A Decade After Lehman, Investors Hunt Clues for Next Crisis
(Bloomberg) -- “It’s something that happens every five to seven years” is how JPMorgan Chase & Co. CEO Jamie Dimon once defined a financial crisis to his daughter. Queen Elizabeth II asked “why did nobody notice” the seeds of the last one.
Stung by their failure to spot the turmoil of 10 years ago and two decades since Asian markets were roiled, policymakers, traders and economists are looking at the clock as they wonder when and where the next meltdown will hit.
As it holds its annual meetings in Bali, Indonesia this week, the International Monetary Fund is already warning investors may be underestimating the risk of a financial shock.
One of the axioms of financial history though is that no two crises are the same so the search is on for potential triggers in the world economy and markets. A policy mistake by the Federal Reserve, such as raising rates too fast or for too long, could sideswipe the U.S. economy and disrupt markets around the world.
Here is a rundown of potential hot spots, including some you may not have thought of.
Credit fueled China’s rapid rise as an economic power. Lately, Beijing has been taking steps to slow the rate of corporate debt growth, but total debt outside the banking sector continued to rise last year and remains on an unsustainable path, according to the IMF.
The odds are against a soft landing. Of 43 cases of rapid growth in debt-to-GDP similar to China’s, only five ended without a major slowdown or financial crisis, according to the fund. Many economists still think Beijing has several factors in its favor, including a strong current-account position and room to ramp up government spending. But the trade war with the U.S. could force China to slow its debt reduction, driving financial risks even higher.
“While a China hard landing still remains a low-probability scenario, if it did in fact occur, it would likely unleash a tsunami of contagion across the Asia-Pacific region,” according to Rajiv Biswas, chief economist for the Asia-Pacific at IHS Markit.
Interest-rate hikes by the Federal Reserve coupled with a rising greenback have sent shock waves through emerging markets, making it harder for companies that borrowed in dollars to pay their debts. Argentina is borrowing $57 billion from the IMF, the largest in the fund’s history, to stem the nation’s currency crisis. The Turkish lira plunged as investors questioned the ability of Recep Erdogan’s administration to contain inflation.
“Emerging markets that are over-leveraged on U.S. dollar debt and large oil importers are probably the most vulnerable,” said Hak Bin Chua, senior economist at Maybank Kim Eng in Hong Kong.
Some emerging markets, such as Mexico and Colombia, have avoided being sucked into the maelstrom. But as central banks raise interest rates, investors may not be so discerning.
“Emerging-market risks will likely be confined to idiosyncratic cases, but the potential for contagion is there,” said Mark Sobel, former U.S. executive director at the IMF and now U.S. chairman of the Official Monetary and Financial Institutions Forum.
Surging private debt has been the driving force behind the steady rise of global debt since 1950, according to the IMF. In the last crisis, U.S. household debt was the ticking time bomb. Consumers have since tightened their belts, but U.S. companies have picked up the slack.
Taking advantage of low rates and strong demand, American companies have issued record amounts of debt, pushing key debt ratios to near 30-year highs, according to Morgan Stanley chief cross-asset strategist Andrew Sheets.
It may be harder for the world to respond this time to turbulence, because central banks still haven’t raised rates back to normal levels, leaving them less ammunition if and when they need to provide stimulus, said Jerome Jean Haegeli, group chief economist at Swiss Re Institute.
In some advanced economies, housing prices never crashed despite the 2008 crisis, and the buildup of household debt is now raising red flags. In its latest global financial stability report, the IMF put Australia, Canada and Nordic countries in this category. Australia’s 27 years of recession-free economic growth helped fuel a property boom with Sydney house prices leaping fivefold. National prices are now in decline and have fallen for 12 straight months.
Italy, Euro Zone
The risk of an ugly exit from the euro zone has a new name: Quitaly.
Fears that Prime Minister Giuseppe Conte will push debt to unsustainable levels by bloating the nation’s budget deficit have driven up Italian bond yields to levels not seen since the euro debt crisis.
Italy’s public debt tops 2 trillion euros, more than any other European Union country and the equivalent of around 130 percent of its economy. Its government though is planning a wider budget deficit next year, a push which has taken a toll on its bond and equity markets.
Rising crude prices are stirring talk of a return to $100 per barrel for the first time since 2014, hitting countries that rely heavily on imports, including India, China, Taiwan, Chile, Turkey, Egypt and Ukraine. Prices have gained more than 15 percent since mid-August and oil traded above $74 a barrel in New York on Wednesday.
While higher prices is a positive for exporters, paying more for oil will put even more pressure on emerging markets vulnerable to rising U.S. interest rates.
Markets are bracing for the risk that the U.K. won’t reach a deal on the terms of its divorce from the EU -- causing a disorderly exit at the end of March, when Britain is scheduled to leave. The fallout could be ugly for the financial sector: British banks will lose their “passport” rights in the EU, which may force them to beef up capital, for example. The IMF is warning central banks to stand ready to provide emergency liquidity.
(An earlier version of this story was corrected to change the name of Sheets’ firm.)
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