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Capital Economics said that while stock prices and the economy look strong, there are four factors that could cause problems.
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Geopolitical risks in the Middle East and high interest rates pose major risks to the market.
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The depreciation of the Chinese yuan and the rise in US debt are also two factors investors should keep an eye on.
Capital Economics said in a report this week that while markets and the economy are fairly strong, there are a number of factors that could cause the situation to deteriorate quickly.
Low level of risk premium suggests 'plenty of room' [for] Capital Economics' Rubén Gargaro Abargues and Jonas Goltermann say that if four key factors start to break down, the financial situation will deteriorate even more significantly.
First, both economists noted that continuing tensions in the Middle East could further disrupt energy markets, with Brent oil prices being the “most obvious proxy” for the escalating Israel-Hamas war. It has not shown any increase since mid-month.
“Similarly, implied volatility in oil options remains low by historical standards. Also, risk reversals, a measure of the perceived balance between upside and downside risk, rose in early April. However, that increase has since reversed,” they wrote on Friday.
Second, stubborn inflation, which is keeping interest rates high, is putting significant pressure on asset prices, even though the Fed indicated at Wednesday's FOMC meeting that it would not raise rates this year.
“As we have seen in 2022 and 2023, and to some extent over the past month, rapid increases in real interest rates could put pressure on asset prices.Furthermore, a hawkish policy shift by the Fed is likely to This will lead to renewed market volatility,” Abargus said. Golterman said.
Third, as the value of the Chinese renminbi has increased, a weaker renminbi could cause currency market volatility in other regions.
“Implementing a de facto peg to the US dollar at a time when most other currencies are depreciating, the renminbi thanks on a trade-weighted basis. “If the Chinese authorities change their approach and choose to devalue the currency, it will likely lead to increased volatility across currency markets,” the note said.
Finally, they argued that the much-concerned US debt does pose a risk of financial instability. Bond king Bill Gross said this week that rampant borrowing is the only way to boost GDP growth, while Capital Economics said it would He said insurance costs are still slightly elevated compared to normal levels.
“Neither presidential candidate seems keen on fiscal consolidation. If fiscal policy remains on its current trajectory, the US will at some point become a 'bond market vigilante' that will increase the risk premium not only in the US but overall. It is quite possible that the Ministry of Finance could be affected by the “Treasury'','' Abargue and Goltermann added.
Read the original article on Business Insider
