What risks will investors face in 2023?

We will see many other potential risks such as a notable turn one way or the other in the Russia/Ukraine war, or China’s struggle with Covid-19.

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A bumpy ride seems to be on the cards for this year, and that’s without any left-field events that could stir things up even more. While it is always hard to say where surprise events might pop up, we’re going to list a few that perhaps won’t be a big surprise if they happen, but could still cause significant financial market dislocation.

The first is a significant shift in monetary policy in Japan. Bank of Japan Governor Kuroda to leave office in April had been regarded as extremely dovish during his decade at the helm. His replacement could prove to be of a similar ilk, but there’s a fair chance that he won’t, and that the new governor will usher in a policy change at some point. The market is positioned to expect up to 30-bps of rate hikes this year. That might not sound much compared to other central banks but, when you consider that the key short-term policy rate has not been raised for seventeen years, it would clearly be a big deal.

But could such action cause significant market dislocation? One reason why it could, relates to the fact that poor returns at home have led Japanese banks to be the global leaders in international lending with around USD4.8tr in international claims. Its nearest rival is the US on USD4.5tr but when you consider that the US economy is nearly five times the size of Japan you can see that Japanese banks are dominant.

The question is whether this international lending will be re-directed to local markets if domestic returns improve because of higher policy rates. There’s already some signs of this in recent data, caused perhaps by higher Japanese bond yields and a possible rise in banks’ risk aversion given the state of the global economy.

A rapid withdrawal of Japanese banks from international lending markets could strain the financial system. While an orderly withdrawal seems the more likely outcome, we still feel that investors should be on their guard for possible market dislocation if, and when, the tide of monetary policy turns in Japan.

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A second area that we’d highlight as possibly provoking some financial stress is the real estate sector. Of course, there’s a well-defined history of tensions going back to the sub-prime mortgage meltdown in the US and, perhaps more recently, the strains in the Chinese property sector. It seems to be a given that property prices will slide this year and probably on a global basis. The only question is whether it will be modest and contained, or more of a rout. The chances of the latter seem quite elevated particularly in countries where an unsustainable boom seemed to be in place beforehand, such as New Zealand. But even if there’s no rout, the simultaneous slide in prices across countries could cause particular difficulties for those holding depreciating assets.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said the risks here would seem to lie outside the banking sector in this case, with private equity firms, for instance most at risk. Of course, non-bank financial institutions could topple for other reasons, as we nearly saw in the UK last September as the pensions sector creaked under the weight of surging gilt yields. But, if investors want to watch out for the possible flash-points that could turn what looks to be widespread economic recessions into financial market stress, then the property sector seems to be an obvious place.

“We could have highlighted many other potential risks such as a notable turn one way or the other in the Russia/Ukraine war, or China’s struggle with Covid-19. In the end, we dare say that there’s also a strong risk that a surprise could occur that neither ourselves, nor anyone else, is anticipating. While we can’t provision for such events, we would argue that investors should stay cautious as adverse surprises when the global economy is so vulnerable and central banks can’t ease make them more potent than usual”, said Mr. Steve Barrow.