This report has been prepared by UBS Switzerland AG, UBS Financial Services Inc. (UBS FS), UBS AG. Please see important disclaimers and disclosures at the end of the document. Global risk radar The end of central bank easing 14 September 2017 Chief Investment Office Americas WM Dirk Effenberger, strategist; Daniil Bargman, strategist; Vittorio Bosio, strategist; Jason Draho, Head of Tactical Asset Allocation Americas, [email protected], +1 212 713-6146; Yifan Hu, Regional CIO and Chief China Economist This publication series helps investors identify and assess global financial market risks and their investment implications. At a glance • After eight months, the five risk themes we introduced in the January edition of the Global Risk Radar remain relevant for global markets. • With several major central banks set to reduce monetary policy support, we elaborate on the potential market consequences of an end to unprecedented monetary easing. We believe an adverse market reaction is highly unlikely in the next six to 12 months. • In China, we turn our attention to the risk of a regional or sector- specific credit crunch, which we see as a higher-probability risk for markets than a full-scale hard landing. • On North Korea, we maintain our view that the risk of an all- out military conflict is low. • CIO retains a slight “risk-on” bias in its tactical asset allocation against the backdrop of strong corporate earnings and a healthy macroeconomic environment. Source: iStock Preface: Risk themes 2017 revisited In the January edition of the Global Risk Radar, we identified five risk themes that we believed would come to the fore this year (see "Global risk radar: Risk themes 2017," 23 January 2017). They were: 1. Donald Trump's domestic policy agenda ("Trumponomics") 2. Rising global protectionism 3. Geopolitics 4. Populism leading to further disintegration risks in Europe 5. Withdrawal of monetary policy support by global central banks All of these themes are still relevant to markets (see also our risk map on page 3). Related reports: • UBS House View Weekly: “Is the market underpricing the Fed?” August 28 • UBS House View Monthly Letter: “Waldorf salad,” August 24 • Global Risk Update: "Raising North Korea tail risk to 'low,'" August 11 • Global Risk Radar: “Risk themes 2017,” January 23
Transcript
This report has been prepared by UBS Switzerland AG, UBS Financial Services Inc. (UBS FS), UBS AG. Please see important disclaimers and disclosures at the end of the document.
Global risk radarThe end of central bank easing14 September 2017Chief Investment Office Americas WMDirk Effenberger, strategist; Daniil Bargman, strategist; Vittorio Bosio, strategist; Jason Draho, Head of Tactical Asset Allocation Americas, [email protected], +1 212 713-6146; Yifan Hu, Regional CIO and Chief China Economist
This publication series helps investors identify and assess global financialmarket risks and their investment implications.
At a glance
• After eight months, the five risk themes we introduced in theJanuary edition of the Global Risk Radar remain relevant forglobal markets.
• With several major central banks set to reduce monetary policysupport, we elaborate on the potential market consequencesof an end to unprecedented monetary easing. We believe anadverse market reaction is highly unlikely in the next six to 12months.
• In China, we turn our attention to the risk of a regional or sector-specific credit crunch, which we see as a higher-probability riskfor markets than a full-scale hard landing.
• On North Korea, we maintain our view that the risk of an all-out military conflict is low.
• CIO retains a slight “risk-on” bias in its tactical asset allocationagainst the backdrop of strong corporate earnings and a healthymacroeconomic environment.
Source: iStock
Preface: Risk themes 2017 revisitedIn the January edition of the Global Risk Radar, we identified five riskthemes that we believed would come to the fore this year (see "Globalrisk radar: Risk themes 2017," 23 January 2017). They were:
1. Donald Trump's domestic policy agenda ("Trumponomics")2. Rising global protectionism3. Geopolitics4. Populism leading to further disintegration risks in Europe5. Withdrawal of monetary policy support by global central banks
All of these themes are still relevant to markets (see also our risk mapon page 3).
Related reports:
• UBS House View Weekly: “Is the marketunderpricing the Fed?” August 28
• UBS House View Monthly Letter: “Waldorfsalad,” August 24
• Global Risk Update: "Raising North Koreatail risk to 'low,'" August 11
• Global Risk Radar: “Risk themes 2017,”January 23
Global risk radar
UBS CIO WMR 14 September 2017 2
Trumponomics: No major legislation, including a repeal ofObamacare, has passed in the US since Donald Trump took office.This calls into question the prospect of corporate tax reform – thecornerstone of Trump's market-friendly policy agenda. Furthermore,the Trump administration soon has to deal with a renewed andhardened debt ceiling debate. In the meantime, markets seem to havepriced out some of the administration's initial plans for policy stimulus.This means that the potential for policy-driven market setbacks mightbe low, while the chances for markets to be spurred by positive surprisesmay be rising.
Rising protectionism: While global trade volumes are likely toaccelerate this year, the latest G20 summit saw the European Unionvowing to retaliate if the US should impose import tariffs. Meanwhile,US-China trade relations seem to be coming under further pressure asa result of the North Korea conflict. Therefore, risks of further globaltrade tensions are non-negligible and rising.
Geopolitics: The last few months have seen an increase in geopoliticalrisk, including a rift between Saudi Arabia and Qatar in the Middle East,as well as a temporary escalation of the North Korea conflict. While weraised the probability of a military escalation on the Korean peninsula to10–20% in mid-August, we still think the risk is low given that neitherside has an incentive for a pre-emptive military strike. However, periodsof temporary escalation are likely, in our view.
Populism in Europe: Although Marine Le Pen lost the Frenchpresidential election in spring and pro-European Chancellor AngelaMerkel will likely be re-elected in Germany, centrifugal forces havenot disappeared in the European Union. Uncertainty around ongoingBrexit negotiations will soon be joined by political risks in Italy, wherea general election, likely in the first half of next year, will be held amidunderwhelming popular support for the European Union.
Withdrawal of central bank support: After multiple years of ultra-loose monetary policy globally, the Federal Reserve has started hikinginterest rates and talking about reducing its balance sheet. We expectone more Fed rate hike this year, and some more clarity on its plans tounwind its balance sheet over the coming months. At the same time,we expect the European Central Bank (ECB) to start tapering its bond-buying program early next year. This U-turn in monetary policy and itspotential effect on global markets is the focus of the current GlobalRisk Radar.
CIO continues to monitor all of these developments. At the moment,we see no indication of imminent danger to global markets or ourasset allocation strategy over the next six to 12 months. Given positiveeconomic momentum and strong corporate earnings growth, wecontinue to have a slight preference for risky assets, including anoverweight in global equities against safe bonds (see latest CIO HouseView).
Fig. 1: Italy: Public opinion towards theEuropean UnionSurvey results, in % of total respondents
0%10%20%30%40%50%60%70%80%90%
100%
2000 2002 2004 2006 2008 2010 2012 2014 2016
Very Positive Positive Neutral
Negative Very Negative Don't Know
Note: The question being answered is "In General, DoesThe European Union Conjure Up For You a Very Positive,Fairly Positive, Neutral, Fairly Negative or Very NegativeImage?"Source: European Commission, Macrobond, UBS, as ofSeptember 2017
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UBS CIO WMR 14 September 2017 3
Fig. 2: Global risk map
Rising protectionism
Risks under review
1 2 3 4 >50% <10%
Europeandisintegration
China: Credit crunch
Geopolitics:North Korea
Failure of Trumponomics Middle East escalation:Oil supply shock
Central banks end the cycle
Source: UBS. Note: The CIO risk score is a composite of four risk "dimensions": probability (the likelihood of occurrence within the nextsix to 12 months), urgency (how soon the event would likely take place), geographic scope (the extent of regional/global financial andeconomic contagion), and expected market impact (by how much the returns on the affected asset classes would deviate from the baseline).Each dimension score can take a value between 1 and 4, with 4 being the highest risk level; the overall CIO risk score is the average ofthe scores for the four risk dimensions.
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UBS CIO WMR 14 September 2017 4
Table 1: Risk calendar
2017-2018 Key Events
· Trump policy with respect to:1) Tax reform2) Regulatory relief3) Fiscal spending4) Global engagement
· Negotiation on new and existingfree trade agreements (e.g. NAFTA)
· New tari(e.g. 45% tari
· EU-UK negotiation
· US-China relations (e.g. One Chinapolicy, South China Sea)
· Geopolitics - other than US-Chinarelations (e.g. Middle East)
· Cyber attacks· Sanctions (e.g. Russia, Iran)
· Early Italian general election· EU refugee crisis
· Statements by key central bankmembers
· In related data (e.g. CPI,wage growth, unemployment)
· PMIs and industrial production· Fixed asset and intrastructure
investments· FX reserves
Central bank policy
China Hard Landing
European disintegration
Rising protectionism
Trumponomics
Geopolitics
September 20, FOMC meetingSeptember 24, German federal electionSeptember 27, 2nd round of NAFTA talksSeptember 30, End of USOctober 1, Catalan independence referendum
December 8, US debt ceiling
October 26, ECB meeting
November 01, FOMC meeting
November 30, OPEC meeting
January 25, ECB meetingJanuary 31, FOMC meeting
March 8, ECB meeting
March 18, Russian presidential electionMarch 21, FOMC meeting
October 18, China's 19th National People's Congress
December 14, ECB meetingDecember 13, FOMC meeting
Sep
Oct
Nov
Dec
Jan 2018
Mar
Apr
Feb
Source: UBS CIO, as of 10 July 2017
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UBS CIO WMR 14 September 2017 5
Focus topic: Central banks are taking a step backAfter the global financial crisis of 2007–2009, the role of central banksin the global economy and global markets has increased dramatically.In an attempt to boost economic growth and inflation, several majorcentral banks deployed unprecedented monetary easing measures,lowering target interest rates to or below 0%, while buying recordamounts of debt and, occasionally, equities (see Table 2).
How does monetary policy affect the economic cycle?Put simply, the effect of supportive monetary policy is to lower interestrates. In a weak and recovering economy, this incentivizes people andcompanies to borrow and invest, which leads to more jobs and strongereconomic activity. However, as the economy grows stronger and newworkers become hard to find, low interest rates may cause economicoverheating: asset bubbles may start to form, while prices of goods andservices may start to rise too quickly.
After nearly a decade of unprecedented monetary stimulus, the globaleconomy finally seems on a solid footing: unemployment rates arelow and falling in many parts of the world, including the US (wherethe latest unemployment rate is at 4.4%, the lowest since 2001), theEurozone (9.2%, lowest since 2009) and Japan (2.9%, lowest since1994); global economic growth is sufficiently strong and broad-based;and financial assets are getting more expensive.
Historically, these conditions would be appropriate for central banksto start normalizing policy. In the US, where the economic cycle isarguably the most advanced, the Fed has already started to raise interestrates and may soon engage in "passive balance sheet reduction" – i.e.letting its accumulated bond holdings expire without reinvesting theproceeds. In the meantime, the Bank of Japan (BoJ) is scaling down itsasset-purchase program for lack of new assets to buy, while the ECB isexpected to reduce the pace of quantitative easing again this January.
Our base case: No immediate danger for marketsAs central banks reduce policy accommodation, interest rates shouldincrease and demand for borrowing and investment is likely todecelerate. However, central banks will take great care not to disruptthe economy with their policy decisions. Furthermore, reducing policysupport now should give central banks more flexibility to intervene inthe future, should the need arise. In other words, even though returnsin global markets may not be as stellar as they have been over the pastyears, moderation in monetary easing may ensure financial stability overthe longer term, reassuring investors.
The direct impact, if any, should be felt in safe fixed income investments.For example, the Fed estimates that the total effect of its QE programs(around USD 4.5 trillion of bond purchases in total) was to suppress the10-year US Treasury yield by about 100 basis points (bps). Assuminga similar sensitivity of bond yields to the Fed's passive balance sheetreduction, all of the Fed's bond holdings expiring within the next 12months (around USD 300bn) would cause the 10-year Treasury yield torise by around 7 bps – a barely noticeable move in the context of thenormal day-to-day fluctuations (monthly standard deviation is about19bps using the past 12 months of data).
Table 2: Easing measures by major central banksover the last decade
Central bankLowest targetinterest rate
Domestic debt purchases(Quantitative Easing)QE1: Dec 2008-Mar 2010QE2: Nov 2010-Jun 2011QE3: Sep 2012-Oct 2014
EuropeanCentral Bank
(ECB)-0.4% QE: Mar 2015-...
QE1: Mar 2001-Mar 2006
QE2: Oct 2010-...
QE1: Mar 2009QE2: Oct 2011QE3: August 2016
0%
-0.1%
0.25%Bank of England
(BoE)
Bank of Japan(BoJ)*
US FederalReserve (Fed)
*The Bank of Japan is also purchasing equities.Source: UBS, as of September 2017.
Fig. 3: Global growth is acceleratingReal GDP growth (in %), with forecasts
2.0 2.1 1.9
6.0
1.1
2.5
3.7
(2)
(1)
0
1
2
3
4
5
6
7
Eurozone US Japan Asia exJapan
LatinAmerica
EmergingEMEA
World
2015 2016 2017F
Source: UBS, as of September 2017
Fig. 4: Development of the unemployment rateover the last decadeIn %
0
2
4
6
8
10
12
14
2002 2004 2006 2008 2010 2012 2014 2016USA Japan EMU UK
Source: Bloomberg, UBS, as of September 2017
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UBS CIO WMR 14 September 2017 6
In the meantime, as long as the global economy and corporatefundamentals remain on track, riskier financial markets such as equitiesshould continue to perform well.
Our risk case: Withdrawal of central bank support causes the endof this economic cycleAt some stage, a turning point could be reached in central banktightening, where borrowing would become prohibitively expensive forbusinesses and households. This could lead to an economic slowdownand, importantly, a sizeable correction in financial markets (in avernacular, central banks would "end this economic cycle"). Riskier andmore lucrative asset classes such as equities would not be immune inthis scenario, and investors would need to consider increasing theirallocation to cash or protect the value of their portfolios in some otherway.
Of course, the timing of such an event is uncertain because the tippingpoint for markets is difficult to identify. However, given that the pathof central bank tightening has only just started and major economiesremain in good shape, CIO only sees such an outcome as a remote tailrisk over the next six to 12 months.
Conclusion: Stay investedCIO believes that positioning for the end of this economic cyclemay prove premature at this time. Global central bank tightening isstill in its nascent stages and interest rates continue to be low ornegative in many parts of the world, while economic and corporatefundamentals remain strong. This speaks in favor of holding a well-diversified portfolio with a preference for global equities over safebonds. Thus, we believe investors who shy away from investing for fearof a sharp market correction face a sizeable opportunity cost and risksurrendering considerable financial gains in the coming months.
Of course, it is also prudent to continue monitoring the global economyclosely for the first signs of an impending correction. If and when thosesigns appear, we will be inclined to revise our investment stance.
For a more detailed list of CIO's investment recommendations, pleaseconsult the UBS House View.
Fig. 5: Monetary policy of the major centralbanks over the last decadePolicy rates (in %), with forecasts
Total 433'060 325'362 1'145'062 342'847 2'385'404 4'631'734
Remaining Maturity All
Source: Federal Reserve, as of September 2017
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UBS CIO WMR 14 September 2017 7
North Korea
Risk of decisive military action remains low.
Recent developments
On 11 September, the UN Security Council passed a new round ofsanctions on North Korea, introducing a limit on the amount of oilthat can be sold to the regime. The new sanctions may prove moreeffective at hampering Pyongyang's nuclear program as they restrictthe country's access to basic materials necessary to sustain a militaryforce. Previous sanctions primarily targeted North Korea's exports, inan attempt to cut off the country's access to foreign currency.
The White House continues to use Sino-US trade negotiations as ameans to incentivize China to take a more proactive role with NorthKorea; however, increased trade tensions between the US and Chinamay prove a potential risk to markets in their own right. Chineseofficials have repeatedly emphasized that avoiding a military conflict onthe Korean peninsula is a top priority. However, China's political stanceremains opaque for the time being and is unlikely to be clarified furtherbefore the National People's Congress (NPC) in October.
Trend StableProbability Low
Risk dimensionsCIO expert assessment
Note: Distance from center (1-4) represents thedimension score. The CIO risk score is an average of thefour risk dimensions.Source: UBS, as of September 2017.
Our view
Base case: Diplomatic process
Our base case remains a combination of diplomacy and increasedeconomic sanctions, aimed at delaying the advancement of NorthKorea's nuclear missile program. Although this course of actionprovides only a temporary solution, it also creates scope for de-escalation if all parties agree to start a peaceful negotiation process. Ifthis were to happen, the tail risk of a severe military escalation couldonce again be reduced.
Tail risk: Military escalation threatening a regime collapse
We currently view a US military campaign against North Korea asunlikely; however, the probability arguably increases as North Koreaprogresses toward a functioning nuclear missile. Thus, further newsabout North Korea's technological advancements could raise the risk ofan extreme escalation even further. (Note that as US president, DonaldTrump has the power to take military action against North Korea at anytime and for up to 60 days without requiring congressional approval.)
Investment conclusions
Temporary escalations with North Korea are becoming less of a concernfor global markets. While North Korea's threat against Guam in earlyAugust caused global equities to stumble for about a week, its sixthnuclear test on 3 September caught the market's attention for nomore than a day. Save an extreme escalation, a well-diversified portfolioshould be able to weather any market jitters resulting from North Koreatensions and related news flow.
For those who wish to take a more active approach to hedging thetail risk, our colleagues in Asia have identified several investment ideasthat could perform well in both our base case and tail risk scenario.They include an overweight on gold and silver against industrial metals,an overweight on the US dollar against the Australian dollar andthe Singapore dollar, and an overweight on Chinese stocks against
Asset class impact
The table illustrates the expected impact of the riskscenario on various asset classes should it materialize:positive (green), negative (red) or neutral (blue).
Emerging market equitiesHigh-grade bondsUS dollar (USD)Japanese yenKorean wonKorean equitiesAsian equities
Past provocative actions by North KoreaImpact on the South Korea (KOSPI) equity index
0
500
1'000
1'500
2'000
2'500
04 05 06 07 08 09 10 11 12 13 14 15 16 17
25 May 20092nd nuclear test
3 Sep 20176th nuclear test
9 Oct 20061st nuclear test
6 Jan 20164th nuclear test
12 Feb 20133rd nuclear test
9 Sep 20165th nuclear test
Source: UBS, Bloomberg, press reports, as of 09/2017.
Key dates to watch
•18 Oct 2017: China's 19th National People'sCongress (NPC)
Taiwanese equities.
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UBS CIO WMR 14 September 2017 8
Failure of Trumponomics
None of Trump's major domestic stimulus packages (tax reform,infrastructure spending) are implemented.
Recent developments
The US Congress recently passed legislation that included a continuingresolution to fund the government through 8 December and allowfor the resetting of the debt ceiling on the same date. In practice,the debt ceiling will probably not become binding until March. Thislegislation avoided a potential government shutdown at the end ofSeptember, but it’s still a risk in December. Getting over these near-term hurdles creates a window this fall to make progress on tax reform.However, we still see the probability of some form of tax cuts by 1Q18as unchanged at 55%. The benefit of an easier policy calendar is offsetby the potential debt ceiling and government shutdown risks beingdelayed, not resolved. At the same time, the legislation exposed thecontinued policy disagreements within the Republican party.
Headwinds to Trump's agenda are the ongoing special probe into hisalleged influence on the FBI investigation of former National SecurityAdvisor Michael Flynn and the investigation into Russian interferencesin the US elections. Although highly unlikely, there is a very small chancethat the investigation could lead to the impeachment of PresidentTrump, though not before 2018.
Our view
Base case: US corporate tax lowered to 25–30%
We expect at least some progress on the Trump agenda, including UScorporate tax reform. The rate is likely to be lowered to 25–30%, notthe 15% (Trump) or 20% (Paul Ryan) had proposed, while there is likelyto be a reduced rate on the repatriation of foreign earnings. In lieu of aborder adjustment tax, the administration may seek to impose targetedimport tariffs in an attempt to improve trade deals and reduce the tradedeficit.
Risk case: Failure of Trumponomics
Although tax reform should be less politically contentious thanhealthcare reform because it mostly provides benefits to the publicrather than taking them away, the risk is that any big comprehensivelegislation gets bogged down by competing interests. If negotiationson tax reform drag into 2018, the loss of political momentum couldmean that nothing of significance on Trump's major domestic stimuluspackages (tax reform, infrastructure spending, etc.) gets implemented.We currently assign a 30–40% probability to this scenario.
Investment conclusions
In the event that Trumponomics fails, risk assets, especially those in theUS, are likely to suffer losses. We see US equities down about 5% asa worst-case scenario with the failure of Trumponomics. In a portfoliocontext, this would be partly offset by a modest decline in Treasuryyields. However, in our base case, we continue to see upside for equitiesbased on accelerating global growth and corporate earnings, whichwould get a boost from tax cuts and ongoing regulatory relief.
Trend StableProbability High
Risk dimensionsCIO expert assessment
Note: Distance from center (1-4) represents thedimension score. The CIO risk score is an average of thefour risk dimensions.Source: UBS, as of September 2017
Asset class impact
The table illustrates the expected impact of the riskscenario on various asset classes should it materialize:positive (green), negative (red) or neutral (blue).
US equitiesHigh-grade bondsUS dollar (USD)
Market-implied probability of corporate taxreform by end of 2017In %
20
30
40
50
60
70
80
Apr 17 May 17 Jun 17 Jul 17 Aug 17
Source: PredictIt.org, as of 6 September 2017
Key dates to watch
•15 Dec 2017: US debt ceiling needs to be raisedby then
For further information please contact Jason Draho , Vittorio Bosio .
Global risk radar
UBS CIO WMR 14 September 2017 9
China: Credit crunch
Will a credit crunch in China cause a global market spillover?
Recent developments
CIO has defined a new risk scenario for the Chinese economy. Althoughwe continue to view a full-scale financial and economic crisis (a hardlanding) in China as highly unlikely, the risk of a regional or sector-specific credit crunch is not negligible. The government should be ableto contain any such event before it leads to a severe downturn inthe Chinese and global economy; however, there could still be globalmarket spillover before policy counter-measures take effect.
In general, a credit crunch is an event that encompasses bond defaults,soaring interest rates, tight liquidity and a fall in bank lending. Althoughnot as severe as a hard landing, a credit crunch can still lead to marketsell-offs and a slowdown in economic growth. As an economy with alot of outstanding debt, China faces this type of event risk. Its debt-to-GDP ratio was 270% as of 2016, increasing by about 20 percentagepoints a year over the past three years. With annual interest paymentsalready totaling above CNY 10 trillion, debt sustainability is one of themajor economic concerns over the long run, and deleveraging effortsare on the agenda for the Chinese authorities.
Our view
Base case: Orderly deceleration
In our base case, deleveraging efforts and ongoing policy supportshould prevent any systemic credit events in China over the next sixto 12 months. The economy should continue to decelerate in anorderly fashion amid slowing infrastructure investment. Consumer priceinflation should stay below 2%. Capital outflows are no longer a majorconcern after eight consecutive months of rising foreign reserves.
Risk case: Regional or sector-specific credit crunch with spillover
Over the next six to 12 months, we see a 10–20% chance of a regionalor sector-specific credit crunch in China with global spillover effects.Within China, a credit crunch is a higher risk for regions with low ornegative GDP growth, and for sectors with overcapacity issues. In theshort term, the risk is somewhat exacerbated by ongoing regulatorytightening. However, in the long run, the probability will likely fall asdeleveraging efforts should lead to a gradual stabilization or decline inthe country's debt-to-GDP ratio.
Investment conclusions
• In equities, China remains our preferred market within Asia, aswe continue to expect further economic stabilization and risingcorporate revenues in the country.
• In fixed income, we view offshore Chinese USD-denominatedbonds as expensive, which could weigh on performance of theasset class in 2017.
• In currencies, CIO sees no need to hedge exposure to theChinese renminbi (CNY) ahead of the 19th Party Congress.Following the introduction of the "counter-cyclical adjustmentfactor" by the central bank in May and better-than-expectedGDP growth in 1H17, CIO expects USDCNY to trade at 6.6 inthree months and 6.7 in six and 12 months, from 6.5 currently.
Trend StableProbability Low
Risk dimensionsCIO expert assessment
Note: Distance from center (1-4) represents thedimension score. The CIO risk score is an average of thefour risk dimensions.Source: UBS, as of September 2017
Asset class impact
The table illustrates the expected impact of the riskscenario on various asset classes should it materialize:positive (green), negative (red) or neutral (blue).
US equitiesEmerging market equitiesHigh-grade bondsUS dollar (USD)Asian equities
China debt-to-GDP ratio by debt typeIn %
0
50
100
150
200
250
300
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Household debt General government debt Nonfinancial corporate debt
145 144176
189 188 200215
230251
272
Source: CEIC, UBS, as of September 2017
Key dates to watch
•30 Sep 2017: China business activity surveys(PMI)
•15 Oct 2017: China new loans•18 Oct 2017: Start of the 19th National People's
Congress (NPC)•19 Oct 2017: China 3Q GDP growth
For further information please contact Yifan Hu , Kathy Li , Daniil Bargman .
Global risk radar
UBS CIO WMR 14 September 2017 10
Middle East escalation
Oil price reaches USD 80/bbl as tensions in the Middle East escalateand sanctions are imposed on Iranian energy exports.
Recent developments
Qatar rejected the list of 13 demands that the Saudi Arabia-ledcoalition submitted in June as the condition for restoring diplomatic andcommercial ties with the country. Instead, Doha filed a WTO complaintagainst Saudi Arabia, the UAE and Bahrain for isolating it. The partiesnow have 60 days to resolve their dispute. If they fail, Qatar can requestthe establishment of an independent panel that could force the end ofthe boycott.
The embargo is affecting the Qatari economy, with imports havingplunged 40% since June and sectors such as tourism and aviationsuffering. Qatar has dealt with the embargo by relying on Turkey andIran for its imports, and officially restored diplomatic ties with Tehran.This emerging alliance could increase tensions in the region, as SaudiArabia has been trying to reduce the growing Iranian influence. Webelieve the probability of a disruption to energy exports out of theregion remains very low (less than 10%), but we keep monitoring thesituation closely.
Our view
Base case: No meaningful disruption to energy exports
We do not expect meaningful sanctions to be raised against Iranianenergy exports, or the long-running tensions between Sunni SaudiArabia and Shiite Iran to escalate to a direct armed conflict. Othergeopolitical risks in the region, such as ISIS attacks aimed at disruptingoil production, shouldn't lead to a large or sustained spike in the oilprice. That being said, the oil market could still price in a geopoliticalrisk premium if tensions in the region rose.
Risk case: Escalating tensions disrupt energy exports
Deeply rooted tensions between Iran and Saudi Arabia could intensifythrough proxy wars in the Middle East and North Africa (MENA)region, possibly disrupting energy exports out of the Middle East. If thiscoincided with renewed sanctions on Iranian energy exports, the oilprice could reach USD 80/bbl and stay there for three to six months.CIO attaches a very low probability (less than 10%) to this risk scenario.
Investment conclusions
During previous episodes of large oil supply shocks, global equities fellby about 15%, but recovered within six months. In credit, high yieldand emerging market bonds suffered the most, but the asset classrecovered within three months. Safe-haven currencies such as the Swissfranc and the Japanese yen strengthened due to increased geopoliticalrisk premium. The US dollar initially appreciated as investors sought asafe haven right after the conflicts started; however, this move wasreversed in the following six months because of higher oil prices. Highgrade bonds offered some protection in the past, but they might beless effective today as rates are at or close to all time lows.
Trend StableProbability Very low
Risk dimensionsCIO expert assessment
Note: Distance from center (1-4) represents thedimension score. The CIO risk score is an average of thefour risk dimensions.Source: UBS, as of September 2017
Asset class impact
The table illustrates the expected impact of the riskscenario on various asset classes should it materialize:positive (green), negative (red) or neutral (blue).
Eurozone equitiesHigh-grade bondsSwiss franc (CHF)
Crude oil production and consumption byregionIn million barrels per day, 2016
0
10
20
30
40
MiddleEast
CIS LatinAmerica
EuropeanUnion
NorthAmerica
AsiaPacific
Consumption Production
Source: BP, UBS, as of 2017
Key dates to watch
•30 Sep 2017: If WTO dispute is not settled bythen, Qatar can request establishment of a panel
For further information please contact Vittorio Bosio , Jérôme Audran , Giovanni Staunovo .
Global risk radar
UBS CIO WMR 14 September 2017 11
Rising protectionism
The US imposes tariffs on imports from countries that contribute themost to its trade deficit, causing them to retaliate swiftly.
Recent developments
Although the risk of rising protectionism is currently still low, it nowseems to be slightly on the rise in the broader geopolitical context.President Trump tends to use trade as a bargaining chip in attempts toconvince China and South Korea to take a harder stance with NorthKorea, making an escalation in North Korea tensions negative for theglobal trade outlook.
The White House investigation into US steel imports did not result innew tariffs. The business community and Congress strongly opposedsuch tariffs as they would have hit steel users and the overall economy.The US free trade agreement with Canada and Mexico is also underrenegotiation, with the business community and farm states such asIowa and Kansas, which supported Trump in last year's election, againstdramatic changes to the current terms. Meanwhile, the administrationhas started an investigation into alleged Chinese intellectual propertytheft – an issue that has broader support among US businesses.
Our view
Base case: No broad-based protectionist measures
The moderation of President Trump's rhetoric on protectionism since hisearly days in office should prevent disruptions in global supply chainsand limit the negative impact to a few industries against which theUS has raised multiple WTO complaints over the years. We believe theUS administration will not impose broad-based protectionist measuressuch as tariffs or a border adjustment tax. In our view, the US will likelyrenegotiate existing trade agreements and focus on bilateral ratherthan multilateral deals. It may raise new complaints to the WTO andbe more aggressive with its trading partners, but not to the extent thatresults in a full-blown trade war with tit-for-tat retaliation.
Risk case: Rising protectionism
In an effort to reduce the US trade deficit, Trump's administration couldimpose tariffs on imports from countries with a high trade surplus vis-à-vis the US. China, the Eurozone, Japan and Mexico are likely candidates.In turn, these countries could retaliate swiftly, triggering a trade conflictbetween the US and the rest of the world and higher import pricesglobally. CIO attaches a 10–20% probability to this scenario.
Investment conclusions
Equities tend to suffer when growth slows as a result of less globaltrade. Equity markets of export-oriented emerging economies and ofdeveloped economies that derive a larger portion of their revenuesfrom abroad (i.e. Eurozone, Japan) are particularly exposed. Initially,high-grade bonds could provide some protection given their safe-havenstatus. However, as yields rise to compensate for higher inflation, bondswould come under pressure. Finally, we would expect emerging marketcurrencies to depreciate against the US dollar, in particular those ofcountries most tightly integrated into global value chains, such as SouthKorea, Taiwan, Malaysia and Mexico.
Trend RisingProbability Low
Risk dimensionsCIO expert assessment
Note: Distance from center (1-4) represents thedimension score. The CIO risk score is an average of thefour risk dimensions.Source: UBS, as of September 2017
Asset class impact
The table illustrates the expected impact of the riskscenario on various asset classes should it materialize:positive (green), negative (red) or neutral (blue).
Eurozone equitiesEmerging market equitiesHigh-grade bondsUS dollar (USD)
Top contributors to US current account deficitIn %
0%
10%
20%
30%
40%
50%
China Eurozone Japan Mexico
% of US trade deficit
Listed companies' revenue exposure to US (%)
Source: World Bank, Factset, UBS, as of 15 May 2017
Key dates to watch
•27 Sep 2017: End of second round of NAFTAtalks in Ottawa
For further information please contact Jason Draho , Vittorio Bosio .
