Annual & Mid-year Outlook | Economy

Politics: Risks May Linger

_{Posted on Dec 17, 2018}

Key Takeaways

Political risks may linger into 2019 as trade tensions, Italian political uncertainties and Brexit discussions continue, even as economic fundamentals appear strong.
Current global trade tensions remain elevated with markets focused more on geopolitical headlines. As a result, despite a still favourable global economic outlook, trade tensions are now leading to downgrades in economic growth forecasts from institutions including the IMF.

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

Trade uncertainties remain despite the US agreeing to a 90-day hold on tariff increases for Chinese imports. The US’s trade dispute is not limited to China and extends to negotiations with Europe and Japan as well. Failure to resolve trade tensions poses downside risks to global (and ultimately US growth) via trade, confidence, and inflation channels.
Citi analysts believe the road to US-Mexico-Canada (USMCA) ratification is unlikely to be smooth given certain objections by the new US Congress. Given the economic significance of the USMCA, the US Administration may be able to gather sufficient votes to ratify the USMCA deal in 2019.

North Korea

Following summit talks on 27 April 2018, the leaders of South Korea and North Korea have agreed to pursue a peace treaty and complete denuclearization. Citi analysts are positive on the outlook for meaningful improvement in US-Korean relations and the opening of North Korea’s economy, but uncertainties remain in the details or/and implementation of the agreed-upon pledges.

China

Beijing’s latest policy moves suggest that the Chinese government may have halted or even abandoned its financial deleverage policy and has relapsed to fiscal pump priming and liquidity injections to boost the economy.
On trade tensions with the US, President Trump has agreed to hold off plans to raise tariffs on $200bn of Chinese imports from 10% to 25% on January 1, 2019 for a period of 90 days while China agrees to buy a “not yet agreed upon, but very substantial amount of agricultural, energy, industrial” and other products from the US. However, it remains to be seen whether a 90-day extension is enough for both sides to convert this to a more sustained thawing of relations.

Citi analysts believe that Q1’2019 could be a high risk period for UK assets including equities, as the UK-EU Brexit deal faces hurdles from the UK parliamentary ratification process. Despite steadying growth, a disorderly Brexit adds risks to the economy. Citi expects PM May’s Brexit Withdrawal Bill may eventually receive ratification.
Nevertheless, political turbulence in the UK carries with it the risks of both a Conservative leadership challenge and a potential snap general election, both of which are likely to pose headwinds for UK assets.

Italy

Debt sustainability and a weak bank sector in Italy remain challenges as economic growth continues to be sluggish. The main risk comes from the Italian populist Budget which could exceed the 3% deficit target in 2019 set by the EU for all member countries.

Middle East

Lebanese and Iraqi elections, along with continued consolidation of Syrian territory may reinforce Iran’s reach. Israel and Saudi Arabia are likely to increase their resistance to Iran’s spreading influence, with material risks of military conflict on Israel’s northern borders.
This may raise the geopolitical risk premium on assets in the Middle East which could be partly offset by higher oil prices.