Bank of Japan is one of the most likely candidates for helicopter money. Although our central case is that Governor Kuroda will be re-appointed, an appointment of Mr. Honda, will be a significant shock to the market and expectations for a much looser fiscal and monetary policy stance, i.e. helicopter money, may be ignited. This is not purely a story of Japanese politics – helicopter money can be a natural step towards further easing for central banks facing policy limitations and the European Central Bank is one of them.

    9. Credit: stealth leverage pops?

    After years of accommodative policy, we think leverage has built up in the system and lurks in various forms: commercial real estate (CRE) loans, subprime auto loans, student loans, and financial leverage. Most of the leverage is not systematic; however, the financial leverage is where the embedded leverage is in the system. Over the past 10 years, the fastest-growing debt was in capital markets and corporate debt is up roughly $3trn. A reprice of corporate credit when balance sheets are still thin could indicate that meaningful risk lies ahead.

    10. What the movies tell us about 2018

    Films may end up being better predictors of grey swans than research analysts. We’ve found Terminator Salvation and Rollerball-movies that are based in 2018- to have eerily similar aspects to the world we are living in today. Although it would be easy to dismiss the extreme scenarios depicted in the films, it’s hard to neglect all the necessary ingredients for these scenarios to emerge such as drones, computer-controlled power grids and artificial intelligence are already firmly ingrained in our lives. Perhaps the movies are not so crazy after all?

    For more insight into the grey swan events and how they could end up disrupting markets in 2018, read the full report on the Global Research Portal.

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