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- Trade tensions, impact from climate change, and corporate debt at an all-time high were among the items HSBC said were the top 10 risks facing the market and the economy in 2019.
- “These are possibilities, not forecasts, and none might come to pass, but they are all things that could spring a surprise,” strategists and economists at the London-based bank said in the report released Tuesday.
Climate change’s impact. Corporate debt. The Federal Reserve hiking interest rates.
Those were some of the items HSBC listed as the top 10 risks facing the market and the economy in the coming year, as detailed in a report to clients released on Tuesday.
After a year marked by the return of volatility in the marketplace, heightened trade tensions between the US and trading partners, and the Federal Reserve’s path to normalize monetary policy, the report gives a glimpse into what investors might expect for 2019.
Strategists and economists from the London-based bank broke the risks into three categories: event risks (the first three items), valuation risks (the fourth through sixth items) and liquidity and volatility risks (the final four items).
Here are the bank’s concerns, the order of which they say did not denote ranking or probability:
“Eurozone crisis 2.0”
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Risk: “If stimulus is needed, the eurozone may have a problem in a year of (possibly disruptive) leadership changes,” the authors wrote.
Investment implications: “The EUR would get close to parity with the USD in such a scenario,” they said. “[The pound] would face great uncertainty as the post Brexit trade negotiations will be more difficult.”
“Trade tensions end”
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Risk: “An end of trade tensions could boost investor sentiment and would have a positive impact on growth expectations and on China in particular,” HSBC wrote.
Investment implications: “Growth expectations and ‘risk-on’ will impact FX,” the strategists said. “The [Chinese yuan] would likely retrace some of the depreciation seen in 2018.”
“Brace for (climate) impact”
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Risk: “Extreme climate events are becoming more costly and more visible,” according to the strategists. “Damage costs are impacting DM regions, not just EM. Risk of adverse market reaction to climate events in 2019.”
Investment implications: “As climate change damage costs become evident, a wide range of securities could be impacted,” the authors wrote. “Preparing for climate impacts will need investment and full preparedness is expensive.”
“US corporate margins fall”
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Risk: “Profit margins have been the key driver of US earnings. Corporate profit margins are at an all-time high and consensus expects them to move up further,” HSBC noted. “But rising costs, including wage growth, trade tariffs and financing cost could bring them down next year.”
Investment implication: “Faster than expected wage growth could cause a significant miss to earnings estimates and derail the equity bull market,” they said.
“EM reform surprises”
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Risk: “We remain broadly cautious on emerging markets going into 2019 given the tightening in financial conditions and enduring trade conflicts,” they added. “But what if EMs start focusing on structural reforms to address their imbalances, boost productivity, and improve efficiency?”
Investment implication: “Fiscal reforms should be positive for EM fixed income markets,” HSBC’s strategists said. “If credible, a reform wave would also lead to a strong rally in EM ‘carry’ currencies.”
“The ECB initiates new unconventional policies”
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Risk: “The ECB might enter the next downturn with negative rates,” they wrote.
Investment implication: “The [euro] would likely weaken in anticipation of the announcement of a new round of easing measures,” the strategists added.
“Leverage risks and accounting tactics”
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Risk: “US nonfinancial corporate debt is at its all-time high and average credit ratings of investment grade debt have fallen sharply,” they wrote.
Investment implication: “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,” HSBC’s strategists said.
“The Fed keeps hiking”
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Risk: “We expect three more Fed hikes until June 2019. But core inflation could accelerate and the Phillips curve steepen, leading to a change in the [Federal Open Market Committee’s] stance,” they said.
Investment implication: “Were the Fed to deliver more than implied by the dots, the boost to the [US dollar] would be sizeable,” HSBC’s strategists wrote. “We think UST2y and US Credit would be under pressure.”
“No bid in a credit sell-off”
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Risk: “Corporate bonds remain a structurally illiquid asset class,” they said.
Investment implication: “In a sharp credit sell-off, there will be a limit to how much investors could sell,” HSBC warned.
“Fixed income volatility comes back?”
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Risk: “Central Banks’ actions and private sector’s yield enhancement strategies have kept interest rate vol subdued,” the strategists said. “With global reserves flow shrinking, there is a risk the trend may change.”
Investment implication: “If fixed income volatility does rise, vol is likely to pick-up in other asset classes as low and stable long-end real rates have been a key determinant of performance of risky assets,” they worried.
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