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11 December 2018 |
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Top 10 risks for 2019
MULTI-ASSET
GLOBAL
The big unknowns
From a new Eurozone crisis or a liquidity run in the corporate bond markets…
…to the end of the trade tensions and an outbreak of EM reforms…
…we present our top 10 risks for 2019
In this report, HSBC economists and strategists highlight the most significant risks to our central scenarios in 2019. These are possibilities, not forecasts, and none might come to pass, but they are all things that could spring a surprise. They vary in terms of their probability and the size of their likely economic and market impact, both globally and regionally. Most risks are negative but we include some positive ones as well.
We break risks down into three categories and provide investment implications. The order of risks below does not imply ranking or probability.
Event risks
Eurozone crisis 2.0
Trade tensions end
Brace for (climate) impact
Valuation risks
US corporate margins fall
EM reform surprises
Pierre Blanchet
Head of Multi Asset Strategy
HSBC Bank plc pierre.blanchet@hsbcib.com +44 20 7991 5388
Steven Major, CFA
Global Head of Fixed Income Research
HSBC Bank plc steven.j.major@hsbcib.com +44 20 7991 5980
Janet Henry
Global Chief Economist
HSBC Bank plc janet.henry@hsbcib.com +44 20 7991 6711
David Bloom
Global Head of FX Research
HSBC Bank plc david.bloom@hsbcib.com +44 20 7991 5969
The ECB initiates new unconventional policies
Liquidity & volatility risks
Leverage risks and accounting tactics
The Fed keeps hiking
No bid in a credit sell-off
Fixed income volatility comes back
Top 10 risks poll
Click here to go to our online poll, pick your top risks for 2019 and see what our readers believe are the major concerns for next year.
Dr. Murat Ulgen
Global Head of Emerging Markets Research
HSBC Bank plc muratulgen@hsbc.com +44 20 7991 6782
Ben Laidler
Global Equity Strategist
HSBC Securities (USA) Inc. ben.m.laidler@us.hsbc.com +1 212 525 3460
Disclosures & Disclaimer
This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it.
Issuer of report: HSBC Bank plc
View HSBC Global Research at: https://www.research.hsbc.com
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Summary of the Top 10 risks |
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Risk |
Brief description |
Investment implications of each scenario |
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Eurozone crisis 2.0 |
If stimulus is needed, the eurozone may have a problem in a year of (possibly |
The EUR would get close to parity with the USD in such a scenario. GBP would face great uncertainty as the |
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disruptive) leadership changes. The political landscape is much changed since |
post Brexit trade negotiations will be more difficult. With renewed focus on credit, we would be cautious on |
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2012, with populist views gaining more traction across Europe. Shaky economic |
Sovereigns with weaker fundamentals and EUR IG credit in general. Bunds usually win in this situation but |
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foundations and political uncertainty, would not be a healthy backdrop and could |
given valuations, flight-to-quality flows may head to US Treasuries instead. European equities might not be hurt |
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lead to a renewed risks for the Eurozone. |
as much as in 2011 as valuations are lower but financial stocks would likely underperform. |
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Trade tensions end |
The post-G20 truce in China-US trade tensions gave some relief to the market, as |
Growth expectations and “risk-on” will impact FX. The RMB would likely retrace some of the depreciation |
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negotiations get underway. But the outcome of the trade conflict remains uncertain, |
seen in 2018. This upside growth surprise would be positive for EM and cyclical commodities in the near |
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and trade prospects are further clouded by WTO disputes and Brexit. An end of |
term. EM equities broadly would benefit with China, Korea and Taiwan benefiting disproportionately. |
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trade tensions could boost investor sentiment and would have a positive impact on |
However over the medium term, a resolution on the trade front might also result in an acceleration in the |
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growth expectations and on China in particular. |
Fed’s tightening cycle. |
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Brace for (climate) impact |
Extreme climate events are becoming more costly and more visible. Damage costs |
As climate change damage costs become evident, a wide range of securities could be impacted. |
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are impacting DM regions, not just EM. Risk of adverse market reaction to climate |
Preparing for climate impacts will need investment and full preparedness is expensive. Credit downgrade |
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events in 2019. |
and spreads widening could happen if the market is more focus on extreme events as in the case of P&G |
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and the Californian wildfires. |
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US corporate margins fall |
Profit margins have been the key driver of US earnings. Corporate profit margins are Faster than expected wage growth could cause a significant miss to earnings estimates and derail the |
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at an all-time high and consensus expects them to move up further. But rising costs, |
equity bull market. Were net profit margins to fall back to their 10-year average of 9%, US equities EPS |
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including wage growth, trade tariffs and financing cost could bring them down next |
would fall by 20% from current levels on our calculations. With leverage measures close to all time high, |
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year. |
USD Credit would become vulnerable. |
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EM reform surprises |
We remain broadly cautious on emerging markets going into 2019 given the tightening in |
Reforms that will help improve long-term growth should support EM equity valuations which are a function |
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financial conditions and enduring trade conflicts. But what if EMs start focusing on |
of future economic performance and cost of capital. Fiscal reforms should be positive for EM fixed income |
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structural reforms to address their imbalances, boost productivity, and improve efficiency? |
markets. If credible, a reform wave would also lead to a strong rally in EM “carry” currencies. |
The ECB initiates new unconventional policies The ECB might enter the next downturn with negative rates. Eurozone growth is slowing and core inflation remains low. With limited scope for fiscal action, the ECB might have to restart QE and, possibly, a range of other unconventional measures
Leverage risks and accounting tactics |
US nonfinancial corporate debt is at its all-time high and average credit ratings of |
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investment grade debt have fallen sharply. Elevated leverage and risk of higher |
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funding costs point to debt servicing and refinancing challenges ahead. |
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The EUR would likely weaken in anticipation of the announcement of a new round of easing measures.
With EUR-CHF, EUR-SEK and EUR-CEE all facing downward pressure, the respective central banks may be forced to reconsider their own domestic policies. 10-year Bund yield could be back to zero. The Euro non-core reaction would depend on the type of announced measures. If CSPP were to restart, EUR IG spreads could tighten and delay the market sell-off. Under this scenario, European equities would likely suffer and banks in particular would be negatively impacted.
Corporates facing the combined challenge of the increased cost of borrowing and potentially lower operating profits in an economic downturn, might be tempted to make more aggressive accounting judgements and decisions. Such accounting practices could ultimately unravel with severe consequences.
The Fed keeps hiking |
We expect three more Fed hikes until June 2019. But core inflation could accelerate |
Were the Fed to deliver more than implied by the dots, the boost to the USD would be sizeable. We think |
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and the Phillips curve steepen, leading to a change in the FOMC stance. |
UST2y and US Credit would be under pressure. If the tightening is a response to inflation rather than growth, |
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US equities should suffer as multiples contract. Defensive sectors with strong balance sheet would fare best. |
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This is a tough scenario for emerging markets and EM EXD would probably outperform LCD. |
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No bid in a credit sell-off |
Corporate bonds remain a structurally illiquid asset class. In a sharp sell-off, there is |
In a sharp credit sell-off, there will be a limit to how much investors could sell. Just as banks engage in |
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a limit to how much investors could sell. Mutual funds and Exchange Traded Funds |
maturity transformation, mutual funds and ETFs engage in liquidity transformation. As a fund sells liquid |
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(ETFs) which tend to have a high level of retail investors are of particular concern. |
holdings, the portfolio gets more illiquid subjecting the remaining investors to time subordination. We |
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highlight a few things which might temper liquidity risk, but there is uncertainty whether it will be sufficient. |
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Fixed income volatility comes back? |
Central Banks’ actions and private sector’s yield enhancement strategies have kept |
If fixed income volatility does rise, vol is likely to pick-up in other asset classes as low and stable long-end |
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interest rate vol subdued. With global reserves flow shrinking, there is a risk the |
real rates have been a key determinant of performance of risky assets. An increase in equity vol would be |
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trend may change. |
associated with equities selling off and the correlation between bonds and equity returns would probably |
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change sign. This might lead to an overall reduction of risk as the benefit of diversification dissipates. |
Source: HSBC
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MULTI-ASSET |
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●GLOBAL |
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MULTI-ASSET ● GLOBAL |
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11 December 2018 |
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Eurozone crisis 2.0
Steven Major, CFA
Global Head of Fixed Income Research
HSBC Bank plc steven.j.major@hsbcib.com +44 20 7991 5980
Simon Wells
Chief European Economist
HSBC Bank plc simon.wells@hsbcib.com +44 20 7991 6718
Pierre Blanchet
Head of Multi Asset Strategy
HSBC Bank plc pierre.blanchet@hsbcib.com +44 20 7991 5388
Wilson Chin, CFA Fixed Income Strategist
HSBC Bank plc wilson.chin@hsbcib.com +44 20 7991 5983
Chris Attfield Strategist
HSBC Bank plc christopher.attfield@hsbcib.com +44 20 7991 2133
Song Jin Lee
European Credit Strategist
HSBC Bank plc songjin.lee@hsbc.com +44 20 7991 5259
Daniel Grosvenor*
Equity Strategist
HSBC Bank plc daniel.grosvenor@hsbcib.com +44 20 7991 4246
* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations
A downside surprise to the economy is a key risk, particularly as there will be leadership changes in key EU institutions
In this scenario, given a renewed focus on credit, we would be cautious on Sovereigns with weaker fundamentals and EUR IG credit in general
Bunds usually win in this situation but given valuations, flight-to- quality flows may head to US Treasuries
2019 rising risk, depleted ammunition
If stimulus is needed, the eurozone may have a problem …
The eurozone economy remains vulnerable. After an unusually strong expansion in 2017, economic growth is slowing back to trend and core inflation remains subdued. It will be hard to agree the necessary reforms due to the growing popularity of more populist parties. The ECB is out of sync with the US Fed and could potentially face a global slowdown with negative interest rates and so little by way of monetary stimulus to offer. At the same time, countries with fiscal headroom are unlikely to use it. Therefore the eurozone economy, which has a relatively high reliance on trade, is at the mercy of the global trade cycle.
… in a year of (possibly disruptive) leadership changes
All this comes at a time of significant change in Europe’s leadership. Four of the EU’s top positions (at the Commission, Council, Parliament and the ECB) are set to change hands in 2019. Meanwhile the domestic political environment in individual countries means that the heads of government in Germany, Italy, Spain and the UK could conceivably change next year as well.
What if populism overcomes Europeanism?
The political landscape has evolved since the last time the eurozone faced an existential crisis, because populist parties have gained more support across the continent. So far tensions have been around immigration rules and budget deficits, but we wonder what would happen if differences between Brussels and member states escalated dramatically. Europe’s recent history suggests it requires an extreme situation to take hold before decisive action is taken. Shaky economic foundations and political uncertainty would not be a healthy backdrop for European debt markets especially if the future of the euro was once again called into question.
Investment implications
The EUR would get close to parity with the USD
The first eurozone crisis prompted EUR weakness, but the political will was there to sustain the project and avoid a break-up. When the ECB’s President Mario Draghi promised to do “whatever it takes” to preserve the EUR, he could be confident of the political support. However, as we’ve seen in the run up to the French presidential election, when the political support is undermined, a more pronounced reappraisal of the currency is likely and the EUR could potentially reach parity against the USD.
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The risk-off environment would favor the USD, JPY and CHF. A particular complication would be for GBP given the UK would likely be in the middle of negotiations with the EU about its future trade relationship. The EU has been able to provide a united front so far where protection of the integrity of the EU and the single market were the key shared objectives. Were this challenged by a more EU-sceptic political make-up, GBP would face even greater uncertainty.
Another eurozone crisis would present a challenge for weaker credits…
As we have seen in the past, a marked ‘flight-to-quality’, resulting in outperformance of German
Bunds is likely. In a repeat of the past both Agencies and supranationals could underperform as
Schatz and Bobl spread could widen.
Markets would likely question whether there is enough firepower or willingness in the eurozone to provide financial support to a bigger country or countries (in terms of GDP) than during the previous sovereign debt crisis.
For Bunds there would be, however, a major valuation challenge. Ten-year Bunds now yield less than 30bp and are close to recent lows having averaged 50bp in the last year. More importantly, Bund yields were 2.0% only five years ago and 3.0% before the last big crisis in 2012. In a ‘flight-to-quality’ the US Treasury market would be likely to attract renewed interest from overseas investors, particularly given yields are close to 3.0%.
…and greater differentiation based on credit fundamentals
Countries in the eurozone periphery are more economically diverse than they were in 2011. Ireland’s closest peer may now be Belgium, and Spain is A-rated with its banking system in better shape and no property bubble. The extent to which contagion would take hold is therefore uncertain if a function of the risk around the future of the euro. The effects might be different than before, and may be concentrated in countries with deteriorating credit fundamentals. Those Sovereigns on a better path would be affected less badly in this scenario. For example, Spain’s long-dated forward bond yields could continue their slow convergence with those of France.
EUR IG Credit: Contagion likely to drive bear flattening
In a new eurozone crisis, we would expect contagion in EUR IG credit, varying by sector and country of risk. Indeed, we highlighted large DM sovereign crises as one of the potential flashpoints for contagion (see: European Credit Outlook 2019, 28 Nov 2018). Sovereign crises, together with financial uncertainty and US recessions are the main trio of credit bear market drivers. It wouldn’t surprise us to see EUR IG spreads widen aggressively and the credit curve bear flatten, especially if concerns about the fate of the euro came back. In such a scenario, mid-duration paper with 3-7y maturities would be more vulnerable and financial bonds would likely underperform.
European equities would probably not be hurt as much as they were in 2011
During the eurozone debt crisis the equity market response to rising bond yields was clearly negative, and we would expect the same if there was a renewed loss in confidence in eurozone debt. However, the extent of any decline would depend on the broader macroeconomic backdrop, and we wouldn’t expect European equities to revisit their 2011 valuation lows without a significant downturn in domestic growth.
Financial stocks would likely underperform in this scenario. The supply and demand for credit and loans would likely weaken. Wider spreads would translate into capital erosion for banks, higher funding costs, and pressure on NPL levels and disposal plans. Associated market volatility would also have a negative impact on fee income. Demand would fall and the ability to service existing debt challenged. Reduced access to the funding market could also affect the viability of individual banks’ business models. Defensive sectors and foreign earners would be the relative winners. Finally, non-Eurozone markets such as the UK and Switzerland would fare best from a country perspective.
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