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June 24, 2016

Impending Recession? Drivers to Watch

by John Mitchem.

Global asset markets are being driven by macroeconomic and central bank policies that are exploring unknown territory. Among these less well-understood factors: negative interest rates, record levels of government debt in Europe and Japan, commodity market oversupply, Britain leaving the European Union, the migration crisis and geopolitical tensions in the Middle East and elsewhere. All of this was discussed at the Lipper Alpha Forum in New York.

Global Events and Market Volatility

  • Markets today are focused on the CBOE Volatility Index (VIX) – a measure of annualized expectation of volatility, projected over the next 30 days. But the abstract levels of this indicator are not as instructive as is the direction of the VIX. And the VIX has been on an upward path after being quiescent across the 2011-2014 period. VIX levels were generally high in the pre-financial crisis period.
  • Volatility has increased in recent months due to geopolitical risk, concerns over China and central bank policies. This “cluster of volatility” may continue to rise across the course of this year.
  • The unity of the European Union is also very much open to question. Grexit or Brexit are factors of concern.  Of more concern is whether the Schengen agreement is collapsing on itself. This may lead to closure of borders and interrupt the free flow of people, capital, goods and services. There is a fundamental contradiction in Europe: greater integration would facilitate a security response to terrorism, while at the same time it would make it easier for bad actors to move between European jurisdictions.

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United Kingdom and “Brexit”

  • There won’t be a quick divorce, but rather a negotiating process leading to an arrangement similar to the prevailing accord between Switzerland and the European Union.  The Swiss are not formally part of the European Union, but they still pay dues and enjoy free flow of capital, goods and services, while retaining their own currency. A post-Brexit arrangement might be similar to what the UK has now, with a different label.
  • Brexit will impact all areas of Europe, which might lead to the re-negotiation of contracts and give pause to companies planning their European strategies. Smaller, less multinational companies may feel the most impact.
  • Brexit is only one part of a larger strategic shift that calls into question the goal of greater fiscal union across the EU. There are also questions related to terrorism, the migrant crisis and independence movements in various countries, notably in Spain.panel 2 25404797423_0a2ce59735_z

Is Federal Reserve policy on the right track?  Was the central bank correct to pause on raising interest rates?

  • Global financial and economic impacts are always informally included in Fed decisions. Given global events, the central bank is correct to remain cautious. The Fed is, effectively, the central bank to the world. The Fed may regret its interest rate increase in December of last year and the pause may continue over the next few quarters.
  • While ultra low interest rates suggest rising inflation in traditional market models, we have also experienced sluggish credit growth, which is deflationary and suggests that interest rates could remain lower, longer.
  • The major central banks are running low on policy ammunition. We have reaped the benefits of policies like zero interest rates, but we have not yet been confronted by the costs. While central banks may have other, more exotic tools (such as negative interest rates), these may imply new risks with which we are not familiar.
  • The recent G-20 meeting cautioned over a possible currency war between Japan and the European Union. The Fed may have turned dovish, in some measure, to forestall an unproductive currency war among countries with negative interest rates.
  • There seems to be a consensus view that we need more fiscal stimulus, but how are we going to have stimulus when government spending in Europe is already 55% of GDP or in Japan, where government debt is approaching 300% of GDP and total debt is approaching 600% of GDP?Panel 2 25940063111_f68a6344c3_z

What may be the impact of the global economic slowdown and collapsed prices in energy and commodities?

  • The collapse of oil prices over recent months has been a major theme, which has eased recently as oil prices have risen to $40 bbl. But other commodity prices generally, notably industrial metals are representative of the global debt bubble.
  • Oil prices will likely remain low, given U.S. fracking and the inability of oil producers like OPEC, Russia and Iran to develop common production and pricing targets. There is still an oversupply in the world market, but markets should be allowed to clear so as to bring supply and demand into balance.
  • Many emerging markets – notably Russia, Brazil, Nigeria and others – are dependent on commodity exports, which has been problematic given the slowdown in China. And China will continue to struggle as the economy is slowing down at the same time that it is evolving from an industrial orientation toward services and to a more market-oriented financial architecture with a reduced role for State-owned banks and greater recourse to securities markets. The US banking system has largely healed itself since the financial crisis; in China, as in Europe, debt servicing will be the greatest challenge going forward.

Lipper Alpha Forum, New York, 22nd March, 2016.


  • Jeff Goldfarb, U.S. Editor Breaking Views/Thomson Reuters (Moderator; pictured far left)
  • Candice Tse, Senior Market Strategist, Goldman Sachs Asset Management (far right)
  • Duncan Balsbaugh, Senior Market Strategist, IFR Markets (left center)
  • Brian Jacobsen, Chief Portfolio Strategist, Wells Fargo (right center)

Watch further panels from the Lipper Alpha Forum 

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