What is the Neon Swan?

A neon swan definition refers to a rare but highly predictable event of serious consequences. As opposed to a black swan event, a neon swan event typically follows a series of warning signs that lead up to it, and therefore, in theory, may be prevented. 

In the financial world, the US debt ceiling crisis in 2011 was first coined as a neon swan event. In 2022, some market analysts argued that a neon swan event is likely.  

Key points 

Neon swan versus black swan

A neon swan differs from a black swan event, which goes beyond what is usually expected of a situation, without obvious warnings and with serious consequences. 

The term was coined in The Black Swan: The Impact of the Highly Improbable, a 2007 book by Lebanese American former options trader Nassim Nicholas Taleb. According to Taleb, examples of black swan events include the invention of Alphabet’s Google (GOOGL) and the 11 September terrorist attack in the US. 

Neon swan explained

In short, what does neon swan mean? While it’s rare and huge, there are clear processes that build up to the event. In theory, neon swan events can be prevented as there are typically red flags and warnings. 

History of the term: US debt ceiling crisis 

The term first emerged during the US debt ceiling crisis in 2011, a prominent example of neon swan event.  Credit rating agency Standard and Poor's (S&P) downgraded the US Treasury debt from AAA to AA+ on 5 August 2011, with a negative outlook on concerns about budget deficit. It was the first time that S&P had downgraded the rating on US long-term debt, assigned for 70 years at that time. 

The credit rating downgrade was the result of a protracted debt ceiling debate that devolved into political squabbling. Although the US government under President Barack Obama and Congress had reached a deal on the budget and debt ceiling, the credit agency was of the view that it’s not enough to address the gloomy outlook of the US economy.

While S&P’s move was unprecedented. Signs leading up to the downgrade had built up. In July, S&P put the US Treasury debt under “CreditWatch with negative implications”, CNN reported. 

S&P’s reasons for downgrading US debts were the country’s debt-to-GDP trajectory, which the firm said was unsustainable, and the perceived inability of lawmakers to make tough decisions to correct the problem. The firm had been highlighting the issues months before the downgrade.

Moody’s and Fitch Rating, two other credit rating agencies, followed suit.

While the lower rating did not cause the US Treasury debt to default, ramifications were felt far and wide. Within days of the downgrade, all three US main stock indices fell between 5% to 7% on 8 August 2011, dragging down global markets. The ratings downgrade, which essentially said that the chance of the US government defaulting its debt payment had increased, hit investor confidence.

Concerns of a neon swan event in 2022

In 2022, the neon swan term has been floating again amid soaring inflation, aggressive monetary policy tightening cycling, war in Ukraine and gloomy economic outlook. In October 2022, the Financial Stress Index, managed by the US Department of Treasury’s Office of Financial Research (OFR), rose to 3.1 in October 2022, the highest since the Covid-19 pandemic in May 2020. 

OFR FSI gauges the strain in the US financial market. It is built from 33 financial market variables, such as yield spreads, valuation measures and interest rates. When stress levels are above average, the OFR FSI is positive; when stress levels are below average, the OFR FSI is negative.

"The velocity of things breaking around the world .. is obviously a 'neon swan' telling us that we are clearly now in the market accident stage," Charlie McElligott, a strategist at Nomura, told the Financial Times in October 2022. 

However, Piero Cignari, Capital.com’s market analyst, disagreed, noting: “If something in the future is completely predictable, the market has already priced it in.” Piero added, as of 4 November 2022:

Final thoughts

With so many unknowns at play in the financial markets, identifying a neon swan event can only be done in retrospect. Analyst forecasts can be wrong and we encourage traders and investors to always conduct their own due diligence, looking at a wide range of commentary, the latest news, and fundamental and technical analysis. 

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