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Systemic risk today echoes 2007

8 August 2017

Arif Husain, head of International Fixed Income at T. Rowe Price warns investors to remain vigilant.

Risks to the global towards China tends to be herd- economy are building. An unpredictable political environment in the US, the possibility of a slowdown in China and the looming prospect of an end to the long period of ultra- accommodative monetary policy are among numerous potential triggers of a market correction.

Cycles begin and end because of triggers. In our view, the number of potential triggers we are seeing is reminiscent of the lead-up to the financial crisis.

Global politics is highly unpredictable today. The rise
 of anti-establishment, anti-immigration sentiment in parts 
of the world has led to some surprising outcomes, including Brexit and Donald Trump’s victory.

The UK is currently trying to negotiate Brexit terms with a severely weakened government, while in the US there is doubt whether Trump can implement his proposed domestic agenda. However, Trump arguably poses more of a risk on the international stage, where he faces fewer checks and balances.

Elsewhere, China is a potential risk the market seems too complacent about. Sentiment towards China tends to be herd-like: one moment everybody is crowding onto one side of the boat; next the other side.

While global growth is set to rise to 3.4% this year and 3.6% in 2018, we believe this is due at least in part to China’s February 2016 stimulus. The cause for concern now is that China is applying the brakes, with the PBoC raising short-term rates three times already this year.
If we accept the world’s recent spurt can be traced back to China’s stimulus, we should be concerned it is being taken away.

But it is also not the only tightening central bank. The Fed has begun, while the ECB and 
the BoE look set to follow this year. Even the BoJ has tentatively discussed ending QE. Combined, these tightening moves could lead to a spike in yields, potentially resulting in a wider correction.

The prospect of tightening, combined with political uncertainty in the US and a possible China slowdown, mean the overall level of systematic risk in the global economy is very high today – possibly as high as it was in 2007 before the crisis. Investors must remain vigilant.



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