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5 big risks financial markets will face in 2015

After an unprecedented correction, financial markets are back in the green, thanks to the continued dovish stance of the US Federal Reserve, but the risks continue to loom. While growth and policy risks also loom, strategists are looking at top five risks that are likely to roil financial markets. 

Severe US Dollar strength: If the dollar continues to rise, it would lead to volatility in world markets as a depreciation of other currencies would lead to a risk-off rally in equities and erode returns from bonds of emerging markets like India. The greenback may rise further in 2015 if the Federal Reserve starts to increase rates – as it hinted today – and its monetary policy stance deviates from the rest of the world. Already the Bank of America Merrill Lynch’s Fund Manager survey suggests that consensus view is now long on deflation, US dollar and cash. But a further strength in the dollar will result in a sharper sell-off in commodities, which would impact commodity exporters in emerging markets like Brazil and Russia. 

Oil Price Spike: While cheap oil is great for equities, the market prefers a balanced decline and not a sharp rout or a spike. If oil producers’ cartel cuts production by a million barrels per day, it see oil prices increase from the second half of 2015, which would have a commensurate impact on the balance of payment situation for countries like India, which are large energy importers. The 40% fall in oil prices has automatically given a stimulus to the Indian economy equivalent to about 2% of GDP in the form of savings. If oil reverses sharply to $ 80/barrel and above, it will impact emerging markets like India, which are expected to see growth revival from FY16. If oil spikes, then energy stocks will make a comeback, further strengthening the US dollar, both of which scenarios are not good for EMs. 

Liquidity black holes: The world’s financial markets have for long been oiled by easy money. If any of the above risks play out or deflation becomes a more prominent risk for the world economy, then liquidity may suddenly dry up. This is what strategists are calling ‘liquidity black holes’. If this happens, markets which are dependent on capital flows from outside would see a sharp pullback. Credit Suisse expects capital flows in 2015 to halve from the $ 16 billion seen in 2014. 

Global Recession: The global economy could slip back into recession if stimulus plans do not either play out or have the desired impact on growth. With little ammunition left to resuscitate growth, markets will revert to risk-on and risk-off mode. This would lead to a selloff in risk assets and lead to flattening of yield curves across the world, says HSBC Global Research. 

Conflicting monetary policies: The fall in world commodity prices, especially oil is leading to divergent impacts on different economies. While cheap oil is good for the world economy at large, a free fall could impact oil producers negatively and low prices would lead to automatic production cuts. This stress in commodity markets has already spilled over into currency markets. More pain is expected from the credit quality across the world, especially for banks that have lent to oil firms. “Amongst the major emerging markets, we previously identified Korea, India, South Africa and Turkey as main beneficiaries of lower oil prices (Emerging Markets Quarterly) and we have updated our estimates in this publication (The EM Economic Impact of Lower Commodity Prices). However, a number of oil producing economies look vulnerable, in particular Venezuela, Russia and, to a lesser extent, Malaysia,” Credit Suisse says. “As with the US energy sector, as well as the direct economic impact, markets have raised questions over credit quality at both the corporate and sovereign level.”

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