22 February 2019
If oil prices continue to slide, it will cause fiscal crisis in some exporting nations. Photo: Bloomberg
If oil prices continue to slide, it will cause fiscal crisis in some exporting nations. Photo: Bloomberg

Five ‘black swan’ scenarios for 2016

Financial markets are poised to be volatile in 2016 following the various ups and downs this year. Investors should brace themselves for some possible “black swan” events. Here, I will list five.

Firstly, an oil price slide may drag exporters of the commodity into fiscal crisis.

The oil market is facing an unprecedented supply glut due to surging US production following a breakthrough in shale gas. Meanwhile, demand from emerging markets led by China has been dwindling. As a result, oil inventory has kept rising steadily in the US and within the OECD nations.

OPEC members may stick to normal production levels, despite plummeting prices, in a bid to phase out high-cost producers. Meanwhile, the market may also take more time to reach a balance, given that oil sanction on Iran will be lifted. Amid this situation, oil price would follow the path seen in the early 1980s.

That would exert a heavy shock for oil exporting nations, whose fiscal revenue is mainly generated by tax levy on oil exploration and export. For example, almost 90 percent of Saudi Arabia’s revenue stems from oil, while oil revenue also contributes half of fiscal revenue in Russia, Nigeria and Venezuela.

Some nations opted to ramp up output in order to boost tax revenue, which has further weighed on oil price. Countries with large forex reserves, like Saudi Arabia and Kuwait, have been relatively more resilient to the oil price slide. However, nations like Venezuela are on the brink of bankruptcy.

The second potential black swan for the markets would be geopolitical risks.

The Paris terror attacks last month prompted a wave of security alerts across the world. Various nations are on alert amid fears that terrorists could be planning more mayhem. The Syrian situation, meanwhile, is becoming more complicated. Increasing geopolitical risk is set to stoke safe-haven demand in the market.

And now, for the third black swan: the US may be forced to cut interest rates if global financial asset prices tumble.

Global credit markets have already witnessed a rise in default rates. Once the liquidity boost from various central banks passes the peak, credit markets will start to tighten, spurring calls for fresh action.

US-listed companies have reported weak earnings for two quarters due to rising human capital and financing costs. 

Federal Reserve forecasts pointing to four interest rate hikes in 2016 are beyond what the market expected. The US economy, high-yield credit and equity markets would face huge downside risk if consumption fails to hit the target.

Any global financial market turmoil would force the Fed to slow its pace in raising rates, or even prompt it to revert to monetary easing measures like a rate cut, under extreme circumstances.

Investors would flee to safe-haven assets like the Japanese yen if US cuts rate amid increasing geopolitical risk. The dollar may return to 100 level against the Japanese yen. Meanwhile, the euro, sterling and Canadian dollar would all stage an uptick due to a weakening dollar, and reverse their depreciation of the past year.

As for the fourth black swan, high-yield debt may face pressure.

High-yield funds like Third Avenue, Lucidus have halted redemptions for investors in December. And other high-yield debts with rating at BB+ or below have taken a hit from the downturn. In fact, the high-yield debt and loans have already reached US$4 trillion as a result of super-low rate during the last eight years, according to estimate from S&P.

Of this, a third will mature within five years. And the unprecedented loose liquidity would also come to an end. Therefore, companies would face mounting pressure to repay debt. Meanwhile, we should also bear in mind that the US authorities intend to tighten regulation over leveraged ETFs.

Liquidity crunch coupled with waning investment demand would mean that firms with low credit ratings would suffer. That could create a spill-over effect in the global debt market.

The fifth black swan is that China still has room for cutting interest rates.

China’s 10-year government bond yield has already tumbled to a year-low of 2.8, and is moving close to the 2002 trough of 2.3. The Chinese central bank has cut the benchmark interest rate by as much as 150 basis points since last November.

However, the nation’s official PMI has been hovering within the contraction territory since July, and PPI has been negative for 40 months in a row.

If the situation doesn’t improve, authorities could relax the monetary policy further to stimulate economic growth.

This article appeared in the Hong Kong Economic Journal on Dec. 30.

Translation by Julie Zhu

[Chinese version中文版]

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General Manager, Head of Investment, Investment Management, Bank of China (Hong Kong)

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