Potential for sharp corrections has 'spiked': S&P

In a new report published this week, S&P Global Ratings said that the steady growth and abundant liquidity in the Asia-Pacific economies are improving credit trends for issuers in the region.

However, S&P credit analyst Terry Chan warns that these benign conditions mask the potential impact of escalating tail risks.

"We see asset repricing; China's debt overhang; geopolitical, trade and physical conflicts; and a liquidity pullback as Asia-Pacific's top risks for the fourth quarter of 2017.

“The potential for sharp corrections in asset prices has spiked. That's because credit, listed equity and real property across many markets have had a strong run in terms of pricing over recent years as investors hunt for yield.”

S&P’s “base case” is for major central banks to manage an orderly correction with transparent and well-planned moves.

Mr Chan said that low volatility, high liquidity conditions in recent years appear to have desensitised market participants to surprise developments.

“Indeed, Asian bond yields have trended down over the past decade, indicating ease of access to funds," Mr Chan said. "This implies a higher threshold of pain and consequence.

“While the specific trigger of a market pullback is uncertain, a liquidity withdrawal is inevitable given the near decade-long era of easy money. China's blistering debt growth since 2009 has diminished systemic financial stability to some extent. Although credit expansion had contributed to China's strong real GDP growth and higher asset prices, debt rose faster than national income growth. In particular, Chinese corporate debt poses a high risk, although its growth appears to have moderated.”

He added that market reactions to geopolitical events could easily be overblown. “The risk of physical conflicts, in particular uncertainty regarding North Korea, is increasing, while that of a trade war appears to be stabilising.

"For these risks, market reaction (or overreaction) to the event, rather than the event itself, could undermine credit conditions.”

[Related: ANZ finds buyer for China bank stake]