Potholes could make for a bumpy year

As we look forward into 2014, I see more "potholes" than "black holes". What I mean by "black holes" is that I cannot see anything presently that might blow up the markets, perhaps worryingly no one else can either. Policymakers and central banks have by-and-large put in place guidance and policies to mitigate many of the systemic risks out there over the last few years. But there are some potential potholes ahead such as those arising as governments try to cope with their fiscal responsibilities and those from the European periphery (Portugal and/or Greece), the Asset Quality Review, or the European parliamentary election in May.

While the strong Forward Guidance from the Fed, the Bank of England and the European Central Bank has led to a lessening of global uncertainty and reduced the volatility of asset prices for now, it has actually made the market less stable in the long-term as central bank interference decreases market resilience - the views of the central bank are reflected in the market, rather than the diversity of views of market participants - and by dampening volatility, and hence risk, it has built stresses elsewhere in the system.

While the US Federal Reserve is intent on tapering off its unprecedented quantitative easing, central bank balance sheets globally will continue to grow as quantitative easing is not going away. It is the rate of growth of the balance sheet that is being tapered. Markets have run a long way, however, the overall direction of markets is probably upwards, albeit at a more moderate pace than in 2013, as the taper is also a sign of confidence that the Fed believes the US economy has reached escape velocity and the financial system's stability has returned. Having said that, a pothole arising from general market complacency around the taper, or miscommunication on forward guidance or renewed concerns around the eurozone are all imaginable.

There are also potential risks for Asian and other developing economies as the Fed's taper takes hold. Remember when quantitative easing started there were massive capital inflows into Brazil, India and other developing countries. Conversely, it stands to reason that the magnitude and perhaps the velocity of these flows will change once the taper kicks in. While it is very difficult to be definitive and to quantify the actual currency flow mechanism, what is very clear is the US dollar's reserve status creates transmission risks globally, especially to developing markets.

However, the overall global economic picture is encouraging. In the United States, the economic momentum continues and the longer-term fundamentals - cheap energy, self-sufficiency in agriculture, positive demographics and innovation - are supportive. The confusion resulting from the messaging on the taper, has abated, although change at the helm of the Fed, while manageable, has created uncertainty.

In Japan, there is a clear political consensus to drive the yen lower. Following on from fiscal and monetary stimulus, the government's determination is reflected in structural reforms. This is positive for Japanese markets in the medium-term although demographics weigh on Japan's long-term outlook.

In the Europe, structural challenges to the financial framework are being addressed and systemic risk has lessened materially. The United Kingdom's economy is rebounding, the periphery seems to have turned the corner and overall and the eurozone is no longer a drag on the global economy, although its recovery is still subdued.

But it is China that some of the most interesting and potentially important medium-term changes are happening. The uncertainty that accompanied the leadership change has abated and this should be positive for GDP growth. The Third Plenary Session of the 18th Central Committee of the Communist Party of China set out an agenda for deepening reform that is positive for growth, given the emphasis on free market solutions, amendment of the family planning policy, the continued shift from manufacturing to services and further urbanization. China's importance to the global economy is reflected in its role as the marginal price setter for many natural resources, for example, some 50 percent of global demand for iron ore is from China.

Meanwhile, over the last five years, the renminbi has made dramatic progress in becoming a significant currency for global transactions. This has often been via bilateral currency swaps. I believe this growth will continue as China's global trade grows. However, the transition from a major transaction currency to a major reserve currency requires a lot more structural change in the economy and the country's financial markets and change to the economy's management. But the Chinese authorities have already signaled they are willing to give up a certain degree of autonomy to market forces and allow access to China's financial markets.

To summarize, global government interventions are creating both distortions and accompanying risks that need guarding against and opportunities that need to be seized.

The author is the founder and CEO of CQS, a global multi-strategy asset management firm and the founder of the Hintze Family Charitable Foundation.