Annual & Mid-year Outlook | Economy

Risks Remain Elevated

_{Posted on Jun 18, 2019}

Key Takeaways

Political and policy uncertainty affecting trade, sanctions and regulation is generating increased levels of investor concern, with impact on the global economy and financial markets.
With volatility anticipated to remain elevated, Citi analysts believe that a highly diversified multi-asset class portfolio approach remains essential in today’s environment.

Some of the main political signposts and geopolitical risks that could move markets in 2019 include:

On 7 June, President Trump announced the signature of an agreement with Mexico that “indefinitely suspended” the 5% tariffs scheduled to be implemented by the US beginning 10 June. The deal came with Mexico’s commitment to a series of measures aimed at curbing migration across the US-Mexico border.
In Citi’s view, while this removes the immediate trade threat and its potential consequences, the risk of the US continuing to threaten Mexico (and other trade partners) with protectionist measures remains. Citi analysts also continue to believe that US-EU trade tensions have not peaked despite the delay in the implementation of the auto tariffs on the EU and Japan (for 6 months in exchange of a deal to restrict exports to the US).

North Korea

The US and North Korea talks have again hit an impasse following the Hanoi summit in February 2019 as Pyongyang is demanding sanctions relief before it begins to denuclearize, while the US insists that Pyongyang relinquish its nuclear weapons before any economic pressure is eased.

China:

On 10 May, the US announced the imposition of tariffs of an additional 15% on $200bn of imports from China. China retaliated by increasing the punitive tariff rate on US$60bn of imports from the US.
On 6 May, the People's Bank of China (PBoC) announced a Reserve Requirement Ratio (RRR) cut for small and medium-size banks. If necessary, the RRR could be further lowered, and more aggressive easing measures such as interest rate cuts could also be expected. On the fiscal front, government bond issuance accelerated earlier this year, and infrastructure spending has started to rebound. Citi analysts believe the next round of fiscal policy stimulus could focus on durable consumption. If the various tax cuts were to fail to boost growth, the authorities might revert to the old ways, namely more infrastructure investment. Given that the scope for fiscal and monetary stimulus remains large in the near term, Citi analysts believe the negative impact from additional tariffs may be managed better this time.

UK:

Prime Minister May announced she will step down as Conservative Party leader on 7 June, paving the way for a contest to decide a new Prime Minister.
The UK is scheduled to leave the EU on 31 October, so the new PM needs to decide quickly whether to try and leave with or without a deal. However, an anti-EU leader may struggle to hang on to a parliamentary majority, which makes it difficult to pass any kind of Brexit, or any other legislation. Hence, Citi analysts expect the PM to call a general election to get a mandate for Brexit and other policies. A second Brexit referendum is a possible alternative, but without control of Parliament would be risky in terms of the question on the ballot. It would not produce a majority in Parliament for other policies.

Italy:

Updated forecasts from the European Commission in May showed a cut in Italy’s GDP growth projections for 2019 down to 0.1%, with a projected widening in the Italian fiscal deficit to 3.5% of GDP, breaching EU’s 3% limit.
Euro zone’s third-largest economy could be hit with a fine of 3 billion euros by the European Commission for accumulating debt and deficits that break EU rule.

Middle East:

On April 22, the United States announced it would no longer grant waivers to buyers of Iranian crude that are expired in May. Iran has threatened retaliation over the US decision to remove sanctions waivers by closing the Strait of Hormuz, a key waterway in the Middle East which carries a fifth of the world’s traded oil. All oil exports of Iraq, Kuwait, UAE, Qatar and Bahrain pass through the narrow passage, as well as some exports from Saudi Arabia. Any attempt by Iran to block this would heighten regional geopolitical tension.