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Terminators To Helicopter Money In Nomura’s 10 Grey Swans For 2018

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As everything from power grids and transport networks to food systems is controlled by computers, does artificial intelligence threaten to take over from humans?

The Terminator-esque doomsday scenario is among the risks that the world will do better to prepare for, brokerage Nomura thinks. Though not among its worst possible worries for next year, it’s among the events that can be foreseen. The brokerage has shortlisted 10 such unpredictable but potentially impactful Grey Swan Events for 2018…

What The Movies Tell Us About 2018

Nomura thinks films may end up being better predictors of grey swans than research analysts, given that they predicted a black president in the U.S. and the rise of China.

That’s the reason it picked the 2009 film, Terminator Salvation, that’s set in 2018. Skynet, an intelligent computer system designed to protect the world from attacks goes rogue. It controls everything from mobile phones to missiles and Terminators—living tissue over a metal endoskeleton made famous by Arnold Schwarzenegger in Terminator 2.

Courtesy: Columbia Pictures

Easy to dismiss, yet the world has the necessary ingredients for it to emerge, Nomura said. Drones, a world connected by computers, machine learning capabilities and even a cryptocurrency. “Is Skynet reading this?”

Not scary enough? A 1975 film Rollerball, again set in 2018, is the story about a global energy monopoly that wishes to replace warfare with a violent sport called Rollerball—two teams race around a track on roller skates attacking each other.

The story portrays a corporate giant trying to distract people behind the veneer of democracy and competition, Nomura wrote. For it to come true, the world would need one or two global companies emerging to dominate the world, ideally in sectors that can distract us with fake news, fun games and constant distractions.

Iron Sky, a 2012 film, revolved around a manned mission to the dark side of the moon where descendants of Nazis are discovered. But the 2011 movie Transformers Dark Side told us that the Decepticons—a robotic lifeform bent to wipe out the world—are already there. Will they invade the Earth in 2018?

Courtesy: Blind Spot Pictures

The ‘Amazonification’ Of Inflation

Policy makers expect the inflation to kick back in 2018. Yet, the recent drag on the U.S. inflation was caused by the sharp decline in goods price inflation and perhaps the “Amazon effect” won’t stop there, Nomura said.

With smartphones, not only is online shopping more convenient, but while trying out goods in typical bricks and mortar stores you can decide to buy online for less, Nomura said. But to focus on one company would do disservice to how far the deflationary force of technological disruption, it said. From Alibaba’s sales on “singles day” that were four times bigger than Amazon’s Cyber Monday or Black Friday, to China’s Wechat and new technologies like 3D printing, disruption can take place in many forms, it said.

2% Inflation Targeting Goes Out Of Style

While inflation targets of around 2 percent are often viewed by markets to be an immutable force of nature, Nomura said it’s a relatively new phenomenon—first adopted by the Reserve Bank of New Zealand in 1989. And longer-term view could reveal it to be nothing more than an economic fad, which may either be jettisoned or modified, it said.

One reason could be given the low rates, the U.S Federal Reserve would have limited ability to use short rates to battle the next downturn.

Source: Giphy

Elsewhere, there is talk of lowering the inflation target for two reasons: not meeting the target and ageing populations in Asia and Europe where the government wouldn’t want the value of their lifetime savings erode.

It cited examples of the 2 percent inflation targets to drive home the point.

  • The U.S. core inflation averaged 1.7 percent since 2000 and 1.5 percent since 2010
  • The euro area consumer inflation managed 1.75 percent and 1.3 percent.
  • Japan’s core CPI has been -0.1 percent and 1.1 percent.
  • Only the U.K. seems to be hitting its target with 2 percent since 2000 and 2.2 percent since 2010.

United States Of Europe?

The European Union, and the Euro area economies in particular, have an opportunity to forge closer ties in 2018. If the near-term hurdles of Germany actually getting a government and an Italian election in first half of next year are resolved, they could work on a ‘United States of Europe’.

Not only does this free up bandwidth to think about European matters, but may end the de facto ban on any European treaty change, besides being a fitting repose to Brexit, according to Nomura. And it’s the right time, given that the European growth is at its strongest in years, unemployment has fallen from 11 percent in 2013 to 7.4 percent currently.

In fact, the President of the European Commission Jean-Claude Juncker and French President Emmanuel Macron think this could be achieved as early as 2025.

Another U.K. Political Turnaround

The real grey swan for the U.K. politics in 2018 would be if nothing interesting happened. The tail risk is if political instability gets so bad that either there is another general election or a second Brexit referendum in 2018. Fresh polls could happen if the government loses a vote of no confidence and that’s possible given the government’s wafer-thin effective majority. Moreover, around 75 percent of MPs, including a slim majority of Conservatives, are pro-remain. While the government is enacting the will of the people after the 2016 Brexit referendum, it can change.

Bitcoin Starts Moving Other Markets

The level of speculative mania in cryptocurrencies, especially bitcoin, has reached a point where stock prices have been boosted by companies simply inserting ‘Blockchain’ onto the end of their names, Nomura wrote. That echoes the dot-com era.

The arrival of Bitcoin futures will likely see Bitcoin exchange-traded funds expand in 2018. But could Bitcoin’s high volatility start to move other markets?

The market cap of Bitcoin is $280 billion and the number rises to $523 billion when all other 1,358 cryptocurrencies are included. Yet, it’s far away from the $79-trillion total world market cap or indeed the peak $2.9-trillion dot-com valuation in 2000. So, Nomura thinks it may be too early for Bitcoin to have a global impact on other asset markets at this stage.

Instead, Nomura suggested looking at investors most exposed to it. With Japan accounting for nearly half the global trade in bitcoin compared with just 25 percent in the U.S., it could be in Asia where it pulls back.

Housing Market Decline = Rate Cuts?

Solid growth, low interest rates and hot money inflows from overseas fuelled rapid house price gains in Australia, Canada, New Zealand, Norway and Sweden, Nomura wrote. Investors have been calling for a downturn for some time in these markets and 2018 could be the year, it said.

Source: Giphy

Residential investment has soared, driving increased supply which could outstrip housing demand and see prices move lower. To offset growing housing imbalances, regulators have tightened macroprudential policy. There is a risk that policymakers have over-tightened and driven a slowdown.

A house price collapse would have significant market implications. Rates markets currently price these economies’ central banks normalising policy significantly over the next two years.

A Bigger Proxy War In The Middle East

Unlike in the past when conflicts in the Middle East tended to start with a bang but then assumed a “low intensity” character, 2018 may be different and the tensions may to threaten regional stability. Two risks are the most significant:

Yemen: Houthi rebels have already shown that they can fire missiles targeting Riyadh. If such attacks continue, Saudi Arabia may decide to increase its military involvement in Yemen, increasing the risk of a direct clash with Iran.

Lebanon/Palestine: The immediate risk of a proxy war in Lebanon that emerged after the unexpected resignation of PM Hariri seems to have been defused. But President Donald Trump’s recognition of Jerusalem as capital of Israel may increase this risk again as Lebanon’s Hezbollah and Palestine’s Hamas have called for a renewed “intifada” in response to Trump’s decision.

That could push up oil prices, stoking inflation globally, particularly countries like India that rely on imported oil.

“Get To The Chopper!”

Inflation has been disappointing globally, but markets now expect central banks to focus on economic recovery and financial stability or higher equity prices, not inflation, Nomura said. Bank of Japan’s further dovish shift by loosening fiscal policy cannot be ruled.

A step towards helicopter money was actually recommended by former Fed Chair Bernanke who suggested that the most promising direction would be through fiscal and monetary cooperation, in which the BOJ agrees to temporarily raise its inflation target as needed to offset the effects of new fiscal spending or tax cuts on the debt-to-GDP ratio.” For central banks facing policy limitations, helicopter money can be a natural step towards further easing.

Stealth Leverage Pops?

Source: Giphy

After years of accommodative policy, Nomura things the risk is that leverage has built up in the system and as the Fed drains liquidity via the balance sheet and higher rates, the potential imbalance that may have been up could be exposed.

Where is the leverage? It lurks in various forms. Commercial real estate and subprime auto loans don’t post a systemic risk, it said.

Financial leverage does. Over the past 10 years, the fastest-growing debt was in capital markets. Much of this went into stock buybacks and/or to highly leveraged corporates, Nomura wrote. The credit quality of the universe has moved towards BBB, the second lowest investment grade. A repricing of corporate credit when balance sheets are still thin could indicate that meaningful risk lies ahead. Deeper under the surface margin debt for stock purchases are also at all-time highs, it said.

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