Reading the Bank of International Settlements (BIS) annual reports and the speeches of Jaime Caruana, the BIS General Manager, who finished his term at the end of last year, I formed a simple checklist of the recurring themes he has focused on in his work. For the last few years, he has emphasized four factors which he closely watches to determine whether there will be a financial downturn:
- Significant rise in inflation
- Financial stress
- Weak consumption
- Rise in protectionism
Looking at these four factors at this point in the year suggests that there is limited risk for a financial downturn through these normal macroeconomic paths.
There is an increase in inflation both in the US and the developed world but the numbers do not suggest strong overshooting at this time. Nevertheless, US CPI is above the “magic 2%” number often used as a benchmark. Financial stress has not appeared in the any indices used to track stress. We watch a number of aggregated and disaggregated number and do not see stress increasing. Volatility has increased with the geopolitical risk with Turkey, but the levels are still below the spike seen in February. There is no weakness in consumption and consumer confidence is still relative high. Some consumer numbers are off highs, but there is little to suggest a downturn. While there has been a rise in protectionism, there have been bilateral talks that may dampen or avert further trade shocks.
The economic expansion in the US seems to be in late stages. There are clear excesses in the credit markets with both pricing and the growth of leverage which will make the global economic more sensitive to a downturn, but there is no strong information to suggest downturns in this financial sector. The equity rally has also had a long life and heightened valuations, but there is no data to suggest imminent declines. Shocks will occur. Turkey is a geopolitical concern, but macro trend indicators are not pointing to a downturn.