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Nicholas Spiro

The one word which summed up sentiment in global financial markets in 2014 was resilience.
One loses count of the number of potential triggers for sharp and sustained sell-offs over the past year; the most conspicuous one being the so-called “flash crash” on October 16 in which wild gyrations in the US Treasury bond market led to steep falls in global equities.
Yet no sooner did bursts of volatility erupt than investors shrugged off the turbulence after brief periods of nervousness.
The S&P 500, the benchmark US equity index, finished last year at a record high and gained more than 15 per cent in 2014 despite losing 7 per cent between mid-September and mid-October.

	Greek assets have taken a beating, with the country’s stocks falling more than 17 per cent last month
So what’s in store for markets in 2015?
A further increase in volatility is almost assured.
The latest focal point for market anxiety is Greece, the country whose fiscal woes set off the euro zone sovereign debt crisis in 2010 and which has had to be bailed out twice. On Monday, the Greek parliament failed to elect Prime Minister Antonis Samaras’s candidate for the country’s next head of state, triggering a snap parliamentary election which is due to take place on January 25 and which could bring to power the far-left Syriza party which wants to scrap the country’s bail-out programme.
Greek assets have taken a beating, with the country’s stocks falling more than 17 per cent last month and the yield on its 10-year bonds surging 400 basis points since early September to 9.5 per cent.
Yet for the time being investors are treating Greece’s problems as idiosyncratic ones – in stark contrast to 2012 when Greek political risk was perceived as the catalyst for a possible break-up of the euro zone, driving up the bond yields of Spain and Italy.
Indeed Greece is now a distraction from Europe’s underlying problems.
The lack of political and economic integration in the euro zone is putting huge pressure on the European Central Bank (ECB) to maintain confidence in Europe’s depressed single currency area – which is now likely to fall into outright deflation given the recent collapse in oil prices – by launching a programme of large-scale government bond purchases in the face of stiff opposition from Germany.
The risk that full-blown quantitative easing (QE) in the euro zone is perceived by investors to lack credibility partly because of the absence of German support is one of the biggest threats to markets this year.
It is also part of broader concerns about the ability of central banks to underpin investor sentiment.
With the US Federal Reserve set to raise interest rates in the middle of this year (and possibly sooner given the strength of the US recovery), doubts about the credibility and effectiveness of European monetary policy and mounting concerns that the Bank of Japan – now the main provider of stimulus among the world’s leading central banks – is effectively bankrolling the government of premier Shinzo Abe in the absence of fiscal and structural reforms, central banks are now increasingly a source of volatility for markets.
The most important prop for markets last year – the central bank “put”, or the belief that central banks will ride to markets’ rescue, thus suppressing volatility – will be significantly weaker this year, forcing investors to pay more attention to countries’ underlying fundamentals.
The gap between the liquidity-driven markets of the past few years and poor economic performance (as well as deteriorating creditworthiness) in many countries is starting to narrow, increasing the scope for sharper volatility in asset prices.
Emerging markets are vulnerable, particularly those, like Turkey and South Africa, which are heavily reliant on external finance to fund their current account deficits, but also those in central and eastern Europe whose financial markets are highly correlated with the bond markets in the euro zone.
Just as an earlier-than-expected rise in US interest rates would place Turkish and South African assets under strain, a loss of confidence in the conduct of European monetary policy would undermine sentiment towards countries such as Hungary whose debt market has been benefiting hugely from expectations that the ECB will launch full-blown QE.
If central bank-driven resilience was the watchword for markets in 2014, differentiation is likely to be one of the dominant themes in 2015.
Country-specific risk is coming back to the fore, presenting both opportunities and risks for investors.
 
Nicholas Spiro is managing director of Spiro Sovereign Strategy
 


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