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Risk Factors - July 2015

JULY 2015

RISK LEVEL

FED: A MISUNDERSTOOD MONETARY POLICY

The labour market has recovered significantly over the last 18 months, and wages are beginning to rise but the Fed will move forward slowly. The clarity of its communications remains the key challenge. The speed of the rate increase will ultimately depend on (1) the reaction of long-term rates, (2) the dollar and (3) the economy’s ability to handle less accommodative monetary conditions.

moderate-risk=

EUROZONE: AN EARLY END OF THE QE

The ECB has committed to continuing its QE until September 2016, even if the economy improves dramatically. There is no threat of a significant rise in inflation while unemployment rates remain high. Real rates must remain sustainably low in order to facilitate deleveraging. A sharp rise in interest rates (or the euro) would quash the recovery. Fears over the solvency of some States would surely resurface. As such, the ECB has no other choice but to intervene if necessary in order to anchor the expectations for a recovery.

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EUROZONE : OVERESTIMATION OF ECONOMIC GROWTH (QE EFFECTS)

The Eurozone is enjoying a conjunction of positive factors: broad QE, depreciation of the euro, a decline in oil, and an easing of financial conditions. The recent rise (in oil, the euro, and interest rates) will not change the game if it stops. From a market standpoint, the risk now is in being disappointed by the scope of the recovery. The recovery in business investment, especially, will need watching.

moderate-risk=

GREECE: GROWTH, INTEREST RATES, FISCAL DISCIPLINE AND SOLVENCY

Greece solvency remains a major stake. Despite two bail-out plans (in 2010 and 2012), a debt restructuring and a significant haircut, the country has been unable to contain a sharp increase of its debt, and this problem came back as a major worry in 2015. There was no consensus among the creditors as regard the proper way to address this issue. The IMF recently recommended Europeans to work for a debt restructuring (interest rates, maturities) while the Greeks would prefer to reduce it. On the other hand, some European countries refuse any haircut. A stronger growth, low interest rates and fiscal and tax discipline are prerequisites for the debt to be contained. Greece is far from respecting these conditions.

moderate-risk=

UNITED KINGDOM: EXITING THE EUROPEAN UNION (BREXIT)

The Conservatives’ sweep of the elections on May 7 means there will be a referendum on the Brexit “by late 2017”, which could open the door to a referendum on Scotland’s status in the Kingdom (Scotland wants to stay in the EU at all costs). In the polls, there is no clear majority emerging on the Brexit. It is much too early to worry about the potentially negative consequences of a Brexit.

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OIL: CONTINUED REBOUND

The rise in oil prices (nearly 50% since its low point at US$ 45) is a partial correction from an overreaction to the downside. From a fundamental standpoint, the supply-demand balance continues to argue for a lower price than in recent years: on the one hand, because supply is structurally more important and, on the other, because demand will be lower (weaker global trade, greater energy efficiency than in the major emerging countries).

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CHINA: A SHARPER DOWNTURN

China’s challenge is to control credit and shadow banking, reduce private debt and NPLs, and return to more solid productivity gains. China has the means to support such a – long – transition, but the stakes, and the task at hand, remain very difficult. Monetary policy easing will continue.

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EMERGING ECONOMIES: A MORE PRONOUNCED DECLINE IN GROWTH

Expectations of a rise in Fed’s key rates (in Q4 2015) seem well anchored. Conversely, some countries’ fundamentals are worrisome: a recession in Russia and Brazil, a marked slowdown in China, inflationary pressures in certain countries, close ties with China, etc. To us, the risk of the downturn accelerating in 2015 for all of the emerging countries seems limited, but should be watched very closely.

moderate-risk=

A BOND CRASH

In the past months, we have seen a rise in inflation expectations (i.e. the rise in real rates is much less apparent than the rise in nominal rates). From a fundamental standpoint, there is no reason to see real rates rise (weakened potential growth, high unemployment). That said, the relative rarity of German paper (related to the ECB’s QE) will weigh down its rates for the long term. Through the impact of portfolio reallocation, this is expected to prevent long-term rates from continuing to rise, in the United States too.

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Cross Asset of July-August 2015 in English

Cross Asset de Juillet-Août 2015 en Français

ITHURBIDE Philippe , Global Head of Research
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Risk Factors - July 2015
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