• China credit risks are still rising
  • Democrats face uphill task to regain control of both houses of Congress
  • Political uncertainty threatens to derail resilient pound
  • MENA – not yet out of the woods

Equity indexes are slowly climbing higher after a rocky start to the year, but volatility in the financial markets could spread much further than this asset class.

Derek Halpenny, European Head of Global Markets Research at MUFG and colleagues, identify four themes that could unsettle markets over the rest of the year.


"When the US sneezes, the world tends to catch a cold", so goes the old saying. Nowadays, this aphorism is applied more frequently to China, which has been well and truly integrated into the global economy for nearly a decade. It's also why investors should be cautious about Chinese banks.

While China is vulnerable to the sort of exogenous shock that could trigger a financial crisis, any tremor that raises debt crisis risks is likely to be domestically driven.

And research shows that China's interbank system has been increasing its level of exposure, through an addiction to debt, far faster than even its notoriously risky "shadow banking" sector.

Another possible candidate for triggering a financial crisis could be a misevaluation of assets, which has already materialized in investor concerns about the creditworthiness of some lower-tier financial institutions.

Mid-term elections

Much has been written about the levels of support for the Trump administration in the 13 months following the President's inauguration. The first real litmus test will be the mid-term elections in November.

There are two factors that will be crucial in shaping Trump's support. If Robert Mueller's investigation into the alleged collusion between Trump's election campaign team and Russia wasn't enough, the President must also overcome the strong scepticism that has greeted his tax reform bill.

While some will argue that any development that undermines Trump is ultimately good for the markets, uncertainty and speculation of impeachment will continue to undermine confidence in the US and the dollar.

That said, the Democrats' task in the mid-terms is not as easy as it looks. Despite needing to win just three seats to gain control of the Senate, there are only eight Republican Senators up for reelection. Of these eight, realistically only two – Senators Jeff Flake of Arizona and Dean Heller of Nevada – are expected to lose to their Democrat challenger at this stage.


The pound defied doomsayers in 2017, climbing a wall of worries to emerge as one of the best-performing G10 currencies. Brexit negotiations even took a more positive turn as the risk of a “No Deal" Brexit outcome slowly receded. The UK's and EU's stated desires for a transitional arrangement increasingly appear aligned.

When combined with the BoE's decision to begin gradually tightening monetary policy, it seems unlikely at first glance that anything will stand in the way of the pound's ongoing resilience.

However, Theresa May's weak majority will remain a concern given the need to pass key legislation in the year ahead. As a result, the threat of a leadership challenge from inside the Conservative Party will continue to hang over May's head in 2018.

The ongoing risk of a destabilised government, when time is running out before the end of the Article 50 deadline in March 2019, threatens to weigh on the pound until the fine print of the transition deal is agreed upon.

Middle East and North Africa

The MENA regional outlook continues to be dominated by lower-for-longer oil prices, which have taken their toll on economic activity. Meanwhile, MENA oil-importing countries have failed to take full advantage of low prices thanks to concerns about escalating geopolitical tensions.

And while oil prices have witnessed a marked improvement following the OPEC/non-OPEC agreement back in November 2016, the adjustment process is far from being done. Fiscal consolidation still has a crucial role to play in curtailing the negative impact on growth.

Structural reforms must be accelerated across the region to take advantage of the strengthening global economy and to secure higher and more inclusive growth.

Finally, perceived waning American influence is likely to compound the risks associated with the Qatar impasse and the Yemen war. This will lead to the fragmentation of the region's approach to foreign and economic policy as individual nations explore alternative partnerships and assume greater responsibility for their own long-term interests.

Seasoned investors might be glad to see the end of an era that has come to be defined by low volatility and predictable interest rates. 2018 has already seen a bumpy start in comparison; there could be plenty more volatility ahead.