Following on from the shock of Russia's full-scale invasion of Ukraine last February, I have been doing some more thinking about what geo-political shocks might arise in 2023.

In descending order of importance, potential shocks are:

1. China v Taiwan - I think it highly unlikely that China will try to invade Taiwan itself. This would require an amphibious assault on a par with, if not bigger than, D-Day by an army that hasn't fought a war in over 40 years, let alone staged such a complex operation. However, China could try invade the islands of Matsu and Quemoy near its coast, or worse impose a blockade on Taiwan. The latter would probably draw in the US in a high stakes game of brinkmanship, and have profound impacts on the global economy which is reliant on Taiwan's sophisticated microchips, and financial markets such as US corporate bonds where Taiwanese institutions are key investors.

2. Israel v Iran - this has been bubbling...

Sorry I haven’t posted for so long. To be honest I found markets difficult to fathom these past two years. Notwithstanding repeated waves of Covid, lockdowns and economic disruption, many markets reached record highs, helped by unprecedented fiscal and monetary stimulus. Then, just when than we reached the point where we learn to live with the virus and revert to normal, Russia invaded Ukraine disrupting global supplies of food and energy.

The war in Ukraine has added to post-Covid supply chain problems to push up prices, with central banks tightening monetary policy as a result. This is turn has led to falls in markets with the S&P500 falling by nearly 20% since the start of the year to 20^th May 2022, with the NASDAQ falling further by 27%. In the UK, the FTSE100 has barely dropped due to the preponderance of oil and gas shares in this index and the boost to dollar earnings from a fall in the pound, but the FTSE250 has fallen by over 15% in the same period....

In my previous blog [1], I warned of a looming crisis in corporate bond markets as a result of the Covid-19 pandemic and intrinsic weaknesses in corporate bond fund liquidity. Sure enough, US investment grade corporate bond spreads rose from just over 100bps in mid-February to a peak of 401bps on the 23rd March [2] as the Covid-19 pandemic took hold in Europe and the US. With liquidity in the market evaporating, corporate bond ETFs started to trade at a discount to NAV [3].

This was linked with a wider market rout with both the S&P500 and FTSE100 falling by 1/3rd in the month to 23rd March. As investors fled to safety, 10-year yields on US Treasury Bonds fell from ca.1.6% p.a. to just over 0.5% p.a. by early March [4] with short-term Treasury bills even going negative for a short while [5]. Worryingly for the UK, long standing concerns over its reliance on overseas investors and the impact of Brexit lead to the pound collapsing from £1:US$1.31 to £1:US$1.15 [6]...

With the falls in equity markets over the past week, there has been a modest uptick in corporate bond spreads with US investment grade spreads up ca.20bps to 120bps or so. However, these are still at the lower end of recent history, with US investment grade spreads frequently trading over 150bps in the last 10 years and reaching over 300bps in the aftermath of the Lehmans default. I think the markets are not properly pricing in the risks associated with Corporate Bonds, and there is a risk of a collapse of this market on a par with the aftermath of Lehmans.

Even before the onset of Covid-19, the IMF was warning of the risks posed by rising corporate burdens and potential issues with corporate bond illiquidity in its 2019 Global Financial Stability Report [1]. On the former, the IMF estimated that in a mild slowdown, about half as severe as that suffered during the Global Financial Crisis of 2007/09, debt owed by firms unable to service the interest could...