Tail Risks to Our Outlook

Genevieve Signoret & Delia Paredes

(Hay una versión en español de este artículo aquí.)

What follows is a slightly edited excerpt from Quarterly Outlook 2023–2025: It All Hinges on Rates.

Tail risks are events that, should they come to pass, would imply a complete reframing of our thinking and the production of all-new scenarios. Today, we lay out the main tail risks to our outlook.

Military engagement with Iran

Despite the Gaza War, we continue to classify a military confrontation between Israel and Iran as a tail risk. We see no possible benefit to either Israel or the United States of engaging in a direct military confrontation with Iran, or vice versa.

El Niño

Last quarter, we pointed out the risk that the El Niño climate event would cause a spike in world commodity prices such that Banxico would feel it had to hike rates again this year. We assumed that this would not occur, and so far that assumption has borne out. While the risk is still latent (El Niño lasts until February), we now see it no longer as a pivotal risk but instead as a tail risk.

Possible constitutional crises in Mexico and the United States

Last September, we told you about that investors could shy away from investing in Mexico on fears that, if in June of 2024 Claudia Sheinbaum were to lose, Mexican President López Obrador might refuse to recognize the outcome and thereby spark a constitutional crisis.

Although we continue to see this risk, because of the continued strong relative performance of the peso, we now see it no longer as a pivotal risk but instead as a tail risk.

Note that, notwithstanding our reclassification from pivotal risk to tail risk, we do expect the peso to weaken sharply as the June elections approach.

Last September, we spoke further of a parallel risk in the United States—namely, that, because of U.S. President Donald J. Trump’s legal quagmire, animal spirits in the United States could collapse on worries over a potential constitutional crisis in that country. Seeing no such collapse in the market data, we downgrade this risk, too, to tail-risk status.

Friendshoring

We expect the boost from friendshoring to Mexican GDP to be weak and slow but see an upside tail risk that instead it will be strong and rapid.

A Mexico Sovereign Debt Downgrade

We assumed in our central scenario last September that, although the Mexican sovereign would continue to support Pemex throughout the forecast period, Mexico would not lose its own sovereign debt investment grade rating. We hold to this assumption. Also, based on the mild reactions that ratings agencies have had to the 2024 fiscal budget, we now see the risk of an out-and-out sovereign debt downgrade before 2026 no longer as a pivotal risk but rather as a mere tail risk.

Full updated list of tail risks

In reading our updated list of tail risks, remember that, in forecasting, a risk can be either upside or downside.

We identify as tail risks the risks that:

1. The Gaza War will lead to direct military involvement by Iran.
2. A new variant of Covid will emerge that is more lethal than previous ones.
3. China will rapidly solve its twin debt crises.
4. A new pandemic will break out.
5. A war will break out over the Taiwan Strait.
6. A cyber terror attack will paralyze the world economy for an extended period.
7. Russia will invade yet another country.
8. S. and Japanese fiscal deficits will trigger a loss of faith in their treasury bonds.
9. A major world leader will be assassinated.
10. Trump will trigger a constitutional crisis.
11. AMLO will trigger a constitutional crisis.
12. El Niño will affect food prices in emerging markets, preventing Banxico from lowering rates in quarter two of  
13. Putin will leave power.

You can find our quarterly and annual forecast tables here.

Previous excerpts from Quarterly Outlook 2023–2025: It All Hinges
on Rates:

1. Summary
2. Long-term rates and equity valuations
3. Rates, Covid and real estate valuations
4. Why have US long-term rates trended up? Hypothesis 1: Debt issuance
5. Why have US long-term rates trended up? Hypothesis 2: Tight policy
6. Why have US long-term rates trended up? Hypothesis 3: Investor inflation worries
7. Why is US nominal income unexpectedly high?
8. Momentum: Recap
9. What about growth in Mexico?
10. Soft Landing Scenario Assumptions
11. Soft Landing Forecast Narrative
12. Downside Risk Scenario: Roller Coaster