A lot of investors breathed a sigh of relief on Thursday after the Fed decided to hold interest rates steady. While it will happen eventually, a number of financial experts say an increase in rates could derail global markets.
With our world more intertwined than ever before, what happens in America could impact the rest of the world. Conversely, a further slowdown in China or political upheaval in Europe could impact the U.S. and other international markets.
While the global economy is still projected to expand by about 3.3 percent this year, according to the IMF, there are several risks that could impact the global economy and its stock markets.
1. China’s corporate debt
If anyone’s been paying attention to the news lately, they’ll know that China has been in a heap of trouble. Its stock market is wobbly, people aren’t sure whether its growth projections are accurate, corporations are carrying loads of debt, and the list of issues goes on.
To Eric Lascelles, chief economist at RBC Global Asset Management, what’s happening in China presents the biggest risk to world markets and, more specifically, its debt issues.
This year the country’s corporate debt levels hit 160 percent of GDP, which is twice as high as America’s corporate debt levels, while Standard & Poor’s estimates that China’s corporate debt will climb by 77 percent, to $28.8 trillion, over the next five years.
Much of that debt has been concentrated in the country’s booming housing market, said Lascelles, and while the government is helping out local governments and companies, non-performing loans on Chinese banks have grown by 57 percent over the last year, he said.
It’s still a low base—only 1.5 percent of loans aren’t being paid, he said—but those growth rates are rising. If this does become a larger problem, then economic growth could slow even further, which, with China being the second-largest economy in the world representing about 16 percent of global GDP, would have an impact on all of us, Lascelles explained.
2. Rise in U.S. interest rates
While most people expect the Federal Reserve to raise rates before the end of the year, a move in the overnight rate could still create volatility on a global stage, said Lisa Emsbo-Mattingly, Fidelity’s director of research for global asset allocation.
A lot of people think that the base rate will simply be increased by about 25 basis points and that everything will look like it does now. However, bond rates bounce around and aren’t as stable as people may think, and that could cause uncertainty.
As well, the U.S. government balance sheet is “extremely large,” she said, and any rise in rates will impact the bonds it holds.
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“The technicalities of this may be more complex than what we’ve seen in the past,” she said. “We’ll see how the market reacts to a little more uncertainty in the Fed funds rate and short-term rates.”
3. Illiquidity in the bond market
One of the consequences of a rising Fed rate could be an illiquid globalbond market. Why? Because when rates rise, bond prices fall, and who wants to buy a security that’s falling in price?
That’s one of Jeff Mortimer’s concerns. The director of investment strategy for BNY Mellon Wealth Management is worried that when people try to sell their bonds into a rising rate environment, there won’t be any takers.
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Regulation, he said, has already pushed traders out of the bond market, so there aren’t as many people buying and selling fixed-income instruments as it is.
“We know that there are less people taking the other sides of trades, so how will the bond market handle selling pressure?” he questioned.
An illiquid market could impact global markets in two ways. First, bond prices will fall even farther than they should. And second, if people can’t sell their bonds, they may start selling other assets.
“If you can’t sell bonds, then what are you going to sell?” he asked. “You’ll sell equity—that’s a lot of what transpired in 2008.”
4. Strengthening U.S. dollar
Over the last year, the greenback’s value has steadily climbed. It’s up 20 percent against the Canadian dollar, 14 percent against the euro, 10 percent against the yen and so on.
There are multiple sides to the U.S. dollar story, said Lascelles. Some countries, like Canada, Europe and Japan, like having a weaker currency as it helps exports, but emerging markets countries do not.
Many of them use American dollars to fund day-to-day operations, and if buying those dollars gets pricier, then they could find themselves strapped for cash.
As well, a too-strong dollar is bad for the U.S. It reduces its global competitiveness, and that ultimately limits economic expansion.
It’s also bad for multinationals who make money in other countries and have to convert those dollars back to American bucks.
“There’s no debating that a stronger dollar is negative for growth,” said Lascelles.
5. Populist politics
Politics is always a risk, but Lascelles has been seeing greater shift to far right and far left politics than he has in the past.
Some of it may be just rhetoric, such as Rand Paul’s “audit the Fed” bill, but with Greece’s rebuff of the IMF and more right- and left-leaning parties getting into power, people have to wonder if the right economic policies will ultimately be put in place.
While he can understand why more populous ideas are being bandied about—rising unemployment and continued economic challenges is causing citizens and governments to think differently—rejecting sound economic policies will slow growth and make it difficult to ultimately reform, he said.
“A healthy does of skepticism is appropriate,” he added, “but in the end these are mostly unwelcome and can jeopardize an economy.”
—By Bryan Borzykowski, special to CNBC.com