Financial markets have been pretty buoyant in recent months. After stocks and commodities sank in the first six weeks of the year, there has been a strong risk-on rally since. Oil has doubled to trade above $50. The S&P 500 is flirting with record highs. Even the pound has stabilised following its EU referendum-inspired slide.

But risks remain and while the threat of a Brexit is arguably the biggest, there is plenty of other things for traders to be mindful of. Here’s our take on the biggest risks to financial markets over the coming months.

BlogImage-20160525_3

Brexit

 

Undoubtedly, Brexit is a potential game-changer for markets. Domestic risks to the UK economy have been well documented – the pound may fall by as much as 20%, according to several big banks. Sterling volatility has already jumped to levels not seen since the depths of the financial crisis.

But there is a wider threat of contagion as markets, notably equities. The International Monetary Fund warns that a vote to leave the EU could lead to a stock market crash.

More worryingly, Britain’s leaving the EU could lead to calls around Europe for states to be untethered from the bloc, producing sharp swings in financial markets.

G7 leaders warned that Brexit poses a “serious risk” to global growth, while the OECD believes it could be as seismic as a so-called hard landing in China. Even the Federal Reserve is wary, with policymakers warning of “adverse reaction” in US markets if Britain leaves the EU.

Strong dollar

 

A strong dollar has long been associated with turmoil for emerging markets, but the central bank watchdog thinks there is a direct link between dollar strength and volatility in forex markets. Anomalies in interest rate markets caused by a strong dollar is threatening wider financial market calm, the Bank for International Settlements (BIS) has warned this week.

“In spite of the outward tranquillity, there are tensions beneath the surface,” said Hyun Song Shin, head of research at BIS.

The fault lies in the breakdown of covered interest parity – the idea that “interest rates implicit in foreign exchange markets should be consistent with market interest rates”. However, the implied dollar interest rate from currency swaps is above Libor. “This means that the borrower of dollars in the FX swap is paying more than the rate available in the open market,” explained Shin.

This has been the case for the Swiss franc, euro and, most notably, the yen.

"The financial tail appears to be wagging the real economy dog. This is not how things are supposed to work. The key takeaway is that a stronger dollar is associated with more severe market anomalies," added Shin.

Renminbi weakness

 

Stock market turmoil seen last summer and at the start of 2016 may be viewed as spasmodic reactions to gyrations in the yuan fix. An abrupt devaluation in August sparked a chaotic response in financial markets; sudden weakness in January delivered a similar effect.

While calm has returned, renminbi weakness is back in view after the currency suffered its biggest monthly drop in May since last August. The People’s Bank of China has promised to adopt a more market-based approach to the currency level, but a Wall Street Journal report alleged it had decided to abandon this in favour of greater exchange rate stability.

Trump Presidency

 

Donald Trump has secured the GOP nomination and now is running Hilary Clinton neck and neck in the polls. Standing on key themes of immigration and trade, a Trump presidency could affect the US and therefore the global economy significantly, which may in turn roil financial markets.

Nomura has warned markets could be volatile if Trump wins the election as his policies could create uncertainty among investors. Trump has even indicated that the US could default on its debt – US Treasuries are cast-iron and underpin just about everything in financial markets. That may be a step too far (he later backtracked on this suggestion) but there is concern about potentially erratic fiscal policy and his comments about replacing Janet Yellen as Fed chair.

Perhaps the biggest worry for interconnected financial markets is the risk that a president Trump would spark a major trade war with China, which could hit commodity markets particularly hard.

Grexit

 

It’s easy to forget about Greece, but this particular threat to financial markets remains. Debt restructuring is happening slowly but really the can is being firmly kicked down the road. Saddled with debt and bearing the brunt of the refugee crisis, Greeks may not want to keep subsidising German exports for much longer. A Brexit could spark a Grexit, but Greece could go it alone even if Britain remains in.

Bookmakers have shortened the odds on Greece leaving to around one in five, while the country’s finance minister, Euclid Tsakalotos, has admitted Grexit is still on the table.

Added market volatility means increased opportunity but also more risk. To reflect this, ETX Capital may be increasing margin rates on certain markets.