PRMIA put on their Risk Year in Review event at the New York Life Insurance Company on Thursday. Some of the main points from the panel, starting with trade:
- The world continues to polarize between "open" and "closed" societies with associated attitudes towards trade and international exposure.
- US growth at around 3% is better than the rest of the world but this progress is not seen/benefitting a lot of the poplation yet.
- This against an economic background of Japan, Europe and China all struggling to maintain "healthy" growth (if at all).
- Looking back at the financial crisis of 2008/9 it was the WTO rules that were in place that kept markets open and prevented isolationist and closed policies from really taking hold - although such populist inward-looking policies are still are major issue and risk for the global economy today.
- Some optimistic examples of progress howver on world trade recently:
- $1T of trade covered by US-China agreement over non-tariff technology items
- $1T of benefit from a US-India agreement over food stock-piling
- US-China agreement over climate change
- US Government is divided and needs to get back to pragmatic decision making
- The Federval Reserve currently believes that external factors/the rest of the world are not major risks to growth in the US economy.
James Church of sponsor FINCAD then did a brief presentation on their recent experience and a recent survey of their clients in the area valuation and risk management in financial markets:
- Risk management is now considered as a source of competitive advantage by many insitutions
- 63% of survey respondents are currently involved in replacing risk systems
- James gave the example of Alex Lurye saying risk is a differentiator
- Aggregate view of risk is still difficult due to siloed systems (hello BCBS239)
- Risk aggregation also needs consistency of modelling assumptions, data and analytics all together if you are avoid adding apples and pears
- Institutions now need more flexibility in building curves post-crisis with OIS/Libor discounting (see FINCAD white paper)
- 70% of survey respondents are involved in changes to curve basis
- Many new calculations to be considered in collateralization given the move to central clearing
- 62% of survey respondents are investing in better risk management process, so not just technology but people and process aswell
James was followed by a discussion on market/risk events this year:
- Predictions are hard but 50 years ago Isaac Asimov made 10 predictions for 2014 and 8 of which have come true
- Bonds and the Dollar are still up but yields are low - this is as a result of relatively poor performance of other currencies and the inward strength of US economy. US is firmly post-crisis economically and markets are anticipating both oil independence and future interest rate movements.
- Employment level movements are no longer a predictor of interest rate moves, now more balance of payments
- October 15th 40bp movement in yields in 3 hours (7 standard deviation move) - this was more positioning/liquidity risk in the absence of news - and an illustration of how regulation has moved power from banks to hedge funds
- Risk On/Off - trading correlation is very difficult - oil price goes means demand up but 30% diver in price over the past 6 months - the correlation has changed
- On the movie Interstellar, on one planet an astronaut sees a huge mountain but another sees it is a wave larger than anything seen before - all depends on forming your own view of the same information as to what you perceive or understand as risk
Some points of macro economics:
- Modest slow down this quarter
- Unemployment to drop to 5.2% in 2015 from 5.8%
- CS see the Fed hiking rates in mid-2015 followed by 3 further hikes
- The market does not yet agree, seeing a move in Q3 2015
- Downside risks are inflation, slow US growth and wages growth anaemic
- Upside risks - oil price boost to spending reducing cost of gas from 3.2% down to 2.4% of disposable income
Time for some audience questions/discussions:
- One audience member asked the panel for thoughts on the high price of US Treasuries
- Quantitative Easing (QE) was (understandably) targetted as having distorting effects
- Treasury yields have been a proxy for the risk free rate in the past, but the volatility in this rate due to QE has a profound effect on equity valuations
- Replacing maturing bonds with lower yielding instruments is painful
- The Fed are concerned to not appear to loose control of interest rates, nor wants to kill the fixed income markets so rate rises will be slow.
- One of the panelists said that all this had a human dimension not just markets, citing effectively non-existing interest rate levels but with -ve equity still in Florida, no incentive to save so money heads into stock which is risky, low IR of little benefit to senior citizens etc.
- Taper talk last year saw massive sell off of emerging market currencies - one problem in assessing this is to define which economies are emerging markets - but key is that current account deficits/surpluses matter - which the US escapes as the world's reserve currency but emergining markets do not.
- Emergining market boom of the past was really a commodities boom, and the US still leads the world's economies and current challenges may expose the limits of authoritarian capitalism
The discussion moved onto central clearing/collateral:
- Interest rate assets for collateral purposes are currently expensive
- Regulation may exacerbate volatility with unintended consequencies
- $4.5T of collateral set aside currently set to rise to $12-13T
- Risk is that other sovereign nations will target the production of AAA securities for collateral use that are not AAA
- Banks will not be the place for risk, the shadow banking system will
- Futures markets may be under collateralized and a source of future risk
One audience member was interested in downside risks for the US and couldn't understand why anyone was pessimistic given the stock market performance and other measures. The panel put forward the following as possible reasons behind a potential slow down:
- Income inequality meaning benefits are not throughout the economy
- Corporations making more and more money but not proportionate increase in jobs
- Wages are flat and senior citizens are struggling
- (The financial district is not representative of the rest of the economy in the US however surprising that may be to folks in Manhattan)
- The rest of the US does not have jobs that make them think the future is going to get better
- Banks have badly underperformed the S&P
- Regulation is a burden on the US economy that is holding US growth back
- Republicans and Democrats need to co-operate much more
- House prices need more oversight
- Currently $1.2T in student loands and students are not expecting to earn more than their parents
- Top 10 oil producers are all pumping full out
- The Saudis are refusing to cut production
- Venezuela funding policies from oil
- Russia desparately generating dollars from oil
- Will the US oil bonanza break OPEC - will they be able to co-ordinate effectively given their conflicting interests
Summary - overall good event with a fair amount of economics to sum up the risks for 2014 and on into 2015. Food and wine tolerably good afterwards too!