2016, Citi’s Tina Fordham and Tiia Lehto say, could be a “very political year for markets”, warning that things may get so messy that central banks may no longer be able to do the heavy lifting needed to manage the political risks that will dominate next year.
The analysts write that geopolitical risks are at a 25-year high. They’re more worried than at “any time in recent memory” about potential military accidents and close encounters, such as the recent Turkish downing of a Russian military jet. There’s the growing complexity and scale of the terrorist threat, as well as the possibility of large-scale unconventional attacks. Also on the 2016 risks watchlist: the militarisation of the South China Sea, the post-Iran sanctions world, and a couple of significant elections on the horizon. And don’t forget the conflict in Syria and the refugee crisis.
So it’s a pretty doom and gloom forecast with plenty of potential to impact markets.
Investors “should be prepared for the convergence of rising ‘Old’ geopolitical risks with evolving ‘New’ socioeconomic risks”, they write. Some of the “old” geopolitics include state to state conflict, military build up, proxy wars, weak and failing states and border and territorial disputes.
As for the “new” socioeconomic risks, there’s the Citi-dubbed Vox Populi risk (“shifting and more volatile public opinion that poses ongoing, fast-moving risks to the business and investment environment”; ie. mass protests, fringe political parties, etc), income inequality concerns, constitutional crises and more.
“Could 2016 be the year when these risks come together, potentially moving from regional to systemic”, the analysts ask?
In the year ahead, geopolitical risks likely bear the greatest potential to disrupt markets in terms of event risk. But failure to address new socio-economic risks, such as lack of trust in elites, income inequality and youth unemployment, runs the arguably much greater risk of undermining the functioning of the global system, creating a negative feedback loop. There is also the potential for geopolitical risks to intersect with economic fragility in the event of a downturn, amplifying both.
And don’t forget two of 2015′s most dominant political issues — the refugee crisis and the risk of terrorism. As you may expect, they’re not going anywhere, and w0rld leaders don’t have the trust, goodwill and influence needed to tackle these issues. Leaning on central banks just won’t cut it anymore, the analysts say, as 2016′s projected convergence of new and old risks may exceed “the capacity of central bank liquidity to mask them”.
Over the long term, failure to devise policies to address middle class anxiety and declining living standards increases the likelihood that Vox Populi risk – including mass protests and government collapses – could move from being episodically disruptive to systemic, undermining globalization in the process.
And we are deeply concerned that the political capital necessary to stem the refugee crisis and terrorist threat, perhaps best characterized as the collision between previous foreign policy failures and current governance capacity, exceeds that available to government leaders, who have relied upon central banks to manage the lion’s share of global crises over the past several years. 2016 could be a very political year for markets.
As Fordham and Lehto write, “it isn’t just about the economy, stupid”.
In terms of marking your calendar, Citi’s not as focused on elections in the next year other than a few key contests that include the US presidential contest in November and the Taiwanese general election in January, as well as a likely Brexit referendum. While there are relatively few significant elections with the potential to influence global markets next year, the analysts say 2016′s major impact will be on how economic and political conditions will play out the following year, specifically regarding the influence on the French and German 2017 elections and leadership transitions in China and Russia.
Just today, after all, we’ve gotten a hint of where French politics could go with the far-right National Front party putting on a stunning display in the first round of regional elections. In Germany, meanwhile, a potentially destablising risk for the EU could be “Merkel-exit”, the analysts predict.
For the first time in a decade in power, German Chancellor AngelaMerkel’s political future is in question. Her approval ratings have fallen sharply since the refugee crisis accelerated, from 67 percent in August to 49 percent in November. Although in our view the Chancellor could very well weather yet another test of her leadership and go on to win a fourth term, we regard Merkel-exit ahead of German elections (due in 2017) as one of the most destabilizing political risks for the EU, and one with the potential to impact markets.
As for the issues roiling Syria, where the conflict is entering its fifth year and is marked by the refugee crisis and now Russia’s expanded military intervention, the analysts say one 2016 regional wildcard comes in the shape of Iran. Remember this summer’s landmark nuclear deal? It’s not all cut and dried. Under the terms, Iran must scale back its nuclear program and the International Atomic Energy Agency needs to verify Tehran has fulfilled its commitments before sanctions are lifted. The analysts write:
A key regional wildcard will be impact of the end of (much of) the sanctions regime against Iran, a rare recent example of a diplomatic breakthrough, but one fraught with controversy. Can the Iran deal withstand rigorous inspections, opposition from Iranian hardliners, and the potential for regime change in Washington? How will Tehran exert influence in the region, and how will other regional players, from Riyadh to Jerusalem, interact with it? Failure of the Iran deal would see a return to the possibility of air strikes on Iran’s nuclear facilities, a risk that once topped most lists of geopolitical risks.
Citi’s got a couple of “silver linings” for the year ahead, of course. There’s possible “cooperation between Turkey and the EU to address the refugee crisis, potentially reviving broader relations, including Turkey’s long-stalled EU membership bid”. But with Russian sanctions announced in response to the jet incident, President Recep Tayyip Erdoğan’s increasing crackdown on freedom of speech and the media, andinvestors pulling $7.6 billion from assets in 2015, it seems a bit unbecoming to make a case for a “silver lining” situation in Turkey just yet.
The analysts are also seeing a positive in the the US-China relationship, which they write “is on a solid and professional footing, the ‘frenemies’ element of competition and occasional friction notwithstanding”. Also optimistically, they highlight that “although 2016’s growth outlook may be sluggish, one answer to boosting growth is right in front of policymakers: women drive economic growth when given greater opportunity to participate in the labor force and can serve as ‘growth accelerators’, both in the advanced and emerging world”. That’s less of a prediction than a reminder.
And it’s all a bit grasping at straws following the doom and gloom of the rest of the political outlook.
After all those predictions, it’s worth taking a little trip down memory lane with Citi as they highlight what they got right and wrong in 2015. Something to keep in mind this crystal ball season:
